    [Senate Hearing 110-735]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 110-735

                                                            Senate Hearings

                                     Before the Committee on Appropriations

    _______________________________________________________________________

                                                         Financial Services

                                                     and General Government

                                                             Appropriations

                                                                Fiscal Year
                                                                       2009

    110th CONGRESS, SECOND SESSION

                                                          H.R. 7323/S. 3260

    COMMODITY FUTURES TRADING COMMISSION

    CONSUMER PRODUCT SAFETY COMMISSION

    DEPARTMENT OF THE TREASURY

    DISTRICT OF COLUMBIA: COURT SERVICES AND OFFENDER SUPERVISION AGENCY

    FEDERAL TRADE COMMISSION

    OFFICE OF MANAGEMENT AND BUDGET

    SECURITIES AND EXCHANGE COMMISSION

    SELECTIVE SERVICE SYSTEM

    THE JUDICIARY
     Financial Services and General Government Appropriations, 2009 (H.R.
                                 7323/S. 3260)

                                                            S. Hrg. 110-735

      FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL
                                   YEAR 2009

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

                                    HEARINGS

                                    before a

                              SUBCOMMITTEE OF THE

                COMMITTEE ON APPROPRIATIONS UNITED STATES SENATE

                           ONE HUNDRED TENTH CONGRESS

                                 SECOND SESSION

                                       on

                               H.R. 7323/S. 3260

        AN ACT MAKING APPROPRIATIONS FOR FINANCIAL SERVICES AND GENERAL
    GOVERNMENT FOR THE FISCAL YEAR ENDING SEPTEMBER 30, 2009, AND FOR OTHER
                                    PURPOSES

                                   __________

                      Commodity Futures Trading Commission
                       Consumer Product Safety Commission
                           Department of the Treasury
      District of Columbia: Court Services and Offender Supervision Agency
                            Federal Trade Commission
                        Office of Management and Budget
                       Securities and Exchange Commission
                            Selective Service System
                                 The Judiciary

                                   __________

             Printed for the use of the Committee on Appropriations

     Available via the World Wide Web: http://www.gpoaccess.gov/congress/
                                   index.html

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                                   __________
                          COMMITTEE ON APPROPRIATIONS

                    ROBERT C. BYRD, West Virginia, Chairman
    DANIEL K. INOUYE, Hawaii             THAD COCHRAN, Mississippi
    PATRICK J. LEAHY, Vermont            TED STEVENS, Alaska
    TOM HARKIN, Iowa                     ARLEN SPECTER, Pennsylvania
    BARBARA A. MIKULSKI, Maryland        PETE V. DOMENICI, New Mexico
    HERB KOHL, Wisconsin                 CHRISTOPHER S. BOND, Missouri
    PATTY MURRAY, Washington             MITCH McCONNELL, Kentucky
    BYRON L. DORGAN, North Dakota        RICHARD C. SHELBY, Alabama
    DIANNE FEINSTEIN, California         JUDD GREGG, New Hampshire
    RICHARD J. DURBIN, Illinois          ROBERT F. BENNETT, Utah
    TIM JOHNSON, South Dakota            LARRY CRAIG, Idaho
    MARY L. LANDRIEU, Louisiana          KAY BAILEY HUTCHISON, Texas
    JACK REED, Rhode Island              SAM BROWNBACK, Kansas
    FRANK R. LAUTENBERG, New Jersey      WAYNE ALLARD, Colorado
    BEN NELSON, Nebraska                 LAMAR ALEXANDER, Tennessee

                        Charles Kieffer, Staff Director
                      Bruce Evans, Minority Staff Director
                                     ------

           Subcommittee on Financial Services and General Government

                     RICHARD J. DURBIN, Illinois, Chairman
    PATTY MURRAY, Washington             SAM BROWNBACK, Kansas
    MARY L. LANDRIEU, Louisiana          CHRISTOPHER S. BOND, Missouri
    FRANK R. LAUTENBERG, New Jersey      RICHARD C. SHELBY, Alabama
    BEN NELSON, Nebraska                 WAYNE ALLARD, Colorado
    ROBERT C. BYRD, West Virginia (ex    THAD COCHRAN, Mississippi (ex
        officio)                             officio)

                               Professional Staff

                                 Marianne Upton
                             Diana Gourlay Hamilton
                            Mary Dietrich (Minority)
                            Rachel Jones (Minority)

                             Administrative Support

                                  Robert Rich
                           LaShawnda Smith (Minority)

                                C O N T E N T S

                                  ----------

                            Wednesday, March 5, 2008

                                                                       Page
    Department of the Treasury.......................................     1

                           Wednesday, March 12, 2008

    The judiciary....................................................    41

                           Wednesday, April 16, 2008

    Department of the Treasury: Internal Revenue Service.............    97

                           Wednesday, April 30, 2008

    Consumer Product Safety Commission...............................   207

                             Wednesday, May 7, 2008

    Commodity Futures Trading Commission.............................   253
    Securities and Exchange Commission...............................   349

                            Wednesday, May 14, 2008

    Federal Trade Commission.........................................   371

                 Material Submitted Subsequent to the Hearings

    Office of Personnel Management...................................   409
    Selective Service System.........................................   413
    Court Services and Offender Supervision Agency for the District
      of Colum-
      bia............................................................   415

      FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL
                                   YEAR 2009

                                  ----------

                            WEDNESDAY, MARCH 5, 2008

                                           U.S. Senate,
               Subcommittee of the Committee on Appropriations,
                                                        Washington, DC.
        The subcommittee met at 3 p.m., in room SD-138, Dirksen
    Senate Office Building, Hon. Richard J. Durbin (chairman)
    presiding.
        Present: Senators Durbin, Brownback, and Allard.

                           DEPARTMENT OF THE TREASURY

    STATEMENT OF HON. HENRY M. PAULSON, JR., SECRETARY OF
                THE TREASURY

                 opening statement of senator richard j. durbin

        Senator Durbin. Good afternoon, and I'm pleased to convene
    a series of hearings to examine fiscal year 2009 funding
    requests. Today we launch our lineup with the Department of the
    Treasury.
        Welcome, Secretary Henry Paulson, to the hearing room,
    along with any associates who would like to join in your
    testimony.
        I welcome my colleagues who will join me shortly, and
    others who may arrive. Although, this is a budget hearing for
    the Treasury, we've scheduled a separate hearing next month to
    devote particular attention to the Internal Revenue Service
    (IRS), the Treasury's largest bureau. We'll defer the bulk of
    our questions relating to the IRS until that hearing.
        The non-IRS portion of the Department's budget constitutes
    over $1.1 billion, supporting many critical activities in the
    central programs we'll concentrate on today.
        The Department plays a pivotal role in the global economy,
    and as an ambassador for the Nation's economic and financial
    institutions. In fulfilling the mission, Treasury promotes
    economic prosperity, and ensures the financial security of our
    Nation.
        Treasury also administers the world's largest collection
    system, over $2 trillion a year. In addition, Treasury supports
    financial institutions in generating community development, and
    leads Government efforts in the area of financial intelligence.
        I'm pleased that for fiscal year 2008, we were able to
    provide additional funds for the Department to address several
    important needs. The funds will further support the
    Department's efforts to combat terrorism, through implementing
    economic sanctions, and gathering and analyzing financial
    intelligence.
        For fiscal year 2009, the budget request for Treasury is
    $12.47 billion, an increase of $461.6 million, or 3.8 percent.
    Excluding IRS, the request for the remainder is $1.11 billion.
    This represents a net decrease of $7.5 million over fiscal year
    2008, overall reduction of less than 1 percent. This would
    appear to be a very restrained budget for the non-IRS portion
    of the Department, however, the top line includes a 70 percent
    decrease from fiscal year 2008 funding level for the Community
    Development Financial Institutions Fund (CDFI), commonly known
    as CDFI.
        Holding CDFI funding at the fiscal year 2008 level, the
    fiscal year 2009 President's budget reflect a $57.9 million, or
    5.2 percent increase for the non-IRS portion of the Treasury
    Department. I'm concerned about this proposed cut in CDFI,
    which we will discuss later, because I believe that the
    infusion of capital to these institutions can help many
    distressed communities, and low-income individuals, who are
    facing the economic downturn, with more severity than most.
        I think it's clear that adequate funding for CDFI is
    critically important.
        For the Office of Terrorism and Financial Intelligence
    (TFI), including Financial Crimes Enforcement Network, known as
    FinCEN, the budget requests $153 million for fiscal year 2009,
    compared to $142.6 million last year, an increase of over $10
    million. I'm pleased to see Treasury continues to emphasize
    strategies to counterterrorist financing and money laundering.
        Beyond the Treasury Department, I also want to talk for a
    few minutes with the Secretary about broader economic issues. I
    know you've faced that already once today, so you've
    undoubtedly been prepared for this by my colleagues in the
    House.
        I appreciate your insights on the current housing crisis
    and the state of the economy, and we'll have a few questions
    along those lines. I look forward to discussing them with you.
        At this point, since Senator Brownback has not arrived, I
    would like to turn the floor over to the Secretary, and Mr.
    Secretary, you may proceed with your remarks.
        Secretary Paulson. Thank you, Senator Durbin--there we go.
        Senator Durbin. Thank you.
        Secretary Paulson. That's always the most difficult part of
    the hearings, turning on the microphone.
        But, thank you very much for your remarks, and for your
    support of the Treasury. I very much appreciate the opportunity
    to discuss the Treasury Department's proposed fiscal year 2009
    budget.
        Our budget request reflects the Department's continued
    commitment to promoting a healthy U.S. economy, fiscal
    discipline, and national security. The Department has broad
    responsibility in Federal cash management, tax administration,
    and plays an integral role in combating terrorism, terrorist
    financing, and advocating the integrity of the U.S. and global
    financial systems.
        Our spending priorities for the 2009 fiscal year fall into
    six main categories. I'll briefly describe their priorities and
    then take your questions.
        Treasury has an important role to play as a steward of the
    U.S. economy, and provides--and our offices provide technical
    analysis, economic forecasting and policy guidance on issues
    ranging from Federal financing, to domestic and global
    financial systems.
        Those functions are especially critical now, as the U.S.
    economy--through a combination of a significant housing
    correction, high energy prices, and capital market turmoil--has
    slowed appreciably.
        Our long-term economic fundamentals are solid, and I
    believe our economy will continue to grow this year, although
    not nearly as rapidly as in recent years.
        In response to economic signals early this year, the
    administration and Congress worked together to quickly pass, on
    a bipartisan basis, the Economic Stimulus Act of 2008, and I
    would like to thank this subcommittee for approving funds for
    the IRS and the Financial Management Service (FMS), to
    administer the stimulus check rebate program under the act, so
    thank you for that.
        As you know, the stimulus payments to households, and the
    incentives to businesses in the act, together are estimated to
    lead to the creation of 500,000 jobs by year-end. This will
    provide timely and effective support for families in our
    economy, and it wouldn't be possible without your leadership.
        Treasury's Office of Terrorism and Financial Intelligence
    (TFI) uses financial intelligence, sanctions, and regulatory
    authorities, to track and combat threats to our security, and
    safeguard the U.S. financial system from abuse by terrorists,
    proliferators of weapons of mass destruction, and other illicit
    actors.
        To continue to build on our efforts to combat these
    threats, we are requesting an $11 million increase for TFI,
    including $5.5 million for the Financial Crimes Enforcement
    Network, to ensure effective management of the Bank Secrecy
    Act.
        The budget request emphasizes infrastructure and technology
    investments to modernize business processes and improve
    efficiency throughout the Treasury Department. We will continue
    to make information technology management a priority, and have
    taken several significant steps to strengthen our systems and
    oversight.
        Treasury is committed to managing the Nation's finances
    effectively, ensuring the most efficient use of taxpayer
    dollars in collecting the revenue due to the Federal
    Government. The IRS, of course, plays an integral role in all
    of this, the budget requests a 4.3 percent increase in IRS
    funding to expand IRS enforcement activities, improve
    compliance, reduce the tax gap, and continue improvements in
    taxpayer service.
        In addition, we are asking your colleagues on the State,
    Foreign Operations Subcommittee to support funding both in
    multilateral development banks--noticeably, new replenishments
    for the World Bank's International Development Association
    (IDA), and the African Development Fund, and have forwarded a
    $400 million request for the first installment of a $2 billion
    clean technology fund that--with additional funding from other
    donors around the world, will help finance clean energy
    projects in the developing world, and make strides toward
    addressing global climate change.
        Overall, the budget request reflects a prudent and forward-
    leaning approach to fulfilling the Treasury Department's core
    responsibilities to support our economy, managing the
    Government's finances, and ensuring financial system security.

                               PREPARED STATEMENT

        I thank you for your past support and consideration of our
    work, and I look forward to working with you during your
    deliberations.
        Thank you, and I welcome your questions.
        [The statement follows:]

                  Prepared Statement of Henry M. Paulson, Jr.

        Chairman Durbin, Senator Brownback, Members of the Committee: Thank
    you for the opportunity to discuss the Treasury Department's proposed
    fiscal year 2009 budget. Our budget request reflects the Department's
    continued commitment to promoting a healthy U.S. economy, fiscal
    discipline and national security. The Department has broad
    responsibility in federal cash management, tax administration and plays
    an integral role in combating terrorist financing and advocating the
    integrity of the U.S. and global financial systems.
        Our spending priorities for the 2009 fiscal year fall into six main
    categories. I will briefly describe the priorities and then take your
    questions.

                             U.S. ECONOMIC STEWARD

        Treasury has an important role to play as steward of the U.S.
    economy, and our offices provide technical analysis, economic
    forecasting and policy guidance on issues ranging from federal
    financing to domestic and global financial systems.
        Those functions are especially critical now as the U.S. economy,
    through a combination of a significant housing correction, high energy
    prices and capital market turmoil has slowed appreciably. Our long term
    economic fundamentals are solid, and I believe our economy will
    continue to grow this year, although not as rapidly as in recent years.
        In response to economic signals, early this year the Administration
    and the Congress worked together to quickly pass, on a bipartisan
    basis, the Economic Stimulus Act of 2008. And I would like to thank
    this subcommittee for approving funds for the IRS and the FMS to
    administer the stimulus check rebate program under that Act.
        As you know, the stimulus payments to households and the incentives
    to businesses in the Act, together, are estimated to lead to the
    creation of half a million jobs by year-end. This will provide timely
    and effective support for families and our economy, and it wouldn't be
    possible without your leadership.

                        STRENGTHENING NATIONAL SECURITY

        Treasury's Office of Terrorism and Financial Intelligence (TFI)
    uses financial intelligence, sanctions, and regulatory authorities to
    track and combat threats to our security and safeguard the U.S.
    financial system from abuse by terrorists, proliferators of weapons of
    mass destruction and other illicit actors.
        To continue and build on our efforts to combat these threats, we
    are requesting an $11 million increase for TFI, including $5.5 million
    for the Financial Crimes Enforcement Network to ensure effective
    management of the Bank Secrecy Act.
    Efficient Management of the Treasury Department
        The budget request emphasizes infrastructure and technology
    investments to modernize business processes and improve efficiency
    throughout the Treasury Department. We will continue to make
    information technology management a priority, and have taken several
    significant steps to strengthen our systems and oversight.

                               FISCAL DISCIPLINE

        Treasury is committed to managing the nation's finances
    effectively, ensuring the most efficient use of taxpayer dollars and
    collecting the revenue due to the federal government.
    Enforcing the Nation's Tax Laws Fairly and Efficiently
        The Internal Revenue Service, of course, plays an integral role in
    this. The budget requests a 4.3 percent increase in IRS funding.
        As in the past three budget requests, we are proposing to increase
    IRS enforcement funding as a Budget Enforcement Act program integrity
    cap adjustment. IRS enforcement efforts have yielded record revenue
    collections. With the requested funding, the IRS will collect an
    estimated $55 billion in direct enforcement revenue in 2009.
        The budget also includes a number of legislative proposals intended
    to target the tax gap and improve tax compliance, with an appropriate
    balance between enforcement and taxpayer service. These proposals are
    estimated to generate $36 billion over the next ten years.

                             INTERNATIONAL PROGRAMS

        We will continue to focus efforts on supporting a stable and
    growing global economy, through on-going dialogue and initiatives with
    developing economies throughout Asia, Latin America and Africa.
        In addition we are asking your colleagues on the Foreign Operations
    Subcommittee to support key objectives of the President's international
    assistance agenda. This includes funding for the multilateral
    development banks_notably new replenishments for the World Bank's
    International Development Association (IDA) and the African Development
    Fund.
        Also included as a Foreign Operations priority is $400 million
    request for the first installment of a $2 billion clean technology fund
    that, with additional funding from the United Kingdom, Japan and other
    donors, will help finance clean energy projects in the developing world
    and make strides towards addressing global climate change.

                                   CONCLUSION

        Overall, the budget request reflects a prudent and forward-leaning
    approach to fulfilling the Treasury Department's core responsibilities
    to support our economy, managing the government's finances and ensuring
    financial system security. I thank you for your past support and
    consideration of our work, and look forward to working with you during
    your deliberations.
        Thank you and I welcome your questions.

        Senator Durbin. Thanks, Mr. Secretary, and I welcome my
    ranking member, Senator Brownback, of Kansas.
        If you have an opening statement, I'll defer to you at this
    point.
        Senator Brownback. I'll just make some of those comments
    during my questions, I think that would probably be the best,
    prudent way.
        If I could, Mr. Chairman, I'd ask if I could put my full
    statement in the record, right now.
        Senator Durbin. Without objection.
        [The statement follows:]

                  Prepared Statement of Senator Sam Brownback

        Good afternoon. At this first hearing of our subcommittee, I want
    to thank you, Chairman Durbin, for your leadership. I look forward to
    working together with you during this coming year as we make funding
    decisions and provide oversight to the various agencies within this
    subcommittee's jurisdiction.
        Secretary Paulson, thank you for appearing before our subcommittee
    today. I look forward to hearing the details of your fiscal year 2009
    budget request and the key efforts that your department will be
    undertaking this year. You have a crucial role in overseeing our
    financial systems and in promoting our participation in the
    international economy so I am interested in hearing your thoughts on
    the domestic and global economic situation.
        Looking at the President's budget, I am pleased that it assumes the
    continuation of the President's tax cuts, which are key to preventing
    recession and allowing our economy to rebound from the sub-prime
    mortgage crisis. I am encouraged that the President's budget projects a
    balanced budget by 2012.
        Mr. Secretary, regarding the economic stimulus package, I support
    the tax rebates to families and the expensing and depreciation changes
    to assist businesses. But I believe that we must look down the road at
    other ways to stave off recession, such as enacting incentives for U.S.
    companies to bring money back to this country from abroad. This would
    allow multi-national corporations to bring funds into the United States
    at a reduced tax rate for a period of time. I believe that we must
    continue to be proactive to keep our economy healthy. The most
    effective way to do this is to lower taxes so that consumers and
    businesses have more of their own money to spend and invest.
        Mr. Secretary, the lion's share of your budget--approximately 90
    percent--is for the Internal Revenue Service. I understand that you are
    seeking additional resources to close the so-called ``tax gap.''
    Certainly, we must ensure that taxes which are owed are collected.
    However, I remain concerned that our tax system is overly complex,
    complicated, and burdensome. Americans spend roughly $157 billion each
    year in tax preparation to ensure they do not run afoul of the IRS. The
    system is desperately in need of reform. One reason we have a ``tax
    gap'' may be that our tax system is so complex that taxpayers cannot
    figure out what they owe.
        Mr. Secretary, I want to commend your Department for its efforts to
    combat terrorism. Your ``Office of Terrorism and Financial
    Intelligence'' is working hard to safeguard the financial system
    against illicit activities and combating rogue nations, terrorist
    facilitators, money launderers, drug kingpins, and other national
    security threats. This is important work and I am supportive of your
    efforts in this area.
        I know that the Treasury Department is aggressively blocking U.S.
    commercial bank transactions connected to the government of Sudan,
    including those involving oil revenues. I am pleased that you are
    taking these actions. Last year, we passed legislation and the
    President signed into law the authority for your Department to levy
    greater criminal and civil penalties for those who violate these
    sanctions. I hope this new authority has acted as a strong deterrent
    for bad behavior.
        Mr. Secretary, I am deeply concerned that American consumers are
    unwittingly purchasing products that have been manufactured with
    natural resources extracted by enslaved and abused children in
    countries where the profits are then used to support murdering and
    raping rebels. For example, I believe that our demand for coltan--which
    is an essential mineral needed for the manufacture of cell phones, TVs,
    and computers--has helped to fuel the conflict in the Congo. We need to
    be vigilant to ensure that American manufacturers are not supporting
    the conflict in the Congo by purchasing coltan. I would like you to
    work with us and perhaps the SEC to prevent American companies from
    purchasing coltan that has been mined by children and whose profits are
    supporting killings in the Congo. Congo's ``conflict coltan'' has
    created a vast and grave humanitarian crisis where 5.4 million people
    have died since 1998 directly and indirectly from the conflict and
    where 1,500 people continue to die each and every day.
        We cannot sit idly by while others suffer. We need to be
    responsible as a nation and as consumers. We must hold our suppliers
    accountable. I plan to introduce legislation to stop the exploitation
    of coltan, particularly in eastern Congo. I am working with leaders of
    non-governmental organizations who understand the situation as I write
    this bill.
        Mr. Secretary, I would like to hear what your Department is doing
    to support a stable and growing global economy through initiatives with
    developing economies throughout the rest of Africa and Latin America. I
    would like to hear how you can help ensure that we are not complicit in
    illegal activities in Congo and the rest of the world.
        So Mr. Secretary, I look forward to hearing your testimony this
    afternoon.
        Thank you, Mr. Chairman.

                               HOPE NOW ALLIANCE

        Senator Durbin. Mr. Secretary, the Treasury Department
    reported Monday that loan modifications under Hope Now helped
    45,000 borrowers in January. But that number, as I understand
    it, includes all modifications of any sort, including those
    that only temporarily delayed foreclosure, rather than only
    counting mortgage changes that would allow families to stay in
    their homes for a longer period of time.
        Isn't it true that Hope Now numbers you're citing include
    all mortgage changes of any sort?
        Secretary Paulson. Yes sir, very much.
        And let me say that with Hope Now, the objective is--and
    the numbers you were citing have to do with subprime mortgage
    holders who were facing resets. And a major objective there is
    to help those homeowners who were facing resets they couldn't
    afford, and help them stay in their homes, and modifications to
    change the terms and to change, you know, the terms on a
    mortgage that lets someone stay in their home, is what we're
    about doing.
        The other thing I would point out is that we're very
    fortunate in the--to the extent that the rate cuts that the
    Federal Reserve had made, made the impact of the some of the
    resets much less severe. And prior to the rate cuts, some of
    the initial resets were going to take the rates from 8.5
    percent to 10.8 percent. After the rate cuts, they, you know,
    the impact was more like 8.5 to 9 percent. So, again, we
    received help there. And I certainly don't discount
    modifications that mortgage servicers made to let people remain
    in their homes.
        Senator Durbin. Are you satisfied that the financial
    institutions across America have responded voluntarily to the
    administration's request, in an adequate way, to deal with the
    current mortgage foreclosure crisis?
        Secretary Paulson. The way I would answer that question is
    I'm gratified by the progress that's been made, to date. And
    again, there's been some criticism, but in terms of an
    initiative that's up and going, I happen to believe it stacks
    up well, relative to anything else I see out there.
        So, I would start off by saying that there's been 1 million
    people helped, to date, and I don't discount that at all, I
    think it's significant.
        Now, the objective here--and I want to put this in
    perspective--that what we have is an industrywide effort in
    looking at subprime mortgages, where we have servicers covering
    90 percent of the market. There are varying degrees of
    aggressiveness and sophistication in that group. And there are
    some firms in that group that didn't even need Hope Now to be
    doing the right things. And they've been out and they've been
    leading, and I thank them.
        There are other servicers in that group that has less
    sophistication, were less prepared, we had significant
    obstacles--legal obstacles, accounting obstacles--we had the
    Securities and Exchange Commission (SEC) sign off on some
    accounting guidance on January 8, and technological issues.
        So, the way I look at it right now is, we have some
    leaders, we have some followers, we have now--the followers
    fully implementing the protocol, and we have them doing that
    ahead of the biggest period of recess----
        Senator Durbin. Let me try to narrow it down, because I
    want to get to the point of understanding this. When you talked
    about 1 million borrowers being helped----
        Secretary Paulson. Yes.
        Senator Durbin. And that you're satisfied with some
    responses--I'm trying to put the response level, or the
    response so far, I should say, in the context of the challenge
    that we face.
        Secretary Paulson. Right.
        Senator Durbin. And I have heard that some 2.2 million--at
    least that's a common figure--mortgage holders in America--
    subprime mortgage holders--face the probability, possibility of
    foreclosure.
        Secretary Paulson. Right.

                               SUBPRIME BORROWERS

        Senator Durbin. I don't know if that's an accepted figure
    or an accepted estimate, but I've heard it repeatedly.
        So, what do you think, what would--how would you describe,
    in percentage terms----
        Secretary Paulson. Right.
        Senator Durbin. The number of those vulnerable homeowners
    who have been helped, to date----
        Secretary Paulson. Right.
        Senator Durbin. By the administration's programs?
        Secretary Paulson. Well, let me say--first of all, let me
    deal with numbers. And if you give me a minute or two on this,
    we'll go through it.
        That in a average, good year, you know, if we looked at
    2002 through 2005, there are 650,000 foreclosures. Last year,
    estimates are there will be about 1.5 million. Some people are
    projecting 2 million foreclosures this year.
        Now, I think, you sir, Mr. Chairman, are right to focus on
    subprime because if we look at the third quarter of last year,
    we had roughly 13 percent of these 55 million mortgages are
    subprime mortgage--they were----
        Senator Durbin. The 55 million mortgages?
        Secretary Paulson [continuing]. 55 million mortgages, 13
    percent were subprime.
        Senator Durbin. That's of all the mortgages, you said,
    universal mortgages, 55 million?
        Secretary Paulson. All the mortgages, yes. And of that
    subprime universe, of that 13 percent, 50 percent of those were
    where we had foreclosures. And if you even look at a smaller
    sample, 6.5 percent were adjustable rate subprime mortgages,
    and they had 50 percent of the foreclosures.
        And we had a--and on top of that--the 18 percent, if you
    take a look at sort of the--the period when there were the
    worst underwriting practices, which was 2006, and these so-
    called ``2-28'' mortgages, you know, teaser rate for the first
    2 years, and then resets--that 18 percent of that pool
    foreclosed 6 months ahead of even the first reset.
        So, again, as I look as the objective--and so, I think
    what's important, that we talk about what's a reasonable
    objective, and to me the reasonable objective is that every
    homeowner who is in a subprime mortgage and is able to afford
    the initial rates--because if they can't even afford the
    initial rates, I think there's a different problem we need to
    deal with--every homeowner that's in a subprime mortgage and is
    able to afford the initial rates, and can't afford the step-up
    rate, there should be a solution that keeps them out of
    foreclosure, if they are willing to talk to someone about it,
    and engage to talk about solutions.
        So, a major issue we continue to have--and we're making
    progress--is that before Hope Now, that roughly 2 to 3 percent
    of those getting letters from servicers responded. Half of
    those going into foreclosure ever talked to anyone. Now the
    response rate is close to 20 percent--that still means 80
    percent aren't having conversations.
        Now, it's very hard for the Government or anyone, to help
    someone who won't try to help themselves, won't respond, won't
    engage in a conversation. There's also some people out there,
    where there's a different issue.
        Just to step back, and the other issue that's out there,
    and you hear a lot of conversation about, is the put-out
    numbers, the 8.8 million homeowners that have mortgages that--
    where they have zero equity or negative equity in their home.
    Now, as you look at that universe, as I look at it, if you're a
    mortgage holder, even if you have negative equity in your home,
    if you can afford to make your mortgage payment, then I believe
    you've got an obligation to make the mortgage payment and you
    don't walk away--you're a speculator if you walk away because
    you happen to think your home is under water and the--your
    mortgage is under water. And I think most homeowners look at it
    this way--I think most homeowners, 93 percent of the homeowners
    are making their payment every month, you know, even if it's
    difficult for them to do so--only 2 percent are in foreclosure.

                                  SPECULATORS

        So, I do believe--but there are some, some of these, and
    they're doing terrible practices. Last year, even last year
    after all of this, 30 percent of the mortgages that remain in
    this country, there was almost no down payment or no down
    payment on a mortgage. And so, there are certain people that--
    sometimes they are second homes, they're speculators, they took
    out a mortgage, if the home value doesn't go up, they're
    walking away from that.
        That's not the focus. The focus of our program is you've
    got to want to stay in your home, and respond to someone, and
    have the capability to do that. And I think on that--and just
    to finish up, Mr. Chairman--on that, we're continuing to make a
    very big effort, and I think the industry is, and we're going
    to monitor that very carefully.
        Senator Durbin. I've gone way over my time, and I want to
    give Senator Brownback his. But I do--I do want to go back to
    my question.
        Secretary Paulson. Right.

                                 LOAN WORK OUTS

        Senator Durbin. You've really described the battleground,
    and the universe, but I want to zero in--how many of these have
    we helped? If, in fact, there are 13 percent of the 55 million
    that are subprime, that calculates out to about 7 million--if
    half of them are facing foreclosure, that's 3.5 million--how
    many have been reached by Hope Now, and this administration's
    efforts?
        Secretary Paulson. I would say, to date, okay, Hope Now,
    since the beginning there have been 1 million homeowners that
    have engaged in some form of modification or work out, okay?
    So, there have been 1 million people that have been helped.
        But what we're not picking up in our numbers are the
    refinancings. So, even when you--the number you cited, I looked
    very carefully at that number, and there were 45,000
    modifications, there were 167,000 work outs, both work outs and
    modifications went up faster than foreclosure starts--which was
    a positive. But we don't know the number of refinancings. And
    it's been hard, and there are a lot of refinancings. And so we
    will do everything we can to measure the numbers that have been
    helped.
        The other thing I'm really focused on is, you can't help
    people that aren't going to help themselves, or reach out. The
    standard I really want to set is that if there's a homeowner,
    and has been able to make the reset, be able to make the
    initial payment, and they said, ``I reached out and I talked to
    my servicer, and I'm still put into foreclosure,'' I want to
    know about that, because again, I want to follow-up. I mean,
    that's, to me, another--and we're going to work to get the
    numbers to help answer more and more of your question.
        Senator Durbin. I have some more questions, but I want to
    defer to my colleague, here.
        Senator Brownback.
        Senator Brownback. Thanks, Mr. Chairman.
        Secretary, thanks for being here. And also, just at the
    outset, I wanted to thank you for your years of expertise that
    you bring into the Government. I think particularly at this
    time with the economic problems we're facing, it's great to
    have somebody with your background and expertise, and I
    appreciate it.
        Now, I'm going to yell at you, but I first want to tell you
    how appreciative I am, of you being in Government with this,
    because I think it does bring a stature that's needed, and it's
    very helpful to have.
        I want to talk about two things--the economy, and terrorist
    financing. And I appreciate your describing the universe of the
    home situation, I wanted to describe a philosophy and then ask
    you questions on how to implement that.
        I've been through a similar crisis in the past, my guess is
    you've also seen a couple of things like this, and so you bring
    a philosophy that's based on your experience, as well.
        I went through the farm crisis of the 1980s, I was a lawyer
    in an undistinguished practice in the Midwest, and then went on
    to be agriculture secretary in the State. One of the things I
    saw in that early 1980s farm crisis--this would have been a
    Dick statement, Bigway, as well--is we took a crisis and we
    made it a huge--we took a problem and we made it a crisis. And
    we did that through trying to get too much done too fast.
        There was land that went on the market at a cheap rate, and
    then--I was representing some farmers and some banks. The
    regulators came out and told the banks, ``Clean up your
    loans,'' the banks went out and started suing a bunch of
    farmers to get their land, so we dropped a whole bunch of land
    on the market, a whole bunch of equipment, everybody's prices
    fell a huge amount, and it just exacerbated the problem--we
    tried to do too much, too fast, and we made it really bad. It
    was bad.
        So, I take that experience and I say that the thing we need
    to do now, because we've got a real problem here, is we've got
    to string this out, over a period of time, and not try to see
    too much housing stock get on the market too fast. Because if
    you get too much out there, you further plummet, and you get a
    whole bunch more people that are in trouble.
        So, if that's the correct philosophy, we need to meter this
    out over a period of time. We've got a problem, we had excess
    capital, or problems coming in, and bad loans taking place, and
    sharks out there, and we've got to work our way through this.
        Is the way to do that not just what the administration is
    proposing, but also tax credits for purchasing housing or even
    distressed housing? Or, some people are proposing changes in
    the bankruptcy code, to provide for a cram-down feature on
    housing? If you agree with the philosophy, I would like for you
    to say which actions by Congress you think would be the
    appropriate ones to prevent this problem from making an even
    worse impact on the overall economy.

                                CAPITAL MARKETS

        Secretary Paulson. Right, Senator, I assume since there's
    just the two of you, I can take a little bit longer time, since
    I took a lot of time on the chairman's question.
        Senator Brownback. Fine.
        Secretary Paulson. Because it's a very good question and I
    think it deserves a thoughtful answer, and I've thought a lot
    about it.
        The, first of all, I've said for some time, that as we look
    at this crisis, there's two focuses. First and foremost is
    getting through this period with as little impact--negative
    impact--as possible on the real economy, and so second, is
    what's the policy response to reduce the likelihood of going
    through this period again, something like this? And so we don't
    want to do something up front that's going to compound the
    problem in the short term, or to make it worse in the longer
    term.
        Now, there are a number of--even before you get to the
    housing, that is why I have been, when we look at what's going
    on with the capital markets turmoil right now, that I have been
    so focused on having all of our financial institutions,
    including the GSEs, raise capital that they need, so that they
    can be active in, you know, in the market--lending, keeping up
    their normal economic activities, as opposed to shrinking their
    balance sheet.
        Now, in looking at housing as I've looked at this, and I've
    looked at a whole lot of things, first I focused on efforts
    that would avoid what I would call a market failure. And the
    level of adjustable rate mortgage resets that were coming is
    such a wave that it wouldn't allow the private sector to react
    the way they normally would react, which would be to have the
    investor have time to strike a deal with each individual
    mortgage holder, and work something out that was in both of
    their best interest, because foreclosures are costly. And so
    that's why this ASF protocol, and working the fast-track
    modifications, to avoid avoidable foreclosures.
        The other big effort we still have--we have a number of
    things that have been done, are when you look at Fannie Mae and
    Freddie Mac, that we have them today to go back far enough in
    our history, we didn't, and they can play a constructive,
    counter-cyclical role. And they have been, but to continue to
    do so, they're going to have to raise more capital, and be very
    active there.
        Senator Brownback. What about tax credits and bankruptcy
    reform?

                                   BANKRUPTCY

        Secretary Paulson. Oh, yeah, I would say this now, let me
    get at both of those. In terms of bankruptcy reform, I've had
    some very good conversations with your chairman, and he and I
    have a very similar objective. We approach this differently,
    and there's two reasons why I don't like the bankruptcy reform.
    First, as a matter of property rights and contract, I don't
    like the idea of retroactively changing contracts, and I'm
    concerned with what it might do to financing availability going
    forward.
        But even more importantly in working through this, I am
    emphasizing a program which says, if you're a homeowner, and
    you want to stay in your home, and you can afford to stay in
    your home--raise your hand. Call, reach out to someone. And
    it's a lot quicker than slowing it down, and bogging down our
    courts.
        Senator Brownback. What about the tax credit ground?

                                  TAX CREDITS

        Secretary Paulson. Yeah, I think the, you know, the tax
    credit, I understand the concept very well, because we're
    looking at it--the overhang, and the inventory of unsold homes.
    I think that what you're apt to get with that is something
    that's going to prolong the issue. And so, net-net--although I
    look at it as a creative idea, there have been some creative
    ideas--we are much more focused right now, and let's get the
    GSE reform, get the Federal Housing Administration (FHA)
    modernization done, get the tax-exempt financing done, and so
    we're not there on the tax credit. But, again, I understand
    what people are seeking to get at with that proposal.

                               CONFLICT MINERALS

        Senator Brownback. If I could just ask one more question in
    the length of time we have. I've handed you a proposal, this is
    on financing--terrorist financing, and also conflict
    commodities financing, I think it's a topic you--the
    administration has done a pretty good job of trying to get at--
    terrorist financing.
        I want to put another issue in your portfolio, and it's
    conflict commodities in Africa, particularly from the Sudan and
    Congo.
        Secretary Paulson. Yes.
        Senator Brownback. And that we really start targeting these
    commodities coming out of conflicts so as to prevent further
    exacerbation of the conflict.
        Secretary Paulson. Yes.
        Senator Brownback. Senator Durbin and I went to Congo
    together, I've even got a picture of one of the coltan coming
    out of Congo, financing it, now tin is being used--these are
    kind of Mom and Pop mining operations.
        Secretary Paulson. Yes.
        Senator Brownback. This is kind of how they mine coltan
    that's in your cell phone, or even tin out of Congo, this
    picture is taken out of Congo. No other group--they've got a
    proposal out of a draft piece of legislation saying that we
    won't purchase commodities from conflict zones, where that
    money is used to finance rebel groups.
        I would urge you to look at it, because I think this going
    to be one of the keys for us to try to stabilize Africa.
        Secretary Paulson. Yes.
        Senator Brownback. We need to keep the money from going to
    these rebel groups, particularly like in the eastern Congo,
    it's a classic place. I think it's also what we need to look at
    in the Sudan.
        Secretary Paulson. Yes.
        Senator Brownback. There you've got a government that's
    being primarily financed by oil and I think we need to be very
    aggressive on this in looking at it.
        And I would draw to your attention to one other thing, that
    we have done, Senator Durbin and a number of others worked on
    the Sudan Divestment Act that passed. I'd like to see us do a
    similar one on Iran, as a way to divest and get money out of
    the financing of the conflicts.
        I draw that one more to your attention than for a response,
    unless you give me a positive response, you don't need to
    respond at all.
        Secretary Paulson. How could I not be positive? Because
    this is a real problem, and your leadership and the chairman's
    leadership are very much appreciated on this. And I will pass
    on the comments to Secretary Rice and others at the State
    Department, because I think this is something that I know is an
    important issue.
        Senator Brownback. Thank you.
        Senator Durbin. Senator Allard.
        Senator Allard. Thank you, Mr. Chairman, thank you for
    holding the hearing to examine the budget request for the
    Treasury Department.
        And it's a pleasure to be here, to be able to welcome you,
    Secretary Paulson. We have an opportunity to see one another
    quite frequently----
        Secretary Paulson. Yes.

                                 COSTS OF COINS

        Senator Allard. And so I do appreciate the job that you're
    doing and I apologize for being--not being able to be here to
    hear your testimony this afternoon, we started markup on the
    budget--we started debating the budget, and so, I'm on the
    Budget Committee, so it's important that I at least be there
    for the opening part of the Budget Committee debate.
        I did want to stop by briefly to raise one issue which has
    important appropriations implications, and I appreciate my
    colleagues accommodating my schedule on this.
        Last week on a radio program, you'd advocated for the
    elimination of the penny, but added that you didn't think it
    was politically doable.
        Secretary Paulson. I didn't----
        Senator Allard. If my information is correct.
        Secretary Paulson. No, I did not advocate it. I've got no
    intent, no plans to advocate it. What we're advocating, though,
    very strongly, for is we have legislation that would change the
    content of the----
        Senator Allard. Well, that's what I'm getting at.
        Secretary Paulson. The penny and the nickel.
        Senator Allard. Yeah.
        Secretary Paulson. Which would save the American taxpayer a
    good bit of money.
        Senator Allard. Okay. This was an Associated Press story.
    They must have got that wrong in the story.
        Secretary Paulson. Yeah, I said--what I had--we have no
    intent or plans to----
        Senator Allard. Well, we can still move forward with my
    question.
        Secretary Paulson. Right.
        Senator Allard. Because I've introduced legislation, I
    believe we've got bipartisan support on this, S. 1968, which
    gives the flexibility to the Treasury Department to manage the
    content of the coin.
        Secretary Paulson. Right.
        Senator Allard. Metal content. So, my question is, is--how
    much do you think this could save, as far as the Treasury
    Department is concerned, and how urgent do you think it is that
    we get this changed, to give you the flexibility with the
    changing metal market. You know, gold right now is at a
    historic high, I think, and a lot of our metals are falling
    right in behind that.
        Secretary Paulson. Yeah, it is, you know, we're losing
    money for every penny we mint and----
        Senator Allard. Even a nickel, too, right?
        Secretary Paulson. I don't have the number offhand--oh, the
    nickel's even more. It's--I think the nickel--directionally
    right, if it's, it costs 7.7 cents or something, to make a
    nickel or 1.4 cents to make a penny, and I'll get you the
    numbers.
        [The information follows:]
                          Cost of Pennies and Nickels
        Using current metal prices (February 2008), production costs this
    year for the Mint will be more than 1.3 cents per penny and 7.7 cents
    per nickel.

        Secretary Paulson. But, when I looked at it over the period
    of time, we're talking about hundreds of millions of dollars.
        But, whatever the number is, there's no reason to be losing
    money in a needless way. And so we just need to change the
    metal content of those coins.

                             METAL CONTENT OF COINS

        Senator Allard. Well, you know, and I sympathize with--
    given you and the various agencies that you work with, the
    flexibility to change that metal content. Because, you know,
    all of these metals--they change in value from year to year,
    and I don't think the action of the Congress can keep up with
    it, and if we can do this in a way that saves taxpayer
    dollars----
        Secretary Paulson. Right.
        Senator Allard [continuing]. I think we ought to do it. And
    the sooner the better. And so anything you can do on that to
    help us get the message out, we'd appreciate it. I do think
    it's a very commonsense kind of piece of legislation, and
    something that I think we need to do.
        Secretary Paulson. It is. It is, very much.
        Senator Allard. So, anything you can do on that, we'd
    appreciate it.
        And you know, I--I guess the question is, are there metals
    that we would use that--we potentially could use--that we're
    not using now?
        Secretary Paulson. Yes.
        Senator Allard. Yes.
        Secretary Paulson. They are--they're composites, and
    there's been a lot of work done on this.
        Senator Allard. Is that right?
        Secretary Paulson. And I'd be very happy to send some
    people up to give you all the details on it, because there's
    been a lot of good work done on this by the Mint.
        Senator Allard. I would appreciate us being briefed on
    that, if you would, please. And maybe other members of the
    subcommittee would be interested in that.
        Secretary Paulson. Go through the whole economic analysis.
        Senator Allard. Okay, well, very good, well I'd like to
    follow-up on that a little bit, and maybe we can all get that
    information, get briefed together, or something. I don't know
    if we need to have a formal hearing on it, Mr. Chairman, but if
    you wanted to include it or something for the members of the
    subcommittee, we could do that. But, I'm particularly
    interested in it, and would like to have that information.
        Thank you.
        Senator Durbin. I thank the Senator from Colorado, and just
    for the record the Lincoln penny was initiated 100 years ago,
    on the 100th anniversary of Lincoln's birth. And the
    bicentennial of that birth, next year, will result in four new
    backs for the penny to show different aspects of Lincoln's
    life. And the metal content is secondary to the people of
    Illinois, as long as Lincoln's on the penny.
        Secretary Paulson. But, we can do them both, right?
        Senator Durbin. Right, no objection.
        Secretary Paulson. We can do them both, and we celebrate
    it.
        Senator Durbin. Yes.

                                   BANKRUPTCY

        Mr. Secretary, Federal Reserve Chairman Bernanke recently
    said, relative to the foreclosure crisis, ``Principal
    reductions that restore some equity for the homeowner may be a
    relatively more effective means of avoiding delinquencies and
    foreclosure.'' And he continued, ``When the mortgage is under
    water, a reduction in principal may increase the expected
    payoff to the bank by reducing the risk of default and
    foreclosure.''
        I want to say a word about the bankruptcy provision which
    you've alluded to, because Senator Brownback will get a chance
    to consider that measure in a day or two in our Senate
    Judiciary Committee.
        Over the months since we've first initiated the concept, we
    have changed it dramatically. Originally, we said that there
    was no equity or justice in allowing a bankruptcy court to
    modify the terms of a mortgage on a vacation condo, a farm or a
    ranch, but to prohibit, by law, any modification of the terms
    of a mortgage on a principal residence or a home. And so,
    initially, we began with the premise, let's treat them all the
    same, allow the bankruptcy court that option.
        But, some have observed that that may have a negative
    impact, so we have dramatically restricted the bankruptcy
    reform that I am proposing. First, it's harder to get into
    bankruptcy court today than it was 5 years ago. You have
    chapter 13, which requires certain requirements, income
    requirements and the like, before you can end up in the
    bankruptcy court.
        Second, we restricted this provision, this change, only to
    homeowners, so no speculators need apply. You have to actually
    live in the home we're talking about.
        Third, we said only subprime mortgages for those homes.
        Fourth, we said that any modification of the terms of the
    mortgage could not reduce the principal any lower than fair
    market value to protect--as best we can--the lender who, if
    they're facing a distress sale, are lucky to see fair market
    value.
        Then we said the interest rate has to be based on the prime
    rate plus a reasonable premium for risk. And, we added another
    provision which, I think, is an effort to go an extra mile to
    win back some support from the banking community, and it did
    win the support of credit unions. If there is a modification of
    the principal on a mortgage in a bankruptcy facing foreclosure,
    and say a house is re-valued from $500,000 to $450,000, and
    then in subsequent years, increases in value, back up over
    $450,000--that delta, that change, that improvement--will go to
    the lender. So, we're trying to protect the lender on the
    downside fair market value and the upside, in terms of
    appreciation.
        What I'm troubled with is this reference by yourself and
    bankers to the ``sanctity of the contract.'' I've seen some of
    these contracts in our home State. There's nothing holy about
    how these contracts were entered into. Many of them were
    deception at its worst. People were taken advantage of. Poor
    people, uneducated people, senior citizens.
        And to hold these as ``holy instruments'' which now must be
    respected, overlooks the obvious--when we changed the
    bankruptcy code 5 years ago, we changed the impact of all of
    the contracts that come in under bankruptcy. The sanctity of
    the contract was never raised by the banks who wanted to change
    the bankruptcy code for their advantage.
        Now, when they may end up negotiating a contract of
    mortgage which they've resisted negotiating, they're arguing
    the sanctity, the ``holiness'' of the integrity of this
    contract. And I will tell you, I can give you chapter and verse
    of some that were as unholy as you can imagine.
        Secretary Paulson. Can I respond to that?
        Senator Durbin. Of course.
        Secretary Paulson. Because there is no way you're ever
    going to get me defending some of those loans. And I am
    cheering on our law enforcement agencies, everyone that is
    going after the fraud.
        What I was talking about was taking a bankruptcy statute,
    that was designed the way it was for a reason. The presumption
    is the judge is going to--you're not going to be altering the
    terms of a vacation home or a sailboat, or whatever. You're in
    bankruptcy, the presumption is, you lose it.
        Senator Durbin. Not in chapter 13.
        Secretary Paulson. It's----
        Senator Durbin. Not in chapter 13.
        Secretary Paulson. But, I'll tell you, it's a much
    different presumption when you're talking about your home. But
    again, rather than--I just make two points, okay? And I'll just
    make them again, and make them quickly. That, to me when you
    change a bankruptcy statute and do it retroactively--I
    recognize you've narrowed it, okay?--to change it
    retroactively, it's something that gives me pause. And then
    second, again, that when you look at bogging down the system
    and dumping this in the courts when I think a simpler, more
    effective way to deal with it is to have homeowners when
    there's a problem, go deal with it.
        And a large number of foreclosures we're seeing, from
    everything I can learn, is homeowners not responding.
        Senator Durbin. But, Mr. Secretary, let me tell you, you
    said that earlier. ``If you can make the original payment and
    can't make the reset, hold up your hand,'' you said. Well,
    you've got hundreds of thousands of borrowers across America
    who are in this predicament, and to say to them, ``You should
    go take care of your problem.''
        What I'm saying to you is, the response so far, the
    voluntary response of your administration programs has reached
    some, but not nearly enough to turn this crisis. The Fed--the
    Chairman of the Federal Reserve, Mr. Bernanke, is basically
    said what I am saying. That there comes a moment in time, that
    if you want to turn this crisis, you have to deal with the
    reality.
        I don't want these people to go to bankruptcy court--if I
    could just finish--I don't want these people to end up in
    bankruptcy court. But if the lender understands that there is a
    possibility of bankruptcy and modification, they are much more
    likely to renegotiate the terms of the mortgage before
    bankruptcy. Currently, there is no incentive.
        Secretary Paulson. Listen, I very much appreciate what
    you're trying to do and your motives, you appreciate mine. As
    far as I know, Ben Bernanke is not advocating changing the
    bankruptcy law retroactively. And again, there's a fact, and
    the fact is that we're making a huge effort. There still are a
    fair number of people that--a large number of people, a
    disappointing number of people--aren't responding when they get
    numerous letters and phone calls and they hear--and all I'm
    saying is, wouldn't it be easier to--and how do you help
    someone if they're not going to raise their hand and----

                               COUNSELING FUNDING

        Senator Durbin. Then let me ask you this question, why did
    the administration issue a statement saying that they would
    veto the housing stimulus bill before the Senate last week, and
    one of the reasons because it would have substantially
    increased the number of counselors available for those facing
    foreclosure. If your argument is that enough people aren't
    seeking help, why did the administration say that that was one
    of the specific reasons they would veto the housing stimulus
    bill?
        Secretary Paulson. Well, I missed that part of it, because
    I will tell you that counseling is vital. And one of the things
    that the administration has been advocating has been funding
    for counseling, and funding a counseling partially by the
    servicers at Hope Now, and the whole effort. And the 888-995-
    HOPE number is to get people to call and get to counseling.
        So, you know, I didn't read that part that you're referring
    to, but I sure know that the--we've got a similar objective and
    I appreciate the fact that you've narrowed it appreciably, and
    again, I'm just giving you my----
        Senator Durbin. Senator Brownback.

                                 LOAN WORK OUTS

        Senator Brownback. Thank you, and this is a good
    discussion, because I remember the same discussion during the
    farm crisis time period. And, a lot of these loans need to be
    restructured.
        Is it your belief that a number of the loans that people
    want to restructure are being restructured by financial
    institutions?
        Secretary Paulson. I sure believe that.
        Senator Brownback. Do you have any hard numbers that you've
    been able to track or to look at?
        Secretary Paulson. What we've got--here's some hard numbers
    I've got. Some are encouraging and some are discouraging.
        That, before this effort, 2 to 3 percent of the people were
    responding to servicers, when they went to homeowners that were
    facing resets or delinquent. Now, 20 percent are responding,
    okay? So, that's a positive.
        We have a hard number that since the beginning of putting
    this together, that there have been 1 million homeowners who
    have been helped--either, you know, through a, through a work
    out of some sort.
        We have hard numbers that this last--the last month, that I
    was encouraged to see modifications and work outs growing
    faster than foreclosure starts. But, I don't have numbers on
    refinancings.
        Part of the problem we have, Senator, is that--as I said
    earlier, there are really--and the chairman made that point--
    there were just egregious, some of the lending contracts and
    some of the way people were put in these loans, and there--but
    there were 18 percent of the 2006 adjustable rate subprime
    mortgage holders defaulted 6 months before the first reset.
    They couldn't afford the initial payment.
        And so, there are, regrettably, going to be some people
    that are going to return to becoming renters. But, again, I'm
    going to work hard to make the Hope Now Alliance work, and work
    better, we're going to work as hard as we know how to get the
    data out there and to track it, and I've got to tell you, if
    something isn't working the way it needs to work, then we're
    open--and I'm sure open--to making modifications in the way we
    approach things. We just have a----
        Senator Brownback. Secretary, if I could, and I just wanted
    to interject, and I appreciate you going through this--my raw
    point on this would be that I really hope that the financial
    institutions and the administration can make the work outs
    work.
        Secretary Paulson. Yes.
        Senator Brownback. Because if it looks like things aren't
    working or that the financial industry says, ``Look, we're just
    going to dig in and start fighting on these,'' then I think the
    issue comes back in front of the Congress at that point in
    time.
        So, I think there is a period where people can look at
    this, and say, ``You know, the bank doesn't want the home
    back,'' the financial institution doesn't want the home--they
    want the person to stay in it.
        But, a lot of times, people have gotten into something they
    shouldn't have, or were talked into something that they
    shouldn't have been. We are where we are today, and we all know
    we've got a problem here, and I just think if we can make the
    work outs work in substantial numbers across the country, then
    great. I would presume, really, Senator Durbin would be very
    happy with that.
        If they don't, then it becomes a more difficult matter if
    these numbers start jumping up. And that would be the point I
    would like to make to you, on a raw basis.
        Secretary Paulson. Senator, can I respond to that in one
    way? Because no matter how well we make this program work,
    given the excesses that were entered into, the foreclosures
    will jump up. And there are a number of homeowners who were
    speculators. There were a number of homeowners in hot markets
    that put very little down, the first time there's some negative
    equity from their home, they're going to walk away from their
    obligation.
        And I think the very interesting question there--to me,
    it's not a difficult question, for some it's a more difficult
    question, to me it isn't--that if someone is going to walk away
    unless someone else pays for their losses, I don't want it to
    be the Government or other taxpayers to pay for their losses.
    To me, those are speculators, and that shouldn't be the focus
    of our efforts.
        Senator Brownback. Fair enough.
        Secretary Paulson. And so, when you look at these
    foreclosures, I'm focused on the same ones that Chairman Durbin
    is focused on--in other words, homeowners that want to stay in
    their home and are having trouble with----

                             REPATRIATION OF FUNDS

        Senator Brownback. I want to build off of that point with
    the little bit of time that I have here. It certainly strikes
    me that one of the biggest things we all want to avoid is this
    soft economy going on into a recession. The economy's soft,
    credit's tight, and we don't want it to slide on into a
    recession. I think the administration is trying to do
    everything they can to stave off a recession.
        One of the issues that I want to draw to your attention--
    I'm sure you've looked at this--is repatriation of funds from
    large corporations bringing back to the U.S. economy. Last time
    we did that, that brought in $284 billion in earnings from
    overseas back into the U.S. economy in a 1-year time period,
    where normally we'd have about $70 billion in the same 1-year
    time period. So, nearly a $200 billion infusion into the U.S.
    economy. I hope the administration would look at something like
    that as an infusion of cash into the economy, which we need to
    have at this point in time.
        Secretary Paulson. Senator, I thank you for pointing that
    out. It's something we've looked at, it's something that I had
    calls from a number of people I knew in the private sector
    advocating very hard for that at the time we did the stimulus
    package. And since we were very rigorous on the stimulus, in
    terms of saying, ``Everything that went in had to be
    stimulus,'' there are some things that are very good economic
    policies, and, you know, I knew from a lot of experience, just
    because a company brings cash back, doesn't mean they're going
    to spend it, okay? And so, we focused much more on things that
    were going to increase the likelihood that it'll be a real
    stimulus.
        But, I understand the incentives and motivations you're
    talking about, and the wisdom of something like that, and I
    thank you for bringing it.
        Senator Brownback. Well, it strikes me that we may be
    getting to a point where we want to put everything out there we
    possibly can to keep the economy from going into recession. And
    even if the corporations don't spend it, if it's sitting
    overseas, they're for sure not going to spend it here.
        Secretary Paulson. Right.
        Senator Brownback. You've assured that one of taking place.
        So, I think we ought to be looking at the next step on
    this, just to----
        Secretary Paulson. Right.
        Senator Brownback [continuing]. Because things are tough
    out there, and it looks like, it's going to be difficult for
    the consumer to come back in the marketplace, to the degree or
    level that we want. So that's going to depend upon a lot of
    corporations and individuals investing, us being very
    competitive with our exports--which have grown substantially.
        Secretary Paulson. Yes.
        Senator Brownback. Us expanding the energy industry
    domestically, I just think now we're looking at some bit of
    restructuring of our economy, probably a little away from the
    consumer, and more towards exports, energy--and these are great
    opportunities for us. I see you put some things on the energy
    market, here, I hope we can do that.

                          ALTERNATIVE METALS FOR COINS

        And just a final comment--I just hope you don't make the
    penny out of plastic, or nickel out of plastic. Make it out of
    some metal.
        Secretary Paulson. Yeah, we're talking about composite
    metals, right, we're just changing the metal content a bit.
        Senator Brownback. All right, thank you. Unless it's wheat-
    based plastics or something like that.
        You know, maybe corn, being from Illinois, but just--don't
    make it out of plastic.

                               COUNSELING FUNDING

        Senator Durbin. We have a bipartisan position on that.
        Mr. Secretary, when you get back, take a look at the
    statement of administration policy issued February 26, this
    year, relative to the housing stimulus bill on the floor, and
    you'll see that the administration said that it would veto this
    bill over the suggestion of tripling the funding for the
    Neighborhood Reinvestment Corporation, which was expressly for
    more counselors.
        Secretary Paulson. Yeah, I just put in front of me, yeah.
    You said it's because--I think the view is we've got plenty of
    funding right now.
        Senator Durbin. Well, I think that--I've been out, locally
    in Chicago and all around our State, and I think that's
    arguable. Because if we are reaching 20 percent, and still have
    80 percent, some of that is because of lack of volition on the
    part of the borrower, but it appears to me that there's a lot
    more that needs to be done if there's truly going to be an
    aggressive approach to this.
        I would just like to close, and I'm going to give you a
    chance to respond, because it's--what I'm about to say is
    critical, and I want to hear your response to it.
        When one of your senior counselors was asked yesterday
    about the Treasury Department report on loan modifications
    under Hope Now, 45,000 borrowers in January, the senior
    mortgage banker who runs the Hope Now program said, and I
    quote, ``A mortgage servicers obligation is to get the maximum
    value to the investor over the life of loan. If you're going to
    modify the loan and keep the borrower in the house, the bias is
    to do that for a shorter, rather than a longer, period of time.
    There's a reluctance to do long-term modifications.''
        So, I think the 45,000 figure may be misleading. If it's
    only temporarily suspending the foreclosure, it's not going to
    help in terms of really trying to right this ship.
        My concern from the beginning, is that I know the
    administration's philosophy, that you have carried out, calls
    for voluntary involvement by lending institutions. When we
    suggest bringing in a bankruptcy court to try to force the hand
    of some of these banks to finally renegotiate, the
    administration opposes it, and says they'll veto a bill.
        I have said, repeatedly, and I won't go into the graphic
    detail, I don't think that the response to this housing crisis
    is adequate. I think it is going to continue to get worse. And
    as long as it worsens, and as long as the housing industry is
    in such terrible shape across America, it's going to be hard to
    see a sound economic recovery.
        It isn't just the builders, and the speculators, and the
    land developers, it's all the material men and skilled
    craftsmen and everyone else who are, frankly, not doing much
    work in my State of Illinois and around this country, waiting
    for the housing market to come back. And those of us who own
    homes are watching the values go down because of foreclosures.
    And we're watching units of local government that will face
    serious problems as assessed valuation goes down, and as
    property tax revenue goes down that's used to sustain local
    units of government.
        If there was ever a time for someone to push away a Herbert
    Hoover view of this, and say, ``We need a New Deal view of
    this, that says there has to be something that's decisive, and
    meaningful, and reaches the most number of people as quickly as
    possible to turn this ship around,'' I think it's now. And the
    longer we wait, the worse, I think, it's going to get.
        And, I invite your response.
        Secretary Paulson. Well, let me respond to that, and the
    counseling.
        I would say on counseling, I get out a fair amount, and
    spend time with counselors, I'll be spending some time when I'm
    out in California later this week, when I was in Chicago, I
    spent time with NeighborWorks. And at least to date, when I've
    talked with counseling firms, they're not impeded by a lack of
    funds, okay? There's not--and so we're, because I just don't
    want there to be a difference between us on that. Because this
    is essential and it is, it's major.

                               LOAN MODIFICATIONS

        Now, in terms of modifications, various firms take various
    approaches to the modification. But to me, the focus I have is
    having mortgage servicers make modifications that help people
    stay in their home, and avoid foreclosure. And that is the
    objective, it is--I think these are costly things to go
    through, I don't think it's in the interest of either the
    borrower or the lender, to have something not be sustainable.
    All I can say to you is that on that effort, I'm going to drive
    that as hard as I know how.
        Now, in terms of your overall comment, where you talked
    about Herbert Hoover--there's been a lot that's changed since
    we went through the Depression and when the foreclosures were
    50 percent and unemployment was 25 percent. We have GSEs, we
    have the FHA, we have the Federal Home Loan Banks, that we're
    going through a period now where 93 percent of the people in
    this country, every single month, no matter how hard it is,
    make their mortgage payment. Two percent--not 50 percent--are
    in foreclosure.
        Now, I believe when you say you think it's going to get
    worse, I'm not arguing with you. I've said that I think that
    those forecasters who say that this is an adjustment, a period
    of adjustment, it's going to take longer to run its course--I
    agree with them.
        You know, when I look at the mortgages that were made in
    2006, that are going to be reset over the next couple of years,
    and when I look at some of the mortgages, the negative
    amortization mortgages, which will be coming, now, even further
    out--I recognize that this is going to take longer. And again,
    I've told you where the focus is, and we're focusing very hard
    on avoiding preventable foreclosures to those who want to stay
    in their home, and have the capability to do that.
        I appreciate you and I want to do the same thing. I'm going
    to keep watching this very closely, we're going to be all over
    it, and I, you know, as again, I know you've got the same
    objective I do. We've got some--and you're supportive of Hope
    Now, you're saying you think there should be some other things
    done----
        Senator Durbin. There should be more.
        Secretary Paulson. And we're just----
        Senator Durbin. Well, let me thank you for coming today and
    testifying--we didn't talk much about your budget. But you will
    get plenty of written questions on that, which we will submit
    to you.
        Secretary Paulson. Thank you.

                         ADDITIONAL COMMITTEE QUESTIONS

        Senator Durbin. And we will provide those for you. And any
    members who wish to make statements and allow them part of the
    record, they will be included, and any questions in writing, I
    ask that you try--I know you're a very busy man, but if you'd
    try to respond to them in a timely fashion, we would appreciate
    that very much.
        [The following questions were not asked at the hearing, but
    were submitted to the Department for response subsequent to the
    hearing:]

                Questions Submitted by Senator Richard J. Durbin

                                     TRADE

        Question. In Illinois, we continue to see losses in manufacturing
    jobs that can at least in part be attributed to the forces of
    globalization. The Trade and Globalization Adjustment Assistance Act of
    2007 extends Trade Adjustment Assistance (TAA) to services sector
    workers and workers affected by offshoring, creates a new TAA program
    for rural and distressed communities, and makes training, healthcare,
    and wage insurance benefits more accessible and flexible. Does the
    Administration support strengthening Trade Adjustment Assistance along
    these lines?
        Answer. The Administration strongly supports TAA reauthorization
    that includes needed reforms to help workers adversely impacted by
    trade access the training and reemployment services they need to return
    to work quickly.
        Reauthorization provides an opportunity to redesign the TAA program
    to make it more effective in enabling workers to gain the skills needed
    to successfully compete in the 21st century global economy.
        The Administration believes there are several flaws in the TAA
    program as it is currently designed. These flaws include:
      --TAA is an ``all or nothing'' program, where participants lose
            access to benefits by choosing to return to work.
      --Training options are limited and the process of applying for
            training is lengthy and bureaucratic.
      --Services cannot be provided until after the worker is laid off--
            even when the layoff is announced well in advance.
      --There is no requirement that One-Stop Career Centers provide
            ``wrap-around'' services such as career counseling, assessment
            and job placement assistance to all TAA participants through
            the Workforce Investment Act (WIA).
        The Administration believes any reauthorization of the TAA program
    should reflect the following priorities:
      --Workers must have increased choice to combine employment with
            training and ``earn while they learn.''
      --Training options should be flexible and easy to access.
      --Services should be available prior to layoff, in order to reduce
            the length of time workers are unemployed.
      --Integration with the Workforce Investment System should be improved
            by requiring states to ensure workers have access to the full
            range of services available through the One-Stop Career Centers
            under WIA.
        Question. It is difficult for workers to complete some courses
    under the current TAA restrictions because it simply takes longer to
    finish the programs than TAA allows. For example, Illinois has an acute
    shortage of nurses, and yet the state is unable to find enough people
    either to teach the training courses or to complete the programs. This
    is a high-growth area for workers that cannot be readily outsourced.
    However, our TAA rules make it nearly impossible for displaced workers
    to enter the nursing profession because the program takes longer to
    complete that TAA allows for training. Do you support common sense
    updates to Trade Adjustment Assistance rules that would address
    difficulties like this?
        Answer. The Administration believes that a high priority for TAA
    reauthorization is that trade-affected workers must have increased
    individual choice to ``earn and learn'' by having access to
    transitional benefits, such as education and training post-employment
    and transitional income support (in certain cases). Benefits under the
    program should include a menu of ``New Economy Worker Services'' that
    allows the worker to choose the option that best fits his or her
    individual needs. For example, training-related options should allow a
    worker to combine either full or part-time work with education and
    training. Similarly, the reauthorization would ensure greater access to
    education and training by providing ``New Economy Scholarships'' to
    workers that could be used over four years. Additional monies would
    also be available to workers who need pre-requisites for training in a
    high demand occupation. The New Economy Scholarship should be portable,
    enabling certified workers to have access to tuition assistance whether
    they are unemployed or return to employment. Workers should be able to
    choose to attend training full or part-time and use the funds for
    tuition, books, fees and required tools.

                         INTERNATIONAL SANCTIONS: SUDAN

        Question. Does the Bush Administration intend to enforce the Sudan
    Accountability and Divestment Act, which I worked very hard to pass in
    conjunction with Chairman Dodd and Chairman Frank over in the House,
    along with the Ranking Member of this committee, Senator Brownback?
        The Treasury Department will provide to Congress the reports called
    for in Section 10 of the Act. Section 6 of the Act governs the
    Executive Branch concerning government contracts with companies that
    conduct certain business operations in Sudan. The Treasury Department
    intends to comply with that provision once the Federal Acquisition
    Regulation is updated by the Federal Acquisition Regulatory Council, as
    provided for in the Act.
        If so, why did the Administration issue a signing statement that
    left in doubt whether that would be the case? If not, why did President
    Bush sign the bill?
        Answer. The Department respectfully recommends that these questions
    be directed to the White House.

                         INTERNATIONAL SANCTIONS: CUBA

        Question. Do you think that the United States should view the
    transfer of power from Fidel Castro to his brother Raul as an
    opportunity to strengthen ties to Cuba? Or do you think our policies of
    sanctions and non-communication should continue? What benefits are
    derived from a stay-the-course, status-quo approach to Cuba that would
    maintain the policy of isolating the Cuban government with economic
    sanctions? Is any consideration being given to an approach aimed at
    influencing the Cuban government through an easing of sanctions and
    increased contact and engagement? If not, why not?
        Answer. The United States foreign policy positions are defined by
    the State Department. The Office of Foreign Assets Control (OFAC)
    administers and enforces the country sanctions against Cuba, which
    restrict the flow of funds to Cuba that would otherwise be used to prop
    up the regime rather than benefit the Cuban people. The
    Administration's policy has been designed to prevent resources from
    reaching the regime, which uses its resources to control and oppress
    the Cuban people. We will continue to monitor developments closely and
    stand ready, if asked, to assist a genuine Cuban transition government
    committed to democracy.

                      REDUCTION IN REQUESTED CDFI FUNDING

        Question. Compared to fiscal year 2008, proposed reductions could
    jeopardize $700 million in private capital for CDFIs that could
    otherwise be made available to communities and individuals currently
    facing credit shortages. Why are you recommending such a drastic
    reduction to a program that demonstrates such a tremendous return on
    the taxpayer's dollars?
        Answer. The fiscal year 2009 President's budget includes over $28
    million for the CDFI Fund, which will be used to expand the capacity of
    financial institutions to provide credit, capital and financial
    services to underserved populations and communities. Specifically, the
    CDFI Fund will continue to provide grants, loans and equity investments
    through the CDFI Program, allocate tax credits through the New Markets
    Tax Credit Program, and support the CDFI Fund's existing grantees.
        The fiscal year 2009 President's budget does not propose funding
    for the Bank Enterprise Award (BEA) Program. The BEA Program provides
    funds to for-profit banks based on their past activity, and has not
    demonstrated that its awards increase lending and financial services in
    economically distressed communities. The BEA program is in the process
    of modifying the program's regulations. With these revisions in place,
    any future BEA funding will encourage future community development
    activities, rather than reward past activity. This change aligns BEA
    Program activities with the CDFI Fund's goals and objectives.
        In fiscal year 2009 the CDFI Fund will continue to serve Native
    communities through the CDFI Program; however, the fiscal year 2009
    President's budget does not include a separate request for Native
    Initiatives.
        Question. How do you reconcile this proposed reduction with the
    Administration's concern with the shrinking availability of credit?
        Answer. The Department of the Treasury encourages the availability
    of capital and credit to all communities, including low-income, through
    a broader system of financial institutions. While the CDFI Fund
    provides capital and credit to financial institutions serving low-
    income communities it is not the only source of funding available to
    these institutions. These intuitions may also receive funds from
    various federal, state, and local entities, such as the U.S. Department
    of Health and Human Services, U.S. Department of Agriculture, state
    economic development agencies, and local municipalities. Non-government
    funding sources for these financial institutions include banks,
    thrifts, credit unions, and non-regulated institutions such as loan
    funds and community development venture funds.

                           ECONOMIC STIMULUS REBATES

        Question. I understand that you anticipate that IRS will begin
    sending rebate checks starting in May. When do you project that the
    payments will have a noticeable positive impact on the economy?
        Answer. The first economic stimulus payments will be issued by
    direct deposit beginning May 2, 2008. The first paper checks will go
    out beginning May 16, following the schedule outlined below.

       STIMULUS PAYMENT SCHEDULE FOR TAX RETURNS RECEIVED AND PROCESSED BY
                                    APRIL 15
    ------------------------------------------------------------------------

    ------------------------------------------------------------------------
              Direct Deposit Payments

    If the last two digits of your Social       Your economic stimulus
     Security number are:                        payment deposit should be
                                                 sent to your bank account
                                                 by:
        00-20.................................      May 2
        21-75.................................      May 9
        76-99.................................      May 16

                    Paper Check

    If the last two digits of your Social       Your check should be in the
     Security number are:                        mail by:
        00--09................................      May 16
        10--18................................      May 23
        19--25................................      May 30
        26--38................................      June 6
        39--51................................      June 13
        52--63................................      June 20
        64--75................................      June 27
        76--87................................      July 4
        88--99................................      July 11
    ------------------------------------------------------------------------

        Based on the payment schedule, the Department projects that the
    stimulus will begin to provide a meaningful boost to spending almost
    immediately and that its effect on economic growth will be felt through
    the rest of the year. The Department also anticipates that the
    individual and business tax relief components of the package together
    could lead to the creation of over half a million jobs by the end of
    the year.

                           NEW 24/7 OPERATIONS CENTER

        Question. The President's 2009 budget for the department requests
    $6.2 million for a new Operations Center, which would provide 24/7
    capability to monitor the global market. How will the enhanced
    capabilities of the new Operations Center support Treasury's mission?
        Answer. The Department of the Treasury serves the American people
    and strengthens national security by managing the U.S. Government's
    finances effectively, promoting economic growth and stability, and
    ensuring the safety, soundness, and security of the United States and
    international financial systems.
        The global scope of the Department's operations requires a 24/7
    response capability. The Treasury Operations Center will act as a
    fusion center for the receipt, analysis, and dissemination of
    information critical to the economic well being of the country. It will
    have enhanced analysis capabilities necessary to monitor international
    and domestic financial markets, coordinate actions with other Federal
    agencies, foreign governments, and global financial markets, and manage
    the Treasury's global operations on a round the clock basis. It will
    have a capability to integrate open source and classified information
    that currently does not exist in the Treasury organizational structure.
    The speed with which financial information is processed and the fact
    that decisions facing the United States are not limited to weekdays
    from 9-5, dictate the creation of a 24/7 facility that will protect and
    enhance the fiscal power and reach of the United States Government.
        Additionally, the Treasury Operations Center will act as a
    communications hub for information directly related to the financial
    markets as well as to national and world events that affect the
    markets. This communications hub will tie together the Treasury program
    offices with their private sector counterparts, foreign financial
    ministries, and other federal government entities. The Treasury
    Operations Center will engage directly with international financial
    market participants, foreign governments, international financial
    institutions, and in multinational fora in an immediate time-sensitive
    manner. Open and secure communications capabilities will be available,
    as will a 24/7 executive switchboard.
        Lastly, the Treasury Operations Center will function as a crisis
    management center. It will be the hub for activities bringing senior
    Treasury Department officials together to manage rapidly developing
    issues affecting the financial community (for example, managing the
    recent sub-prime mortgage situation and bolstering confidence in the
    investment banking community). Current financial crises require the
    Secretary to manage operations on a daily if not hourly basis, as well
    as implementing policies that affect the future course of the nation's
    economic health. Open and secure conference rooms will be available,
    along with fully equipped private office space.

                          CROSS-BORDER WIRE TRANSFERS

        Question. In October of 2006, Treasury's Financial Crimes
    Enforcement Network released a study that found that it is technically
    feasible to require financial institutions to report data on wire
    transfers that cross borders. What is the status of Treasury's efforts
    to implement reporting of Cross-Border Wire Transfers?
        Answer. The Financial Crimes Enforcement Network (FinCEN) continues
    to study regulatory proposals for the collection of Cross-Border
    Electronic Transmittals of Funds. FinCEN is currently analyzing the
    costs and benefits of a proposed regulation that will affect law
    enforcement and regulatory agencies, and the financial industry. Upon
    completion of the study, a report will be provided to the Secretary for
    review and consideration.
        Question. Have you conducted any analyses in order to weigh the
    additional costs that data reporting on cross border wire transfers
    might impose on the financial sector against the benefits of gathering
    this data?
        Answer. As mentioned above, FinCEN is actively engaged in a review
    of the costs and benefits of a proposed regulation to collect Cross-
    Border Electronic Transmittals of Funds. Data collection efforts that
    contribute to the evaluation of costs and benefits include surveys, in-
    person interviews, and ``use case scenarios.'' Specifically, FinCEN has
    reached out to affected parties of the Bank Secrecy Act Advisory Group
    (BSAAG), a statutorily created forum for discussing Bank Secrecy Act
    (BSA) administration, to assess the impact on industry. FinCEN has also
    coordinated with the Federal Reserve Board to survey financial
    institutions that transmit funds internationally. This voluntary survey
    asked institutions to identify the impact of a reporting requirement,
    including the cost of reporting such information. Finally, FinCEN
    conducted in-person interviews with law enforcement and regulatory
    agency officials and collected ``use case scenarios,'' which are
    specific examples of exactly how the agencies would use the cross
    border data and its resulting benefits.

                    BUDGETARY IMPLICATIONS OF CUBA SANCTIONS

        Question. How many fiscal year 2008 budget and staff resources
    (stated in dollars and actual staff, either part-time or full-time, and
    work location) are presently designated for administering the Cuba
    sanctions? What proportion of total Treasury/OFAC resources do those
    levels represent?
        Answer. Most of OFAC's Cuba-related work is centered in its
    Licensing Division and includes processing applications for travel to
    Cuba to market and sell agricultural products to Cuba as provided for
    by the Trade Sanctions Reform and Export Enhancement Act of 2000, as
    well as applications to engage in family and religious travel and other
    Cuba-related transactions. Of the 155 OFAC FTE, six FTE (approximately
    $1.1 million) in Washington, DC and five FTE (approximately $.9
    million) in Miami, FL are devoted full-time to the Cuba program. These
    eleven FTE represent approximately seven percent of OFAC's budget. In
    addition, some other individuals, including supervisors, who dedicate
    time to one or more of the other 20-plus sanctions programs
    administered by OFAC, work on aspects of the Cuba program as necessary.
        Question. How do those levels compare to the resources that are
    devoted to the other sanctions programs that OFAC implements, including
    sanctions related to terrorism, weapons proliferation, and narcotics
    trafficking?
        Answer. The balance of OFAC's budget (approximately ninety-two
    percent) is devoted to the other 20-plus sanctions programs that OFAC
    implements, including those related to Iran, Sudan, terrorism, weapons
    proliferation, and narcotics trafficking. However, as noted in the
    response to the question above, some individuals, including
    supervisors, who dedicate time to one or more of the other sanctions
    programs administered by OFAC, work on certain aspects of the Cuba
    program as necessary.
        Within OFAC's Designations Investigations Division, there are
    currently six FTE (two of which are currently vacant) devoted full-time
    to administering counter-terrorism sanctions programs; eight FTE
    devoted full-time to administering counter-proliferation sanctions
    programs; eleven FTE devoted full-time to administering counter-
    narcotics sanctions programs; and eight FTE (two of which are currently
    vacant) devoted full-time to administering country/regime sanctions
    programs. These figures are fluid and the resources assigned to
    administer these programs can change at any time to accommodate foreign
    policy interests and national security priorities. The FTE within the
    other operating divisions (Licensing, Policy, Compliance, Civil
    Penalties and Enforcement) are not assigned to administer and implement
    specific sanctions programs; rather, these divisions assign employees
    on a cross-program basis.
        It should be further noted that in 2005, as part of the creation of
    the Office of Terrorism and Financial Intelligence, twenty-three
    analysts assigned to OFAC's terrorism sanctions program in the Foreign
    Terrorist Division of OFAC were transferred to Treasury's Office of
    Intelligence and Analysis (OIA) to form the nucleus of OIA's analytic
    team. These analysts have continued to support OFAC's counter-terrorism
    sanctions program through in-depth targeting, research, analysis, and
    drafting of evidentiaries. Over time, the number of analysts assigned
    to counter-terrorism work in OIA has grown to thirty-five,
    strengthening and deepening Treasury's counter-terrorism sanctions
    program and also allowing OIA to provide expanded analytical support to
    the Treasury Department and interagency community on terrorist
    financing matters.
        Question. How do the fiscal year 2008 levels (resources and
    staffing) compare to funds and personnel devoted to Cuba efforts in the
    previous four fiscal years (fiscal years 2004 through 2007)?
        Answer. In fiscal year 2008, OFAC employed new strategies on Cuba
    matters in the Enforcement and Civil Penalty divisions that have
    reduced and are expected to continue to reduce resources committed to
    Cuba; specifically, OFAC increased its targeting of enforcement efforts
    by concentrating on those facilitating illegal travel to Cuba. It is
    expected that the percentage of staff time expended by the Enforcement
    and Civil Penalties divisions on Cuba matters will decrease as a result
    of the new strategies being deployed. Resources and staffing devoted to
    Cuba will otherwise remain consistent with the previous four fiscal
    years (fiscal years 2004 through 2007).
        Question. Please provide the Subcommittee with a data table
    detailing the resources (dollars and personnel) allocated for fiscal
    year 2008 for investigating and penalizing violations of the Cuba
    embargo, describing the types of activities involved, and specifying,
    for comparison purposes, the amounts dedicated to each of the other 20-
    plus sanctions programs that OFAC administers.
        Answer. As noted above, OFAC has adopted new strategies with
    respect to sanctions violations in recent years. These strategies have
    resulted in a significant reduction in Cuba penalty cases. Enforcement
    resources committed to Cuba are also being reduced and enforcement
    efforts are being targeted in a more effective way by concentrating on
    those facilitating illegal travel to Cuba. The data table below
    identifies the FTE within OFAC that are devoted to administering and
    implementing the Cuba program for fiscal year 2008.
        As previously noted, some individuals, including supervisors, who
    dedicate time to one or more of the other 20-plus sanctions programs
    administered by OFAC, work on aspects of the Cuba program as necessary.
    Because of the significance and demands related to the other programs
    to which these individuals are assigned, OFAC does not track their time
    spent on the Cuba program. For comparison purposes approximately
    ninety-two percent of OFAC's budget is devoted to other sanctions
    programs that OFAC implements, including sanctions related to Iran,
    Sudan, terrorism, weapons proliferation, and narcotics trafficking.

                                                    FISCAL EYAR 2008
                                                 [Dollars in thousands]
    ----------------------------------------------------------------------------------------------------------------
                                                            Cuba           All other programs           Total
      Divisions with FTE dedicated to a specific   -----------------------------------------------------------------
                      program \1\                      FTE      Dollars      FTE      Dollars      FTE      Dollars
    ----------------------------------------------------------------------------------------------------------------
    Licensing.....................................         11     $1,969  .........  .........         11     $1,969
    Designations Investigations:
        Counterterrorism..........................  .........  .........          6     $1,041          6      1,041
        Counterproliferation......................  .........  .........          8      1,388          8      1,388
        Counternarcotics..........................  .........  .........         11      1,909         11      1,909
        Country/regime............................  .........  .........          8      1,388          8      1,388
                                                   -----------------------------------------------------------------
          Total...................................         11      1,969         33      5,726         44      7,695
    ----------------------------------------------------------------------------------------------------------------
    \1\ As noted above, OFAC's other operating programs assign FTE on a cross-program basis rather than to a
      particular sanctions program.

                      MANAGEMENT OF TREASURY'S IT SYSTEMS

        Question. The Inspector General's 2008 Annual Plan repeats a
    continuing concern with the Department's management of large capital
    investments--particularly information technology (IT) investments.
    While this is a challenge for any organization, the Department has had
    particular problems in this area. How are you addressing these
    deficiencies from a department-wide perspective? What measures and
    procedures are in place to ensure the success of new systems?
        Answer. Over the past year, the Department has taken a number of
    significant steps to address the IT management challenges. The
    Department's strategy has focused on three key elements: (1) regular
    engagement of the Treasury Department and Bureau executives in the
    management of IT; (2) more rigorous planning and management of IT
    projects; and (3) improved IT investment review and evaluation tools,
    processes and practices.
        In order to better engage executives across Treasury and its
    Bureaus, the Department has revitalized the Executive Investment Review
    Board (E-Board), which was a key recommendation by the Government
    Accountability Office's July 2007 report (GAO-07-865). The E-Board was
    re-chartered in December 2007 and held its first meeting in February
    2008. The E-Board is chaired by the Deputy Secretary and is comprised
    of the heads of each of the Department's Bureaus. The Assistant
    Secretaries for Management and Legislative Affairs, the General Counsel
    and the Chief Information Officer (CIO) also participate on the E-
    Board. The E-Board is tasked with ensuring the Department's IT
    portfolio decisions are driven by Treasury's business requirements and
    that each Bureau and the Department have in place appropriate planning,
    monitoring and evaluation mechanisms. The E-Board will also identify
    strategic priorities for IT use and address Department-wide IT policy
    issues as they arise.
        To improve the effectiveness of planning and management of IT
    projects, the Treasury CIO has issued new policy and guidance regarding
    requirements for project planning in order to receive CIO endorsement
    for funding. The CIO, in collaboration with the Treasury Chief
    Procurement Executive, has drafted a new IT acquisition policy to
    strengthen the Department's IT contract management. The Department is
    working with the bureaus to implement the new OMB required, Federal
    Acquisition Council Project and Program Management qualifications to
    ensure that the Treasury federal staff that oversee our IT projects
    have the appropriate knowledge and skills required to successfully
    deploy and manage Treasury IT systems. Finally, the Department
    continues to strengthen its ability to defend against cyber attacks and
    protect the sensitive information entrusted to the Treasury by the
    public.
        Another element of the Department's overall IT management strategy
    is to improve the review and evaluation of Treasury IT investments.
    Rigorous review at both the bureau and Department level is a
    prerequisite for successful deployment and management of IT systems. In
    addition, the Treasury CIO has taken action to improve the Department's
    visibility into and influence on IT projects. In the fall of 2007, the
    Treasury CIO made the decision to require non-major investments to
    participate in a process similar to the Department's formal selection
    and review processes for major investments. As a result, all IT
    investments (both major and non-major) are considered during the
    portfolio selection process that is integrated with the Department's
    budget request. Likewise, bureaus must report quarterly for all IT
    investments (both major and non-major) on cost, schedule, and
    performance goals. Finally, the Treasury CIO is expanding its IT
    investment evaluation process to assess not only ``completed'' projects
    against planned objectives, but also those portions of IT developmental
    projects that have implemented discrete operational components.
        Question. The President's fiscal year 2009 budget requests $2.9
    million to fund an upgrade to the IT system used for financial
    reporting under the Bank Secrecy Act. In July 2006, FinCEN halted work
    on BSADirect, the previous attempt to upgrade its IT systems. Treasury
    spent two years of planning and $14.4 million on that failed system.
    What improvements have you made to the planning and implementation
    process that will avoid problems that plagued the previous failed
    upgrade?
        Answer. During fiscal year 2007, FinCEN made significant progress
    on the full range of organizational, program management, and technical
    architecture-related efforts needed to modernize the bureau's IT
    systems. FinCEN identified the specific action items in its October
    2006 Information Technology Plan, created in response to the BSA Direct
    project termination. In fiscal year 2007, FinCEN launched an effort to
    establish the organization's first enterprise business transformation
    and IT modernization strategy, which serves as the roadmap for aligning
    FinCEN's IT portfolio with business objectives and processes. FinCEN
    also expanded its capacity for executing complex IT projects by (1)
    hiring new project managers; (2) introducing management tools and
    techniques through the creation of a Project Management Office; (3)
    establishing a Data Management Framework to improve the management and
    visibility of BSA data issues; (4) awarding a performance-based
    contract for acquiring IT services; (5) and strengthening collaboration
    with internal and external stakeholders. FinCEN is also fully engaged
    in Treasury's revised processes in the question above.
        Question. The President's fiscal year 2009 budget requests $3
    million for a new debt management system. Treasury reports that the new
    system will enhance the efficiency of federal borrowing, which will
    save taxpayers money. How much do you estimate that the current system
    is costing taxpayers? What kind of return will the taxpayers get on
    this investment?
        Answer. Currently, Treasury's Office of Debt Management (ODM)
    spends approximately $600,000 annually to manage its $9+ trillion
    liability portfolio. Given the size of the portfolio, ODM believes
    there is significant opportunity cost foregone due to its current
    outdated IT infrastructure and modeling capabilities which limit
    sophisticated portfolio analysis.
        Treasury issues $4.3 trillion of debt per year using basic Excel
    spreadsheets and manual operations. The current size of Treasury's
    marketable debt portfolio is $4 trillion, with an annual interest cost
    of $244 billion in 2007. The additional funds to improve ODM's systems
    will make a huge difference in costs. For example, if the Department
    can issue just $1 billion less over a one month period due to better
    portfolio analytics and sound modeling capabilities, Treasury would
    save $3 million at current interest rates. Over the long term, the
    Department could potentially save one one-hundredth of a percent
    (.0001) on the $4 trillion marketable debt portfolio, resulting in
    potential interest costs savings of over $400 million annually. We
    believe this cost saving is conservative, and that additional savings
    are eminently possible given better risk management systems and
    operations.
        More importantly, for global financial markets, a disruption in the
    ability to make debt issuance decisions or the inability to function in
    the event of a contingency event would precipitate severe financial
    distress and cost. Since every fixed income market in the world is tied
    to the Treasury market, such disruption would be significantly costly
    from a financial perspective.
        The proposed systems would provide: (1) a robust infrastructure on
    top of the new Treasury auction system (providing 24/7 reliability,
    back office servicing, and applications development), (2) a secure
    contingency site with numerous business continuity options, (3) the
    ability to remotely access and make debt issuance recommendations, (4)
    the ability to make informed debt issuance decisions using advanced
    portfolio analytics, (5) the ability to provide key interest rate data
    to Congress as mandated and to financial markets as necessary without
    interruption, and (6) major infrastructure upgrades (including servers
    which are severely antiquated). The immediate implementation of these
    systems is necessary for the national and financial security of the
    United States.

    COMMITTEE ON FOREIGN INVESTMENT IN THE UNITED STATES (CFIUS)--CASELOAD
                                   MANAGEMENT

        Question. The Foreign Investment and National Security Act of 2007
    became law in July of 2007, increasing Congressional oversight of the
    CFIUS review process. How is the Department preparing to meet the
    increase in requirements under the new law?
        Answer. CFIUS and Treasury have been in compliance with the
    requirements of the Foreign Investment and National Security Act
    (FINSA) since FINSA became effective in October 2007. To ensure that
    Treasury and all CFIUS agencies comply fully with FINSA and meet the
    increased Congressional oversight requirements that it presents, the
    Department has made multiple changes and taken multiple steps, which
    include: increases in staffing levels, increases in accountability, and
    higher level cooperation between CFIUS agencies and agencies outside of
    the CFIUS process.
        Regarding staffing, Treasury and other CFIUS agencies have
    substantially increased staffing for CFIUS-related issues. In Treasury,
    we established a new Deputy Assistant Secretary position focused on
    CFIUS issues and reporting to the Assistant Secretary and the Under
    Secretary for International Affairs. Treasury has also hired additional
    staff to handle the increased requirements, including reporting
    requirements under FINSA and the increased case load. The total number
    of full-time staff assigned to work on investment security issues in
    Treasury has nearly tripled, rising from 5 full-time positions to 14.
        On accountability, CFIUS has implemented formal processes to ensure
    that CFIUS matters are fully considered at the highest levels. This
    includes strong internal procedures to ensure that every case is
    certified at the Assistant Secretary or Deputy Secretary level, as
    appropriate, that the required post-review or post-investigation
    certifications are submitted to Congress in a timely manner, and that
    requested briefings are provided to Congress as required.
        On coordination, Treasury (in consultation with other CFIUS
    agencies) has issued internal CFIUS guidelines to ensure that the
    reporting requirements under FINSA are fully satisfied in a timely
    manner. CFIUS agencies meet each week to discuss and deliberate on all
    cases before CFIUS, and where appropriate, outside agencies and
    departments (such as the Departments of Transportation and Health and
    Human Services, and NASA) are called on to bring their expertise into
    the CFIUS process. Improvements have also been made in intelligence
    analysis, which is now being coordinated by the Director of National
    Intelligence, who is consulting with each of the key intelligence
    agencies in the U.S. government. Further, the Executive Order issued by
    the President on January 23, 2008, establishes executive branch rules
    to ensure that CFIUS is able to meet the reporting requirements under
    FINSA in an efficient and orderly manner. Treasury is coordinating with
    other CFIUS agencies to submit the required annual report to Congress
    by July 31, 2008.
        Question. I understand that the CFIUS caseload has increased over
    the last few years. Why are we seeing such a dramatic increase, and how
    is Treasury adapting to respond to this increase while ensuring that
    the CFIUS cases are completed in a reasonable time frame?
        Answer. There are numerous reasons for the recent increase in the
    CFIUS caseload, including the rate of foreign direct investment into
    the United States, heightened public awareness of the CFIUS review
    process following several high-profile cases in recent years, and
    increased recognition among businesses that certain transactions could
    raise national security considerations in the current security
    environment. In addition, there have been a number of ``defensive''
    filings where there is a cross-border acquisition that has little
    relevance to national security.
        In the last few years, Treasury has made numerous organizational
    and procedural improvements to ensure that all cases continue to be
    processed efficiently, with all national security considerations fully
    analyzed. As noted above, Treasury established a new Deputy Assistant
    Secretary position in 2006 focused on CFIUS issues. Treasury has also
    hired additional staff to focus on CFIUS issues. Meanwhile, the
    increased caseload requires additional resources to be dedicated to
    CFIUS matters. The regulations and guidance that Treasury will be
    publishing this spring will also help ensure an efficient process.
        Further, CFIUS agencies have made it clear to companies and their
    advisors that, where appropriate, advance pre-filing briefings and
    consultations ensure that CFIUS has adequate time for reviews.

            INTEGRATION OF TREASURY INTO U.S. INTELLIGENCE COMMUNITY

        Question. How well is the Office of Terrorism and Financial
    Intelligence being integrated in the intelligence community?
        Answer. Since its creation in 2004, the Office of Intelligence and
    Analysis (OIA)--Treasury's Intelligence Community (IC) component--has
    become a fully-integrated member of the IC. OIA is recognized as a key
    player in IC efforts to address the financial underpinnings of national
    security threats and threats to international financial stability. The
    Assistant Secretary for Intelligence and Analysis is a member of the
    Director of National Intelligence's (DNI) Executive Committee (the IC's
    ``Board of Directors'') and OIA is an active participant in the various
    working groups and committees guiding IC efforts against key threats,
    including the National Intelligence Analysis Production Board, the
    Counterterrorism Advisory Group, the IC Leadership Council, the WMD-T
    Steering Group, and the Interagency Intelligence Committee on
    Terrorism. The Office of the Director of National Intelligence recently
    acknowledged OIA's status as a key IC figure by asking it to serve as
    the National Intelligence Priorities Framework Topic Expert for
    Economic Stability and Financial Networks.
        OIA routinely coordinates on (and provides input to) articles
    drafted for the National Terrorism Bulletin (NTB) and the President's
    Daily Brief. In addition, OIA provides regular support to the Federal
    Bureau of Investigations (FBI) counterterrorism investigations, and
    frequently offers input to counterterrorism and counter-proliferation
    analytic products drafted by the FBI, the Central Intelligence Agency
    (CIA), and other IC agencies. On numerous occasions, OIA analysts have
    drafted intelligence reports jointly with their counterparts at the FBI
    and CIA. In order to strengthen cooperation with these agencies, OIA
    has detailed officers to the FBI's Terrorist Finance Operations Section
    and to the CIA. OIA also has officers forward-deployed to U.S. Central
    Command, U.S. Pacific Command, U.S. European Command, and the joint
    Treasury-DOD Iraq Threat Finance Cell in Baghdad. OIA is in the process
    of identifying an officer to serve as Treasury's representative to the
    DNI's National Intelligence Coordination Center (NIC-C). The Defense
    Intelligence Agency, and the National Security Agency have assigned
    officers to OIA to facilitate cooperation and information sharing.
        Question. What improvements are needed to maximize the ability of
    Treasury and other components of the intelligence community to exchange
    critical information?
        Answer. OIA's fiscal year 2009 Global Finance Initiative (GFI)
    would give Treasury the resources it needs to successfully leverage its
    status as a fully-integrated member of the IC. GFI would provide $2
    million, including a realignment of $1 million in Department base
    resources, and 10 positions to establish a capability in OIA to advance
    global finance intelligence issues within the IC. Resources would be
    targeted to: (a) aligning IC collection requirements on finance-related
    issues more closely with policymaker needs, (b) developing and taking
    advantage of new sources of information, (c) enhancing analysis on
    finance-related issues in coordination with the IC, and (d) expanding
    OIA's role and relationships within the IC. This initiative is aligned
    with key tasks and objectives of the National Security Strategy, the
    National Intelligence Strategy, the National Implementation Plan for
    the War on Terror, and the Treasury Strategic Plan.
        GFI would enhance the effectiveness of IC collection and analysis
    on global financial networks. Addressing global financial networks
    involves assessing the financial underpinnings of national security
    threats, identifying our adversaries' financial vulnerabilities,
    measuring the impact of targeted financial measures, and uncovering
    threats to the stability of the international financial system. By
    assuming a greater role in guiding financial intelligence collection
    and analysis, OIA would address a growing need in the IC, and take a
    large step toward meeting the expectations of Congress and Treasury
    leadership when they created OIA.
        Question. What organizational, technical, or other types of
    barriers hamper the ability of the office to fit successfully into the
    overall intelligence community, and how are those impediments being
    addressed?
        Answer. Since its creation in 2004, the Office of Intelligence and
    Analysis (OIA)--Treasury's Intelligence Community (IC) component--has
    made great strides in its efforts to integrate itself into the IC. OIA
    is recognized as a key player in IC efforts to address the financial
    underpinnings of national security threats and threats to international
    financial stability. OIA's fiscal year 2009 Global Finance Initiative
    (GFI) would give Treasury additional resources for aligning collection
    requirements on finance-related issues more closely with policymaker
    needs; developing and taking advantage of new sources of information;
    enhancing analysis on finance-related issues in coordination with the
    IC; and expanding OIA's role and relationships within the IC.
        Despite these advancements, OIA faces significant challenges in
    hiring highly qualified analysts. The conventional hiring process is
    cumbersome and lengthy, and competition within the Intelligence
    Community for qualified candidates is fierce. The Treasury Department
    strongly supports section 121 of the fiscal year 2009 Intelligence
    Authorization Bill, which establishes the authority to convert
    positions within the intelligence component of the Treasury Department,
    DHS, and other departmental intelligence components to excepted service
    status, which would go a long way towards leveling the playing field.
                                     ______

                  Questions Submitted by Senator Sam Brownback

        Question. Could you give us an update on how your ``HOPE NOW
    alliance'' is working to prevent further foreclosures in the nation's
    housing market?
        Answer. Treasury is pleased with progress of the HOPE NOW Alliance,
    a private group of lenders, servicers, non-profit counselors and trade
    organizations that was initially facilitated by Treasury and HUD.
    However, we recognize more work remains. As of February 29, 2008, the
    industry had helped almost 1.2 million homeowners find alternatives to
    foreclosure through either a loan modification or repayment plan since
    July of 2007. These data do not include refinancing statistics. Of
    particular significance is the fact that modifications are continuing
    to rise as a proportion of work-outs. In February alone, 39,000
    subprime borrowers received loan modifications. Modifications accounted
    for more than 38 percent of borrower work-out plans in February, up
    from just under 19 percent in July 2007. In total, the three-month rate
    of change in modifications was up approximately 40 percent in February,
    while the rate of change in foreclosure starts was up only 16 percent.
        FHA has also aided HOPE NOW's efforts and played a vital role in
    helping more current and delinquent homeowners find affordable
    solutions. The recent announcement to expand FHA Secure to more
    delinquent borrowers will enable FHA to refinance an additional 100,000
    homeowners this year. In total, FHA Secure is estimated to refinance up
    to 500,000 homeowners by the end of 2008.
        Through a variety of outreach tools and operational best practices
    established by HOPE NOW, Treasury believes the Alliance has laid the
    groundwork for increased success in the coming months.
        It is imperative that HOPE NOW continue to improve on its progress
    to date, and Treasury will be sure to consistently convey that message
    to the Alliance.
        Question. What are your thoughts on the Durbin Bankruptcy bill that
    would allow judges to re-write loan provisions? What would be the
    effects on the banking system of the provisions of this bill?
        Answer. While Treasury respects the efforts of Senator Durbin to
    explore potential solutions for the current mortgage market downturn,
    Treasury is concerned about the unintended consequences such
    legislation may have on the mortgage market in going forward.
        Amending the bankruptcy code in this manner would undermine
    existing contracts, leading to a contraction in available and
    affordable mortgage credit. This bankruptcy provision would rewrite
    certain tenets of bankruptcy law in ways that would fundamentally alter
    the expectations of parties to thousands of home purchases after the
    fact. These provisions would also likely prolong the time it will take
    the market to recover from the current downturn.
        Question. I understand that the World Bank is sending U.S. taxpayer
    funds to Iran through banks that we have already sanctioned as WMD
    proliferators. What is the Treasury Department doing to try to stop
    this from happening, since it is contrary to everything we are trying
    to accomplish with our Iran policy?
        Answer. The Administration shares Congressional concern with the
    deceptive practices of Iranian financial institutions and the
    involvement of these institutions in proliferation activities. The
    Treasury Department has been a leader in singling out Iranian banks for
    sanctions as a result of their illicit activities.
        The Department has worked closely and diligently with the World
    Bank to ensure that it is fully abreast of the evolving sanctions being
    put in place by the United Nations Security Council, the inter-
    governmental Financial Action Task Force (FATF), and the most recent
    Treasury Department designation of Future Bank as being controlled by
    Iran's Bank Melli.
        The Administration has taken and will continue to take an active
    role in opposing World Bank lending to Iran. The United States has
    opposed every proposal for Iran since the early 1980s. However, despite
    these efforts, projects have been approved by the 24-member Board and
    continue to disburse funds. The Department has been assured that
    disbursement of loan proceeds under these World Bank-financed projects
    and the project accounts have been transferred to commercial banks
    which are neither on the list of entities sanctioned pursuant to the
    U.N. Security Council resolutions nor on the list of entities
    sanctioned for nuclear proliferation activities by the U.S. Treasury.
    When making such disbursements, the World Bank screens the list of
    beneficiary entities as well as financial intermediaries against the
    U.N. list maintained pursuant to the aforementioned U.N. Security
    Council decisions, and the list maintained by the Treasury Department's
    Office of Foreign Assets Control (OFAC).
        The Treasury Department will continue to strongly oppose and vote
    against any World Bank Group loan or other type of assistance to Iran
    and will also ensure that the Bank continues to comply with the full
    range of sanctions regimes to avoid any activity that could facilitate
    Iran's nuclear or missiles programs.
        Question. We have enacted legislation to allow States to divest
    from Sudan. What are your thoughts on allowing States to divest from
    Iran?
        Answer. The Administration shares Congressional concern with the
    conduct of the Iranian regime, and the Treasury Department has played a
    leading role in seeking to isolate Iran financially. Such efforts
    targeting Iran are most likely to succeed if they are multilateral in
    nature, and much of our effort has been targeted at persuading our
    allies and private sector institutions to cut back or terminate their
    financial dealings with Iran. The multilateral efforts that resulted in
    the recent United Nations Security Council Resolution with respect to
    Iran (U.N. Security Council Resolution 1803, passed March 3, 2008) are
    but one example of the cooperation we are receiving from our allies
    abroad. Legislation authorizing divestment from companies that do
    business in Iran risks alienating the very allies whose assistance we
    need. It also limits the President's ability to conduct U.S. foreign
    policy with one voice.
        Question. You've asked for some increases in your budget for the
    Office of Terrorism and Financial Intelligence. Can you update us on
    the progress you have made in cutting off funds to terrorist
    organizations and rogue nations?
        Answer. The Office of Terrorism and Financial Intelligence (TFI)
    has made significant progress in this area by using a combination of
    financial measures, fueled by financial intelligence, in a way that
    engenders the support of other governments and the private sector. TFI
    has successfully drawn on a range of tools for this effort, including
    executive orders issued by the President pursuant to the International
    Emergency Economic Powers Act, Section 311 of the USA PATRIOT Act, and
    FinCEN advisories. Combining these authorities with targeted
    intelligence about illicit financing networks, TFI has used conduct-
    based, intelligence-grounded, targeted financial measures to address
    the threat of terrorist organizations and rogue nations in a way that
    encourages support from both the private sector and larger
    international community.
        Executive Order (E.O.)13224 has proven to be a powerful and
    flexible tool for targeting terrorist organizations, allowing the
    Department to block the assets of individuals and entities controlled
    by or acting on behalf of named terrorist organizations, freezing any
    of the target's assets that are held by U.S. persons and preventing
    U.S. persons from having any future dealings with them. To date, the
    United States has designated 486 individuals and entities pursuant to
    E.O. 13224, of which nearly 400 were named by Treasury. In addition, 19
    individuals and entities have been designated pursuant to E.O. 12947,
    which prohibits transactions with terrorists who threaten the Middle
    East peace process.
        Treasury has also drawn on this range of tools to influence the
    conduct of rogue nations like North Korea, using targeted financial
    measures and systemic controls like those previously described. In the
    case of North Korea, the Department took two important actions to
    address conduct ranging from WMD proliferation-related activities to
    counterfeiting of U.S. currency and other illicit behavior. First, a
    number of North Korean proliferation firms were targeted under E.O.
    13382. That Order authorizes the Treasury and State Departments to
    target key nodes of WMD and missile proliferation networks, including
    their suppliers and financiers, in the same way as is done with
    terrorists. A designation under this order cuts the target off from
    access to the U.S. financial and commercial systems and puts the
    international community on notice about a particular threat. Second,
    regulatory action was taken to protect the financial system against
    Banco Delta Asia (BDA). In September 2005, Treasury designated BDA as a
    primary money laundering concern. At that time, Treasury issued a
    proposed rule, which was subsequently finalized in March 2007,
    prohibiting U.S. financial institutions from opening or maintaining
    correspondent accounts for or on behalf of BDA. Treasury took this step
    to protect the U.S. financial system from BDA, which exhibited systemic
    failures in its application of appropriate standards and due diligence,
    as well as its facilitation of unusual or deceptive financial practices
    by North Korean-related clients. In addition to protecting the U.S.
    financial system from the significant vulnerability that BDA
    represents, the Section 311 action has spurred improvements in Macau's
    regulatory environment. Following the BDA action, the Macanese
    authorities took substantial steps to strengthen Macau's anti-money
    laundering and counter-terrorist financing regime, notably by passing a
    new law to strengthen these controls and starting the jurisdiction's
    first-ever Financial Intelligence Unit (FIU). Perhaps most importantly,
    the action against BDA has had a profound effect, not only in
    protecting the U.S. financial system from abuse, but also in notifying
    financial institutions and jurisdictions globally of an illicit finance
    risk. Following these actions, responsible foreign jurisdictions and
    institutions have taken steps to ensure that North Korean entities
    engaged in illicit conduct are not receiving financial services.
        Question. You have identified the targeting of state sponsors of
    terrorism such as Iran and Syria as an immediate challenge for the
    Office of Terrorism and Financial Intelligence (TFI). What can you tell
    us about those activities and the progress you have made so far?
        Answer. TFI has taken important steps with both Iran and Syria by
    using a combination of financial measures, fueled by financial
    intelligence, to target their conduct in a way that engenders the
    support of other governments and the private sector.
        Syria.--Targeted financial measures have proved effective in
    addressing the threat Syria's problematic behavior poses to the United
    States. To respond and take additional measures to address this threat
    to our national security, foreign policy, and economy, President George
    W. Bush issued E.O. 13460 on February 13, 2008. This measure targets
    individuals and entities determined to be responsible for or who have
    benefited from the public corruption of senior officials of the Syrian
    regime. On February 21, 2008, the Treasury used this authority to
    designate Rami Makhluf, a powerful Syrian businessman and regime
    insider whom improperly benefits from and aides the public corruption
    of Syrian regime officials. In addition to this use of targeted
    economic sanctions against Syrian entities involved in WMD
    proliferation, Treasury has taken action under Section 311 to protect
    the U.S. financial system against the Commercial Bank of Syria (CBS),
    which has been used by criminals and terrorists to facilitate or
    promote money laundering and terrorist financing, including the
    laundering of proceeds from the illicit sale of Iraqi oil and the
    channeling of funds to terrorists and terrorist financiers. In March
    2006, Treasury issued a final rule, pursuant to Section 311,
    designating CBS as a ``primary money laundering concern'' and requiring
    U.S. financial institutions to close correspondent relationships with
    CBS. Consequently, prominent international financial institutions have
    begun to reassess their relationships with Syria and a number of Syrian
    entities.
        Iran.--Due to U.S. concern about Iran's well-documented illicit
    behavior, the Treasury Department maintains broad sanctions against
    Iran (measures that build upon our overall and long-standing Iran
    policy). U.S. commercial and financial sanctions against Iran, as
    administered by OFAC, prohibit U.S. persons from engaging in a wide
    variety of trade and financial transactions with Iran or the Government
    of Iran, and prohibit most trade in goods and services between the
    United States and Iran, and any investments by U.S. persons in Iran.
    U.S. persons are also prohibited from facilitating transactions via
    third-country persons that they could not engage in themselves. Against
    this backdrop of long-standing sanctions against Iran, Treasury has
    taken a number of actions to address the threat of Iranian
    proliferation activity in recent years.
        First, while under our general Iran country sanctions program,
    Iranian financial institutions are prohibited from directly accessing
    the U.S. financial system, they are permitted to do so indirectly
    through a third-country bank for payment to another third-country bank
    in transactions not involving the United States or U.S. persons. In
    September 2006, OFAC cut off one of the largest Iranian state-owned
    banks, Bank Saderat, from any access, including this indirect, or ``u-
    turn,'' access to the U.S. financial system. This bank, which has
    approximately 3,400 branch offices, is used by the Government of Iran
    to transfer money to terrorist organizations. As noted below, OFAC
    later designated Bank Saderat for its support for terrorist groups.
        Second, OFAC is relying increasingly on the targeted financial
    measures to combat Iran's pursuit of nuclear capability, development of
    ballistic missiles, and its support for terrorism. With respect to
    Iran, OFAC has been able to apply these measures in the context of U.N.
    Security Council Resolution (UNSCR) 1737 and 1747, enabling the
    Department to secure greater multilateral implementation by governments
    and the private sector and use targeted financial measures against
    Iranian individuals and entities in both our counterterrorism and
    counterproliferation sanctions programs. Treasury took several major
    actions under these programs in October 2007, building on previous
    successes with designations of Iranian entities supporting
    proliferation using U.S. unilateral authorities and at the United
    Nations. On October 25, 2007, Treasury and State (acting in tandem)
    were able to expose Iranian banks, companies, and individuals that had
    been involved in proliferation and terrorism-related activities and cut
    them off from the U.S. financial system. These actions included making:
      --Treasury designations of two of Iran's state-owned banks (Banks
            Melli and Mellat) and three individuals affiliated with Iran's
            Aerospace Industries Organization (AIO) for proliferation
            activities under E.O. 13382;
      --Treasury designations of nine Islamic Revolutionary Guard Corps
            (IRGC)-affiliated entities and five IRGC-affiliated individuals
            as derivatives of the IRGC under E.O. 13382;
      --The designation of the IRGC-Qods Force (IRGC-QF) under E.O. 13224
            for providing material support to the Taliban and other
            terrorist organizations; and
      --The designation of Iran's state-owned Bank Saderat as a terrorist
            financier.
        Many of the U.S. designations against Iranian entities and
    individuals under E.O. 13382 have been similarly designated under UNSCR
    1737 and UNSCR 1747. Most recently, UNSCR 1803 added additional names
    to the growing list of Iranian individuals and entities that are
    subject to multilateral targeted financial sanctions. UNSCR 1803 also
    includes a warning regarding Iranian financial institutions more
    generally, establishing obligations for U.N. member states to exercise
    vigilance over their own financial institutions activities with
    financial institutions domiciled in Iran, and their branches and
    subsidiaries abroad. The Resolution further names two Iranian financial
    institutions that Treasury previously designated, Bank Melli and Bank
    Saderat, as institutions of particular concern.
        Third, in addition to these ``formal'' actions, the Treasury has
    engaged in unprecedented, high-level outreach to the international
    private sector, meeting with more than forty banks worldwide to discuss
    the threat Iran poses to the international financial system and to
    their institutions. Through this outreach, OFAC has shared information
    about Iran's deceptive financial behavior and raised awareness about
    the high financial and reputational risk associated with doing business
    with Iran. The use of targeted measures has aided this effort by
    highlighting specific threats, helping isolate these bad actors, and
    preventing them from abusing the financial system. By thus partnering
    with the private sector, there is an increasingly less desire to work
    around sanctions. Even those institutions not formally bound to follow
    U.S. law pay close attention to the targeted actions and often adjust
    their business activities accordingly. Many leading financial
    institutions have scaled back dramatically, refused to issue new
    letters of credit to Iranian businesses, or even terminated their Iran-
    related business entirely. They have done so of their own accord, many
    concluding that they did not wish to be the banker for a regime that
    deliberately conceals the nature of its dangerous and illicit business.
        TFI has also communicated with the U.S. financial sector regarding
    Iran through the issuance of advisories. In October 2007, following a
    statement by the FATF on the threat posed by deficiencies in Iran's
    anti-money laundering/combating the financing of terrorism regime, the
    FinCEN followed suit by issuing an advisory to alert U.S. financial
    institutions of similar concerns regarding Iran. In this advisory,
    FinCEN advised that financial institutions should be particularly aware
    that there may be an increased effort by Iranian entities to circumvent
    sanctions and related financial community scrutiny through the use of
    deceptive practices involving shell companies and other intermediaries
    or requests that identifying information be removed from transactions.
    The advisory went on to explain that such efforts may originate in Iran
    or Iranian free trade zones subject to separate regulatory and
    supervisory controls, including Kish Island. Such efforts may also
    originate wholly outside of Iran at the request of Iranian-controlled
    entities.
        Question. Treasury's Office of Intelligence Analysis was
    established in fiscal year 2005. Since that time, how has it
    contributed to overall intelligence collection?
        Answer. OIA has limited authority to collect foreign financial and
    monetary information, and general foreign economic information. OIA's
    primary mission is to analyze intelligence collected by other agencies
    in order to support the formulation of Treasury policy and the
    execution of its authorities. To support its mission, OIA leadership
    firmly believes that the organization should drive intelligence
    collection by providing timely and insightful analytic support to IC
    members engaged in clandestine and open-source intelligence activities.
    OIA analysts routinely provide their intelligence requirements to
    collectors at the Central Intelligence Agency, the National Security
    Agency, the Federal Bureau of Investigation, the Defense Intelligence
    Agency, and other IC elements in order to help those organizations more
    effectively direct their resources. OIA also provides feedback to IC
    Collectors as to the timeliness, relevance, and accuracy of the
    information provided by their sources. All in all, this support helps
    ensure that scarce IC collection resources are focused on the hardest
    targets and finance-related collection requirements are closely aligned
    with policymaker needs.
        In fiscal year 2008, OIA is expanding its ability to drive
    collection by increasing its cadre of dedicated Requirements Officers.
    OIA's fiscal year 2009 Global Finance Initiative (GFI) would provide
    additional resources to ensure that each of OIA's core mission areas
    receives dedicated collection requirements support.
        Question. Question from the Republican Staff Director of the JEC:
        Recent turmoil in financial markets is continuing, particularly the
    markets for asset backed debt instruments. It's clear that in many
    instances debt that received a AAA-rating was in fact not AAA grade at
    all. Up until now, the credit rating agencies have relied solely on
    traditional risk indicators, all of which are either borrower-focused
    or collateral-focused.
        It seems that both home owners and mortgage lenders alike could
    benefit from an independent, objective and standardized third-party
    verification step that verifies the quality and risk associated with
    these loans before they are sold on the secondary market or before they
    are finalized by a broker. Consumers and investors could also benefit
    by having the ability to review the record of particular lenders.
        Do you believe that assigning such a pre-securitization rating
    based upon borrower information, adequacy of collateral and loan
    quality would help to prevent future crises in the mortgage market?
        Answer. On March 13th, the President's Working Group on Financial
    Markets (PWG), which is chaired by the Secretary, released the
    comprehensive ``Policy Statement on Market Developments.'' The PWG's
    statement was intended to help to restore market liquidity, market
    discipline, and investor confidence through recommendations to enhance
    disclosure/transparency, due diligence/independent analysis, valuation
    techniques, risk management practices, regulatory policies, and market
    infrastructure. There are recommendations for all stakeholders (all
    market participants and regulators) and for all links in the chain of
    the securitization process (mortgage brokers, originators,
    securitizers, financial institutions, credit rating agencies,
    investors, and state and federal regulators).
        The PWG made several recommendations to improve the quality and
    disclosure of information about and analysis of mortgage loans
    underlying securitized products, including:
      --All states should implement strong nationwide licensing standards
            for mortgage brokers;
      --Federal and state regulators should strengthen and make consistent
            government oversight of entities that originate and fund
            mortgages and otherwise interface with customers in the
            mortgage origination process;
      --The Federal Reserve should issue stronger consumer protection and
            disclosure rules;
      --Overseers of institutional investors should require investors to
            obtain from sponsors and underwriters of securitized credits
            better information about the risk characteristics of such
            credits, including information about the underlying asset
            pools;
      --Overseers should ensure that these investors develop an independent
            view of the risk characteristics of the instruments in their
            portfolios, rather than rely solely on credit ratings;
      --The PWG will form a committee to develop best practices regarding
            disclosure to investors in securitized credits;
      --Credit rating agencies (CRAs) should disclose the reviews they
            perform on originators of assets and should require
            underwriters to represent the level and scope of due diligence
            performed on the underlying assets;
      --CRAs should publish sufficient information about the assumptions
            underlying their credit rating methodologies, so that users of
            credit ratings can understand how a particular credit rating
            was determined;
      --CRAs should provide the information investors need to make informed
            decisions about risk, including measures of the uncertainty
            associated with ratings and of potential ratings volatility;
            and
      --The PWG will form a group to develop recommendations for further
            steps that issuers, underwriters, CRAs, and policymakers could
            take to ensure the integrity and transparency of ratings, and
            to foster appropriate use of ratings in risk assessment.
        Question. What key ways is your Department proposing to employ to
    close the ``tax gap?'' You once stated in a Finance Committee hearing
    that this is not a pot of gold. How big is the gap and what will it
    cost to close it?
        Answer. The estimated size of the tax gap is as follows. In 2001,
    the overall compliance rate was estimated at over 86 percent, after
    late payments and recoveries from IRS enforcement activities. The tax
    gap results from noncompliance, specifically the amount of tax that
    should be paid but is not paid. After enforcement efforts and late
    payments, this amount was approximately $290 billion.
        The key ways in which the Treasury Department is proposing to
    reduce the tax gap were set forth in a comprehensive strategy to
    improve tax compliance released in September 2006. The strategy builds
    upon the demonstrated experience and current efforts of the Treasury
    Department and IRS to improve compliance. Four key principles guided
    the development of this strategy: both unintentional taxpayer errors
    and intentional taxpayer evasion should be addressed; sources of non-
    compliance should be targeted with specificity; enforcement activities
    should be combined with a commitment to taxpayer service; and tax
    policy and compliance proposals should be sensitive to taxpayer rights
    and maintain an appropriate balance between enforcement activity and
    imposition of taxpayer burden. These principles underscore the Treasury
    Department's and IRS' comprehensive, integrated, multi-year strategy to
    improve tax compliance. Components of this strategy include: (1)
    legislative proposals to reduce opportunities for evasion; (2) a multi-
    year commitment to compliance research; (3) continued improvements in
    information technology; (4) improvements in IRS compliance activities;
    (5) enhancements of taxpayer service; (6) simplification of the tax
    law; and (7) coordination between the government and its partners and
    stakeholders.
        More specifically, the Treasury Department's fiscal year 2009
    Revenue Proposals include a number of legislative proposals intended to
    improve tax compliance with minimum taxpayer burden. The fiscal year
    2009 President's budget does include a number of legislative proposals
    intended to improve tax compliance with minimum taxpayer imposition.
    These proposals could generate $36 billion over the next ten years. The
    Administration proposes to expand information reporting, improve
    compliance by businesses, strengthen tax administration, and expand
    penalties.
      --Expand information reporting.--Compliance with the tax laws is
            highest when payments are subject to information reporting to
            the IRS. Specific information reporting proposals would:
            require information reporting on payments to corporations;
            require basis reporting on security sales; require information
            reporting on merchant payment card reimbursements; require a
            certified Taxpayer Identification Number (TIN) from
            contractors; require increased information reporting on certain
            government payments; increase information return penalties; and
            improve the foreign trust reporting penalty.
      --Improve compliance by businesses.--Improving compliance by
            businesses of all sizes is important. Specific proposals to
            improve compliance by businesses would: require electronic
            filing by certain large organizations; and implement standards
            clarifying when employee leasing companies can be held liable
            for their clients' Federal employment taxes.
      --Strengthen tax administration.--The IRS has taken a number of steps
            under existing law to improve compliance. These efforts would
            be enhanced by specific tax administration proposals that
            would: expand IRS access to information in the National
            Directory of New Hires for tax administration purposes; permit
            disclosure of prison tax scams; make repeated willful failure
            to file a tax return a felony; facilitate tax compliance with
            local jurisdictions; extend statutes of limitations where state
            tax adjustments affect federal tax liability; and improve the
            investigative disclosure statute.
      --Expand penalties.--Penalties play an important role in discouraging
            intentional non-compliance. A specific proposal to expand
            penalties would impose a penalty on failure to comply with
            electronic filing requirements.
        In the fiscal year 2009 President's budget, the IRS has budgeted
    over $23 million to implement these proposals. The budget also includes
    other items relating to the tax gap: over $286 million to reduce the
    tax gap for large business, small business, and the self-employed
    sector, to increase compliance of domestic taxpayers with offshore
    activity, and to minimize revenue loss by increasing document matching
    efforts; and over $51 million to increase support for research to
    understand better the reasons for taxpayer non-compliance.
        Question. If we simplified our tax code with, for example, a flat
    income tax, what effect would there be on revenue receipts and revenue
    collection?
        Answer. Replacing the existing income tax with a flat income tax
    could raise, lower, or leave unchanged tax revenue, depending on such
    design features as the tax rate imposed by the flat tax. A standard
    objective of tax reform efforts is to broaden the tax base and reduce
    tax rates. Generally speaking, the broader the base, the lower tax
    rates can be and still raise the same revenue as the current tax
    system. So, for example, eliminating or minimizing special exclusions,
    exemptions, deductions, and credits allows setting lower tax rates
    without reducing revenue. Both a broad tax base and lower tax rates are
    desirable from a policy perspective because they reduce economic
    distortions caused by the tax system.
        Question. Will you commit to working with us and with SEC in
    preventing U.S. manufacturing companies from purchasing ``blood
    minerals'' like coltan from exporters who are abusing and murdering
    innocent people?
        Answer. The Administration shares Congressional concern regarding
    the conflict in the Democratic Republic of Congo, which has been marked
    by serious violations of human rights and international law. To address
    this threat to the foreign policy of the United States, the President
    declared a national emergency and issued E.O. 13413 (October 27, 2006)
    implementing sanctions directed at persons contributing to the
    widespread violence and atrocities in the Democratic Republic of the
    Congo, as called for by U.N. Security Council Resolutions 1596 of April
    18, 2005, and 1649 of December 21, 2005. The E.O. blocks the assets of,
    and prohibits U.S. persons from engaging in transactions and dealings
    with, persons listed in the Annex to, or designated pursuant to, the
    E.O. The Annex to the E.O. listed seven persons, including the
    notorious international arms dealer Viktor Bout, and OFAC designated an
    additional seven companies and three individuals pursuant to the E.O.
    in March 2007. A number of the March 2007 designations specifically
    related to exploitation of the gold sector in support of armed militia
    activity. OFAC continues to investigate aggressively the operations and
    holdings of rogue actors operating in the Democratic Republic of Congo.
        Question. Last year, Congress passed and the President signed
    legislation to give your Office of Foreign Assets Control the ability
    to levy larger civil and criminal penalties for those who violate
    sanctions against rogue nations. Have the stronger tools helped provide
    a greater deterrent for those who would be inclined to deal with
    countries on whom we have imposed sanctions?
        Answer. We appreciate Congressional efforts in increasing the
    maximum civil penalties available to the Office of Foreign Assets
    Control and believe that the availability of such meaningful penalties
    will serve as a meaningful deterrent for those who might otherwise
    treat civil penalties as merely ``the cost of doing business.'' Indeed,
    OFAC has conducted several outreach events specifically on this topic.
    While it is still too soon to assess the full impact of the legislation
    that was passed last year, we note that there has been significant
    interest from the media and the general public related to these
    enhanced penalties.

                                  CONGO/COLTAN

        Question. The Office of Foreign Assets Control (OFAC) administers
    and enforces economic and trade sanctions, based on U.S. foreign policy
    and national security goals against foreign countries, terrorists,
    international narcotics traffickers, and those engaged in activities
    related to the proliferation of weapons of mass destruction.
        While the issue of exploited natural resources in the Democratic
    Republic of Congo, or specifically the issue of coltan may not be an
    engagement of proliferation of weapons of mass destruction, these
    activities are some of the most brutal human rights abuses we see in
    our world today (human-trafficking, child labor, sexual abuse and
    rape). The product of many of these actions leads to the refined
    component of a mineral which then ends up in much of our high
    technology industry here--cell phones, DVD players, flat screen
    televisions, etc. What are the limitations of OFAC's capabilities to
    target these rogue actors in eastern Congo?
        Answer. Within the framework of E.O. 13413 (October 27, 2006) and
    related U.N. Security Council Resolutions, the Treasury Department has
    the authority to designate rogue actors engaging in activities
    contributing to the violence and atrocities taking place in the
    Democratic Republic of the Congo. OFAC continues to aggressively
    investigate the operations and holdings of such rogue actors (including
    militia leaders and their financial enablers) operating in the
    Democratic Republic of Congo. Improved access to credible and reliable
    on-the-ground information pertaining to the business activities of
    these rogue actors is always vital to OFAC's ability to designate
    potential targets.
        Question. Has OFAC looked into targeting these rogue actors before?
        Answer. The Annex to the E.O. 13413 listed seven persons, including
    the notorious international arms dealer Viktor Bout, and OFAC
    designated an additional seven companies and three individuals pursuant
    to the E.O. in March 2007. A number of the March 2007 designations
    specifically related to exploitation of the gold sector in support of
    armed militia activity. OFAC continues to investigate aggressively the
    operations and holdings of rogue actors operating in the Democratic
    Republic of Congo.
        Question. What assistance might OFAC need in this procedure?
        Answer. As stated above, access to on-the-ground information
    pertaining to the business activities of these rogue actors is vital to
    OFAC's ability to designate potential targets. OFAC is working to
    enhance its access to this type of information. OFAC as a matter of
    policy does not comment publicly on its techniques and sources for
    gathering this type of information.
        Question. In regards to the budget, what accountability measures
    are in place, specifically regarding Congo, to ensure material
    resources are not siphoned off by these rogue actors? If any, what is
    Department of Treasury doing to implement these measures?
        Answer. Pursuant to E.O.13413 (October 27, 2006), OFAC continues to
    investigate aggressively the operations and holdings of rogue actors
    operating in the Democratic Republic of Congo; designated individuals
    and entities are deprived of access to the U.S. financial system and
    any transactions involving U.S. persons.
        Question. As a former board member of the Nature Conservancy, I
    know that you have a great interest in natural resource conservation.
    Would you support protecting parts of the Congo so that its natural
    resources are not further exploited?
        Answer. The Department of the Treasury strongly supporting ongoing
    efforts to strengthen natural resource management in the Democratic
    Republic of Congo (DRC), particularly the efforts of the World Bank to
    encourage reform of the forestry and mining sectors. Some important
    steps taken to date by the Congolese authorities include establishing a
    moratorium on new logging titles and the promulgation of new Mining and
    Forest Codes. Treasury sees these as strong building blocks for longer-
    term reform and important steps toward filling the legal vacuum with
    respect to the governance of the Congolese forest and mining sectors.
    However, the situation in the DRC is extremely challenging and much
    work remains, including developing appropriate regulatory frameworks
    and strong institutions to manage these sectors. Treasury will continue
    to urge the World Bank to work with the Congolese authorities on the
    issue of natural resource management.
        Further, the United States is a founding member and financial
    supporter of the Congo Basin Forest Partnership (CBFP) which brings
    together governments, the private sector, civil society and development
    organizations to conserve the unique natural resources of the Congo
    Basin, fight illegal logging and poaching, and improve the livelihoods
    of the Basin's 100 million inhabitants. The Department of Treasury
    respectfully refers you to the State Department and USAID for
    additional information, as they are the lead U.S. government agencies
    with regard to our involvement in the CBFP.

                              SUBCOMMITTEE RECESS

        Secretary Paulson. We will, and I thank you very much for
    the way you have supported Treasury's budget. And thank you
    very much.
        Senator Durbin. Thanks, Mr. Secretary. This meeting of the
    Subcommittee on Financial Services and General Government will
    stand recessed.
        [Whereupon, at 4 p.m., Wednesday, March 5, the subcommittee
    was recessed, to reconvene subject to the call of the Chair.]

      FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL
                                   YEAR 2009

                                  ----------

                           WEDNESDAY, MARCH 12, 2008

                                           U.S. Senate,
               Subcommittee of the Committee on Appropriations,
                                                        Washington, DC.
        The subcommittee met at 4:02 p.m., in room SD-138, Dirksen
    Senate Office Building, Hon. Richard J. Durbin (chairman)
    presiding.
        Present: Senator Durbin.

                                 THE JUDICIARY

    STATEMENT OF HON. JULIA S. GIBBONS, JUDGE, U.S. COURT
                OF APPEALS, SIXTH CIRCUIT; CHAIR, BUDGET
                COMMITTEE OF THE JUDICIAL CONFERENCE

                 OPENING STATEMENT OF SENATOR RICHARD J. DURBIN

        Senator Durbin. Good afternoon. This is the second of the
    subcommittee's hearings, and today we are going to focus on the
    fiscal year 2009 budget for the Federal judiciary.
        We will be hearing from two distinguished witnesses: Judge
    Julia Gibbons--welcome--and Director James Duff. Welcome as
    well. I am pleased that you are here speaking on behalf of our
    Federal judiciary.
        I welcome my colleagues who will come as the meeting
    progresses.
        In fiscal year 2008, despite the difficulty the
    subcommittee faced in attempting to adequately fund all the
    various agencies within our jurisdiction and remain within the
    President's overall spending level, we managed to provide the
    judiciary with a 4.5 percent increase overall. With the prior 3
    fiscal year increases of 5 percent, all this has helped put the
    courts back on track after suffering significant cuts in fiscal
    year 2004.
        With fiscal year 2008 funds, hirings for probation and
    pretrial services are increasing back to previous levels; non-
    capital panel attorney rates were increased from $94 an hour to
    $100, a modest increase; courts were provided additional
    funding to absorb the additional caseload expected with
    increased border enforcement; court security requirements were
    fully funded; and authority was clarified that the U.S.
    Marshals may assume responsibility from the Federal Protective
    Service (FPS) for perimeter security at several designated
    courthouses.
        For fiscal year 2009, you are requesting a 7.6 percent
    increase overall for the judiciary above last year's levels. In
    addition, within the defender services account, you are
    requesting an increase in the non-capital panel attorney rate,
    which would boost hourly rates from $100 to $118 and then to
    $140 in fiscal year 2010. The subcommittee provided a 7.6
    percent increase for defender services last year, and such
    large pay increases for these attorneys this year will likely
    be optimistic, given our anticipated funding constraints. It is
    why I hope that we will be able to at least provide a modest
    increase in the non-capital panel attorney rate.
        Regarding court security, I look forward to being updated
    on the progress of the pilot program undertaken with the U.S.
    Marshals Service at designated courthouses. I will also be
    interested to learn how the judiciary is implementing the Court
    Security Improvement Act. And I will want to discuss with you
    the Justice Department's inspector general's report on the U.S.
    Marshals Service.
        I will have questions about courthouse construction, the
    impact of increased border enforcement, your workload, offender
    reentry programs, General Services Administration (GSA) rent,
    and more. If we cannot cover all the questions in the hearing,
    we will send them to you for the record, and I am sure that you
    can get them back to us in a reasonable period of time.
        Senator Brownback will be unable to attend today's hearing,
    but has asked that his statement be submitted for the record.
        [The statement follows:]

                  Prepared Statement of Senator Sam Brownback

        Good afternoon. I want to thank you, Chairman Durbin, for your
    leadership. I look forward to working together with you during this
    coming year as we make funding decisions and provide oversight for the
    Federal Judiciary as well as the other agencies within this
    subcommittee's jurisdiction.
        I would like to thank Judge Gibbons and Mr. Duff for appearing
    before our subcommittee today. I look forward to hearing the details of
    your fiscal year 2009 budget request and the key efforts that the
    Judiciary will be undertaking this year. The Judiciary has the critical
    role of interpreting our laws and I am interested in hearing your
    thoughts on the state of our Nation's courts.
        Looking at the budget submission, I am pleased to see an increase
    in defender services which is extremely important in light of last
    night's Senate passage of the Second Chance Act. This bill reshapes the
    way we look at prisoner re-entry. It is comprised of grant programs
    targeted at States, local governments and non-profit, faith-based
    organizations. And unlike most grant programs, in order to receive
    future funding under this act, programs must show real progress in
    reducing the recidivism rate of the program participants. As you all
    know, the U.S. Sentencing Commission recently passed the Crack Cocaine
    Sentencing Amendment, and it took effect in November. This sentence
    reduction for crack cocaine offences is retroactively applicable, thus
    allowing thousands of Federal offenders to seek reductions in their
    sentences. I would hope that with the passage of the Second Chance Act
    that we will be able to get much-needed re-entry programs to the
    inmates who truly need these essential services.
        I would like to mention my concerns about the overall slowdown in
    Federal judge confirmations. There are currently 45 vacancies--14
    circuit court vacancies and 31 district court vacancies with 27
    nominees awaiting confirmation. I understand the hardship this places
    on the Judiciary. There is bit of progress being made, however, because
    yesterday the Judiciary Committee reported out several district court
    judges for confirmation on the Senate floor and tomorrow a circuit
    court judge is on the agenda for the Judiciary Committee markup. I am
    hopeful that we will continue to make progress in confirming judges and
    reducing the strain on the Judiciary.
        Judge Gibbons and Mr. Duff, I look forward to hearing your
    testimony this afternoon.
        Thank you, Mr. Chairman.

        Senator Durbin. I also note that the subcommittee is in
    receipt of written testimony submitted by the Court of Appeals
    for the Federal Circuit, the Court of International Trade,
    Federal Judicial Center, and the U.S. Sentencing Commission,
    all of which will be submitted for the hearing record.
        Judge Gibbons, I am going to allow you to begin. I thank
    you for being here today and look forward to putting your
    remarks in the record. Judge Gibbons.

                        JUDGE GIBBONS' OPENING STATEMENT

        Judge Gibbons. Thank you for the opportunity to be here.
        Chairman Durbin, I appear as Chair of the Judicial
    Conference Committee on the Budget, and with me today, of
    course, is Jim Duff, who is the Director of the Administrative
    Office of the United States Courts.
        We thank you, Mr. Chairman, for attending the Judicial
    Conference session yesterday and for your remarks there.

                            FISCAL YEAR 2008 FUNDING

        Let me begin by thanking the subcommittee for making the
    judiciary a funding priority in the fiscal year 2008
    appropriations cycle. The courts are in good financial shape
    for 2008. The funding you provided will allow us to finance
    continuing operations in the courts and to address workload
    needs.
        We are particularly appreciative of the $25 million you
    provided in emergency funding to respond to workload associated
    with immigration enforcement initiatives.
        We are also grateful for two provisions that were included
    in the omnibus bill: the increase in the non-capital hourly
    rate for panel attorneys that you have referred to and the
    pilot project in our court security program.

                        FISCAL YEAR 2009 BUDGET REQUEST

        Turning to the 2009 budget request, the judiciary is
    requesting $6.7 billion, an increase of $475 million over the
    2008 enacted level; 86 percent of the increase is for standard
    pay and non-pay inflationary adjustments and for adjustments to
    base, reflecting increases in space, information technology,
    defender services, and court security programs. We are not
    requesting any new staff in clerks and probation offices.
        The remaining $68 million of our requested increase is
    primarily for program improvements in our information
    technology program and an enhancement in the defender services
    program that you already referred to, increasing the hourly
    rate for private panel attorneys. We are appreciative of the
    increase you provided this year but believe an additional
    increase is warranted.
        Our budget request reflects our continuing efforts to
    contain costs. We are now more than 3 years into an intensive
    effort to reduce costs throughout the judiciary and our cost
    containment program is producing results.
        We have achieved so far the most significant savings in our
    space and facilities program through an ongoing rent validation
    project in which our court staff identify errors in rent for
    GSA to correct and give us rent credits. GSA has been very
    cooperative in this endeavor.
        In the information technology area, we are consolidating
    the deployment of computer servers which generate savings from
    reduced maintenance and equipment replacement costs.
        We are also containing personnel costs. At its September
    2007 meeting, the Judicial Conference approved recommendations
    from a major court compensation study that will slow the growth
    in personnel costs. Containing costs is a top priority for us.

                          COURT SECURITY PILOT PROJECT

        Let me talk briefly about the pilot project approved in the
    2008 omnibus bill. During my testimony last year before you, I
    discussed the judiciary's concerns regarding the expense and
    quality of security provided the courts by the Federal
    Protective Service. Chairman Durbin, you responded quickly to
    our concerns and convened a meeting with Director Duff and the
    Directors of the Marshals Service and the FPS.
        As a result of your personal interest and commitment to
    improve court security, the subcommittee's bill included a
    provision for a pilot project permitting the Marshals Service
    to assume perimeter security duties from FPS at seven
    courthouses that have been selected. The Dirksen Federal
    Courthouse in Chicago will be the first pilot site to move
    forward. The project will begin later this year and will be in
    effect for approximately 18 months. We will provide you an
    evaluation of the project.

                  IMPACT OF INCREASED IMMIGRATION ENFORCEMENT

        An issue that has received significant attention from
    Congress and the administration in recent years is illegal
    immigration. Despite zero tolerance immigration enforcement
    initiatives like Operation Streamline, in recent years resource
    constraints in the justice enforcement system on the border
    have limited the number of immigration cases prosecuted. It now
    appears that additional resources are making their way to the
    border through the Department of Justice's emergency funding
    received in 2008 and potentially through the funding requested
    in the President's 2009 budget. We believe the courts' workload
    will increase from this infusion of resources. Although we are
    not requesting funding for new clerks or probation staff on the
    border or elsewhere, we are very grateful for your provision of
    $45 million over the last 2 years to address the immigration-
    related workload so that we can respond in the short term to
    any increased workload.
        We do need additional judgeships on the Southwest border.
    The Judicial Conference has requested 10 more judgeships on the
    border, and we make a special plea for the subcommittee's
    support of the $110 million requested for GSA in the
    President's budget to fund fully a new Federal courthouse in
    San Diego. This is our top space priority.

                              PREPARED STATEMENTS

        I would ask that my statement, along with the others you
    referred to, be placed in the record. And, of course, we are
    available for your questions.
        [The statements follow:]

                  Prepared Statement of Hon. Julia S. Gibbons

                                  INTRODUCTION

        Chairman Durbin, Senator Brownback, and members of the
    Subcommittee, I am Judge Julia Gibbons of the Sixth Circuit Court of
    Appeals. Our court sits in Cincinnati, Ohio, and my resident chambers
    are in Memphis, Tennessee. As the Chair of the Judicial Conference
    Committee on the Budget, I come before you to testify on the
    Judiciary's appropriations requirements for fiscal year 2009. In doing
    so, I will apprise you of some of the challenges facing the Federal
    courts. This is my fourth appearance before an appropriations
    subcommittee on behalf of the Federal Judiciary and my second
    appearance before the Financial Services and General Government panel.
    Appearing with me today is James C. Duff, the Director of the
    Administrative Office of the United States Courts.
        In addition to a discussion of our fiscal year 2009 request, my
    testimony will cover several policy issues that impact the Federal
    courts. I will also update you on the Judiciary's efforts to contain
    costs as well as discuss several information technology innovations
    that are examples of the Judiciary(s continual efforts to improve
    Federal court operations.

                           STATEMENTS FOR THE RECORD

        Mr. Chairman, in addition to my statement and Director Duff's, I
    ask that the entire statements of the Federal Judicial Center, the
    Sentencing Commission, the Court of Appeals for the Federal Circuit,
    and the Court of International Trade be included in the hearing record.

                            FISCAL YEAR 2008 FUNDING

        Mr. Chairman and Senator Brownback, let me begin today by thanking
    you and your colleagues for making the Judiciary a funding priority in
    the fiscal year 2008 appropriations cycle. The funding you provided,
    combined with greater than anticipated fee carryover balances and
    reduced requirements due to our cost containment initiatives, will
    allow us to finance continuing operations in the courts as well as to
    address workload needs. We are particularly appreciative of the $25
    million you provided the Judiciary in emergency funding to respond to
    workload associated with immigration enforcement initiatives being
    implemented by the Department of Homeland Security and the Department
    of Justice. We are fully cognizant of the difficult funding choices you
    faced during conference on the omnibus bill and appreciate your
    willingness to support the needs of the Judiciary. We appreciated the
    opportunity to work with the Subcommittee to identify our highest
    priority funding needs when your allocation was significantly reduced
    during conference on a final bill.
        We also are grateful for several provisions included in the omnibus
    bill, which we believe will improve Federal court operations. Two that
    are particularly important are the pilot project to assess the
    feasibility of transferring responsibility for perimeter security at
    several designated primary courthouses from the Federal Protective
    Service to the United States Marshals Service and the increase in the
    non-capital hourly rate paid to private panel attorneys who represent
    eligible defendants under the Criminal Justice Act. I will discuss the
    pilot project in more detail next and return to panel attorney rates
    later in my testimony.

                                 COURT SECURITY

        Mr. Chairman, during my testimony last year I conveyed to the
    Subcommittee the Judiciary's concerns regarding the expense and quality
    of security provided the courts by the Federal Protective Service
    (FPS). FPS provides, on a reimbursable basis, exterior perimeter
    security for Federal agencies, including at courthouses and multi-
    tenant court facilities. The Judiciary's FPS costs are paid from our
    Court Security appropriation and fiscal year 2009 billings are
    projected to be $72 million.
        Last year I spoke of incidents of inoperable FPS-provided exterior
    cameras at courthouses and the absence of cameras altogether at key
    locations resulting in ``dead zones'' with no camera surveillance,
    despite our paying FPS for the equipment. Security lapses such as these
    left courthouses with serious security vulnerabilities. Fortunately, to
    help ensure that the courts had adequate security, the United States
    Marshals Service (USMS) assumed responsibility for repairing or
    replacing FPS-provided perimeter cameras at a number of courthouses
    where it was apparent that FPS did not have the resources to do so.
    This resulted in the Judiciary's paying for the same services twice:
    once to FPS in its security charges, and also to the USMS in the
    funding we transferred to it for systems and equipment for interior and
    perimeter courthouse security. The Judicial Conference had become
    increasingly concerned about this issue and consequently, in March
    2007, it endorsed a recommendation to expand the USMS's current mission
    to include perimeter security of court facilities nationwide where the
    Judiciary is the primary tenant.
        Mr. Chairman, within a month after last year's hearing you convened
    a meeting with the Directors of the United States Marshals Service,
    Federal Protective Service, and the Administrative Office of the United
    States Courts to learn more about this issue. As a result of your
    personal interest and commitment to improve court security, the Senate
    version of the fiscal year 2008 Financial Services and General
    Government appropriations bill (H.R. 2829) included the provision
    approving a pilot project permitting the USMS to assume responsibility
    from FPS for perimeter security at several designated courthouses. And,
    as I just mentioned, the provision was included in the final conference
    agreement on the fiscal year 2008 omnibus appropriations bill thus
    allowing the Judiciary and the USMS to begin implementation of the
    pilot. Specifically, the pilot project involves the USMS monitoring the
    exterior of the courthouses with court security officers and assuming
    control of FPS monitoring equipment. The USMS, working with the
    Administrative Office of the U.S. Courts, selected seven courthouses
    for the pilot. I would note that the Everett McKinley Dirksen U.S.
    Courthouse in Chicago will be the first pilot site to move forward. The
    other six sites are: the Theodore Levin U.S. Courthouse, Detroit,
    Michigan; the Sandra Day O'Connor U.S. Courthouse, Phoenix, Arizona;
    the Evo A. DeConcini U.S. Courthouse, Tucson, Arizona; the Russell B.
    Long Federal Building/U.S. Courthouse, Baton Rouge, Louisiana; the Old
    Federal Building and Courthouse, Baton Rouge, Louisiana; and the Daniel
    Patrick Moynihan U.S. Courthouse, New York, New York.
        The pilot project is anticipated to begin in the fourth quarter of
    fiscal year 2008 and will be in effect for approximately 18 months at
    which time an evaluation of the pilot will be provided to the
    Subcommittee. The annualized cost of the pilot is estimated to be $5
    million, which will be offset by anticipated reductions in FPS
    billings. We appreciate your concern with the security of our
    courthouses, and we will provide the Subcommittee with updates as the
    pilot project gets underway.
    Work of the United States Marshals Service
        I would like to say a few words about the vitally important work of
    the United States Marshals Service. Inside the courthouse, judges,
    court staff, attorneys, jurors, defendants, litigants, and the public
    depend entirely on the USMS for their safety. Heightened security at
    courthouses due to high-threat trials and terrorism concerns have made
    the work of the USMS more difficult, and it has responded extremely
    well to those challenges. For judges like myself, the USMS also ensures
    our security outside of the courthouse, and it takes this charge
    seriously. In September 2007, the USMS established a new Threat
    Management Center that serves as the nerve center for responding to
    threats against the Judiciary. The Center provides vital data to U.S.
    Marshals nationwide on threats against judges and court personnel. The
    USMS also has overseen the installation of nearly all of the 1,600
    intrusion detection systems in the homes of Federal judges in order to
    provide increased judicial security outside of courthouse facilities.
    This has been a 2-year effort and includes ongoing system monitoring by
    a security firm. All of us in the Federal court family are grateful to
    John F. Clark, Director of the U.S. Marshals Service, his staff, and
    the U.S. Marshals throughout the 94 judicial districts for their
    dedication and responsiveness to the security needs of the Federal
    Judiciary. The USMS operates within very tight resource levels, and we
    urge Congress to fund fully the USMS's fiscal year 2009 budget request
    to enable it to continue meeting its statutory mandate to protect the
    Federal Judiciary.

              RETROACTIVITY OF CRACK COCAINE SENTENCING AMENDMENT

        Mr. Chairman, I would like to discuss an issue that has received
    some attention in recent months: the changes to Federal sentencing
    guidelines for crack cocaine offenses approved by the United States
    Sentencing Commission. The Commission is a bipartisan, independent
    agency within the Judicial Branch that was established by the
    Sentencing Reform Act of 1984 to develop national sentencing policy for
    the Federal courts. The Commission promulgates the sentencing
    guidelines that Federal trial court judges consult when sentencing
    defendants convicted of Federal crimes.
        On May 1, 2007, the Commission submitted a package of amendments to
    the Federal sentencing guidelines that, in the absence of congressional
    action to the contrary, went into effect on November 1, 2007. Among the
    amendments was one that modified the Federal sentencing guidelines for
    crack cocaine offenses. The amendment reduced the base offense level,
    or starting point, for crack cocaine offenses under the guidelines
    downward by two offense levels. This amendment does not affect the
    statutory mandatory minimum penalties for crack cocaine offenses
    established by Congress. The Commission took this action to alleviate
    some of the longstanding problems associated with the penalty scheme
    for cocaine offenses, which requires 100 times more powder than crack
    cocaine to receive the same statutory mandatory minimum penalty
    commonly referred to as the (100-to-1 ratio.) As a result of the
    amendment, the average sentence for crack cocaine offenders sentenced
    on or after November 1, 2007 will be approximately 16 months less than
    those sentenced before that date.
        The Commission is authorized by statute to decide whether
    amendments that reduce penalties should be given retroactive effect. In
    December 2007, the Commission voted unanimously to give retroactive
    effect to the amendment for crack cocaine offenses. Retroactivity of
    the amendment became effective on March 3, 2008.
        Pursuant to statute, once the Commission has given an amendment
    retroactive effect, a defendant, the director of the Bureau of Prisons,
    or a court on its own may move to have a defendant's term of
    imprisonment reduced pursuant to the Commission's policy statement on
    retroactivity and the limits of the amendment. The Commission estimates
    that approximately 19,000 Federal offenders over a span of several
    years may be eligible to seek to have their terms of imprisonment
    reduced as a result of retroactivity. These individuals were sentenced
    throughout the country although a large number of potentially eligible
    offenders were sentenced in districts located within the Fourth Circuit
    (West Virginia, Virginia, Maryland, North Carolina, and South
    Carolina).
        A Federal sentencing judge will make the final determination of
    whether an offender is eligible for a lower sentence and how much that
    sentence should be lowered. That determination will be based on many
    factors, including whether the offender's reduced sentence or release
    would pose a danger to public safety.
        I will not discuss the merits of retroactivity since such policy
    decisions are outside the Budget Committee's area of responsibility;
    however, I will note that the Criminal Law Committee of the United
    States Judicial Conference supported the Commission's decision on
    retroactivity. The Criminal Law Committee and its staff at the
    Administrative Office of the United States Courts have been working
    closely with the Commission to give the courts sufficient time,
    resources, and guidance to prepare for and process these cases. It is
    this process that I would like to take a moment to discuss.
        We anticipate there may be an initial surge of motions for
    reductions in sentence filed in the Federal courts. These filings will
    be handled by various district court components, including district
    judges, clerks offices, probation and pretrial services offices, and
    Federal defender offices. It is generally agreed that a large number of
    motions for a reduction in sentence will not involve court hearings and
    will be decided on written filings, so our workload associated with
    processing those cases should not be unduly burdensome. The cases that
    require hearings will require more court resources. At present, no
    extraordinary measures have been necessary to address the increased
    workload due to retroactivity, although additional resources will be
    available if needed for smaller districts that may be
    disproportionately impacted by the number of Federal offenders seeking
    a reduction in sentence based on retroactivity.
        We believe retroactivity will have the greatest impact on our
    probation offices. The crack cocaine offenders who may be released
    after a Federal judge grants the motion for a reduction in sentence
    will require close probation supervision, drug testing, and possibly
    drug and other treatment services as do other Federal offenders leaving
    Federal prison. At this time, however, our fiscal year 2009 budget does
    not request additional staffing or other resources associated with
    retroactivity of the crack cocaine sentencing amendment. The Judiciary
    believes the additional workload associated with retroactivity can be
    absorbed within existing resource levels.

                     IMPACT OF INCREASED BORDER ENFORCEMENT

        Another issue that has received significant attention from Congress
    and the administration is illegal immigration, so I would like to
    discuss the impact of increased border and immigration enforcement
    initiatives on the work of the Federal courts. In recent years the
    administration has dedicated significant resources to address the issue
    of illegal immigration. The President's fiscal year 2009 budget
    includes $12 billion for the Department of Homeland Security (DHS) for
    border security and enforcement efforts, a 19 percent increase over
    fiscal year 2008, and a more than 150 percent increase since 2001. DHS
    has used the funding to increase the number of border patrol agents
    significantly, particularly on the Southwest border with Mexico. Since
    2001, more than 5,000 additional border patrol agents have been hired
    with most of them placed along the southwest border. In fiscal year
    2008, DHS received funding to hire an additional 3,000 border patrol
    agents, and the President's fiscal year 2009 budget includes funding
    for another 2,200 agents, bringing the total to 20,000 agents. When
    fully staffed the Border Patrol will have more than doubled in size
    since 2001.
        The level of criminal case filings in the Federal courts in the
    five judicial districts along the southwest border is high by
    historical standards--19,825 filings in 2007 versus 17,184 in 2001--but
    filings have not increased commensurate with the increased resources
    provided to DHS for border enforcement. Despite zero tolerance border
    initiatives such as Operation Streamline in which nearly everyone
    apprehended for violating U.S. immigration laws is prosecuted, resource
    constraints in the justice system have precluded more cases from being
    prosecuted in the Federal courts. Staffing shortages in U.S. Attorney
    offices, lack of detention beds needed to secure offenders awaiting
    prosecution, and staffing constraints in U.S. Marshals offices have
    resulted in the establishment of certain threshold levels in some
    border districts that must be met before a case is prosecuted. For
    example, a U.S. Attorney in one district may prosecute someone coming
    into the country illegally after the tenth attempt, while a U.S.
    Attorney in another district may prosecute after the fifth attempt.
        To the extent the Federal courts are perceived as a factor that
    limits the number of cases that can be prosecuted on the border, I
    would note it is Congress that establishes the number of district
    judgeships and the districts to which they are assigned, and Congress
    and the Executive Branch that control the authorization, funding, and
    construction of new courthouses. The district courts on the southwest
    border have not received any new district judgeships since 2002 despite
    Judicial Conference requests for additional judgeships in 2003 (11
    judgeships), 2005 (11 judgeships), and 2007 (10 judgeships). In recent
    years Congress has been responsive to the need for new courthouse space
    on the southwest border, and we hope that you will support the
    additional $110 million included in the President's fiscal year 2009
    budget to fund fully a new Federal courthouse in San Diego, California.
    The Judicial Conference designated the San Diego courthouse a judicial
    space emergency in 2003, but the General Services administration has
    been unable to award a contract for the project due to escalating
    construction costs in Southern California.
        It now appears that Congress has taken steps to address the
    resource needs across the justice system on the southwest border by
    providing additional resources beyond those provided to DHS. In fiscal
    year 2008 the Department of Justice received $7 million in emergency
    funding to hire more assistant U.S. Attorneys (AUSAs) in the five
    judicial districts along the southwest border. The U.S. Marshals
    Service received $15 million in emergency funding to address southwest
    border workload needs including the hiring of 100 additional deputy
    U.S. Marshals. The President's fiscal year 2009 budget includes $100
    million for a new Southwest Border Enforcement Initiative focusing law
    enforcement and prosecutorial efforts on fighting violent crime, gun
    smuggling, and drug trafficking in that region. If funded, this
    initiative will increase the number of AUSAs along the southwest border
    by another 50 positions. The President's budget also seeks $88 million
    to expand detention capacity along the southwest border. The resultant
    increase in criminal filings we expect to see from this infusion of
    resources will impact our district judges, clerks offices, probation
    and pretrial services offices, and Federal defender offices on the
    border. I would note, however, that the Judiciary's fiscal year 2009
    budget submission does not request funding for new clerks or probation
    office staff on the border or elsewhere. Congress provided the
    Judiciary with $45.4 million over the last 2 years--$20.4 million in
    fiscal year 2007 and $25 million in fiscal year 2008--to address
    immigration-related workload so, from a staffing perspective, the
    courts are well positioned in the short term to respond to the
    increased workload that we expect will materialize. However, as I just
    mentioned, we do require additional district judgeships on the
    southwest border, and construction of a new Federal courthouse in San
    Diego is the Judiciary's top space priority.

                            COST CONTAINMENT EFFORTS

        The Judiciary recognizes that continuing pressures on the Federal
    budget due to the conflicts in Iraq and Afghanistan, investments being
    made to improve security here at home, and the goal of eliminating the
    budget deficit by 2012, will necessitate austere Federal spending going
    forward, particularly for non-security discretionary programs. Indeed,
    the President's fiscal year 2009 budget proposes a 0.3 percent increase
    in this category of spending, well below the rate of inflation. The
    administration and Congress are rightfully concerned about overall
    Federal spending and budget deficits, and we recognize that you face
    tough choices. I want to assure the Subcommittee that the Judiciary is
    doing its part to contain costs.
        We are now more than 3 years into an intensive effort to reduce
    costs throughout the Judiciary. As I mentioned in my testimony last
    year, this cost containment effort was born out of our fiscal year 2004
    experience in which a funding shortfall necessitated staff reductions
    of 1,350 clerk and probation office employees, equal to 6 percent of
    the courts' on-board workforce. As a result of this situation and the
    prospect of continuing Federal budget pressures, the late Chief Justice
    William H. Rehnquist charged the Judicial Conference's Executive
    Committee with developing an integrated strategy for controlling costs.
    After a rigorous 6-month review by the Judicial Conference's various
    program committees, the Executive Committee prepared, and the Judicial
    Conference endorsed in September 2004, a cost-containment strategy for
    the Federal Judiciary. The strategy focuses on the primary cost drivers
    of the Judiciary's budget--compensation costs and the rent we pay to
    the General Services Administration for courthouses and leased office
    space. We have had great cooperation Judiciary-wide as we have moved
    forward on implementing cost containment initiatives. I will highlight
    several cost containment initiatives for you.

    Containing Rent Costs
        The amount of rent we pay to GSA has been a matter of concern to
    the Judiciary for a number of years. Since fiscal year 2004 we have
    made a concerted effort to contain rent costs, with considerable
    success. In fiscal year 2004, prior to the implementation of cost
    containment, we projected that our GSA rent bill would be $1.2 billion
    in fiscal year 2009. I am pleased to report that our current GSA rent
    estimate for fiscal year 2009 is now projected to be $200 million less,
    or $1 billion, 17 percent below the pre-cost containment projection.
    Following are two of our rent containment initiatives that have
    contributed to these reduced rent costs.
      --Rent Validation Project.--In recent years we have been working
            cooperatively with GSA to reduce our space rent costs through a
            rent validation program that has yielded significant savings
            and cost avoidances. This rent validation initiative originated
            in our New York courts where staff spent months scrutinizing
            GSA rent bills and found rent overcharges. The cumulative
            effect of this discovery were savings and cost avoidances over
            3 fiscal years totaling $30 million. The Administrative Office
            expanded this effort nationwide by training all circuit
            executive offices to analyze and detect errors in GSA rent
            billings. Although it is quite time consuming, detailed reviews
            of GSA rent billings are now a standard business practice
            throughout the courts. Through this national effort, in fiscal
            year 2007 we identified additional overcharges totaling $22.5
            million in multi-year savings and cost avoidances, bringing
            cumulative savings/cost avoidances to $52.5 million. We
            anticipate receiving additional rent adjustments and credits
            resulting from over $10 million in rent errors that we recently
            reported to GSA. By identifying and correcting space rent
            overcharges we have been able to re-direct these savings to
            other Judiciary requirements, thereby reducing our request for
            appropriated funds.
      --Rent Caps.--To contain costs further, the Judiciary established
            budget caps in selected program areas in the form of maximum
            percentage increases for annual program growth. For our space
            and facilities program, the Judicial Conference approved a cap
            of 4.9 percent on the average annual rate of growth for GSA
            rent requirements for fiscal years 2009 through 2016. By
            comparison, the increase in GSA rent in our fiscal year 2005
            budget request was 6.6 percent. This cap will produce a GSA
            rent cost avoidance by limiting the annual amount of funding
            available for space rental costs. Under this initiative,
            circuit judicial councils around the country will be
            responsible for managing rent costs in their circuits, which
            will require the councils to prioritize space needs--and in
            some instances deny requests for new space--in order to stay
            within the 4.9 percent cap.

    Containing Information Technology Costs
        Another cost containment success has been identifying and
    implementing more cost-effective approaches in deploying computer
    servers around the country. Before this initiative, each court unit
    maintained local servers to access Judiciary applications and
    databases. New technology, along with improvements in the Judiciary's
    national data communications network, has allowed the consolidation of
    servers at a single location without compromising the performance
    levels of existing applications. In some cases performance has actually
    improved. As a result of this initiative, the Judiciary reduced by 89
    the number of servers needed to run the jury management program,
    producing savings of $2 million in the first year and expected savings
    of $4.8 million through fiscal year 2012. In addition, servers that run
    the case management system in our probation program were consolidated,
    with projected savings and cost avoidances of $2.6 million through
    fiscal year 2012. The Judiciary expects expanded implementation of this
    initiative to result in significant information technology cost savings
    or cost avoidances. A big cost saver will be the consolidation of
    servers for the Judiciary's national accounting system in fiscal year
    2008, which is expected to achieve savings and cost avoidances totaling
    $55.4 million through fiscal year 2012.

    Containing Personnel Costs
        A major focus of the Judiciary's cost containment efforts involves
    controlling personnel costs. At its September 2007 meeting, the
    Judicial Conference approved recommendations from a major court
    compensation study which will slow the growth in personnel costs
    throughout the Judiciary, specifically in clerks and probation offices
    and judges' chambers staff. The approved actions will reduce funding
    available to the courts for annual salary step increases for employees,
    limit the number of career law clerks (who are typically paid more than
    term law clerks), revise salary setting policies for new law clerks,
    and modernize the Federal courts' position benchmarks which govern the
    classification and grading of staff nationwide. We estimate these
    measures may save up to $300 million from fiscal year 2009 through
    fiscal year 2017.

                        INNOVATION IN THE FEDERAL COURTS

        While we look to contain costs wherever possible, we continue to
    make investments in technologies that improve Federal court operations,
    enhance public safety, and increase public access to the courts to name
    just a few examples. The Judiciary is a leader in taking state-of-the-
    art technology and adapting it to the courts' unique needs, and we
    continually look for innovative ways to apply new technologies to our
    operations. These investments are made possible through the funding we
    receive from Congress, and we are grateful for Congress's continuing
    support of our information technology program. Let me describe for you
    several of our innovations.

    Use of Global Positioning System Technology
        Some of our probation and pretrial services offices are now using
    Global Positioning System (GPS) technology to monitor around the clock
    the location of individuals under pretrial release or post-conviction
    supervision. As a condition of their sentence or supervised release, an
    offender or defendant might be required to carry a GPS unit. Some GPS
    tracking devices let officers send a text message or voice message
    directly to the receiver worn by the offender enabling an alert to be
    sent if the offender wanders into forbidden territory.
        An incident that occurred in California offers an example of the
    application of GPS technology. A defendant on a GPS tracking device was
    ordered by a Federal judge to stay away from his ex-wife due to a prior
    history of domestic violence. He was also subject to an active
    restraining order. In the middle of the day, the defendant drove by his
    ex-wife's place of employment. The pretrial services officer received a
    text message alert and immediately contacted the defendant on the
    tracking device, instructing him to come to the office. The officer
    contacted the ex-wife, the court was notified, and appropriate action
    was taken. In this instance, the pretrial services officer had
    established exclusion zones around the wife's home and work. For
    convicted sex offenders whose victims included children, these
    exclusion zones can include schools, parks, and playgrounds. Many
    offenders help defray the cost of monitoring on an ability-to-pay
    basis. GPS monitoring can cost up to $9 per day, roughly double the
    cost of less expensive electronic monitoring, but still well below the
    more than $63 per day required to incarcerate an offender.

    Case Management/Electronic Case Files System
        The Case Management/Electronic Case Files (CM/ECF) system is an
    electronic case management system that provides Federal courts with
    docket management capabilities, including the option of permitting case
    documents to be filed with the court over the Internet. Managing case
    filings electronically is more cost efficient than the labor-and-space
    intensive process of paper filings previously used. The electronic case
    filing system was launched in November 1995, when a team from the
    Administrative Office of the United States Courts helped the U.S.
    District Court in the Northern District of Ohio cope with more than
    5,000 document-intensive asbestos cases. The court faced up to 10,000
    new pleadings a week, a workload that quickly became unmanageable. The
    team developed a system that allowed attorneys to file and retrieve
    documents and receive official notices electronically. More than 10
    years and several upgrades later, the system has fundamentally changed
    how the entire judicial system operates. The system is currently
    operating in all of our district and bankruptcy courts and will be
    operational in all of the regional courts of appeals in early 2009.
    Over 30 million cases are on CM/ECF systems nationwide, and nearly
    350,000 attorneys and others have filed documents over the Internet. On
    average, four million new electronic documents are filed into the
    system each month, and roughly half of those are filed over the
    Internet by attorneys. CM/ECF is considered the world's most
    comprehensive court electronic case filing system. It has been one of
    the most important innovations in U.S. Federal court administration.

    Public Access to Court Electronic Records
        The Public Access to Court Electronic Records (PACER) system is an
    electronic access service run by the Federal Judiciary that allows the
    public to obtain case and docket information from Federal appellate,
    district, and bankruptcy courts via the Internet. The PACER system
    offers an inexpensive, fast, and comprehensive case information service
    to any individual with a computer and Internet access. Users can
    retrieve, among other information, a listing of parties and
    participants in a case, a compilation of case-related information, such
    as cause of action, nature of suit and dollar demands, judgments or
    case status, and appellate court opinions. The data is displayed
    directly on the user's computer screen within a few seconds. The system
    is available 24 hours a day and is simple enough that little user
    training is required. The PACER program has been hugely successful. In
    2007 alone, over 350 million requests for information were processed by
    PACER. As directed by Congress, nominal fees are charged for accessing
    court records although some records are available without charge. Given
    the high-volume usage of PACER, the fees collected in the aggregate are
    substantial. Congress has authorized the Judiciary to utilize these
    fees to run the PACER program as well as to offset some costs in our
    information technology program that would otherwise have to be funded
    with appropriated funds. The Judiciary's fiscal year 2009 budget
    request assumes $68 million in PACER fees will be available to finance
    information technology requirements in the courts' Salaries and
    Expenses account, thereby reducing our need for appropriated funds.
                          the judiciary's workload \1\
    ---------------------------------------------------------------------------
        \1\ Unless otherwise stated, caseload figures reflect the 12-month
    period ending in June of the year cited (i.e., 2008 workload reflects
    the 12-month period from July 1, 2007 to June 30, 2008).
    ---------------------------------------------------------------------------
        I turn now to a discussion of the workload facing the courts. As
    indicated in the caseload table in our fiscal year 2009 budget request,
    2008 caseload projections are used to compute fiscal year 2009 staffing
    needs. Our projections indicate that caseload will increase slightly in
    probation (+1 percent) and pretrial services (+3 percent) and increase
    substantially for bankruptcy filings (+23 percent). For 2008 we are
    projecting small declines in appellate (-3 percent) and criminal (-3
    percent) caseload, and a steeper decline in civil filings (-8 percent).
    Let me discuss some recent trends and caseload drivers and offer some
    context for these projections.

    Probation and Pretrial Services \1\
        Workload in our probation and pretrial services programs continues
    to grow. The number of convicted offenders under the supervision of
    Federal probation officers hit a record 115,930 in 2007 and is expected
    to increase again in 2008 to 116,900. In addition to the increased
    workload, the work of probation officers has become significantly more
    challenging. In 1985, fewer than half of the offenders under
    supervision had served time in prison. By 2007, the percentage had
    climbed to 80 percent. As these figures indicate, probation officers no
    longer deal primarily with individuals sentenced to probation in lieu
    of prison. Offenders coming out of prison on supervised release have
    greater financial, employment, and family problems than when they
    committed their crimes. In addition, the number of offenders sentenced
    in Federal court with prior criminal convictions more than doubled
    between fiscal years 1996 and 2006, and the severity of the criminal
    histories of persons under probation officer supervision has been
    increasing as well. Offenders re-entering the community after serving
    time in prison require close supervision by a probation officer to
    ensure they secure appropriate housing and employment. Successful re-
    entry improves the likelihood that offenders will pay fines and
    restitution and become taxpaying citizens.
        Recent legislation will also increase the workload of probation and
    pretrial services officers. For example, we expect that the Adam Walsh
    Child Protection and Safety Act of 2006 will significantly increase the
    number of sex offenders coming into the Federal court system. The Adam
    Walsh Act also increases the registration requirements for sex
    offenders, which means probation officers must coordinate closely with
    State and local authorities to ensure that law enforcement and the
    public receive the required notice. Monitoring the behavior of sex
    offenders is challenging and requires intense supervision on the part
    of probation and pretrial services officers to protect the community.
        As I discussed earlier in my testimony, the retroactive application
    of the crack cocaine sentencing amendment will also have an impact on
    the work of probation officers although it is difficult to predict with
    certainty at this point how many current Federal prison inmates will
    gain early release and enter the Federal probation system.

    Bankruptcy Filings
        The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
    (BAPCPA), implemented in October 2005, has significantly affected
    workload trends in the Nation's bankruptcy courts. While filings are
    still below pre-BAPCPA levels--751,056 filings in 2007 versus 1,635,725
    filings in 2004--we forecast that filings will increase 23 percent in
    2008 to 923,000 and top one million filings in 2009. The state of the
    economy, particularly as it impacts home foreclosures and credit
    availability, will be a major factor in the number of personal
    bankruptcies--which constitute the majority of bankruptcy cases. It is
    possible that 2008 bankruptcy filings will be above the current
    projection.
        The number of filings alone, however, should not be viewed as the
    sole indicator of overall workload. BAPCPA created new docketing,
    noticing, and hearing requirements that make addressing the petitions
    far more complex and time-consuming. Our bankruptcy courts have
    indicated that the actual per-case work required of the bankruptcy
    courts has increased significantly under the new law, at least
    partially offsetting the impact on the bankruptcy courts of lower
    filings. For example, BAPCPA requires Chapter 7 filers to complete and
    pass a complex ``means test'' and receive a credit counseling briefing
    by an approved agency. Also, filers under Chapters 7 and 13 may not
    receive a discharge of their debts unless they have completed an
    approved financial management course. These and other new requirements
    must be reviewed by the clerk's office, which must take further action
    if the filers do not meet the requirements. BAPCPA also requires more
    than 35 new motions and pleadings in various chapters of the bankruptcy
    code. Each new motion requires judicial review and can result in
    hearings, orders, and opinions, thus consuming more judicial resources.

    Appellate Filings
        After hitting an all-time high of 68,313 filings in 2006, appellate
    caseload declined to 58,809 filings in 2007 and is expected to decline
    by 3 percent to 57,300 filings in 2008. This decline comes on the heels
    of significant workload growth from 2002 to 2006 during which filings
    increased 20 percent initially due to a surge in challenges to Board of
    Immigration Appeals (BIA) decisions in the appellate courts and later
    due to the large number of criminal and habeas corpus petitions filed
    by State and Federal prisoners from 2004 to 2006 challenging their
    sentences pursuant to the Supreme Court's decisions in Blakely v.
    Washington (2004), and in the consolidated cases, United States v.
    Booker and United States v. Fanfan (2005). After the initial surge of
    sentence-related filings associated with these decisions, we are now
    seeing appellate filings for criminal and habeas corpus petitions
    approach pre-Blakely and Booker/Fanfan levels.
        About one-third of all BIA decisions are challenged in the Federal
    appellate courts with 70 percent of those challenges occurring in the
    Second and Ninth Circuits. While BIA appeals have dropped in the last
    year, these cases continue to demand extensive resources since they
    often turn on a credibility determination by a Department of Justice
    immigration judge, thus requiring close judicial review of a factual
    record by the appellate courts.

    Civil Filings
        Civil filings in the courts generally follow a more up and down
    filing pattern. In 2005 civil filings reached a record 282,758 filings,
    declined to 244,343 filings in 2006, then increased again to 272,067
    filings in 2007. The increase in 2007 was due primarily to asbestos
    diversity case filings in the Eastern District of Pennsylvania. The
    Judiciary projects civil case filings will continue this up and down
    pattern, decreasing 8 percent to 250,500 filings in 2008.

    Criminal Filings
        Criminal filings in the Federal courts have been trending downward
    the last several years, and this trend is expected to continue through
    2008. From the previous year, filings declined 2 percent in 2005, 3
    percent in 2006, and a half-percent in 2007 to 67,503 filings. Filings
    are projected to decline another 3 percent in 2008 to 65,800 filings.
        Last year I testified that criminal filings were likely depressed
    due to significant vacancies in AUSA positions nationwide and that once
    vacancies were filled criminal filings would reverse course and begin
    to increase. As I mentioned earlier in my testimony, it now appears
    that additional resources are being provided to fill AUSA positions,
    particularly in the five judicial districts along the Southwest border
    with Mexico. Also, the administration is committing more resources to
    the prosecution of sexual exploitation of children. In fiscal year
    2008, the Department of Justice received $5 million to hire 40
    additional AUSAs to prosecute these exploitation cases under the Adam
    Walsh Act. I would emphasize that our criminal caseload projection for
    2008 does not take into account the impact additional AUSAs will have
    on criminal case filings, so we may see 2008 filings above the
    projected level.

                        FISCAL YEAR 2009 BUDGET REQUEST

        For fiscal year 2009, the Judiciary is seeking a 7.6 percent
    overall increase above the fiscal year 2008 enacted appropriations. The
    courts' Salaries and Expenses account, which funds clerks and probation
    offices nationwide, requires a 7.4 percent increase. Fiscal year 2009
    appropriations requirements for each Judiciary account are included at
    Appendix A.
        The goal of our fiscal year 2009 request is to maintain staffing
    levels in the courts at the level Congress funded in fiscal year 2008,
    as well as to obtain funding for several much needed program
    enhancements. As I noted earlier in my testimony, we are not requesting
    additional staff for our clerks or probation offices. We believe the
    requested funding level represents the minimum amount required to meet
    our constitutional and statutory responsibilities. While this may
    appear high in relation to the overall budget request submitted by the
    administration, I would note that the Judiciary does not have the
    flexibility to eliminate or cut programs to achieve budget savings as
    the Executive Branch does. The Judiciary's funding requirements
    essentially reflect basic operating costs of which more than 80 percent
    are for personnel and space requirements.
        Eighty-six percent ($407 million) of the $475 million increase
    being requested for fiscal year 2009 funds the following base
    adjustments, which represent items for which little to no flexibility
    exists:
      --Standard pay and benefit increases for judges and staff. This does
            not pay for any new judges or staff but rather covers the
            annual pay adjustment and benefit increases (e.g., COLAs,
            health benefits, etc.) for currently funded Judiciary
            employees. The amount budgeted for the cost-of-living
            adjustment is 2.9 percent for 2009.
      --An anticipated increase in the number of on-board senior Article
            III judges.
      --The projected loss in non-appropriated sources of funding due to
            the decline in carryover balances available in fiscal year 2009
            versus the level available to finance the fiscal year 2008
            financial plan (see discussion on the following page).
      --Space rental increases, including inflationary adjustments and new
            space delivery, court security costs associated with new space,
            and an increase in Federal Protective Service charges for court
            facilities.
      --Adjustments required to support, maintain, and continue the
            development of the Judiciary's information technology program
            which, in recent years, has allowed the courts to ``do more
            with less''--absorbing workload increases while downsizing
            staff.
      --Mandatory increases in contributions to the Judiciary trust funds
            that finance benefit payments to retired bankruptcy,
            magistrate, and Court of Federal Claims judges, and spouses and
            dependent children of deceased judicial officers.
      --Inflationary increases for non-salary operating costs such as
            supplies, travel, and contracts.
      --Costs associated with Criminal Justice Act (CJA) representations.
            The Sixth Amendment to the Constitution guarantees that all
            criminal defendants have the right to the effective assistance
            of counsel. The CJA provides that the Federal courts shall
            appoint counsel for those persons who are financially unable to
            pay for their defense.
        After funding these adjustments to base, the remaining $68 million
    requested is for program enhancements. Of this amount:
      --$33 million will provide for investments in new information
            technology projects and upgrades, and courtroom technology
            improvements.
      --$18 million to increase the non-capital panel attorney rate from
            $100 to $118 per hour. I will discuss this requested increase
            in more detail in a moment.
      --$8 million is requested for the Supreme Court's exterior
            renovations and roof system repairs.
      --$5 million is for additional staff and associated costs to address
            fiscal year 2009 workload requirements (32 FTE), two additional
            magistrate judges and staff (9 FTE), library renovations and
            new equipment at the Court of Appeals for the Federal Circuit,
            and the start-up costs for two new Federal defender
            organizations.
      --$4 million would provide for necessary investments in court
            security, such as court security systems and equipment and new
            positions at the United States Marshals Service (9 FTE).

    Non-Appropriated Sources of Funding
        I would like to discuss briefly the non-appropriated sources of
    funding that the Judiciary uses to partially finance its operations and
    how they impact our appropriations needs. In addition to appropriations
    from Congress, the Judiciary collects fees from bankruptcy and civil
    case filings, from the public for on-line access to court records, and
    from other sources. Fees not utilized during the year they are
    collected may be carried over to the next fiscal year to offset
    appropriations requirements in that year. Every fee dollar collected
    that is not needed to finance current year needs represents a dollar
    less that the Judiciary must seek from Congress in the following year.
        In formulating the Judiciary's fiscal year 2009 budget request, we
    made certain assumptions regarding the level of fees and carryover that
    would be available to finance fiscal year 2009 requirements. Because
    the projection for carryover balances are below the level that was
    available to finance fiscal year 2008 operations, the fiscal year 2009
    request includes a line item requesting appropriated funds--$95 million
    in the courts' Salaries and Expenses account--to replace the
    anticipated decline in carryover balances. (New fee collections are
    projected to be flat from fiscal year 2008 to fiscal year 2009 so there
    is no restoration requested or needed for that component of our
    financing.) While it is premature for me to identify a specific amount,
    I am confident that we will not need the full $95 million we requested
    to replace carryover balances. This is due to several factors,
    including the courts' frugal spending during the continuing resolution
    for the first quarter of fiscal year 2008 and fewer judge confirmations
    than we anticipated. As we did this past year, we will keep the
    Subcommittee apprised of changes to fee and carryforward projections
    that could impact our fiscal year 2009 appropriation needs as we move
    through fiscal year 2008. The Judiciary will submit the first of two
    fiscal year 2009 budget re-estimates to the Subcommittee in May 2008.

                  INCREASE IN NON-CAPITAL PANEL ATTORNEY RATE

        We believe that one program enhancement in our budget request
    deserves strong consideration in order to ensure effective
    representation for criminal defendants who cannot afford to retain
    their own counsel. We are requesting $17.5 million to increase the non-
    capital panel attorney rate to $118 per hour, effective January 2009. A
    panel attorney is a private attorney who serves on a panel of attorneys
    maintained by the district or appellate court and is assigned by the
    court to represent financially-eligible defendants in Federal court in
    accordance with the Criminal Justice Act (CJA). In the fiscal year 2008
    omnibus spending bill, the Subcommittee approved an increase in the
    non-capital rate paid to these panel attorneys from $94 to $100 per
    hour, and provided a cost-of-living adjustment to the capital rate from
    $166 to $170 per hour. These new rates took effect on January 1, 2008.
        While we are very appreciative of the increase to $100 per hour for
    non-capital work, we believe a more significant increase is required to
    enable the courts to attract and retain enough qualified attorneys to
    accept appointments and to provide them a fair rate of pay. This is
    critical in order for the Judiciary to ensure that persons represented
    by panel attorneys are afforded their constitutionally guaranteed right
    to effective assistance of counsel.
        We believe there is a direct relationship between the lack of
    qualified panel attorneys available to take CJA appointments and the
    significant financial difficulties panel attorneys encounter
    maintaining their legal practices at the current rate. It is
    predominantly solo and small-firm lawyers that take on CJA cases, and
    these panel attorneys must first cover their overhead costs. With
    overhead costs of approximately $64 per hour, at the $100 rate, that
    leaves a net average of only $36 per hour, before taxes. We believe
    that this net rate of $36 per hour, when compared to the net national
    average ``market rate'' of $148 per hour for non-CJA private criminal
    cases, prevents the courts from attracting sufficient numbers of
    qualified attorneys to take CJA appointments because those attorneys
    can obtain higher pay on non-CJA cases. Each time a panel attorney is
    asked by the court to accept a non-capital CJA appointment, he or she
    must consider the inherent ``opportunity'' cost associated with the
    higher hourly rate he or she could otherwise earn on a non-CJA case.
        The CJA authorized the Judicial Conference to implement annual
    cost-of-living adjustments (COLAs) to panel attorney rates, subject to
    congressional funding. If the statutory COLAs provided to Federal
    employees (the base employment cost index component only) had been
    provided to panel attorneys on a recurring, annual basis since 1986,
    the authorized non-capital hourly rate for fiscal year 2009 would be
    $136. While the Judicial Conference supports the $136 rate, it is
    mindful of the constrained Federal budget environment and, therefore,
    proposes attaining the authorized rate in two stages, an $18 per hour
    increase in fiscal year 2009 from $100 to $118 per hour, with a second
    increase to $140 per hour in fiscal year 2010 (the $140 rate includes a
    $4 COLA to the fiscal year 2009 rate of $136). The Judiciary is
    committed to fully restoring the non-capital panel attorney rate, in a
    cost-conscious manner, by implementing the authorized rate over 2
    years.
        I will close on this topic by reiterating that the Judiciary
    greatly appreciates the $100 non-capital rate Congress provided in
    fiscal year 2008, but the concern remains that, after overhead is
    considered, the rate does not provide compensation that will attract
    enough qualified panel attorneys to take on the complex work involved
    in Federal criminal cases. I urge the Subcommittee to provide the
    funding necessary to increase the non-capital panel attorney rate to
    $118 per hour in fiscal year 2009.

                   CONTRIBUTIONS OF THE ADMINISTRATIVE OFFICE

        I would like to briefly outline the important work performed by the
    Administrative Office (AO) of the United States Courts. Year in and
    year out, the AO provides critical support to the courts. With only a
    fraction (1.3 percent) of the resources that the courts have, the AO
    does a superb job of supporting our needs.
        The AO has key responsibilities for judicial administration, policy
    implementation, program management, and oversight. It performs
    important administrative functions, but also provides a broad range of
    legal, financial, program management, and information technology
    services to the courts. None of these responsibilities has gone away
    and new ones are continually added, yet the AO staffing level has been
    essentially frozen for 15 years. As an example, despite no new staff,
    the AO has been instrumental in implementing the Judiciary's cost
    containment strategy which has achieved significant savings and cost
    avoidances.
        In my role as Chair of the Judicial Conference Committee on the
    budget, I have the opportunity to work with many staff throughout the
    AO. They are dedicated, hard working, and care deeply about their role
    in supporting this country's system of justice.
        The fiscal year 2009 budget request for the Administrative Office
    is $82 million. The AO's request represents a current services budget,
    no additional staff or program increases are sought. All of the
    requested increase is necessary to support current services, mainly
    standard pay and general inflationary increases, as well as funding to
    replace the anticipated lower level of carryover amounts with
    appropriated funds in fiscal year 2009.
        I urge the Subcommittee to fund fully the Administrative Office's
    budget request. The increase in funding will ensure that the
    Administrative Office continues to provide program leadership and
    administrative support to the courts, and lead the efforts for them to
    operate more efficiently. Director Duff discusses the AO's role and
    budget request in more detail in his testimony.

                  CONTRIBUTIONS OF THE FEDERAL JUDICIAL CENTER

        I also urge the Subcommittee to approve full funding for the
    Federal Judicial Center's request of $25.8 million for fiscal year
    2009.
        The Center's director, Judge Barbara Rothstein, has laid out in
    greater detail the Center's needs in her written statement. I simply
    add that the Center plays a vital role in providing research and
    education to the courts. The Center's research and its educational
    programs are highly respected and valued for their quality and
    objectivity. The Judicial Conference and its committees request and
    regularly rely on research projects by the Center. The Center's
    educational programs for judges and court staff are vital in preparing
    new judges and court employees to do their jobs and in keeping them
    current so that they can better deal with changes in the law, and in
    tools--like technology--that courts rely on to do their work
    efficiently.
        The Center has made good use of its limited budget. It uses several
    technologies to deliver information and education to more people more
    quickly and inexpensively. The relatively small investment you make in
    the Center each year (less than one-half of 1 percent of the
    Judiciary's budget) pays big dividends in terms of the effective,
    efficient fulfillment of the courts' mission.

                                   CONCLUSION

        Mr. Chairman, I hope that my testimony today provides you with some
    insight into the challenges facing the Federal courts as well as what
    we are doing to contain costs and become more efficient. I realize that
    fiscal year 2009 is going to be another tight budget year as increased
    mandatory and security-related spending will result in further
    constrained domestic discretionary spending. We recognize the fiscal
    constraints Congress is facing. Through our cost-containment efforts
    and information technology innovations we have significantly reduced
    the Judiciary's appropriations requirements without adversely impacting
    the administration of justice. I know you agree that a strong,
    independent Judiciary is critical to our Nation. I urge you to fund
    this request fully in order to enable us to maintain the high standards
    of the U.S. Judiciary.
        Thank you for your continued support of the Federal Judiciary. I
    would be happy to answer any questions the Subcommittee may have.

                      APPENDIX A.--JUDICIARY APPROPRIATIONS
                             [Dollars in thousands]
    ------------------------------------------------------------------------
                                                                 Percentage
                                     Fiscal year   Fiscal year     change:
                                    2008 enacted      2009       fiscal year
         Appropriation account          level      President's    2009 vs.
                                     (Public Law  budget (Feb.   fiscal year
                                    110-161) \1\    4, 2008)    2008 enacted
    ------------------------------------------------------------------------
    U.S. Supreme Court:
        Salaries & Expenses.......       $66,526       $69,777          +4.9
        Care of Building and              12,201        18,447         +51.2
         Grounds..................
                                   -----------------------------------------
          Total...................        78,727        88,224         +12.1
                                   =========================================
    U.S. Court of Appeals for the         27,072        32,357         +19.5
     Federal Circuit..............
    U.S. Court of International           16,632        19,622         +18.0
     Trade........................
                                   =========================================
    Courts of Appeals, District
     Courts & Other Judicial
     Services:
        Salaries & Expenses:\1\
            Direct................     4,619,262     4,963,091          +7.4
            Vaccine Injury Trust           4,099         4,253          +3.8
             Fund.................
                                   -----------------------------------------
              Total...............     4,623,361     4,967,344          +7.4
                                   =========================================
            Defender Services \1\.       846,101       911,408          +7.7
            Fees of Jurors &              63,081        62,206          -1.4
             Commissioners........
            Court Security........       410,000       439,915          +7.3
                                   -----------------------------------------
              Subtotal............     5,942,543     6,380,873          +7.4
                                   =========================================
    Administrative Office of the          76,036        81,959          +7.8
     United States Courts.........
    Federal Judicial Center.......        24,187        25,759          +6.5
    Judiciary Retirement Funds....        65,400        76,140         +16.4
    U.S. Sentencing Commission....        15,477        16,257          +5.0
    Direct........................     6,241,975     6,716,938          +7.6
    Vaccine Injury Trust Fund.....         4,099         4,253          +3.8
                                   -----------------------------------------
          Total...................     6,246,074     6,721,191          +7.6
    ------------------------------------------------------------------------
    \1\ Pursuant to Public Law 110-161, fiscal year 2008 appropriations
      include $25 million in emergency appropriations ($14.5 million in the
      courts' Salaries and Expenses account and $10.5 million in the
      Defender Services account) for workload associated with DOJ and DHS
      immigration enforcement initiatives.

                                     ______

    Prepared Statement of Paul R. Michel, Chief Judge, United States Court
                       of Appeals for the Federal Circuit

        Mr. Chairman, thank you for allowing me to submit my statement
    supporting the United States Court of Appeals for the Federal Circuit's
    fiscal year 2009 budget request.
        Our request totals $32,357,000, an increase of $5,285,000 (19.5
    percent) over the fiscal year 2008 appropriation of $27,072,000. The
    primary justification for such an unusual increase is the need to
    accommodate seven senior judges who will expand our court's judicial
    output in 2009.
        Thirty percent of this requested increase ($1,575,000) is for
    Congressionally and contractually mandated adjustments to base (such as
    COLAs and escalation in rent and contracts). The only addition included
    in the adjustment to the base appropriation is $298,000 to lease
    chambers outside the courthouse for senior judges for whom there is no
    space in the courthouse.
        Four Federal Circuit judges are eligible to take senior status now;
    three more will become eligible in fiscal year 2009; and another judge
    will become eligible in fiscal year 2010. Of the three Federal Circuit
    judges who will become eligible to take senior status in fiscal year
    2009, at least two are expected to do so. An increase to the Court's
    base of $298,000 will cover the cost of an off-site lease for these two
    judges and up to three of the other four senior judges who are eligible
    for senior status.
        Seventy percent of the Federal Circuit's fiscal year 2009 budget
    request, $3,710,000, is to fund three specific program requests.
      --The first specific program request ($1,860,000) is to build out
            off-site chambers for five senior judges.
      --The second specific program request ($932,000) is for 12 law clerk
            positions for active judges, and
      --The third specific program request ($918,000) is for court
            improvements and a court employee position.

                                     PART 1

        Half of the 70 percent increase for specific program requests
    ($1,860,000) will fund build out of leased chambers for five of the
    seven judges who either are, or will be, eligible to take senior status
    in fiscal year 2009. This amount is based on an estimate coordinated
    with the Administrative Office of the United States Courts and on
    personal experience with GSA in renovating chambers in this courthouse.
    This amount will provide the leased chambers with the furniture,
    furnishings and finishes consistent with the U.S. Courts Design Guide.
    The amount requested is the amount needed to support judges eligible
    and expected to take senior status now through fiscal year 2010 and for
    whom there is no room in the existing courthouse.
        As noted, two of the seven judges who will be eligible to take
    senior status have indicated a desire to do so when they become
    eligible for senior status in fiscal year 2009. Personal circumstances
    make it likely that at least two more will also do so. It is imperative
    then that the Federal Circuit acquire suitably built-out, off-site
    leased chambers for the two judges who have indicated a desire to take
    senior status in fiscal year 2009, two or three of the four already
    eligible, and another who is likely to do so in fiscal year 2010.

                                     PART 2

        Twenty-five percent of the specific program requests ($932,000)
    will fund 12 additional law clerk positions. The Court is requesting
    $932,000 to cover the cost of hiring an additional law clerk for each
    of the court's active judges for 6 months of fiscal year 2009. The
    court's increased workload now justifies funding a fourth law clerk for
    each active judge. Four law clerks are the norm at every Federal
    Appeals Court in the Nation except the Federal Circuit. In our fiscal
    year 2008 appropriation, Congress authorized three additional law
    clerks but provided no funding. We are now requesting funding for all
    12 additional law clerks: the three approved but unfunded in fiscal
    year 2008, and the remaining nine, for a total of 12, or one per judge.
        Patent infringement cases make up one-third or more of the Federal
    Circuit docket. The number of patent infringement cases has grown by
    more than 25 percent in the 15 years since the third clerk was first
    provided. Patent infringement cases are critical to the Nation's
    economy, and the decisions of the Federal Circuit in these cases often
    have significant and sometimes dramatic economic implications for
    parties whose patents are upheld and found to have been infringed,
    whose patents are found not to have been infringed by other parties,
    and many other economic actors. The difficulty and complexity of patent
    infringement and other intellectual property cases have increased
    exponentially in recent years.
        Most of the patent cases now filed in the Federal Circuit Court of
    Appeals are highly technical and require great insight and judgment.
    The issues presented in these cases involve arcane breakthroughs on the
    frontiers of science, technology, manufacturing, engineering,
    mathematics and medicine. In such cases legal judgments must be made,
    not only about the law itself but often on the basic underlying
    technical innovation, with few if any precedents, analogies or
    objective metrics to apply to help determine the outcome.
        Many such cases involve a multitude of issues, no one of which can
    be ignored in an effort to narrow and focus the decision-making process
    as so often happens on appellate review. In patent infringement cases,
    all issues must typically be left together because together they frame
    the problem and the outcome. The practical effect is that one case
    takes on the nature of several, whose many issues must be understood
    individually and collectively before the court can integrate them into
    a unifying substantive decision.
        Timeliness is also an issue in many of these cases because the
    speed of technological change can render a delayed decision essentially
    ineffectual in a rapidly-changing economic marketplace.
        In the appeal of such cases the question is not only whether the
    law was correctly applied below, but also whether the science or
    technology was understood correctly by the trial judge or jury. The
    latter issue is especially important in the innovative appeals that
    come so often before this court, where there are few if any boundaries,
    signposts, or rules to guide the deciding judges. In many cases the
    court is required to engage in de novo review. This means the judges
    must review all elements of the decision below, in some cases retracing
    the actual footwork of the trial judge, if not actually embarking on
    entirely new lines of thought, logic and analysis.
        In patent infringement and other intellectual property cases most
    judges and their law clerks have to master an unfamiliar field of
    science and draw the best conclusions they can from scarce and limited
    resources. Because judges are assigned to panels randomly and not by
    specific subject matter expertise, all judges and their law clerks on
    the Federal Circuit are required to engage in extensive, and
    fundamental scientific inquiries in every area of science and
    technology. The practical effect is that each judge with his or her
    Chambers staff is engaged simultaneously in varied and complicated
    exercises, as opposed to deciding a series of often less complex,
    single issue cases, as in other courts of appeals.
        The Federal Circuit's need for additional law clerks is based on an
    increased caseload in highly technical and complex appeals. Having a
    fourth law clerk would ensure that the judges of the United States
    Court of Appeals for the Federal Circuit can give the Nation,
    practitioners and litigants and the Patent and Trademark Office timely
    and thoughtful deliberation on the many challenging, critical and
    complex issues that come before the Court.

                                     PART 3

        Approximately 25 percent of the specific program requests
    ($918,000) will fund the following:
      --Cooling equipment for the network server room ($350,000);
      --A new Internal Controls Analyst position ($71,000);
      --Renovations to the Circuit Library ($200,000);
      --Enhancements to courtroom computer technology ($255,000); and
      --Furniture and equipment for the new positions requested ($42,000).
        These items are important to the management and internal operation
    of the United States Court of Appeals of the Federal Circuit.
        Permanent Cooling Equipment.--The Court requests $350,000 to
    provide permanent cooling equipment for the network server room. The
    Court's server room was jerry-built out of an internal office space. It
    was never properly configured, ventilated, wired or equipped. Following
    several instances of dangerously high temperatures, we took temporary
    steps to mitigate some of the immediate problems. These funds would
    enable us to reconfigure and cool the server room properly, thereby
    saving the life of expensive hardware and equipment and greatly
    improving the reliability of information technology for the court's
    judges and staff.
        Internal Controls Analyst.--The Court is requesting $71,000 for a
    new Internal Controls Analyst position which was authorized and
    encouraged throughout the judiciary by the Judicial Conference. We have
    already assigned existing staff additional duties to conduct internal
    audits, inspections and inventories. But having a dedicated, trained
    professional to perform these responsibilities would fulfill the vision
    the Judicial Conference contemplates and materially improve the
    stewardship of the court's property, funds, and internal procedures.
        Circuit Library Renovations.--The Court is requesting $200,000 to
    design and construct renovations to the Circuit Library, which has not
    been renovated since the courthouse was built in 1965. These modest
    renovations would improve access to and efficiency in managing the
    Library collection.
        Courtroom Technology Enhancements.--The Court is requesting
    $255,000 to finance technological enhancements in our third courtroom,
    consistent with long-standing policy of the Judicial Conference. Such
    enhancements include digital sound recording equipment to enable
    uploading the audio portion of oral arguments on the court's website;
    laptop connectivity equipment and training to bring the courtroom into
    the 21st century and allow judges and their law clerks and counsel to
    use personal computers during arguments; under-floor cabling for
    safety, security and easy access; and video-conferencing infrastructure
    for remotely conducted oral arguments.
        Furniture and Equipment.--The Court is requesting $42,000 for
    furniture and equipment for the new positions described above: 12 law
    clerks and an internal controls analyst.
        Mr. Chairman, I would be pleased to answer any questions the
    Committee may have or to meet with the Committee members or staff about
    our budget request. Thank you.
                                     ______

    Prepared Statement of Jane A. Restani, Chief Judge, United States Court
                             of International Trade

        Mr. Chairman, Members of the Committee: I would like to once again
    thank you for providing me the opportunity to submit this statement on
    behalf of the United States Court of International Trade, which is
    established under Article III of the Constitution with exclusive
    nationwide jurisdiction over civil actions pertaining to matters
    arising out of the administration and enforcement of the customs and
    international trade laws of the United States.
        The Court's budget request for fiscal year 2009 is $19,622,000.
    This represents an overall increase of $2,990,000 or 18 percent over
    the Court's fiscal year 2008 enacted appropriation of $16,632,000. The
    primary reason for this increase in the fiscal year 2009 budget request
    is a substantial increase in GSA rent charges. The total GSA rent
    estimate for fiscal year 2009 is $7,527,041, which is an increase of
    $2,336,000 over the fiscal year 2008 rent estimate. To put these
    charges in perspective, it is important to note that these fiscal year
    2009 rent charges represent 78 percent of the Court's total requested
    increase and 38 percent of the Court's total requested budget. The rent
    rate increase reflects a 50 percent increase in the shell rate as a
    result of a new appraisal by GSA. While the shell rate is primarily
    responsible for the increase in GSA rent charges, those increase
    charges also include a new expenditure of $803,012 for the amortized
    cost of the Court's Congressionally-approved security pavilion. The
    process for the construction of this security pavilion began in fiscal
    year 2002 when Congress authorized $75,000 for an architectural
    analysis of the repairs and upgrades needed to ensure the health,
    security and effective operation of the Court. The results of this
    analysis eventually led to the construction of the security pavilion
    that will be completed toward the end of fiscal year 2008.
        Despite the substantial increase in rent charges, which is outside
    of the Court's control, the Court continues, as it has done for the
    past 13 years, to budget conservatively and request only funds that
    will provide for mandatory increases in pay, benefits and other
    inflationary factors, as well as funds for the essential on-going
    operations and initiatives of the Court. These increases are in line
    and consistent with the Court's prior average budgetary requests of 4.8
    percent. I note also that these modest increases include increases in
    costs paid to the Federal Protective Service for basic and building-
    specific security surcharges. The security surcharges provide for the
    Court's pro-rata share of installing, operating and maintaining systems
    for the critical and necessary security of the Federal Complex in lower
    Manhattan.
        Through the use of its annual appropriation and the Judiciary
    Information Technology Fund (JITF), the Court continues to promote and
    implement the objectives set forth in its Long Range Plan. These
    objectives promote access to the Court through the effective and
    efficient delivery of services and information to litigants, the bar,
    public, judges and staff. As a national court, this access is critical
    in realizing the Court's mission to resolve disputes by (1) providing
    cost effective, courteous and timely service, (2) providing
    independent, consistent, fair and impartial interpretation and
    application of the customs and international trade laws and (3)
    fostering improvements in customs and international trade law and
    practice and improvement in the administration of justice.
        The Court continues to aggressively implement its information
    technology and cyclical maintenance/replacement programs. In fiscal
    year 2007, the Court: (1) purchased, configured and tested three new
    replacement servers, two new file servers and one internet server; (2)
    tested the new 3.1 version of the Court's customized version of the
    Federal Judiciary's Case Management/Electronic Case Files (CM/ECF)
    System; (3) cyclically upgraded, replaced and supported desktop
    computers and printers throughout the Court; (4) upgraded the Court's
    photo-copiers with new digital copiers with scanning and faxing
    capabilities; (5) installed the new version of Word Perfect; (6)
    supported and maintained all technical equipment and software
    applications; and (7) utilized an Administrative Office contract for
    professional consulting services for an evaluation of the needs of the
    Court in the design and implementation of a new video conferencing
    system. Additionally, in fiscal year 2007, the Court continued its
    cyclical maintenance program by: (1) refurbishing the finance/property/
    procurement and the technical development support sections of the
    Clerk's Office; and (2) refurbishing two case file rooms and the
    confidential storage room for better space utilization.
        In fiscal year 2008, the Court plans to expend funds to: (1) review
    and subsequently implement the consultant's recommendations, mentioned
    in the above, for the purchase of a new video conferencing system; (2)
    install the file and internet servers and replace the Court's voice,
    fax and domain name servers; (3) replace desktop computer systems and
    VPN laptops in accordance with the Judiciary's cyclical replacement
    program; (4) upgrade and support existing software applications; (5)
    purchase new software applications to ensure the continued operational
    efficiency of the Court; and (7) support Court equipment by the
    purchase of yearly maintenance agreements. The Court will also continue
    to expand its developmental and educational programs for staff in the
    areas of job-related skills and technology.
        In fiscal year 2009, the Court will not only remain committed to
    using its carryforward balances in the Judiciary Information Technology
    Fund to continue its information technology initiatives and to support
    the Court's short-term and long-term information technology needs, but
    will also continue its commitment to its cyclical replacement and
    maintenance program for equipment and furniture for the Courthouse.
    This latter program not only ensures the integrity of equipment and
    furnishings, but maximizes the use and functionality of the internal
    space of the courthouse. Additionally, the fiscal year 2009 request
    includes funds for the support and maintenance of the Court's upgraded
    security systems. Lastly, the Court will continue its efforts to
    address the educational needs of the bar and Court staff.
        As I have continually stated in previous years, the Court remains
    committed to maintaining its security systems to ensure the protection
    of those who work in and visit the Courthouse. The Court is looking
    forward to the completion of its security pavilion in the third quarter
    of fiscal year 2008. This pavilion is expected to be fully operational
    in fiscal year 2009. The Court has worked in partnership with GSA in
    the design, construction and completion of this entrance pavilion and
    is most gratified to see that everyone's efforts and hard work will
    finally be realized.
        I would like to again emphasize that the Court will continue to
    conservatively manage its financial resources through sound fiscal,
    procurement and personnel practices. As a matter of internal operating
    principles, the Court routinely has engaged in cost containment
    strategies in keeping with the overall administrative policies and
    practices of the Judicial Conference. For over 5 years the Court has
    only requested funds to maintain current services. The extraordinary
    increase in the fiscal year 2009 projected rent charges has caused
    concerns regarding the Court's ability to maintain current services
    without additional funds to support the rent increase. In an effort to
    lessen the projected impact of this rent increase, at the end of fiscal
    year 2007 and continuing into fiscal year 2008, the Court began the
    initial review process of the fiscal year 2009 rent rate. Several
    meetings were held with high level regional GSA personnel responsible
    for the review and implementation of the rent pricing rates.
    Additionally, the Clerk of Court met with the Administrative Office. In
    order to proceed with the process and at the suggestion of the
    Administrative Office, the Court, in fiscal year 2008, will issue a
    work order for an independent appraisal analysis. Once the new
    appraisal is completed and reviewed, subsequent meetings will be held
    with GSA's high level regional and national office personnel in an
    effort to reduce the high rent increase.
        Lastly, I would like to personally extend my deepest thanks and
    appreciation to Congress for recognizing the needs of the Court by
    providing, in fiscal years 2007 and 2008, adequate funding to maintain
    current services. I am confident that Congress, in fiscal year 2009,
    will provide the needed funds for the increase in rent costs, thereby
    enabling the Court to continue to operate in a cost effective and
    efficient manner.
        The Court's ``General Statement and Information'' and
    ``Justification of Changes,'' which provide more detailed descriptions
    of each line item adjustment, were submitted previously. If the
    Committee requires any additional information, we will be pleased to
    submit it.
                                     ______

      Prepared Statement of Hon. Barbara J. Rothstein, Director, Federal
                                Judicial Center

        I am Barbara Rothstein. I have been the Center's director since
    2003, and a district judge since 1980. I am pleased to submit the
    Center's 2009 budget request on behalf of the Center's Board, which the
    Chief Justice chairs, and which approved this request.
        First, the Center is grateful for the efforts of Congress to
    provide in fiscal year 2008 not only full adjustments to its 2007 base
    (for only the second time in more than a decade) but also $156,000 for
    three new positions (30 percent of the $504,000 we sought in fiscal
    2008 to restore 10 of the 22 Center positions vacated and frozen since
    2003 because of budget shortfalls).
        Our 2009 request is for $25,759,000, a $1,572,000 (or 6.5 percent)
    increase over 2008. The increase includes $1,060,000 for standard
    adjustments to base, $387,000 for four full-time equivalent positions
    (seven positions for approximately 6 months), and $125,000 for critical
    education and training programs.
        Before providing more detail on this request, let me provide you
    with a little background on the Center and its activities. I hope with
    this description to convey to you the important contribution that the
    Center makes to the effective and efficient functioning of the Federal
    courts.

                    THE CENTER'S CONTRIBUTION TO THE COURTS

        The Center's mission is to provide objective, well-grounded
    empirical research and balanced, effective educational programs for the
    courts.
        The courts, and particularly the Judicial Conference of the United
    States, as well as Congress and the public, are regular consumers of
    the Center's research projects. They rely on the Center for thorough,
    unbiased, well-documented research. Examples include examining the
    impact of the Class Action Fairness Act of 2005 on the resources of the
    Federal courts; providing information to assist judges in handling
    capital cases; and developing empirically sound case weights that
    accurately reflect judicial workload. Not only do projects such as
    these help judges decide cases efficiently and fairly, they also help
    the judiciary and Congress make better-informed decisions about
    policies and procedures affecting the courts.
        Center education programs are vital to judges and court staff. For
    new judges, orientation programs enable them to assume their new
    responsibilities quickly. Continuing education programs bring judges up
    to date on topics ranging from case-management techniques to new
    statutes and case law. (For example, the Center quickly responded to
    the U.S. Sentencing Commission's decision to retroactively apply
    changes to the sentencing guidelines on crack cocaine by providing
    educational programs and other resources to help judges, probation
    officers, and others deal carefully, efficiently, and fairly with the
    many issues this raised.)
        Court staff, who play a critical role in supporting judges and
    ensuring the efficient operation of the courts, rely on the Center for
    educational programs and materials that help them do their jobs better
    (for example, integrating new technologies and executing cost-
    containment strategies). The Center's Professional Education Institute,
    which provides basic and advanced programs on leadership and management
    for managers and supervisors at all levels in the courts, is a key
    component of court staff training.
        The Center uses a wide range of tools to deliver education. One
    reality of the information age is that people can (and expect to)
    receive information in many different ways. Where once the Center
    relied almost exclusively on in-person programs, audiotapes, and hard-
    copy publications to reach judges and court staff, we have expanded
    into satellite television broadcasting, teleconferencing, and use of
    the Internet and the courts' intranet, and, more recently, web-
    conferencing and streaming video. All these delivery means are needed
    to meet the diverse needs of a diverse population of judges, managers,
    and staff.
        The importance of the Center's educational programs is reflected in
    their use by the courts. All Center training is voluntary; large
    numbers of judges and court staff choose to participate in Center
    programs and use its services because they know the Center's products
    will help them do their jobs better. In 2007, over 9,000 employees of
    the courts (including over 2,000 judges) attended Center programs in
    person--over half did so in their own districts. Over 1,000 court staff
    participated in Center video, audio, and web conferences, and thousands
    of judges and court staff watched Center television programs, accessed
    resources and downloaded materials from the Center's intranet site, and
    used Center publications.

              THE CENTER HAS MANAGED ITS APPROPRIATION RESPONSIBLY

        Understanding the need for fiscal responsibility, the Center has
    made careful use of its appropriation each year. As I noted earlier, we
    use a wide variety of cost-effective delivery tools to provide
    education and information to judges and staff efficiently. The various
    delivery tools we use have enabled us to reach a larger and larger
    audience for less money than we could with only one or two of these
    media. But new technology also requires a highly professional staff
    with diverse skills in order to take full advantage of these tools and
    to identify and implement newer technologies as they emerge.
        In-person programs remain a vital part of our education efforts.
    Here we economize in several ways. Most in-person staff training (and
    some judge education) is done by bringing faculty to the courts for
    local training. Most programs to which participants must travel are
    conducted in hotels in large cities where we can negotiate reasonable
    rates and take advantage of competitive airfares. We conduct smaller
    seminars in collaboration with several outstanding law schools,
    enabling us to avoid faculty and overhead costs.
        We stretch our appropriation by working closely with our sister
    agencies, the Administrative Office of the U.S. Courts and the U.S.
    Sentencing Commission. We regularly consult with them to avoid
    duplicative efforts, and we often provide them an opportunity to convey
    their information to the courts at Center-sponsored programs.

                     THE CENTER'S FISCAL YEAR 2009 REQUEST

        Our request for 2009 is modest--standard adjustments to our 2008
    base, $387,000 to enable us to fill the seven positions sought but not
    funded in our fiscal year 2008 request, and $125,000 for programs that
    are needed but which we cannot currently afford without cutting equally
    important programs elsewhere. The seven positions will return the
    Center to approximately its fiscal year 2005 staffing level, but that
    level will still be more than 10 percent below the number of staff the
    Center had as recently as 2003, and over 20 percent below the number of
    staff employed by the Center in the early 90s. With these resources we
    can continue to help the courts prepare for and meet the many
    substantive, procedural, and operational challenges they face. The
    additional program funds would provide expanded programming for judges
    on sentencing, ethics, and case management (including the use of
    information technology). These additional funds would also provide
    programs for attorneys in the courts; the Center has not kept pace with
    the growing educational needs of these attorneys. The requested amounts
    represent a total increase of only 6.5 percent over the Center's fiscal
    year 2008 level. I ask you to please find the resources to fund them in
    full.
        Thank you for your careful consideration of our request. I would be
    pleased to respond to any questions you may have.
                                     ______

         Prepared Statement of the United States Sentencing Commission

        Chairman Durbin, Ranking Member Brownback, and members of the
    subcommittee, the United States Sentencing Commission thanks you for
    the opportunity to submit this statement in support of its
    appropriations request for fiscal year 2009. The Commission's statutory
    mission, as set forth in the Sentencing Reform Act of 1984, continues
    to be both reaffirmed and significantly impacted by recent United
    States Supreme Court decisions regarding Federal sentencing policy.
    Full funding of the Commission's fiscal year 2009 request will ensure
    that the Commission can continue to fulfill its statutory mission.

                              RESOURCES REQUESTED

        The Commission is requesting $16,257,000 for fiscal year 2009,
    representing a 5 percent increase over the fiscal year 2008
    appropriation of $15,477,000. The Commission recognizes that it must
    use its allotted resources carefully and that Congress expects the
    same. The Commission accordingly has tailored its fiscal year 2009
    request narrowly and is seeking a limited increase over its fiscal year
    2008 appropriation to account for inflationary increases and certain
    adjustments for personnel costs.

           JUSTIFICATION FOR THE COMMISSION'S APPROPRIATIONS REQUEST

        The statutory duties of the Commission include, but are not limited
    to: (1) developing sentencing guidelines to be determined, calculated,
    and considered in Federal criminal cases; (2) collecting, analyzing,
    and reporting Federal sentencing statistics and trends; (3) conducting
    research on sentencing issues in its capacity as the clearinghouse of
    Federal sentencing data; and (4) providing training on sentencing
    issues to Federal judges, probation officers, law clerks, staff
    attorneys, defense attorneys, prosecutors, and others.
        These statutory duties and the continuing importance of the
    sentencing guidelines have repeatedly been reaffirmed by recent Supreme
    Court decisions beginning with United States v. Booker.\1\ In Booker,
    the Supreme Court reemphasized the Commission's continuing role with
    regard to (writing Guidelines, collecting information about district
    court sentencing decisions, undertaking research, and revising the
    Guidelines accordingly.'' \2\ In Rita v. United States,\3\ the Supreme
    Court reinforced the role of the Commission and the importance of the
    guidelines in holding that a court of appeals may apply a presumption
    of reasonableness to a sentence imposed within the properly calculated
    sentencing guideline range. The Court noted that ([t]he Commission's
    work is ongoing. The statutes and the Guidelines themselves foresee a
    continuous evolution helped by the sentencing courts and courts of
    appeals in that process.\4\ In Gall v. United States,\5\ the Court
    reemphasized that ``([a]s a matter of administration and to secure
    nationwide consistency, the Guidelines should be the starting point and
    the initial benchmark'' in determining an appropriate sentence.\6\
    ---------------------------------------------------------------------------
        \1\ 543 U.S. 220 (2005).
        \2\ 543 U.S. at 264.
        \3\ 127 S. Ct. 2456 (2007).
        \4\ Id. at 2464.
        \5\ 128 S. Ct. 586 (2007).
        \6\ Id. at 596.
    ---------------------------------------------------------------------------
        While reaffirming the ongoing nature of the Commission's work,
    these decisions also have had a significant impact on that work.
    Consistent with Booker and its progeny, the Commission has continued
    its core mission to review and revise the guidelines, taking into
    account 18 U.S.C. Sec.  3553(a) and other congressional statutes and
    directives and in response to information it receives from sentencing
    courts, Congress, the Executive Branch, Federal defenders, and others.
    The Commission also has increased its efforts to provide training on
    Federal sentencing issues, including application of the guidelines, to
    Federal judges, probation officers, law clerks, staff attorneys,
    prosecutors, defense attorneys, and others.
        Furthermore, in response to these Supreme Court cases, the
    Commission has continued to refine its data collection, analysis, and
    reporting efforts to provide real-time data about Federal district
    court sentencing practices and trends. The Commission must continue to
    disseminate sentencing information in real-time and in a thorough
    manner so that Congress and others can be fully informed and advised on
    sentencing policy in the wake of the Booker line of cases. In addition,
    the Commission must continue to monitor appellate case law applying
    these cases, requiring the Commission to further refine its appellate
    court database.
        Despite the impact of these cases, the Commission is not requesting
    program increases for fiscal year 2009. The Commission has worked
    diligently over the past several years to maximize its resources
    overall and appreciates the support and funding it has received from
    Congress.
    Sentencing Policy Development and Guideline Promulgation
        As part of its statutory duty to develop sentencing guidelines to
    be determined, calculated, and considered in Federal criminal cases,
    the Commission promulgated a number of guideline amendments during the
    amendment cycle ending on May 1, 2007. These amendments, which absent
    congressional action to the contrary became effective on November 1,
    2007, related to several substantive areas of the criminal law,
    including transportation, terrorism, intellectual property, and drug
    offenses. As part of this work, the Commission updated its extensive
    2002 report on Federal cocaine sentencing and amended the guidelines
    prescribing sentences for crack cocaine offenses, keeping the guideline
    penalties within the statutorily-prescribed mandatory minimum
    sentences. The Commission received voluminous public comment on this
    issue, including whether these changes should be applied retroactively.
    It held multiple public hearings on the amendment and the issue of
    retroactivity, receiving testimony from a cross-section of witnesses.
    Based on this testimony and its own research, the Commission decided to
    give retroactive effect to its amendment for crack cocaine offenses. It
    now is working closely with the Federal criminal justice community to
    ensure its efficient application.
        For the amendment cycle ending May 1, 2008, the Commission is
    considering several guideline amendments in response to recent
    congressional action. The Commission has proposed amendments in
    response to the Animal Fighting Prohibition Enforcement Act of 2007,
    the Honest Leadership and Open Government Act of 2007, the Emergency
    and Disaster Assistance Fraud Penalty Enhancement Act of 2007, and the
    Court Security Improvement Act of 2007. The Commission also is
    considering amendments in the areas of immigration offenses, drug
    offenses, and criminal history. These proposed amendments respond to
    input received from the criminal justice community and reflect the
    Commission's ongoing work to refine the guidelines in accordance with
    its statutory obligations.
        Consistent with the requirements of the Sentencing Reform Act of
    1984, the Commission engages in a collaborative process for sentencing
    policy development and guideline promulgation. That process continues
    to include significant outreach to, and input from, representatives of
    the criminal justice community, as well as the review of pertinent
    literature, data, and case law. For example, the Commission recently
    held a public briefing session on disaster fraud offenses and the
    illegal use of human growth hormone. During this briefing session, the
    Commission received testimony from the Department of Justice, the
    Federal Defenders Service, the Department of Housing and Urban
    Development, the American Red Cross, and the Food and Drug
    Administration.

    Collecting, Analyzing and Reporting Sentencing Data
        In fulfillment of its statutory duties related to collecting,
    analyzing, and reporting Federal sentencing statistics and trends, the
    Commission collects documentation from the district courts on over
    70,000 Federal felony and class A misdemeanor cases annually.\7\ From
    this documentation, the Commission extracts, analyzes, and reports
    information on national sentencing trends and practices. As with other
    aspects of the Commission's statutory mission, data collection,
    analyzing, and reporting efforts continue to be impacted by the Supreme
    Court's recent sentencing-related decisions.
    ---------------------------------------------------------------------------
        \7\ See 28 U.S.C. Sec.  994(w), which requires the chief judge of
    each district court, within 30 days of entry of judgment, to provide
    the Commission with: (1) the charging document; (2) the written plea
    agreement (if any); (3) the Presentence Report; (4) the judgment and
    commitment order; and (5) the statement of reasons form.
    ---------------------------------------------------------------------------
        Immediately after the Supreme Court's 2004 decision in Blakely v.
    Washington,\8\ the Commission recognized that one of the most critical
    functions it could perform was reporting timely and accurate sentencing
    data. The Commission refined its data collection, analysis, and
    reporting requirements to such a degree that it was able to produce
    relevant information beyond that which it promulgated in its annual
    reports and sourcebooks. By the time the Supreme Court issued its
    Booker decision in January 2005, the Commission was able to provide
    real-time data about national sentencing trends and practices.
    ---------------------------------------------------------------------------
        \8\ 542 U.S. 296 (2004). Blakely was a precursor to the Booker
    decision, which applied to a State guideline sentencing scheme. After
    the Blakely decision, several Federal courts questioned whether the
    Federal sentencing guideline system was still viable and Federal
    sentencing practices became uncertain. The Commission's data collection
    and analysis efforts assisted the criminal justice community in
    evaluating the impact of Blakely, and later Booker, on the Federal
    system.
    ---------------------------------------------------------------------------
        The Commission further refined its processes throughout fiscal
    years 2006 and 2007 to maximize the information it made available to
    the criminal justice community. The Commission now provides detailed
    quarterly national sentencing data similar to the format and types of
    data produced in its year-end annual reports. In addition, the
    Commission has begun to provide real-time data on the impact on Federal
    sentencing practices of the Supreme Court's recent decisions in Rita,
    Gall, and Kimbrough v. United States.\9\ The Commission also has
    expedited publication of its year-end annual reports, which are now
    released in February of each year. For fiscal year 2007, the Annual
    Report and Sourcebook contained information on 72,865 Federal cases,
    which represents approximately 24,000 more cases than the Commission
    processed a decade ago. The information contained in these reports and
    other analyses conducted by the Commission are used by, among others,
    Congress, the judiciary, the Department of Justice, defense
    practitioners, and academics.
    ---------------------------------------------------------------------------
        \9\ 128 S. Ct.558 (2007).
    ---------------------------------------------------------------------------
    Information Technology Issues Associated with Data Collection, Analysis
            and Reporting
        Over the past 3 fiscal years, the Commission has apprised Congress
    of its development of an electronic document submission system that
    enables courts to electronically submit the five statutorily required
    sentencing documents directly to the Commission. This system is now
    used by 91 of the 94 judicial districts, an increase from 80 districts
    in fiscal year 2007 and 64 districts in fiscal year 2006. The
    electronic document submission system has greatly alleviated the
    Courts' need to spend judicial resources on copying, bundling, and
    mailing hard copies to the Commission.
        During fiscal years 2008 and 2009, the Commission intends to
    continue to make technological advancements related to data collection,
    analysis, and reporting. For example, working with the courts, the
    Commission has begun to advance the evolution of its electronic
    submission system to a web-based system with the ability to accept both
    the statutorily required sentencing documents and data fields from the
    courts. Specific projects include the planning, coordination, and
    implementation of a pilot project for the expanded use of this web-
    based system.
                Increased Requests for Commission Work Product from
                        Congress
        In addition to providing quarterly and annual data reports on
    national sentencing practices, the Commission continues to experience
    increased requests for particularized data analysis from Congress. The
    Commission is statutorily required to assist Congress in assessing the
    impact proposed criminal legislation will have on the Federal prison
    population. These assessments are often complex, time-sensitive, and
    require highly specialized Commission resources. The Commission also
    has experienced an increase in requests for information from Congress
    on issues such as drugs, gangs, fraud, immigration, and sex offenses.
    The Commission increasingly is providing data to assist Congress during
    oversight and legislative hearings on proposed changes to substantive
    areas of the criminal law. Informational requests from the
    Congressional Research Service have also increased. The Commission
    anticipates that congressional requests will continue to increase
    throughout fiscal year 2009 and looks forward to fulfilling them in a
    timely and thorough manner.

    Conducting Research
        The Sentencing Reform Act of 1984 directed the Commission to
    establish a research agenda as part of its role as the clearinghouse on
    Federal sentencing statistics and policy and to assist the courts,
    Congress, and the Executive Branch in the development, maintenance, and
    coordination of sound sentencing policies. As part of this statutory
    mission, the Commission issued its fourth comprehensive report on
    Federal cocaine sentencing policy in May 2007. It also released an
    analysis on the impact of the amendment to the guidelines for crack
    cocaine offenses if it were given retroactive effect. The Commission's
    research agenda in fiscal year 2008 includes reports associated with
    its policy work and other projects of interest to the criminal justice
    community. One of these projects is an examination of alternatives to
    incarceration, which will include a 2-day symposium featuring leading
    experts in the field.

    Training and Outreach
        The Sentencing Reform Act of 1984 also directed the Commission to
    provide specialized sentencing training and guidance to the criminal
    justice community. In fulfillment of this statutory duty, the
    Commission provides training, technical assistance, and other
    educational programs to Federal judges, probation officers, law clerks,
    staff attorneys, prosecutors, and defense attorneys throughout the
    year. The Commission's training and outreach efforts have expanded in
    each of the past four years, particularly in response to the Supreme
    Court's recent sentencing-related decisions and to the Commission's
    annual promulgation of guideline amendments. In fiscal years 2007 and
    2008, the Commission provided training in every Federal judicial
    circuit and a majority of the districts. It also participated in
    numerous symposia, conferences, and workshops. In May 2008 in Orlando,
    Florida, the Commission will co-host its annual national training
    program at which several hundred participants will receive Federal
    sentencing guideline training. The Commission expects that the need to
    provide specialized training on Federal sentencing issues will continue
    to increase throughout fiscal year 2009.

                                    SUMMARY

        The Commission remains uniquely positioned to assist all three
    branches of Government in ensuring sound and just Federal sentencing
    policy. Located in the judicial branch and composed of Federal judges,
    individuals with varied experience in the Federal criminal justice
    community, and ex-officio representatives of the Executive Branch, the
    Commission is an expert, bipartisan body that works collaboratively
    with Congress. It therefore sits at the crossroads where all three
    branches of Government intersect to determine Federal sentencing
    policy.
        The Commission appreciates the funding it has received from
    Congress to meet its ever-increasing needs. Full funding of the
    Commission's fiscal year 2009 request will ensure that the Commission
    continues to fulfill its statutory mission to develop Federal
    sentencing guidelines, collect, analyze and report Federal sentencing
    statistics and trends, conduct research on sentencing issues, and
    provide training to the criminal justice community. The Commission
    respectfully asks that Congress fully support the Commission's fiscal
    year 2009 appropriation request of $16,257,000 so that it can continue
    its statutory role as a leader in Federal sentencing policy.

        Senator Durbin. Mr. Duff, do you have a statement that you
    would like to add to the record?

    STATEMENT OF JAMES C. DUFF, DIRECTOR, ADMINISTRATIVE
                OFFICE OF THE U.S. COURTS
        Mr. Duff. Yes, Mr. Chairman. Thank you very much for
    inviting us to be here today. I am very pleased to present the
    budget request for the Administrative Office of the United
    States Courts (AO). I will make some brief remarks and ask that
    my written testimony be included in the record.
        Senator Durbin. Without objection.
        Mr. Duff. Thank you.
        I join Judge Gibbons in thanking you for the additional
    funding provided the judiciary in the 2008 appropriations bill
    during such a tight funding environment. We sincerely
    appreciate your recognizing the impact enhanced border
    enforcement will have on the judiciary by providing emergency
    appropriations to address the additional workload. This funding
    will provide some staffing increases for courts whose workload
    is heavily impacted by immigration and other law enforcement
    initiatives.
        This is my second appearance before the subcommittee. I
    have now had the opportunity to work with this subcommittee and
    its staff through one full appropriations cycle and have
    appreciated being able to work closely with you as our
    requirements changed and your allocation was reduced during
    conference. I want to take particular note, Chairman Durbin, of
    the good working relationship that we have with the
    subcommittee and its staff. Just this week, for example, in our
    executive committee meeting at the Judicial Conference, we
    singled out our relationship with the subcommittee as an
    example of how we should interact with Congress. It is
    exemplary, and we very much appreciate the dialogue and the
    subcommittee's openness and willingness to talk with us. We
    hope to emulate it across the board in all of our dealings with
    Congress. It is something we are proud of and very much
    appreciate.

                       ROLE OF THE ADMINISTRATIVE OFFICE

        I will talk very briefly on a couple of items here. First,
    by way of background--and you may be familiar with this, but
    just briefly for the record--the AO was created by Congress in
    1939 to assist Federal courts in fulfilling the mission to
    provide equal justice under the law. It is a unique entity in
    Government. It does not operate as the headquarters for the
    courts. Court operations, as you know, are decentralized,
    although the AO provides administrative, legal, financial,
    management, program, security, information technology, and
    other support services to all the Federal courts.
        The AO also provides support staff and staff counsel to the
    Judicial Conference of the United States and its 25 committees
    and it helps implement Judicial Conference policies, as well as
    applicable Federal statutes and regulations. The AO has evolved
    over the years to meet the changing needs of the judicial
    branch. Service to the courts, however, will always remain our
    core function and mission.

                      REVIEW OF THE ADMINISTRATIVE OFFICE

        Last year I reported to you that I was assembling a small
    advisory group of judges and court executives to assist me and
    our new Deputy Director, Jill Sayenga, in a review of the
    organization and mission of the AO. The ad hoc advisory group
    confirmed that the AO is an organization of dedicated service-
    oriented professionals, but it also identified some areas where
    the AO's performance or ways of conducting business could be
    improved. Teams of AO managers have been assembled to plan and
    implement the recommendations.
        My goal is to ensure that the AO is the best and most
    efficient service organization in the Government. In supporting
    the courts, the AO frequently finds itself responding to new
    developments, such as the Booker and Fanfan Supreme Court
    decisions, or implementing the new bankruptcy legislation. And
    to do so, we work with court leaders to develop plans and
    processes for the judiciary to respond to new challenges.

                  CURRENT ISSUES AT THE ADMINISTRATIVE OFFICE

        Two developments on which we are currently responding are
    the impact of enhanced immigration enforcement on the courts,
    and implementation of the pilot program that you authorized
    last year under which the U.S. Marshals Service assumes
    responsibility from the Federal Protective Service for
    perimeter security at several designated courthouses.
        I will mention very briefly two other items.
        Last year I spoke about the efforts to improve our working
    relationship with GSA. I reported that substantial progress was
    being made and that we were working on significant changes in
    how GSA determines or calculates courthouse rents. Today, I am
    very pleased to report that we have successfully concluded the
    effort on determining how GSA calculates rent.
        On February 19, I signed a memorandum of agreement, which
    was cosigned by GSA's Public Buildings Service Commissioner,
    that changes the way rent will be calculated for all federally
    owned courthouses to be delivered in the future, and it also
    applies to 32 of our existing courthouses. Both the judiciary
    and GSA will benefit from knowing with certainty how much rent
    the judiciary has to pay and how much rent GSA will receive.
    Judiciary and GSA staff time and resources for contractor
    support to conduct and validate market appraisals will no
    longer be used.
        Next, I would also like respectfully to request that you
    consider providing assistance in solving our two major
    courthouse construction problems in San Diego and Los Angeles
    where market conditions and delays have increased the cost of
    these projects.

                        FISCAL YEAR 2009 BUDGET REQUEST

        And last, I would note that the fiscal year 2009
    appropriations request for the Administrative Office of the
    U.S. Courts is $82 million. This is an increase of $5.9
    million, or 7.8 percent. Although the increase we are seeking
    may appear significant, overall it represents a no-growth,
    current-services budget. The requested increase is exclusively
    to cover base adjustments to maintain current services. We are
    requesting no program increases.

                               PREPARED STATEMENT

        Chairman Durbin, I recognize that fiscal year 2009 will be
    another difficult year for you and your colleagues as you
    struggle to meet funding needs of the agencies and programs
    under your review. I look forward to working with you and your
    staff on meeting the needs of the Judiciary.
        Senator Durbin. Thanks, Mr. Duff.
        Mr. Duff. Thank you.
        [The statement follows:]

                      Prepared Statement of James C. Duff

                                  INTRODUCTION

        Chairman Durbin, Senator Brownback, and members of the
    subcommittee, I am pleased to appear before you this morning to present
    the fiscal year 2009 budget request for the Administrative Office of
    the United States Courts (AO) and to support the overall request for
    the entire Judicial Branch.
        First, I would like to join Judge Gibbons in thanking you and your
    Committee for the support you provided the Judiciary in the fiscal year
    2008 appropriations bill. In addition to the regular funding, we deeply
    appreciate your recognizing the impact enhanced border enforcement will
    have on the Judiciary by providing emergency appropriations to address
    the additional workload. In the aggregate, the funding will allow the
    Judiciary to provide some staffing increases in courts whose workload
    is heavily impacted by immigration and other law enforcement
    initiatives.
        This is my second appearance before the Financial Services and
    General Government subcommittee and I have now had the opportunity to
    work with this subcommittee and its staff through one full
    appropriations cycle. We recognize the very tight fiscal constraints in
    which you operate and appreciated being able to work closely with your
    staff throughout the process as our requirements changed and your
    allocation was reduced. I look forward to a continued productive
    relationship with your very able staff as we move through the year. I
    want to answer any questions you might have, and to describe the
    important needs of the Federal Judiciary.

                       ROLE OF THE ADMINISTRATIVE OFFICE

        In July 2006, I accepted the appointment of Chief Justice Roberts
    to become only the 7th Director of the Administrative Office of the
    United States Courts in its 69-year history. Created by Congress in
    1939 to assist the Federal courts in fulfilling their mission to
    provide equal justice under law, the AO is a unique entity in
    Government. Neither the Executive Branch nor the Legislative Branch has
    any one comparable organization that provides the broad range of
    services and functions that the AO does for the Judicial Branch.
        Unlike most Executive Branch agencies in Washington, the AO does
    not operate as a headquarters for the courts. The Federal court system
    is decentralized, although the AO provides administrative, audit, human
    resources, legal, financial, management, program, security, information
    technology and other support services to all Federal courts. It
    provides support and staff counsel to the policy-making body of the
    Judiciary, the Judicial Conference of the United States, and its 25
    committees, and it helps implement Judicial Conference policies as well
    as applicable Federal statutes and regulations. The AO carries out a
    comprehensive financial audit program to ensure the Judiciary expends
    its resources properly. It also coordinates Judiciary-wide efforts to
    improve communications, information technology, program leadership, and
    administration of the courts, and is leading the effort to contain
    costs throughout the Judiciary. Our administrators, auditors,
    accountants, systems engineers, personnel specialists, analysts,
    architects, lawyers, statisticians, and other staff provide
    professional services to meet the needs of judges and staff working in
    the Federal courts nationwide. The AO staff also respond to
    Congressional inquiries, provide information on pending legislation,
    and prepare Congressionally mandated reports.

                     ADMINISTRATIVE OFFICE INTERNAL REVIEW

        Last year I reported to you that I was assembling a small advisory
    group of judges and court executives to assist me and our Deputy
    Director, Jill Sayenga, in a review of the organization and mission of
    the AO. I wanted to ensure that the structure and services provided by
    the AO are appropriate and cost-effective, and that they address the
    changing needs of the courts. We examined our core mission of service
    to the courts as defined by statute and directives from the Judicial
    Conference to determine if internal adjustments were needed to improve
    efficiency and responsiveness.
        I am pleased to tell you the ad hoc advisory group confirmed that
    the AO is an organization of dedicated, service-oriented, capable
    professionals, but it did identify some areas where the AO's
    performance or ways of conducting business could be improved. The group
    provided practical and achievable recommendations on how to improve
    both the services of the AO to, and our working relationship with, the
    courts. To that end, teams of AO managers have been assembled to plan
    and implement the recommendations. Among other things, we will be
    reviewing internal operations, the deployment of our workforce, the
    best ways to obtain court input and advice, and improvements in
    communications with the courts and in working procedures. My goal is to
    ensure that the AO is the best service organization in the Government.
        Although the internal review was undertaken primarily to determine
    how well the AO currently fulfills its responsibilities, the ad hoc
    advisory group raised questions about the agency's continuing ability
    to deliver critical services, as well as its capacity to adapt to our
    court customers' future needs. Areas of concern include future
    budgetary constraints, the anticipated retirements of highly
    experienced and knowledgeable employees in senior management and
    technical positions, growing numbers of staff vacancies in critical
    areas, AO competitiveness in the labor market, the changing nature of
    work and required competencies, and the impact of change on employee
    morale.
        After reviewing carefully our operations for the past year-and-a-
    half, I am convinced that we require the current services level of
    staff and funding we request for fiscal year 2009 to provide adequate
    support to the courts. The services provided by the AO are critical to
    the effective operation of our Federal courts, and I hope you will
    continue to provide the resources we require.

                        ADMINISTRATIVE OFFICE CHALLENGES

        As I indicated when I testified last year, when I became Director
    in July 2006, I restricted recruitment actions for filling vacant
    positions to give me time to evaluate the organization, its mission,
    and priorities. Any exceptions for external recruitment were
    scrutinized carefully by an executive review committee and required my
    approval. I am pleased to report that, having completed this review,
    the hiring freeze has been partially lifted and critical vacancies are
    being filled.
        In the interim, with significant additional effort on the part of
    our existing staff, and at times with great difficulty, the AO
    continues to perform vital human resources and financial functions,
    implements the policymaking efforts of the Judicial Conference,
    monitors program performance and use of resources, develops and
    supports automated systems and technologies, collects and analyzes
    court workload statistics, coordinates construction and management of
    court facilities, defines court resource needs through caseload
    forecasts and work measurement analyses, monitors the U.S. Marshals
    Service's (USMS) implementation of the judicial facility security
    program, provides program leadership and support for court unit
    executives, develops and conducts education and training programs, and
    performs cyclical court audits and other financial and system audits to
    ensure integrity.
        In addition to striving to perform its fundamental responsibilities
    outlined above in the most efficient and effective matter, the AO must
    look beyond the immediate day-to-day needs of the courts. It is our
    responsibility to anticipate and plan for changes in workload,
    workforce demographics, legislative mandates and other areas so that we
    can serve the courts effectively in the years ahead.

                            PLANNING FOR THE FUTURE

        The AO frequently finds itself in uncharted waters. Whether it is
    responding to the Booker and Fanfan Supreme Court decisions or
    implementing the Bankruptcy Abuse Prevention and Consumer Protection
    Act, we are working with court leaders to develop plans and processes
    for the Judiciary to respond to new challenges. I highlight three of
    the initiatives on which we are currently working--responding to
    enhanced immigration enforcement, preparing to implement the
    retroactive application of the crack cocaine sentencing amendment, and
    implementing a pilot project you authorized last year under which the
    USMS assumes responsibility from the Federal Protective Service (FPS)
    for perimeter security at several designated courthouses. Judge
    Gibbons' testimony addresses the policy issues and impact on the
    Judiciary of these three initiatives. I would like to talk about the
    operational concerns and what the Administrative Office is doing to
    ensure the courts are prepared to support these efforts.

    Enhanced Immigration Enforcement
        Increased border enforcement is a priority of this Congress and the
    administration. We are grateful for your recognition that the Judiciary
    is integral to this effort by providing significant resources to the
    courts in 2007 and 2008 for us to respond to the resulting
    apprehensions and prosecutions. In addition to having the increased
    funding you provided, the Judiciary must plan and coordinate the
    management of the new workload effectively, particularly as Operation
    Streamline is implemented in more locations along the Southwest border.
    To that end, Administrative Office staff participated in a conference
    of top law enforcement officials from Southwest border districts and
    continue to maintain contact with executive branch personnel to ensure
    we are aware of and can respond to their priorities. Further, we have
    established a task force within the AO to facilitate the Judiciary's
    response to enhanced immigration enforcement and work with the
    Southwest border courts.
        In conversations with judges, court managers, and Federal
    defenders, particularly in the Southwest border districts, but also in
    districts throughout the country, we are finding that limitations
    beyond funding can make it difficult for courts to respond to the
    increased workload. Lack of space to hold court proceedings and to
    detain those apprehended, rising caseloads of Federal defenders,
    finding enough panel attorneys willing to accept these cases at the
    current non-capital hourly rate of $100, locating sufficient numbers of
    qualified interpreters, and hiring and retaining probation and pretrial
    services officers in the difficult work environment that exists along
    the Southwest border are all challenges that the AO, in coordination
    with the courts, is trying to address. These are difficult problems
    that will require creative and innovative solutions.
        AO staff, in collaboration with court personnel, are systematically
    developing an inventory of areas where we do not have all of the
    resources to address the existing and potential new workload. Initially
    we are focusing on the Southwest border districts, but these issues are
    not necessarily limited to the Southwest border. Many districts
    throughout the country are affected by enhanced immigration efforts,
    resulting in increased numbers of legal and illegal alien defendants in
    locations such as the Middle District of North Carolina, the Western
    District of Arkansas, Nebraska, Idaho, the Northern District of
    Georgia, Oregon, Colorado, and the Southern District of Iowa. This
    leads, for example, to a need for more interpreters in some districts
    where the availability is quite limited and the demand and supply have
    not existed previously. To resolve these issues, we will have to look
    beyond the traditional ways we have addressed these needs and develop
    innovative, creative solutions.

    Perimeter Security Pilot Program
        Another new endeavor for the AO is implementation of a pilot
    project whereby the USMS will assume FPS perimeter security
    responsibilities in selected court facilities. As Judge Gibbons stated
    in her testimony, we are very grateful that you have given us the
    opportunity to pursue this project and to ensure that the Judiciary has
    comprehensive and effective security in place.
        We are particularly troubled by the February 8, 2008, Government
    Accountability Office's (GAO) Preliminary Observations on the Federal
    Protective Service's Efforts to Protect Federal Property which found
    that FPS has not always maintained the security countermeasures and
    equipment it was responsible for, such as perimeter cameras, which may
    expose Federal facilities to a greater risk of crime or terrorist
    attack. This GAO report verifies the situation that Judge Gibbons
    described in testimony before this subcommittee last spring regarding
    perimeter security equipment for which FPS was responsible, but which
    was not maintained, fixed or replaced, despite FPS being paid by the
    Judiciary for that service. Please be assured that courthouses do not
    have these problems because of the security provided the Judiciary by
    the USMS. It is specifically for the reasons identified in the GAO
    report, however, as well as the need to have one entity responsible for
    security, that we raised concerns about FPS perimeter security last
    year. We are grateful that you responded by authorizing the pilot
    project. The test-site courts will be provided with a consistent level
    of perimeter security as is the case in the interior of courthouses,
    and will allow those courts to rely on the Marshals Service as its
    single provider of security services, rather than FPS.
        I would point out that GAO identified funding shortfalls as a
    primary cause of the FPS security deficiencies. This concerns us
    because, as you know, FPS is funded fully from the fees it charges
    other Government agencies for its security services. While we have
    suggested on several occasions that FPS receive a direct appropriation
    at a funding level Congress deems appropriate to secure Federal
    buildings, this proposal has not been pursued. Consequently, under the
    current funding scheme, any budgetary shortfall is borne by all Federal
    agencies in the form of increased fees, thus increasing the Judiciary's
    funding requirements, as well as those of the Executive Branch agencies
    under your jurisdiction.
        With regard to the pilot project, I assure you that AO staff are
    involved in every aspect of implementation and will be monitoring the
    project carefully. We have been on site at every pilot location to
    assess the level of security provided by FPS and to participate in
    determining the appropriate level of security to be provided by USMS.
    We are cognizant of the need to control costs during this pilot and for
    the future if it is determined that nationwide implementation is
    appropriate.

    Crack Cocaine Sentencing Retroactivity
        The last new area I would like to address is implementation of the
    retroactive application of the Federal sentencing guidelines amendment
    for crack cocaine offenses. This effort is similar to our response to
    enhanced immigration enforcement in that it involves many components of
    the Judiciary as well as Executive Branch entities, as Judge Gibbons
    mentioned in her testimony. The AO's role in this endeavor began in
    November, when we hosted a contingency planning meeting prior to the
    decision of the Sentencing Commission to apply the amendment
    retroactively. We invited chief probation officers from the districts
    with the largest number of crack cocaine cases to meet at the AO, and
    we invited officials of the Sentencing Commission, the Department of
    Justice, and the Bureau of Prisons to join us. The discussion centered
    around identifying offenders in prison who may be eligible for
    immediate release, and planning for the successful reentry into the
    community of those qualified for release. At the planning meeting, two
    chief probation officers volunteered to host large conferences in
    Charlotte, North Carolina, and St. Louis, Missouri, that would gather
    judges, probation officers, prosecutors, and Federal defenders from
    districts with a significant number of crack cocaine cases, and provide
    a forum to develop practical plans for dealing with the workload at the
    district level. The 2-day conferences included presentations by the
    Sentencing Commission, the Bureau of Prisons, the USMS, and also panel
    discussions with judges, prosecutors, and defenders. There was
    widespread agreement at the conferences that the courts involved are
    capable of meeting the challenges posed by the additional workload. To
    ensure that the valuable information discussed during these conferences
    was available to all judges and court staff, AO staff recorded the
    sessions and posted the video on the Judiciary's intranet site.
        In addition to the conferences, AO staff have worked to make
    implementation of the amendment easier for all of the courts. In
    coordination with the Sentencing Commission and the Judicial
    Conference's Committee on Criminal Law, AO staff developed a model
    order that can be used by the courts when resentencing inmates. This
    one-page form captures all of the information needed by the Commission
    and the Bureau of Prisons, and will allow judges and court staff to
    process the orders quickly. Also, databases used in the clerks offices,
    probation and pretrial services offices, and Federal public defenders
    offices to capture statistics and workload data related to crack
    cocaine resentencings have been updated. Additionally, AO staff have
    disseminated important information about Bureau of Prisons procedures
    to the courts. I am pleased to report that all of these efforts were in
    place prior to the March 3, 2008, effective date.

              PARTNERSHIP WITH THE GENERAL SERVICES ADMINISTRATION

        Last year when I testified before you I talked about my efforts to
    improve our working relationship with the General Services
    Administration (GSA). At that time I reported that substantial progress
    was being made and that we were working on significant changes in how
    GSA determines or calculates courthouse rents. Today, I am pleased to
    report that we have successfully concluded that effort. On February 19,
    2008, I signed a Memorandum of Agreement (MOA), co-signed by the GSA
    Public Buildings Service Commissioner, that changes the way rent will
    be calculated for all federally owned courthouses to be delivered in
    the future. This new methodology will also be applied to a limited
    number of courthouses that the Judiciary already occupies.
        The conventional approach that had been used to determine rent for
    most of our buildings, as well as those building occupied by other
    Federal tenants of GSA space, is based on appraisals of commercial
    space in the same rental market as the federally-owned building. Every
    5 years a new appraisal of the market was done and rental rates paid to
    GSA were adjusted accordingly. I would note that using this former
    ``fair market value'' method, in fiscal year 2009, the rent for the
    Court of International Trade, a GSA-owned building in Manhattan that is
    over 40 years old, will increase by $1.5 million or 30 percent, based
    on the 5-year cyclical reappraisal done by GSA.
        The MOA outlines a new process for determining rental rates based
    on a return on investment (ROI) methodology. Under the MOA, the rent
    will be fixed for the first 20 years of occupancy and will be set to
    return to GSA approximately 7 percent per year of its capital costs;
    operating costs will be adjusted annually to reflect GSA's actual
    operating expenses.
        We are pleased that this MOA has been signed for several reasons.
    First and foremost, it ushers in a new era of collaboration and
    cooperation between the Judiciary and GSA and demonstrates that by
    working together, we can resolve problems in a way that is mutually
    beneficial to both parties. Second, it provides the Judiciary with
    certainty about the amount of rent it will pay for a 20-year time
    period, rather than being subject to changes every 5 years as a result
    of changing commercial market conditions. Third, the amount of rent
    will be based directly on the capital resources the Judiciary consumes,
    i.e., how much it costs to construct the building, rather than on
    periodic assessments of market rents in nearby commercial office
    buildings. Finally, with GSA agreeing to an ``open-book'' accounting of
    costs, the Judiciary will not have to hire consultants and expend
    considerable staff time reviewing appraisals based on subjective
    opinions of market value.
        I have just outlined the many benefits that the Judiciary will
    enjoy under this MOA. Because this subcommittee also has jurisdiction
    over the General Services Administration, I assure you that GSA will
    also benefit from the provisions of the MOA. Specifically, GSA will
    have a guaranteed return on investment at a set rate with no market
    risk or vacancy risk. As mentioned above, under appraisal pricing,
    every 5 years the rate is reset. These reappraisals result in rent
    decreases as well as increases, so should market conditions be lower
    than the previous appraisal, GSA would get less rent. Also, under the
    MOA, the Judiciary is assuming the vacancy risk in the ROI buildings.
    That is, the Judiciary will pay the same rent over the 20-year time
    period even if space becomes vacant in the building. Consequently, GSA
    will not lose rental income until such time that it could backfill the
    space with another tenant. Finally, GSA will no longer have to respond
    to challenges to the fairness and validity of the rent determination
    process, which has led to criticism, tension, and unexpected reductions
    in the Federal Buildings Fund when GSA refunded overcharges to the
    Judiciary.

                            COURTHOUSE CONSTRUCTION

        I next will discuss another facility-related issue--the status of
    our courthouse construction needs. We appreciated your willingness to
    fund new courthouse construction projects requested by the Judicial
    Conference in fiscal year 2008 even though the administration did not
    include them in the President's budget. We find ourselves in a similar
    situation this year with the President's budget only requesting the
    additional funds needed for the San Diego courthouse. Despite
    reductions in the scope of the San Diego project, costs have increased
    significantly over the original GSA projections because of changing
    market conditions and the construction boom in California. The project
    has been delayed several years and is critically needed in this
    California Southwest border district because the existing courthouse is
    out of space.
        As you know, we have another courthouse problem in Los Angeles.
    California (Central) is the largest district in the country and current
    facilities are seriously inadequate. Because of market conditions and
    delays, the cost of the Los Angeles project far exceeds GSA's original
    estimates. Despite the sizable reductions in scope made by the court,
    the cost of this project continues to grow and will only get more
    expensive as time passes. The AO, the court, and GSA have been working
    together to find a solution. While we recognize how costly this project
    is, especially in a time of constrained resources for non-security
    discretionary programs, we believe the final project design must
    address long-term needs and provide an environment in which the
    judicial process can function safely and effectively. We also want to
    ensure that when alternatives are considered, all costs associated with
    the options are included in the analysis. Consequently, we are pleased
    that GAO has been asked to conduct a review of this project and trust
    that it will address all aspects of the issue. We also look forward to
    collaborating with GSA on the report this subcommittee asked it to
    provide and trust that our views will be reflected fully. I have stated
    on numerous occasions that the situation in Los Angeles is an
    extraordinary problem that may ultimately warrant an extraordinary
    solution.
        Finally, we respectfully request that you consider the new
    courthouse construction projects included on the Judicial Conference
    approved Five-Year Courthouse Project Plan for fiscal years 2009-2013,
    a copy of which is attached to this Statement. As I mentioned, none of
    these projects is included in the President's 2009 budget request, yet
    they have been on the Five Year Plan for a number of years. Most of the
    projects have sites, have been or soon will be designed, and are
    awaiting construction funding. Every year a project is not funded its
    cost increases by about 10 percent based solely on inflation. We
    appreciate your consideration of these needs.

             ADMINISTRATIVE OFFICE FISCAL YEAR 2009 BUDGET REQUEST

        Last I will address the fiscal year 2009 appropriations request for
    the Administrative Office of the United States Courts which is
    $81,959,000. This represents an increase of $5,923,000, or 7.8 percent,
    over fiscal year 2008 enacted appropriations. Although the percentage
    increase in appropriations we are seeking may appear significant,
    overall it represents a no-growth, current services budget request. I
    note this request funds 6 percent fewer staff than were funded in 1995
    even though court staffing has increased almost 14 percent over the
    same time period.
        The AO's appropriation comprises less than 2 percent of the
    Judiciary's total budget, yet the work performed by the AO is critical
    to the effective operation of the U.S. Courts. In addition to the
    appropriation provided by this Committee, as approved by the Judicial
    Conference and the Congress, the AO receives non-appropriated funds
    from sources such as fee collections and carryover balances to offset
    appropriation requirements. The AO also receives reimbursements from
    other Judiciary accounts for information technology development and
    support services that are in direct support of the courts, the court
    security programs, and defender services.
        The requested increase of $5.9 million is exclusively to cover base
    adjustments to maintain current services; the AO requests no program
    increases. Over half of the increase is to fund the proposed fiscal
    year 2009 pay adjustment and to annualize the fiscal year 2008 pay
    adjustment. The balance is for inflationary adjustments and to replace
    non-appropriated funds (carryover) that were used to finance the fiscal
    year 2008 financial plan, but which at this time are expected to
    decline in fiscal year 2009. If carryover is not replaced with direct
    appropriated funds, we would be forced to reduce current on-board
    staffing. This would, in turn, adversely affect our ability to carry
    out the AO's statutory responsibilities and serve the courts. We will
    keep you apprised of actual carryover estimates as the year progresses.
    Should carryover surpass our estimates, the amount of appropriations we
    are requesting could be reduced.

                                   CONCLUSION

        Chairman Durbin, Senator Brownback, members of the subcommittee, I
    have shared with you only a few examples of the diverse issues we
    handle and the type of services and support the Administrative Office
    provides the Federal Judiciary. In addition to our service to the
    courts, the AO works closely with the Congress, in particular, the
    Appropriations Committee and its staff, to provide accurate and
    responsive information about the Federal Judiciary. I recognize that
    fiscal year 2009 will be another difficult year for you and your
    colleagues as you struggle to meet the funding needs of the agencies
    and programs under your purview. I urge you, however, to consider the
    significant role the AO plays in supporting the courts and the mission
    of the Judiciary. Our budget request is one that does not seek new
    resources for additional staff or programs. I hope you will support it.
        Thank you again for the opportunity to be here today. I would be
    pleased to answer your questions.

                                   Attachment

       FIVE-YEAR COURTHOUSE PROJECT PLAN FOR FISCAL YEARS 2009-2013 AS APPROVED BY THE JUDICIAL CONFERENCE OF THE
                                             UNITED STATES ON MARCH 11, 2008
                                             [Estimated dollars in millions]
    ----------------------------------------------------------------------------------------------------------------
                                                                                                          Estimated
                                                                                   Cost        Score      net annual
                                                                                                             rent
    ----------------------------------------------------------------------------------------------------------------
    Fiscal year 2009:
        Austin, TX..........................  Add'l S&D/C....................       $114.0         82.0         $6.5
        Salt Lake City, UT..................  C..............................        168.5         67.9         11.4
        Savannah GA.........................  Add'l. D.......................          2.0         61.3          3.5
        San Antonio, TX.....................  S..............................         18.0         61.3          9.2
        Mobile, AL..........................  Add'l. S /C....................        181.5         59.8          4.7
                                                                              --------------------------------------
          TOTAL.............................  ...............................        484.0  ...........         35.4
                                                                              ======================================
    Fiscal year 2010:
        Nashville, TN.......................  Add'l D/C......................        164.6         67.3          7.0
        Cedar Rapids, IA....................  Add'l D/C......................        136.8         61.9          6.1
        Savannah GA.........................  C..............................         52.4         61.3          3.5
        San Jose, CA........................  Add'l S........................         32.0         54.5          9.4
        Greenbelt, MD.......................  S&D............................         10.5         53.8          1.6
                                                                              --------------------------------------
          TOTAL.............................  ...............................        396.3  ...........         27.5
                                                                              ======================================
    Fiscal year 2011:
        San Antonio, TX.....................  C..............................        160.8         61.3          9.2
        Charlotte, NC.......................  C..............................        106.1         58.5          7.1
        Greenville, SC......................  C..............................         66.4         58.1          4.1
        Harrisburg, PA......................  C..............................         48.1         56.8          5.4
        San Jose, CA........................  D..............................         14.4         54.5          9.4
                                                                              --------------------------------------
          TOTAL.............................  ...............................        395.8  ...........         35.2
                                                                              ======================================
    Fiscal year 2012:
        Norfolk, VA.........................  C..............................         87.8         57.4          5.1
        Anniston, AL........................  C..............................         17.1         57.1          1.1
        Toledo, OH..........................  C..............................         91.8         54.4          5.9
        Greenbelt, MD.......................  C..............................         59.0         53.8          1.6
                                                                              --------------------------------------
          TOTAL.............................  ...............................        255.7  ...........         13.8
                                                                              ======================================
    Fiscal year 2013: San Jose, CA..........  C..............................        188.0         54.5          9.4
                                                                              --------------------------------------
          TOTAL.............................  ...............................        188.0  ...........          9.4
    ----------------------------------------------------------------------------------------------------------------
     S = Site; D = Design; C = Construction; Add'l. = Additional.
     In fiscal year 2004, GSA requested only design funds for San Antonio, TX, which was planned to be built on a
      federally owned site. GSA advises that a privately owned site will be needed, which, therefore, requires
      funding to acquire a site.
     All cost estimates subject to final verification with GSA.

                  FEDERAL PROTECTIVE SERVICE AND PILOT PROJECT

        Senator Durbin. Let me go to some questions here, if I can.
        Judge Gibbons, last year when there was testimony about the
    adequacy or inadequacy of the Federal Protective Service, we
    did have a meeting and discussed options, and one of those was
    to extend perimeter security responsibility to the U.S.
    Marshals in seven different instances of primary courthouses.
    In your testimony, you indicated the pilot will begin in the
    fourth quarter of 2008 and will be in effect for 18 months.
        I have a couple questions for you. Why did it take so long?
    Why could it not begin earlier? And second, has the performance
    of the Federal Protective Service in other places--these in
    particular and other places as well--improved during the past
    year?
        Judge Gibbons. To answer the second part of it first, we
    are not aware of any improvements. In fact, you may be aware
    that there was a Government Accountability Office (GAO) report
    that addressed perimeter security at Federal buildings
    generally, not court facilities in particular, and its findings
    seemed similar to our observations, although the judiciary was
    not specifically mentioned or consulted in the course of the
    report.
        Why did it take so long? I am not sure I can answer that
    directly other than in Government, these things take a while.
    What has to happen in each particular facility is an assessment
    of the needs, acquisition of the necessary equipment, and the
    hiring of the necessary personnel. These, of course, are court
    security officers who would not be already on board, and they
    must have the background checks, all the vetting that
    accompanies law enforcement or security-type employees. That is
    my supposition.
        [The statement follows:]

        While the Senate's version of the Judiciary's fiscal year
    2008 appropriations bill included a provision establishing the
    pilot project, the House version of the bill did not include
    such a provision. The pilot project provision was included in
    the final conference agreement on the omnibus appropriations
    bill which was enacted into law on December 26, 2007. The
    Judiciary and the U.S. Marshals Service (USMS) took preliminary
    steps regarding the pilot project prior to and after the Senate
    Appropriations Committee reported its bill with the provision
    in July 2007, but enactment of the 2008 omnibus bill was needed
    in order to take definitive steps to implement the pilot
    project.
        The current plan is to initiate contracting actions for
    both security systems and court security officers at all sites
    during fiscal year 2008. Due to contractual timelines, however,
    most sites will probably not be fully transitioned and ready
    for implementation until the first quarter of fiscal year 2009.
    A pilot site will only be implemented when it can be
    accomplished in a manner that is satisfactory to the local
    court, the USMS, and the Committee on Judicial Security. The
    actual implementation at each site will also need to take into
    consideration the length of time necessary for the USMS to:
    medically screen court security officer applicants; conduct
    background investigations; provide the necessary notification
    to the security companies that provide the FPS contract guards
    to stop service; and to assume control of the FPS security
    systems and equipment, which can vary by location.
        The Moynihan Courthouse pilot was implemented in March 2008
    although that site, unlike the other six sites, only involved
    bringing FPS equipment under USMS control. For the six
    remaining sites, in addition to bringing FPS equipment under
    USMS control, each will also require the hiring of additional
    court security officers which can take several months to
    accomplish. Of these six sites, the Dirksen Courthouse will be
    the next brought online. The USMS and the Committee on Judicial
    Security will conduct formal evaluations periodically
    throughout the pilot period to assess whether the program's
    goals are being met and to identify areas for improvement.
    Congress will be kept apprised of the program's status. The
    seven sites selected for the pilot and their planned
    implementation date are detailed in the table below.

    ------------------------------------------------------------------------
                  Pilot Site                   Planned Implementation Date
    ------------------------------------------------------------------------
    Daniel Patrick Moynihan U.S.            Implemented March 2008
     Courthouse, New York, NY.
    Everett McKinley Dirksen U.S.           September/October 2008
     Courthouse, Chicago, IL.
    Sandra Day O'Connor U.S. Courthouse,    October/November 2008
     Phoenix, AZ.
    Evo A. DeConcini U.S. Courthouse,       October/November 2008
     Tucson, AZ.
    Russell B. Long Federal Building/U.S.   October/November 2008
     Courthouse, Baton Rouge, LA.
    Old Federal Building and Courthouse,    October/November 2008
     Baton Rouge, LA
    Theodore Levin U.S. Courthouse,         November/December 2008
     Detroit, MI.
    ------------------------------------------------------------------------

                                 COURT SECURITY

        Senator Durbin. Let us go to the issue of the adequacy of
    the Marshals Service in gauging threat assessments against
    Federal judges and courthouses. The Justice Department's
    inspector general came up with a list of six recommendations to
    improve the protection of the judiciary. Five I understand were
    implemented. One that was not related to whether or not the
    Marshals Service should be notified, in addition to local law
    enforcement authority, of any alarm events at the home of a
    Federal judge. This is, of course, of special interest to us in
    Chicago because of the tragedy involving Judge Joan Lefkow's
    family not that long ago.
        Does the judiciary have an opinion about whether dual
    notification of both law enforcement and the Marshals Service
    is necessary when a home alarm goes off?
        Judge Gibbons. I am not aware of whether we have taken a
    formal position about that. Perhaps Director Duff knows. But I
    am aware, at least in the district court where I formerly
    served in Memphis and where I am still in the same building,
    that in that particular district, the marshals are notified
    because I am aware of an incident that occurred last week in a
    district judge's home.
        Senator Durbin. If you could find out whether any formal
    position has been taken and let us know, we would appreciate
    it.
        Judge Gibbons. We will certainly supplement the record.
        Senator Durbin. And what is the general reaction of the
    judiciary to this home protection system that we have underway?
        Judge Gibbons. We are very grateful for it.
        Senator Durbin. Well, that is good to hear.
        [The information follows:]

        The Judicial Conference's Committee on Judicial Security
    has discussed the recommendation in the Department of Justice
    Inspector General's report concerning the response to home
    intrusion detection system alarm events at judges' residences.
    The Committee concluded that, in general, local law enforcement
    personnel are best suited to respond to an alarm; however, the
    Committee also supports appropriate coordination with the U.S.
    Marshals Service of instances that warrant further
    investigation.

                            COURTHOUSE CONSTRUCTION

        Senator Durbin. Now let us talk about courthouse
    construction. The fiscal year 2009 budget from the President
    provides funding for only one courthouse, the courthouse annex
    in San Diego. In fiscal year 2005, 4 years ago, San Diego was
    one of four emergency projects on the judiciary's revised 5-
    year courthouse project plan. Due to increased construction
    materials costs, the scope of the project was reduced, but the
    project still requires $110 million as requested by the
    President in fiscal year 2009 in order to be completed.
        Why do emergency projects such as this not appear on the
    judiciary's updated 5-year plan?
        Mr. Duff. If I might answer that one, Mr. Chairman. It is
    because they require additional funding that needs to be sought
    by GSA. Our 5-year plan identifies the top priorities each year
    for new courthouse construction funding. What happened with
    regard to San Diego, as well as Los Angeles, is they
    encountered difficulties hiring construction companies within
    the funding that was provided to build the courthouse. The
    delays in construction have caused the cost to escalate
    enormously, particularly in California. And it then becomes
    GSA's responsibility to seek that additional funding, and while
    we fully support the additional funding for the new courthouses
    in San Diego and Los Angeles, they do not go back on our 5-year
    plan list. As I said, the GSA is responsible for seeking the
    additional funding for those courthouses.

                                 SENIOR JUDGES

        Senator Durbin. I want to ask a question for the record on
    the budgetary impact of judges seeking senior status. I
    understand that when judges become eligible, they decrease
    their workload by 50 percent and relocate to other office
    space, freeing up their former space and staff for existing
    full-time judges. The senior judge is entitled to new staff,
    three law clerks and one administrative staffer. So all this
    results in requiring more resources.
        How many judges are currently eligible for senior status?
        Judge Gibbons. I am not sure about that, and perhaps
    Director Duff can answer that.
        But I do want to comment on an assumption that the question
    makes. Senior judges may take a 50 percent caseload. They may
    take a full caseload and some do. They may take variations on
    those two. Their space may become available. If they are taking
    a full caseload, the space likely does not become available,
    particularly if they are an appellate judge. Their need for
    staff and their need for space are assessed in most circuits
    according to the caseload they happen to be taking. So it is
    not really just a one-profile situation. There are many, many
    variations on both the caseload they take, the staff they have,
    and the space they occupy.
        Senator Durbin. Mr. Duff, do you know?
        Mr. Duff. I do. As of December 31, 2007, there were 473
    Article III senior judges, and 92 active judges were eligible
    to take senior status. An additional 48 currently active judges
    have senior status eligibility dates between January 1, 2008,
    and December 31, 2008. Whether those 48 will choose to take
    senior status, of course, remains to be seen.
        Senator Durbin. But it sounds, in most instances, that
    choosing senior status will require more resources.
        Mr. Duff. Yes, in the sense that when a judge takes senior
    status, a new judge may be appointed, and so that does require
    additional resources.
        Judge Gibbons. But that is really too simplistic because if
    they are continuing to do work, that alleviates our need for
    new judgeships which come with accompanying space and staff
    needs. I believe about 17 percent of the overall work of the
    Federal judiciary is performed by senior judges.
        Mr. Duff. Yes. That is an important figure. Without our
    senior judges, we would be overwhelmed with work.
        [The information follows:]

        While there are staff and space costs associated with a
    judge taking senior status, it is important to emphasize that
    senior judges are essentially volunteering their time in
    continued service to the federal judiciary. A judge eligible
    for senior status could otherwise choose to retire and leave
    office at the same pay without rendering any judicial service
    at all. But over 400 appellate and district court judges forego
    full retirement, and instead take senior status and continue
    taking cases. They are essential to the work of the federal
    courts. In 2007, senior judges participated in 19 percent of
    cases terminated on the merits in the appellate courts. In the
    district courts, senior judges handled 18 percent of the civil
    and criminal caseload. Both of these statistics are at the
    highest level in a decade.
        The number of senior judges working in the courts does
    impact the number of new judgeships the Judicial Conference
    requests from Congress. If the Judiciary were to see a sharp
    dropoff in the number of senior judges working in the courts,
    it would likely result in more judgeships being requested from
    Congress in order to make up for the lost productivity
    resulting from fewer senior judges.

                   COURTS OF APPEALS FOR THE FEDERAL CIRCUIT

        Senator Durbin. The Federal Circuit is requesting an almost
    20 percent, or $5.3 million, increase in the budget for next
    fiscal year. The largest part of this, $2.5 million, appears to
    be for staffing and leased office space and build-out for
    senior judges.
        What is the space situation at the Federal Circuit and what
    is the status of judges going to senior status? Is that
    included in the original number that you gave me?
        Judge Gibbons. Well, actually as you know or may know, the
    Federal Circuit has the statutory authority to submit its own
    budget directly to Congress, and its budget does not go through
    the process of approval by the Judicial Conference, nor is it
    subject to the oversight of the Budget Committee. We do ask for
    its submission, along with our own. But I would prefer to let
    that court respond to its own budget submission.
        Senator Durbin. I see. So you do not talk to those people.
        Judge Gibbons. We do talk to them. I just think it
    appropriate that they be their own advocates.
        [The information follows:]

        The United States Court of Appeals for the Federal Circuit
    has requested in fiscal year 2009 an adjustment to the base
    appropriation to lease chambers workspace outside the
    courthouse for senior judges for whom there is no remaining
    space in the courthouse.
        This increase for leased space, in the amount of $298,000,
    will help enable the Court to provide the workspace necessary
    for up to five additional senior judges for whom there is no
    remaining space in our courthouse. Four Federal Circuit judges
    are eligible to take senior status now, three more will become
    eligible in fiscal year 2009, and another judge will become
    eligible in fiscal year 2010.
        In addition, the Federal Circuit has also requested
    $1,860,000 to build out leased chambers for five of the seven
    judges who either are now or will be eligible to take senior
    status in fiscal year 2009 (plus an eighth judge eligible and
    expected to take senior status in fiscal year 2010) and for
    whom there is no room in the existing courthouse. This amount
    is based on an estimate coordinated with the Administrative
    Office of the United States Courts and on personal experience
    with GSA in renovating chambers in this courthouse. This amount
    will provide the leased chambers with the furniture,
    furnishings and finishes consistent with the U.S. Courts Design
    Guide.
        In fiscal year 2009 the Federal Circuit will have seven
    judges who are or will be eligible to take senior status.
    Currently, the Federal Circuit has no additional space
    available in the National Courts Building for senior judge
    chambers, and has no off-site leased space for senior judge
    chambers. If any of the seven judges who are or will be
    eligible to take senior status in fiscal year 2009 do so, there
    will be no available chambers for them in the National Courts
    Building or in off-site leased space once a replacement judge
    is confirmed. At least two of the seven judges who will be
    eligible for senior status are expected to take senior status
    when they become eligible in fiscal year 2009. It is imperative
    that the Federal Circuit acquire off-site leased chambers for
    the two judges who have indicated a desire to take senior
    status in fiscal year 2009.
        By fiscal year 2010, eight of the twelve active judges on
    the Federal Circuit will be eligible to take senior status. If
    the Federal Circuit acquires off-site chambers for senior
    judges one chambers at a time, only after the President has
    been notified a judge is taking senior status, the Federal
    Circuit could have senior judges occupying off-site leased
    space in eight different locations around Washington, DC,
    perhaps far from the courthouse. Accordingly, the Court is
    working with the General Services Administration and the
    Administrative Office of the U.S. Courts to identify and lease
    nearby space off-site this year (fiscal year 2008) to
    accommodate up to five senior judges. Five is a mid-range
    number the Court believes to be reasonable in providing space
    for fewer than all prospective senior judges but more than none
    or one. The number will allow for changes in decision by judges
    based on health or other personal issues without over-reaching
    by seeking off-site space for every eligible judge who may or
    may not choose to take senior status. Five will allow for
    economies of scale in long-term leasing and building out
    prospective chambers while reducing the risk of leaving space
    unoccupied.

                      SUPREME COURT MODERNIZATION PROJECT

        Senator Durbin. The care of the buildings and grounds
    fiscal year 2009 appropriation request totals $18.4 million, an
    increase of $6.2 million over the 2008 appropriation level.
    Modernization of the Supreme Court construction project began
    in 2004 and expected completion is the fall of this year, a
    total cost of $122.3 million.
        Can you tell me in the most general terms--I do not want
    you to talk about security, obviously--what was achieved with
    the expenditure?
        Mr. Duff. Mr. Chairman, that was the Supreme Court?
        Senator Durbin. Yes.
        Mr. Duff. They submit their own budget request, and as I
    understand it, they have a hearing tomorrow, at least over on
    the House side. I am sure they will be pleased to respond
    directly to the question. We can submit it to them for their
    response. But their budget request is separate from the Federal
    courts generally.
        [The information follows:]

        In 2004, the Architect of the Capitol commenced a major
    project to provide the first significant renovation of the
    Supreme Court building since it was constructed in 1935.
        Phase I of the project--the construction of the underground
    police annex, the Architect of the Capitol (AOC) shop and
    parking areas--was completed in late 2005. Phase II of the
    project--the interior building modernization--is ongoing and
    includes updated life safety systems, windows, mechanical,
    electrical, and plumbing systems. The work on one of the four
    building quadrants is complete. The second quadrant is
    scheduled for completion during the summer of 2008.
        The contractor's projected completion date for the entire
    modernization project is September 2009. The Court and the AOC
    project team believe, however, that this estimate is overly
    optimistic and that the project will be completed in the summer
    of 2010. Although the building modernization project is more
    than a year behind, the project continues to be within budget.
        The fiscal year 2009 appropriation request of $18.4 million
    also includes funding for two projects in addition to the
    modernization project: (1) landscape expenses, including
    repairs of driveways and walkways; and (2) the continuation of
    roof repairs. The Architect of the Capitol expects to request
    additional funds for roof repairs through fiscal year 2011.

        Senator Durbin. And before anyone is critical of this 4-
    year construction timetable for the Supreme Court, let me tell
    you we are still anxiously awaiting the opening of the Capitol
    Visitor Center which, according to the most recent report, will
    be done manana.

              RETROACTIVITY OF CRACK COCAINE SENTENCING AMENDMENT

        I would like to ask about the retroactivity of crack
    cocaine sentencing. The U.S. Sentencing Commission promulgated
    sentencing guidelines that Federal trial court judges consult
    when sentencing defendants. Last year, the Commission amended
    Federal guidelines, reducing offenses under Federal sentencing
    guidelines for crack cocaine. Furthermore, the Commission
    unanimously decided to make the policy change retroactive and
    the retroactivity became effective March 3 of this year.
        Judge Gibbons, regarding the retroactivity of crack cocaine
    sentencing, is it correct that you expect not to need
    additional resources despite a surge of motions for reductions
    in sentence?
        Judge Gibbons. That is correct. There will be a lot of
    defendants processed with requests for resentencing by the
    Federal courts. And we know that obviously resources will be
    required to process those. Probably the biggest resource
    challenge will be for our probation officers who will have an
    increase in the numbers of individuals they will be supervising
    as a result of this. But we do believe that we can likely
    handle it within existing resources. If you want a more
    detailed explanation about why we think that to be so, I will
    be happy to go into it in more detail.
        Senator Durbin. I appreciate it.
        Will crime victims be notified of an inmate's release, and
    will they have an opportunity to provide comment to the court
    prior to an inmate's release?
        Judge Gibbons. I do not think that it is required in the
    same way that victim notification is required in terms of an
    initial sentencing. But if I am incorrect about that, we will
    certainly let you know.
        [The information follows:]
    The Judiciary's Ability to Absorb Retroactivity Workload
        While the U.S. Sentencing Commission estimates that approximately
    19,000 inmates sentenced under the previous crack cocaine sentencing
    guidelines may be eligible for a reduced sentence as a result of
    retroactive application of the revised sentencing guidelines, it is
    important to note that these 19,000 would potentially be released over
    the course of 30 years. The Commission estimates that 3,804 of the
    19,000 offenders would be eligible for a reduced sentence and early
    release within the first year of the effective date for retroactivity
    (March 3, 2008). In year two another 2,118 would be eligible, 1,967
    more in year three, 1,773 more in year four and 1,353 more in year
    five. The remaining offenders would be eligible in year six and after.
    These filings will be handled by various district court components,
    including district judges, clerks offices, probation offices, and
    federal defender offices. The Judiciary believes retroactivity will
    have the greatest impact on its probation offices, which will supervise
    any crack cocaine offenders that may be granted early release,
    including overseeing any drug testing and treatment needs that may be
    imposed by a court as a condition of release.
        It is generally agreed that a large number of motions for a
    reduction in sentence will not involve court hearings and will be
    decided on written filings, so the courts' workload associated with
    processing those cases should not be unduly burdensome. The cases that
    require hearings will require more court resources. At present, no
    extraordinary measures have been necessary to address the increased
    workload due to retroactivity, although additional resources will be
    available if needed for smaller districts that may be
    disproportionately impacted by the number of federal offenders seeking
    a reduction in sentence based on retroactivity. Given all of these
    factors, and the staggered nature of offenders becoming eligible for a
    reduced sentence, the Judiciary believes it can absorb the additional
    workload within existing resource levels by shifting funds as necessary
    to meet workload demands, including ensuring that released offenders
    receive close supervision by a probation officer.
    Victim Notification of Early Release
        Judges have been asked by the Bureau of Prisons (BOP) to delay for
    10 days the effective date of any sentence reduction that results in an
    inmate's immediate release. This delay is needed, in part, to give the
    BOP adequate time to notify victims and witnesses of the offender's
    release, as they are required to do per 18 U.S.C. Sec. 3771. The
    Judiciary is unaware if the Department of Justice will attempt to
    contact victims to seek comment prior to an inmate's release. It should
    also be noted that due to the nature of these offenses, most cases will
    not have an identifiable victim within the meaning of the Crime Victim
    Rights Act.

                         WORKLOAD IN THE FEDERAL COURTS

        Senator Durbin. Statistics indicate the caseload is
    projected to decline in some areas, criminal, appellate, civil.
    What is the impact of this on the workload in the courts?
        Judge Gibbons. Well, obviously, over time our workload has
    trended upward. We are expecting and projecting declines in a
    number of areas. Those are projections done with statistical
    models.
        Obviously, there will be impacts in all areas. We are
    expecting bankruptcy filings to continue to trend back upward.
    What happens with the economy will be a major factor likely in
    what happens with bankruptcy filings. We are expecting at least
    modest increases in supervision activity by probation and
    pretrial services officers. We are projecting modest declines
    in criminal caseload across the country, without regard to what
    may happen in border States and other areas with heavy illegal
    immigration impact, and modest declines in appellate cases, and
    a somewhat slightly steeper decline in civil filings. But what
    happens one year is not necessarily what happens the next year.
        [The information follows:]

        Although the Judiciary's workload has begun to level off,
    workload in the federal courts has increased considerably in
    nearly all workload categories when viewed over a 10 year
    perspective. As summarized in the table below, from 1997 to
    2007, criminal filings increased 37 percent, the number of
    criminal defendants grew 27 percent, offenders under
    supervision of a federal probation officer increased 27
    percent, the number of cases activated in the pretrial services
    program increased 37 percent, and appellate filings grew 13
    percent. Civil filings follow a more up-and-down filing pattern
    from year to year and grew 3 percent overall in the last
    decade. Bankruptcy filings are down nearly 566,000 filings from
    the 1997 level due in large part to the sharp decline in
    filings after the Bankruptcy Abuse Prevention and Consumer
    Protection Act took effect in October 2005.

    ----------------------------------------------------------------------------------------------------------------
                                                                                                           Percent
                          Workload Factor                        1997 Actual  2007 Actual   Change 2007  Change 2007
                                                                     \1\          \1\        vs. 1997      vs. 1997
    ----------------------------------------------------------------------------------------------------------------
    Criminal Filings...........................................       49,376       67,503       18,127            37
    Criminal Defendants Filed..................................       69,052       88,006       18,954            27
    Probation: Persons Under Supervision.......................       91,423      115,930       24,507            27
    Pretrial Services: Cases Activated.........................       69,959       95,955       25,996            37
    Appellate Filings..........................................       52,271       58,809        6,538            13
    Civil Filings..............................................      265,151      272,067        6,916             3
    Bankruptcy Filings.........................................    1,316,999      751,056     (565,943)          -43
    ----------------------------------------------------------------------------------------------------------------
    \1\ Data reflects the 12-month period ending June of each year.

                        PAY FOR BANKRUPTCY CASE TRUSTEES

        Senator Durbin. On the subject of bankruptcy, I am still
    baffled, troubled, and find it hard to explain that a chapter 7
    bankruptcy trustee receives $60--$60--for presiding in a no-
    asset case. We recently proposed raising that to $120.
        Do you believe the bankruptcy trustees are entitled to a
    raise in compensation in no-asset cases?
        Judge Gibbons. Well, I am not sure. Can we get back to you
    on that? I have some information about it somewhere in this
    material, but you probably do not want to sit there while I try
    to locate it. And it is not coming to the top of my head
    whether we have a position about that or not.
        Senator Durbin. It is not a trick question.
        Judge Gibbons. No, I know.
        Senator Durbin. We will let you provide that later.
        [The information follows:]

        The Judicial Conference has no position on the amount of
    compensation Congress deems appropriate for chapter 7 case
    trustees. However, the Judiciary in the past has expressed its
    opposition to any case trustee compensation increase that is
    made at the Judiciary's expense. If the Judiciary were required
    to pay the case trustees an additional $60 per case and did not
    receive a specific appropriation for that purpose, it would
    cost the Judiciary $30 million which could mean the loss of 375
    FTEs.

        Senator Durbin. Unless there is anything further you would
    like to add, I want to thank you for participating in this
    hearing. I appreciate all of the work you did to prepare your
    testimony and to answer my questions. I think this forum has
    given us some further insights into judiciary operations.

                         ADDITIONAL COMMITTEE QUESTIONS

        The hearing record is going to remain open for a period of
    1 week until Wednesday, March 19 at noon for subcommittee
    members to submit statements and/or questions for the record,
    which we hope you can answer in a timely fashion.
        [The following questions were not asked at the hearing, but
    were submitted to the judiciary for response subsequent to the
    hearing:]

                Questions Submitted by Senator Richard J. Durbin

                     COURT SECURITY--U.S. MARSHALS SERVICE

        Question. Your fiscal year 2009 budget request seeks 17 new U.S.
    Marshals positions (9 FTE). Why are these additional positions needed?
    Are they new positions or are they replacing vacancies?
        Answer. For fiscal year 2009, the U.S. Marshals Services (USMS)
    requests 17 new Judiciary-funded positions (9 FTE) for a total of 64
    full-time positions (56 FTE). These are new positions, not backfills.
    The Judiciary currently funds 47 full-time USMS positions to administer
    the Judicial Facility Security Program. This program includes the
    Office of Court Security, which is responsible for the daily operations
    and personnel management of the court security officer (CSO) program;
    the Office of Security Contracts, which is responsible for the daily
    contract responsibilities with the private contractors and the district
    contracting officer's technical representatives; the Office of Security
    Systems, which is responsible for all security and monitoring systems
    for judicial space; and the Office of Financial Management, which is
    responsible for the daily oversight responsibility on financial
    matters.
        A summary of the requested positions is listed below:
      --The Office of Security Systems requests funding for five additional
            physical security specialists and one administrative assistant/
            management support specialist in order to keep up with the
            workload that has resulted from expanding responsibilities and
            additional oversight duties. The court security equipment
            program has changed dramatically over the past few years, and
            program requirements and oversight responsibilities have
            increased significantly. This occurred as a result of the
            growth of the court security systems program and focus on
            improved security procedures, systems technologies and
            maintenance. The additional personnel are required to keep pace
            with these expanded duties.
      --The Office of Court Security requests funding for four program
            analyst positions to manage the growing workload in medical
            evaluations for CSOs, and the new background investigation
            requirements for CSOs mandated by Homeland Security
            Presidential Directive 12.
      --The Office of Security Contracts (OSC) requests funding for one
            supervisory contract specialist and two contract specialists.
            Over the past several years, the dollar value of contracts has
            grown significantly, as has the number of procurement actions
            required to support the JFSP. Staffing has not grown to match
            the increase in workload. Currently, the OSC has two
            supervisory contract specialists, six contract specialists, and
            a chief. In light of workload increases, the current number of
            contract specialists is insufficient. To provide appropriate
            contract management, including an expanded audit capability,
            three additional positions are required.
      --The Office of Financial Management requests funding for one
            additional budget analyst to address the increased workload of
            the Judicial Facility Security Program. The Office of Financial
            Management currently has a staff of five, consisting of a
            chief, deputy chief and three budget analysts.
      --Two new equal employment opportunity counselors are requested to
            handle the growing number of equal employment opportunity (EEO)
            complaints filed by CSOs. Previously, EEO counselors handing
            CSO complaints have been funded through the USMS's Salaries and
            Expenses account and represented a relatively small number of
            total EEO workload. With the growth in EEO activity, this
            request will ensure that the Judiciary's Court Security
            appropriation properly funds the USMS's costs associated with
            administrating the court security program.
      --The Technical Operations Group requests funding to convert a
            contractor position to a program analyst to provide the
            necessary financial, administrative and contractual expertise
            to support the Courthouse/CSO Radio Program. Funding for the
            current contractor position will be used to partially offset
            the cost of this position. Contractors are limited in the
            duties that they can perform so this conversion will provide an
            employee who can perform all procurement duties.

         COURT SECURITY--DEPARTMENT OF JUSTICE INSPECTOR GENERAL REPORT

        Question. Last September, the Justice Department's Inspector
    General released a report indicating a continued problem with the
    Marshals Service and their effectiveness in gauging threat assessments
    against federal judges and courthouses. The IG's report said the
    Marshals Service had a backlog of threat assessments and was slow in
    staffing a new office designed to collect and analyze information on
    potential threats.
        The IG's report made six recommendations for the Marshals Service
    to improve its protection of the Judiciary. In its response to the
    recommendations, the Marshals Service said it would follow five of
    them.
        The one item that the Marshals Service disagreed with was the
    recommendation to require that the Marshals Service, in addition to
    local law enforcement, be notified of all alarm events at the home of a
    federal judge. This is of particular interest to me because my
    colleague Senator Obama and I initiated the home alarm program for
    federal judges after the tragic killings of Judge Lefkow's husband and
    mother inside her home.
        Does the Judiciary have an opinion about whether dual
    notification--of both local law enforcement and the Marshals Service--
    is necessary when a home alarm goes off?
        Answer. The Judicial Conference's Committee on Judicial Security
    has discussed the recommendation in the Department of Justice Inspector
    General's report concerning the response to home intrusion detection
    system alarm events at judges' residences. The Committee concluded
    that, in general, local law enforcement personnel are best suited to
    respond to an alarm; however, the Committee also supports appropriate
    coordination with the U.S. Marshals Service of instances that warrant
    further investigation.
        Question. Has the Marshals Service implemented the other five
    recommendations of the IG's report relating to threat assessments?
        Answer. We understand that, with the exception of one
    recommendation for the USMS to develop a formal plan that defines
    objectives, tasks, milestones, and resources for implementing a
    protective intelligence function to identify potential threats, the
    USMS has responded to the other four recommendations in the IG's report
    relating to threat assessments. Specifically, the USMS has: (1)
    developed a formal plan that defines objectives, tasks, milestones, and
    resources for the new threat assessment process; (2) created a workload
    tracking system for threat assessments; (3) modified the USMS databases
    to support the new threat assessment process and protective
    intelligence function to identify potential threats; and (4) issued
    operational guidance for requesting and deploying Technical Operations
    Group resources and Rapid Deployment Teams.
        Question. In your testimony, you indicated the Marshals Service
    established a new Threat Management Center last September which you
    said ``serves as the nerve center for responding to threats against
    judges and court personnel.''
        Do you believe this new Threat Management Center has helped the
    Marshals Service implement the recommendations made in the IG's report?
        Answer. Yes. The Threat Management Center (TMC) that is part of the
    Office of Protective Intelligence at the USMS and was opened in
    September 2007 provides a 24/7 response capability for intake and
    review of threats made against the Judiciary. A new threat analysis
    process was initiated, and weekly and monthly reports about pending
    threats against the Judiciary are now produced. A workload tracking
    system for the TMC has been developed to insure a backlog of threat
    assessment does not occur again. Additional staffing for the TMC in
    fiscal year 2007 has also enabled the USMS to dedicate more resources
    to investigating and responding to threats in a more timely manner.
        Question. In its September 2007 report, the Inspector General at
    the Justice Department indicates it conducted a survey of federal
    judges regarding implementation of the home alarm program that Senator
    Obama and I initiated. According to the IG's study, 88 percent of
    federal judges said they were ``very'' or ``somewhat'' satisfied with
    the home alarm program. About the same number of federal judges, 87
    percent, said they were ``very'' or ``somewhat'' satisfied with the
    Marshals Service performance in providing protection.
        Judge Gibbons, I realize you're the chair of the Judicial
    Conference's Budget Committee, not the Judicial Security Committee, but
    can you give us a sense of how the Marshals Service could do a better
    job with the home alarm program?
        Answer. First, I would like to thank the Subcommittee for its
    support of such an important program to protect judges and their
    families at home. The Judiciary and the USMS worked hard to make sure
    that the money Congress appropriated for this project was spent wisely,
    and that every judge who wanted a home alarm system received one. We
    have heard very few complaints associated with USMS's implementation of
    the alarm program. I would add that the USMS has been responsive to our
    needs when questions have arisen about the program.
        Question. Has every federal judge who wanted a home alarm system
    had one installed at this point?
        Answer. To the best of our knowledge, yes. As of March 11, 2008,
    1,565 judges have participated in the program and have a home alarm
    system.
        Question. Can you give us a sense of how the Marshals Service could
    do a better job with their overall mission of providing protection to
    the Judiciary?
        Answer. The biggest challenge facing the USMS is securing adequate
    resources to make sure their statutory mission to protect the federal
    Judiciary is realized. The continued budgetary constraints on the staff
    of deputy U.S. marshals (funded through the USMS's Salaries and
    Expenses account, not the Judiciary's Court Security account) for
    courthouse operations is troubling, especially in light of new
    Executive Branch initiatives such as Operation Streamline that will
    increase the volume of defendants being produced in courts along the
    southwest border.
        Question. In your testimony, you asked for an increase of $4
    million ``for necessary investments in court security, such as court
    security systems and equipment and new positions at the U.S. Marshals
    Service (9 FTE).'' Please describe in more specific detail what the $4
    million would go toward and why you think it's necessary above and
    beyond the current allocation.
        Answer. The $4 million requested for program increases will provide
    funding for 17 new U.S. Marshals Service positions as explained in the
    response to the question above ($1.1 million); one new contractor
    position at the U.S. Marshals Service ($124,000); rent reimbursement to
    the U.S. Marshals Service for Judiciary funded positions ($710,000);
    reimbursement to the U.S. Marshals Service for EEO investigations
    ($123,000); and additional security systems and equipment ($2.0
    million).
        The request of $124,000 is for a contract electronics technician
    position to handle the increase in troubleshooting and repair of
    infrastructure and portable radio equipment than is currently possible
    by the sole program manager on board. Funding is essential for the
    continued success of the program with respect to the nationwide
    reprogramming and encryption goals set forth in fiscal year 2007 and
    beyond. Without funding, the USMS's efforts to encrypt all CSO radios
    nationwide will be further delayed.
        The request of $710,000 would allow the Administrative Office (AO)
    of the U.S. Courts to reimburse the USMS headquarters for the space
    occupied by Judiciary-funded USMS staff. The AO currently transfers
    funding to the USMS to fund personnel compensation and benefits and
    other costs necessary to administer the Judicial Facility Security
    Program. In the past, the transfer has not included funding for
    associated rent costs.
        The request of $123,000 is to reimburse the USMS for contractors
    hired by the USMS to investigate, process and resolve the anticipated
    increase in EEO complaints filed by CSOs. This request will ensure that
    the Judiciary's Court Security appropriation properly funds the USMS's
    costs associated with administrating the court security program.
        A $2 million increase is requested for cyclical replacement of
    access control head end computers. On August 27, 2004, President Bush
    signed Homeland Security Presidential Directive (HSPD)-12 for the
    purpose of establishing a mandatory, government-wide standard for
    security and reliable forms of identification, known as the Personal
    Identity Verification (PIV) ID Card, to be issued by Executive Branch
    agencies to its employees and contractor staff. This new initiative
    consists of upgrading and replacing access control systems nationwide
    to meet HSPD-12 compliance requirements, as well as the implementation
    of a cyclical replacement program for these systems. Finally, since
    this is going to be the standard ID card for the majority of government
    employees and long-term contractors, Judicial Branch employees and
    contractors will need the card to facilitate access to federal
    facilities.

              IMPLEMENTATION OF THE COURT SECURITY IMPROVEMENT ACT

        Question. Less than three months ago, Congress passed and the
    President signed the Court Security Improvement Act of 2007. This is
    one of the most comprehensive court security bills ever passed by
    Congress. One of the provisions requires the Marshals Service to
    consult with the Judicial Conference on a continuing basis regarding
    court security.
        Has this provision been implemented yet? Has a consultation process
    begun between the Marshals Service and the Judicial Conference?
        Answer. Even prior to the enactment of the Court Security
    Improvement Act of 2007, the relationship between the USMS and the
    Judicial Conference had improved dramatically under the leadership of
    the current USMS Director John Clark. In addition, in October 2005 the
    Judicial Conference created a Committee on Judicial Security to focus
    solely on security issues for the Judiciary and to liaison with the
    USMS. Since that time, the USMS has attended the bi-annual meetings of
    the Committee to discuss issues of importance to the court security
    program.
        An example of the consultation process that exists between the USMS
    and the Judicial Conference is the recent pilot project that was
    approved in the fiscal year 2008 omnibus appropriations bill for the
    USMS to assume perimeter security protection from the FPS at select
    primary courthouses. The judges on the Committee on Judicial Security
    have consulted extensively with the USMS to craft a pilot program that
    is both responsive to the Judiciary's needs and reflective of budgetary
    constraints.
        Question. Have other provisions of the Court Security Improvement
    Act been implemented yet? Is everything going smoothly so far? If not,
    what are the impediments?
        Answer. Implementation of provisions that directly impact the
    Judiciary in the new law appear to be going smoothly although it
    remains to be seen whether the $20 million per year in appropriations
    through 2011--authorized in section 103 of the Act for the USMS to hire
    additional deputy marshals--will be provided. There are multiple
    provisions in the Act that do not directly affect the Judiciary, so the
    Judiciary has no view regarding those.

              COURTHOUSE CONSTRUCTION (SAN DIEGO AND LOS ANGELES)

        Question. The fiscal year 2009 President's budget provides funding
    for only one courthouse--the Courthouse Annex in San Diego. In fiscal
    year 2005, San Diego was one of four emergency projects on the
    Judiciary's Revised Five-Year Courthouse Project Plan (fiscal years
    2005-2009). Due to increased construction materials costs, the scope of
    the project was reduced but the project still requires $110 million, as
    requested by the President in fiscal year 2009, in order to be
    completed. The Los Angeles courthouse project is in a similar
    situation, requiring much more funding. What is the latest on that
    project?
        Answer. The courthouse problem in Los Angeles is a serious one. The
    Central District of California is the largest district in the country
    and current facilities are completely inadequate, primarily because of
    an insufficient number of courtrooms to meet the growing needs of the
    district court and significant security issues at the current location.
    Market conditions and delays have created a price tag for the Los
    Angeles project that far exceeds GSA's original estimates. Despite the
    sizable reductions in scope already made by the court, the cost of this
    project continues to grow and will only get more expensive as time goes
    on. The AO, the court, and GSA have been working together to find a
    solution.
        While the Judiciary recognizes how costly this project is,
    especially in a time of constrained resources for non-security
    discretionary programs, we believe the final project design must
    address long-term needs and provide an environment in which the
    judicial process can function safely and effectively. The Judiciary
    also wants to ensure that when alternatives are considered, all costs
    associated with the options are included in the analysis. Consequently,
    the Judiciary is pleased that GAO has been asked to conduct a review of
    this project and trusts that it will address all aspects of the issue.
    The Judiciary's understanding is that GAO will look into the reasons
    for the delay, the effects of the delay, and the challenges faced in
    managing this project. The Judiciary looks forward to receiving GAO's
    findings.

               BUDGETARY IMPACT OF JUDGES ASSUMING SENIOR STATUS

        Question. My understanding of senior status is when judges become
    eligible for senior status, they decrease their workload by 50 percent,
    and need to relocate to other office space, freeing up the former space
    and staff for an existing full-time judge. Then the senior judge is
    entitled to new staff: 3 law clerks and one administrative staff. So,
    all this results in requiring more resources (for which less work may
    be accomplished).
        Answer. Many senior judges do not reduce their workload by 50
    percent. Many continue to carry a full caseload. There is no specific
    workload requirement for senior judges although a senior judge must
    perform ``substantial judicial work'' to employ staff and receive
    ``suitable quarters.'' The number of staff the senior judge receives
    must relate directly to the workload he or she performs. An annual
    certification process in place considers projected and actual workload
    in order for a senior judge to continue having office space and staff
    support.
        While there are staff and space costs associated with a judge
    taking senior status, it is important to emphasize that senior judges
    are essentially volunteering their time in continued service to the
    federal Judiciary. A judge eligible for senior status could otherwise
    choose to retire and leave office at the same pay without rendering any
    judicial service at all. But over 400 appellate and district court
    judges forego full retirement, and instead take senior status and
    continue taking cases. They are essential to the work of the federal
    courts. In 2007, senior judges participated in 19 percent of cases
    terminated on the merits in the appellate courts. In the district
    courts, senior judges handled 18 percent of the civil and criminal
    caseload. Both of these statistics are at the highest level in a
    decade.
        When Article III judges take senior status, they continue to
    receive the salary they were earning at the time they left active
    service. For a senior judge to receive the same cost of living
    increases as an active Article III judge, the senior judge must perform
    at least 25 percent of the work performed by ``an average judge in
    active service.'' 28 U.S.C.  371(b)(1), (e)(1).
        The number of senior judges working in the courts are taken into
    consideration when determining the number of new judgeships the
    Judicial Conference requests from Congress. If the Judiciary were to
    see a sharp dropoff in the number of senior judges working in the
    courts, it would likely result in more judgeships being requested from
    Congress in order to make up for the lost productivity resulting from
    fewer senior judges.
        Question. How many judges are currently eligible for senior status?
        Answer. As of December 31, 2007 there were 473 Article III senior
    judges, and 92 active judges were eligible to take senior status. An
    additional 48 currently active judges have senior status eligibility
    dates between January 1, 2008 and December 31, 2008.
        Question. Of those, how many have been eligible for more than one
    year?
        Answer. Of the 92 active judges that were eligible to take senior
    status as of December 31, 2007, 77 had been eligible to take senior
    status prior to January 1, 2007. The other 15 active judges became
    eligible for senior status during 2007.
        Question. So, this means that the Judiciary must continually
    request funding for space and staffing for senior judges--and sometimes
    you receive this funding--but you may not always need it?
        Answer. The Judiciary does not assume that all judges eligible to
    retire or take senior status will in fact do so. The Judiciary uses
    historical patterns to estimate the number of judges that will retire
    or take senior status. In formulating the fiscal year 2009 budget
    request, the Judiciary estimated that 33 of the 55 judges eligible in
    fiscal year 2009 will retire or take senior status. Based on the
    Judiciary's projection of when judges would retire/take senior status
    during the year, the Judiciary estimates that the 33 judges would
    equate to 20 FTE for budget purposes. Of the 20 FTE, 18 are projected
    to take senior status and continue taking cases, and two to retire and
    leave the federal bench.
        In the event fewer judges take senior status than the Judiciary
    requested funding for, that funding is carried forward to offset the
    Judiciary's appropriation requirements in the following fiscal year.
    However, the Judiciary endeavors to provide the Appropriations
    Subcommittees with the most accurate projection of judges expected to
    take senior status. As is done each year, the Judiciary will continue
    to refine its estimates of judges retiring/taking senior status and
    will update the Appropriations Subcommittees--through the 2008 Spring
    and Fall budget re-estimate process--on any changes to senior judge
    projections that will impact the Judiciary's fiscal year 2009
    appropriation requirements.

         SENIOR JUDGES AT THE COURT OF APPEALS FOR THE FEDERAL CIRCUIT

        Question. The Federal Circuit is requesting an almost 20 percent
    (or $5.3 million) increase in its budget for fiscal year 2009. The
    largest part of this increase ($2.5 million) appears to be the
    staffing, and leased office space and build-out for senior judges.
        [Clerk's Note.--The Court of Appeals for the Federal Circuit's
    budget request does not fall under the jurisdiction of the Judicial
    Conference of the United States and its Budget Committee. Accordingly,
    this response was prepared by the Federal Circuit and its Chief Judge
    Paul R. Michel.]
        What is the space situation at the Federal Circuit and what is the
    status of judges going to senior status?
        Answer. Federal Circuit Judges occupy every judge's chambers
    available to the Federal Circuit in the National Courts Building
    complex. (The building complex houses two courts, and both courts have
    assigned all available chambers space to judges.) This includes one
    sub-standard chambers on the ground floor of Dolley Madison House. That
    chambers has historically been used as swing space or to house visiting
    judges temporarily sitting by designation, or for other special
    purposes. There is no other space suitable or available to judges. The
    Federal Circuit has no vacant and unassigned chambers, and none is
    anticipated.
        In fiscal year 2009 the Federal Circuit will have seven judges who
    are or will be eligible to take senior status. Today the Federal
    Circuit has no space available in the National Courts Building for even
    one additional senior judge and has no off-site leased space for them,
    either. If any one of the seven judges who is or will be eligible to
    take senior status in fiscal year 2009 does so, there will be no
    chambers available in the National Courts Building or in off-site
    leased space once a replacement judge is confirmed. At least two of the
    seven judges who will be eligible for senior status are expected to
    take senior status when they become eligible in fiscal year 2009. The
    Federal Circuit must acquire leased space off-site for the judges who
    have indicated a desire to take senior status in fiscal year 2009 and
    2010.
        Note about staffing for a senior judge: Historically, senior judges
    at the Federal Circuit work less than 50 percent of an active judge's
    caseload and are therefore entitled by rule to only one law clerk.
        Question. So, the Federal Circuit seeks the funding associated with
    senior status, not knowing whether the judges will actually take senior
    status?
        Answer. As a rule, no one knows when a judge will decide to take
    senior status except that judge. Timing can be highly personal, and
    advance notice varies for each individual. There are strong indications
    that at least one of the judges eligible to take senior status in
    fiscal year 2009 plans to do so, and that at least one additional judge
    will choose to take senior status in fiscal year 2010. By fiscal year
    2010, eight of the twelve active judges on the Federal Circuit will be
    eligible to take senior status. If the Federal Circuit acquires off-
    site chambers for senior judges one chambers at a time, only after the
    President has been notified that a judge is taking senior status, the
    Federal Circuit could have senior judges occupying off-site leased
    space in as many as eight different locations around Washington, DC,
    perhaps far from the courthouse. Logistics, security, and
    transportation would be challenges, and judges would feel isolated from
    their colleagues. Accordingly, the Court has been working with the
    General Services Administration and the Administrative Office of the
    U.S. Courts to lease nearby off-site space this year (fiscal year 2008)
    to accommodate up to five senior judges in the next two years. Five is
    a mid-range number the Court believes to be reasonable in providing
    space for prospective senior judges. The number will allow for changes
    in decision by judges based on health or other personal issues without
    over-reaching by seeking off-site space for every eligible judge who
    may or may not choose to take senior status. Five chambers will allow
    for economies of scale in long-term leasing and building out
    prospective chambers while reducing the risk of leaving significant
    space unoccupied.
        Question. What happens if the funding is provided and the judges do
    not take senior status?
        Answer. The chambers will remain available until occupied by
    whichever judge needs them. If Judge A does not take senior status in
    fiscal year __ the chambers will remain available for Judges B, C, D,
    etc. As described above, it is virtually certain that off-site chambers
    will be occupied in the next two years by at least one judge and most
    probably by at least two judges, although not all chambers will likely
    be occupied at the outset. It is possible that housing senior judges
    together in suitable space near the courthouse will induce judges to
    take senior status when they wish to take it, knowing they have
    appropriate space in close proximity to their colleagues. It takes time
    to find suitable space, negotiate a lease through GSA, and design and
    complete the build out. The Court has been at this effort for several
    years and is very nearly out of time. Funds appropriated to house
    senior judges will not be wasted, and space will be available even on
    short notice to accommodate situations that arise with little or no
    advance warning.

                     IMPACT OF INCREASED BORDER ENFORCEMENT

        Question. Our borders, particularly the Southwest Border, have been
    an area of increased enforcement in order to combat illegal immigration
    over the past several years. Because that increased enforcement results
    in more cases in the courts, we have provided the Judiciary with
    additional resources to manage that workload. Director Duff, your
    testimony indicates that this increased enforcement affects other parts
    of the country, not only the Southwest Border. Please discuss this in
    further detail as well as the resulting implications.
        Answer. The increased emphasis by Congress and the Administration
    on immigration enforcement has had the greatest impact on the five
    federal district courts along the Southwest border with Mexico. Other
    districts throughout the country, however, have also been impacted by
    this increased enforcement. In 2002, there were 11,791 criminal cases
    for violations of federal immigration laws. Of these, 7,735 cases were
    in the five Southwest border district courts and 4,056 cases were in
    the remaining 89 judicial districts. In 2007, there were 15,898
    criminal cases for violations of federal immigration laws. Of these,
    10,953 were in the Southwest border courts, and 4,945 were in the
    remaining 89 judicial districts. Non-border immigration caseload in the
    federal courts increased 22 percent in this five year period.
    Immigration-related cases can present challenges to a court, including
    the need to hire or contract for qualified interpreters to assist in
    court proceedings.
        Increased immigration enforcement has impacted our appellate courts
    as well. Challenges to Board of Immigration Appeals (BIA) decisions in
    the appellate courts totaled 1,777 cases in 2001, peaked at 12,725
    cases in 2006, then declined to 9,338 cases in 2007--a more than 400
    percent increase over 2001. About one-third of all BIA decisions are
    challenged in the federal appellate courts with 70 percent of those
    challenges occurring in the Second and Ninth Circuits. While BIA
    appeals have dropped in the last year, these cases continue to demand
    extensive resources since they often turn on a credibility
    determination by a Department of Justice immigration judge, thus
    requiring close judicial review of a factual record by the appellate
    courts.
        The Judiciary will utilize the additional resources provided by
    Congress to respond to workload needs throughout the federal court
    system and not just on the Southwest border.

               JUDICIAL AUTHORITY FOR OFFENDER RE-ENTRY PROGRAMS

        Question. I have supported offender reentry programs like job
    training, education, drug and mental health treatment for many years,
    as part of the effort to reduce criminal recidivism. Does the Judiciary
    have the legislative authority it needs to increase the likelihood of
    successful offender reentry into the community and positive outcomes
    for post-conviction supervision?
        Answer. The Judicial Conference believes it needs explicit
    authority to permit the Director of the Administrative Office to
    contract for non-treatment services (e.g., medical, educational,
    emergency housing, and vocational training) and other re-entry
    interventions for post-conviction offenders generally. At its September
    2005 session, the Conference approved proposed language which was
    submitted to Congress on November 14, 2005. Specifically, the proposed
    legislation amends 18 U.S.C.  3672 to allow the AO Director to
    contract for re-entry services, including treatment, equipment,
    emergency housing, vocational training, and other re-entry
    interventions. I am pleased to report this provision was included in
    the Second Chance Act which was signed into law on March 30, 2008
    (Public Law 110-199).
        The Judicial Conference also supports legislation that would amend
    18 U.S.C.  3154 to authorize the AO Director to contract for similar
    services for defendants released pending trial, and to amend both 18
    U.S.C.  3154 and 18 U.S.C.  3672 to authorize the Director to expend
    funds for emergency services for defendants on pretrial release and
    offenders on post-conviction supervision respectively. This proposed
    legislation was submitted to Congress on April 16, 2007.
        Expansion of the Director's authority will allow probation and
    pretrial services officers to obtain contract services for all persons
    under their supervision who need them. Research consistently indicates
    that certain approaches yield demonstrable and measurable results in
    the reduction of recidivism. With expanded authority, officers will
    make greater use of practices such as cognitive-behavioral treatment,
    job training, and employment placement programs that have been proven
    effective in obtaining successful outcomes and making the community
    safer.
        The addition of authority to expend funds for emergency services
    for defendants on pretrial release and offenders on post-conviction
    supervision respectively would provide officers with the ability to
    deal with day-to-day incidental expenses. Officers often use their own
    personal money to assist offenders with small expenditures such as bus
    fare to go for a job interview.
        Of course, if expenditure authority is enacted, guidance and
    clarification would be developed to ensure that it is used
    appropriately. Some of the issues requiring clarification would include
    the type of ``emergency'' services that are authorized and the spending
    limit.

                                  RENT SAVINGS

        Question. Over the past few years, the Judiciary has realized
    substantial savings (more than $50 million) in rent overcharges from
    the General Services Administration. Judge Gibbons, your testimony
    indicates that another $10 million savings is expected in fiscal year
    2008. Now that you and GSA are working cooperatively in this effort, at
    what point do you expect this savings to level off (or do you expect to
    continue to have a savings in the tens of millions)?
        The Judiciary believes it is important to continue to work with the
    courts and GSA to compare the space actually occupied by the courts to
    the space assignment drawings used by GSA. These drawings are used to
    establish the basis for rent bills and it is therefore very important
    that they are accurate. The Judiciary and GSA have recently revised the
    existing approach to verifying the assignment drawings to the space
    actually occupied and to adjust the rent bill in connection with errors
    identified during rent validation so that rent bill adjustments for
    overcharges can be performed on a more expedited basis. Although we
    believe that the major rent overcharges have been identified and
    corrected, savings will continue to be realized if further overcharges
    are identified during our ongoing and continuous reviews of GSA rent
    bills.
        A second initiative underway for the Judiciary is the review of GSA
    appraisals used to set rental rates to ensure their accuracy. It is
    uncertain at this time whether this review will result in significant
    savings for the Judiciary.

     PROJECTS UNDER THE ``CARE OF THE BUILDING AND GROUNDS OF THE SUPREME
                                    COURT''

        Question. The Care of the Building and Grounds fiscal year 2009
    appropriation request total $18.4 million, an increase of $6.2 million
    (51.2 percent) over the fiscal year 2008 appropriation level.
    Modernization of the Supreme Court construction project began in 2004
    and expected completion is the fall of this year, costing a total of
    $122.3 million.
        [Clerk's Note.--The Supreme Court's budget request does not fall
    under the jurisdiction of the Judicial Conference of the United States
    and its Budget Committee. Accordingly, this response was prepared by
    the Supreme Court.]
        What was achieved with this expenditure of funds?
        Answer. Phase I of the project--the construction of the underground
    police annex, the Architect of the Capitol (AOC) shop and parking
    areas--was completed in late 2005. Phase II of the project--the
    interior building modernization--is ongoing and includes updated life
    safety systems, windows, mechanical, electrical, and plumbing systems.
    The work on one of the four building quadrants is complete. The second
    quadrant is scheduled for completion during the summer of 2008.
        The contractor's projected completion date for the entire
    modernization project is the summer of 2010. Although the building
    modernization project is more than a year behind, the project continues
    to be within budget.
        Question. Do you expect any further modernization needs in the
    short-term future?
        Answer. The Court does not foresee further modernization
    requirements outside the current scope of the modernization project.
    With the project two years away from completion, however, unforeseen
    circumstances may arise that would require a request for additional
    funding.
        Question. Separate projects include the exterior property
    renovation/landscaping project and the roof system project. For fiscal
    year 2009, the Supreme Court is requesting $6.3 million to complete
    construction to renovate the exterior landscape of the Supreme Court as
    well as $2.1 million for phase 2 (of 5 phases) to repair the roof,
    which is to be completed in 2011. Once the modernization, property
    renovation/landscaping, and roof projects are completed, will Care of
    the Buildings and Grounds of the Supreme Court go back down to a
    maintenance request level or are further projects anticipated in the
    near future?
        Answer. When the modernization project is completed, approximately
    $3 million will be needed to complete the installation of the perimeter
    security plan around the Court building and grounds. Additional funding
    will also be needed to complete the planned roof repairs. Although some
    funding has been already provided to restore the stone sculptures of
    the East and West pediments and roof perimeters of the building, it is
    likely that more funding will be needed to repair and restore the
    stonework in the building's four interior courtyards. At this time, no
    other major projects are anticipated, and future funding requests
    should be more in keeping with normal maintenance-level requirements
    for the care of the building and grounds.

              RETROACTIVITY OF CRACK COCAINE SENTENCING AMENDMENT

        Question. The U.S. Sentencing Commission, an independent agency
    within the Judiciary, promulgates the sentencing guidelines that
    federal trial court judges consult when sentencing defendants convicted
    of federal crimes. Last year, the Sentencing Commission amended federal
    guidelines reducing offenses under federal sentencing guidelines for
    crack cocaine offenses. Furthermore, the Commission unanimously decided
    to make the policy change retroactive and this retroactivity became
    effective on March 3, 2008.
        Will crime victims be notified of an inmate's release and will they
    have an opportunity to provide comment to the court prior to an
    inmate's release?
        Answer. Judges have been asked by the Bureau of Prisons (BOP) to
    delay for 10 days the effective date of any sentence reduction that
    results in an inmate's immediate release. This delay is needed, in
    part, to give the BOP adequate time to notify victims and witnesses of
    the offender's release, as they are required to do per 18 U.S.C.
    3771. The Judiciary is unaware if the Department of Justice will
    attempt to contact victims to seek comment prior to an inmate's
    release. It should also be noted that because of the nature of these
    offenses, most cases will not have an identifiable victim within the
    meaning of the Crime Victim Rights Act.
        Question. What measures are U.S. probation offices taking to
    address community safety issues and to ensure a smooth transition for
    inmates released into the community?
        Answer. Probation officers will play a key role in recalculating
    the inmate's amended guideline range and identifying any post-sentence
    conduct that may impact the judge's decision. Officers will do that in
    part by reviewing the inmates disciplinary records and progress reports
    that are prepared by the BOP. Officers were recently provided with
    refresher training for the BOP's Sentry system, which allows officers
    to access information on an inmate's performance while in the BOP. If
    the officer identifies a risk that cannot be addressed by the
    conditions originally imposed, the probation officer may ask the court
    to modify or impose additional conditions of supervised release. These
    may include conditions for halfway house placement, drug or mental
    health treatment, or home confinement.
        Prerelease planning ordinarily begins several months before an
    inmate's release, and addresses issues such as an inmate's release
    residence, continuity of any treatment, and potential employment. It is
    possible that some offenders will receive a sentence of time served and
    not have a pre-release plan in place. In such cases, the probation
    officer and BOP staff will use the 10-day period requested by the
    government to develop a plan for the inmate's release. The probation
    officer and BOP staff will prioritize the inmate's needs and attempt to
    address as many as possible before the inmate's release. Most pressing
    will be to identify an appropriate release residence. Once released,
    the officer will conduct a thorough assessment and make any necessary
    referrals to assist the offender in his or her reentry back to the
    community.
        Question. Please discuss your post-conviction supervision program.
    How do you determine the services and support supervisees require and
    receive, including education, job training, and treatment?
        Answer. In most cases, an offender's needs have been identified
    well before supervision begins, either at the pretrial or presentence
    stage of the Federal criminal justice system. The presentence report
    and the resulting sentencing document identify treatment, educational,
    employment, and other needs that will most likely have associated
    special conditions of the supervision term.
        Following an offender's placement on probation or release from an
    institution, the probation officer works with the offender to assess
    the offender's risks, needs and strengths to prepare an individualized
    comprehensive supervision plan. Not all offenders require the same
    level of supervision to reach this goal. It is the officer's job to
    distinguish among them and to implement supervision strategies that are
    appropriately matched with the offender's risks, needs and strengths.
        If substance abuse or mental health treatment conditions are
    ordered, the officer will either conduct an informed assessment or
    direct the person to undergo a clinical assessment performed by a
    professional treatment provider. If treatment is necessary, the officer
    refers the offender to a treatment program tailored to his needs.
    Treatment is part of the overall supervision objectives and strategies
    for the case. The officer monitors the offender's progress in treatment
    and collaborates with the treatment provider to further the offender's
    chances for success on supervision.
        If education is identified as a need for an offender who never
    completed high school, the officer may identify obtainment of a GED as
    a supervision objective. If so, the officer assists the offender in
    enrolling in a local educational program. The officer continually
    monitors the offender's progress in this type of program, as well as in
    many others, intended to enhance the offender's success on supervision
    and beyond.
        With respect to an unemployed or underemployed offender, federal
    probation officers are now working in partnership with the Bureau of
    Prisons, the Department of Labor and the National Institute of
    Corrections to create a systems approach to offender reentry and
    workforce development. Points of contact in each state have been
    identified to bring implementation of these partnerships to the local
    level. Probation and pretrial services officers have been trained as
    ``offender workforce development specialists'' in 36 states. Federal
    probation continues to expand the initiative by training more probation
    officers each year as offender employment specialists. Those trained
    then develop workforce development partnerships within their states and
    communities. Career fairs sponsored by Federal Probation for ex-
    offenders have been held in communities in each region of the country,
    and partnerships have been developed with colleges, one-stop centers,
    and community and faith-based organizations to provide resources and
    training for ex-offenders that provide career opportunities in
    occupations identified by the President's High Growth Jobs Initiative.
    This collaborative effort has reduced violations, revocations, and
    recidivism rates with respect to those who have participated in the
    employment initiative. Nearly 93 percent of those who start federal
    supervision employed are still employed at the time their cases close,
    a strong indicator that they have adapted to the community and are more
    likely to be successful after completing supervision.
        If, during the period of supervision, an officer identifies
    educational, vocational or treatment needs for which there is no court-
    ordered special condition requiring the offender participation in the
    program(s), the officer will petition the court to modify the release
    conditions accordingly. A court-ordered special condition allows the
    officer to leverage sanctions if the offender does not comply with the
    condition. In many cases, the backing of the court will induce the
    offender to achieve the necessary skills and/or treatment necessary to
    succeed on supervision and beyond. All of the above interventions, in
    addition to individualized professional care and concern, contribute
    toward the goal of increasing the likelihood of success on supervision.
        Question. Do you have any data on education levels of people under
    supervision and do you ensure that supervisees have opportunities to
    earn a GED if needed?
        Answer. If education is identified as a need for an offender who
    never completed high school, the officer may identify obtainment of a
    GED as a supervision objective. If so, the officer assists the offender
    in enrolling in a local educational program. The officer continually
    monitors the offender's progress in this type of program, as well as in
    many others, intended to enhance the offender's success on supervision
    and beyond.
        Data on education levels of people under supervision:

    PERSONS RECEIVED FOR POST-CONVICTION SUPERVISION FOR THE 12 MONTH PERIOD
                                ENDING 09/30/2007
    ------------------------------------------------------------------------
                    Education Level                    Number      Percent
    ------------------------------------------------------------------------
    No Formal Education...........................          476            1
    Some Elementary...............................            1  ...........
    Elementary through 8th Grade..................        3,112            7
    Some High School..............................       12,581           27
    Graduate Equivalency..........................        7,123           15
    Some Vocational School........................            9  ...........
    Vocational School Graduate....................          441            1
    High School Diploma...........................       10,312           22
    Some College..................................        8,905           19
    College Graduate..............................        2,920            6
    Post Graduate.................................          643            1
                                                   -------------------------
          Total...................................       46,523          100
    ------------------------------------------------------------------------
    Modified Table E-1. Excludes pre-existing cases transferred between
      districts and cases where the education level was unavailable or not
      applicable.

                               JUDICIARY WORKLOAD

        Question. The new bankruptcy legislation took effect in October
    2005 and it appears that filings are still down from pre-Bankruptcy Act
    levels. From your testimony, it appears that you expect a significant
    increase in the number of bankruptcy filings--a 23 percent increase.
        What trend do you expect in the future?
        Answer. Following the implementation of the Bankruptcy Abuse
    Prevention and Consumer Protection Act of 2005 (BAPCPA) in October
    2005, filings plummeted, falling roughly 50 percent from 1,484,570
    filings in 2006 to 751,056 filings during 2007. The Judiciary's latest
    projections indicate that the number of petitions filed is expected to
    rise rapidly over the next two years, growing 23 percent in 2008 and
    another 13 percent in 2009. While, historically, there have been a
    handful of years where double-digit percentage increases have occurred,
    these 2008 and 2009 projections are still well below what would have
    been projected had BAPCPA not been enacted. The number of more work-
    intensive chapter 13 petitions is expected to reach pre-BAPCPA levels
    much sooner than the number of chapter 7 petitions.
        Question. Will the current downturn in the economy likely further
    increase filings?
        Answer. The Judiciary's bankruptcy filing projections assume that
    economic growth will be slow--but positive--and that consumer debt will
    remain high. If the economy worsens, filings would increase more
    rapidly in the near term. No consensus opinion exists regarding the
    degree to which a recession would affect overall filings.
        Along with a slowing economy, a number of other factors indicate
    that filings could continue to grow at a fast pace, namely (1) the debt
    service burden is at or near record levels, (2) mortgage foreclosure
    rates have been rising, and (3) adjustable rate mortgage resets have
    made some monthly mortgage payments prohibitively expensive.
        Passage and enactment of bankruptcy reform legislation currently
    under consideration in Congress, which would strike the current
    exemption of a mortgage on a debtor's principal residence, would likely
    result in a surge in chapter 13 filings.
        Question. In your written testimony, you discussed the impact of
    the bankruptcy law passed by Congress in 2005. You wrote: ``Our
    bankruptcy courts have indicated that the actual per-case work required
    of the bankruptcy courts has increased significantly under the new
    law.'' You also discussed the increased workload for debtors filing for
    bankruptcy under Chapter 7. Do you also agree that in the aftermath of
    the 2005 bankruptcy law there has also been an increased workload for
    bankruptcy trustees?
        Answer. Yes, the workload for bankruptcy trustees has increased in
    the aftermath of the 2005 bankruptcy reform legislation. For example, a
    Chapter 7 case trustee must now review results of the debtor's means
    test, review extensive documentation provided by the debtor (pay stubs,
    mortgage documents, etc.), and provide the court a statement if the
    debtor's case is presumed to be abusive. The trustee must prosecute a
    motion to dismiss a case if substantial abuse of a Chapter 7 filing is
    discovered. There are also audit responsibilities for the case trustee
    to ensure that the debtor's schedules of income and expenses are
    accurate.
                                     ______

                  Questions Submitted by Senator Sam Brownback

        Question. Your fiscal year 2009 budget submission does not request
    resources for additional staff in clerks and probation offices. Do you
    feel that you currently have the appropriate number of staff to address
    your workload?
        Answer. Although the courts do not currently have the appropriate
    number of staff on board to address workload needs, the funding made
    available by Congress in fiscal year 2007 and fiscal year 2008 will
    allow the courts to narrow the gap between current staffing levels and
    workload. This funding will be utilized over a three year period--
    fiscal years 2007-2009--to increase staffing levels in the courts. In
    addition to the staff hired in fiscal year 2007, the Judiciary
    anticipates the courts will bring on another 305 FTE during fiscal
    years 2008 (150 FTE) and 2009 (155 FTE).
        In fiscal year 2007, Congress provided the courts with $20.4
    million to address the most critical workload needs. Because full-year
    funding was not made available to the courts until six months into the
    fiscal year, most of these new staff will be brought on board in fiscal
    year 2008. Hence, the $20.4 million was planned to be utilized during
    fiscal years 2007 and 2008. The fiscal year 2008 financial plan
    includes $15 million of the $20.4 million to hire 150 FTE to meet
    critical workload demands.
        In fiscal year 2008, Congress provided the Judiciary with $25
    million in emergency appropriations to address workload stemming from
    increased immigration enforcement. Of this amount, $14.5 million will
    be used to hire 155 FTE in clerks and probation offices, and the
    remaining $10.5 million provided for Defender Services will be used to
    pay private panel attorneys handling immigration cases. With the $14.5
    million, the Judiciary estimates that the courts will bring on the 155
    FTE over two years: 35 FTE in fiscal year 2008 and 120 FTE in fiscal
    year 2009.
        Question. Please describe your current workload along the Southwest
    Border. Has the Judiciary been impacted by the additional law
    enforcement resources added to the border?
        Answer.
    Impact on the Federal Courts
        The federal courts along the Southwest Border (SWB) have been
    impacted by additional law enforcement resources provided to the
    Department of Homeland Security (DHS) and the Department of Justice
    (DOJ) for border and immigration enforcement initiatives.
        Criminal filings along the SWB increased 11 percent between 2002
    and 2007, and filings in those five district courts currently account
    for nearly one-third of all criminal cases nationwide. The time
    sensitive nature of criminal cases, created by statutory issues
    involving speedy trials requirements, multiple hearings for defendants
    (e.g. initial appearances, arraignments, and pleas in the early
    stages), and the need for interpreter services, increase the courts'
    need for adequate staffing resources.
        The SWB courts have the five highest number of felony defendants
    per judgeship and felony defendants along those five district courts
    currently account for nearly one-third of all felony defendants
    nationwide. In addition, the districts of Texas-Southern, New Mexico,
    and Texas-Western have experienced compounded growth rates in criminal
    caseload of 9.2 percent, 4.6 percent, and 9.1 percent, respectively, in
    the number of felony defendants from 2004 to 2007.
        Pretrial caseload along the SWB has increased as well. From 2002 to
    2007, the five SWB districts experienced a 28 percent increase in
    pretrial services cases activated compared to 8 percent growth
    nationally over the same period. By June 2007, the SWB districts
    accounted for 35 percent of all pretrial cases activated in the federal
    system.
        In the probation program, SWB districts experienced a 10 percent
    increase in the number of supervision cases from 2002 to 2007.
    Nationally, the growth in post-conviction cases for that period was 7
    percent. The five SWB district have consistently made up 13-14 percent
    of the total number of cases under post-conviction supervision in the
    federal system between 2002 and 2007.
        While criminal case filings in the federal courts in the five
    judicial districts along the Southwest border is high by historical
    standards, filings have not increased commensurate with the increased
    resources provided to DHS for border enforcement. Despite zero
    tolerance border initiatives such as Operation Streamline in which
    nearly everyone apprehended for violating U.S. immigration laws is
    prosecuted, resource constraints in the justice system have precluded
    more cases from being prosecuted in the federal courts. Staffing
    shortages in U.S. Attorney offices, lack of detention beds needed to
    secure offenders awaiting prosecution, and staffing constraints in U.S.
    Marshals offices have resulted in the establishment of certain
    threshold levels in some border districts that must be met before a
    case is prosecuted. For example, a U.S. Attorney in one district may
    prosecute someone coming into the country illegally after the tenth
    attempt, while a U.S. Attorney in another district may prosecute after
    the fifth attempt.
    More Resources Being Provided to the Border
        The President's fiscal year 2009 budget includes $12 billion for
    DHS for border security and enforcement efforts, a 19 percent increase
    over fiscal year 2008, and a more than 150 percent increase since 2001.
    DHS has used the funding to increase the number of border patrol agents
    significantly, particularly on the Southwest border with Mexico. Since
    2001, more than 5,000 additional border patrol agents have been hired
    with most of them placed along the Southwest border. In fiscal year
    2008, DHS received funding to hire an additional 3,000 border patrol
    agents, and the President's fiscal year 2009 budget includes funding
    for another 2,200 agents, bringing the total to 20,000 agents. When
    fully staffed the Border Patrol will have more than doubled in size
    since 2001.
        In fiscal year 2008 DOJ received $7 million in emergency funding to
    hire more assistant U.S. Attorneys (AUSAs) in the five judicial
    districts along the Southwest border. The U.S. Marshals Service
    received $15 million in emergency funding to address Southwest border
    workload needs including the hiring of 100 additional deputy U.S.
    Marshals. The President's fiscal year 2009 budget includes $100 million
    for a new Southwest Border Enforcement Initiative focusing law
    enforcement and prosecutorial efforts on fighting violent crime, gun
    smuggling, and drug trafficking in that region. If funded, this
    initiative will increase the number of AUSAs along the Southwest border
    by another 50 positions. The President's budget also seeks $88 million
    to expand detention capacity along the southwest border.
        The resultant increase in criminal filings from this infusion of
    resources will impact district judges, clerks offices, probation and
    pretrial services offices, and federal defender offices on the border.
    The Judiciary's fiscal year 2009 budget submission, however, does not
    request funding for new clerks or probation or pretrial services staff
    on the border or elsewhere. Congress provided the Judiciary with $45.4
    million over the last two years--$20.4 million in fiscal year 2007 and
    $25 million in fiscal year 2008--to address immigration-related
    workload so, from a staffing perspective, the courts are well
    positioned in the short term to respond to the increased workload that
    is expected to materialize.
        Question. What additional actions is the Judiciary taking to reduce
    rent?
        Answer. The fiscal year 2009 Judiciary budget request reflects
    lower requirements as a result of measures incorporated since the cost-
    containment strategy was initiated in fiscal year 2004. Specific
    examples of planned or ongoing initiatives that are helping the
    Judiciary manage costs, or will help in the future include:
    establishing an annual budget cap for GSA space rental costs for fiscal
    years 2009 through 2016, which limits annual growth by an average of
    4.9 percent per year; revising the U.S. Courts Design Guide to lower
    future rental costs of space for chambers, attorneys, and court staff;
    validating GSA rent bills for each court facility and examining the GSA
    appraisal methodology to ensure rent charged is comparable to
    commercial rates; establishing ``asset management planning'' as the
    Judiciary's new long-range facilities planning methodology that will
    identify the most cost-effective strategy for meeting the court's
    operational needs, while controlling and containing costs, especially
    rent to GSA; and negotiating a return on investment pricing structure
    with GSA for all new space acquisitions, which replaces a market
    pricing approach.
        Question. In particular, a GAO report identified several
    opportunities for the Judiciary to reduce its space usage and therefore
    its rent costs. What has the Judiciary done in response to that report?
        Answer. Recommendation 1: Work with GSA to track rent and square
    footage trend data on an annual basis for the following factors: (1)
    rent component (shell rent, operations, tenant improvements, and other
    costs) and security (paid to the Department of Homeland Security); (2)
    judicial function (district, appeals, and bankruptcy); (3) rentable
    square footage; and (4) geographic location (circuit and district
    levels). This data will allow the Judiciary to create a better national
    understanding of the effect that local space management decisions have
    on rent and to identify any mistakes in GSA data.
        Actions of the Judiciary:
      --The Judiciary is continuing its efforts to obtain from GSA more
            specific information with regard to its rent bills that will
            aid the Judiciary in assigning costs to its various components.
            This effort has been quite time consuming as it requires GSA to
            remeasure its space and reclassify the information in GSA's
            database according to its type, e.g., district court courtrooms
            and chambers, clerk's office space, libraries, etc.
      --The Judiciary is also continuing its national rent validation
            initiative to identify mistakes in GSA data. The program has
            been successful on a number of fronts. The Judiciary has
            received rent credits and long-term savings (cumulative savings
            over a 3-year period of over $50 million) and has benefited
            from GSA's improved internal management controls on its rent-
            setting practices. We anticipate receiving additional rent
            adjustments and credits resulting from over $10 million in rent
            errors that we recently reported to GSA. Additionally, the
            Judiciary (and GSA) now has in place a program to help ensure
            that accurate rent bills are sustained over the long term.
      --As a follow-on to the base-line review of current rent bills, the
            Judiciary has embarked on a program to: (1) ensure future rent
            rates are appropriate; (2) maintain a website that will allow
            court personnel to determine quickly and easily the amount and
            cost of the space they occupy in federally owned facilities;
            and (3) design a training curriculum to provide court personnel
            with a comprehensive understanding of the rules, regulations,
            and procedures that govern the assignment, classification, and
            rental-rate determination for the space they occupy in
            federally owned facilities.
      --On February 19, 2008, the Director of the Administrative Office and
            the Commissioner of GSA's Public Buildings Service signed a
            Memorandum of Agreement (MOA) that changes the way rent will be
            calculated for all federally owned courthouses to be delivered
            in the future. The MOA outlines a new process for determining
            rental rates based on a return on investment methodology. Under
            the MOA, the rent will be fixed for the first 20 years of
            occupancy and will be set to return to GSA approximately 7
            percent per year of its capital costs; operating costs will be
            adjusted annually to reflect GSA's actual operating expenses.
            Both the Judiciary and GSA will benefit from knowing with
            certainty how much rent the Judiciary has to pay and how much
            rent GSA will receive.
        Recommendation 2: Create incentives for districts/circuits to
    manage space more efficiently. These incentives could take several
    forms, such as a pilot project that charges rent to the circuits and/or
    districts to encourage more efficient space usage.
        Actions of the Judiciary:
      --In September of 2007, the Judicial Conference approved creation of
            the Circuit Rent Budget (CRB) program as part of the
            Judiciary's overall cost containment efforts. CRB is designed
            to promote greater fiscal discipline in the management of the
            Judiciary's use of space by aligning, at the circuit judicial
            council level, the budget responsibility for rent, with the
            authority to determine space need.
      --The chief purpose of CRB is to enable the Judiciary to hold space
            cost growth to no more than 4.9 percent, on average, over the
            next eight years. The 4.9 percent cap on rent growth was
            approved by the Judicial Conference in September of 2006.
      --In essence, CRB allocates rent funds to circuits to cover both
            existing space assignments as well as space growth, with space
            growth carefully limited through centralized approval of large
            projects, and by a formulaic distribution to individual
            circuits of authority to add to the rental base.
      --Since its approval by the Judicial Conference in September 2007,
            the CRB program has been one of the Judiciary's main priorities
            in the space area. This initiative constitutes a dramatic
            change in the Judiciary's management of space and rent costs
            and its implementation affects virtually every work process and
            system currently in place.
      --Now in its pilot year, CRB is transforming the way the Judiciary
            plans for and approves new space acquisitions. Numerous
            initiatives are in progress to make the CRB program fully
            functional and successful. Some of the initiatives include, but
            are not limited to: a major communications and training plan;
            and implementation and testing of updated procedures, forms,
            and processes. The automated system, the Judiciary's Facilities
            Asset and Construction System (JFACTS), is also being
            redesigned to support the re-engineering of the Judiciary's
            space and rent program.
        Recommendation 3: Revise the Design Guide to: (1) establish
    criteria for the number of appeals courtrooms and chambers; (2)
    establish criteria for space allocated for senior district judges; and
    (3) make additional improvements to space allocation standards related
    to technological advancements (e.g., libraries, court reporter spaces,
    staff efficiency due to technology) and decrease requirements where
    appropriate.
        Actions of the Judiciary:
      --Over the last two years, the Judicial Conference of the United
            States approved multiple reductions to the space standards set
            forth in the U.S. Courts Design Guide that have reduced staff
            office sizes and chambers space for senior, district,
            appellate, bankruptcy and magistrate judges. In addition, the
            Committee on Space and Facilities plans to consider the
            criteria for the number of appeals courtrooms. Finally, the
            Judicial Conference approved technical amendments including
            reductions in atrium, lighting, and HVAC systems that will
            result in cost savings.
      --As to the impact of electronic filing on court space, the Judiciary
            has reduced Design Guide requirements for some of the clerk's
            office space, including intake areas and records storage,
            because of the impact of the electronic case filing/case
            management system and has reduced the library space by 13
            percent as a result of reductions in lawbook collections.
        Question. More specifically, what is the Judiciary's stance on
    courtroom sharing?
        Answer. The current Judicial Conference policy on courtroom sharing
    is that every active district judge, magistrate judge, and bankruptcy
    judge should have a courtroom. In response to an authorizing resolution
    passed by the House Committee on Transportation and Infrastructure, the
    Judiciary has instituted a policy of one courtroom for every two senior
    judges in all pending courthouse projects. All of the Judiciary's
    courtroom sharing policies for all types of judges are currently being
    studied by the Judicial Conference.

                              SUBCOMMITTEE RECESS

        Senator Durbin. The subcommittee will now stand in recess.
        [Whereupon, at 4:33 p.m., Wednesday, March 12, the
    subcommittee was recessed, to reconvene subject to the call of
    the Chair.]

      FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL
                                   YEAR 2009

                                  ----------

                           WEDNESDAY, APRIL 16, 2008

                                           U.S. Senate,
               Subcommittee of the Committee on Appropriations,
                                                        Washington, DC.
        The subcommittee met at 3 p.m., in room SD-192, Dirksen
    Senate Office Building, Hon. Richard J. Durbin (chairman)
    presiding.
        Present: Senator Durbin, Brownback, and Allard.

                           DEPARTMENT OF THE TREASURY

                            Internal Revenue Service

    STATEMENT OF DOUGLAS SHULMAN, COMMISSIONER
    ACCOMPANIED BY:
            RICHARD SPIRES, DEPUTY COMMISSIONER
            LINDA STIFF, DEPUTY COMMISSIONER

                 OPENING STATEMENT OF SENATOR RICHARD J. DURBIN

        Senator Durbin. Good afternoon. This hearing will come to
    order.
        I am pleased to welcome you to this session before the
    Financial Services and General Government Appropriations
    Subcommittee. My colleagues will be joining me a little later
    on, and I will certainly welcome them.
        Our focus today is on the President's fiscal year 2009
    budget request for the Internal Revenue Service (IRS). It is a
    perfect day, is it not, the day after tax day?
        Funding for the IRS alone constitutes just over one-half of
    the total amount requested by the administration for the nearly
    30 agencies under this subcommittee's jurisdiction. Each year
    IRS employees make hundreds of millions of contacts with
    American taxpayers and businesses, and the IRS represents the
    face of Government to more U.S. citizens than any other agency.
        Appearing before the subcommittee is a distinguished group
    of witnesses. They bring valuable expertise and public service
    experiences in their lives to this hearing today, and I
    appreciate it.
        First, I am going to welcome Douglas Shulman, now in his
    fourth week--4 weeks now, Mr. Commissioner--as the 47th
    Commissioner of the Internal Revenue Service of the United
    States. Thank you for embarking on this challenge.
        Joining us on the second panel will be three of IRS's key
    partners and watchdogs: J. Russell George, Treasury Inspector
    General for Tax Administration; Paul Cherecwich, Chairman of
    the IRS Oversight Board; and Nina Olson, National Taxpayer
    Advocate. I appreciate their work and look forward to their
    testimony.

           PREPARED STATEMENT OF THE GOVERNMENT ACCOUNTABILITY OFFICE

        I also want to acknowledge the helpful contributions of the
    Government Accountability Office (GAO) in response to our
    request for analysis. I welcome senior GAO officials: James R.
    White, Director of Strategic Issues, and David Powner, Director
    of Information Technology, Management Issues; and other members
    of their team. Their prepared statement will be a part of the
    record, and they stand ready to respond to questions.
        [The statement follows:]
       Prepared Statement of James R. White, Director, Strategic Issues,
                        Government Accountability Office

      Internal Revenue Service: Assessment of the Fiscal Year 2009 Budget
                                    Request

                                   HIGHLIGHTS

    Why GAO Did This Study
        The fiscal year 2009 budget request for the Internal revenue
    Service (IRS) is a road map for how IRS plans to allocate resources and
    achieve ambitious goals for improving taxpayer service, increasing
    research, and continuing to invest in modernized information systems.
    One complicating factor in implementing IRS's plans in the immediate
    future is the recent passage of the Economic Stimulus Act of 2008,
    which creates additional, unanticipated workload for IRS.
        GAO was asked to (1) assess how the President's budget request for
    IRS allocates resources and justifies proposed initiatives; (2)
    determine the status of IRS's efforts to develop and implement its
    Business Systems Modernization (BSM) program; and (3) determine the
    total costs of administering the economic stimulus legislation. To meet
    these objectives, GAO drew upon and updated recently issued reports.
    What GAO Recommends
        GAO is not making new recommendations, but the statement highlights
    outstanding recommendations to extend the use of return on investment
    (ROI) analysis to cover major enforcement programs and improve BSM
    management controls and capabilities.
    What GAO Found
        The President's fiscal year 2009 budget request for IRS is $11.4
    billion, 4.3 percent more than last year's enacted amount. The request
    proposes to maintain taxpayer service at recent levels, in part by
    realizing efficiency gains from electronic filing, despite a decrease
    in staffing. It also proposes a 7 percent increase in enforcement
    spending, including spending for 21 legislative and nonlegislative
    initiatives. The legislative proposals are projected to cost $23
    million in fiscal year 2009, funding that IRS would not need if the
    proposals are not enacted. Similarly, if IRS were to fall behind in its
    proposed enforcement hiring efforts, it would not need all $226 million
    of the associated funding. IRS justified its nonlegislative enforcement
    initiatives with ROI analyses, which are useful, despite limitations,
    for making resource allocation decisions. The budget request does not
    provide ROI information for activities that constitute a large part of
    the budget request--activities other than the proposed initiatives.
        The request for BSM is over $44 million lower than the fiscal year
    2008 enacted amount. IRS said this funding level will allow it to
    continue its primary modernization projects, but it did not describe
    how specific projects or benefits to taxpayers would be affected. IRS
    has continued to make progress in implementing BSM projects and
    improving modernization management controls and capabilities. However,
    further improvements are needed. For example, the agency has yet to
    develop long-term plans for completing BSM and consolidating and
    retiring legacy systems.
        IRS estimated that the costs of implementing the economic stimulus
    legislation may be up to a total of $767 million--including a $202
    million supplemental appropriation. In addition to the supplemental
    appropriation, IRS is reallocating hundreds of collections staff to
    answering taxpayer telephone calls, resulting in up to $565 million in
    foregone enforcement revenue. In addition, IRS expects some
    deterioration in telephone service because of the increased call
    volume. For example, IRS is expecting its assistor level of service to
    drop to as low as 74 percent compared to its goal of 82 percent.

       THE PRESIDENT'S FISCAL YEAR 2009 REQUEST FOR IRS FULL-TIME EQUIVALENTS (FTES) COMPARED TO FISCAL YEAR 2008
                                                   ENACTED BUDGET FTES
    ----------------------------------------------------------------------------------------------------------------
                                                                        Fiscal year     Fiscal year     Percentage
                              Appropriation                            2008 enacted   2009 requested      change
    ----------------------------------------------------------------------------------------------------------------
    Enforcement.....................................................          47,349          49,792            +5.2
    Taxpayer Service................................................          31,218          30,792            -1.4
    Operations Support..............................................          12,181          11,989            -1.6
    BSM.............................................................             358             333            -7.0
    Health Insurance Tax Credit.....................................              17              16            -5.9
                                                                     -----------------------------------------------
          Total.....................................................          91,123          92,922            +2.0
    ----------------------------------------------------------------------------------------------------------------
    Source: GAO analysis of IRS data.

        Mr. Chairman and Members of the Subcommittee: We appreciate this
    opportunity to comment on the President's fiscal year 2009 budget
    request for the Internal Revenue Service (IRS).
        Financing of the Federal Government depends largely on IRS's
    ability to effectively administer the tax laws. The President has
    requested $11.4 billion in program dollars to fund IRS's fiscal year
    2009 operations, including $11.1 billion for service to taxpayers and
    tax law enforcement, plus $223 million for the BSM program, IRS's
    ongoing effort to improve the agency's business and tax processing
    systems.
        The fiscal year 2009 budget request is a road map for how IRS
    intends to allocate resources in order to carry out ambitious plans of
    improving enforcement, improving taxpayer service, increasing research,
    and continuing to invest in modernized information systems. Together
    with the budget request, IRS's recently published strategies spell out
    its intentions for improving taxpayer service and reducing the net tax
    gap--the difference between the taxes owed and eventually paid, most
    recently estimated at $290 billion for tax year 2001.\1\ The budget
    request and strategies aim to build on recent IRS accomplishments such
    as annually bringing in more revenue through enforcement and making
    progress on modernizing IRS's business and tax processing systems. One
    complicating factor for carrying out IRS's ambitious plans in the
    immediate future is the recent passage of the Economic Stimulus Act of
    2008, which creates additional, unanticipated workload for IRS this
    year.\2\ Passage of this act required IRS to act quickly to deal with
    taxpayers' questions and begin issuing payments.
    ---------------------------------------------------------------------------
        \1\ Internal Revenue Service, Reducing the Federal Tax Gap
    (Washington, D.C.: Aug. 2, 2007); and Internal Revenue Service, The
    2007 Taxpayer Assistance Blueprint (Washington, D.C.: 2007).
        \2\ Pub. L. No. 110-185 (2008).
    ---------------------------------------------------------------------------
        Based on your request, our objectives were to (1) assess how the
    President's budget request for IRS for fiscal year 2009 allocates
    resources for enforcement, service, research, and systems modernization
    primarily compared to fiscal year 2008 enacted levels; (2) assess the
    rationales for differences between the 2 years, including the
    rationales for initiatives and the extent to which those rationales
    have been justified; (3) determine the status of IRS's efforts to
    develop and implement its BSM program; and (4) determine the total cost
    of administering the economic stimulus program.
        To meet these objectives, we drew upon and updated a recently
    issued report on the budget request and IRS's 2008 tax filing season,
    and for our BSM work, we relied primarily on our review of the fiscal
    year 2008 BSM expenditure plan.\3\ For the first report, we compared
    enacted and requested budgets for IRS; reviewed documents, including
    estimates of revenues and costs from initiatives; and interviewed IRS
    officials. For our BSM report, we analyzed the expenditure plan,
    reviewed other documents, and interviewed IRS officials. In assessing
    the cost of the economic stimulus package, we obtained performance and
    production data, looking for factors that significantly affected
    performance, and we interviewed IRS officials. We conducted the current
    performance audit from March 2008 through April 2008 in accordance with
    generally accepted government auditing standards. Those standards
    require that we plan and perform the audit to obtain sufficient,
    appropriate evidence to provide a reasonable basis for our findings and
    conclusions based on our audit objectives. We believe that the evidence
    obtained provides a reasonable basis for our findings and conclusions
    based on our audit objectives. For a more detailed discussion of our
    scope and methodology, see the appropriate sections in the budget and
    filing season and the BSM reports.
    ---------------------------------------------------------------------------
        \3\ GAO, Internal Revenue Service: Fiscal Year 2009 Budget Request
    and Interim Performance Results of IRS's 2008 Tax Filing Season, GAO-
    08-567 (Washington, D.C.: Mar. 13, 2008) and GAO, Business Systems
    Modernization: Internal Revenue Service's FISCAL Year 2008 Expenditure
    Plan, GAO-08-420 (Washington, D.C.: Mar. 7, 2008).
    ---------------------------------------------------------------------------
        In summary, we make the following major points:
      --The President's budget request for IRS proposes to maintain
            taxpayer service at recent levels and increase enforcement.
            Overall, it increases spending on IRS by 4.3 percent. Spending
            on taxpayer service would increase by less than 1 percent,
            which would result in reduced staffing, but the level of
            taxpayer service would be maintained by realizing efficiency
            gains, in part, through increases in electronic filing. The
            budget proposes a 7 percent increase in enforcement spending,
            including funds and staffing for various legislative and
            nonlegislative initiatives. According to the proposal, the
            legislative initiatives would raise about $36 billion in
            revenue over 10 years. They are projected to cost $23 million
            in fiscal year 2009, funding IRS would not need if none of the
            legislative initiatives were enacted. Similarly, if IRS were to
            fall behind in meeting its challenging hiring goals for the
            nonlegislative initiatives, it would not need all $226 million
            of the associated funding for fiscal year 2009.
      --IRS included more information than past years on the initiatives in
            the fiscal year 2009 proposed budget. Of particular note, IRS
            included return on investment (ROI) information for all
            nonlegislative initiatives. However, beyond those initiatives,
            the budget request does not provide an analytic basis for key
            resource allocation decisions. Such decisions include
            allocating resources among a variety of enforcement programs
            and taxpayer services. Analytic data such as ROI can be helpful
            to IRS's management and the Congress for making these decisions
            as well as decisions about the overall balance between taxpayer
            service and enforcement. Although the budget request provides
            performance measure data, it does not provide ROI for programs
            or activities that constitute a large part of the budget
            request--activities other than the proposed initiatives.
      --The requested budget for BSM is over $44 million lower than the
            fiscal year 2008 enacted amount of about $267 million and
            roughly $185 million less than the amount the IRS Oversight
            Board is proposing. Modernized e-File (MeF) is the project with
            the largest difference between the requested budget and the
            fiscal year 2008 enacted amount. IRS stated that the requested
            BSM funding level will allow it to continue developing and
            delivering its primary modernization projects but did not
            provide details on how plans to deliver specific projects or
            benefits to taxpayers would be affected. IRS continues to make
            progress in implementing BSM projects and meeting cost and
            schedule commitments for most deliverables, but three project
            milestones recently experienced significant cost or schedule
            delays.\4\ IRS has also taken steps to address our prior
            recommendations; however, work remains to fully implement them,
            including developing long-term plans for completing the BSM
            program. Future releases of the Customer Account Data Engine
            (CADE) and Account Management Services (AMS) continue to face
            risks and challenges, which IRS is working to mitigate.
            Finally, we recently recommended that IRS complete a plan with
            specific time frames for implementing initiatives supporting
            its information technology (IT) human capital strategy, and IRS
            agreed.
    ---------------------------------------------------------------------------
        \4\ Milestones represent different phases in IRS's project life
    cycle.
    ---------------------------------------------------------------------------
      --IRS estimates that the cost of implementing the economic stimulus
            legislation may be up to a total of $767 million, including a
            $202 million supplemental appropriation. In addition to the
            supplemental appropriation, IRS is reallocating resources from
            enforcement to taxpayer service by shifting hundreds of
            collections staff to answering telephone calls and, as a
            result, may forego up to $565 million in enforcement revenue.
            IRS has experienced a deterioration of telephone access and
            expects a further decline. For example, IRS's assistor level of
            service--which measures a taxpayer's ability to get through and
            speak to an assistor--has already declined, and IRS expects
            access to continue to drop to as low as 74 percent, down from
            the fiscal year 2008 goal of 82 percent.

       THE FISCAL YEAR 2009 BUDGET REQUEST PROPOSES TO MAINTAIN TAXPAYER
               SERVICE AT RECENT LEVELS AND INCREASE ENFORCEMENT

        The President's budget request is proposing to maintain taxpayer
    service levels with fewer staff by realizing efficiency gains; it also
    proposes to increase enforcement by adding staff. The President's
    fiscal year 2009 budget request of $11.4 billion for IRS is 4.3 percent
    more than the fiscal year 2008 enacted budget and represents an
    increase of less than 1 percent for taxpayer service and 7 percent for
    enforcement, as shown in table 1.

       TABLE 1.--THE PRESIDENT'S FISCAL YEAR 2009 REQUEST FOR IRS COMPARED TO THE FISCAL YEAR 2008 ENACTED BUDGET
                                                 [Dollars in thousands]
    ----------------------------------------------------------------------------------------------------------------
                                                                        Fiscal year     Fiscal year     Percentage
                                 Program                               2008 enacted   2009 requested      change
    ----------------------------------------------------------------------------------------------------------------
    Enforcement.....................................................      $6,997,226      $7,487,209            +7.0
    Taxpayer Service................................................       3,612,833       3,636,230            +0.6
    BSM.............................................................         267,090         222,664           -16.6
    Health Insurance Tax Credit.....................................          15,235          15,406            +1.1
                                                                     -----------------------------------------------
          Total.....................................................      10,892,384      11,361,509            +4.3
    ----------------------------------------------------------------------------------------------------------------
    Note: Dollar amounts include amounts for operations support.

    Source: GAO analysis of IRS data.

        The budget request increases IRS-wide staff levels, measured in
    full-time equivalents (FTEs), by 2 percent, with a 1.4 percent decrease
    in taxpayer service FTEs and a 5.2 percent increase in enforcement
    FTEs, as shown in table 2.

    TABLE 2.--THE PRESIDENT'S FISCAL YEAR 2009 REQUEST FOR IRS FTES COMPARED TO FISCAL YEAR 2008 ENACTED BUDGET FTES
    ----------------------------------------------------------------------------------------------------------------
                                                                        Fiscal year     Fiscal year     Percentage
                              Appropriation                            2008 enacted   2009 requested      change
    ----------------------------------------------------------------------------------------------------------------
    Enforcement.....................................................          47,349          49,792            +5.2
    Taxpayer Service................................................          31,218          30,792            -1.4
    Operations Support..............................................          12,181          11,989            -1.6
    BSM.............................................................             358             333            -7.0
    Health Insurance Tax Credit.....................................              17              16            -5.9
                                                                     -----------------------------------------------
          Total.....................................................          91,123          92,922            +2.0
    ----------------------------------------------------------------------------------------------------------------
    Note: The decline in taxpayer services, including operations support, reflects 91 FTEs in efficiency savings and
      207 FTEs in electronic filing savings. The increase in enforcement, including operations support, includes an
      additional 1,431 revenue agents and 582 revenue officers who will work on initiatives.

    Source: GAO analysis of IRS data.

        The President's budget proposal is consistent with longer-term
    trends for IRS. Compared to actual spending in fiscal year 2006, the
    proposed fiscal year 2009 budget increases taxpayer service funding by
    3.7 percent, a real decrease after inflation, while increasing IRS's
    enforcement funding by 10 percent.
        The budget request proposes to maintain taxpayer service at recent
    levels. As an example, the key taxpayer service measures shown in table
    3 are projected to remain relatively stable through fiscal year 2009.

                                          TABLE 3.--TELEPHONE SERVICE MEASURES
                                                      [In percent]
    ----------------------------------------------------------------------------------------------------------------
                                                        Fiscal year     Fiscal year     Fiscal year     Fiscal year
                         Measure                        2006 actual     2007 actual    2008 planned    2009 planned
    ----------------------------------------------------------------------------------------------------------------
    Telephone performance--access: Assistor level of            82.0            82.1            82.0            82.0
     service (percentage of taxpayers who wanted to
     talk with an assistor and actually got through
     and received service)..........................
    Telephone performance--accuracy:
        Tax law customer accuracy (percentage of                90.9            91.2            91.0            91.0
         calls in which telephone assistors provided
         accurate answers on tax law and took
         appropriate action)........................
        Accounts customer accuracy (percentage of               93.2            93.4            93.5           93.7
         calls in which telephone assistors provided
         accurate answers on customer accounts and
         took appropriate action)...................
    ----------------------------------------------------------------------------------------------------------------
    Source: GAO analysis of IRS data.

        In order to maintain taxpayer service at recent levels despite a
    decrease in real spending and staffing, IRS expects to realize
    efficiency gains. For instance, IRS expects to devote 207 fewer FTEs to
    the labor-intensive processing of paper returns because of expected
    increases in electronic filing. These expected efficiency gains are
    consistent with past trends--between 1999 and 2007, IRS reduced staff
    devoted to processing paper returns by about 1,800 FTEs.
        IRS's ability to maintain or improve taxpayer service beyond 2009
    will likely depend on its ability to continue to improve efficiency. To
    this end, in recent reports, we made recommendations to further
    increase electronic filing. We recommended that IRS determine the
    actions needed to require software vendors to include bar codes on
    printed returns, and we suggested that the Congress mandate electronic
    filing by certain paid tax preparers.\5\ IRS agreed with our bar code
    recommendation and outlined the actions it would take.
    ---------------------------------------------------------------------------
        \5\ GAO, Tax Administration: 2007 Filing Season Continues Trend of
    Improvement, but Opportunities to Reduce Costs and Increase Tax
    Compliance Should Be Evaluated, GAO-08-38 (Washington, D.C.: Nov. 15,
    2007) and GAO, Tax Administration: Most Filing Season Services Continue
    to Improve, but Opportunities Exist for Additional Savings, GAO-07-27
    (Washington, D.C.: Nov. 15, 2006).
    ---------------------------------------------------------------------------
        Some of the real spending decrease proposed for fiscal year 2009 is
    because of one-time investments made in fiscal year 2008 or carryovers
    in funds from fiscal year 2008. For instance, the budget request
    proposes a $31 million reduction in funding for taxpayer assistance
    centers and outreach. However, IRS officials told us that this
    reduction includes funding used for long-term investments in fiscal
    year 2008 that would not need to be duplicated in fiscal year 2009. IRS
    officials also told us that a $7.7 million decrease in funding for the
    Taxpayer Advocate offsets a funding increase in fiscal year 2008 that
    is being used to lower the Advocate's outstanding caseload. Finally, an
    $8 million reduction in the Volunteer Income Tax Assistance (VITA)
    program reflects fiscal year 2008 funding that was not spent and
    carried over into fiscal year 2009.\6\
    ---------------------------------------------------------------------------
        \6\ The funding provided in fiscal year 2008 was 2-year funding.
    Since IRS was ramping up the program being funded--providing matching
    grants to volunteer preparer organizations--in 2008, additional funding
    was not needed for 2009. Despite not asking for additional funding, IRS
    is expecting to see large, but unquantified, growth in tax returns
    prepared at VITA sites. According to IRS officials, IRS does not have a
    separate line item showing how much it spent on VITA overall.
    ---------------------------------------------------------------------------
        The budget request for IRS's enforcement programs includes
    nonlegislative and legislative initiatives. According to the proposal,
    the five nonlegislative enforcement initiatives would cost about $338
    million in fiscal year 2009 and are expected to raise about $2 billion
    of direct revenue annually starting in fiscal year 2011.\7\ In
    addition, the budget request estimates that the enforcement initiatives
    would generate at least another $6 billion annually in indirect
    revenue. The indirect revenue results from improved voluntary
    compliance induced by taxpayers' awareness of expanded IRS enforcement.
    The budget request also proposes increases in examination coverage for
    corporations with assets of $10 million or more from a planned 6.6
    percent for fiscal year 2008 to 6.8 percent for fiscal year 2009. The
    coverage rate would increase to 7.6 percent in fiscal year 2010 as new
    enforcement staff hired in fiscal year 2009 complete training and can
    audit more returns.
    ---------------------------------------------------------------------------
        \7\ These nonlegislative initiatives involve (1) reducing the tax
    gap for small businesses and the self-employed; (2) reducing it for
    large businesses; (3) increasing reporting compliance related to
    offshore activity; (4) through research, improving tax gap estimates,
    measurement, and detection of noncompliance; and (5) expanding document
    matching.
    ---------------------------------------------------------------------------
        The budget request includes 16 legislative initiatives budgeted at
    $23 million for fiscal year 2009 that it says would raise about $36
    billion in revenue over 10 years; if none were enacted, IRS would not
    need the $23 million. We have reported on three of the proposals. In
    2006, we suggested that the Congress consider an idea for reducing
    securities capital gains noncompliance.\8\ In 1991, we supported the
    notion that payments to corporations be reported on information
    returns.\9\ Finally, in 2007, we described ways to mitigate the
    compliance costs related to these information returns and to other
    information returns associated with credit and debit card payments.\10\
    ---------------------------------------------------------------------------
        \8\ GAO, Capital Gains Tax Gap: Requiring Brokers to Report
    Securities Cost Basis Would Improve Compliance if Related Challenges
    Are Addressed, GAO-06-603 (Washington, D.C.: June 13, 2006).
        \9\ GAO, Tax Administration: Benefits of a Corporate Document
    Matching Program Exceed the Costs, GAO/GGD-91-118 (Washington, D.C.:
    Sept. 27, 1991).
        \10\ GAO, Tax Administration: Costs and Uses of Third-Party
    Information Returns, GAO-08-266 (Washington, D.C.: Nov. 20, 2007).
    ---------------------------------------------------------------------------
        The revenue expected from IRS's enforcement initiatives is modest
    compared to the net tax gap, which was last estimated at $290 billion
    for tax year 2001. As we noted in our statement to this Committee last
    year, no single approach, such as IRS enforcement, is likely to fully
    and effectively address noncompliance.\11\ Multiple approaches are
    needed because noncompliance has multiple causes and spans different
    types of taxes and taxpayers.
    ---------------------------------------------------------------------------
        \11\ GAO, Internal Revenue Service: Assessment of the 2008 Budget
    Request and an Update of 2007 Performance, GAO-07-719T (Washington,
    D.C.: May 9, 2007).
    ---------------------------------------------------------------------------
        Hiring needed staff for the nonlegislative initiatives will be
    challenging for IRS's Large and Mid-Size Business (LMSB) and Small
    Business/Self-Employed (SB/SE) divisions. For instance, the initiatives
    call for adding 1,431 revenue agents in addition to those who must be
    replaced from attrition, a high number relative to past years. IRS
    divisions have previously hired large numbers of staff in a short time
    because of specific budget initiatives, but officials reported that
    hiring gradually over time would reduce challenges. If IRS were to fall
    behind in its hiring efforts, it would not need all $226 million of the
    funding for staff for fiscal year 2009 initiatives.

     IRS HAS ENHANCED ITS JUSTIFICATIONS FOR INITIATIVES AND COULD BENEFIT
       FROM USING ROI ANALYSES MORE BROADLY, EVEN WITH THEIR LIMITATIONS

        Responding to our recommendations from last year, IRS included more
    information on initiatives in the fiscal year 2009 proposed budget,
    including ROI information for all nonlegislative initiatives. Last
    year, we recommended that IRS have available basic descriptive, cost,
    and expected performance information on all new initiatives and include
    such information in future budget submissions.\12\ This year, the
    budget request has sections explicitly entitled, for instance,
    ``Initiative Summary,'' ``Implementation Plan,'' ``Expected Benefits,''
    and ``ROI.'' Four of the five nonlegislative enforcement initiatives
    for fiscal year 2009 were revisions of fiscal year 2008 initiatives,
    but with more total funds requested and generally more informative
    justifications than for fiscal year 2008.
    ---------------------------------------------------------------------------
        \12\ GAO-07-719T.
    ---------------------------------------------------------------------------
        However, IRS's ROI calculations have limitations that reflect the
    challenges of estimating ROIs. For example, the calculations do not
    account for benefits that are harder to measure, such as improved
    voluntary compliance. Another example showing ROI limitations is the
    $51 million National Research Project (NRP) initiative for which IRS
    estimates the ROI to be $0.40 per $1.00 invested. NRP funds research
    audits in order to develop more effective enforcement programs. The ROI
    calculation only includes direct revenue resulting from the research
    audits, not the potential for increased revenue from improved
    enforcement programs; nor does the calculation include the benefits of
    the Department of the Treasury's use of NRP data to provide the basis
    for legislative recommendations.
        Although the budget request for IRS provides performance measure
    data, it does not provide ROI analyses for programs or activities other
    than the new initiatives. As we noted in our recent report, analytic
    data such as ROI can be helpful to managers and the Congress when
    making resource allocation decisions.\13\ ROI analyses, even with their
    limitations, can help answer questions such as the following:
    ---------------------------------------------------------------------------
        \13\ GAO-08-567.
    ---------------------------------------------------------------------------
      --What are the implications for IRS's resource allocation of the
            lower costs per taxpayer contact for some services compared to
            others as shown in table 4?
      --Are there extra benefits that offset the higher costs of some
            services, or could costs be reduced by promoting increased
            reliance on the lower-cost options?

        TABLE 4.--COST OF PROVIDING TAXPAYER SERVICE IN FISCAL YEAR 2005
    ------------------------------------------------------------------------
                                                              Estimated cost
                             Service                            per contact
    ------------------------------------------------------------------------
    Answering tax law questions via e-mail..................          $52.51
    Providing assistance at taxpayer assistance centers.....           28.73
    Answering correspondence................................           24.97
    Providing assistance by assistors via toll-free                    19.46
     telephones.............................................
    Providing assistance through VITA sites.................           12.01
    Providing assistance by automation via toll-free                    0.71
     telephones.............................................
    Providing assistance such as downloads and searches on              0.13
     IRS's Web site.........................................
    ------------------------------------------------------------------------
    Note: IRS reported that these estimates do not fully allocate all
      indirect overhead and support costs. We have reported that because of
      long-standing limitations in IRS's cost accounting capability, cost
      data at this detailed level have not been audited (see, for example,
      GAO-07-310 and 07-247). From our perspective, it would be important to
      know more about the indirect and support costs to see if they might
      significantly change the cost estimates.

    Source: GAO analysis of IRS data.

        Similar questions can be asked about enforcement based on table 5:
      --Is IRS appropriately allocating resources between field audits,
            often conducted at a taxpayer's business, and correspondence
            audits, which are simpler and conducted by mail? \14\
    ---------------------------------------------------------------------------
        \14\ In fiscal year 2007 correspondence audits took, on average,
    1.4 hours to conduct compared to the 30.8-hour average for field audits
    done at taxpayers' locations and the 7.8-hour average for field audits
    done at IRS offices.
    ---------------------------------------------------------------------------
      --For the rows in table 5 with average recommended additional tax per
            return greater for correspondence audits than for field audits,
            could resources be reallocated from field audits to
            correspondence audits in order to help close the tax gap?
      --Are there other benefits to field audits, such as a greater impact
            on voluntary compliance, that are not captured in IRS's data?

     TABLE 5.--FIELD AND CORRESPONDENCE AUDITS OF SOME BUSINESS CATEGORIES OF TAXABLE INDIVIDUAL INCOME TAX RETURNS,
                                               FISCAL YEARS 2006 AND 2007
    ----------------------------------------------------------------------------------------------------------------
                                                        Number of returns examined    Average recommended additional
                                                     --------------------------------         tax per return
                 Type and size of return                                             -------------------------------
                                                           Field      Correspondence       Field      Correspondence
    ----------------------------------------------------------------------------------------------------------------
    Fiscal year 2006:
        Business nonfarm returns by size of total
         gross receipts (TGR):
            Under $25,000...........................          19,801         107,802          $3,918          $2,614
            $25,000 under $100,000..................          38,722          42,070           5,464           7,600
            $100,000 or more........................          54,716          34,515          25,787          27,863
    Fiscal year 2007:
        Business nonfarm returns without earned
         income tax credit, by size of TGR:
            Under $25,000...........................          53,092          81,237           4,836          11,048
            $25,000 under $100,000..................          31,363          31,513           6,320          11,793
            $100,000 under $200,000.................          28,286          28,041          24,582          32,640
            $200,000 or more........................          11,319           1,730          15,959           7,017
    Business returns with total positive income at            17,499          15,280          20,880          33,406
     least $200,000 and under $1 million............
    ----------------------------------------------------------------------------------------------------------------
    Note: This table does not include all categories of audits. For a number of those categories, field audits
      produce a higher average recommended additional tax per return than do correspondence audits.

    Source: GAO analysis of IRS data.

        We recognize that developing ROI estimates for IRS's ongoing
    programs such as examinations and taxpayer service will be a challenge.
    However, because of the potential benefits of ROI analyses, we
    recommended in our previous report on the fiscal year 2009 budget
    request that the Commissioner of Internal Revenue extend the use of ROI
    in future budget proposals to cover major enforcement programs. At that
    time, IRS officials said that because of the short time frame for our
    report, they did not have time to fully analyze its recommendations,
    and, therefore, were unable to respond.\15\ We have agreed to meet with
    IRS to further discuss the ROI recommendation.
    ---------------------------------------------------------------------------
        \15\ GAO-08-567.
    ---------------------------------------------------------------------------
      FURTHER PROGRESS MADE IN IMPLEMENTING BSM, BUT CHALLENGES AND RISKS
                                     REMAIN

        IRS's BSM program, initiated in 1999, involves the development and
    delivery of a number of modernized tax administration, internal
    management, and core infrastructure projects that are intended to
    provide improved and expanded service to taxpayers as well as IRS
    internal business efficiencies. Key tax administration projects include
    CADE, which is intended to provide the modernized database foundation
    to replace the existing Individual Master File processing system that
    contains the repository of individual taxpayer information; AMS, which
    is intended to enhance CADE by providing applications for IRS employees
    and taxpayers to access, validate, and update accounts on demand; and
    MeF, which is to provide a single standard for filing electronic tax
    returns. We recently reported that while IRS has continued to make
    progress in implementing BSM projects and improving modernization
    management controls and capabilities, challenges and risks remain, and
    further improvements are needed.\16\
    ---------------------------------------------------------------------------
        \16\ GAO-08-420.
    ---------------------------------------------------------------------------
        As shown in table 6, the fiscal year 2009 budget request for the
    BSM program is less than the enacted fiscal year 2008 budget by over
    $44 million and about $185 million less than the amount the IRS
    Oversight Board is proposing. When we asked about the impact of this
    reduction on its operations, IRS told us that the proposed funding
    level will allow it to continue developing and delivering its primary
    modernization projects but did not provide details on how plans to
    deliver specific projects or benefits to taxpayers would be affected.
    MeF is the project with the largest difference between the requested
    budget and the fiscal year 2008 enacted amount.

          TABLE 6.--BSM FUNDING DIFFERENCES, FISCAL YEAR 2008 AND 2009
                            [In thousands of dollars]
    ------------------------------------------------------------------------
                                                                Fiscal year
                     Project                    Fiscal year     2009 budget
                                               2008 enacted       request
    ------------------------------------------------------------------------
    Customer Account Data Engine............          58,500          58,800
    Accounts Management Services............          28,983          26,158
    Modernized e-File.......................          55,802          25,000
    Filing & Payment Compliance.............  ..............  ..............
    Core Infrastructure.....................          39,150          32,000
    Architecture, Integration, and                    35,100          35,000
     Management.............................
    Management Reserve......................           4,310           2,300
                                             -------------------------------
          Subtotal Capital Investments......         221,845         179,258
    BSM Labor...............................          44,000          42,052
                                             -------------------------------
          Subtotal Program Request..........         265,845         221,310
    Maintaining Current Levels..............           1,245           1,354
                                             -------------------------------
          Total BSM Budget Request..........         267,090         222,664
    ------------------------------------------------------------------------
    Source: IRS data.

        IRS has made progress in implementing BSM projects and meeting cost
    and schedule commitments for most deliverables, but three project
    milestones experienced significant cost or schedule delays.\17\ During
    2007, IRS completed milestones of the Filing and Payment Compliance
    (F&PC), a tax collection case analysis support system; MeF; CADE; and
    AMS. Our analysis of reported project costs and completion dates showed
    that 13 of the 14 associated project milestones that were scheduled for
    completion during this time were completed within 10 percent of cost
    estimates, and 11 of the 14 milestones were completed within 10 percent
    of schedule estimates. However, a milestone for CADE exceeded its
    planned schedule by 66 percent and experienced a 15 percent cost
    increase; another milestone for the same project incurred a 153 percent
    schedule delay, and a milestone for MeF experienced a 41 percent
    schedule delay (see fig. 1).
    ---------------------------------------------------------------------------
        \17\ Milestones represent different phases in IRS's project life
    cycle.

        IRS has taken steps to address our prior recommendations to improve
    its modernization management controls and capabilities. However, work
    remains to fully implement them. For example, in July 2005, we
    recommended that IRS fully revisit the vision and strategy for the BSM
    program and develop a new set of long-term goals, strategies, and plans
    consistent with the budgetary outlook and IRS's management
    capabilities.\18\ We also noted that the vision and strategy should
    include time frames for consolidating and retiring legacy systems. In
    response, IRS has developed a Modernization Vision and Strategy
    framework and supporting 5-year Enterprise Transition Plan. However,
    the agency has yet to develop long-term plans for completing BSM and
    consolidating and retiring legacy systems. We also recommended in
    February 2007 that IRS ensure that future BSM expenditure plans include
    a quantitative measure of progress in meeting scope expectations.\19\
    We further recommended that, in developing this measure, IRS consider
    using earned value management since this is a proven technique required
    by the Office of Management and Budget for measuring cost, schedule,
    and functional performance against plans.\20\ While IRS has developed
    an approach to address our recommendation, it has not yet fully
    implemented it.
    ---------------------------------------------------------------------------
        \18\ GAO, Business Systems Modernization: Internal Revenue
    Service's Fiscal Year 2005 Expenditure Plan, GAO-05-774 (Washington,
    D.C.: July 22, 2005).
        \19\ GAO, Business Systems Modernization: Internal Revenue
    Service's Fiscal Year 2007 Expenditure Plan, GAO-07-247 (Washington,
    D.C.: Feb. 15, 2007).
        \20\ Earned value management is a project management tool that
    integrates the investment scope of work with schedule and cost elements
    for investment planning and control. This method compares the value of
    work accomplished during a given period with that of the work expected
    in the period. Differences between accomplishments and expectations are
    measured in both cost and schedule variances.
    ---------------------------------------------------------------------------
        Future BSM project releases continue to face significant risks and
    issues, which IRS is addressing. Specifically, the agency recently
    identified significant risks and issues with planned system deliveries
    of CADE and AMS and reported that maintaining alignment between the two
    systems will be a significant challenge and source of risk for the BSM
    program. IRS recognizes the potential impact of identified risks and
    issues on its ability to deliver projects within cost and schedule
    estimates and has developed mitigation strategies to address them.
    While mitigation strategies have been developed, the risks and
    challenges confronting future releases of CADE and AMS are nevertheless
    significant, and we will continue to monitor them and actions to
    address them.
        IRS also made further progress in addressing high-priority BSM
    program improvement initiatives during the past year. In September
    2007, IRS completed another cycle of initiatives and initiated a new
    cycle, which was scheduled to be completed at the end of March 2008.
    Initiatives that were addressed in the 6-month cycle ending in
    September 2007 included IT human capital, information security, and
    process improvements (e.g., developing and implementing standardized
    earned value management practices for major projects). IRS's program
    improvement process continues to be an effective means of regularly
    assessing, prioritizing, and incrementally addressing BSM issues and
    challenges. However, more work remains for the agency to fully address
    these issues and challenges.
        Finally, we recently reported that efforts to address human capital
    challenges continue, but more work remains. IRS developed an IT human
    capital strategy that addresses hiring critical personnel, employee
    training, leadership development, and workforce retention, and agency
    officials stated that they plan to undertake a number of human capital
    initiatives to support their human capital strategy, including
    conducting analyses of turnover rates and continuing efforts to replace
    key leaders lost to retirement. However, a specific plan with time
    frames for implementing these initiatives has not been developed. We
    recommended that IRS complete such a plan to help guide the agency's
    efforts in addressing its IT human capital gaps and measure progress in
    implementing them. IRS agreed with our recommendation and stated that
    it intends to develop a plan to implement its IT human capital
    strategy.

         IRS ESTIMATES THE COST OF IMPLEMENTING THE ECONOMIC STIMULUS
     LEGISLATION MAY BE UP TO A TOTAL OF $767 MILLION AND EXPECTS DECLINES
                           IN SOME TAXPAYER SERVICES

        The Economic Stimulus Act of 2008 is resulting in a significant
    workload increase not anticipated in the fiscal year 2008 budget. As
    part of the legislation, IRS received $202 million in a supplemental
    appropriation. However, because IRS could not find an alternative
    according to responsible officials, it has reallocated resources from
    enforcement to taxpayer service and is allowing some deterioration in
    telephone service.
        IRS will begin sending economic stimulus payments to more than 130
    million households in early May, after the current tax filing season,
    and is scheduled to be done by mid-July. These include an estimated 20
    million retirees and disabled veterans, and low-wage workers who
    usually are exempt from filing a tax return but will be eligible for
    stimulus payments. Taxpayers required to file a tax return must do so
    by April 15 in order to receive a stimulus payment by mid-July.\21\
    People who are not required to file a tax return, but are doing so to
    receive a stimulus payment, are required to file an IRS Form 1040A by
    October 15, 2008.
    ---------------------------------------------------------------------------
        \21\ Taxpayers who are unable to meet the April 15 filing deadline
    can file a Form 4868, the automatic extension of time to file, which
    gives them until October 15 to submit a 2007 tax return.
    ---------------------------------------------------------------------------
        As part of the legislation, IRS received a supplemental
    appropriation of $202 million to help fund its costs for implementing
    the stimulus package. This funding will remain available until
    September 30, 2009. As shown in table 7, IRS plans to spend the bulk of
    the funding--$151.4 million--for Operations Support, most of it on
    postage for two mass mailings and on IT support. IRS also expects to
    spend $50.7 million for Taxpayer Services, including $26.2 million for
    staffing and overtime for telephone assistors. IRS is expecting 2.4
    million additional telephone calls in March and April with questions
    for IRS assistors about the economic stimulus legislation. These calls
    are in addition to the more than 14 million calls typically answered by
    IRS assistors between January and mid-April.

                    TABLE 7.--IRS'S ESTIMATED COSTS OF IMPLEMENTING THE ECONOMIC STIMULUS LEGISLATION
                                                  [Dollars in millions]
    ----------------------------------------------------------------------------------------------------------------
                                                                                          Revised
                                                                         2008 goal       estimate         Amount
    ----------------------------------------------------------------------------------------------------------------
    Supplemental appropriation:
        Operations Support:
            Postage.................................................  ..............  ..............         $90.613
            IT support..............................................  ..............  ..............         $43.965
            Telecommunications......................................  ..............  ..............          $8.370
            Printing................................................  ..............  ..............          $6.767
            Communications plan.....................................  ..............  ..............          $1.700
                                                                     -----------------------------------------------
              Total for Operations Support..........................  ..............  ..............        $151.415
    Taxpayer Services: Additional staffing/overtime.................  ..............  ..............         $50.720
                                                                     -----------------------------------------------
          Total supplemental funding................................  ..............  ..............        $202.135
                                                                     ===============================================
    IRS estimates of foregone revenue from shifting Automated
     Collection System (ACS) staff: \1\
        Wage and Investment (W&I)...................................  ..............  ..............        $191.728
        Small Business/Self-Employed (SB/SE)........................  ..............  ..............        $373.065
                                                                     -----------------------------------------------
          Total foregone revenue (up to)............................  ..............  ..............        $564.793
                                                                     -----------------------------------------------
          Total (up to).............................................  ..............  ..............        $766.928
                                                                     ===============================================
    Taxpayer service: Assistor level of service (percent)...........              82         ( \2\ )         ( \3\ )
    ----------------------------------------------------------------------------------------------------------------
    \1\ Revised as of early April 2008.
    \2\ As low as 74.
    \3\ Reduction--Down 8 percentage points.

    Source: GAO analysis of IRS and Treasury data.

        To help meet the increased telephone demand, IRS is shifting about
    half of its over 2,000 Automated Collection System (ACS) telephone
    staff from collecting delinquent taxes to answering economic stimulus
    telephone calls from March through May.\22\ To accommodate this shift,
    IRS stopped sending out some ACS-generated notices, such as notices of
    levy, several weeks ago.\23\ According to IRS officials, it takes about
    3 to 4 weeks before this adjustment in ACS-generated notices affects
    the ACS workload. IRS originally estimated that the revenue foregone by
    shifting ACS staff to be up to $681 million. However, according to IRS
    officials, in early April, IRS revised its foregone revenue estimate
    down to $565 million, shown in table 7, largely because of lower-than-
    expected demand for telephone assistance in March.\24\
    ---------------------------------------------------------------------------
        \22\ When IRS has completed sending its initial series of notices
    to tax debtors, it assigns the debts to its collections programs, such
    as ACS. ACS is an automated telephone-based system designed to call tax
    debtors. ACS staffers then attempt to talk with tax debtors to try to
    collect outstanding tax debt. IRS estimated there are about 1,200 ACS
    staff in its W&I division and about 1,100 in its SB/SE division.
        \23\ IRS suspended notices sent by ACS examiners, such as final
    notices before enforcement, collection due process notices, and notices
    of levy.
        \24\ IRS arrived at the estimates by taking a 3-year average of
    dollars collected by closing ACS cases for both its W&I and SB/SE
    divisions. IRS determined the projected foregone revenue by multiplying
    the average dollars collected per ACS staff by the projected lost case
    closures. IRS plans to minimize the use of SB/SE staff because the
    revenue collected by SB/SE is greater than for W&I.
    ---------------------------------------------------------------------------
        According to IRS officials, IRS's priority is to respond to
    taxpayers' questions about the stimulus program; therefore, the
    officials are monitoring call volume and adjusting the number of ACS
    staff answering telephones accordingly. When call volume is low, ACS
    staff work on outstanding ACS collection cases. However, IRS officials
    stated that this work does not produce the same revenue as the ACS-
    generated notices, particularly revenue generated from notices of levy.
    When IRS adjusts the volume of ACS-generated notices, it takes several
    weeks before that adjustment affects ACS workload. IRS officials do not
    want to resume sending ACS-generated notices until they are sure ACS
    staffers are available to handle the resulting workload.
        Should the lower-than-expected call volume continue, IRS may have
    an opportunity to shift the ACS staff back to their most productive
    collection work. This could further reduce the revenue foregone from
    using ACS staff to answer stimulus-related telephone calls. To date,
    IRS has not reduced its projections for future stimulus-related call
    volume. If the projections are reduced, IRS may be able to resume
    sending out at least some ACS-generated notices.
        According to IRS officials, IRS considered alternatives to shifting
    ACS staff, including contracting out, using other IRS staff, or using
    Social Security Administration or other Federal staff, but decided the
    alternatives were not feasible. For example, contracting out was not
    deemed feasible because of insufficient time to negotiate the contract
    and conduct background checks and training.
        Another cost--although not measured in dollars--is the decline in
    telephone service shown in table 7. Because of the increased call
    volume, IRS expects its assistor level of service to drop from 82
    percent (the 2008 goal) to as low as 74 percent--the lowest level since
    2002. IRS is already experiencing some declines in telephone service.
    As of March 29, the level of service had dropped to 80 percent,
    taxpayers were waiting a minute and a half longer than last year, and
    they were hanging up 43 percent more often while waiting to speak to an
    assistor. Between March 3 and March 29, IRS assistors answered over
    572,000 stimulus-related calls.\25\ IRS expects call volume to increase
    rapidly in upcoming weeks as taxpayers receive their stimulus notices
    in the mail.
    ---------------------------------------------------------------------------
        \25\ According to IRS officials, before March 3, taxpayers with
    stimulus-related calls were transferred to an automated message, which
    told taxpayers that additional information would be forthcoming. IRS
    estimated that the number of these calls frequently ranged from 20,000
    to 60,000 per day. IRS assistors started answering stimulus-related
    questions on March 3, and IRS established its dedicated telephone line
    for stimulus-related calls on March 14.
    ---------------------------------------------------------------------------
        Because IRS is in the early stages of implementing the stimulus
    legislation, IRS officials do not have much information about the
    actual costs. Through March, IRS estimates that it has spent almost
    $103 million, mostly for postage.

                                AGENCY COMMENTS

        In commenting on a draft of our earlier report on the fiscal year
    2009 budget request and 2008 tax filing season, IRS officials said
    that, because of the short time frame for our report, they did not have
    time to fully analyze our recommendation and, therefore, were unable to
    respond at the time. They provided technical comments at that time and
    again for this statement, and we made those changes where appropriate.
    We have agreed to meet with IRS to further discuss the ROI
    recommendation.
        Mr. Chairman, this concludes my prepared statement. Mr. Powner and
    I would be happy to respond to questions that you or other members of
    the subcommittee may have at this time.

              PREPARED STATEMENTS OF OMB WATCH AND COLLEEN KELLEY

        Senator Durbin. In addition, written statements have been
    received from OMB Watch and Colleen Kelley, President of the
    National Treasury Employees Union, on behalf of the employees
    of the Internal Revenue Service. Without objection, these
    materials will be made a part of the permanent record.
        [The statements follow:]

     Prepared Statement of Colleen M. Kelley, National President, National
                            Treasury Employees Union

        Chairman Durbin, Ranking Member Brownback, and distinguished
    members of the subcommittee, I would like to thank you for allowing me
    to provide comments on the administration's fiscal year 2009 budget
    request for the Internal Revenue Service (IRS). As president of the
    National Treasury Employees Union (NTEU), I have the honor of
    representing over 150,000 Federal workers in 31 agencies, including the
    men and women at the IRS.

                      IRS FISCAL YEAR 2009 BUDGET REQUEST

        Mr. Chairman, as you know, the IRS budget forms the foundation for
    what the IRS can provide to taxpayers in terms of customer service and
    how the agency can best fulfill its tax enforcement mission. Without an
    adequate budget, the IRS cannot expect to continue providing taxpayers
    with top quality service and will be hampered in its effort to enhance
    taxpayer compliance and close the tax gap.
        While acknowledging that IRS employees continue to provide world
    class customer service and are more efficient than ever in collecting
    taxes and enforcing tax law, the administration continues to put forth
    insufficient and unrealistic budget requests that fail to allow the
    service to meet its customer service and enforcement challenges.
        Staffing levels are dramatically below 1995 levels.
        The decline in IRS personnel, particularly enforcement staff, can
    be attributed to unrealistic budget requests, which since 2003, have
    contemplated internally generated savings or ``efficiency savings'' to
    help fund proposed increased staffing for enforcement. For fiscal year
    2009, the budget request identifies ``efficiency savings'' of more than
    $94 million at the cost of almost 976 FTEs. If, as sometimes has been
    the case in previous years, IRS fails to realize all expected savings
    then the funds available for new enforcement personnel would be further
    reduced.
        And although it's widely recognized that additional funding for
    enforcement provides a great return on the investment, the IRS has
    repeatedly told Congress that the IRS does not need any additional
    funding above the President' budget request.
        Employee productivity is not the issue. Despite the significant
    decline in enforcement staff over the past 10 years, enforcement
    revenue has increased significantly, reaching $59.2 billion in 2007, up
    from $48.7 billion in 2006 and an increase of $46 billion since 2000.
    The $59.2 billion in collections in 2007 represents a 5.6 to 1 return
    on investment for all IRS activities. In addition, earlier this year
    the IRS Data Book for 2007 was released which demonstrated that the IRS
    is one of the most efficient tax collection systems in the world,
    spending only 40 cents to collect $100.
        Yet, between 1995 and 2007, the total number of employees has
    shrunk from 114,064 to 86,638. Even more alarming is that during that
    period, revenue officers and revenue agents--two groups critical to
    reducing the tax gap--have shrunk by 33 and 20 percent respectively.
    Revenue officers went from 8,139 to 5,468 and revenue agents fell from
    16,078 to 13,026. These drastic cuts have come at a time when the IRS
    workload has increased dramatically. According to IRS's own annual
    reports and data, taxpayers filed 114.6 million returns in 1995. After
    a steady annual climb, 11 years later, the Service saw 134.4 million
    returns filed. In addition, between 1997 and 2007, the number of
    individual tax returns with $100,000 in reported income, which are
    generally more complex returns, increased by 103 percent.
        Unfortunately, instead of recognizing that the dramatic cuts to the
    IRS workforce are straining the ability of IRS employees to handle the
    increasing workload, the IRS has continued to reduce its workforce.
    Further exacerbating the dire staffing situation at the Service is the
    aging of the IRS workforce. Approximately 4,000 of its employees are
    retiring annually presenting the Service with the difficult challenge
    of replacing a large portion of its workforce each year and the
    institutional knowledge they take with them. These retirements of some
    of the Services' most experienced personnel will only further stress
    the current IRS workforce already straining under a rising workload.
        Amazingly, IRS efforts to reduce the overall workforce have
    targeted some of the Service's most productive employees. These include
    the recent re-organization of the Estate and Gift Tax Program which
    sought the elimination of 157 of the agency's 345 estate and gift tax
    attorneys--almost half of the agency's estate tax lawyers--who audit
    some of the wealthiest Americans. The Service pursued this drastic
    course of action despite internal data showing that estate and gift
    attorneys are among the most productive enforcement personnel at the
    IRS, collecting $2,200 in taxes for each hour of work. It is difficult
    to understand why the IRS sought the elimination of key workforce
    positions in an area that could produce significant revenue to the
    general treasury.
        In addition, the Service continues to move forward with its plan to
    close 5 of its 10 paper tax return submission facilities by 2011. The
    IRS originally sought the closings of the five paper return submission
    centers due to the rise in the use of electronic filing (e-filing) and
    in order to comply with the IRS Restructuring and Reform Act of 1998
    (RRA 98) which established a goal for the IRS to have 80 percent of
    Federal tax and information returns filed electronically by 2007. But
    the IRS recently reported that in 2007 just 57 percent of Federal tax
    returns were filed electronically and has previously acknowledged that
    it is getting harder to convert additional taxpayers to e-filing as
    those that might convert most readily have already done so.
        The continued slow migration of taxpayers to e-filing recently
    caused the IRS Oversight Board to call on Congress to extend the 80
    percent deadline to 2012 in its recent report to Congress on e-filing.
        In addition, while the IRS has stated that it will achieve millions
    of dollars in cost savings as a result of the paper submission
    consolidation effort, an August 2007 report by the Treasury Inspector
    General for Tax Administration (TIGTA) found that the agency's business
    decision to consolidate sites did not even include a cost-benefit
    analysis (TIGTA Report Number: 2007-40-165). Furthermore, the report
    found that the IRS had not adequately updated or monitored financial
    information on the personnel costs of consolidations and had included
    savings not attributable to site consolidation in some of its analyses.
    What is most disturbing is that while the IRS acknowledged some of the
    assumptions used to determine the consolidation plan may have changed,
    they refused to complete a cost-benefit analysis to determine if the
    existing plan is optimal or if alternatives need to be considered.
        Mr. Chairman, while overall use of e-filing may be on the rise, it
    is clear that the number of taxpayers opting to use this type of return
    is not increasing as rapidly as the IRS had originally projected.
    Combined with the fact that the IRS consolidation strategy rests on an
    incomplete business plan which did not include any type of cost-benefit
    analysis, NTEU believes that the IRS should immediately postpone
    further site consolidations until a comprehensive cost-benefit analysis
    can be completed to ensure that the existing plan is optimal in terms
    of cost savings and benefits.
        It is clear that drastic reductions in some of the agency's most
    productive tax law enforcement employees directly contradict the
    Service's stated enforcement priority to discourage and deter non-
    compliance. In addition, we believe these staffing cuts have greatly
    undermined agency efforts to close the tax gap which the IRS recently
    estimated at $345 billion. As Nina Olson, the National Taxpayer
    Advocate noted, this amounts to a per-taxpayer ``surtax'' of some
    $2,000 per year to subsidize noncompliance. And while the agency has
    made small inroads and the overall compliance rate through the
    voluntary compliance system remains high, much more can and should be
    done. NTEU believes that in order to close the tax gap and handle a
    rising workload, the IRS needs additional employees on the frontlines
    of tax compliance and customer service. In addition, we believe
    Congress should establish a dedicated funding stream to provide
    adequate resources for those employees.

                             NTEU STAFFING PROPOSAL

        In order to address the staffing shortage at the IRS, NTEU believes
    the workforce should be gradually increased to its pre-1996 levels.
    Specifically, we support a 3 percent annual net increase in staffing
    (roughly 2,600 positions per year) over a 5-year period to gradually
    rebuild the depleted IRS workforce to its pre-1996 levels from its
    current level of 86,638. Because it takes time and careful management
    to hire, train, and deploy qualified professional staff, consistent but
    modest annual increases are necessary. A similar idea was proposed by
    former IRS Commissioner Charles Rossotti in a 2002 report to the IRS
    Oversight Board. In the report, Rossotti quantified the workload gap in
    non-compliance, that is, the number of cases that should have been, but
    could not be acted upon because of resource limitations. Rossotti
    pointed out that in the area of known tax debts, assigning additional
    employees to collection work could bring in roughly $30 for every $1
    spent. The Rossotti report recognized the importance of increased IRS
    staffing noting that due to the continued growth in IRS' workload
    (averaging about 1.5 to 2 percent per year) and the large accumulated
    increase in work that should be done but could not be, even aggressive
    productivity growth could not possibly close the compliance gap.
    Rossotti also recognized that for this approach to work, the budget
    must provide for a net increase in staffing on a sustained yearly basis
    and not take a ``one time approach.''
        Adding staff to handle an increasing workload at the IRS is not a
    new concept. In its 2001 budget request, IRS asked for funding for the
    Staffing Tax Administration for Balance and Equity program (STABLE), an
    initiative aimed at restoring IRS staffing to mid-1990s levels and
    strengthening the Service's tax compliance and customer service
    functions. The STABLE initiative envisioned hiring nearly 4,000 new
    employees to help increase compliance and improve customer service. The
    proposal sought to boost staff in Field Offices, where IRS employees
    provide direct, in-person service to taxpayers, and Service Center/Call
    Sites, where service is typically provided via telephone and
    correspondence. Hiring requirements for the Field Offices was to be
    determined based on projected workload in the office's geographic area,
    and existing staff capabilities. Conversely, Service Center/Call Site
    workload would be planned on a nationwide basis due to the nature of
    the work, and staffing allocations based upon physical space and local
    labor market conditions around the center in question.
        Although such a staffing initiative would require a substantial
    financial commitment, the potential for increasing revenues, enhancing
    compliance and shrinking the tax gap makes it very sound budget policy.
    One option for funding a new staffing initiative would be to allow the
    IRS to hire personnel off-budget, or outside of the ordinary budget
    process. This is not unprecedented. In fact, Congress took exactly the
    same approach to funding in 1994 when Congress provided funding for the
    administration's IRS Tax Compliance Initiative which sought the
    addition of 5,000 compliance positions for the IRS. The initiative was
    expected to generate in excess of $9 billion in new revenue over 5
    years while spending only about $2 billion during the same period.
    Because of the initiative's potential to dramatically increase Federal
    revenue, spending for the positions was not considered in calculating
    appropriations that must come within annual caps.
        A second option for providing funding to hire additional IRS
    personnel outside the ordinary budget process could be to allow IRS to
    retain a small portion of the revenue it collects. The statute that
    gives the IRS the authority to use private collection companies to
    collect taxes allows 25 percent of collected revenue to be returned to
    the companies as payment, thereby circumventing the appropriations
    process altogether. Clearly, there is nothing magical about revenues
    collected by private collection companies. If those revenues can be
    dedicated directly to contract payments, there is no reason some small
    portion of other revenues collected by the IRS could not be dedicated
    to funding additional staff positions to strengthen enforcement.
        While NTEU agrees with IRS' stated goal of enhancing tax compliance
    and enforcement, we don't agree with the approach of sacrificing
    taxpayer service in order to pay for additional compliance efforts.
    That is why we were disappointed to see that the President's proposed
    budget calls for a $31 million cut in funding for Taxpayer Assistance
    Center (TACs) at a cost of 262 FTEs. NTEU believes providing quality
    services to taxpayers is an important part of any overall strategy to
    improve compliance and that reducing the number of employees dedicated
    to assisting taxpayers meet their obligations will only hurt those
    efforts. It is clear that IRS employees are continuing to provide
    quality customer service to American taxpayers. 2007 year end data from
    the IRS shows that IRS' customer assistance centers met the 82 percent
    level of service goal, with an accuracy rate of 91 percent for tax law
    questions. And while these numbers show that employees providing
    taxpayer services are helping taxpayers understand and meet their tax
    responsibilities, more can and should be done.
        Mr. Chairman, in order to continue to make improvements in taxpayer
    services while handling a growing workload and increasing collections,
    it is imperative to reverse the severe cuts in IRS staffing levels and
    begin providing adequate resources to meet these challenges. With the
    future workload only expected to continue to rise, the IRS will be
    under a great deal of pressure to improve customer service standards
    while simultaneously enforcing the Nation's tax laws. NTEU strongly
    believes that providing additional staffing resources would permit IRS
    to meet the rising workload level, stabilize and strengthen tax
    compliance and customer service programs and allow the Service to
    address the tax gap in a serious and meaningful way.

                             PRIVATE TAX COLLECTION

        Mr. Chairman, as stated previously, if provided the necessary
    resources, IRS employees have the expertise and knowledge to ensure
    taxpayers are complying with their tax obligations. That is why NTEU
    continues to strongly oppose the administration's private tax
    collection program. NTEU believes this misguided proposal is a waste of
    taxpayer's dollars, invites overly aggressive collection techniques,
    jeopardizes the financial privacy of American taxpayers and may
    ultimately serve to undermine efforts to close the tax gap.
        NTEU strongly believes the collection of taxes is an inherently
    governmental function that should be restricted to properly trained and
    proficient IRS personnel. When supported with the tools and resources
    they need to do their jobs, there is no one who is more reliable and
    who can do the work of the IRS better than IRS employees.
        As you know, in September 2006, the IRS began turning over
    delinquent taxpayer accounts to private collection agencies (PCAs) who
    are permitted to keep up to 24 percent of the money they collect. NTEU
    strongly believes the collection of taxes is an inherently governmental
    function that should be restricted to properly trained and proficient
    IRS personnel.
        NTEU believes this misguided proposal is a waste of taxpayer's
    dollars, invites overly aggressive collection techniques, jeopardizes
    the financial privacy of American taxpayers and may ultimately serve to
    undermine efforts to close the tax gap.
        According to the IRS, in fiscal year 2007, the PCAs brought in just
    $32 million in gross revenue, far below original projections of up to
    $65 million. After deducting commission payments to the PCAs, the true
    net revenue from PCA (non-IRS) collection activity was just $20
    million. Therefore, after spending $71 million in start up and ongoing
    maintenance costs through the end of fiscal year 2007, the IRS private
    tax collection program lost more than $50 million.
        According to Nina Olson, the National Taxpayer Advocate, the dismal
    performance of the private collectors is forcing the IRS to downwardly
    revise its original 10-year projections for the program. For fiscal
    year 2008, the IRS is now projecting gross revenues of just $23
    million, despite projections as recently as last May indicating the
    program would bring in up to $127 million. In addition, despite
    assurances that the program would recover all start-up and maintenance
    costs by April of this year, the IRS is now projecting the program will
    not break even until late fiscal year 2010.
        NTEU also believes that sky high commission payments to the private
    contractors for work on the easiest to collect cases is unjustified and
    unnecessary. Under current contracts, private collection firms are
    eligible to retain 21 percent to 24 percent of what they collect. The
    legislation authorizing the program actually allows PCAs to retain up
    to 25 percent of amounts collected. These commission rates were never
    put up for competition. Before the initial bid solicitations went out,
    the IRS set commission rates at 21 to 24 percent of the revenue
    collected by contractors, denying bidders an opportunity to make offers
    on terms that would have resulted in the IRS getting a greater share of
    the collected revenue. Consequently, one of the companies that lost its
    bid for a contract filed a protest with GAO and noted in its bid
    protest that ``offerors were given no credit for proposing lower fees
    than the ``target' percentages recommended by the IRS.''
        The problem of excessive commission rates was recently addressed by
    Congress in legislation overhauling the Department of Education's
    student loan program, which the IRS has consistently held up as a model
    for the IRS private collection program. Amid charges that student aid
    lenders have engaged in abusive and potentially illegal collection
    tactics including charging excessively high collection fees, coercing
    consumers into payment plans they could not afford and misrepresenting
    themselves as Department of Education employees, the House and Senate
    approved H.R. 2669, the ``Higher Education Access Act of 2007,'' which
    lowers from 23 percent to 16 percent the amount of recovered money that
    private guaranty agencies contracted by the Government can retain on
    defaulted loans.
        Mr. Chairman, in addition to being fiscally unsound, the idea of
    allowing PCAs to collect tax debt on a commission basis also flies in
    the face of the tenets of the IRS Restructuring and Reform Act of 1998
    (RRA 98) which specifically prevents employees or supervisors at the
    IRS from being evaluated on the amount of collections they bring in.
    But now, the IRS has agreed to pay PCAs out of their tax collection
    proceeds, which will clearly encourage overly aggressive tax collection
    techniques, the exact dynamic the 1998 law sought to avoid.
        The fear that allowing PCAs to collect tax debt on a commission
    basis would lead to contractor abuse was realized when the IRS recently
    confirmed that the agency had received more than five dozen taxpayer
    complaints against the PCAs, including violations of the taxpayer
    privacy laws under Code section 6103. At least one of those complaints
    was confirmed by an IRS Complaint Panel to be a serious violation of
    law. In addition, penalties totaling $10,000 have been imposed by the
    IRS on the PCAs for taxpayer violations. In one instance, private
    collectors made 150 calls to the elderly parents of a taxpayer after
    the collection agency was notified he was no longer at that address.
    And one of the three private contractors was dropped by the IRS for
    dubious practices despite the Service's previous assurance that its
    oversight would prevent abuse.
        Mr. Chairman, NTEU is not alone in our opposition to the private
    tax collection program. Opposition to the IRS tax debt collection
    program has also been voiced by a growing number of major public
    interest groups, tax experts, two former IRS Commissioners as well as
    the National Taxpayer Advocacy Panel, whose members are appointed by
    the IRS and the Treasury Department. In addition, the National Taxpayer
    Advocate, an independent official within the IRS previously identified
    the IRS private tax collection initiative as one of the most serious
    problems facing taxpayers and recently renewed her prior call for
    Congress to immediately repeal the IRS' authority to outsource tax
    collection work to private debt collectors.
        Opposition to the program has also been growing within Congress.
    Since granting IRS the authority to use PCAs in the American Jobs
    Creation Act of 2004, the House of Representatives, with bi-partisan
    support, has twice passed language prohibiting the IRS from moving
    forward with its private collection initiative. In addition, last
    session, the House overwhelmingly approved two separate tax bills (H.R.
    3056, the ``Tax Collection Responsibility Act of 2007'' & H.R. 3996,
    the ``Temporary Tax Relief Act of 2007'') that contain language that
    would repeal IRS' authority to use private debt collectors to pursue
    tax debts.
        In the Senate, stand alone legislation (S. 335) introduced by
    Senator Byron Dorgan (D-ND) that would force the IRS to immediately and
    permanently suspend its plan to outsource part of its tax debt
    collection responsibilities to PCAs and prohibit the use of any IRS
    funds for that purpose has 24 co-sponsors.
        Mr. Chairman, instead of rushing to privatize tax collection
    functions which jeopardizes taxpayer information, reduces potential
    revenue for the Federal Government and undermines efforts to close the
    tax gap, NTEU believes the IRS should increase compliance staffing
    levels at the agency to ensure that the collection of taxes is
    restricted to properly trained and proficient IRS personnel.
        The IRS already has a significant collection infrastructure with
    thousands of trained employees, including 14 Automated Collection
    System (ACS) sites which allow the IRS to contact taxpayers by
    telephone and collect delinquent taxes. The ACS function is a critical
    Collection operation, collecting nearly $1.49 million per employee per
    year. The IRS itself has analogized the use of private collectors to
    the ACS, where IRS collection representatives interact with taxpayers
    on the telephone. But unlike the private collectors, ACS personnel are
    able to analyze financial statement information, research assets, enter
    into installment agreements, make currently not collectible
    determinations, and can take lien and/or levy enforcement actions. ACS
    employees also receive training that is far more comprehensive and
    rigorous than that of the private collectors. In addition, these
    employees undergo mandatory annual training on topics such as
    confidentiality and privacy of taxpayer information, ethics awareness,
    taxpayer rights and computer security.
        Unfortunately, inadequate staffing at ACS sites has prevented the
    IRS from using its current systems to proactively contact taxpayers by
    telephone to resolve delinquent accounts. The need for the IRS to
    expand ACS' use of outbound calls has been recognized by IRS management
    and at least two recent internal IRS study groups have recommended
    making more outbound calls as a way to make the ACS operation more
    effective and efficient.
        Mr. Chairman, according to the IRS they will spend $7.65 million to
    run the private collection program in fiscal year 2008. NTEU believes
    that instead of continuing to expend valuable IRS resources on this
    failed program, this $7.65 million should instead be used to fund
    roughly 102 additional ACS employees that could return more than $151
    million to the Treasury annually. By comparison, the IRS is now
    projecting the PCAs to bring in just $23 million in gross revenue in
    fiscal year 2008, far less than its original estimate of up to $127
    million.
        NTEU believes that increasing the number of ACS personnel would
    allow the IRS to maximize its ability to proactively resolve delinquent
    accounts by contacting taxpayers directly. This would also help ensure
    that the high level of customer service to those taxpayers who call the
    ACS seeking account resolution is preserved. The IRS has acknowledged
    that ACS employees are already performing admirably noting that in
    2006, ACS customer service and quality ranged between 89.5 to 99.5
    percent (pg. 54--IRS response to Olson 2006 Report to Congress). These
    exceptional ratings are all the more impressive when you consider ACS
    employees generally work on much more complex and often contentious
    cases than those being worked by the private collectors and that the
    total number of cases worked by ACS employees dwarfs those worked by
    the private collectors.
        Mr. Chairman, NTEU understands and commends efforts to ensure that
    all taxpayers pay their fair share of taxes. Without a doubt, rank and
    file IRS employees are committed to achieving this goal in the most
    cost-effective manner while providing a high level of customer service
    to American taxpayers. But the facts make clear that the use of private
    tax collection companies is not in the best interest of American
    taxpayers, could potentially undermine future efforts to close the tax
    gap, and should be terminated immediately.
        A number of other issues important to NTEU members are often
    addressed in the FSGG Appropriations bill and I would like to address
    some of them here.

                                   PAY RAISE

        The Federal Employees Pay Comparability Act (FEPCA), enacted in
    1990 to close the gap between Federal and private sector pay, has never
    been fully implemented. As a result, there is now a 23 percent
    disparity between Federal employees and their private sector
    counterparts. Under the President's plan, Federal employees will fall
    even further behind the private sector.
        The administration's budget proposed a 2.9 percent pay raise for
    Federal workers next year. This not only fails to recognize the
    important role of our Nation's workforce, it is below the 3.4 percent
    pay raise the President recommended for the military. The
    administration's recommendation ignores the essential role of Federal
    employees in protecting our Nation at the borders, in the domestic and
    international movement of money, in public health, in nuclear security,
    and in the collection of revenue among others. Further, it ignores the
    longstanding principle of pay parity, the recognition that Federal
    civil servants and their brothers and sisters in the military, work
    side by side and should receive an equal level of pay increase.
    Importantly, pay parity was just reaffirmed on March 13, 2008, in House
    of Representatives when it passed H. Con Res. 312, the fiscal year 2009
    budget resolution. I urge the subcommittee to report its bill in
    keeping with this pay parity principle.
        For most of the last 20 years, Government employees in civil
    service and military personnel have received the same level of pay
    increase. Last year, both the military and Federal civil servants
    received a 3.5 percent pay raise in the final fiscal year 2008 bills.
    That amounted to the annual raise in the Employment Cost Index (ECI)
    plus one-half percent, the standard pay figure received in every year
    of the current administration with the exception of 2007. For 2009, the
    current raise in the ECI as calculated by the Department of Labor is
    3.4 percent, and an extra one-half percent equals 3.9 percent. NTEU
    urges the subcommittee to follow the precedent of ECI plus one-half
    percent and report legislation for fiscal year 2009 providing a 3.9
    percent raise to Federal employees. We will be working with the
    appropriate committees to enact a military raise of the same level.
    SEC Pay
        NTEU represents the employees of the Securities and Exchange
    Commission (SEC). We believe that the SEC must be provided with
    adequate resources to ensure that its performance based pay system can
    be a viable tool for employee retention and recruitment. While there
    have been numerous problems with this pay system, adequate funding is
    essential. From fiscal year 2002 to fiscal year 2005, the SEC budget
    included a 3 percent increase over current compensation levels to fund
    the performance pay system. However, for the past 2 years, the SEC's
    budget has included only a 2 percent increase. This year, the President
    has only requested a 1.5 percent increase. The continuing performance
    pay funding crisis has hamstrung SEC managers' ability to provide
    meaningful and appropriate performance based salary increases to their
    employees. As budget shortfalls have shifted the system from being
    fundamentally performance based, some senior managers at the SEC have
    sent notices to their employees stating that they are being given lower
    ratings not for performance reasons but because of budgetary
    limitations. This state of affairs is having severe and negative
    impacts on employee morale and retention at SEC, contrary to the stated
    purpose of the performance pay system. NTEU would ask for an additional
    $5 million in funding for the SEC for this purpose.

                         OPM PRESCRIPTION DRUG SUBSIDY

        Mr. Chairman and members of the subcommittee, it is NTEU's position
    that OPM should apply for the drug subsidy to which it is entitled
    under the Medicare Prescription Drug, Improvement, and Modernization
    Act of 2003 (Public Law 108-173). Under this law, which created the
    Medicare Part D prescription drug program, the Government, as an
    employer, is eligible to receive a subsidy payment made available to
    all employers that provide prescription drug benefits as generous as
    the Medicare program. The ``Medicare employer payment'' was designed to
    encourage employers to retain such benefits.
        According to GAO, if OPM had applied for the subsidy, it would have
    lowered the average 2006 FEHBP premium by 2.6 percent. Some of the
    individual health plans that serve a high number of retirees could have
    realized a slowdown in premium growth by as much as 3.5 to 4 percent.
    These savings could have been passed on to keep the enrollee portion of
    the premium down. Unfortunately, estimates are that OPM has have left
    more than $1 billion on the table by forgoing the subsidy. NTEU would
    support legislative language require OPM to apply for the subsidy,
    which would help keep FEHBP costs down for millions of Federal
    employees and their families who are enrolled.

                                CONTRACTING OUT

        Another issue pertinent to the subcommittee's jurisdiction is the
    contracting out of Government positions and responsibilities. I want to
    commend and thank the subcommittee for incorporating important
    privatization language in its portion of the fiscal year 2008 Omnibus
    Appropriations bill to help level the playing field for Federal
    employees.
        Unfortunately, the administration's fiscal year 2009 budget request
    has called for the repeal of these important provisions. We strongly
    urge Congress to oppose any efforts to repeal these important
    provisions that allow Federal employees the ability to fairly compete
    with the private sector.
        In addition, NTEU strongly supports making Government-wide a number
    of additional contracting out reforms included in the fiscal year 2008
    Defense Authorization Bill which currently only apply to the Department
    of Defense. These include provisions that would encourage
    ``insourcing'' by providing employees Government-wide the opportunity
    to compete for new work or work currently performed by contractors,
    allow Government employees to acquire new work by allowing agencies to
    bring work in-house without going through the A-76 process, eliminate
    the automatic recompetition requirement which previously only applied
    to Federal employees and not contractor employees, and establishment of
    a contractor inventory in every Government agency to track the cost and
    performance of every service contract to help identify contract work
    that could be converted to performance by Federal employees.
        By making these important contracting out reforms applicable to the
    entire Federal workforce, Congress can help bring fairness and
    accountability to the entire competitive sourcing process. NTEU firmly
    believes that Federal employees are the best value for taxpayers'
    dollars and they deserve a fair and level playing field on which to
    demonstrate their effectiveness and efficiency to the White House,
    Congress, and the American public.

                                   CONCLUSION

        Mr. Chairman, while Federal workers, and in particular IRS
    employees, continue to get mixed signals regarding their value to this
    administration, they remain committed to serving the American public to
    the best of their abilities. With the expected surge in Federal
    retirements in the coming years, it is imperative that the Federal
    Government do all it can to retain the hundreds of thousands of
    talented public servants who have the knowledge and expertise to
    continue contributing to the Federal workforce while at the same time
    preparing to compete for the best and brightest of the young new
    workers.
        Therefore, NTEU believes it is imperative that the administration
    reverse many of its policies that have devalued the role of Federal
    employees and the work that they do including the failure to pay
    competitive salaries and the constant focus on downsizing and
    outsourcing. These misguided policies have reduced morale of Federal
    employees Government-wide and have put the Federal Government at a
    disadvantage when it comes to attracting, developing and retaining
    qualified employees.
                                     ______

                        Prepared Statement of OMB Watch

        OMB Watch would like to submit the report, ``Bridging the Tax Gap:
    The Case for Increasing the IRS Budget,'' into the record for the
    Committee on Appropriations Subcommittee on Financial Services and
    General Government hearing on the IRS fiscal year 2009 budget on April
    16, 2008.
        OMB Watch supports efforts by the IRS to close the so-called ``tax
    gap,'' and believes increased funding of the IRS budget is a necessary
    condition to achieving this goal. The $4.6 billion appropriated to the
    IRS's enforcement budget in fiscal year 2008 is less than the 1995 IRS
    enforcement budget (in inflation-adjusted terms). As the enforcement
    budget was cut, the IRS saw the number of tax returns filed increase 11
    percent from 205 million in 1995 to 228 million in 2006 (the last year
    for which such data are available).
        In addition to the amount of resources available to the IRS, also
    of concern are the means by which the IRS enforces tax laws. The use of
    private tax collectors not only exposes taxpayer data to private firms,
    but when compared to Federal tax collectors, private collectors are
    extremely inefficient. Use of Federal employees for tax collection
    results in a 13:1 return-on-investment (ROI) ratio ($13 collected for
    each dollar spent), while private tax collectors achieve an ROI of
    4.5:1. That the IRS would continue this program represents an egregious
    mismanagement of tax collection resources.
        OMB Watch also believes better targeting of audits and the types of
    audits performed would enhance the IRS's ability to close the tax gap.
    Although the overall audit rate has seen a slight increase in recent
    years (a positive development, to be sure), that increase has been
    largely constituted of increases in correspondence audits. Compared to
    face-to-face audits, correspondence audits result in lower revenue
    yields. Whereas correspondence audits of individuals earning over
    $100,000 per year result in about a $32,000 increase in identified tax
    liability, face-to-face audits yield, on average, about $55,000.
        Additionally, the IRS has been spending too much time auditing low-
    income Americans. Forty percent of all audits performed in 2006 were of
    taxpayers claiming the EITC, resulting in a 2.25 percent audit rate for
    EITC claimants--more than double the 1 percent rate for all taxpayers.
    With an average yield of $2,895, EITC-return audits have the lowest
    rate of return of any audit conducted by the IRS. That so many IRS
    resources are devoted to these low-yield audits underscore the depth of
    inefficient enforcement practices.
        Instead of employing this punitive approach to closing the tax gap
    through EITC compliance, the IRS should increase resources devoted
    Taxpayer Assistance Centers (TAC) to increase EITC return accuracy.
    TAC-prepared EITC returns reduce overpayments by $640-$1,300. However,
    the number of TAC-prepared returns have been declining as TACs
    experience staffing shortages. By increasing resources devoted to TACs,
    the IRS would not only reduce the tax gap, but would expand much-needed
    services to low-income taxpayers.
        These important tax enforcement issues, and others, are explored in
    greater detail the report we are submitting. We hope this will help
    raise awareness of the importance of addressing enforcement issues at
    the IRS and that the committee will use the findings of this report in
    formulating IRS legislation.

                                                          January 2008.
          Bridging the Tax Gap--The Case for Increasing the IRS Budget
                                acknowledgements

        Matt Lewis, a Federal Fiscal Policy Analyst, conducted the primary
    research and writing of this report, with assistance from Adam Hughes,
    Director of Federal Fiscal Policy. Other OMB Watch staff provided
    advice and research support. Brian Gumm, Communications Coordinator,
    provided editorial support and designed the report.
        OMB Watch is a nonprofit research and advocacy organization whose
    core mission is increasing Government accountability and improving
    citizen participation. Responsible, fair, and equitable budget and tax
    policy has been an important part of our work for more than 20 years,
    and we have practical experience in promoting and informing the public
    on budget and tax legislation and regulations.
        This report is available electronically at: http://
    www.ombwatch.org/budget/irstaxgap2008.pdf.

                                  INTRODUCTION

        A significant and pernicious problem facing the Nation is the tax
    gap, the difference between what is owed in taxes and what is paid.
    Estimated to be over $300 billion annually, the tax gap represents an
    enormous revenue loss for the Government. This lack of revenue often
    causes unnecessary increases in annual deficits and the national debt,
    increasing national interest payments and adding pressure to cut vital
    Government services. Unfortunately, much of the gap must be made up
    eventually by honest taxpayers through higher taxes and by
    beneficiaries of Federal investments through service cuts.
        The Internal Revenue Service (IRS) is responsible for enforcing tax
    laws and collecting taxes, and therefore, it has the greatest capacity
    and responsibility to reduce the tax gap. The extent to which the IRS
    can influence the tax gap is mostly a product of the resources and
    powers lawmakers in Congress provide the agency and how well IRS
    administers those resources and powers.\1\
    ---------------------------------------------------------------------------
        \1\ Significant changes to tax laws have reduced the IRS's
    influence over tax enforcement, and many proposals have been made to
    increase tax compliance with authorizing legislation. For one in-depth
    overview, see Max Sawicky's Bridging the Tax Gap: Addressing the Crisis
    in Federal Tax Administration (Washington, DC: Economic Policy
    Institute, 2005).
    ---------------------------------------------------------------------------
        Congress has given considerable lip service to doing something
    about the tax gap for years but has done little to actually give the
    IRS the tools to make significant progress in closing it. Despite this
    fact, Congress has demanded the IRS close the tax gap without making
    more resources available for the agency to do so. Thus, the IRS has
    been forced to make difficult choices as to how to use the limited
    resources it has been allocated. As a result, at the very least, the
    tax gap remains a large problem, and most experts believe it has
    probably increased in size as the IRS has largely scaled back tax law
    enforcement over the last 10 years.
        The IRS can reduce the size of the tax gap--progress that would
    yield billions in additional revenue each year. In order to accomplish
    this, Congress and the IRS will need to invest more in three areas of
    the IRS budget: audits, collections, and tax preparation services for
    low-income taxpayers eligible for the Earned Income Tax Credit. With
    sufficient resources, the IRS should be able to implement effective and
    efficient tax enforcement policies and programs that will have a real
    impact on reducing the tax gap.

                     THE $300 BILLION PROBLEM: THE TAX GAP

        IRS defines the tax gap in two ways. The gross tax gap is the total
    amount of taxes that were not paid when tax returns were first filed,
    while the net tax gap consists of taxes that are not paid after the IRS
    takes steps to enforce tax laws. The most recent data on the gross tax
    gap comes from the IRS National Research Project, which evaluated tax
    returns from fiscal year 2000. It put the gross tax gap at between $312
    billion and $353 billion annually, or about 16 percent of all taxes
    owed. Although the percentage of the economy the tax gap represents has
    not changed significantly, the absolute size of the gross tax gap has
    in all likelihood grown in step with the economy.\2\ Most of the tax
    gap results from taxpayers underreporting their income.
    ---------------------------------------------------------------------------
        \2\ Internal Revenue Service, ``New IRS Study Provides Preliminary
    Tax Gap Estimate,'' http://www.irs.gov/newsroom/article/
    0,,id=137247,00.html (accessed October 10, 2007).
    ---------------------------------------------------------------------------
        It is unclear, however, how much the tax gap has increased as a
    percentage of the total amount of taxes owed. In the last two decades,
    IRS has only measured the tax gap three times. Each time, it found the
    tax gap represented between 16 and 20 percent of total revenues
    owed.\3\ On the other hand, anecdotal evidence, particularly the work
    of Pulitzer Prize-winning journalist David Cay Johnston, suggests the
    tax gap has grown as wealthier taxpayers have responded to and
    requested reductions in the IRS enforcement presence.
    ---------------------------------------------------------------------------
        \3\ Eric Toder, ``Reducing the Tax Gap: The Illusion of Pain-Free
    Deficit Reduction,'' Urban-Brookings Tax Policy Center, http://
    www.taxpolicycenter.org/UploadedPDF/411496_reducing_tax_gap.pdf
    (accessed October 10, 2007).
    ---------------------------------------------------------------------------
        In any case, the IRS can influence both the net and the gross tax
    gap by encouraging and requiring tax compliance. The IRS recovered
    $48.7 billion of the tax gap in fiscal year 2006, which, coupled with
    late payments, brought the net tax gap to between $257 billion and $298
    billion.\4\ Enforcement efforts also have a strong impact on the gross
    tax gap, because voluntary compliance tends to increase when
    enforcement programs are more active. More enforcement increases the
    fear of being audited and perhaps heightens the public sense of civic
    responsibility, both of which are thought to promote voluntary
    compliance. But the exact extent of the impact is subject to debate.
    Some studies have found the increase in voluntary compliance is many
    times greater than the money the IRS directly recovers through
    enforcement programs.\5\
    ---------------------------------------------------------------------------
        \4\ Internal Revenue Service, ``IRS Enforcement Activities Continue
    To Recover,'' http://www.irs.gov/pub/newsroom/11-06_stat_charts.pdf
    (accessed October 10, 2007).
        \5\ Eric Toder, ``Reducing the Tax Gap: The Illusion of Pain-Free
    Deficit Reduction,'' Urban-Brookings Tax Policy Center, http://
    www.taxpolicycenter.org/UploadedPDF/411496_reducing_tax_gap.pdf
    (accessed October 10, 2007).

                             IMPACT OF THE TAX GAP

        The tax gap affects the public in two ways. Mainly, it reduces what
    compliant taxpayers already have. Because this revenue is intended to
    be collected and used by the Government, not collecting it makes
    implementing Government services and investments more difficult. The
    existence of the tax gap is kind of like a recurring and permanent tax
    cut, in the sense it generally must be paid for by either shifting the
    tax burden to others (in this case, compliant taxpayers), curtailing
    Government services, or increasing debt. The IRS National Taxpayer
    Advocate (NTA), for example, has testified before Congress that unpaid
    taxes shift the tax burden onto compliant taxpayers. If all compliant
    taxpayers were to assume an equal portion of the tax gap, it would add
    $2,200 to their annual tax bills.\6\ Looked at another way, if the IRS
    eliminated the tax gap, Americans could receive the same level of
    services and programs while paying significantly less in taxes. The
    actual impact of the tax gap on the taxes paid by each individual most
    likely depends on personal circumstances and future policy decisions.
    ---------------------------------------------------------------------------
        \6\ National Taxpayer Advocate, ``National Taxpayer Advocate's 2006
    Annual Report To Congress,'' Internal Revenue Service, http://
    www.irs.gov/advocate/article/0,,id=165806,00.html (accessed October 10,
    2007).
    ---------------------------------------------------------------------------
        But unlike a tax cut, the tax gap creates a patently perverse set
    of winners and losers--taxpayers who do not follow the law benefit and
    taxpayers who do lose out. Larger burdens also tend to fall on lower-
    and middle-income taxpayers, whose compliance rates are higher than
    other income levels. Higher-income taxpayers, small business owners,
    and corporations are the main beneficiaries, as their compliance rates
    are lower. Because of this, on the whole, the tax gap makes the tax
    code less progressive than the statutory structure indicates, though by
    exactly how much has not been quantified.\7\
    ---------------------------------------------------------------------------
        \7\ Jason Furman, Lawrence H. Summers, and Jason Bordoff,
    ``Achieving Progressive Tax Reform in an Increasingly Global Economy,''
    Brookings Institution, http://www3.brookings.edu/views/papers/furman/
    200706bordoff_summers.pdf (accessed October 10, 2007).
    ---------------------------------------------------------------------------
        Secondly, and perhaps more importantly, the tax gap reduces what
    the public could have. The tax gap deprives the Government of more
    revenue to finance the expansion of Government services and
    investments, a reduction in the annual deficit, or payments to reduce
    the national debt. If the tax gap were reduced or eliminated, the
    additional revenue brought into the Government would, in most
    circumstances, make the tax code much more progressive. There are
    surely many different proposals about how to invest the revenue owed,
    but regardless of how the $300 billion would be used, the Federal
    Government is never afforded the opportunity to decide.
        On a less practical, but equally important level, the tax gap also
    represents the eroding integrity of the tax system and could reduce
    public support for the Federal Government. Such a large amount of
    unpaid taxes makes the tax system appear ineffective and unfair, since
    the tax gap regressively favors wealthier people and businesses who
    have the means to avoid and evade tax law. These perceptions of
    unfairness in the tax system may have large-scale effects on public
    policy, undermining public confidence in Government as a fiscal
    manager.\8\ Compliant taxpayers may also object to tax increases on the
    grounds they would be paid arbitrarily and regressively, and, as a
    corollary, new Government services or investments financed by tax
    increases may receive less support. Taxpayers may also view ineffective
    tax enforcement as indicative of Government incompetence generally and,
    therefore, oppose expansion of the Government's role. Too many citizens
    may see no option but to favor tax cuts as a way to restore the
    integrity of revenue collection and protect themselves from bearing
    unjust burdens as compliant taxpayers.
    ---------------------------------------------------------------------------
        \8\ Alison Kladec and Will Friedman, ``Understanding Public
    Attitudes about the Federal Budget: A Report on Focus Groups,'' Public
    Agenda, http://www.publicagenda.org/research/pdfs/
    understanding_public_attitudes_about_the_federal_budget.pdf (accessed
    October 10, 2007).
    ---------------------------------------------------------------------------
                 A PRIMARY CAUSE: LACK OF RESOURCES AT THE IRS

        While it is widely established that increased resources at the IRS
    could help to reduce the tax gap, IRS funding levels have not kept up
    with growing demands on its budget. The total IRS budget has remained
    static after adjusting for inflation since the mid-1990s. The funding
    decline has been most pronounced in the enforcement account of the IRS
    budget, which includes funding for tax return examinations, tax
    collections, and document matching services that compare financial
    records with tax returns. In fiscal year 1995, IRS had $4.43 billion in
    its enforcement account. By fiscal year 2006, this budget had only
    risen to $4.65 billion--less than a 5 percent increase. During the same
    period:
      --Inflation had eroded the value of this funding by 36 percent; \9\
    ---------------------------------------------------------------------------
        \9\ Bureau of Labor Statistics. ``Inflation Calculator,'' U.S.
    Department of Labor, http://www.bls.gov/cpi/ (accessed October 10,
    2007).
    ---------------------------------------------------------------------------
      --The size of the economy grew 42 percent; \10\
    ---------------------------------------------------------------------------
        \10\ Bureau of Economic Analysis, ``National Economic Accounts''
    U.S. Department of Commerce, http://www.bea.gov/national/index.htm#gdp
    (accessed October 10, 2007).
    ---------------------------------------------------------------------------
      --The number of tax returns the IRS processed increased 11 percent,
            from 205 million to 228 million; \11\ and
    ---------------------------------------------------------------------------
        \11\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books,''
    http://www.irs.gov/taxstats/article/0,,id=102174,00.html (accessed
    October 10, 2007).
    ---------------------------------------------------------------------------
      --Hundreds of changes to the IRS's authority and tax laws gave the
            agency more work.\12\
    ---------------------------------------------------------------------------
        \12\ Charles O. Rossotti, ``Report to the IRS Oversight Board:
    Assessment of the IRS and Tax System,'' http://nteuirswatch.org/
    documents/numbers/Rossotti%2002%20report%20to%20oversight%20board.pdf
    (accessed October 10, 2007).
    ---------------------------------------------------------------------------
        Experts inside and outside Government have recognized the resource
    problem at IRS. IRS National Taxpayer Advocate Nina Olson, who operates
    independent of the IRS, believes funding shortages have become so
    problematic, she has called for the creation of special rules for IRS
    budget bills. Charles Rossotti, former commissioner of the IRS, told
    the IRS Oversight Board in 2002 that much of the tax gap is a result of
    the failure of Congress to provide enough resources for tax law
    administration:

        The source of this problem are two conflicting, long-term trends:
    one, ever increasing demands on the tax administration system due to
    rapid growth in the size and complexity of the economy; and two, a
    steady decline in IRS resources due to budget constraints. The
    cumulative effect of these conflicting trends over a 10-year period has
    been to create a huge gap between the number of taxpayers who are not
    filing, not reporting or not paying what they owe, and the IRS'
    capacity to require them to comply.
        The resources crunch can be seen more apparently in staffing
    levels: the number of IRS employees is down sharply from 10 years ago.
    Between 1995 and 2006, the total number of IRS employees shrunk 18
    percent--falling from 114,000 to less than 92,000. The number of
    revenue agents and officers--IRS employees who perform audits--has
    decreased even faster, by 40 and 30 percent, respectively.\13\ Those
    categories of employees have decreased from 8,139 to 5,665 for revenue
    agents and 16,078 and 12,859 for revenue officers.\14\ Fewer staff at
    the IRS has a direct impact on the auditing function at the agency.
    ---------------------------------------------------------------------------
        \13\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
        \14\ Ibid.
    ---------------------------------------------------------------------------
        There have been many experts who have called for increased funding
    for the IRS, including the Treasury Inspector General for Tax
    Administration,\15\ the Government Accountability Office,\16\ the IRS
    Oversight Board, Max Sawicky, then of the Economic Policy
    Institute,\17\ Robert McIntyre of Citizens for Tax Justice,\18\ Eric
    Toder of the Urban-Brookings Tax Policy Center,\19\ and former IRS
    Commissioner Donald C. Alexander.\20\
    ---------------------------------------------------------------------------
        \15\ Treasury Inspector General for Tax Administration. ``Trends In
    Compliance Activities Through Fiscal Year 2006,'' U.S. Department of
    the Treasury, http://www.treas.gov/tigta/auditreports/2007reports/
    200730056fr.html (accessed October 10, 2007).
        \16\ Michael Brostek, ``Tax Compliance: Multiple Approaches Are
    Needed To Reduce The Tax Gap,'' Government Accountability Office,
    http://www.gao.gov/new.items/d07488t.pdf (accessed October 10, 2007).
        \17\ Max Sawicky, ``Do-it-yourself tax cuts: The crisis in U.S. tax
    enforcement'' in Bridging the Tax Gap: Addressing the Crisis in Federal
    Tax Administration (Washington, DC: Economic Policy Institute, 2005).
        \18\ Robert McIntyre, ``Statement of Robert S. McIntyre Before the
    Senate Budget Committee, January 23, 2007,'' Senate Budget Committee,
    http://budget.senate.gov/democratic/testimony/2007/
    McIntyre_TaxGap012307.pdf (accessed October 10, 2007).
        \19\ Eric Toder, ``Reducing the Tax Gap: The Illusion of Pain-Free
    Deficit Reduction,'' Urban-Brookings Tax Policy Center, http://
    www.taxpolicycenter.org/UploadedPDF/411496_reducing_tax_gap.pdf
    (accessed October 10, 2007).
        \20\ Max Sawicky, ``Interview: Former IRS Commissioner Donald C.
    Alexander'' in Bridging the Tax Gap: Addressing the Crisis in Federal
    Tax Administration (Washington, DC: Economic Policy Institute, 2005)
    52.
    ---------------------------------------------------------------------------
        IRS needs additional funding to fulfill its mission as the
    guarantor of tax compliance. Where funding is needed most is in the IRS
    enforcement budget, particularly for audits of high-income taxpayers
    and corporations, the collection function, and services for low-income
    taxpayers who receive the Earned Income Tax Credit (EITC).

                         INCREASES RESOURCES FOR AUDITS

        One of the most disturbing trends in enforcement policy over the
    last 10 years has been a sharp decline in audits, which are an
    essential tool in the fight against unpaid taxes. Most of the gross tax
    gap--between $250 and $260 billion--results from individuals and
    businesses underreporting their income. The IRS determines who
    inaccurately reported their income and how much they owe in taxes
    through a variety of means. Examinations, or audits, are one way the
    IRS makes this determination. In fiscal year 2006, IRS audits showed
    that an additional $43.95 billion was owed on all tax returns that were
    audited.\21\ The IRS performed 1.4 million audits, resulting in an
    audit coverage rate of 0.8 audits per 100 tax returns, or less than 1
    percent.\22\
    ---------------------------------------------------------------------------
        \21\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
        \22\ Ibid.
    ---------------------------------------------------------------------------
        In the last decade, there has been a general decline in most types
    of audits. In fiscal year 1996, the audit rate for all individual
    income tax returns was 1.67 percent.\23\ In fiscal year 2006, the rate
    had dropped to 1 percent of all individuals, after reaching a low of
    0.5 percent in 2000.\24\ The recent upswing in audits is encouraging,
    but the rate is still far below earlier levels and even farther below
    historic and adequate levels, according to tax administration
    experts.\25\
    ---------------------------------------------------------------------------
        \23\ Government Accountability Office, ``Tax Administration: Audit
    Trends and Results for Individual Taxpayers,'' http://www.gao.gov/
    archive/1996/gg96091.pdf (accessed October 16, 2007).
        \24\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
        \25\  Sawicky, ``Interview: Former IRS Commissioner Sheldon S.
    Cohen,'' 25.
    ---------------------------------------------------------------------------
        Making things worse, the general decrease in audits has been
    unequally distributed by taxpayer income with audits of higher-income
    earners falling faster than the overall decrease. The decline in audits
    has been the steepest among taxpayers reporting an income over
    $100,000. Audits of these filers have dropped from 2.85 percent in
    fiscal year 1996 to 1.3 percent in fiscal year 2006. Decreases in these
    audits before 1996 were even more drastic: in fiscal year 1992, higher-
    income filers were audited 5.28 percent of the time.
        Furthermore, business income has been insufficiently audited.
    Business income, which is reported on individual income tax returns,
    has been audited at a relatively steady rate since fiscal year 1995.
    Nevertheless, more audits are needed, as the IRS National Research
    Project identified the underreporting of income by small businesses as
    the category that contributed the most to the tax gap, accounting for
    more than $109 billion in unpaid taxes annually. $68 billion of these
    unpaid taxes are owed by self-proprietorships, known more commonly as
    the self-employed, and another $22 billion came from partnerships, S
    corporations, estates, and trusts. In order to close the tax gap, the
    IRS will need the necessary resources to expand its investigation and
    enforcement of tax laws related to these returns, not hold them steady.
    Decline in Quality and Quantity of Corporate Audits
        Individual taxpayers are not alone in experiencing a decrease in
    the likelihood of being audited. Audits related to the corporate income
    tax for all sizes of corporations have declined significantly. The
    overall corporate audit rate has been cut in half, dropping from 2.4
    percent in 1996 to 1.2 percent in 2006.\26\ What's more, new data from
    the last 5 years obtained by the Transactional Records Access
    Clearinghouse (TRAC) show that the quality of those audits has also
    suffered.
    ---------------------------------------------------------------------------
        \26\ Transactional Records Access Clearinghouse, ``IRS Spending
    More Time on Face-to-Face Corporate Audits that Produce No Revenue,''
    Syracuse University, http://trac.syr.edu/tracirs/newfindings/current/
    (accessed October 16, 2007).
    ---------------------------------------------------------------------------
        Disturbingly, the decline has been most pronounced among the
    largest corporations. Audits of corporations with assets between $5 and
    $10 million dropped from 14 percent in fiscal year 1995 to 3.4 percent
    in fiscal year 2006--a 70 percent drop.\27\ Slightly larger
    corporations--with assets of $50 million to $100 million--were audited
    at a rate of 13.8 percent in fiscal year 2006, down from 21.3 percent
    in fiscal year 1996--a 35 percent decline. Audits of the largest
    corporations, those with assets of $250 million or more, have declined
    by almost a third, from 50 percent in fiscal year 1995 to 35.2 percent
    in fiscal year 2006.\28\ While companies with over $250 million in
    assets are small in number--they filed only 0.2 percent of corporate
    tax returns in 2002--they accounted for a staggering 90 percent of all
    corporate assets and 87 percent of all corporate income during that
    year.\29\ The decrease in audits among these corporate tax filers must
    be reversed.
    ---------------------------------------------------------------------------
        \27\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
        \28\ Transactional Records Access Clearinghouse, ``IRS Spending
    More Time on Face-to-Face Corporate Audits that Produce No Revenue.''
        \29\ Transactional Records Access Clearinghouse, ``Relatively Few
    Corporations Have Most Income and Assets,'' Syracuse University, http:/
    /trac.syr.edu/tracirs/trends/v10/corpassets.html (accessed October 17,
    2007).

        Audits of the largest corporations inexplicably vary by sector,
    which seems to be an inefficient method of tax enforcement. In fiscal
    year 2006, only 15 percent of financial services corporations were
    audited, compared to 100 percent of all large manufacturing and
    transportation 1corporations.\30\ Yet companies in the financial sector
    make up a large part of the economy. The largest corporations in the
    financial sector account for 25 percent of total receipts of large
    corporations and over 62 percent of total net income--more than 2.5
    times the next highest sector.\31\
    ---------------------------------------------------------------------------
        \30\ Transactional Records Access Clearinghouse, ``Corporate Audit
    Rates--Wide Disparities Found for Different Industries,'' Syracuse
    University, http://trac.syr.edu/tracirs/latest/127/. (accessed October
    16, 2007).
        \31\ Transactional Records Access Clearinghouse, ``Net Income of
    Largest Corporations,'' Syracuse University, http://trac.syr.edu/
    tracirs/trends/v10/netincsecG.html (accessed October 16, 2007).
    ---------------------------------------------------------------------------
        What's more unfortunate, however, is that the audits that have been
    done for corporate filers have been increasingly unproductive,
    particularly among face-to-face corporate audits--the most thorough and
    intense audits the IRS conducts. The number of nonproductive auditing
    hours, which is defined by the IRS as face-to-face examination hours
    that produce a ``no change'' result in the amount of tax owed, has
    increased for every corporate asset class over the last 5 years.\32\
    The average increase in unproductive hours across all corporate asset
    classes between fiscal year 2001 and fiscal year 2006 was 40 percent.
    If the IRS audited a high percentage of corporations, a rise in
    unproductive hours could be interpreted as a good thing, with companies
    increasingly paying the taxes they owe. However, because the IRS audits
    too few corporations and because the tax gap points to large amounts of
    taxes not being collected, a rise in unproductive hours shows the IRS
    is being inefficient in selecting which corporations it chooses to
    audit--a waste of valuable enforcement resources and a missed
    opportunity to collect more tax revenues.
    ---------------------------------------------------------------------------
        \32\ Transactional Records Access Clearinghouse, ``Net Income of
    Largest Corporations.''
    ---------------------------------------------------------------------------
        The rise in unproductive auditing hours increased at faster rates
    as the size of the corporation increased, especially for large
    corporations (those with assets over $10 million). While all four asset
    classes over $10 million saw increases in unproductive hours well above
    the average of 40 percent, as the asset class grows larger, the
    increases are even more pronounced. At the low end, audits of
    corporations between $10 million and $50 million saw a 61 percent
    increase in unproductive hours, while audits of corporations above $250
    million in assets saw the largest increases, at 109 percent--more than
    double the rate from 5 years earlier.\33\
    ---------------------------------------------------------------------------
        \33\ Transactional Records Access Clearinghouse, ``IRS Corporate
    Audit Hours Spent on Nonproductive Examinations Increasing,'' Syracuse
    University, http://trac.syr.edu/tracirs/trends/v12/audittimechange.html
    (accessed October 16, 2007).
    ---------------------------------------------------------------------------
        Another alarming trend is the decrease in the number of hours spent
    per corporate audit. In the last 5 years, every corporate asset class
    except one ($10-$50 million) has seen double-digit decreases in the
    average length of audits, with the average corporate audit lasting 21
    fewer hours.\34\ This represents almost a 10 percent drop in the length
    of corporate audits.
    ---------------------------------------------------------------------------
        \34\ Transactional Records Access Clearinghouse, ``Change in
    Average Audit Length Fiscal Year 2001 vs Fiscal Year 2006,'' Syracuse
    University, http://trac.syr.edu/tracirs/trends/v12/
    auditlengthchange.html (accessed October 16, 2007).
    ---------------------------------------------------------------------------
        IRS data on corporate audits, combined with the new data obtained
    by TRAC on audit length, depict disturbing trends in both the quality
    and quantity of corporate audits--particularly those of the largest
    corporations. Not only is the IRS performing fewer corporate audits
    overall than it did 10 years ago, the ones they do perform are done too
    quickly and are poorly targeted. Due to the size and complexity of the
    business transactions of large corporations, those returns are likely
    to produce more reporting errors, and therefore, the IRS should be
    auditing more of those companies (not less) and spending more time (not
    less) on each audit.
        There have been a few reports that some of the changes within the
    corporate auditing section (the Large and Mid-Sized Business Division)
    have been forced on IRS auditors by senior level managers at the IRS.
    These changes put a strong focus on completing more audits by pre-set
    deadlines in order to drive up total audit numbers regardless of the
    quality of the audit or of auditors' opinions about possible serious
    tax violations they had not had time to investigate during audits.
    David Cay Johnston reported in The New York Times on March 20, 2007,
    that almost two dozen revenue agents had been pressured by their
    managers to close open audits too soon--actions the auditors said could
    cost the Government billions of dollars in unpaid taxes.\35\
    ---------------------------------------------------------------------------
        \35\ David Cay Johnston, ``IRS Agents Feel Pressed To End Cases.''
    New York Times, March 20, 2007. http://www.nytimes.com/2007/03/20/
    business/20tax.html.
    ---------------------------------------------------------------------------
        This phenomenon was recognized by Colleen Kelley, President of the
    National Treasury Employees Union, in testimony before the House
    Appropriations Committee on Financial Services and General Government.
    Kelley testified the pressure put on IRS auditors was not a recent
    occurrence but had been happening since 2002. Kelley believes it was
    the result of a new IRS policy called Limited Focused Examination
    (LIFE) and said the union had heard directly from its members that the
    policy was undermining both efforts to make sure companies were paying
    all the taxes they owed and employee morale at the IRS.\36\
    ---------------------------------------------------------------------------
        \36\ Colleen Kelley, ``Statement of Colleen Kelley, National
    President, National Treasury Employees Union on `Internal Revenue
    Service Budget fiscal year 2008,' '' National Treasury Employees Union,
    http://nteuirswatch.org/documents/numbers/CMK%20Testimony%20to%20House
    %20FServices%20sub%203-29-07.pdf (accessed October 18, 2007).
    ---------------------------------------------------------------------------
        The combination of a decrease in overall corporate audit rates, and
    reports that those audits being done are closed too soon, will
    encourage tax evasion behavior among corporations, which may have more
    cause to believe they will not be audited, and that audits themselves
    are not to be feared.

    Wrong Strategy: Relying on Correspondence Audits
        As far as reducing the tax gap is concerned, the type of audit
    being administered is equally, if not more important than who is being
    audited. There are two types of audits: a traditional face-to-face
    audit, which can happen inside an IRS office or at a taxpayer's home or
    business, and a correspondence audit. Traditional face-to-face audits
    involve comprehensive reviews of assets and records, requiring more
    time and effort for both the taxpayer and the IRS. Correspondence
    audits consist of the IRS sending a letter to a non-compliant taxpayer
    in which he or she is asked a few questions about his or her tax
    return. Striking the right balance between these two types of audits is
    essential to effective tax enforcement.
        Face-to-face audits typically generate far more revenue than
    correspondence audits, and ones on high-income earners in particular
    produce the highest yields. In fiscal year 2006, face-to-face audits of
    high-income earners generated an average of $54,934.\37\ Face-to-face
    audits on individuals earning between $50,000 and $100,000, in
    contrast, only averaged a $3,877 yield, yet these taxpayers were
    audited almost as much (0.23 percent) as their higher-income
    counterparts (0.44 percent).\38\ Even face-to-face audits on returns
    with business income over $100,000 yielded less than half as much
    ($25,787) as audits of high-income filers.\39\ The high yields on face-
    to-face audits of high-income filers show both that they are a good
    investment and also that there are significantly more taxes due among
    those filers.
    ---------------------------------------------------------------------------
        \37\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
        \38\ Ibid.
        \39\ Ibid.
    ---------------------------------------------------------------------------
        Despite the high yields of these audits, the IRS is performing them
    too rarely. IRS administered face-to-face audits for 0.44 percent of
    all high-income filers in fiscal year 2006, compared to 2.9 percent in
    fiscal year 1992 and 1.7 percent in fiscal year 1996.\40\ Yet the IRS
    claims, and rightly so, that overall audit rates have been gradually
    increasing in the last few years. These additional audits have
    increased the yield on tax enforcement, from a 10-year low of $32.9
    billion in fiscal year 1999 to $48.7 billion in fiscal year 2006.
    ---------------------------------------------------------------------------
        \40\ Transactional Records Access Clearinghouse, ``IRS `Face-to-
    Face' Audits of Federal Income Tax Returns Filed by Individuals,''
    Syracuse University, http://trac.syr.edu/tracirs/highlights/current/
    audpctcompare_ind.html (accessed October 16, 2007).

        Unfortunately, the details behind the IRS data on increased audits
    tell a different story. Much of the increase cited by the IRS has been
    due to an emphasis on correspondence audits, not the more effective
    face-to-face audits. Overall, in fiscal year 2006, 77 percent of all
    audits--more than three out of four--were by correspondence.\41\ What's
    more, correspondence audits--not face-to-face audits--have accounted
    for 74 percent of the recent increase in audits among high-income
    individuals.\42\ Face-to-face audit levels have increased only modestly
    over that time.
    ---------------------------------------------------------------------------
        \41\ Transactional Records Access Clearinghouse, ``Targeting of
    Correspondence Audit Improves,'' Syracuse University, http://
    trac.syr.edu/tracirs/newfindings/current (accessed October 16, 2007).
        \42\ Treasury Inspector General For Tax Administration, ``Trends in
    Compliance Activities Through Fiscal Year 2006,'' U.S. Treasury
    Department, http://www.treas.gov/tigta/auditreports/2007reports/
    200730056fr.html (accessed October 16th, 2007).
    ---------------------------------------------------------------------------
        This trend is problematic because correspondence audits are less
    effective than face-to-face audits, partly because this type of audit
    can only spot problems that are evident from information submitted by
    the taxpayer or from information reported by third parties (employers,
    banks, and other sources). For comparison, in fiscal year 2006, face-
    to-face audits on individual income tax returns for earners over
    $100,000 yielded an average of $54,934, while correspondence audits
    brought in $31,912.\43\ For other types of tax returns, such as large
    corporations, the difference was even more dramatic. The average yield
    of a face-to-face audit for large corporations in fiscal year 2006 was
    $2.6 million, but correspondence audits of similarly sized companies
    averaged a meager return of $285,000.\44\
    ---------------------------------------------------------------------------
        \43\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
        \44\ Ibid.
    ---------------------------------------------------------------------------
        The IRS seems to have chosen to use correspondence audits so much
    mainly because administering them requires less staff time and
    resources. In fiscal year 2006, correspondence audits took an average
    of only 1.4 auditor hours each, drastically lower than the hundreds of
    hours face-to-face audits can take.\45\ Indeed, IRS data shows even as
    overall audit rates have increased in the last few years, few
    additional staff have been added.
    ---------------------------------------------------------------------------
        \45\ Transactional Records Access Clearinghouse, ``Targeting of
    Correspondence Audit Improves,'' Syracuse University, http://
    trac.syr.edu/tracirs/newfindings/current (accessed October 17, 2007).
    ---------------------------------------------------------------------------
        The IRS has decided, perhaps because of limited resources, to shift
    to less efficient and effective processes for auditing. If Congress and
    others in Government are serious about creating a robust tax
    enforcement system and closing the tax gap, additional resources are
    crucial. Increased funds could be used to raise staffing levels enough
    that IRS may gradually perform more high-yield face-to-face audits,
    which would have a greater impact on reducing the tax gap.

                         EXPAND INTERNAL TAX COLLECTION

        Tax law enforcement does not end once an audit has been completed.
    The IRS will have to actively pursue unpaid taxes it identifies if they
    are not paid voluntarily. IRS collection officers may make an agreement
    with the taxpayer to pay the taxes, or issue levies, liens, or property
    seizures. Agents are also charged with identifying taxpayers who do not
    file a tax return and collecting the taxes owed. To do these things,
    significant staffing and resources are required.
        Billions are lost annually because Congress does not sufficiently
    finance the IRS collection department. In 2002, former IRS Commissioner
    Charles Rossotti reported to the IRS Oversight Board that an annual
    investment of under $400 million in IRS collections could generate over
    $11 billion each year.\46\ This additional funding could be used to
    hire more full-time employees to pursue cases the IRS has not taken
    action on due to insufficient personnel. Even without additional
    resources, NTA Nina Olson has recently stated the IRS can tackle many
    of those additional cases by implementing improvements to its current
    collection regimes.
    ---------------------------------------------------------------------------
        \46\  Charles O. Rossotti, ``Report to the IRS Oversight Board:
    Assessment of the IRS and Tax System.''
    ---------------------------------------------------------------------------
        Since Rossotti issued the 2002 report, activity in the collection
    function has increased modestly. Some key measurements have been on a
    steady upward trajectory, including the quantity of liens and levies
    issued by IRS collection staff.\47\ However, the level of liens and
    levies is still down sharply from fiscal year 1996 levels, even
    excluding growth in the economy and tax returns. Some measures--such as
    the quantity of seizures--have not increased at all. Indeed, a 2007
    Treasury Inspector General for Tax Administration (TIGTA) report found
    a robust collection function continues to be hampered by inadequate
    resources, as staffing for collection activities remains 30 percent
    below fiscal year 1997 levels.\48\
    ---------------------------------------------------------------------------
        \47\  Transactional Records Access Clearinghouse, ``IRS Collection
    Enforcement Trends,'' Syracuse University, http://trac.syr.edu/tracirs/
    highlights/current/collenfG.html (accessed October 16, 2007).
        \48\ Treasury Inspector General for Tax Administration, ``Trends In
    Compliance Activities Through Fiscal Year 2006.''
    ---------------------------------------------------------------------------
    Wrong Strategy: Private Debt Collection
        In 2004, Congress enacted--and in September 2006, the IRS
    implemented--a program to outsource the responsibility of collecting
    small tax debts to private debt collection firms. The principle
    rationale for creating the program was that its funding would not show
    up in the IRS budget. Although the Government still spends resources,
    using private collectors does not require additional annual
    appropriations. Under the program, private collectors get to keep a
    portion of the taxes they collect as payment. Therefore, given limited
    budgets, the IRS would be afforded an opportunity to collect taxes it
    otherwise could not.
        However, the private tax collection program is wasteful and
    dangerous. Private collection agencies (PCAs) yield a return-on-
    investment (ROI) of 4:1, whereas--as former IRS Commissioner Mark
    Everson has acknowledged--Federal employees at the IRS produce a 13:1
    ROI. Even more efficient, the IRS' Automated Collection System
    currently collects about $20 for every $1 spent on staffing, according
    to the NTA.\49\
    ---------------------------------------------------------------------------
        \49\ National Taxpayer Advocate Service, ``National Taxpayer
    Advocate's 2007 Annual Report to Congress,'' Internal Revenue Service,
    http://wwwrs.gov/advocate/article/0,,id=177301,00.html (accessed
    January 9, 2008).
    ---------------------------------------------------------------------------
        Furthermore, despite claims the program has no costs, as of May 23,
    2007, the IRS had spent $71 million in appropriated funding to set it
    up. If that money had instead been spent on those high-yield automated
    functions, an additional $1.4 billion in revenues could have been
    collected in just 1 year. Yet for all those missed opportunities, the
    private collection program is expected to yield only around $1.1
    billion altogether over the next 10 years.
        Initial data on the program are now available for the first year of
    operation, and the Washington Post has reported the PCAs averaged a
    4.5:1 ROI, collecting $29 million, from which they were paid $6.34
    million--far below both the IRS' ROI levels and initial revenue
    projections for the program.\50\
    ---------------------------------------------------------------------------
        \50\ Business Section ``Collectors Get $29 Million for IRS,''
    Washington Post, January 9, 2008, http://www.washingtonpost.com/wp-dyn/
    content/article/2008/01/08/AR2008010804439.html.
    ---------------------------------------------------------------------------
        Regardless of the program's cost, many experts continue to worry
    PCAs might violate taxpayer rights. Olson has expressed a great deal of
    concern that profit-motivated companies could abuse taxpayers.
    According to Olson, PCAs have the opportunity to use ``trickery,
    device, and belated Fair Debt Collection Practices Act warnings to take
    advantage of taxpayers,'' and yet they are not obligated to disclose
    their ``operational plans'' regarding practices, letters, or scripts
    they will use.\51\
    ---------------------------------------------------------------------------
        \51\ National Taxpayer Advocate Service, ``National Taxpayer
    Advocate's 2006 Annual Report to Congress,'' Internal Revenue Service,
    http://www.irs.gov/advocate/article/0,,id=165806,00.html (accessed
    October 16, 2007).
    ---------------------------------------------------------------------------
        Indeed, anecdotal reports on the program's operations have borne
    out many of the concerns Olson voiced regarding abusive practices. At a
    May 23, 2007, hearing of the House Ways and Means Committee, Rep. John
    Lewis (D-GA) presented tapes of conversations between PCA employees and
    taxpayers.\52\ Due to IRS privacy protections, PCA employees did not
    identify themselves, the nature of their business, or the purpose of
    their calls, and haggled with taxpayers to obtain their Social Security
    numbers. The taxpayers in the conversations refused to reveal their
    Social Security numbers and responded angrily when PCA employees asked
    repeatedly for the numbers but did not disclose the purpose of the
    conversations.
    ---------------------------------------------------------------------------
        \52\ For a transcript of the tapes, see http://
    waysandmeans.house.gov/media/pdf/110/07
    %2005%2023%20Debt%20Collector%20call%20transcript.pdf.
    ---------------------------------------------------------------------------
        Olson reiterated her concerns about the ability of the program to
    operate efficiently and effectively in the recently released 2007 NTA
    report, stating tax collection is an inherently governmental function
    that should be handled only by Government employees trained to protect
    taxpayer rights. Olson argues the IRS could currently collect the
    outstanding debts given to the PCAs by improving its collection
    strategy and use of currently available resources, enabling the IRS to
    reach ``most, if not all, of these cases [given to PCAs] at less cost
    to taxpayers and less risk to taxpayer rights.'' \53\
    ---------------------------------------------------------------------------
        \53\ National Taxpayer Advocate Service, ``National Taxpayer
    Advocate's 2007 Annual Report to Congress,'' Internal Revenue Service,
    http://www.irs.gov/advocate/article/0,,id=177301,00.html (accessed
    January 9, 2008).
    ---------------------------------------------------------------------------
        The sum of the evidence supports the need to shut down this program
    immediately. In 2007, Ways and Means Chairman Charles Rangel (D-NY)
    requested the IRS not issue any new contracts for the program, and the
    House passed a bill in October 2007 to end it entirely. This would be a
    wise change in IRS policy. Unfortunately, the IRS is moving forward
    with soliciting bids from additional PCAs for the second part of the
    program--full implementation. While Olson has pushed the IRS to include
    more transparency and taxpayer safeguards in the solicitation of new
    contracts, she continues to voice strong concerns and recommends
    Congress end the program.
        Congress needs to act immediately to end this program and instead
    should make more resources available to the IRS to expand existing
    internal collection efforts.

                      INCREASE SERVICES FOR EITC TAXPAYERS

        Re-establishing a robust auditing regime at the IRS is crucial to
    closing the tax gap. But focusing on enforcement at every turn,
    particularly having that focus land disproportionally on low-income
    taxpayers, is not the best solution. The IRS has taken an approach to
    overseeing and enforcing the Earned Income Tax Credit (EITC) that
    relies far too much on audits and not enough on services. This is
    unfair to those taxpayers who claim the EITC, who are held to a higher
    standard by the IRS than any other taxpayer group, and it fails to
    address EITC over-claims caused by errors, not malfeasance.
        The EITC is a refundable tax credit for low-income workers. In tax
    year 2005, the EITC provided more than $41 billion to over 21 million
    families and individuals.\54\ It lifts more working families out of
    poverty than any other work support; in 2003, the EITC helped raise 4.4
    million people, including 2.4 million children, above the poverty
    line.\55\
    ---------------------------------------------------------------------------
        \54\ Center on Budget and Policy Priorities, ``EIC Participation
    for Tax Year 2005, by State,'' http://www.cbpp.org/eic2008/docs/
    EIC%20participation%20prelim%20ty%202005.pdf (accessed October 17,
    2007).
        \55\ Robert Greenstein, ``The Earned Income Tax Credit: Boosting
    Employment, Aiding the Working Poor,'' Center on Budget and Policy
    Priorities, http://www.cbpp.org/7-19-05eic.htm (accessed October 17,
    2007).
    ---------------------------------------------------------------------------
        Since it is a tax credit, the IRS administers the EITC and is
    responsible for maintaining its integrity. In 1999, the IRS estimated
    the EITC noncompliance rate at between 27 and 32 percent, resulting in
    between $8.5 to $9.9 billion annually in overpayments, or about 3
    percent of the tax gap (though the NTA believes that rate is
    overstated).\56\
    ---------------------------------------------------------------------------
        \56\ Ibid.
    ---------------------------------------------------------------------------
    Wrong Strategy: Punishing EITC Taxpayers
        Mostly by congressional mandate, the IRS has taken a punitive
    approach to EITC error reduction. Congress designates a portion of the
    annual IRS budget specifically for EITC compliance. In fiscal year
    2006, Congress allocated $167 million for EITC compliance, which the
    IRS used on several initiatives that focus disproportionate enforcement
    efforts on EITC taxpayers.
        With this funding, Congress has instructed the IRS to heavily audit
    EITC taxpayers. Under the EITC compliance initiative in fiscal year
    2006, almost 517,617 audits were performed on tax returns where the
    EITC was claimed. These audits constituted about 40 percent of all
    audits performed on individual tax returns in fiscal year 2006.\57\ The
    examination rate for EITC recipients was 2.25 percent, compared to 1
    percent for all individual income tax returns, and 1.3 percent of all
    individuals making over $100,000.\58\ Yet EITC audits yield only a
    fraction of the total revenues recovered by IRS examinations. EITC
    audits identified nearly $1.5 billion in excess payments, resulting in
    a yield of only $2,895 per audit--the lowest rate of return for any
    type of audit performed by the IRS.\59\
    ---------------------------------------------------------------------------
        \57\ Internal Revenue Service, ``SOI Tax Stats--IRS Data Books.''
        \58\ Ibid.
        \59\ Ibid.
    ---------------------------------------------------------------------------
        Aside from a disproportionately large number of audits, EITC
    taxpayers are subject to a set of additional enforcement programs.
    First, the IRS applies a unique type of examination--called
    ``recertification''--only to EITC taxpayers. The recertification
    program requires taxpayers to ``recertify'' if they had the EITC denied
    during an examination. This denial places recertification indicators on
    a taxpayer's account until the taxpayer proves he or she is eligible to
    receive the credit again. Once the taxpayer has provided sufficient
    evidence, he or she is deemed ``recertified,'' and the taxpayer is once
    again eligible for the EITC. The number of taxpayers subject to this
    recertification tripled from 326,000 in September 1999 to almost 1
    million by December 2003.\60\ No other tax credit, deduction, or
    exemption requires such a high burden of proof.
    ---------------------------------------------------------------------------
        \60\ Treasury Inspector General for Tax Administration, ``The
    Earned Income Credit Recertification Program Continues to Experience
    Problems,'' U.S. Department of Treasury, http://www.treas.gov/tigta/
    auditreports/2005reports/200540039fr.html (accessed October 17, 2007).
    ---------------------------------------------------------------------------
        The IRS has also put holds on millions of refunds to crack down on
    EITC errors. Beginning in 2005, the Criminal Investigations Division of
    the IRS began a program that postponed sending EITC refunds to people
    suspected of fraud. The NTA's 2005 Report to Congress revealed that of
    the 1.6 million taxpayers who had their refunds frozen, 75 percent were
    EITC recipients.\61\ In 80 percent of the frozen refund cases brought
    to the NTA last year, the IRS ended up paying full or partial refunds,
    indicating a very large percentage of innocent filers had to face
    hardships resulting from delayed refunds.
    ---------------------------------------------------------------------------
        \61\ National Taxpayer Advocate Service, ``National Taxpayer
    Advocate's 2005 Annual Report to Congress,'' Internal Revenue Service,
    http://www.irs.gov/advocate/article/0,,id=152735,00.html (accessed
    October 17, 2007).
    ---------------------------------------------------------------------------
        Moreover, anecdotal evidence indicates the fear of punitive action
    by the IRS discourages workers from claiming the EITC. Currently, one
    in five workers who is eligible for the EITC does not claim it. Much of
    the energy and funding the IRS devotes to EITC compliance programs
    could be better spent by offering the helping hand of taxpayer services
    rather than punitive enforcement.

    Expanded Assistance Would Reduce Error Rates
        The EITC error rate could be significantly reduced by increasing
    the capacity of nonprofit or Government tax preparation services to
    assist EITC-eligible taxpayers.\62\ EITC error rates do not distinguish
    taxpayers who intentionally cheated on their returns from those who
    simply made mistakes. EITC filings are complicated, requiring a 50-page
    instruction manual, \63\ and therefore, many EITC over-claims are the
    result of mistakes that could be prevented. In fact, as much as 50
    percent of all tax returns with errors are thought to be unintentional
    and have been linked to the complexity of EITC eligibility
    requirements.\64\ These errors could be addressed principally by
    simplifying tax laws and, when necessary, giving taxpayers help in
    preparing what may unavoidably be a complicated application process.
    ---------------------------------------------------------------------------
        \62\ Another effective approach is to simplify the credit. See Max
    Sawicky, ``Where the Money Isn't,'' Economic Policy Institute, http://
    www.epinet.org/content.cfm/issuebriefs_ib183.
        \63\ See the IRS web site for the manual: http://www.irs.gov/pub/
    irs-pdf/p596.pdf.
        \64\ Max Sawicky, ``Where the Money Isn't,'' Economic Policy
    Institute, http://www.epinet.org/content.cfm/issuebriefs_ib183
    (accessed October 17, 2007).
    ---------------------------------------------------------------------------
        Through its nationwide network of Taxpayer Assistance Centers
    (TACs), the IRS makes tax return preparation services available for
    low-income tax filers on a walk-in basis. Studies have found IRS-
    prepared returns from these centers are substantially more accurate
    than both self-prepared and commercially prepared returns.\65\ Audits
    show that TAC-prepared EITC returns resulted in between $640-$1,300
    less in erroneous payments than unprepared returns.\66\
    ---------------------------------------------------------------------------
        \65\ Nina Olson, ``The IRS and the Tax Gap,'' Testimony before the
    Committee on the Budget, U.S. House of Representatives, http://
    www.house.gov/budget_democrats/hearings/2007/08Olsontestimony.pdf
    (accessed October 16, 2007).
        \66\ Ibid.
    ---------------------------------------------------------------------------
        Yet the IRS has decided to reduce the quantity and quality of
    services available at TACs. The number of tax returns TACs prepared
    declined from 665,868 in fiscal year 2003 to a projected 406,612 in
    fiscal year 2006.\67\ A 2006 report by TIGTA also found more than 10
    percent of TACs (47 of 400) were critically understaffed.\68\ As the
    sheer volume of returns processed by TACs has decreased, the range of
    services they provide has also been narrowed.\69\ For example, in North
    Dakota, where farming is a major industry, the TACs have been
    instructed not to answer questions related to reporting farm income on
    tax returns.\70\ As more evidence of the detrimental combination of
    limited resources and unwise decisions at the IRS, employees at TACs
    have also been reassigned to jobs unrelated to taxpayer assistance,
    including being instructed to perform collection activities. This
    change diverts additional resources away from services offered at
    TACs.\71\
    ---------------------------------------------------------------------------
        \67\ Nina Olson, ``Hearing on Internal Revenue Service Fiscal Year
    2008 Budget Request'' Written Statement before the Subcommittee on
    Financial Services and General Government Committee on Appropriations,
    U.S. Senate, April 9, 2007.
        \68\ Treasury Inspector General for Tax Administration, ``The Field
    Assistance Office Has Taken Appropriate Actions to Plan for the 2006
    Filing Season But Challenges Remain for the Taxpayer Assistance
    Program.'' U.S. Department of Treasury, http://www.treas.gov/tigta/
    auditreports/2006reports/200640067fr.pdf (accessed October 16, 2007).
        \69\ National Taxpayer Advocate Service, ``National Taxpayer
    Advocate's 2005 Annual Report to Congress,'' Internal Revenue Service.
    http://www.irs.gov/advocate/article/0,,id=152735,00.html
        \70\ Nina Olson, ``Hearing on Internal Revenue Service Fiscal Year
    2008 Budget Request.''
        \71\ National Taxpayer Advocate Service, ``National Taxpayer
    Advocate's 2005 Annual Report to Congress,'' Internal Revenue Service.
    http://www.irs.gov/advocate/article/0,,id=152735,00.html
    ---------------------------------------------------------------------------
        Even more worrisome, the IRS has also been attempting to close
    TACs. In 2005, the IRS announced plans to shut down 68 of the 400 TACs
    nationwide. Before the IRS could carry out these plans, Congress passed
    a bill prohibiting the IRS from closing the TACs until TIGTA could
    evaluate the potential impact the closures would have on taxpayers. In
    March 2006, TIGTA completed the report, which concluded the data
    concerning TAC usage, on which the IRS based its plans for TAC
    closures, was unreliable. IRS has so far delayed the closures.\72\
    ---------------------------------------------------------------------------
        \72\ Treasury Inspector General for Tax Administration, ``The
    Taxpayer Assistance Center Closure Plan Was Based on Inaccurate Data.''
    U.S. Department of Treasury, http://www.treas.gov/tigta/auditreports/
    2006reports/200640061fr.pdf (accessed October 16, 2006).
    ---------------------------------------------------------------------------
        Dedicating additional resources to low-income services would have
    the benefit of reducing EITC error rates, closing the tax gap, and
    expanding needed services to more low-income taxpayers. At a minimum,
    the IRS and Congress should dedicate sufficient resources to maintain
    existing TACs. Even more funding would make the TAC network more
    responsive to taxpayer needs, both by opening more centers around the
    country and expanding the scope of services offered to taxpayers.

                      TAX ENFORCEMENT HAS TO BE A PRIORITY

        The tax gap is an eminently solvable problem. If Congress were to
    prioritize funding for IRS examination, collection, and tax preparation
    services, it would drastically reduce the tax gap. The practical effect
    of expanding these activities at the IRS would be to make the tax code
    more equitable, and it would bring in additional revenue that could
    responsibly finance new programs and services. If implemented in the
    right way, closing the tax gap could also help to increase public
    confidence in the tax system and the Federal Government.
        Congress needs to enact sustained increases in the IRS budget
    immediately and should make a commitment to continue to provide the IRS
    with the extra resources that are so crucial to effective tax
    enforcement.
        This report has only highlighted a few sections of the IRS budget
    that merit additional funding and reforms. However, it refrains from
    specifying the dollar amounts needed to address these concerns and
    recommends a thorough congressional review of the entire IRS budget. We
    believe Congress, IRS administrators, and outside experts, upon whose
    research and expertise this report mainly relies, should come together
    to find common ground on what an appropriate funding increase would
    look like, how quickly it should be implemented, and how it could be
    sustained in coming years. Most experts, both inside the IRS and out,
    prefer gradual increases in funding, as opposed to a sudden increase. A
    sudden increase would likely overwhelm the IRS and be implemented
    inefficiently and with too little oversight. Despite this
    recommendation, we believe the IRS funding shortage is an urgent matter
    and should be addressed as quickly as possible.
        Ultimately, as with most fiscal issues, the root of the problem is
    political. The case must be made that fears of an IRS run amok are, in
    a way, a self-fulfilling prophecy. Attempting to curtail the powers of
    the IRS through inadequate funding levels has had unintended
    consequences--it has forced the IRS to institute policies and
    enforcement practices detrimental to tax collection, taxpayers' rights,
    and the progressivity of the tax code. So long as the IRS is
    underfunded, it will be forced to enforce the tax code unfairly and
    punitively. However, if the IRS is properly funded and administered
    correctly, the Federal Government will have the opportunity to make
    substantial progress in reducing the tax gap and to ensure the tax
    system is as progressive in practice as it is in law.

                     STATEMENT OF SENATOR RICHARD J. DURBIN

        Senator Durbin. The IRS administers the tax laws and
    collects $2.4 trillion in revenue that fund over 96 percent of
    Federal Government operations. With approximately 90,000
    employees, the IRS is effectively the accounts receivable
    department of the United States. Simply stated, the more
    revenue the IRS collects, the more revenue Congress may spend
    to either cut taxes, reduce the deficit, or advance important
    programs. And conversely, the less that is collected, the less
    revenue Congress has for these same purposes.
        The IRS relies on three sources of funds it needs to
    operate: appropriated funds, user fees, and reimbursables,
    which are payments to the IRS which they receive from other
    Federal agencies and State government for services. Nearly the
    entire IRS budget, 97 percent of it, is derived from
    appropriated funds.
        For fiscal year 2009, the Bush administration is asking a
    direct appropriation of $11.36 billion. It is an overall
    increase of $469 million, or 4.3 percent, above fiscal year
    2008.
        In addition to the request for appropriated funds in fiscal
    year 2009, the IRS also expects to realize nearly $108 million
    from reimbursable programs and $177 million in user fees,
    bringing total spending to $11.647 billion.
        By breakdown of the nearly $11.4 billion appropriation
    requested, $2.15 billion is for taxpayer services; $5.12
    billion for enforcement; $3.86 billion for operations support;
    $222.7 million for business system modernization; and $15.4
    million for health insurance tax credit administration.
        As the subcommittee evaluates the President's request, we
    will take stock of the recommendations of the Oversight Board
    and a lot of experts. I know the Oversight Board is tasked by
    law to review and assess the annual budget request for the IRS
    to make sure it supports the agency's annual and long-term
    strategic plans.
        Before we hear our panelists, I would like to mention just
    a few of the issues we will be considering.
        First, how does the proposed budget address the tax gap?
    The great majority of Americans pay their fair share of taxes,
    but there is still a significant tax gap. That is the
    difference between what taxpayers are supposed to pay and what
    they actually pay. I note that as part of its budget
    submission, the IRS proposes 16 legislative reforms to recoup
    $36 billion of the $290 billion net tax gap over the next 10
    years.
        Questions have been raised that such an approach is not
    aggressive enough and amounts to a return of just slightly over
    a penny on the dollar. I am anxious to hear perspectives from
    our panel members.
        Second, does this proposed budget achieve the proper
    balance between enforcement and service? It is fundamental that
    as enforcement initiatives to boost compliance are advanced,
    resources for taxpayer services not be sacrificed. Taxpayer
    service plays an integral role in facilitating voluntary
    compliance.
        Third, does the proposed budget promote critical
    investments and ensure meaningful progress in information
    technology enhancements? Let me just say that we know that the
    IRS is facing, in addition to the regular tax return filing
    season, the issuance of $100 billion in stimulus payments in
    the form of rebate checks over the next few months. I
    understand that as of March 28, the IRS received an estimated
    1.4 million tax returns from individuals who filed them solely
    to receive the rebates. I also understand the IRS has been
    receiving an average of more than 63,000 calls per day above
    the normal volume asking questions about the rebates.
        Let me just say there are many topics of concern that we
    will go into in the hearing, but in the interest of moving it
    along, I am going to ask my colleague, Senator Allard from
    Colorado, if he has an opening statement or a comment that he
    would like to make.
        Senator Allard. I do, Mr. Chairman, just brief comment, if
    I might.
        Senator Durbin. And when he is finished, we will proceed
    with questions.

                       STATEMENT OF SENATOR WAYNE ALLARD

        Senator Allard. Thank you, Mr. Chairman, for holding
    today's hearing. I would like to thank our panelists for
    joining us this afternoon.
        For some time now, I have been following closely and
    showing some concern on the IRS's ongoing audit process
    involving the conservation easement donations in Colorado. I
    understand Colorado is one of the top States in the number of
    conservation efforts that it has undertaken, and it is an issue
    of great importance to our State and many people in it and our
    quality of life as far as our goals for open space. And I
    support the IRS investigation and enforcement of legitimate
    fraud in an effort to route out abuse of the conservation
    easements tax credit program.
        However, at times I wonder if the IRS has wrongly targeted
    honest and hardworking Coloradans throughout their
    investigation. I hope that they would refocus its investigation
    and approach the issue in a fair and reasonable manner. There
    are at least 96 audits involving donations to mainstream
    conservation organizations that follow the letter and the
    spirit of the law, I believe. Some of the 96 donations were
    verified by legitimate conservation easements by the U.S.
    Department of Agriculture and other Government agencies, I am
    led to believe.
        I would urge you to follow the model set by Colorado and
    refocus on cases involving an appraiser or land trust who has
    been disciplined or is currently under investigation by the
    State. Hopefully, this approach will rightly target the actual
    abuse, while releasing lawful easement donations from
    multiyear, stressful, and unjustified audits.
        So we will be following this particular area closely, Mr.
    Chairman. My office has been contacted by a number of
    organizations that work with these easements. And I would
    encourage the Internal Revenue Service on their investigations
    to use common sense in their approach, and I understand that
    there are violations and there have been reasons why you have
    had to look at some of these deals in Colorado. But on the
    other hand, we hope that we do not get too broad and snare and
    tie up innocent parties that perhaps did not violate the law.
        So thank you very much, Mr. Chairman.
        Senator Durbin. Thank you, Senator Allard.
        [The statement follows:]

                   Prepared Statement of Senator Wayne Allard

        Thank you, Mr. Chairman, for holding today's hearing. I would also
    like to thank our panelists for joining us this afternoon.
        For some time now I have been involved and concerned by the IRS'
    ongoing audit process involving conservation easement donations in
    Colorado. Colorado is a national leader in conservation, and it is an
    issue of great importance to our state's economy and quality of life.
        I support the IRS' investigation and enforcement of legitimate
    fraud in an effort to root out abuse of the conservation easement tax
    credit program. However, I feel the IRS has wrongly targeted honest and
    hard working Coloradoans throughout their investigation.
        I hope the IRS would refocus its investigation and approach the
    issue in a fair and reasonable manner. There are at least 96 audits
    involving donations to mainstream conservation organizations that
    follow the letter and spirit of the law. Some of these 96 donations
    were verified to be legitimate conservation easements by the U.S.
    Department of Agriculture and other Government agencies.
        The IRS should follow the model set by Colorado and refocus on
    cases involving an appraiser or land trust who has been disciplined or
    is currently under investigation by the State. This approach will
    rightly target the actual abuse while releasing lawful easement donors
    from multi-year, stressful, and unjustified audits.
        If the IRS decides not to alter the ongoing audit process they and
    the hardworking taxpayers can expect a long drawn-out battle. If they
    stay on their current course, the IRS may be faced with over 200
    appeals. This many appeals will take a lot of time and resources to
    build a case for every easement in question. At what cost? The American
    taxpayers are on the hook for this process that has been going on for
    several years already and there is no end in sight.
        There is a significant need for conservation easements in Colorado
    and a few abuses should not end the charitable tax credit for everyone.
        Thank you, Mr. Chairman.

        Senator Durbin. Senator Brownback.

                       STATEMENT OF SENATOR SAM BROWNBACK

        Senator Brownback. Thank you very much, Mr. Chairman. I
    appreciate this.
        Welcome, Commissioner. Glad to have you here, 4 weeks onto
    the job. Yesterday, I guess, was your big day. The rest of us
    were not celebrating yesterday. But delighted to have you here
    and in that job and position.
        I do want to make a point about yesterday, and I appreciate
    the hearing, appreciate you being here on our budget. But I was
    noting in my opening remarks that on the complexity of the Tax
    Code, you have 800 different IRS tax forms--800. And I do not
    know if any one person fills out all 800 of them. If they fill
    out 100 of them or if they fill out 50, this is an unbelievably
    complex Tax Code. That is your problem to enforce, but that is
    our problem in the creation of it. And as I just pointed out I
    think we are well overdue for tax simplification.
        You are only 4 weeks into a job, but it is a 5-year
    appointment, and I would hope that over the period of time that
    you are Commissioner, that you really help us work on tax
    simplification and that you become an advocate for it. I
    mention that you note there is a part of your enforcement
    problem that is involved the so-called tax gap. In your
    congressional budget justification, you state that a major
    contributing factor to the tax gap is that our tax system is so
    complex that taxpayers cannot figure out what they owe. So a
    big part of your enforcement problem is taxpayers not being
    able to figure out which of the 800 forms they are supposed to
    fill out. That is why I really think we have got to look at tax
    simplification.
        I have put forward a proposal, an optional flat tax, leave
    the Code in place, but let people choose a simpler system. And
    I do not expect you to put a proposal forward in the short term
    while you are in, but I do hope during the time that you are
    Commissioner you really help us wrestle with that problem. It
    will make your job a lot simpler. I think it will be well
    received across the country, that they want to see a simpler,
    fairer, flatter system, and I would hope that we could learn in
    your position to get a Code that is a lot easier for people to
    understand and a lot easier to enforce too.
        Thank you, Mr. Chairman.
        [The statement follows:]

                  Prepared Statement of Senator Sam Brownback

        Good afternoon. I want to thank you, Chairman Durbin, for your
    leadership on this subcommittee. As always, I look forward to working
    with you during this coming year as we make funding decisions and
    provide oversight to the various agencies within this subcommittee's
    jurisdiction.
        Commissioner Shulman, thank you for appearing before our
    subcommittee today. I understand you have only been with the IRS a few
    weeks, so this is certainly a busy time for you to be taking the reins.
    I'm pleased we have such a highly qualified person in the job and I
    look forward to hearing the details of your fiscal year 2009 budget
    request. Your budget justification says that the IRS ``represents the
    face of the U.S. government to more American citizens than any other
    agency.'' As surprising as it may seem in Washington, many Americans
    only come into direct contact with the Federal Government on Tax Day. I
    appreciate the work that you and your staff do to ensure taxpayer
    compliance and to provide taxpayer assistance.
        I must take this opportunity, though, to express my deep concerns
    about the current tax system. Yesterday was a dark day for most
    Americans as they rushed to file their tax returns. Every year,
    taxpayers suffer under the burden of our complex and complicated tax
    code, confused by over 800 different IRS tax forms, perplexed by
    hundreds of pages of IRS instruction books, and nervous that they will
    make a mistake trying to calculate how much of their money they owe the
    Federal Government.
        This current maze of tax regulations is so convoluted and complex
    that many Americans believe it is not only incomprehensible, but
    unfair. This confusion is one reason why almost two-thirds of all
    taxpayers have given up on trying to figure out how to complete their
    own tax returns and now spend even more of their hard-earned wages to
    pay someone else to sort it all out.
        I'm not blaming you for this state of affairs, Commissioner
    Shulman. Lawmakers have created this labyrinthine maze and you and your
    people are just working to administer it.
        Looking at the President's budget request, I am pleased that it
    includes a 7 percent increase for taxpayer enforcement to work toward
    closing the so-called ``tax gap.'' Certainly, we must ensure that taxes
    which are owed are collected. But your own congressional budget
    justification states that a major contributing factor to the ``tax
    gap'' is that our tax system is so complex that taxpayers cannot figure
    out what they owe. I have been informed that the annual tax gap is
    about $290 billion. I'm glad to see that the IRS is devoting resources
    to closing this gap, but I believe that as long as we have this
    convoluted and burdensome system, the gap between taxes owed and taxes
    paid will remain substantial.
        Again, Commissioner Shulman, this system is one that you have
    inherited. I am in no way blaming you for this state of affairs. But I
    have to take this opportunity to continue to push for an optional flat
    Federal income tax. A flat tax would be a clear and fair way for
    American families to figure out what they owe and put it on a one-page
    form to the Federal Government. As long as a flat tax rate is
    reasonable, it is a fairer tax than the current system because it taxes
    all earned income at the same rate. Workers would not be punished for
    working harder and earning more money, because each dollar that they
    earn would be taxed at the same exact rate. This would be fairer,
    simpler, easier to understand, and would produce more economic activity
    and jobs.
        Finally, I am pleased that Americans will soon be receiving
    economic stimulus checks in the mail. I certainly support these tax
    rebates to hard-working families. But the complexity of the tax system
    was again evident when the IRS recently had to hold a ``Super
    Saturday,'' opening hundreds of IRS offices to help folks file their
    returns so that they could receive their economic stimulus payments. In
    fact, your agency must spend over $2 billion every year just to help
    people figure out how to complete their tax returns. Quite frankly,
    that says it all.
        So Commissioner Shulman, I thank you for your service and I look
    forward to hearing your testimony this afternoon.
        Thank you, Mr. Chairman.

                 STATEMENT OF IRS COMMISSIONER DOUGLAS SHULMAN

        Senator Durbin. Thanks a lot.
        Commissioner Shulman, the table is yours for a 5-minute
    statement. All the rest will be put in the record. And welcome.
        Mr. Shulman. Thank you, Chairman Durbin, Ranking Member
    Brownback, Senator Allard. I appreciate the opportunity to
    appear here before the subcommittee. As you have noted and
    noticed, I am in my fourth week on the job. Let me reiterate to
    this subcommittee that I look forward to working with you
    during my entire tenure here to address the critical issues
    related to the IRS.
        I would also like to introduce the IRS's two Deputy
    Commissioners, Richard Spires and Linda Stiff, who are here
    with me today. They have really done an excellent job guiding
    the agency through what, by any measure, are some tough times:
    this filing season, the late enactment of the alternative
    minimum tax (AMT) legislation, and then the stimulus package. I
    am lucky to have them on the team. I also wanted to make sure
    we are responsive to any questions and given that I am 4 weeks
    into this, I wanted to make sure they were here with me today.
        This morning I will touch quickly on the filing season and
    our proposed budget, but I will also try to give you a little
    sense of my approach to the job.
        Yesterday we completed what looks like a successful filing
    season. Electronic filers were up 10 percent as of yesterday.
    The number of returns prepared by our volunteer income tax
    assistance and tax counseling for the elderly centers
    throughout the country were up 26 percent. The usage of our
    Free File program, which allows 70 percent of all Americans to
    prepare and file their returns electronically, was up 20
    percent this year. And visits to IRS.gov were up 21 percent.
        We also, as I mentioned, are having a successful filing
    season despite some pressures, including late enactment of the
    AMT and, as you mentioned, Mr. Chairman, the stimulus program
    which was put on top of filing season.
        Regarding the stimulus program, we have done an extensive
    outreach program to make sure Americans know that all they need
    to do is file a tax return in order to get a stimulus payment.
    We put particular emphasis on informing Americans who normally
    would not file a return, but are eligible for stimulus
    payments, that they need to file a return this year. These are
    people who receive Social Security, receive veterans benefits,
    low income workers.
        I also want to urge this subcommittee to support full
    funding of the IRS's 2009 budget request. This budget will
    allow us to continue a strong emphasis on taxpayer service, but
    also to continue to build on our good record of enforcement
    programs to target noncompliance.
        During my confirmation process, I was asked by the Senate
    Finance Committee whether I thought it was most important to
    focus on service or to focus on enforcement. And my answer
    there--and I fervently believe this--is that for the IRS to
    achieve its compliance objectives, we have to continue to focus
    on both service and enforcement. Said another way, I think we
    need to do everything we can to make it as seamless and easy as
    possible for taxpayers who want to pay the right amount of
    taxes to navigate our organization, get their questions
    answered, pay their taxes, and get on their way. But for anyone
    who understands his or her tax obligation and is trying to
    evade that obligation, we need to have aggressive enforcement
    programs.
        Another area of focus for me will be technology
    modernization. The evolution of technology has changed the way
    that every major organization, private and public, goes about
    doing its work. As we adapt to this changing world, my goal is
    relatively simple. It is to get the right information into the
    hands of the right people at the right time, whether that is
    getting information into the hands of taxpayers or our people
    trying to do service or enforcement.
        The other area I would mention quickly is our need to
    continue to focus on leadership and workforce. The IRS, like
    other Government agencies, is going to have a lot of people
    retiring in the next couple of years. There is competition for
    talent, and we are going to need to keep focusing on building
    our next generation of leaders and developing our workforce.

                               PREPARED STATEMENT

        So let me thank you again, Mr. Chairman, for the
    opportunity to appear this morning. In my short tenure, I have
    found the people at the IRS to be extremely professional,
    hardworking, and dedicated to the American people every day. I
    am committed to work every day to provide the level of service
    that taxpayers deserve, as well as to rigorously enforce the
    tax laws. We obviously need resources to execute this mission,
    and I encourage this subcommittee to fully fund the
    administration's 2009 proposed budget. Thank you, and I am
    happy to answer questions.
        Senator Durbin. Thanks, Mr. Commissioner.
        [The statement follows:]

                     Prepared Statement of Douglas Shulman

                                  INTRODUCTION

        Chairman Durbin, Ranking Member Brownback, and members of the
    subcommittee, thank you for the opportunity to appear today. This is my
    third hearing as the IRS Commissioner and I look forward to working
    with the Members of this subcommittee in the future as we address
    issues related to the IRS.
        As I settle in to my new role, it becomes clearer to me each day
    what a privilege it is to be the Commissioner of the IRS. The IRS and
    its employees represent the face of United States Government to more
    American citizens than any other Government agency. We administer
    America's tax laws and collect over 96 percent of the revenues that
    fund the Federal Government each year.
        My most recent experience has been as the Vice Chairman of the
    Financial Industry Regulatory Authority (FINRA), formerly the NASD. In
    2007, NASD consolidated with the member regulation, enforcement, and
    arbitration functions of the New York Stock Exchange to form FINRA.
    Based on my previous experience, I believe that leaders of large
    organizations--public and private--always must be focused on ensuring
    that resources are aligned with strategic priorities. It is incredibly
    important that there be a balance of resources between day-to-day
    execution and investments for the longer term. In my first 4 weeks, I
    have been working with the senior executive team of the IRS to
    understand how resource allocation decisions have been made. The
    subcommittee can expect ongoing dialog and personal engagement from me
    on these issues.

                               2008 FILING SEASON

        The biggest challenge the IRS faced at the end of 2007, as it
    approached the 2008 filing season, was the uncertain status of
    legislation to address the situation of an additional 21 million
    taxpayers who otherwise would have become subject to the alternative
    minimum tax (AMT).
        On October 30, 2007, Chairman Baucus, Ranking Member Grassley of
    the Senate Finance Committee House and their counterparts on the House
    Ways and Means Committee, sent a letter assuring the IRS that Congress
    intended to enact AMT relief (the AMT patch) in a manner acceptable to
    the Senate, the House of Representatives, and the President. I am told
    that this letter was very helpful because it allowed the IRS to move
    forward on certain planning and design aspects of implementing the AMT
    relief legislation, shortening the implementation process by a number
    of weeks.
        However, the IRS indicated at the time that its key systems could
    accommodate only one programming option without introducing excessive
    risk to the filing season. As a result, the IRS was able to proceed
    only so far without actual legislation being enacted. When the
    President signed the AMT relief law on December 26, 2007, the IRS
    immediately began the detailed reprogramming of systems to accommodate
    the new law. IRS employees worked diligently to modify systems to
    implement the changes in a very short time period. My thanks go out to
    all of those dedicated employees who worked almost around the clock to
    enable us to implement this AMT relief legislation in record time.
        Given their efforts, we were able to begin the filing season on
    schedule for most taxpayers. However, the processing of returns filed
    by approximately 13.5 million taxpayers that included one of five forms
    associated with the AMT legislation was delayed. These taxpayers had to
    wait until February 11, 2008, before their returns could be processed.
        The other challenge facing us this filing season is the
    implementation of the economic stimulus package enacted in early
    February, specifically the planning for the distribution of the
    stimulus payments to eligible recipients throughout the country this
    spring. To deliver the 2008 stimulus payments, we have been programming
    our systems to calculate the appropriate amount for each eligible
    taxpayer based on their 2007 returns so that the payments can be
    distributed, through Treasury's Financial Management Service, by direct
    deposit or by paper check, based on the preferences expressed on the
    taxpayer's return.
        We will begin immediately after the close of the filing season to
    distribute those payments with the expectation that the first payments
    will be sent electronically starting in the first week of May and with
    the first paper checks being mailed shortly thereafter. We have
    established a distribution schedule that is published on the IRS
    website on a page dedicated to informing citizens about the economic
    stimulus payments.
        However, there are millions of individuals who may be eligible for
    economic stimulus payments, but who typically do not have an income tax
    filing requirement. This group includes retirees or those who have
    minimal income and are thus not required to file. But in order to
    receive the 2008 stimulus payment, the recipient must file a tax return
    for 2007. To reach these recipients and educate them requires an
    extensive outreach program that includes the mailing of information
    packets and IRS coordinating with the Social Security Administration
    and Department of Veterans Affairs, along with private groups such as
    the AARP.
        Despite the challenges presented by the late enactment of the AMT
    patch and the implementation of the economic stimulus payments, I am
    proud to report that thus far the filing season has gone very well.
    Allow me first to give an update on some of the numbers we are looking
    at as we close out the filing season.
    Numbers Thus Far
        We expect to process nearly 140 million individual tax returns in
    2008, and we anticipate continued growth in the number of those that
    are e-filed. In the 2007 filing season, almost 60 percent of all income
    tax returns were e-filed. We fully expect to exceed that number this
    year. As of April 5, we have received over 67 million tax returns
    electronically, an increase of 10 percent compared to the number of
    returns that were e-filed during the same period last year.
        This increase in e-filing is being driven by people preparing their
    own returns using their personal computers. The total number of self-
    prepared returns that are e-filed is up by 18.2 percent compared to the
    number of self-prepared returns filed during the same period a year
    ago. Over 19 million returns have been e-filed by people from their
    personal computers, up from just over 17 million for the same period a
    year ago.
        Overall, nearly 70 percent of the returns filed through April 5
    have been e-filed. Encouraging e-filing is good for both the taxpayer
    and for the IRS. Taxpayers who use e-file can generally have their tax
    refund deposited directly into their bank account in 2 weeks or less.
    That is about half the time it takes us to process a paper return. For
    the IRS, the error-reject rate for e-filed returns is significantly
    lower than that for paper returns.
        More people are choosing to have their tax refunds deposited
    directly into their bank account than ever before. As of April 5, we
    have directly deposited over 53.6 million refunds, or over 71 percent
    of all refunds issued this tax filing season.
        People are also visiting our web site--IRS.gov--in record numbers.
    We have recorded over 132 million visits to our site this year, up over
    21 percent from 109 million for the same period a year ago. The
    millions of taxpayers that have visited IRS.gov have benefited from
    many of the services that are available through the IRS.gov web site.
    The web site:
      --Allows taxpayers to obtain information on the economic stimulus
            package including determining the payment amount they can
            expect to receive and learning when they can expect their
            payment based on their Social Security Number (SSN);
      --Assists taxpayers in determining whether they qualify for the
            Earned Income Tax Credit (EITC);
      --Assists taxpayers in determining whether they are subject to the
            Alternative Minimum Tax (AMT);
      --Allows more than 70 percent of taxpayers the option to prepare and
            file their tax returns at no cost through the Free File
            program. This includes giving a free option for those taxpayers
            who normally do not file a tax return, but are required to this
            year in order to receive their stimulus payment;
      --Allows taxpayers who are expecting refunds to track the status via
            the ``Where's My Refund?'' feature; and
      --Allows taxpayers to calculate the amount of their deduction for
            State and local sales taxes.
        We have issued 75.1 million refunds as of April 5, for a total of
    $183 billion. The average refund thus far is $2,436. In addition,
    nearly 28 million taxpayers have tracked their refund on IRS.gov, up
    nearly 20 percent over last year.
        As of March 29, our Taxpayer Assistance Centers (TACs) are
    reporting over 2.1 million taxpayers assisted. Our telephone assistors
    have answered over 13 million calls, and over 17 million callers
    received automated services.
    Free File
        Over 3.6 million people have utilized Free File as of April 5,
    2008, an increase of 19.7 percent compared to the number of taxpayers
    that used Free File during the same period a year ago. This year anyone
    with adjusted gross income of $54,000 or less is eligible for Free
    File, which includes 97 million taxpayers. The number of Free File
    returns compared to the prior year has been steadily increasing, and we
    expect to meet or exceed 2007 totals by the end of the filing season.
    One reason for this increase is that we have committed additional
    resources to promote the Free File program.
    VITA/TCE Sites and Other Community Partnerships
        The use of tax return preparation alternatives, such as volunteer
    assistance at Volunteer Income Tax Assistance (VITA) sites and Tax
    Counseling for the Elderly sites (TCEs), has steadily increased over
    the years. In 2007, over 2.6 million returns were prepared by
    volunteers. As of April 5, 2008, volunteer return preparation is up
    over 26 percent compared to the number of volunteer-prepared returns
    filed during the same period a year ago. This is reflective of
    continuing growth in existing community coalitions and partnerships.
        We also have made a concerted effort to expand outreach to
    taxpayers, particularly those taxpayers who may be eligible for the
    EITC. For example, we sponsored again this year EITC Awareness Day on
    January 31, 2008, in an effort to partner with our community coalitions
    and partnerships to reach as many EITC-eligible taxpayers as possible
    and urge them to claim the credit. Over 125 coalitions and partners
    hosted local news conferences and issued more than 100 press releases
    highlighting EITC Awareness Day this year.

             A COMMITMENT TO SERVICE, ENFORCEMENT AND MODERNIZATION

        I understand that in fiscal year 2007, the IRS continued making
    improvements in our service and enforcement programs as well as having
    significant successes in our IT modernization program. A few highlights
    of the IRS' fiscal year 2007 accomplishments include:
      --The IRS customer assistance call centers answered 33.2 million
            assistor telephone calls and 21.1 million automated calls. We
            maintained an 82.1-percent level of service on the telephone
            with an accuracy rate of 91.2 percent on tax law questions.
      --Outreach and educational services were enhanced through
            partnerships between the IRS and public organizations. Through
            its 11,922 VITA and TCE sites, the IRS provided free tax
            assistance to the elderly, disabled, and limited English
            proficient individuals and families. Over 76,000 volunteers
            filed 2.63 million returns for these individuals. Additionally,
            the IRS established 6 new tax clinics in rural areas to help
            low-income taxpayers meet their tax obligations.
      --Enforcement revenue has risen from $33.8 billion in fiscal year
            2001 to $59.2 billion, an increase of 75 percent. These numbers
            do not include the deterrent effect that an increased
            enforcement presence has on voluntary compliance.
      --Both the levels of individual returns examined and coverage rates
            have risen substantially. The IRS conducted nearly 1.4 million
            examinations of individual tax returns in fiscal year 2007, an
            8-percent increase over fiscal year 2006. This level of
            examinations is over three-quarters more than were conducted in
            fiscal year 2001, and reflects a steady and sustained increase
            since that time. Similarly, the audit-coverage rate has risen
            from 0.6 percent in fiscal year 2001 to 1 percent in fiscal
            year 2007. This increase was achieved without a significant
            increase in resources as compared to the previous fiscal year.
      --The Customer Accounts Data Engine (CADE) Release 3.2 was delivered
            on time (January 14, 2008) for this filing season and is doing
            well in production. As, of April 11, CADE had processed 24.98
            million returns, which is more than 25 percent of all
            individual returns filed to date for this year. CADE also has
            issued almost $38 billion in tax refunds.
      --Modernized e-File (MeF) is the IRS designated e-File platform
            (electronic filing system) for the future and provides e-Filing
            capability for large corporations, small businesses,
            partnerships, and non-profit organizations. As of April 5, MeF
            has accepted 1.82 million corporate, partnership, and tax
            exempt tax returns, a 45-percent increase from this same period
            a year ago. MeF Release 5 went into production as planned in
            January 2008 and provides the ability to file electronically
            Form 1120F (tax returns for foreign corporations) and Form 990N
            (so-called electronic postcard for small tax-exempt
            organizations to meet their filing requirement).

    THE ADMINISTRATION'S FISCAL YEAR 2009 BUDGET FUNDS TAXPAYER SERVICE AND
                                  ENFORCEMENT

        The fiscal year 2009 budget request funds activities that promote
    better tax administration and compliance with the tax laws. The fiscal
    year 2009 budget request for the enforcement program is $7,487,209,000,
    an increase of $489,983,000, or 7 percent, over the fiscal year 2008
    enacted level. The Administration proposes to include these enforcement
    increases as a Budget Enforcement Act program integrity cap adjustment.
    The enforcement program is funded from the Enforcement appropriation
    and part of the IRS Operations Support appropriation.

    Budget Request
        For fiscal year 2009, the President is requesting a total of
    $11,361,509,000 for IRS activities. This amount is a $469,125,000
    increase, or 4.3 percent, over the fiscal year 2008 enacted level.
        The overall IRS budget is broken down into the following five
    appropriations:
      --Taxpayer Services.--The fiscal year 2009 requested level for this
            area is $2,150,000,000. This is the same as the fiscal year
            2008 enacted level. The Operations Support account provides an
            additional $1.5 billion to support taxpayer service activities.
      --Enforcement.--The fiscal year 2009 request is $5,117,267,000. This
            level is an increase of 7.1 percent from the fiscal year 2008
            enacted level. As mentioned earlier, the Operations Support
            budget provides an additional $2.4 billion to support
            enforcement activities.
      --Operations Support.--The fiscal year 2009 request is
            $3,856,172,000. This level is an increase of 4.8 percent from
            the fiscal year 2008 enacted level.
      --Business Systems Modernization.--The fiscal year 2009 request is
            $222,664,000. This level is a reduction of 16.6 percent from
            the fiscal year 2008 enacted level. This appropriation funds
            the planning and capital asset acquisition of information
            technology to modernize the IRS business systems, including
            labor and related contractual costs.
      --Health Insurance Tax Credit Tax Administration.--The fiscal year
            2009 request for this program is $15,406,000. This is an
            increase of 1.1 percent from the fiscal year 2008 enacted
            level. This appropriation funds costs to administer a
            refundable tax credit for health insurance to qualified
            individuals, which was enacted as part of the Trade Adjustment
            Assistance Reform Act of 2002.
        The justification for the requests in each of these areas is
    discussed in detail below.

    Adjustments from Fiscal Year 2008 Levels To Help Improve Compliance
        The IRS total requested funding increase for fiscal year 2009 is
    $469,125,000. This increase will go to improving compliance. These
    investments fund increased front-line enforcement efforts, enhanced
    research, and implementation of legislative proposals to help narrow
    the tax gap. By fiscal year 2011, these investments are projected to
    increase annual enforcement revenue by $2 billion. In addition, the
    legislative proposals included in the fiscal year 2009 budget to
    improve tax compliance are estimated to generate $36 billion over the
    next ten years, if enacted.
        Specific increases to improve compliance include:
      --Reduce the Tax Gap for Small Business and the Self Employed
            (+$168,498,000/+1,608 FTE).--This enforcement initiative will
            increase enforcement efforts to improve compliance among small
            business and self-employed taxpayers by: increasing audits of
            high-income returns, increasing audits involving flow-through
            entities, implementing voluntary tip agreements, increasing
            document-matching audits, and collecting unpaid taxes from
            filed and non-filed tax returns. This request will generate
            $981 million in additional annual enforcement revenue once new
            hires reach full potential in fiscal year 2011.
      --Reduce the Tax Gap for Large Businesses (+$69,488,000/+519 FTE).--
            This enforcement initiative will increase examination coverage
            of large and mid-size corporations, including multi-national
            businesses, foreign residents, and smaller corporations with
            significant international activity. It also will enable the IRS
            to use existing systems further to capture other electronic
            data through scanning and imaging. The initiative will allow
            the IRS to address risks arising from the rapid increase in
            globalization, and the related increase in foreign business
            activity and multi-national transactions where the potential
            for non-compliance is significant. Funding of this request will
            generate $544 million in additional annual enforcement revenue
            once the new hires reach full potential in fiscal year 2011.
      --Improve Tax Gap Estimates, Measurement, and Detection of Non-
            Compliance (+$51,058,000/+393 FTE).--This enforcement
            initiative will support and expand ongoing research studies,
            including the National Research Program, of filing, payment,
            and reporting compliance to provide a comprehensive picture of
            the overall taxpayer compliance level. Research allows the IRS
            to target better specific areas of noncompliance, improve
            voluntary compliance, and allocate resources more effectively.
            Improved research data will be used to refine workload
            selection models, reducing audits of compliant taxpayers.
      --Increase Reporting Compliance of U.S. Taxpayers with Offshore
            Activity (+$13,697,000/+124 FTE).--This enforcement initiative
            will address domestic taxpayer offshore activities. Abusive tax
            schemes, under-reporting of flow-through income, and certain
            high-income individuals are prime channels or candidates for
            tax evasion. This initiative will focus on uncovering offshore
            credit cards, disguised corporate ownership, and brokering
            activities in order to identify individual taxpayers who are
            involved in offshore arrangements that facilitate
            noncompliance. Funding of this request will generate $102
            million in additional annual enforcement revenue once the new
            hires reach full potential in fiscal year 2011.
      --Expand Document Matching (+$35,060,000/+413 FTE).--This enforcement
            initiative will increase coverage within the Automated
            Underreporter (AUR) program. This program matches third-party
            information returns (e.g., Form W-2 and Form 1099 income
            reports) against income claimed on tax returns. When potential
            underreporting is discovered taxpayers are contacted to resolve
            the issue. This request will produce $359 million in additional
            annual enforcement revenue once the new hires reach full
            potential in fiscal year 2011.
      --Implement Legislative Proposals To Improve Compliance
            (+$23,045,000/0 FTE).--While the IRS continues to address
            compliance by improving customer service and using traditional
            methods of enforcement, the fiscal year 2009 budget also
            includes legislative proposals that would provide additional
            enforcement tools to improve compliance. It is estimated that
            these proposals, if enacted, will generate $36 billion in
            revenue over 10 years (see the Treasury Blue Book, available on
            the Treasury Department web site, for more information). The
            proposals would expand information reporting, improve
            compliance by businesses, strengthen tax administration, and
            expand penalties. This enforcement initiative includes funding
            for purchasing software and making modifications to the IRS IT
            systems necessary to implement the proposals. The specific
            legislative proposals are discussed below.

    Specific Legislative Proposals
        The Administration's fiscal year 2009 budget includes a number of
    legislative proposals intended to improve tax compliance while
    minimizing the burden on compliant taxpayers as much as possible. These
    include:
      --Expand information reporting.--Compliance with the tax laws is
            highest when payments are subject to information reporting to
            the IRS. Specific information reporting proposals would:
        --Require information reporting on payments to corporations;
        --Require basis reporting on security sales;
        --Require information reporting on merchant card payment
                reimbursements;
        --Require a certified Taxpayer Identification Number (TIN) from
                contractors;
        --Require increased information reporting on certain Government
                payments;
        --Increase information return penalties; and
        --Improve the foreign trust reporting penalty.
      --Improve compliance by businesses.--Improving compliance by
            businesses of all sizes is important. Specific proposals to
            improve compliance by businesses would:
        --Require electronic filing by certain large organizations; and
        --Implement standards clarifying when employee leasing companies
                can be held liable for their clients' Federal employment
                taxes.
      --Strengthen tax administration.--The IRS has taken a number of steps
            under existing law to improve compliance. These efforts would
            be enhanced by specific tax administration proposals that
            would:
        --Expand IRS access to information in the National Directory of New
                Hires for tax administration purposes;
        --Permit disclosure of prison tax scams;
        --Make repeated willful failure to file a tax return a felony;
        --Facilitate tax compliance with local jurisdictions;
        --Extend statutes of limitations where State tax adjustments affect
                Federal tax liability; and
        --Improve the investigative disclosure statute.
      --Expand penalties.--Penalties play an important role in discouraging
            intentional non-compliance. A specific proposal to expand
            penalties would impose a penalty on failure to comply with
            electronic filing requirements.

    Improve Tax Administration and Other Miscellaneous Proposals
        The Administration has put forward additional proposals relating to
    IRS administrative reforms. Five of these proposals are highlighted
    below:
      --The first proposal modifies employee infractions subject to
            mandatory termination and permits a broader range of available
            penalties. It strengthens taxpayer privacy while reducing
            employee anxiety resulting from unduly harsh discipline or
            unfounded allegations.
      --The second proposal allows the IRS to terminate installment
            agreements when taxpayers fail to make timely tax deposits and
            file tax returns on current liabilities.
      --The third proposal eliminates the requirement that the IRS Chief
            Counsel provide an opinion for any accepted offer-in-compromise
            of unpaid tax (including interest and penalties) equal to or
            exceeding $50,000. This proposal requires that the Secretary of
            the Treasury establish standards to determine when an opinion
            is appropriate.
      --The fourth proposal extends the IRS authority to use the proceeds
            received from undercover operations through December 31, 2012.
            The IRS was previously authorized to use proceeds it received
            from undercover operations to offset necessary and reasonable
            expenses incurred in such operations. This authority expired on
            December 31, 2007.
      --The fifth proposal equalizes penalty standards between tax return
            preparers and taxpayers, reducing unnecessary conflicts of
            interest between them. The standard applicable to tax return
            preparers for undisclosed positions would be ``substantial
            authority'' but for certain reportable transactions with a
            significant purpose of tax avoidance, the existing standard
            would persist (i.e., the preparer should have a reasonable
            belief that the position, more likely than not, would be
            sustained on the merits).

                                   CONCLUSION

        Thank you again, Mr. Chairman, for the opportunity to appear this
    morning and update the subcommittee on the filing season and the fiscal
    year 2009 proposed IRS budget. In my short tenure, I have found IRS
    employees to be professional, hardworking, and dedicated.
        I am committed to working hard everyday to provide taxpayers the
    high level of service they deserve and to pursue enforcement actions
    against those unwilling to meet their tax obligations.
        We need resources to execute against our plan, and I hope this
    subcommittee will support the full funding of the Administration's
    fiscal year 2009 proposed budget.
        I also urge this subcommittee to support the enactment of the
    legislative proposals included in the budget to improve compliance.
    Collectively, they will generate more $36 billion over the next 10
    years if enacted.
        I will be happy to respond to any questions.

                                  CONTRACTORS

        Senator Durbin. In preparation for this hearing, I am
    hoping that you have read Parade magazine in last Sunday's
    newspaper because my first question relates to enforcement and
    an article in that Parade magazine. It was under their so-
    called intelligence report entitled ``Are You Paying for
    Corporate Fat Cats?'' 61 percent of U.S. corporations paid no
    taxes, including 39 percent of large companies, according to
    this article. They went on to describe one company in
    particular, which I would like to ask you about.
        It turns out that one company employs one-third of our
    private contractors in Iraq. That company is Kellogg, Brown &
    Root (KBR), a former subsidiary of Halliburton. The company has
    54,000 people working in Iraq. Of these, over 21,000, including
    10,500 Americans, are considered Cayman Island hires. What has
    happened is that this company has created some subsidiaries or
    offices in the Cayman Islands, and by listing these employees
    paid by our Government as Cayman Island hires, they avoid
    paying the Medicare and Social Security taxes that all other
    American workers pay.
        So here we have Federal taxpayer dollars, emergency
    appropriations adding to our deficit to fund the private
    contractors who are being channeled through the Cayman Islands
    so that they will not have to pay taxes into the United States
    for Medicare and for Social Security. I want to know if the IRS
    is looking into it, and I want to know what more we can do to
    try to stop this.
        Mr. Shulman. Thank you for the question. Let me just state
    before I start, I obviously cannot speak about any specific
    taxpayers or any tax matters because of privacy laws. Let me
    just react on a general level, and then we would be happy to
    follow up.
        We are well aware and focused on the issue of independent
    contractors. Employment taxes are one of our responsibilities.
    Any issue with employment taxes is very fact-specific. We have
    a 20-point factor test that gets into the specific facts of a
    case. It is difficult for corporations and us to work through
    these issues, but we have a number of investigations ongoing in
    relation to employment taxes and subcontractors, and we view
    that as part of our job.
        I would also mention something I have spoken about publicly
    is that one of the challenges of our next 5 years is going to
    be grappling with the global economy, globalization,
    international tax issues. I have sat down with our team that
    focuses on these areas. I am quite familiar with these issues
    from my experience as a securities regulator and the global
    flow of capital. So issues around cross-border trade, employees
    located in multiple countries, paying the proper amount of U.S.
    taxes is something that is going to get focus from me.
        Senator Durbin. And I might say that it is not just KBR. A
    2004 study by the Government Accountability Office found that
    24 of the largest Federal contractors, contractors we pay by
    our Government, use the Cayman Islands to shave their tax
    bills. This bothers me that American companies doing the right
    thing are being penalized and other companies are profiting
    simply because they are creating these phony tax havens like
    the Cayman Islands.

                            PRIVATE DEBT COLLECTION

        Now let us talk for a minute about an issue that you have
    been asked a lot about, and that is this private collection
    agency for the IRS. This has been in place for a while now,
    these private debt collectors. There are several of them across
    the country, and they are not doing a very good job. If you
    take a look at our own IRS employees collecting taxes, the
    return on investment for taxpayers is 13 to 1. For the private
    collectors, it is only 3 to 1. To date, after spending $71
    million on startup and ongoing maintenance costs through the
    end of fiscal year 2007, the IRS private tax collection program
    has lost us $50 million.
        Why should we continue this?
        Mr. Shulman. This is an issue that I understand quite well
    has a lot of attention, and there are people who support the
    program and detractors from the program. I have committed to
    get my arms around this. As you can imagine, there are a
    variety of programs, most programs, that I still need some time
    to get up to speed on, and I am going to spend time getting up
    to speed on this.
        What I will tell you is I know the program has been
    authorized in the past by Congress. I have been told by the
    people at the IRS that they are working this program to the
    best of their abilities. We are very focused on the protection
    of taxpayer rights and data privacy. This year the program will
    do better than break even, and so there are variety of sunk
    costs that have not been recovered, but it is now at a point
    where it actually is bringing dollars into the Federal coffer.
        So on this one, I would say I plan on looking at it closely
    and studying the issue and would be happy and like to have
    further conversations.
        Senator Durbin. Thank you.

                              FORMS AND COMPLEXITY

        Senator Brownback.
        Senator Brownback. Thank you, Mr. Chairman.
        Do you really need 800 different forms?
        Mr. Shulman. As we have had a chance to discuss, clearly
    the tax law is complex. Clearly, that adds burden on the
    American people and makes our job difficult. I cannot speak to
    all the specific forms 4 weeks into the job.
        I will tell you a goal of mine is to create as much clarity
    as we can within the context of the law to the American people,
    make it as easy as possible, given the complexity of the law,
    for the American people to comply with their tax obligation.
        Senator Brownback. I hope you will look at that. That is
    just mind-boggling to me.
        I was just looking at the numbers that were just handed to
    me. The IRS spends $2 billion on taxpayer service helping
    people figure out their taxes. It is estimated that taxpayers
    spend $150 billion to figure out their taxes, either hiring
    third parties or in time taken away from other activities. $150
    billion that people are spending to figure out their taxes.
    That is amazingly high.
        Do you have any sense of how that compares to other
    countries in the developed world?
        Mr. Shulman. I do not, Senator.
        Senator Brownback. You have now got a growing set of
    countries that have moved to a flat tax. I think there is
    something like 16 that have gone to that system. I think it
    would be an interesting question to look at, what those
    countries spend in tax preparation time and money versus other
    places.

                               STIMULUS PAYMENTS

        Are you going to have any difficulty getting the economic
    stimulus checks out on time?
        Mr. Shulman. Since I have started the job, obviously this
    is something I am very focused on. Three times a week I have
    been in meetings with our staff. Everything looks like it is on
    track to have direct deposit checks go out the first week in
    May--start going out--and paper checks start going out shortly
    thereafter. So from everything I know, being in here 4 weeks,
    things look like they are on track to get the stimulus payments
    out on time.
        Senator Brownback. And to hit the dates?
        Mr. Shulman. Hit the targets that are on our web site that
    we have promised all along.
        Senator Brownback. You have said that you have spent a lot
    of time getting people signed up to file tax forms so they
    could get their stimulus check. Did you get a number of new
    registrants filing tax returns? I believe you had a special
    super Saturday, March 29, to do this?
        Mr. Shulman. We did something I am quite proud of, and it
    was a great way to start my first Saturday on the job. I went
    out to a retired veterans home and worked with our team. And we
    had 700 sites around the country open that Saturday, staffed
    with about one-half IRS and one-half volunteers. That day we
    had over 50,000 come into that combined group of sites.
        We are tracking very closely people who we think are only
    filing for stimulus payments. Yesterday we just got all the
    2007 returns. We are still processing paper returns. Later this
    month, we are actually going to look at the number of returns,
    try to figure out who we think is eligible, who has not filed
    yet, and then do another round of outreach. Our plan is
    actually to enlist both the administration and Members of
    Congress, if we see States where it looks like a lot of people
    have not availed themselves of the stimulus payments. We are
    going to be doing outreach and we will try to bring you in, as
    well, as partners.
        Senator Brownback. I do not know if many Members of
    Congress want to be very closely associated with the IRS, but
    maybe if it is passing checks out, that would change it.
        Do you have any idea of numbers of what you are talking
    about here? I see your activities, but do you have any idea on
    numbers?
        Mr. Shulman. We do not. It is very hard to estimate how
    many people are eligible. We are going to have a much better
    sense at the end of this month, and I can assure you our team
    will work on it. I have been pushing on this, and we are going
    to, hopefully by the end of the month, have a real sense of how
    many have come in and how many we think might still be
    eligible, based on Social Security rolls and other sources, and
    go out to more people.
        Senator Brownback. Will you be publishing, putting those
    numbers forth publicly?
        Mr. Shulman. We would be happy to share them with you.
        Senator Brownback. I think it would be good just because we
    are all very concerned about the economy, how many people are
    going to get checks, or an estimate?
        Mr. Shulman. Well, I am sorry. I might have misspoken. I
    was talking about the people who normally do not file who are
    eligible. We do have estimates of the broad numbers. We
    anticipate sending out over $100 billion in stimulus payments
    this year to over 130 million taxpayers. That is the gross
    number. We have not pinpointed the people who may be eligible
    who otherwise would not file a tax return, which is a group
    that we are very focused on providing service to.
        Senator Brownback. My time is up, but that is the number I
    was asking for, the number of people that you think would
    qualify but are not in the system getting or are not signed up,
    in your estimation who that would be? I would like to see if we
    could get that number.
        Mr. Shulman. Absolutely.
        Senator Durbin. Senator Allard.

                             CONSERVATION EASEMENTS

        Senator Allard. Thank you, Mr. Chairman.
        I want to pursue my opening comments on the conservation
    easements of Colorado. It is my understanding in mid-November,
    the Internal Revenue Service began making settlement offers to
    a significant number of conservation easement donors under
    audit in Colorado. According to your agency, the settlements
    were only offered in those cases where the sole issue between
    the owner and the Internal Revenue Service was the valuation.
    The offers generally fell into a bucket where the IRS stated
    only 30 percent or 60 percent or 75 percent of the original
    value of the charitable donation was allowed.
        And the question I have is, what were the criteria that you
    used to place different taxpayers into these various buckets,
    and did the IRS indicate in writing to the donor how and why
    you arrived at your decision, and if not, why?
        Mr. Shulman. Senator, I understand this issue. I had the
    opportunity to speak with your colleague from Colorado, Senator
    Salazar, at length about this issue. And what I shared with him
    I will share with you. I have also done some research on this,
    knowing that this would be of issue to you.
        My belief is that our job is to implement the tax laws in a
    way that achieves the intent of the policy that Congress puts
    forward, and so I share your goal that you talked about. The
    goal for quality of life and open space in Colorado is what we
    should be pursuing, which means we should make sure that we do
    not unduly restrict people trying to do the right thing and
    donate open space.
        I have been briefed on this issue, and I will tell you what
    I know. And I would like to come back with Steve Miller for
    anything I do not know, and meet with you and continue to
    pursue this.
        Since last fall, there has been some good progress, and 170
    offers have been made. The numbers I was given were higher than
    the ones you just discussed, and so I have to dig into it more.
    But I understand that, in general, these 170 offers across the
    board--the general number was in the 70 percent range of the
    tax deduction that people had looked for. So it was a little
    higher.
        Senator Allard. I just want to clarify for the record. You
    determined that it was overvalued by 70 percent. Is that what
    you said?
        Mr. Shulman. No, that people were offered 70 percent of
    their original claim. So if they claimed $100, they were----
        Senator Allard. You said, well, we will give you $70.
        Mr. Shulman. $70--and that is in aggregate of these
    offers--is the number as I understand.
        Senator Allard. Got you.
        Mr. Shulman. I also know that you requested that we be
    liberal in granting extensions of time for people to analyze
    offers and come back, and the Service was responsive to that.
        And I have been told that 20 to 25 more offers will go out
    in the next several weeks.
        These offers were the valuation cases. There are a number
    of much more complex cases that were put behind the valuation
    cases to move forward. They are very fact-intensive. We are
    coordinating with the State of Colorado on all of those. So
    there is some time around coordination and these will take some
    more time.
        Let me also tell you that the people running this program
    have told me they understand the frustration that you have
    around the length of time this has taken, and that they are not
    happy with the pace and would like to pick up the pace. They
    actually asked me for some more resources for appraisers, and
    it is something that I authorized today to try to move this
    backlog through. As I said, I believe we need to be thorough,
    but we also need to be expeditious, so people can get on with
    their business.
        Regarding the exact criteria, I have talked to the team
    about the program. I have not talked about any specific cases.
    I am 4 weeks into the job. I would like to request, if I could,
    to come back and talk with you.
        What I will tell you is I believe we need to move the
    backlog. I have requested and authorized to put some more
    appraisers onto these cases, and I will be focused on it. I
    have told your colleague Senator Salazar that as well.
        Senator Allard. Well, we are interested in seeing--you
    certainly have general criteria that you come to in doing your
    appraisals, and we would like to look at the qualifications of
    your appraiser on land values in Colorado particularly and have
    a concern about where maybe the Colorado Department of Revenue
    has already done a lot of the investigation, I hope you are not
    duplicating what they do. Maybe you can just assume that they
    have done a pretty good job and you follow with that and maybe
    save some time and expedite some of these jobs. And if you feel
    like you cannot, I would like to know why you feel like the
    State of Colorado is not doing an adequate job, and you need to
    go ahead and do that.
        So I have a list of questions here, and my time is expired
    here. So we would like to get those to you and then you can
    review them and get back and give us some detail on where we
    are on getting this process moving forward in Colorado. Thank
    you.
        Mr. Shulman. Thank you.
        Senator Allard. Thank you, Mr. Chairman.

                          MISCLASSIFICATION OF WORKERS

        Senator Durbin. Thanks, Senator Allard.
        Commissioner Shulman, this may have been done before you
    arrived, but the IRS prepared 16 legislative proposals and
    several administrative proposals for closing the tax gap with
    their 2009 budget submission. The one that is missing is a
    pretty big one. It is the misclassification of workers. It
    accounts for $148 billion in lost taxes each year. It
    represents 43 percent of the gross tax gap that we face as a
    country. It relates to people who call themselves independent
    contractors and evade payment of taxes that they are duly owing
    to the Federal and State government.
        So I would like to ask you if you are familiar with this
    issue, if you know of any initiatives underway, if you can
    explain why it was not included as one of the proposals to
    close the tax gap.
        Mr. Shulman. I was not here when that tax gap proposal, the
    general one, was put together, although I have studied it and I
    support moving forward with those proposals. I was also asked a
    lot about the tax gap during my confirmation hearing with the
    Senate Finance Committee. And I have made a commitment to take
    a fresh look at the tax gap and at least engage in a dialogue.
    And some of the tax gap issues have political consequences, as
    well as administrative consequences, which are going to be
    beyond the IRS's purview, but my promise is to study it, come
    to my conclusions, and at least engage in that dialogue.
        I do not want to answer your question wrong. I mean, my
    focus, and what I believe, is that a huge part of the tax gap
    is small business, pass-through business, and self-employed.
    And I have looked at that issue and am a big supporter of at
    least having the dialogue around information reporting and
    other issues around there. All of the studies I have done
    around the tax gap show that where there is withholding, there
    are the highest levels of compliance. Where there is
    information reporting, so people know that someone else is
    reporting information about them, there is the next highest
    level, and where there is no reporting and it is just on the
    honor system, there is a lower level of compliance, although a
    lot of people--most Americans--want to pay their fair share,
    and do pay their fair share, in taxes.
        So I think that is what you are referring to. If not, I
    apologize for not being responsive.
        Senator Durbin. That is, and I will certainly give you time
    to take a look at that. A little more time.
        Senator Brownback.

                               STIMULUS PAYMENTS

        Senator Brownback. Yes. On the next panel, one of the
    testimonies will be from the National Taxpayer Advocate, Nina
    Olson. I was just looking at her testimony. They were saying
    that you are planning on tax rebate checks to the 130 million
    taxpayers who file income tax returns, but also you must
    identify and process returns from and payments to more than
    20.5 million people who have no filing requirement, yet are
    qualified for a tax rebate. That was just the number that has
    come out of this testimony. And if that is the case, that is a
    big number you are going to need to hit in pretty short order.
        Mr. Shulman. Yes. That number--let me speak to that. I was
    hesitant to throw that one out because that was the gross
    estimate early on in the process. That does not take into
    account potentially eligible people on Social Security who are
    married, but who are not both eligible. So that number would be
    drawn down. It does not take into account dependents or people
    who are claimed as dependents on other forms. So I think that
    was the early gross estimate. We are going to have a much
    better sense once we get the filed numbers in.
        Let me also just tell you, there are a variety of reasons--
    when I was out at the retired veterans home, there are a lot of
    people who are not part of the system and have not filed a
    return and might not want to file a return.
        Senator Brownback. They are not interested in being part of
    the system. I understand that.
        Mr. Shulman. Yes, to get their $300 check.
        So we are very focused on doing everything the IRS can do.
    I understood your comment about maybe not wanting to go out
    with us and publicize this, but we are going to try to be
    creative, once we see these numbers, about enlisting as many
    people as we can to get the word out.
        Senator Brownback. It is just that everybody is concerned
    about the economy. This was a big bipartisan push by the
    Congress and the administration to get this done. So we want as
    broad a reach as possible, and 20 million is a large number of
    people. But also I understand what you are saying about not
    everybody wanting to be in the system. Still, getting all those
    checks out is going to take a lot of work and you are on a
    short tether to get it done in the time period you are talking
    about.
        Thank you, Mr. Chairman.
        Senator Durbin. Thank you, Mr. Commissioner. I appreciate
    it very much.
        And we are now going to invite panel number 2 to be seated.
    The panel includes Mr. J. Russell George, Mr. Paul Cherecwich,
    and Ms. Nina Olson. They have submitted extensive written
    statements, and Senator Brownback and I would appreciate it if
    they would do their best to confine themselves to 5-minute
    statements. Any statement that goes beyond 5 minutes, they will
    be presumed guilty and subject to penalties and interest.
        Mr. George, how would you like to start?

    STATEMENT OF J. RUSSELL GEORGE, TREASURY INSPECTOR
                GENERAL FOR TAX ADMINISTRATION, DEPARTMENT
                OF THE TREASURY
        Mr. George. Thank you, Chairman Durbin, Ranking Member
    Brownback. I appreciate the opportunity to testify on the
    Internal Revenue Service's fiscal year 2009 budget.
        As you heard from the Commissioner, the IRS's proposed
    fiscal year budget requests approximately $11 billion in direct
    appropriations. This amount is approximately a 4.3 percent
    increase over its fiscal year 2008 budget. The 2009 budget
    request seeks an increase of $337 million for enforcement.
    Meanwhile, funding for taxpayer services remains virtually the
    same as the 2008 appropriation. Funding for the business
    systems modernization project is reduced by more than 16
    percent.
        The previous Commissioner of Internal Revenue frequently
    stated that taxpayer service plus enforcement equals
    compliance. The budget request provides a 7 percent increase
    for the IRS's enforcement activities. As you are well aware and
    noted earlier, our Nation has a tax gap estimated to be grossly
    about $345 billion per year. A vital component of the effort to
    reduce the amount requires the IRS to take steps to ensure that
    everyone who owes Federal taxes pays their debt.
        The fiscal year 2009 budget request seeks nearly $361
    million in program increases for IRS enforcement initiatives.
    This amount accounts for 77 percent of the agency's overall
    funding increase. Part of the enforcement initiative funding
    would allow the Service to hire just over 3,000 new enforcement
    and operation support employees. The IRS estimates that these
    new employees will help generate more than $2 billion in
    additional annual enforcement revenue by fiscal year 2011.
        In addition to hiring new employees, IRS enforcement
    initiatives will focus on enhancing activities targeted at
    improving compliance. The budget request supports this by
    proposing funding to reduce the tax gap for large and small
    businesses, as well as the self-employed, increase compliance
    of domestic taxpayers with offshore activity, and minimize
    revenue loss by increasing document matching efforts.
        The initiatives also include increased support for research
    to better understand the reasons for taxpayer noncompliance and
    implementation of legislative proposals to improve compliance.
        It is noteworthy that the 2009 budget request does not seek
    additional funding for any taxpayer service initiatives above
    the 2008 funding levels. This was of concern to the Treasury
    Inspector General for Tax Administration (TIGTA). As you know,
    at the request of this subcommittee and Congress as a whole,
    the IRS has expended considerable resources to develop the
    taxpayer assistance blueprint. Many of the blueprint's
    initiatives would provide IRS customers with services similar
    to those that they are accustomed to receiving from private
    financial organizations such as online access to their
    accounts.
        The IRS must continue to determine the kinds of assistance
    taxpayers want and need to ensure that the blueprint strategy
    is effectively implemented to meet those demands. However, most
    of these initiatives were not funded in 2008 and would remain
    unfunded in fiscal year 2009.
        A key component of any success the IRS would hope to
    achieve in providing better service, as well as increased
    enforcement, is its business systems modernization effort. The
    modernization program has been a long-term challenge for the
    IRS. The 2009 budget request cuts funding for projects that are
    at the heart of the IRS's efforts to replace its antiquated
    computer systems. The program is in its 10th year and has paid
    out approximately $2.5 billion for contractor services. In
    addition, the IRS has spent $265 million through fiscal year
    2007 in internal IRS costs and plans to spend an additional
    $223 million on a program in fiscal year 2008.
        According to the IRS's original plan, the modernization
    program should have been past the halfway point this year.
    Although the IRS has made advances in the effort, it has not
    progressed as anticipated. While the IRS has improved its
    project management and contract oversight, the program remains
    behind schedule, over budget, and is not delivering what was
    promised.
        For example, the IRS originally planned to complete the
    replacement of its individual master file with the customer
    accounts data engine in 2005. The current estimated completion
    date for this replacement is the year 2012.
        In January 2005, the Government Accountability Office
    designated business systems modernization as a high-risk area.
    One reason for that designation is that the IRS's new systems
    need to include adequate audit trails to capture improper
    intrusions and unauthorized transactions.
        Consistent with recommendations made by TIGTA in the past,
    the IRS has narrowed its efforts and is focused on three of its
    most important projects: the customer accounts data engine, the
    accounts management services, and the modernized e-file
    program. At this time, TIGTA does not know what impact the cuts
    on the modernization budget may have on these programs. The IRS
    declined to provide TIGTA with that information.
        The final issue I will discuss--I beg your indulgence, Mr.
    Chairman--is the impending retirement wave. Thirty percent of
    the IRS's current employees will be eligible to retire within
    the next 2 years, while nearly 40 percent of its executives are
    currently eligible to retire. GAO has designated human capital
    as a high-risk Government-wide concern. TIGTA has also
    designated the strategic management of human capital as one of
    the IRS's major management challenges. The loss of
    institutional knowledge places several of the IRS's critical
    projects at great risk, including the multiyear, multi-billion
    dollar effort to modernize its technology and related business
    processes.
        It is vital that the IRS effectively implement the human
    capital strategies listed in its fiscal year 2009 budget
    request. Not only will the IRS need to place significant focus
    on recruiting, it will need to ensure that the new employees
    reach their full potential. At the same time, the IRS will need
    to retain its more experienced employees and capture the
    knowledge of those who leave the IRS.
        Mr. Chairman, Ranking Member Brownback, thank you for your
    indulgence. I hope my discussion will help you in your
    deliberations.
        Senator Durbin. Thank you, Mr. George.
        [The statement follows:]

             Prepared Statement of the Honorable J. Russell George

        Chairman Durbin, Ranking Member Brownback, and Members of the
    subcommittee, thank you for the opportunity to testify today. My
    comments will focus on the Internal Revenue Service's (IRS) fiscal year
    2009 budget and, at your request, the Treasury Inspector General for
    Tax Administration's (TIGTA) fiscal year 2009 budget request. I will
    also briefly comment on the status of the 2008 Filing Season.
        The IRS administers America's tax laws and collects approximately
    95 percent of the revenues that fund the Federal Government. The IRS
    has four major components: the Wage and Investment Division, the Small
    Business/Self-Employed Division, the Large and Mid-Size Business
    Division and the Tax Exempt and Government Entities Division. Together,
    these divisions are largely responsible for collecting more than $2
    trillion in tax revenues each year. At a time when our Nation is at
    war, it is imperative to identify the resources required to support the
    IRS's role as steward of the country's tax administration system.
        The IRS must continue to address management and operational issues,
    including modernization of its computer systems, addressing the tax
    gap, protecting taxpayer rights, and ensuring the security of its
    resources. To that end, the IRS has requested $11.4 billion to fund the
    agency's operations for fiscal year 2009. This is a 4.3 percent
    increase over the 2008 enacted budget. The IRS's fiscal year 2009
    budget request for systems modernization is $40 million less than the
    fiscal year 2008 enacted amount. The IRS does not specify which
    programs will absorb these costs, only that the requested amount will
    allow continued progress on key modernization projects. However,
    millions of taxpayers entrust the IRS with sensitive financial and
    personal data stored and processed by its computer systems. The IRS
    faces enormous challenges in securing this vast amount of personally
    identifiable information, including ensuring that all systems have
    sufficient controls to prevent and detect intrusions and improper
    accesses.
        The budget request includes a 7 percent increase for enforcement
    and less than a 1 percent increase for taxpayer service. In 2007 the
    IRS finalized strategies to reduce the tax gap and improve customer
    service.\1\ The IRS is in the preliminary stages of both strategies.
    Determining what role taxpayer service plays in increasing voluntary
    compliance and reducing the tax gap will continue to be a challenge in
    the near future. The IRS must strive to enforce the tax laws fairly and
    efficiently while balancing service and enforcement to promote
    voluntary compliance and reduce taxpayer burden.
    ---------------------------------------------------------------------------
        \1\ Reducing the Federal Tax Gap: A Report on Improving Voluntary
    Compliance (Washington, D.C.: Aug. 2, 2007); The 2007 Taxpayer
    Assistance Blueprint Phase 2 (Washington, D.C.: 2007).
    ---------------------------------------------------------------------------
             overview of the irs's fiscal year 2009 budget request
        The proposed fiscal year 2009 IRS budget requests approximately
    $11.4 billion in direct appropriations, $107.9 million from
    reimbursable programs, and $177.7 million from user fees. The direct
    appropriation is approximately a $469.1 million increase (4.3 percent)
    over the fiscal year 2008 enacted level of $10.9 billion.
        In fiscal year 2008, the IRS requested a budget of approximately
    $11.1 billion, an increase of $498 million (4.7 percent) over its
    fiscal year 2007 spending authority. The amount enacted by Congress for
    fiscal year 2008 was $203 million (1.8 percent) less than the budget
    request. Congress also made substantial changes in budget priorities in
    fiscal year 2008 by increasing the Taxpayer Services appropriation by
    $46.9 million above the IRS's request while cutting the
    Administration's Enforcement and Operations Support appropriation
    requests by a total of $235 million. The budget request also included a
    net increase in the overall size of the IRS of nearly 1,800 Full-Time
    Equivalent \2\ employees.
    ---------------------------------------------------------------------------
        \2\ A Full-Time Equivalent is a measure of labor hours. One Full-
    Time Equivalent is equal to 8 hours multiplied by the number of
    compensable days in a particular fiscal year.
    ---------------------------------------------------------------------------
        The fiscal year 2009 IRS budget request includes appropriations for
    five IRS budget accounts (categories): Enforcement, Operations Support,
    Taxpayer Services, Business Systems Modernization, and the Health
    Insurance Tax Credit Administration (see Figure 1).

        Within these appropriation accounts, the IRS seeks to increase
    funding for Enforcement, Operations Support, and the Health Insurance
    Tax Credit Administration while decreasing funding for Business Systems
    Modernization (Modernization). The budget request seeks an Enforcement
    Appropriation of $5.12 billion, an increase of $337 million (7.1
    percent) over the current fiscal year 2008 appropriation of $4.78
    billion. The funding for Taxpayer Services remains the same as the
    fiscal year 2008 enacted level.
        The Modernization program is a complex effort to modernize IRS
    technology and related business processes. It involves integrating
    thousands of hardware and software components while replacing outdated
    technology and maintaining the current tax system.
        The Modernization program is in its 10th year and has received
    approximately $2.5 billion for contractor services. Additionally, the
    IRS had spent $265 million through fiscal year 2007 for internal IRS
    costs, and plans to spend an additional $223 million on the program in
    fiscal year 2008. According to the IRS's original plan, the
    Modernization program should be past the halfway point in Calendar Year
    2008. However, the IRS has not completed as many Modernization projects
    as planned because it has received less funding than initially
    anticipated and has had difficulties in managing the scope and
    complexity of the work. For example, the Customer Account Data Engine
    (CADE) is the foundation of the Modernization program. The IRS
    originally planned to complete replacement of its Individual Master
    File with the CADE in 2005.\3\ The current estimated completion date
    for this replacement is 2012.
    ---------------------------------------------------------------------------
        \3\ The Individual Master File is the IRS database that stores
    individual taxpayer account information.
    ---------------------------------------------------------------------------
        Although the IRS has made advances in its Modernization effort, it
    has not progressed as anticipated. TIGTA has reported that inconsistent
    compliance with project development controls has contributed to delays
    in project deliveries, increased development costs, and reduced
    capabilities.\4\ Since fiscal year 2002, TIGTA's Modernization program
    annual assessments have cited the following four specific challenges
    the IRS needs to overcome to deliver a successful modernization effort:
    ---------------------------------------------------------------------------
        \4\ Annual Assessment of the Business Systems Modernization Program
    (Reference Number 2007-20-121, dated August 24, 2007).
    ---------------------------------------------------------------------------
      --Implement planned improvements in key management processes and
            commit necessary resources to enable success;
      --Manage the increasing complexity and risks of the Modernization
            program;
      --Maintain the continuity and strategic direction with experienced
            leadership; and
      --Ensure that contractor performance and accountability are
            effectively managed.
        Accordingly, because solutions to the IRS's serious and intractable
    financial management problems largely depend upon the success of its
    Modernization efforts, in January 2005 the financial management risk
    was combined with the Modernization risk into the Business Systems
    Modernization high-risk area.\5\ Modernization remains a high risk for
    the IRS. One reason is that all of its new systems need to include
    adequate audit trails.
    ---------------------------------------------------------------------------
        \5\ In January 2005, the Government Accountability Office (GAO)
    combined its two previous high-risk areas, IRS Business Systems
    Modernization and IRS Financial Management, into one Business Systems
    Modernization high-risk area. See U.S. Government Accountability
    Office, GAO-05-207, High Risk Series: An Update (2005).
    ---------------------------------------------------------------------------
        For fiscal year 2008, the IRS requested funding of approximately
    $222.7 million for Modernization, a cut of 16.6 percent ($44.4 million
    from the $267.1 million enacted). This cut is expected to eliminate at
    least 25 employees. However, the fiscal year 2008 enacted amount was an
    increase of $54.4 million (25.6 percent) from the $212.7 million
    enacted for fiscal year 2007.
        The fiscal year 2009 budget request does not specify which programs
    will absorb the cuts, although it states that the requested amount will
    allow continued progress on key modernization projects, including the
    CADE, Accounts Management Services (AMS), and Modernized e-File (MeF).
    However, the Government Accountability Office (GAO) recently issued a
    report that included proposed spending by major project.\6\ Figure 2
    shows the funding proposed for major Modernization projects in fiscal
    year 2009 compared to the amounts enacted for fiscal year 2008:
    ---------------------------------------------------------------------------
        \6\ Internal Revenue Service: Fiscal Year 2009 Budget Request and
    Interim Performance Results of IRS's 2008 Tax Filing Season, (GAO 08-
    567, dated March 2008).

                FIGURE 2.--BUSINESS SYSTEMS MODERNIZATION PROJECTS IN FISCAL YEAR 2009 IRS BUDGET REQUEST
                                                [In millions of dollars]
    ----------------------------------------------------------------------------------------------------------------
                                                                                       Fiscal year     Change from
                                Project                                Fiscal year     2009 budget     fiscal year
                                                                      2008 enacted       request       2008 enacted
    ----------------------------------------------------------------------------------------------------------------
    Customer Account Data Engine...................................            58.5            58.8             0.3
    Accounts Management Services...................................            29.0            26.2            (2.8)
    Modernized e-File..............................................            55.8            25.0           (30.8)
    Core Infrastructure............................................            39.2            32.0            (7.2)
    Architecture, Integration, and Management......................            35.1            35.0            (0.1)
    Management Reserve.............................................             4.3             2.3            (2.0)
                                                                    ------------------------------------------------
          Subtotal Capital Investments.............................           221.9           179.3           (42.6)
    Business Systems Modernization Labor...........................            44.0            42.0            (2.0)
                                                                    ------------------------------------------------
          Subtotal Program Request.................................           265.9           221.3           (44.6)
    Maintaining Current Levels.....................................             1.2             1.4             0.2
                                                                    ------------------------------------------------
          Total Business Systems Modernization Budget..............           267.1           222.7           (44.4)
    ----------------------------------------------------------------------------------------------------------------
    Source: TIGTA analysis of GAO Report, Internal Revenue Service: Fiscal Year 2009 Budget Request and Interim
      Performance Results of IRS's 2008 Tax Filing Season (GAO 08-567, dated March 2008).

        TIGTA requested information from the IRS on the impact of the
    proposed funding on the projects above, which the IRS declined to
    provide. The IRS also declined to provide this information to GAO for
    its report.
    Customer Account Data Engine
        The IRS states that the CADE is the lynchpin modernization project
    to replace the antiquated master file. The master file currently
    requires 2 weeks to update taxpayer tax accounts. The CADE consists of
    current and planned databases and is designed to post information to
    taxpayers' accounts daily rather than weekly, which will facilitate
    faster refunds to taxpayers and provide IRS employees with more up-to-
    date and accurate account information.
        The latest release of the CADE, Release 3.0, was originally
    developed to deliver 17 new functions and capabilities. The IRS divided
    Release 3.0 into two sub-releases. CADE Release 3.1 contained four
    major functions and was deployed between August and October 2007. CADE
    Release 3.2 included seven major functions and was delivered in
    February 2008. The major functions delivered include the capability of
    processing tax returns with a disaster area designator; processing tax
    returns claiming the Earned Income Tax Credit, Credit for Child and
    Dependent Care, and requests for Split Refunds; providing address
    change service requests; and validating tax balances. The remaining six
    functions will be determined for delivery in future releases of the
    CADE. These additional capabilities were expected to significantly
    increase the volume of returns posting to the CADE from the
    approximately 11.2 million returns posted during Calendar Year 2007. As
    of March 28, 2008, about 21.1 million tax returns had been posted to
    the CADE.
        In 2009, the IRS plans to continue the development of the CADE in
    stages, and its fiscal year 2009 budget request includes $58.8 million
    for the project. TIGTA's review of CADE Release 2.1 found that tax
    return information was accepted and generally posted accurately to CADE
    accounts during the 2007 Filing Season.\7\ However, several programming
    problems were affecting the accurate posting of Itemized Deductions,
    Adjusted Gross Income, and Taxable Income amounts. TIGTA reported this
    issue to the IRS, and it promptly corrected the programming. TIGTA is
    currently reviewing the accuracy of the expanded capabilities offered
    by the most current release of the CADE.\8\
    ---------------------------------------------------------------------------
        \7\ The Customer Account Data Engine Release 2.1 Generally Posted
    Tax Return Information Accurately (Reference Number 2007-40-131, dated
    August 10, 2007).
        \8\ Customer Account Data Engine Release 3, (Audit Number 2008-20-
    009).
    ---------------------------------------------------------------------------
    Accounts Management Services Project
        The IRS is continuing to modernize its databases to provide
    immediate access to account data, enable real-time transaction
    processing, and ensure daily account settlement to improve customer
    service and business results. The Accounts Management Services (AMS)
    project, initiated in May 2006, was chartered to address these needs.
    The project objective is to provide an integrated approach to view,
    access, update, and manage taxpayer accounts. This is accomplished by
    providing IRS employees with the tools to access information quickly
    and accurately in response to complex customer inquiries and to update
    taxpayer accounts on demand. The fiscal year 2009 budget request
    includes $26.2 million for the AMS project.
        In March 2008, TIGTA determined that the AMS project team
    successfully implemented project management processes and activities,
    which included project justification, contract management, risk
    management, configuration management, performance management, and
    transition management.\9\ The AMS project team successfully planned
    work schedules, identified and addressed potential risks to project
    development, and coordinated with appropriate staff to implement
    initial release capabilities. Although the AMS project team is on
    schedule to make the proposed processing capabilities available, its
    implementation is dependent on the IRS's Modernization and Information
    Technology Services organization's abilities to integrate these project
    capabilities into taxpayer account processing.
    ---------------------------------------------------------------------------
        \9\ The Account Management Services Project Is Meeting Its
    Development Goals (Reference Number 2008-20-053, dated March 3, 2008).
    ---------------------------------------------------------------------------
        The IRS, however, does not collect all transactions and audit logs
    on its modernized systems, including CADE and AMS. Without audit logs,
    the IRS cannot conduct proper intrusion investigations and hold
    individuals accountable for unauthorized transactions and disclosures.

    Modernized e-File
        The MeF project provides a standard filing structure for all types
    of IRS tax returns and can meet performance and capacity needs with
    enhanced and up-to-date technologies, therefore providing greater
    appeal to external customers and stakeholders. The MeF project's goal
    is to replace the IRS's current tax return filing technology with a
    modernized, Internet-based electronic filing platform.
        In fiscal year 2009, the IRS will continue development of Release
    7, which was initiated in fiscal year 2008. Release 7 will roll out an
    additional 90 supporting schedules and forms that will expand the reach
    of MeF to 99 percent of the e-File population, or approximately 93.7
    million filers. The IRS's fiscal year 2009 budget request includes $25
    million for the MeF project.
        Previous TIGTA audits of the MeF project found that the IRS's plans
    for processing additional tax forms using the MeF system were
    uncertain, including plans to schedule development of the U.S.
    Individual Income Tax Return (Form 1040) family. In addition, the IRS
    can improve its management of requirements development and testing
    activities to assure that the requirements expected and approved for
    deployment are the requirements that are actually deployed.\10\
    ---------------------------------------------------------------------------
        \10\ The Modernized e-File Project Can Improve the Management of
    Expected Capabilities and Associated Costs (Reference Number 2007-20-
    005, dated December 27, 2006); The Modernized e-File Project Can
    Improve Its Management of Requirements (Reference No. 2007-20-099,
    dated July 9, 2007).
    ---------------------------------------------------------------------------
        Furthermore, TIGTA continues to be concerned that the IRS is
    developing its modernized systems and bringing them online without
    adequately contemplating the security implications.

    Human Capital
        The IRS, like many organizations, is concerned about an impending
    retirement wave, or brain drain. According to the IRS, 30 percent of
    its current employees will be eligible to retire by 2010 and nearly 40
    percent of its executives are currently eligible to retire. The GAO has
    designated human capital as a ``high risk'' Government-wide concern and
    recently reported that ample opportunities exist for agencies to
    improve. TIGTA has also designated the strategic management of human
    capital as one of the IRS's major management challenges.
        Due to the potential loss of institutional knowledge, the IRS has
    several critical projects underway, such as a 5-year strategic plan for
    enhancing the services it provides to taxpayers and a complex,
    multiyear, multibillion dollar effort to modernize its technology and
    related business processes. The IRS is also battling a tax gap,\11\ as
    well as implementing and adjusting to changes in its managerial and
    executive pay structure.
    ---------------------------------------------------------------------------
        \11\ The IRS defines the gross tax gap as the difference between
    the estimated amount taxpayers owe and the amount they voluntarily and
    timely pay for a tax year.
    ---------------------------------------------------------------------------
        It is critical that the IRS effectively implement the human capital
    strategies listed in the IRS's fiscal year 2009 budget request. While
    acting to replace those employees lost through retirement and other
    attrition, the fiscal year 2009 budget request seeks more than 3,000
    additional Full-Time Equivalents. The IRS states that additional
    employees will lead to increased revenue of more than $2 billion by the
    time new employees reach their full potential in fiscal year 2011. Not
    only will the IRS need to place a significant focus on recruiting, it
    will need to ensure that new employees reach their full potential. At
    this same time, the IRS will need to retain its more experienced
    employees and capture the knowledge of those who leave the IRS.
        If the IRS is not able to effectively accomplish the human capital
    strategies:
      --There might not be a sufficient number of qualified employees to
            adequately administer the tax code. In addition, fewer
            qualified employees may be on the front-line to assist
            taxpayers.
      --The tax gap could increase if high-performing, well-trained
            taxpayer service and enforcement personnel cannot be hired and
            retained.
      --The IRS might not be able to replace its leadership cadre and
            ensure that significant projects remain on track.
      --The aging workforce could retire before its vast knowledge of tax
            administration is transferred to younger workers.
        TIGTA has an ongoing Human Capital audit strategy reviewing these
    areas and will continue to monitor the IRS's efforts to strategically
    plan and monitor human capital resources to ensure having the right
    resources in the right place at the right time to achieve its mission
    and goals.

                    SECURITY OF THE INTERNAL REVENUE SERVICE

        Privacy and security are growing concerns in nearly every
    organization, both private and public. As technology advances, the
    IRS's ability to protect sensitive information must advance to meet new
    threats. In addition to the IRS's commitment to protect sensitive
    taxpayer data and personally identifiable information, a robust
    security program also requires adequate financial and human capital
    resources.
        Each year, millions of taxpayers entrust the IRS with their
    sensitive financial and personal data that are stored in and processed
    by IRS computer systems. The risk that this sensitive data could be
    compromised and computer operations disrupted continues to increase.
    Both internal factors, such as the increased connectivity of computer
    systems and greater use of portable laptop computers, and external
    factors, such as the volatile threat environment related to increased
    phishing scams and hacker activity, contribute to these risks.
    Network Security
        Because the IRS sends sensitive taxpayer and administrative
    information across its networks, routers and switches on the networks
    must have sufficient security controls to deter and detect unauthorized
    use. In March 2008, TIGTA reported that access controls for IRS routers
    were not adequate and reviews to monitor security configuration changes
    were not conducted to identify inappropriate use.\12\ Of 374 accounts
    for employees and contractors to access routers and switches in
    performing system administration duties, 141 (38 percent) did not have
    proper authorization to access the routers. Of particular concern, 27
    employees and contractors had accessed the routers and switches to
    change security configurations.
    ---------------------------------------------------------------------------
        \12\ Inadequate Security Controls Over Routers and Switches
    Jeopardize Sensitive Taxpayer Information (Reference Number 2008-20-
    071, March 26, 2008).
    ---------------------------------------------------------------------------
        To authenticate users, the IRS relies on a security application
    that requires users to enter an account name and password. Users
    circumvented this control by setting up unauthorized accounts that
    appeared to be shared-user accounts. Any person who knew the password
    to these accounts could have changed configurations without
    accountability and with little chance of detection. For this reason,
    the IRS requires that shared accounts be used only on a limited basis
    and that they be subjected to special authorization controls. However,
    during fiscal year 2007, 4.4 million (over 84 percent) of the 5.2
    million accesses to the routers were made by the 34 user accounts.
    Audit trail reviews necessary to detect security events were also not
    being conducted. The IRS agreed with TIGTA's findings and is taking
    corrective actions to address the recommendations made to correct these
    weaknesses.

    Database Security
        The IRS stores its taxpayer, financial, and other data in more than
    2,100 databases. TIGTA reported in fiscal year 2008 that high-risk
    weaknesses continue to exist and sufficient corrective actions have not
    been taken.\13\ TIGTA scanned IRS networks and determined that 11
    percent of the approximately 1,900 databases scanned had one or more
    installation accounts with a default or blank password. A total of 369
    installation accounts had default or blank passwords, including 26
    containing powerful database administrator privileges.
    ---------------------------------------------------------------------------
        \13\ Internal Revenue Service Databases Continue to Be Susceptible
    to Penetration Attacks (Report Reference Number 2008-20-029, dated
    December 14, 2007).
    ---------------------------------------------------------------------------
        Databases found with default or blank passwords during the scans
    included those that contained personally identifiable tax information.
    Malicious users can exploit accounts with default or blank passwords to
    steal taxpayer identities and carry out fraud schemes.
        TIGTA made several recommendations, including ensuring that
    security training is provided to employees with key security
    responsibilities and improving the process for identifying and
    correcting accounts with blank or default passwords by expanding the
    scanning criteria. IRS management agreed with all of the
    recommendations in the report and plans to take appropriate corrective
    actions.

                            IMPROVE TAXPAYER SERVICE

        Since the late 1990s, the IRS has increased its delivery of quality
    customer service to taxpayers. The first goal in the IRS's current
    strategic plan is to improve taxpayer service. However, since the late
    1990s, the IRS has allocated more resources to its collection,
    examination, and criminal investigation functions and fewer resources
    to taxpayer service functions. See Figure 3 for a comparison of funding
    for taxpayer service and enforcement since fiscal year 2006.

        As a result of this resource shift and other factors, in July 2005,
    Congress requested that the IRS develop a 5-year plan, including an
    outline of which services the IRS should provide and how it will
    improve services for taxpayers. The IRS developed the plan, the
    Taxpayer Assistance Blueprint, in two phases.
        The IRS is already facing challenges with its Blueprint. For the
    Phase I report, the conclusions and strategic improvement themes were
    valid; however, not all information was accurate or consistent.\14\
    Given the importance of this plan as the IRS moves forward,
    inaccuracies and inconsistencies will put the plan at risk of
    improperly aligning service content, delivery, and resources with
    taxpayer and partner expectations. In fiscal year 2007, the IRS issued
    its Taxpayer Assistance Blueprint Phase 2 report that details the
    research and analyses efforts of the IRS and outlines the Blueprint
    Strategic Plan for taxpayer services. The Phase 2 report contains
    information from over 100 data sources and represents the first large-
    scale effort to attempt to collect data specific to Taxpayer Assistance
    Center customers. In February 2008, TIGTA reported that the data in the
    Phase 2 report was for the most part accurate.\15\
    ---------------------------------------------------------------------------
        \14\ The Strategic Improvement Themes in the Taxpayer Assistance
    Blueprint Phase I Report Appear to Be Sound; However, There Were Some
    Inaccurate Data in the Report (Reference Number 2007-40-078, dated
    March 18, 2007).
        \15\ The Taxpayer Assistance Blueprint Phase 2 Was Generally
    Reliable, but Oversight of the Survey Design Needs Improvement
    (Reference Number 2008-40-059, dated February 5, 2008).
    ---------------------------------------------------------------------------
        A second review of the Phase 2 report focused on the Taxpayer
    Assistance Center \16\ Geographic Footprint--the IRS's step-by-step
    process for future decisions regarding Taxpayer Assistance Center
    locations--and found that inaccurate and incomplete management
    information continues to delay its implementation.\17\ The IRS has yet
    to determine the optimum locations for the Taxpayer Assistance Centers
    and which taxpayers they most effectively serve. Additionally, of the
    41 criteria used for the Taxpayer Assistance Center Geographic
    Blueprint, 19 (46 percent) contained inaccurate or incomplete data.
    Without accurate and complete data, the IRS cannot measure the
    effectiveness of the Taxpayer Assistance Center Program or determine
    where to best offer its face-to-face services.
    ---------------------------------------------------------------------------
        \16\ Taxpayer Assistance Centers are walk-in sites where taxpayers
    can receive answers to account and tax law questions, as well as
    assistance in preparing their tax returns.
        \17\ Inaccurate and Incomplete Data Has Adversely Affected the
    Implementation of the Taxpayer Assistance Center Geographic Footprint
    (Audit # 200740042), Draft issued March 20, 2008.
    ---------------------------------------------------------------------------
        The IRS is also still unable to measure how closing Taxpayer
    Assistance Centers might affect taxpayers and compliance. The IRS does
    not have the means to capture all interactions between a Taxpayer
    Assistance Center employee and a taxpayer to determine why the taxpayer
    visited the Taxpayer Assistance Center, what service he or she
    received, and, most importantly, the effect the service or action had
    on the taxpayer's future compliance.
        The President' fiscal year 2009 budget request for the Taxpayer
    Service Program is $2.15 billion. The fiscal year 2009 funding for the
    direct appropriation maintains the fiscal year 2008 enacted level. The
    Operations Support budget provides an additional $1.5 billion to
    support taxpayer services.
      --Fiscal year 2009 program decreases include funds provided in the
            fiscal year 2008 enacted. Specifically, $31 million is being
            used for long-term investments that would not be duplicated in
            2009, and $8 million from the Community Volunteer Income Tax
            Assistance (VITA) Matching Grant Program that was provided in
            fiscal year 2008 and is still available through fiscal year
            2009.
      --Fiscal year 2009 increases include an additional 426 Full-Time
            Equivalents and $14.8 million to fully fund postal costs.
        The budget request does not include funding to support any taxpayer
    service initiatives that increase its 2009 request over the 2008
    enacted amount. The IRS has expended considerable resources to develop
    the Blueprint and many of its initiatives would provide its customers
    with the same services currently available to them from private
    financial organizations. Most of the Blueprint initiatives have not
    been funded. The IRS must continue to find out what assistance
    taxpayers want and need, and ensure that the Blueprint Strategy Plan is
    effectively implemented.
        The IRS is implementing a new matching grant program for the
    Community VITA Grant Program with $8 million in fiscal year 2008
    funding. The IRS's Volunteer Program, including the VITA and the Tax
    Counseling for the Elderly Programs,\18\ plays an increasingly
    important role in the IRS's efforts to improve taxpayer service and
    facilitate participation in the tax system. TIGTA recently reviewed the
    Tax Counseling for the Elderly Program and found that it has not been
    effectively administered. The IRS does not have effective controls or
    monitoring processes to ensure that funds are appropriately spent, and
    management information is not sufficient to provide adequate oversight
    for the program. The IRS is using TIGTA's audit results to develop the
    VITA grant program.\19\
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        \18\ The Tax Counseling for the Elderly Program is a grant program
    that provides free tax help to people age 60 and older using grants
    appropriated. The Tax Counseling for the Elderly Program appropriation
    was $3.95 million for each of fiscal years 2005 through 2007 and $3
    million in fiscal year 2008.
        \19\ Oversight and Administration of the Tax Counseling for the
    Elderly Program Need Improvement.
    ---------------------------------------------------------------------------
                        ENHANCE ENFORCEMENT OF TAX LAWS

        A compelling challenge confronting the IRS is tax compliance. Tax
    compliance initiatives include the administration of tax regulations,
    collection of the correct amount of tax for businesses and individuals,
    and oversight of tax-exempt and Government entities. Late in fiscal
    year 2007, the Department of the Treasury and the IRS issued a report
    on improving voluntary compliance.\20\ The report outlines steps that
    the IRS plans to take to increase voluntary compliance and reduce the
    tax gap.
    ---------------------------------------------------------------------------
        \20\ Internal Revenue Service, U.S. Department of the Treasury,
    Reducing the Federal Tax Gap: A Report on Improving Voluntary
    Compliance (2007).
    ---------------------------------------------------------------------------
        The fiscal year 2009 IRS budget request seeks nearly $361 million
    in program increases for IRS enforcement initiatives, which account for
    77 percent of the agency's overall funding increase of $469 million.
    Part of the enforcement initiative funding is intended to hire 3,057
    new IRS Enforcement and Operations Support employees who are expected
    to help generate over $2 billion \21\ in additional annual enforcement
    revenue, once the new hires reach full potential in fiscal year 2011.
    The $361 million increase is split between three appropriation
    accounts: Enforcement ($261 million), Operations Support ($97 million),
    and Taxpayer Services (nearly $3 million). Many of the same or similar
    enforcement proposals described in the fiscal year 2009 budget request
    were included in the fiscal year 2008 IRS budget request but not funded
    by Congress in the final appropriations bill, the Consolidated
    Appropriation Act of 2008.\22\ The programs included in the enforcement
    initiatives in the fiscal year 2009 IRS budget request are shown in
    Figure 4:
    ---------------------------------------------------------------------------
        \21\ Amount does not include annual $3.6 billion expected from
    legislative proposals.
        \22\ Consolidated Appropriation Act of 2008, Public Law 110-161.

                    FIGURE 4.--ENFORCEMENT INITIATIVE PROGRAMS IN FISCAL YEAR 2009 IRS BUDGET REQUEST
                                                  [Dollars in millions]
    ----------------------------------------------------------------------------------------------------------------
                                                                                Staffing
                                                                Expected     increase (full- Included in fiscal year
                    Program                       Cost       revenue fiscal       time       2008 IRS budget request
                                                                year 2011     equivalents)
    ----------------------------------------------------------------------------------------------------------------
    Reduce the tax gap for small business/           $168.5            $981           1,608  Yes
     self-employed taxpayers.
    Reduce the tax gap for large businesses            69.5             544             519  Yes
    Improve tax gap estimates, measurement             51.1              16             393  Yes
     and detection of non-compliance.
    Increase reporting compliance of U.S.              13.7             102             124  No
     taxpayers with offshore activity.
    Expand document matching...............            35.1             359             413  Yes
    Implement legislative proposals to                 23.0           3,600  ..............  Yes
     improve compliance.
                                            ------------------------------------------------------------------------
          Totals...........................           360.9           5,602           3,057  .......................
    ----------------------------------------------------------------------------------------------------------------
    Source: TIGTA analysis of fiscal year 2008 and fiscal year 2009 IRS Budget Requests.

                             ADDRESSING THE TAX GAP

        Tax compliance initiatives include administering tax regulations,
    collecting the correct amount of tax for businesses and individuals,
    and overseeing tax-exempt and Government entities for compliance.
    Increasing voluntary compliance and reducing the tax gap are currently
    the focus of many IRS initiatives. Nevertheless, the IRS is facing
    significant challenges in obtaining more complete and timely data, and
    developing the methods necessary for interpreting the data. The IRS
    must continue to seek accurate measures for the various components of
    the tax gap and the effectiveness of the actions taken to reduce it.
    Broader strategies and better research are needed to determine what
    actions are most effective in addressing non-compliance.
    Unreported Self-Employment Taxes Contribute to the Tax Gap
        According to the GAO, outlays from the main trust funds of the
    Social Security and Medicare programs are projected to exceed revenues
    in the next decade. As the tax collector for these programs, the IRS
    must ensure that self-employed taxpayers meet their tax
    responsibilities by assessing and collecting the proper amount of self-
    employment taxes. Self-employment tax is estimated to make up about $39
    billion (72 percent) of underreported employment taxes, or 11 percent
    of the total gross tax gap, making it one of the largest components of
    the tax gap.
        TIGTA's fiscal year 2007 review of the self-employment tax found
    that IRS procedures were inconsistent for identifying Form 1040
    reporting income on line 21 that is potentially subject to the self-
    employment tax.\23\ Also, there was a significant problem with
    assigning an audit code to tax returns with potentially unreported
    self-employment taxes.
    ---------------------------------------------------------------------------
        \23\ Identification of Unreported Self-Employment Taxes Can Be
    Improved (Reference Number 2008-30-001, dated October 11, 2007).
    ---------------------------------------------------------------------------
        TIGTA recommended that the IRS: (1) improve processing of those tax
    returns with potential self-employment tax liabilities and provide
    additional training to tax examiners; (2) strengthen reviews of tax
    returns for potential unpaid self-employment taxes; and (3) reconsider
    the decision to cancel TIGTA's previous recommendation to immediately
    work significant unreported self-employment tax cases with refunds
    available and no response or an inadequate response to any letter
    issued by the IRS.
        IRS management agreed with the first two recommendations and
    disagreed with the third. The IRS planned to explore the possibility of
    expanding existing returns processing training material issued in
    January 2008. However, IRS management stated that the parameters could
    not be accurately identified to ensure that the IRS would not be
    withholding the refunds of taxpayers who were not subject to self-
    employment taxes. Based on the findings of this and previous audits,
    TIGTA maintained that it was feasible for the IRS to begin examining
    the tax returns of taxpayers who appear to owe a significant amount of
    self-employment tax, have an available refund, and have not responded
    to contact letters from the IRS.

    Schedule C Hobby Losses Contribute to the Tax Gap
        About 1.5 million taxpayers, many with significant income from
    other sources, filed Form 1040 Schedules C (Profit or Loss From
    Business) showing no profits, only losses, over four Tax Years 2002-
    2005; 73 percent were assisted by tax practitioners. By claiming these
    losses to reduce their taxable incomes, about 1.2 million of the 1.5
    million taxpayers potentially avoided paying $2.8 billion in taxes in
    Tax Year 2005. Changes are needed to prevent taxpayers from continually
    deducting losses in potential not-for-profit activities to reduce their
    tax liabilities.
        The ``hobby loss'' provision and related regulations do not
    establish specific criteria for the IRS to use in determining whether a
    Schedule C loss is a legitimate business expense without conducting a
    full examination of an individual's books and records.\24\ The purpose
    of the hobby loss provision was to limit the ability of wealthy
    individuals with multiple sources of income to apply losses incurred in
    ``side-line'' diversions to reduce their overall tax liabilities. TIGTA
    reported in September 2007 that 332,615 high-income taxpayers received
    the greatest benefit by potentially avoiding approximately $1.9 billion
    in taxes for tax year 2005.\25\
    ---------------------------------------------------------------------------
        \24\ Internal Revenue Code Section 183 (Activities not engaged in
    for profit); related Treasury Regulation Section 1.183-1.
        \25\ Significant Challenges Exist in Determining Whether Taxpayers
    With Schedule C Losses Are Engaged in Tax Abuse (Reference Number 2007-
    30-173, dated September 7, 2007).
    ---------------------------------------------------------------------------
        The law does not require a taxpayer to have a reasonable
    expectation of profit; rather, the taxpayer needs only the
    ``objective'' of making a profit. Internal Revenue Code (I.R.C.) 183
    makes it difficult for the IRS to efficiently administer tax law that
    ensures taxpayers are not deducting not-for-profit losses to reduce
    their taxes on other incomes year after year.
        TIGTA recommended that the IRS provide a copy of the report to the
    Department of the Treasury, Office of Tax Policy, to consider
    legislative changes to I.R.C.  183. The proposal should include
    establishing a clearly defined standard or bright-line rule for
    determining whether an activity is a business or a not-for-profit
    activity. Due to the large number of these tax returns being prepared
    by tax practitioners, TIGTA also recommended that the IRS continue
    coordinating with practitioner organizations to encourage compliance
    with existing provisions.
        In their response to the report, IRS officials stated that they
    agreed with the recommendations and planned to take appropriate
    corrective actions. The IRS plans to coordinate with the Office of
    Legislative Affairs to forward a copy of the final report to the
    Department of the Treasury, Office of Tax Policy, and to include key
    messages and talking points about I.R.C. 183 tax obligations as a
    fiscal year 2008 outreach initiative directed to practitioner
    organizations.

                             LEGISLATIVE PROPOSALS

        The fiscal year 2009 IRS budget request includes 16 legislative
    proposals--13 submitted in prior budget requests--that are expected to
    generate $36 billion in additional tax over 10 years as a result of
    improving tax compliance and administration. Of the 13 proposals in
    prior budget requests, 12 await some form of congressional action. Many
    of these proposals also represent a significant part of the IRS
    strategy to improve tax compliance and reduce the tax gap described in
    the IRS's August 2, 2007, report, Reducing the Federal Tax Gap: A
    Report on Improving Voluntary Compliance.

                               2008 FILING SEASON

        The 2008 Filing Season appears to be progressing without major
    problems. As of March 29, 2008, the IRS reported that it had received
    approximately 86.8 million tax returns. Of those, approximately 62.2
    million were filed electronically (e-filed) (an increase of 9.3 percent
    from this time in 2007), and approximately 24.6 million were filed on
    paper (an increase of 4.8 percent from this time in 2007).
    Additionally, nearly 69.8 million refunds totaling approximately $172
    billion had been issued. Of these, 50.8 million (73 percent of all
    refunds) were directly deposited to taxpayer bank accounts, an increase
    of 7.3 percent compared to 2007.
        Use of the IRS's free online filing program had been declining in
    prior years. However, based on the current volume, it appears that
    taxpayers are increasingly taking advantage of this option, as the
    number has increased by 17.4 percent from 2007. Additionally, the
    number of taxpayers who e-file from their home computers increased by
    17.3 percent this filing season.
        So far this filing season, over 2 million tax returns have been
    prepared by volunteers, an increase of 22 percent over the 2007 Filing
    Season. TIGTA's accuracy rate at the Volunteer Program sites has
    improved from 56 percent last year to 67 percent this year. The IRS is
    reporting a 76 percent accuracy rate. Volunteers are doing a better job
    using the tools and information available when preparing tax returns.
        As of March 29, 2008, use of IRS.gov is up over 19 percent, with
    almost 122 million visits to the Web site. Nearly 26 million taxpayers
    went to IRS.gov to obtain their refund information via the ``Where's My
    Refund?'' option, a 19.7 percent increase over the same time period
    last year.
        Additionally, calls to the toll-free assistance lines are up from
    the 2007 Filing Season and the Level of Service \26\ is lower,
    primarily because taxpayers are calling about the stimulus payments.
    The IRS had planned to provide an 82 percent Level of Service for
    fiscal year 2008, but has projected that the Level of Service could be
    as low as 74 percent. For the 2008 Filing Season (as of March 29,
    2008), the IRS had already answered about 112 percent of the planned
    10.9 million assistor-answered calls. Its 80 percent Level of Service
    is 4.5 points lower than the actual 2007 Filing Season Level of Service
    of 84.5 percent. Additionally, the IRS had planned to answer 14.8
    million automated calls but has answered 16.1 million automated calls.
    ---------------------------------------------------------------------------
        \26\ The Level of Service is the primary measure of service to
    taxpayers. It is the relative success rate of taxpayers who call for
    services on the IRS toll-free telephone lines.
    ---------------------------------------------------------------------------
                       economic stimulus act of 2008 \27\
    ---------------------------------------------------------------------------
        \27\ Economic Stimulus Act of 2008, Pub. L. No. 110-185 (2008).
    ---------------------------------------------------------------------------
        In keeping with the intent of the Economic Stimulus Act of 2008,
    the IRS expects to issue more than $100 billion in stimulus payments
    (often referred to as rebates) and is trying to ensure that everyone
    who is entitled to a rebate knows what to do to receive it. The IRS
    sent Economic Stimulus Payment Notices (Notice 1377) to more than 130
    million taxpayers who filed a Tax Year 2006 income tax return.
    Beginning in May, an additional notice will be mailed to those
    taxpayers eligible for the payments to explain the payment amount and
    how it was calculated. The IRS believes it will receive significantly
    fewer calls to its toll-free telephone information line as a result of
    issuing the advance notices.
        As of March 28, 2008, the IRS had received an estimated 1.4 million
    tax returns from individuals who filed them solely to receive the
    rebates. Because these are tax returns that would generally not be
    filed, the normal IRS refund controls are not designed for this
    situation. The IRS is evaluating alternatives to identify any of these
    tax returns that are fraudulent so it can prevent any associated
    fraudulent stimulus payments. TIGTA is currently evaluating the
    controls over the processing of these tax returns and monitoring their
    volume and effect on the 2008 filing season.
        Since the Economic Stimulus Act of 2008 was enacted, the IRS has
    been receiving an average of more than 63,000 calls per day above
    normal volume to its toll-free telephone lines related to the upcoming
    rebates. The IRS is using over 1,000 Automated Collection System \28\
    telephone assistors to take rebate telephone calls during their regular
    tours of duty and has also trained more than 500 tax examiners and
    assistors who normally work taxpayer correspondence and paper casework
    to answer general rebate calls.
    ---------------------------------------------------------------------------
        \28\ The Automated Collection System is an integral part of the IRS
    process for collecting unpaid taxes and securing unfiled tax returns
    from both individual and business taxpayers. When taxpayers do not
    comply with the IRS's computer-generated notices, Automated Collection
    System tax examiners attempt to contact them by telephone to secure
    payments or unfiled returns. The Automated Collection System is the
    computer system that assigns these cases to the individual tax
    examiners.
    ---------------------------------------------------------------------------
        The IRS stopped the issuance of Automated Collection System
    enforcement tools (systemic notices and letters were stopped on
    February 22 and systemic levies were stopped on February 29). However,
    issuance of regular delinquency notices on accounts not yet assigned to
    the Automated Collection System has not been stopped, and the IRS
    expects to reserve 40 percent to 50 percent of the available Automated
    Collection System staff to answer calls from taxpayers who respond to
    these notices. The IRS plans to restart the notices when telephone
    demand decreases. The IRS reports that the foregone revenue associated
    with these actions could be as high as $666 million.

      TREASURY INSPECTOR GENERAL FOR TAX ADMINISTRATION FISCAL YEAR 2009
                                 BUDGET REQUEST

        TIGTA was created by Congress to provide independent oversight of
    the IRS. TIGTA's audits and investigations protect and promote the fair
    administration of the Nation's tax system. Responsibilities include
    ensuring that the IRS is accountable for more than $2 trillion in tax
    revenue received each year. Audit recommendations aim to improve IRS's
    systems and operations while maintaining fair and equitable treatment
    of taxpayers. Investigations are focused on IRS employee misconduct and
    infrastructure security, as well as external attempts to corrupt
    Federal tax administration.
        TIGTA's Office of Audit (OA) conducts audits that advise Congress,
    the Secretary of the Treasury, and IRS management of high-risk issues,
    problems, and deficiencies related to the administration of IRS
    programs and operations. Audits not only focus on the economy and
    efficiency of IRS functions but also ensure that taxpayers' rights are
    protected and the taxpaying public is adequately served. Overall, as of
    March 31, 2008, audit reports potentially produced financial
    accomplishments of $172.5 million, and potentially impacted
    approximately 1,217,000 taxpayer accounts in areas such as taxpayer
    burden, rights, and entitlements. OA develops an annual audit plan that
    communicates oversight priorities to Congress, the Department of the
    Treasury, and the IRS. Emphasis is placed on mandatory coverage imposed
    by the IRS Restructuring and Reform Act of 1998 \29\ and other
    statutory authorities, as well as issues impacting computer security,
    taxpayer rights and privacy, and financial-related audits. OA's work
    focuses on the IRS's major management challenges, the progress in
    achieving its strategic goals, the elimination of the IRS's systemic
    weaknesses, and the IRS's response to the President's Management Agenda
    initiatives.
    ---------------------------------------------------------------------------
        \29\ Pub. L. No. 105-206, 112 Stat. 685 (codified as amended in
    scattered sections of 2 U.S.C., 5 U.S.C. app., 16 U.S.C., 19 U.S.C., 22
    U.S.C., 23 U.S.C., 26 U.S.C., 31 U.S.C., 38 U.S.C., and 49 U.S.C.).
    ---------------------------------------------------------------------------
        TIGTA's Office of Investigations (OI) conducts investigations that
    protect the integrity of IRS employees, contractors, and other tax
    professionals; provides for infrastructure security; and protects from
    external attempts to threaten or corrupt the administration of Federal
    tax laws.
        TIGTA's OI investigates employee misconduct involving unauthorized
    access (UNAX) of confidential taxpayer records, theft, false
    statements, financial fraud, taxpayer abuses, and extortion.
        OI assists in maintaining IRS employee and infrastructure security
    by investigating incidents of threats or assaults made against IRS
    employees, facilities, and data infrastructure. As mentioned
    previously, the IRS's fiscal year 2009 budget request seeks a 7.1
    percent increase in its enforcement appropriation. This continued focus
    on enforcement has resulted in OI receiving higher levels of reported
    assaults and threats against IRS personnel. Additionally, the IRS's
    increasing reliance on electronic processes has resulted in an
    increased need for OI to investigate and respond to cyber attacks.
        TIGTA also investigates allegations involving external attempts to
    corrupt tax administration, such as bribes offered by taxpayers to
    compromise IRS employees, the use of fraudulent IRS documentation to
    commit crimes, taxpayer abuse and misconduct by tax practitioners,
    impersonation of IRS employees, and the corruption of IRS programs
    through procurement fraud.
        TIGTA faces major human capital challenges in delivering and
    adapting its oversight activities to the increasingly complex and high-
    risk issues associated with IRS operations. Some of these issues
    include detection and investigation of fraud and electronic crime,
    procurement activities, taxpayer privacy, and an increasing number of
    requests for IRS program reviews from Congress and other IRS
    stakeholders. While adapting to this changing environment,
    approximately 37 percent of TIGTA employees are eligible for retirement
    by fiscal year 2011.
        Additionally, in order to accomplish its mission, TIGTA employees
    need to possess the appropriate skills. As the IRS continues to
    modernize and operate in an automated environment, it is essential that
    TIGTA auditors and investigators are appropriately trained to operate
    in this environment.
        To help address these challenges, TIGTA has initiated or is
    initiating the following actions in fiscal year 2008:
      --Created the Office of Inspections and Evaluations whose mission is
            to provide TIGTA with additional flexibility, capacity and
            capability to provide value-added products and services to
            improve tax administration and promote good Government. This
            function was created and staffed by a realignment of existing
            resources.
      --Implementing a bureau-wide electronic learning management system
            containing a skills assessment program that identifies the
            critical skills needed for each of TIGTA's major occupations
            and provides a means to assess resident skill levels. Based on
            the results, TIGTA will develop a strategic recruitment program
            to fill critical vacancies with the skills necessary to carry
            out its increasingly complex oversight activities and align
            future hiring in critical geographic areas.
      --Building its first Senior Executive Service Candidate Development
            Program. The objective of the program is to promote a greater
            understanding of the mission and culture of the Federal
            Government and to train outstanding leaders and prepare them
            for the Senior Executive Service.
        Mr. Chairman, as you requested, I will discuss TIGTA's 2009 budget
    needs. From fiscal year 2001 to fiscal year 2007, TIGTA's labor
    expenses have grown 20 percent from $88 million to $106.3 million,
    despite a substantial reduction in Full-Time Equivalents (a decrease of
    16 percent from 938 to 792). Labor costs currently account for 80
    percent of TIGTA's annual budget. As the number of TIGTA employees
    covered under the more expensive Federal Employees Retirement System
    increases, labor costs will continue to rise, reducing the funds
    available to TIGTA for non-labor spending.
        Since fiscal year 2001, TIGTA has only been able to meet its
    financial obligations through Full-Time Equivalent losses and
    implementation of cost-cutting initiatives in non-labor expense
    categories. From fiscal year 2001 to fiscal year 2007, non-labor
    spending (such as training, travel, equipment, etc.) fell 9 percent
    from $19.5 million to $17.7 million. These costs currently consume 13
    percent of TIGTA's annual budget.
        The fiscal year 2009 President's budget request for TIGTA will be
    used to continue to provide critical audit and investigative services,
    ensuring the integrity of tax administration on behalf of the Nation's
    taxpayers. While there are a number of critical areas in which TIGTA
    will provide oversight, highlights of TIGTA's investigative and audit
    priorities include:
      --Adapting to the IRS's continually evolving operations and
            mitigating intensified risks associated with modernization;
      --Addressing the tax gap and enforcement efforts;
      --Responding to threats and attacks against IRS employees, property,
            and sensitive information;
      --Improving the integrity of IRS operations by detecting and
            deterring fraud, waste, abuse or misconduct by IRS employees;
      --Conducting comprehensive audits, inspections, and evaluations that
            include recommendations for cost savings and enhancing the
            IRS's service to taxpayers; and
      --Informing Congress and the Secretary of the Treasury of problems
            and progress made to resolve identified issues.
        The total resources needed in fiscal year 2009 to support TIGTA's
    mission are $146,636,000, including $145,736,000 from direct
    appropriations and approximately $900,000 from reimbursable agreements.
    This is a $5.2 million (3.7 percent) increase over the fiscal year 2008
    spending authority compared with the IRS's 4.3 percent increase.
        I hope my discussion of the continuing challenges that face the IRS
    and TIGTA will assist you as you consider the fiscal year 2009 budget.
    Mr. Chairman and Members of the subcommittee, thank you for the
    opportunity to share my views.

        Senator Durbin. You should have filed for an extension 1
    minute and 6 seconds ago.
        Willie Nelson will be your hearing officer.
        On behalf of the IRS Oversight Board, Paul Cherecwich.

    STATEMENT OF PAUL CHERECWICH, JR., CHAIRMAN, INTERNAL
                REVENUE SERVICE OVERSIGHT BOARD
        Mr. Cherecwich. Chairman Durbin, Ranking Member Brownback,
    and members of the subcommittee staff who are here, thank you
    very much. My name is Paul Cherecwich. I am chair of the IRS
    Oversight Board.
        One of our most important responsibilities is to ensure the
    IRS budget and related performance expectations support the IRS
    strategic plans. I would like to take this time to summarize
    the Board's recommendations for the IRS fiscal year 2009
    budget.
        If I had one word to characterize the difference between
    the Board's recommendations and the President's request, it
    would be ``direction.'' I have taken the liberty of making a
    chart of one of the key figures in my written statement because
    I think that best illustrates the difference in the direction
    the Board is recommending.
        This chart shows the four major line items in the IRS
    budget. The Board wants to spend more for service and
    information technology (IT) modernization. The President would
    spend less. It would appear that the Board and the President
    have similar recommendations for enforcement, but when you get
    inside the numbers, there are real differences in balance. And
    the Board would spend about $100 million more for
    infrastructure, but the President's budget would keep the
    infrastructure budget at its present underfunded state.
        Let us start at the top with funding for taxpayer service.
    To put it simply, the Board wants the IRS to do more service,
    not less, especially service that helps taxpayers better
    understand their obligations and service targeted at
    underserved taxpayers. Most of the additional money for service
    that Congress added to the IRS budget last year would be
    eliminated by the President's budget. The Board believes the
    taxpayer assistance blueprint needs to be funded, and I have
    personally visited volunteers in tax assistance (VITA) sites in
    Utah, Georgia, and Kansas and can tell you that VITA is
    delivering important services to underserved taxpayers.
        With respect to enforcement, it may seem that the Board and
    the President are making identical recommendations, for the
    funding is so close, about $360 million. And reality is my
    written statement shows the Board's recommended enforcement
    programs are spread more broadly and not focused exclusively in
    a few areas. As discussed in my statement, the Board has also
    questioned the ability of the IRS to absorb the requested
    staffing in its small business, self-employed, and large
    business divisions.
        With respect to infrastructure, that is something that
    tends to be forgotten, but it is really quite important. The
    Board believes more funding for security is important in an age
    where the IRS is under increasing pressure to protect its
    databases from assault and keep taxpayer records private. I
    note that just the last week my colleague, Mr. George, issued a
    report chastising the IRS for their lack of security. The IRS
    does put a high priority on maintaining taxpayer privacy, but
    more should be done.
        People are also an important part of the IRS infrastructure
    and more attention must be paid to having an aging workforce
    effectively pass along their skills and special expertise to
    the next wave of leaders and employees.
        Now, the biggest difference in dollars between the Board
    and the President's budget is in business systems modernization
    (BSM). We have a $185 million difference between the Board's
    recommendation and the President's recommendation. By the way,
    this is the appropriations line. Technology modernization will
    result in major benefits to taxpayers and the Government. The
    Board believes the BSM to be the highest priority because of
    its ability to contribute to reducing the tax gap in the long
    term. We simply have to make progress faster. TIGTA and GAO
    have recently been reporting positively on the business systems
    modernization program. This is not the time to go backward in
    funding.
        Among other things, erratic funding makes program
    management more difficult and creates staffing issues for both
    the IRS and the contractors. When projects are cut back, you
    always lose the talented people you most want to keep.
        Few taxpayers would use a financial institution that
    updated its accounts weekly. Yet, we accept that for the IRS.
    This has to change.
        Modernized systems are required for electronic filing and
    financial controls. The failure of funding to upgrade the
    integrated financial system is going to prevent the IRS from
    managing its own accounts better.
        Now that I have summarized the Board's recommendations on
    the four major accounts, let me make a point on the entire IRS
    budget. There is a television program on the Discovery channel
    called ``Myth Busters'' whose avowed mission is to separate
    truth from fiction, and I want to bust a myth about the IRS.
    The myth is that taxpayers who are also voters will be unhappy
    if too much money is appropriated for the IRS. The Board has
    tested that myth in our taxpayer attitude surveys and found it
    was wrong. My written statement provides the details.

                               PREPARED STATEMENT

        In conclusion, the Congress must choose whether it wants to
    pursue short-term growth in enforcement activity over a more
    balanced path that stresses the benefits of long-term
    investments in technology infrastructure, service, and
    research.
        Thank you for the opportunity to present the board's views.
        Senator Durbin. Thanks.
        [The statement follows:]

                   Prepared Statement of Paul Cherecwich, Jr.

        Chairman Durbin, Ranking Member Brownback, and members of the
    Subcommittee, thank you for this opportunity to present the Oversight
    Board's views on the administration's fiscal year 2009 IRS budget
    request. My name is Paul Cherecwich and I serve as Chairman of the IRS
    Oversight Board. My testimony explains the Board's recommendations for
    the IRS fiscal year 2009 budget and why the Board believes this level
    of funding is needed to meet the needs of the country and of taxpayers.
        Created as part of the IRS Restructuring and Reform Act of 1998
    (RRA 98), the Oversight Board's responsibilities include overseeing the
    IRS in its administration, management, conduct, direction and
    supervision of the execution and application of the internal revenue
    laws. The Board is also responsible for ensuring that the IRS'
    organization and operations allow the agency to carry out its mission.
    To this end, the Board was given specific responsibilities for
    reviewing and approving annual budgets and strategic plans.
        In fulfilling its responsibilities, the Board must ensure that the
    IRS' budget and the related performance expectations contained in the
    performance budget support the annual and long range plans of the IRS,
    support the IRS mission, are consistent with the IRS goals, objectives
    and strategies and ensure the proper alignment of IRS strategies and
    plans. In addition to my statement today, the Board developed a formal
    report in which it explains why it has recommended this budget for the
    IRS. I request that my statement and the report be entered into the
    committee record.

                  FISCAL YEAR 2009 IRS BUDGET RECOMMENDATIONS

        One of the IRS Oversight Board's most important statutory
    responsibilities is to ensure that the IRS' budget request supports the
    agency's annual and long-term strategic plans. A budget request is more
    than a mechanism for appropriating funding; it's also a plan and a
    commitment. Not only does a proposed budget request funding, it also
    describes the activities the IRS will perform, how those activities
    align with the long-range strategic plan, and identifies measures to
    evaluate the expected results. A performance budget, properly used,
    enhances the ability of the IRS to meet its short-term performance
    targets and three strategic plan goals: (1) improve customer service;
    (2) enhance enforcement of the tax law; and (3) modernize the IRS
    through its people, processes and technology.
        Achieving these three strategic goals will enable the IRS to
    address the most serious problem facing tax administration today--
    reducing the tax gap, the difference between what taxpayers should be
    paying and what they actually pay in a timely manner. The size of the
    tax gap is significant, with the IRS' most recent estimates placing it
    at approximately $290 billion (net) annually, based on 2001 tax
    returns. The imperative for closing the tax gap has never been greater.
    An annual net tax gap of $290 billion averages to about $2,200 per
    individual tax return, an enormous burden for the average taxpayer, and
    one that should not be tolerated by honest taxpayers. It is far too
    large to be dismissed lightly--it imposes a large burden on all
    taxpayers and undermines respect for tax administration.
        The IRS Oversight Board recommends an IRS fiscal year 2009 budget
    of $11.737 billion, an increase of $845 million over the enacted fiscal
    year 2008 amount of $10.892 billion, as summarized in Tables A-1 and A-
    2 in Appendix A.
        The recommended budget takes a long-term view of IRS needs. Despite
    the severity of the tax gap, the Board believes such a view is both
    warranted and needed. In submitting its fiscal year 2009 budget
    recommendations to the Treasury Department in June 2007, the Board
    identified increased funding for Business Systems Modernization (BSM),
    security, infrastructure, and research as high priorities. These
    initiatives offer the best opportunity to reduce the tax gap in the
    long term.
        By following this approach, the Board's recommended budget
    maintains balance at its core: enforcement, taxpayer service, business
    systems modernization, and employee development must be adequately
    funded for the IRS to succeed in all parts of its mission and to ensure
    the long-term health of our tax administration system.
        The Board's recommended IRS budget compares to the President's
    request of $11.361 billion, an increase of $469 million over the fiscal
    year 2008 enacted appropriation. Although the two budgets are within
    3.3 percent, they take different approaches to funding priority program
    initiatives at the margin. The Board recommends a total of $644 million
    in program initiatives, spread among four areas: enforcement, taxpayer
    service, infrastructure and IT, and BSM. The President's budget
    requests a nearly identical amount of funding for enforcement
    initiatives as the Board, but cuts taxpayer service and BSM funds, and
    includes no program initiatives for infrastructure and IT. Figure 1
    shows the differences in graphic form.

        Although both budgets have as a core objective the reduction of the
    tax gap, the Board recommends funding initiatives across the full range
    of IRS functions and taxpayer segments. In contrast, the President's
    budget has as its central focus a short-term effort to build up IRS
    revenue-producing enforcement staffing at a time when the IRS is hard-
    pressed to replace the high number of experienced employees who are
    retiring. Increased staffing is important, but the Oversight Board
    believes the IRS cannot ``audit its way out of the tax gap,'' and
    should avoid the temptation to close the tax gap with large staffing
    increases in revenue-producing functions that cannot be absorbed
    effectively. The Board believes its recommended budget avoids this
    problem by focusing on ways to make the IRS more efficient in the long
    term, and putting more resources into technology, infrastructure, and
    service as well as enforcement.
        Because reducing the tax gap is of critical importance, the Board
    has identified a subset of its recommended initiatives as having the
    highest priority. These initiatives are generally infrastructure and
    research intensive and will have the greatest effect on reducing the
    tax gap in the long term, and are identified in Table 1.

           TABLE 1.--IRS OVERSIGHT BOARD HIGHEST PRIORITY INITIATIVES
                              [Dollars in millions]
    ------------------------------------------------------------------------
                                                                     Amount
    ------------------------------------------------------------------------
    Technology/Infrastructure:
        Fund Business Systems Modernization in Line with Current      $141.0
         Strategy.................................................
        Enhance IT Security.......................................     $16.7
        Enhance Contingency Planning and Disaster Recovery........      $8.7
        Implement Security Auditing...............................      $6.8
        Preserve quality IT workforce in applications development.     $36.8
        Build alternate power supply for computing center.........     $11.0
                                                                   ---------
          Subtotal, Technology/Infrastructure.....................    $221.2
                                                                   =========
    Enforcement: Improve tax gap estimates, measurement, and           $11.1
     detection of non-compliance..................................
    Taxpayer Service: Research Taxpayer Burden, Complexity, and        $10.0
     Compliance...................................................
                                                                   ---------
          Total Highest Priority Initiatives......................      $2.3
    ------------------------------------------------------------------------

        None of these initiatives, except the enforcement initiative for
    improving tax gap estimates, are funded in the President's budget.
    Moreover, as shown in Figure 1, the BSM program and taxpayer service
    programs undergo reductions of $45 million and $47 million,
    respectively. The Board recommends that the appropriated IRS fiscal
    year 2009 budget closely follow the priorities and balance reflected in
    this statement.
        The following sections discuss the Board's budget recommendations
    in the context of each of the IRS' strategic goals.
    Strategic Goal 1--Improve Taxpayer Service
        IRS customer service has made consistent gains since fiscal year
    2002. For example, Toll-Free Tax Law Accuracy and Accounts Accuracy are
    at 91 percent and 93 percent respectively in fiscal year 2007, as
    compared to 84.4 percent and 90 percent 5 years ago. Of particular
    note, overall customer satisfaction with IRS Toll-Free Service has held
    steady at 94 percent for four consecutive years. Such stability is most
    welcome and a good indicator that best practices have taken root.
        As a result, a more pressing challenge is to deliver more extensive
    electronic self-assistance tools and to perform research that
    identifies innovative ways to expand taxpayer education and outreach to
    all taxpayer segments, especially those who are now under served.
        To a large degree, many of the IRS' customer service activities are
    designed to respond to taxpayer inquiries. Examples include toll-free
    telephone service and Taxpayer Assistance Centers. Overall, the IRS has
    done a good job fielding and answering questions, whether via toll-free
    telephone, the Internet, or in person at Taxpayer Assistance Centers.
        The IRS expends considerably fewer resources on education and
    outreach services. A broader approach to customer service would entail
    giving taxpayers access to self-service applications so they could
    ``pull'' specific information on accounts or tax law, and ``pushing''
    answers, information and updates to taxpayers, practitioners and other
    affected parties as the need for such information became apparent.
    Lastly, the IRS must seize opportunities to provide innovative
    outreach, education and community partnerships. For example, given
    limited resources and elimination of programs such as TeleFile, the IRS
    must also work to broaden and strengthen partnerships, such as
    Volunteers in Tax Assistance (VITA).
        To take service to the next level, the IRS must better understand
    the taxpayers they serve. The IRS must conduct more insightful
    research, and develop services better tailored to the specific needs of
    particular taxpayer segments. By better understanding taxpayers, the
    IRS can focus both its service and enforcement efforts to increase
    compliance through targeted pre-filing, filing, and post-filing
    efforts. The IRS must find out what kind of information and assistance
    taxpayers need and the most effective ways of delivering that
    information to them.
        In the last 2 years, the IRS has put considerable effort into
    developing the Taxpayer Assistance Blueprint (TAB), which establishes a
    5-year plan for delivering service to taxpayers. This vision entails a
    much broader use of electronic interactions between taxpayers,
    practitioners and the IRS, such as account management and the ability
    to resolve taxpayer issues securely over the Internet. The TAB
    describes an IRS that is an ``interactive and fully integrated, online
    tax administration Agency'' with the capability ``for any exchange or
    transaction that occurs face-to-face, over the phone, or in writing to
    be completed electronically.'' These types of services are much along
    the lines of what customers of large financial institutions already
    experience today but are still for the most part unavailable to
    taxpayers.
        The Oversight Board disagrees with the President's program
    reductions for taxpayer service and recommends that the following three
    initiatives be funded for a total of $26.3 million:
      --Maintain Processing of Critical Pension Plan Returns ($6.3
            million);
      --Research Taxpayer Burden, Complexity, and Compliance ($10 million);
            and
      --Expand Volunteer Income Tax Assistance and Low Income Tax Clinics
            ($10 million).
        The first initiative supports customer service by providing funds
    to maintain processing of essential pension plan return information
    while transitioning to a new mandated electronic filing system
    ``EFAST2'' in 2010. It also enables processing of residual returns that
    are IRS-only forms and not part of the mandated EFAST2 system (Form
    5500EZ and Schedule SSA filings).
        The second initiative provides funding to enhance understanding of
    the interaction between taxpayer burden, tax law complexity, and
    taxpayer compliance. This research will help improve understanding of
    these inter-relationships, in keeping with strategies put forth in the
    Taxpayer Assistance Blueprint (TAB) and the Department of the Treasury
    report, A Comprehensive Strategy for Reducing the Tax Gap.
        The third initiative provides funding to improve service to two
    taxpayer segments with special needs: the growing number of elderly and
    the ethnically diverse. These taxpayer segments face unique challenges
    in meeting their tax obligations because of limited access to or
    inability to use all of the channels offered for service delivery.
    Additional resources will enhance the IRS's volunteer return
    preparation and other services provided by the Volunteer Income Tax
    Assistance (VITA) and the Low Income Tax Clinic programs with emphasis
    on both targeted taxpayer segments. Such services help created a more
    fair and just tax system.

    Strategic Goal 2--Enhance Enforcement of the Tax Law
        Increases in IRS enforcement activity intended to produce gains in
    direct revenue collection must be balanced with a broad view of the tax
    gap. The Board recognizes that increased enforcement activity over the
    past five years has produced noticeable results--enforcement revenue
    has increased from $34.1 billion in fiscal year 2002 to $59.2 billion
    in fiscal year 2007, a gain of nearly 74 percent. The IRS estimates
    that it can produce more than a four-to-one return on every dollar
    invested in additional enforcement resources, a fact that the Board
    believes warrants the appropriation of additional enforcement funding.
        However, while the Board applauds the increases in enforcement
    activity and revenue, it also recognizes that the IRS cannot ``audit
    its way out'' of the tax gap. There is wide belief, as evidenced by the
    Board's recommendations for reducing the tax gap and the Treasury
    Department's tax gap strategy, A Comprehensive Strategy for Reducing
    the Tax Gap, that an integrated set of comprehensive actions is needed.
    Even a large infusion of resources for more enforcement personnel--
    something highly unlikely--would not eliminate the tax gap. There are
    many reasons for taxpayer non-compliance. Only a balanced program that
    promotes voluntary compliance across a broad continuum of taxpayers,
    from education and service for those who want to comply, to enforcement
    and even criminal prosecutions for those who refuse to comply, can be
    effective.
        Table 2 compares the Board's and President's enforcement
    initiatives. Although very close in dollars, the President's
    initiatives place more emphasis on enforcement resources that can be
    shown to produce revenue in the short term. The Board takes a broader
    view of enforcement, and recommends program increases in such areas as
    expanded collection of proper taxes from recipients of Federal
    payments, investigation of tax-related criminal activity, Bank Secrecy
    Act compliance, tax exempt organization examination, more published
    guidance for Tax Exempt taxpayers, additional litigation staff, and tax
    preparer monitoring.
        Additional enforcement resources produce a positive return on
    investment and result in short-term benefits, so the benefits of
    increased enforcement are apparent. However, increases in enforcement
    resources must also be balanced with more systemic long-range actions
    that improve voluntary compliance, and priorities must be considered as
    budget resources are limited. The Oversight Board considers technology
    modernization and research a higher priority than additional
    enforcement resources, in recognition of the long-term impact that
    technology modernization and research have on the IRS' ability to work
    more efficiently to reduce the tax gap and to be better able to focus
    both its service and enforcement resources optimally.

                   TABLE 2.--COMPARISON OF ENFORCEMENT INITIATIVES FOR BOARD'S AND PRESIDENT'S BUDGETS
                                                  [Dollars in millions]
    ----------------------------------------------------------------------------------------------------------------
        Oversight board's budget enforcement                       President's budget  enforcement
                    initiatives                     Amount                   initiatives                    Amount
    ----------------------------------------------------------------------------------------------------------------
    Reduce the Tax Gap for Small Business/Self-       $120.7  Reduce the Tax Gap for Small Business/         $168.50
     Employed.                                                 Self-Employed.
    Increase Reporting Compliance of Domestic           16.4  Improve Reporting Compliance of U.S.             13.70
     Taxpayers with Offshore Activity.                         Taxpayers with Offshore Activity.
    Reduce the Tax Gap for Large Businesses....         52.0  Reduce the Tax Gap for Large Business....        69.49
    Expand Federal Payment Levy Program........         17.3  .........................................  ...........
    Reduce Tax Fraud...........................         72.2  .........................................  ...........
    Enhance Financial Investigations of                 24.0  .........................................  ...........
     Narcotics Trafficking Organizations.
    Enhance BSA Compliance Program.............          3.4  .........................................  ...........
    Address Complexity through Up-Front                  8.9  .........................................  ...........
     Guidance, Education, and Correction.
    Expand Examination of Tax Exempt                    28.6  .........................................  ...........
     Organizations.
    Increase Tax Court Litigation..............          5.8  .........................................  ...........
    Implement New Procedural Tax Court                   3.4  .........................................  ...........
     Requirements.
    Improve Tax Gap Estimates, Measurement, and         11.1  .........................................        51.06
     Detection of Non-Compliance.
    Increase Monitoring of Preparers...........          2.5  .........................................  ...........
                                                 ...........  Expand Document Matching.................        35.06
                                                 ...........  Implement Legislative Proposals to               23.05
                                                               Improve Compliance.
                                                --------------------------------------------------------------------
          Total Enforcement....................        366.3  .........................................       360.85
    ----------------------------------------------------------------------------------------------------------------

        Another factor that must be considered is the degree to which
    additional staffing can be absorbed into various IRS organizational
    units. Figure 2 depicts the distribution of new hires in major IRS
    organizations under the President's and Board's budgets. The Board
    believes its budget strikes a more balanced posture across all IRS
    organizational units and expands enforcement resources for a range of
    activities that are important elements of IRS enforcement, although
    they do not generate revenue directly, such as examination of tax
    exempt organization reporting, regulation of pension plans, and
    criminal investigation of tax fraud and abusive tax shelters. These
    activities are all part of a balanced, enforcement program that has as
    a goal the promotion of voluntary compliance among all taxpayer
    segments.
        To better understand the impact of both budgets on the Small
    Business/Self-Employed (SB/SE) and Large and Mid-Sized Business (LMSB)
    organizations, the Board examined hiring requirements during fiscal
    year 2009 for both divisions. Table 3 shows the number of Mission
    Critical Occupation (MCO) employees projected to be on-rolls as of
    September 30, 2008, as well as the hiring requirements contained in
    both budgets. The Board has used a rule of thumb that 15 percent new
    hires is a reasonable limit on the amount of new employees that can be
    effectively accommodated into an organization in a year. It had
    concerns with the hiring implications of its own budget on SB/SE, but
    thought this risk could be mitigated. The President's budget would
    increase the percentage of new hires in SB/SE to over 23 percent of its
    employees in fiscal year 2009, and over 16 percent for LMSB.

          TABLE 3.--SB/SE AND LMSB HIRING REQUIREMENTS IN THE BOARD'S AND PRESIDENT'S FISCAL YEAR 2009 BUDGETS
    ----------------------------------------------------------------------------------------------------------------
                                                                      Operating Unit Mission Critical Occupations
                                                                 ---------------------------------------------------
                                                                   Oversight board budget      President's budget
                                                                 ---------------------------------------------------
                                                                     SB/SE         LMSB        SB/SE         LMSB
    ----------------------------------------------------------------------------------------------------------------
    Projected on rolls as of 9/30/2008..........................       19,394        5,126       19,394        5,126
                                                                 ---------------------------------------------------
    Projected Attrition Hires in fiscal year 2009...............        2,612          403        2,612          403
    Projected New Hires in fiscal year 2009 to Meet Budget              1,177          273        1,918          433
     Request....................................................
                                                                 ---------------------------------------------------
          Total Attrition Hires and New Hires...................        3,789          676        4,530          836
                                                                 ---------------------------------------------------
    Percent of Hires to total MCO population....................         19.5         13.2         23.4         16.3
    ----------------------------------------------------------------------------------------------------------------

        As in fiscal year 2006 through fiscal year 2008, the administration
    proposes to include its requested enforcement increases as a Budget
    Enforcement Act program integrity cap adjustment. The Oversight Board's
    recommended enforcement initiatives would also qualify for such
    treatment, should Congress decide to make such an adjustment.

    Strategic Goal 3--Modernize the IRS Through its People, Processes and
            Technology
        The most effective strategy for reducing the tax gap in the long
    term is to provide the IRS with modern technology that enables it to
    operate at a high performance level. The Board has no doubts that a
    high performing organization with high service, quality, and
    satisfaction levels also minimizes taxpayer burden. Under such
    conditions, service and enforcement activities are prompt, efficient,
    and correct.
        The Board has identified program initiatives for IT and
    infrastructure activities that are funded under the BSM and Operations
    Support accounts. These initiatives will further modernize the IRS core
    IT systems used for tax administration, upgrade its infrastructure, and
    improve its security posture.

               BUSINESS SYSTEMS MODERNIZATION PROGRAM INITIATIVE

        Tax administration is a knowledge-intensive activity and the IRS
    depends heavily on information technology (IT) to leverage the
    knowledge and perform its mission. The IRS has made slow but steady
    progress in replacing its antiquated IT systems. The most noticeable
    improvements to taxpayers have been increased use of electronic
    products and services to interact with the IRS. However, the IRS'
    performance is still hampered by archaic IT systems used for central
    record-keeping that update taxpayer account information on a weekly
    instead of a daily basis.
        The Board has long advocated that the BSM program be funded at a
    higher level so progress could be made more quickly. Admittedly the
    program experienced a series of cost and schedule overruns during its
    first several years, and the result has been to slow down the funding
    stream to levels that dictate only modest progress can be made in
    modernizing the core IRS master files and account management systems.
    Because of its long-term effect on reducing the tax gap, the Board
    considers increasing BSM funding so that the pace of IT modernization
    can be increased as having the highest priority.
        Figure 3 compares the BSM budget recommended by the Oversight
    Board, the amount requested by the President, and the BSM funding
    appropriated by Congress for fiscal years 2003 to 2008. BSM funding
    needs to be restored to the levels realized in fiscal year 2003 and
    fiscal year 2004 to make progress faster.

        Table 4 shows the Board's and President's budgets for the BSM
    program in fiscal year 2009. Had the Board's funding recommendations
    been followed, the IRS would be closer to the day when it could update
    its central records on a daily basis.

     TABLE 4.--APPLICATION OF FISCAL YEAR 2009 BSM FUNDING TO PROJECTS IN THE IRS OVERSIGHT BOARD'S AND PRESIDENT'S
                                                         BUDGETS
                                                  [Dollars in millions]
    ----------------------------------------------------------------------------------------------------------------
                                                                              Oversight board         President
                                                                           -----------------------------------------
                                                                   Fiscal              Increase             Increase
                         Project activities                         year     Fiscal      over     Fiscal      over
                                                                    2008      year      fiscal     year      fiscal
                                                                              2009    year 2008    2009    year 2008
    ----------------------------------------------------------------------------------------------------------------
    Customer Account Data Engine................................      58.5      80.0      21.5       58.8       0.3
    Accounts Management Services................................      29.0      47.4      18.4       26.2      (2.8)
    Modernized e-File...........................................      55.8      36.1     (19.7)      25.0     (30.8)
    Common Services Project.....................................  ........      16.0      16.0   ........  .........
    Integrated Financial System.................................  ........      73.0      73.0   ........  .........
    Core Infrastructure; Architecture Integration & Management;       78.6      98.1      19.5       69.3      (9.3)
     and Management Reserve.....................................
                                                                 ---------------------------------------------------
          Subtotal Capital Investments..........................     221.8     350.6     128.8      179.3     (42.6)
    BSM Labor...................................................      45.2      56.7      11.5       43.4      (1.8)
                                                                 ===================================================
          BSM Program Total.....................................     267.1     407.3     140.2      222.7     (44.4)
    ----------------------------------------------------------------------------------------------------------------
    Note: BSM program excludes $1.2 million of corporate costs in Operations Support.

        The Board believes that when implemented, modernized IT systems
    will literally save taxpayers billions of dollars in burden reduction
    and make the IRS much more efficient. For example, replacement of the
    Individual Master File by the Customer Account Data Engine (CADE) will
    allow the IRS to update the tax accounts for individuals on a daily
    basis, instead of its current weekly update process. The Oversight
    Board expects that a rapid refund from the IRS of 3 to 5 days will
    reduce the number of Refund Anticipation Loans (RALs). The National
    Consumer Law Center and Consumer Federation of American estimate that
    approximately 12 million American taxpayers spent an unnecessary $1.6
    billion on RALs in 2004 (the latest year for which data is available)
    to obtain their refund monies faster by 2 weeks. Moreover, daily
    updating of account records will give IRS employees and taxpayers
    access to the most current taxpayer account data, eliminating the
    problems associated with having various data bases with less than
    current status. The Oversight Board expects that daily posting of
    account information will improve the IRS' analysis capability and
    greatly reduce the burdens associated with the account resolution
    process.
        The Modernized e-File system not only makes it easier for taxpayers
    to file tax returns with the IRS, it reduces the human resources needed
    to receive and process tax returns and eliminates the error-prone
    transcription process. For corporate filers, it helps the LMSB division
    improve currency and cycle time in working large corporate tax cases.
    When implemented for individual tax returns, it will make the
    electronic filing process even simpler than it is today with the
    current legacy electronic filing system.
        The Integrated Financial System (IFS) will provide necessary
    improvements to the system the IRS uses to manage its financial
    resources, clearly a must for any agency, especially one that is
    responsible for managing taxpayers' accounts as well as its own
    appropriated resources. The IFS upgrade is needed to ensure that the
    IRS remains in compliance with Federal accounting and other financial
    management requirements. The additional funding for the IFS initiative
    will enable the IRS to add procurement and asset management modules to
    the existing IFS application and integrate related business processes
    with core accounting and financial management operations. The funding
    will also provide for the subsequent transfer of IFS to a Shared
    Service Center and thereby maintain its longer term viability.
        The Board believes that funding for the BSM program should be
    accelerated, not slowed down. Failure to fund the IRS BSM program at
    higher levels, in the view of the Board, is a case of being penny-wise
    and pound foolish.

           INFORMATION TECHNOLOGY/INFRASTRUCTURE PROGRAM INITIATIVES

        The IRS must be held to the highest standards for security and data
    integrity while increasing its engagement in the electronic world in
    which most taxpayers already live. Meeting this dual challenge of high
    security and a high degree of electronic interaction with taxpayers
    demands that the IRS have a modern information systems and
    infrastructure.
        The Board recommends six program initiatives for a total of $103
    million that will improve the IRS' operations by allowing it to make
    critical improvements to its technology and personnel infrastructure.
    By comparison, the President's budget contains no initiatives for IRS
    infrastructure.
        Three of the initiatives, totaling $32.2 million, enhance the IRS'
    security posture as the way the IRS does business continues to evolve
    and security threats seem to increase on a daily basis. Data security
    has taken on an expanded meaning in a post-9/11 world. Terrorists from
    around the globe are actively working to exploit weaknesses in
    Government IT security systems with the intent of producing both great
    physical and economic harm. Disrupting IRS returns processing and
    stealing sensitive information could wreak havoc on the economy and
    financial markets. The IRS cannot be complacent with respect to
    security, and the Board recommends the following security initiatives:
      --Enhance IT Security ($16.7 million);
      --Enhance Contingency Planning and Disaster Recovery ($8.7 million);
            and
      --Implement Security Auditing ($6.8 million).
        The first initiative enables the IRS to further implement key IT
    security and privacy safeguards to assure the integrity of sensitive
    taxpayer and employee data and supporting infrastructure processes.
    Protecting taxpayer data is paramount. The second initiative is to
    enhance the IRS enterprise-wide contingency planning and disaster
    recovery capabilities to support critical business systems. Any
    unavailability of critical IRS business systems poses an unacceptably
    high risk to the Nation's security. The third initiative, Security
    Auditing, will allow the IRS to more effectively monitor key networks
    and systems to identify any unauthorized activities.
        The remaining three initiatives, for a total of $71.3 million,
    allow the IRS to improve other elements of its infrastructure. They
    are:
      --Redesign Form 990 for Tax Exempt Organizations ($23.5 million);
      --Preserve Quality IT Workforce in Applications Development ($36.8
            million); and
      --Build Alternate Power Supply for the Computing Centers ($11
            million).
        The first initiative, the only one that is not considered high
    priority, is recommended because it brings new efficiencies to tax
    filing for a segment of taxpayers who are frequently ignored because
    their tax returns do not produce revenue--tax exempt organizations. The
    Form 990 tax return is difficult to complete for tax exempt
    organizations to complete and for reviewers to comprehend. Worse, it
    fails to provide the IRS with sufficient information to detect and
    analyze compliance trends in the sector and target enforcement actions
    as needed.
        The second initiative will give the IRS better tools to retain its
    IT workforce by mitigating intellectual and experiential loss through a
    series of supporting strategies such as workforce re-tooling,
    succession planning, and retention. The third initiative provides
    alternate power supply for three of the IRS's computing centers.
    Currently there is but a single power supply facility at each of the
    computing centers. An alternate power supply capability at each of the
    three computing centers would ensure the continuous operation of, and
    continuous access to, tax processing systems at the computing centers
    during unplanned emergencies and planned power supply tests, and avoid
    the revenue loss and overtime expense associated with the current
    process that requires total shut down periods.

      INVESTING IN IRS IS A GOOD BUSINESS DECISION SUPPORTED BY THE PUBLIC

        In spite of recommendations made by the IRS Oversight Board, the
    IRS has not been funded at the most effective levels to achieve its
    strategic objectives. Figure 4 illustrates funding recommendations made
    by the Board since its inception, the President's budget request during
    this same time frame, and the funding appropriated by Congress. One of
    the principal reasons for this so-called ``resource gap'' is the budget
    process which treats the IRS the same as it does all other
    discretionary spending requests. It does not credit the IRS with
    bringing in 95 percent of all the revenue to fund the Federal
    Government, nor does it recognize the previously discussed four-to-one
    return on every dollar invested in tax enforcement.
        The Oversight Board has urged previously Congress to view funding
    of the IRS as an investment.\1\ Other members of the tax administration
    community, such as the National Taxpayer Advocate and the National
    Treasury Employees Union, have made similar recommendations.\2\
    ---------------------------------------------------------------------------
        \1\ IRS Oversight Board reports, Fiscal Year 2006 IRS Budget
    Recommendations/Special Report, Fiscal Year 2007 IRS Budget
    Recommendations/Special Report, and Fiscal Year 2008 IRS Budget
    Recommendations/Special Report.
        \2\ NTA, 2006 Report to Congress, Section 2, p. 445, and Statement
    of Colleen M. Kelley, President, National Treasury Employees Union,
    Testimony Before the House Committee on Ways and Means, May 23, 2007.

        There are a number of approaches that Congress could take to
    achieve this result, such as funding the IRS outside of budget caps,
    and the Board believes that the implementation of such a change is best
    left for Congress to decide. The Board would be remiss, however, if it
    didn't point out providing additional funds to the IRS has been
    consistently supported by nearly two out of three members of the
    public. In its annual Taxpayer Attitude Survey, the Board has asked
    taxpayers whether they support additional funding for the IRS. The
    results for 2005 through 2007 are shown in Table 5.

                              TABLE 5.--RESULTS OF TAXPAYER ATTITUDE SURVEY ON IRS FUNDING
    ----------------------------------------------------------------------------------------------------------------
                                                            Percent completely agree        Percent mostly agree
                     Survey question 11                  -----------------------------------------------------------
                                                            2007      2006      2005      2007      2006      2005
    ----------------------------------------------------------------------------------------------------------------
    The IRS should receive extra funding to enforce tax         24        24        20        40        39        43
     laws and ensure taxpayers pay what they owe........
    The IRS should receive extra funding so it can              21        24        22        42        42        44
     assist more taxpayers over the phone and in person.
    ----------------------------------------------------------------------------------------------------------------

        The Board believes such strong support indicates the public
    understands the need for effective tax administration and realizes
    that, ultimately, it pays for itself.

                                   CONCLUSION

        Approving a budget is not just about money; it's also about
    choices. The Board believes its budget recommendations, if implemented,
    will put the IRS on an effective long-term path to achieving the IRS
    strategic goals, improving voluntary compliance, and reducing the tax
    gap.
        Although the Board's recommended budget is $375 million more than
    the President's request, there are some important decisions that must
    be made with respect to priorities and balance. The Congress must not
    only decide the amounts to be appropriated, but must also choose
    whether it wants to pursue short-term growth in enforcement activity
    over a more balanced path that stresses the benefits of long-term
    investments in technology, infrastructure, service, and research.

       Appendix A.--IRS Oversight Board Recommended IRS Fiscal Year 2009
                                     Budget

       TABLE A-1.--IRS OVERSIGHT BOARD'S RECOMMENDED FISCAL YEAR 2009 IRS
                          BUDGET BY PROGRAM INITIATIVE
                            [In millions of dollars]
    ------------------------------------------------------------------------
                                                                  Amount
    ------------------------------------------------------------------------
    Fiscal Year 2008 Enacted Appropriation.................       10,892.38
        Base Adjustments...................................          262.62
        Savings/Reinvestments..............................          (61.65)
                                                            ----------------
          Fiscal Year 2008 Base Budget.....................       11,093.35
                                                            ================
                          INITIATIVES

    Enforcement:
        Reduce the Tax Gap for Small Business/Self-Employed          120.7
        Increase Reporting Compliance of Domestic Taxpayers           16.4
         with Offshore Activity............................
        Reduce the Tax Gap for Large Businesses............           52.0
        Expand Federal Payment Levy Program................           17.3
        Reduce Tax Fraud...................................           72.2
        Enhance Financial Investigations of Narcotics                 24.0
         Trafficking Organizations.........................
        Enhance BSA Compliance Program.....................            3.4
        Address Complexity through Up-Front Guidance,                  8.9
         Education, and Correction Opportunities...........
        Expand Examination of Tax Exempt Organizations.....           28.6
        Increase Tax Court Litigation......................            5.8
        Implement New Procedural Tax Court Requirements....            3.4
        Improve Tax Gap Estimates, Measurement, and                   11.1
         Detection of Non-Compliance.......................
        Increase Monitoring of Preparers...................            2.5
                                                            ----------------
          Total Enforcement................................          366.3
                                                            ================
    Taxpayer Services:
        Maintain Processing of Critical Pension Plan                   6.3
         Returns...........................................
        Research Taxpayer Burden, Complexity, and                     10.0
         Compliance........................................
        Expand Volunteer Income Tax Assistance and Low                10.0
         Income Tax Clinics................................
                                                            ----------------
          Total Service....................................           26.3
                                                            ================
    Infrastructure/IT:
        Enhance IT Security................................           16.7
        Enhance Contingency Planning and Disaster Recovery.            8.7
        Implement Security Auditing........................            6.8
        Redesign Form 990 for Tax Exempt Organizations.....           23.5
        Preserve Quality IT Workforce in Applications                 36.8
         Development.......................................
        Build Alternate Power Supply for the Computing                11.0
         Centers...........................................
                                                            ----------------
          Infrastructure/IT Initiatives Subtotal...........          103.5
                                                            ================
    Business Systems Modernization (BSM)...................          142.4
    HITCA..................................................            5.50
                                                            ================
          Total Initiatives................................          644.00
                                                            ================
    Fiscal Year 2009 Budget Request........................       11,737.35
    Fiscal Year 2009 Request Increase over Fiscal Year 2008          844.97
     Base..................................................
    Fiscal Year 2009 President's Request for IRS...........       11,361.51
    Increase Over President's Budget Request...............          375.8
    ------------------------------------------------------------------------

                               TABLE A-2.--IRS OVERSIGHT BOARD'S RECOMMENDED FISCAL YEAR 2009 IRS BUDGET BY APPROPRIATION ACCOUNT
                                                                    [In millions of dollars]
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                   Taxpayer                    Ops
                                                                                   services   Enforcement    support        BSM        HITCA        Total
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Fiscal Year 2008 Enacted Appropriation.....................................     2,150.0      4,780.0      3,680.1        267.1        15.2     10,892.4
        Base Adjustments.......................................................        54.7        125.0         81.2          1.4         0.3        262.6
        Savings/Reinvestments..................................................       (10.5)       (48.8)        (2.2)  ..........        (0.2)       (61.6)
                                                                                ----------------------------------------------------------------------------
          Fiscal Year 2009 Base Budget.........................................     2,194.2      4,856.2      3,759.0        268.4        15.4     11,093.4
                                                                                ============================================================================
                                    INITIATIVES

    Enforcement:
        Reduce the Tax Gap for Small Business/Self-Employed....................         2.9         94.0         23.8   ..........  ...........       120.7
        Increase Reporting Compliance of Domestic Taxpayers with Offshore        ...........        13.8          2.6   ..........  ...........        16.4
         Activity..............................................................
        Reduce the Tax Gap for Large Businesses................................  ...........        44.0          8.0   ..........  ...........        52.0
        Expand Federal Payment Levy Program....................................         0.4         16.5          0.4   ..........  ...........        17.3
        Reduce Tax Fraud.......................................................  ...........        55.8         16.4   ..........  ...........        72.2
        Enhance Financial Investigations of Narcotics Trafficking Organizations  ...........        21.0          3.0   ..........  ...........        24.0
        Enhance BSA Compliance Program.........................................  ...........         2.8          0.6   ..........  ...........         3.5
        Address Complexity through Up-Front Guidance, Education, and Correction         1.1          6.5          1.3   ..........  ...........         8.9
         Opportunities.........................................................
        Expand Examination of Tax Exempt Organizations.........................         0.2         23.3          5.1   ..........  ...........        28.6
        Increase Tax Court Litigation..........................................  ...........         5.0          0.8   ..........  ...........       115.8
        Implement New Procedural Tax Court Requirements........................  ...........         2.8          0.5   ..........  ...........         3.4
        Improve Tax Gap Estimates, Measurement, and Detection of Non-Compliance  ...........         7.6          3.5   ..........  ...........        11.1
        Increase Monitoring of Preparers.......................................  ...........         2.2          0.4   ..........  ...........         2.5
                                                                                ----------------------------------------------------------------------------
          Total Enforcement....................................................         4.7        295.2         66.5   ..........  ...........       366.3
                                                                                ============================================================================
    Taxpayer Services:
        Maintain Processing of Critical Pension Plan Returns...................         6.0   ...........         0.2   ..........  ...........         6.3
        Research Taxpayer Burden, Complexity, and Compliance...................  ...........  ...........        10.0   ..........  ...........        10.0
        Expand VITA and Low Income Tax Clinics.................................         9.8   ...........         0.2   ..........  ...........        10.0
                                                                                ----------------------------------------------------------------------------
          Total Service........................................................        15.8   ...........        10.5   ..........  ...........        26.3
                                                                                ============================================================================
    Infrastructure/IT:
        Enhance IT Security....................................................  ...........  ...........        16.7   ..........  ...........        16.7
        Enhance Contingency Planning and Disaster Recovery.....................  ...........  ...........         8.7   ..........  ...........         8.7
        Implement Security Auditing............................................  ...........  ...........         6.9   ..........  ...........         6.9
        Redesign Form 990 for Tax Exempt Organizations.........................  ...........  ...........        23.5   ..........  ...........        23.5
        Preserve Quality IT Workforce..........................................  ...........  ...........        36.8   ..........  ...........        36.8
        Build Alternate Power Supply for the Comp Centers......................  ...........  ...........        11.0   ..........  ...........        11.0
                                                                                ----------------------------------------------------------------------------
          Infrastructure/IT Initiatives Subtotal...............................  ...........  ...........       103.5   ..........  ...........       103.5
                                                                                ============================================================================
    Business Systems Modernization (BSM).......................................  ...........  ...........         1.2        141.2  ...........       142.4
    HITCA......................................................................  ...........  ...........  ...........  ..........         5.5          5.5
                                                                                ----------------------------------------------------------------------------
          Total Initiatives....................................................        20.5        295.2        181.6        141.2         5.5        644.0
                                                                                ============================================================================
    Fiscal Year 2009 Budget Recommendation.....................................     2,214.7      5,151.4      3,940.6        409.7        20.9     11,737.4
    Fiscal Year 2009 Recommendation over Fiscal Year 2008 Enacted..............        64.7        371.4        260.6        142.6         5.7        845.0
    Fiscal Year 2009 President's Request for IRS...............................     2,150.0      5,117.3      3,856.2        222.7        15.4     11,361.5
    Increase Over President's Budget Request...................................        64.7         34.2         84.5        187.0         5.5        375.9
    --------------------------------------------------------------------------------------------------------------------------------------------------------

        Senator Durbin. Taxpayer Advocate, Nina Olson.
    STATEMENT OF NINA E. OLSON, NATIONAL TAXPAYER ADVOCATE,
                INTERNAL REVENUE SERVICE
        Ms. Olson. Chairman Durbin, Ranking Member Brownback, and
    members of the subcommittee, thank you for inviting me to
    testify on the proposed budget of the IRS for fiscal year 2009.
        As an initial matter, I want to acknowledge that the IRS is
    doing an excellent job with most of its core services as
    illustrated by its ability to pull off the recent filing season
    despite the late AMT patch and the need to apply its limited
    resources to providing stimulus payments. There are always
    tasks the IRS could perform better and I will address some of
    those today, but I think it is important to take a moment to
    reflect on the vast responsibilities the IRS must meet to
    collect the revenue our Government requires to function and to
    acknowledge how much the IRS does very well.
        Now, I would like to emphasize five points.
        First, in my 2006 annual report to Congress, I recommended
    that Congress provide the IRS with after-inflation budget
    increases of about 2 to 3 percent a year for the foreseeable
    future. Assuming the funds are wisely spent, I believe that
    each additional dollar appropriated for the IRS will generate
    substantially more than $1 in increased Federal revenue.
    Providing adequate funding for the IRS, which is in reality the
    accounts receivable department of the Federal Government, is a
    wise financial investment.
        Second, one of the most critical choices facing tax
    administration is how to allocate resources between taxpayer
    services and tax law enforcement. While I believe that both
    categories would benefit from additional funding, I am
    concerned that the IRS has been emphasizing enforcement at the
    expense of taxpayer services. Over the 5-year period, fiscal
    year 2004 through fiscal year 2008, GAO concluded that funding
    for enforcement has increased substantially while funding for
    taxpayer services has been reduced. The budget proposal for
    fiscal year 2009 would continue this trend.
        Moreover, while the taxpayer services appropriation is
    currently $2.2 billion, more than 70 percent of those funds are
    used for filing and account services, mostly the processing of
    tax returns. Return processing is not pure taxpayer service but
    also constitutes the first step in screening returns for audit.
    The budget subcategory titled ``pre-filing taxpayer assistance
    and education'' is what most people think of as core taxpayer
    service, and significantly, only 6 percent--6 percent--of the
    IRS budget, or $645 million, is currently devoted to this area.
    The budget proposal would reduce this $645 million taxpayer
    service amount by about $28 million, a reduction of 4.35
    percent in nominal terms and a larger reduction after taking
    into account inflation.
        There are no reliable data that show that more enforcement
    is more effective than more taxpayer service in increasing
    compliance. I believe the IRS can produce a positive return on
    investment from more funding in both areas, but given limited
    resources, I think it is misguided to continue to ramp up
    enforcement at the expense of providing core taxpayer services.
        Third, research plays a vital role in helping the IRS make
    the major strategic and operational decisions needed to
    effectively administer the tax system. Just as research and
    development (R&D) is critical to a technology company as it
    seeks to improve the products and services it provides to
    customers, tax administration-related research is critical to
    the IRS as it seeks to meet taxpayer service needs and improve
    tax compliance in a cost effective manner. For that reason, I
    have consistently advocated for a more robust IRS research
    capability.
        The Taxpayer Advocate Service has initiated or worked with
    the IRS to conduct taxpayer-centric research on several
    enforcement and service issues. Some of these projects have
    been undertaken in response to appropriations directives and
    they are detailed in my written statement.
        In my annual reports to Congress and in prior testimony, I
    have expressed serious concerns about many aspects of the
    private debt collection initiative. I now add to these concerns
    the issue of foregone revenue. Very simply, the PDC initiative
    will cost the Government more than $81 million in foregone
    revenue this year, and the cost is likely to reach nearly $500
    million over the next 6 years. Moreover, 46 percent of the
    fully paid liabilities included in PDC gross revenue have been
    collected through offsets or direct payments made by the
    taxpayer after receiving a letter from the IRS informing the
    taxpayer that his or her account would be placed with a private
    collection agency (PCA), but before the PCA made contact with
    the taxpayers. These fully paid liabilities are a direct result
    of IRS action, not action taken by the PCA. Although the
    purpose of the private debt collection (PDC) program is
    obviously to raise revenue, the PDC program has lost revenue in
    absolute terms and will continue to cost the Government
    significant foregone revenue each year.
        I will make my fifth point in my written statement so I am
    not penalized.
        Senator Durbin. Thank you very much, Ms. Olson.
        [The statement follows:]

                      Prepared Statement of Nina E. Olson

        Mr. Chairman, Ranking Member Brownback, and distinguished Members
    of the Subcommittee: Thank you for inviting me to submit this written
    statement regarding the proposed budget of the Internal Revenue Service
    (IRS) for fiscal year 2009. I will address the overall level of funding
    I believe the IRS should receive, the allocation of that funding
    between enforcement and taxpayer service, and a number of important tax
    administration issues in which this Committee has expressed an
    interest. I approach these issues from my perspective as the National
    Taxpayer Advocate, the voice for taxpayers and taxpayer rights inside
    the IRS.\1\
    ---------------------------------------------------------------------------
        \1\ The views expressed herein are solely those of the National
    Taxpayer Advocate. The National Taxpayer Advocate is appointed by the
    Secretary of the Treasury and reports to the Commissioner of Internal
    Revenue. However, the National Taxpayer Advocate presents an
    independent taxpayer perspective that does not necessarily reflect the
    position of the IRS, the Treasury Department, or the Office of
    Management and Budget. Congressional testimony requested from the
    National Taxpayer Advocate is not submitted to the IRS, the Treasury
    Department, or the Office of Management and Budget for prior approval.
    However, we have provided courtesy copies of this statement to both the
    IRS and the Treasury Department in advance of this hearing.
    ---------------------------------------------------------------------------
        As a threshold matter, I want to acknowledge that the IRS is doing
    an excellent job with most of its core services, and it is seriously
    attempting to improve its operations in other areas. This filing season
    alone demonstrates that when the IRS devotes its full attention to a
    task, it performs it extraordinarily well. As I noted in my 2007 Annual
    Report, late-year tax-law changes impact both taxpayers and the IRS,
    and the uncertainty surrounding such changes increases the risk that
    problems will arise with basic service delivery and return
    processing.\2\ These challenges increase when the IRS must devote
    substantial resources during the filing season to a major new
    initiative, such as preparing to issue the recently authorized economic
    stimulus payments. To deliver these payments, the IRS not only must
    process payments to the over 130 million taxpayers who currently file
    income tax returns, but it also must identify and process returns from
    and payments to more than 20.5 million persons who have no filing
    requirement.\3\ All of these exigencies divert the IRS from other
    important work, yet the fact that the IRS has managed to turn on a dime
    and deliver this filing season without significant glitches is a
    testament to the extraordinary people who work at the IRS.
    ---------------------------------------------------------------------------
        \2\ See National Taxpayer Advocate 2007 Annual Report to Congress
    3-12 (Most Serious Problem: The Impact of Late-Year Tax-Law Changes on
    Taxpayers).
        \3\ Approximately 20.5 million persons received Social Security or
    Veterans benefits and are therefore likely to qualify for stimulus
    payments but did not file tax returns in 2006. IRS News Release,
    Special Economic Stimulus Payment Packages Go to Social Security,
    Veterans Recipients, IRS-2008-37 (Mar. 10, 2008). There is also an
    unknown number of low income taxpayers who ordinarily would not have a
    filing requirement but will have to file this year to receive stimulus
    payments.
    ---------------------------------------------------------------------------
        There are always tasks the IRS could perform better--and I will
    address some of them below--but I think it is important to take a
    moment to reflect on the vast responsibilities the IRS must meet to
    collect the revenue our Government requires to function and to
    acknowledge how much the IRS does very well.

    To Increase Federal Revenue, Congress Should Provide Increases in IRS
            Personnel Funding at a Rate of About Two Percent to Three
            Percent a Year Above Inflation
        In my 2006 Annual Report to Congress, I recommended that Congress
    provide the IRS with after-inflation increases of about 2 percent to 3
    percent a year for the foreseeable future. Assuming the funds are
    wisely spent, I said that I believe increasing the IRS budget at this
    rate is an excellent financial investment. I continue to believe this
    is the case.
        Most Federal expenditure programs are just that--expenditure
    programs. The funds are intended to be spent on worthwhile programs,
    but the expenditures generally do not directly generate more Federal
    revenue.
        The IRS is different. The IRS is effectively the Accounts
    Receivable Department of the Federal Government, and it collects about
    96 percent of all Federal revenue.\4\ On a budget of about $10.6
    billion,\5\ the IRS collected about $2.24 trillion in fiscal year
    2006.\6\ In other words, every $1 spent on the IRS produced about $210
    in Federal revenue.\7\
    ---------------------------------------------------------------------------
        \4\ Government Accountability Office, GAO-07-136, Financial Audit:
    IRS's Fiscal Years 2006 and 2005 Financial Statements 84 (Nov. 2006).
        \5\ Department of the Treasury, Fiscal Year 2007 Budget in Brief at
    59.
        \6\ Government Accountability Office, GAO-07-136, Financial Audit:
    IRS's Fiscal Years 2006 and 2005 Financial Statements at 95 (Nov.
    2006). The IRS actually collected $2.51 trillion on a gross basis in
    fiscal year 2006, but issued $277 billion in tax refunds.
        \7\ When collecting tax from the vast majority of taxpayers who
    file returns and pay all or substantially all of the tax they owe
    voluntarily, the cost the IRS incurs per taxpayer is very low. As the
    IRS attempts to collect tax from noncompliant taxpayers through broader
    outreach efforts or through examination and collection actions, the
    cost per taxpayer rises substantially. Therefore, the marginal ROI the
    IRS achieves as it attempts to collect unpaid taxes is likely to be
    considerably lower than the average ROI of 210:1 that the IRS achieves
    on taxes paid voluntarily. But if the IRS were given more resources,
    most data indicate that the IRS could generate a substantially positive
    marginal ROI.
    ---------------------------------------------------------------------------
        If the Federal Government were a private company, its management
    clearly would fund the Accounts Receivable Department at whatever level
    it believed would maximize the company's bottom line. Since the IRS is
    not a private company, maximizing the bottom line is not--in and of
    itself--an appropriate goal. But the public sector analogue should be
    to maximize tax compliance, especially voluntary compliance, with due
    regard for protecting taxpayer rights and minimizing taxpayer burden.
    Studies show that if the IRS were given more resources, it could
    collect substantially more revenue.
        In his final report to the IRS Oversight Board in 2002, former
    Commissioner Charles Rossotti presented a discussion titled ``Winning
    the Battle but Losing the War'' that detailed the consequences of the
    lack of adequate funding for the IRS. He identified 11 specific areas
    in which the IRS lacked resources to do its job, including taxpayer
    service, collection of known tax debts, identification and collection
    of tax from non-filers, identification and collection of tax from
    underreported income, and noncompliance in the tax-exempt sector.
        Commissioner Rossotti provided estimates of the revenue cost in
    each of the 11 areas based on IRS research data. In the aggregate, the
    data indicated that the IRS lacked the resources to handle cases worth
    about $29.9 billion each year. It placed the additional funding the
    agency would have needed to handle those cases at about $2.2
    billion.\8\
    ---------------------------------------------------------------------------
        \8\ Commissioner Charles O. Rossotti, Report to the IRS Oversight
    Board: Assessment of the IRS and the Tax System 16 (Sept. 2002).
    ---------------------------------------------------------------------------
        Significantly, this estimate reflected only the potential direct
    revenue gains. Economists have estimated that the indirect effects of
    an examination on voluntary compliance provide further revenue gains.
    While the indirect revenue effects cannot be precisely quantified, two
    of the more prominent studies in the area suggest the indirect revenue
    gains are between 6 and 12 times the amount of a proposed
    adjustment.\9\
    ---------------------------------------------------------------------------
        \9\ Alan H. Plumley, Pub. 1916, The Determinants of Individual
    Income Tax Compliance: Estimating The Impacts of Tax Policy,
    Enforcement, and IRS Responsiveness 35-36 (Oct. 1996); Jeffrey A.
    Dubin, Michael J. Graetz & Louis L. Wilde, The Effect of Audit Rates on
    the Federal Individual Income Tax, 1977-1986, 43 Nat. Tax J. 395, 396,
    405 (1990).
    ---------------------------------------------------------------------------
        I want to emphasize that the existing modeling in this area is not
    especially accurate, and estimates of both the direct and indirect
    effects of IRS programs vary considerably. As I will discuss below, the
    IRS needs to develop better modeling to produce more accurate return-
    on-investment estimates. But I also want to emphasize that almost all
    studies show that, within reasonable limits, each additional dollar
    appropriated to the IRS should generate substantially more than an
    additional dollar in Federal revenue, assuming the funding is wisely
    spent.

    The IRS Currently Spends Only Six Percent of Its Budget on Taxpayer
            Assistance and Education; a More Equitable Balance Between
            Taxpayer Services and Enforcement Should Be Achieved
        One of the most critical choices facing tax administration is how
    to allocate resources between taxpayer services and tax-law
    enforcement. While I believe that both categories would benefit from
    additional funding--and I do not believe the categories should be
    viewed as mutually exclusive--I am concerned that the IRS has been
    emphasizing enforcement at the expense of taxpayer service.
        After the administration issued its fiscal year 2008 budget
    proposal last year, the GAO analyzed recent IRS funding trends. Over
    the 5-year period fiscal year 2004 through fiscal year 2008, it
    concluded that funding for enforcement has increased substantially
    while funding for taxpayer services has been reduced. Based on the
    administration's proposal for fiscal year 2008, it pointed out that
    funding over the fiscal year 2004 through fiscal year 2008 period would
    increase by 19.4 percent for enforcement while funding for taxpayer
    services would decline by 3.8 percent.\10\ The final appropriations
    bill for fiscal year 2008 made a modest adjustment to the
    administration's proposal, providing about $46.9 million more for
    taxpayer service and $145 million less for enforcement.\11\
    ---------------------------------------------------------------------------
        \10\ Government Accountability Office, GAO-07-673, Internal Revenue
    Service: Interim Results of the 2007 Tax Filing Season and the Fiscal
    Year 2008 Budget Request 27 (April 2007). These numbers are apparently
    not adjusted for inflation. GAO reported that overall IRS funding would
    increase, on an inflation-adjusted basis, by a mere 0.5 percent from
    fiscal year 2004 to fiscal year 2008 under the Administration's
    proposal. Id. at 26.
        \11\ Compare Department of the Treasury, Fiscal Year 2009 Budget in
    Brief at 53 with Department of the Treasury, Fiscal Year 2008 Budget in
    Brief at 55.
    ---------------------------------------------------------------------------
        However, the proposal for fiscal year 2009 would continue the trend
    of spending relatively more on enforcement. The pending budget proposal
    would increase enforcement spending by $490 million (7 percent), while
    increasing spending for taxpayer services by only $23 million (0.6
    percent).\12\ Thus, after inflation, the proposal would reduce taxpayer
    services spending still further.
    ---------------------------------------------------------------------------
        \12\ Department of the Treasury, Fiscal Year 2009 Budget in Brief
    at 54. These dollar amounts reflect the allocation of the Operations
    Support budget to the Taxpayer Services and Enforcement categories.
    ---------------------------------------------------------------------------
        Moreover, the budget categories of ``Taxpayer Services'' and
    ``Enforcement'' are misleading. Of the $2.2 billion in the ``Taxpayer
    Services'' category, only $645 million, or 6 percent of the IRS budget,
    is currently allocated for ``Pre-filing Taxpayer Assistance and
    Education.'' \13\ A significant majority of funds under the ``Taxpayer
    Services'' category is allocated for ``Filing and Account Services,''
    which largely covers the processing of tax returns. Returns processing
    is hardly a pure service activity. While it does enable the IRS to
    issue tax refunds, it is an internal processing function that also
    constitutes the first step in screening returns for audit. In any
    event, it is far removed from the type of taxpayer service that informs
    taxpayers about their tax obligations and assists them in complying
    with the laws. The budget proposal would reduce funding for taxpayer
    assistance and education from $645 million to $617 million--a reduction
    of 4.34 percent in nominal terms and a larger reduction after taking
    into account inflation.\14\
    ---------------------------------------------------------------------------
        \13\ Id. at 53.
        \14\ Department of the Treasury, Fiscal Year 2009 Budget in Brief
    at 53.
    ---------------------------------------------------------------------------
        I am deeply concerned about this long-term shift in the balance
    between taxpayer services and enforcement and the fact that only 6
    percent of the IRS budget is devoted to pre-filing taxpayer assistance
    and education, which I view as core taxpayer service. There is no
    reliable data showing that more enforcement is more effective than more
    taxpayer service in increasing compliance. I believe the IRS can
    produce a positive return on investment from more funding in both
    areas. But given limited resources, I think it is misguided to continue
    to ramp up enforcement at the expense of taxpayer service.
        The concerns I am expressing about the relative shift in emphasis
    from taxpayer service to enforcement do not reflect simply the
    misgivings of a zealous taxpayer advocate. My concerns are shared by
    former IRS Commissioner Rossotti. In a memoir about his experience
    running the IRS from 1997 to 2002, Mr. Rossotti wrote:

        Some critics argue that the IRS should solve its budget problem by
    reallocating resources from customer support to enforcement. In the
    IRS, customer support means answering letters, phone calls, and visits
    from taxpayers who are trying to pay the taxes they owe. Apart from the
    justifiable outrage it causes among honest taxpayers, I have never
    understood why anyone would think it is good business to fail to answer
    a phone call from someone who owed you money.\15\
    ---------------------------------------------------------------------------
        \15\ Charles O. Rossotti, Many Unhappy Returns: One Man's Quest to
    Turn Around the Most Unpopular Organization in America 285 (2005).

        At his confirmation hearing, Commissioner Shulman said that he
    believes the choice between service and enforcement is a ``false
    choice'' because the IRS must do both well.\16\ I agree completely. But
    the IRS needs adequate funding in both areas to do the job.
    ---------------------------------------------------------------------------
        \16\ Hearing Before the S. Comm. on Finance, 110th Cong. (2008)
    (Jan. 29, 2008) (statement of Douglas H. Shulman).
    ---------------------------------------------------------------------------

    The IRS Has Improved Its Research in Recent Years, But Significant
            Improvements Are Still Needed
        Research plays a vital role in helping the IRS make the major
    strategic and operational decisions needed to effectively administer
    the tax system. Just as R&D is critical to a technology company as it
    seeks to improve the products and services it provides to customers,
    tax administration-related research is critical to the IRS as it seeks
    to meet taxpayer service needs and improve tax compliance in a cost-
    effective manner. For that reason, I have consistently advocated for a
    more robust IRS research capability.
        The IRS has more information available today than it did 5 years
    ago, particularly in the area of taxpayer service because of ongoing
    work in connection with the Taxpayer Assistance Blueprint. However, the
    IRS should continue to expand its available knowledge and should make
    research an integral part of its next strategic plan. In particular,
    the IRS should make it a priority to improve the accuracy of its return
    on investment (ROI) estimates for various categories of work,
    particularly taxpayer service and the indirect effect of enforcement
    actions. Improved methods should also be developed to verify,
    retrospectively, the marginal ROI that the IRS has achieved for major
    categories of its work. Such information would be extremely helpful in
    guiding future resource-allocation decisions.
        Because of the value I place on research, TAS has initiated or
    worked with the IRS to conduct taxpayer-centric research on enforcement
    and service issues. Some of these projects have been undertaken in
    response to Appropriations directives. For example, TAS Research is
    currently working with the central IRS research function and the
    research functions in the IRS's Wage & Investment and Small Business/
    Self-Employed Divisions to develop and implement a 5-year research plan
    to enhance taxpayer service in support of the Taxpayer Assistance
    Blueprint initiative. TAS Research is collaborating with the IRS
    research community to develop a 5-year research plan directly
    supporting enterprise-wide strategic goals. TAS Research is working
    with the central IRS research function to identify and quantify the
    numerous factors that impact taxpayer compliance behavior. TAS Research
    is working with the Office of Electronic Tax Administration and
    Refundable Credits to study alternatives for increasing electronic
    filing, and will work with the IRS's National Research Program to
    conduct research into the causes of noncompliance (whether advertent or
    inadvertent).
        In addition, TAS Research is involved in a number of other
    initiatives addressing significant tax administration issues, such as:
      --A collaborative effort with the research function in the Wage &
            Investment Division to explore development of a filter for the
            Federal Payment Levy Program to protect low income taxpayers
            from systemic levies;
      --A collaborative effort with the Office of Program Evaluation and
            Risk Analysis (OPERA) to explore new applications of ``agent-
            based modeling,'' a technology that simulates taxpayer behavior
            in social networks, to tax administration issues;\17\
    ---------------------------------------------------------------------------
        \17\ National Taxpayer Advocate 2007 Annual Report to Congress,
    vol. 2 (Research Study: Simulating EITC Filing Behaviors: Validating
    Agent Based Simulation for IRS Analyses: The 2004 Hartford Case Study).
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      --A collaborative effort with the IRS research community to explore
            ways to positively influence the impact practitioners and
            preparers have on taxpayer compliance; and
      --Ongoing research by an independent contractor into the impact
            preparers have on taxpayer compliance.\18\
    ---------------------------------------------------------------------------
        \18\ National Taxpayer Advocate 2007 Annual Report to Congress,
    vol. 2 (Research Study: Study of the Role of Preparers in Relation to
    Taxpayer Compliance with Internal Revenue Laws).
    ---------------------------------------------------------------------------
        In Volume 2 of the 2007 National Taxpayer Advocate's Annual Report
    to Congress, I published a comprehensive literature review of the
    cognitive and normative factors that influence taxpayer compliance
    behavior.\19\ In another section of the report, I adopt the central
    recommendation of the study--that the IRS should establish a cognitive
    learning and applied research laboratory to explore how taxpayer
    values, social norms, and cognitive processes influence taxpayers'
    compliance.\20\
    ---------------------------------------------------------------------------
        \19\ National Taxpayer Advocate 2007 Annual Report to Congress,
    vol. 2 (Research Study: Normative and Cognitive Aspects of Tax
    Compliance: Literature Review and Recommendations for the IRS Regarding
    Individual Taxpayers).
        \20\ See National Taxpayer Advocate 2007 Annual Report to Congress
    158 (Most Serious Problem: Taxpayer Service and Behavioral Research).
    ---------------------------------------------------------------------------
        Toward that end, TAS Research is proposing a survey conducted as a
    component of the National Research Program (NRP), in which an
    independent firm surveys taxpayers who were subjects of NRP audits and
    explores the causes of any detected noncompliance and the factors
    influencing taxpayer compliance behavior. This information, combined
    with the compliance data from the NRP audits themselves and the
    observations of IRS auditors about the reasons for the detected
    noncompliance, should provide a rich resource for future studies and
    initiatives, and should improve the IRS's ability to improve taxpayer
    compliance.\21\
    ---------------------------------------------------------------------------
        \21\ For an example of how one might conduct such a study and an
    interesting analysis of some of the attitudinal and knowledge factors
    that might impact taxpayer compliance in a self-assessment tax system,
    see Ern Chen Loo, Margaret McKerchar, & Ann Hansford, An International
    Comparative Analysis of Self-Assessment: What Lessons are there for Tax
    Administrators?, 20 Australian Tax Forum 667 (2005).
    ---------------------------------------------------------------------------
        I cite these studies as important examples of research studies that
    I hope and expect will improve the IRS's ability to serve taxpayers and
    collect revenue. However, these studies are merely a starting point. If
    the IRS has better information, it can make more informed resource
    allocation decisions. Absent clear information, the IRS unavoidably
    bases its resource allocation decisions on intuition and bases its best
    guesses on incomplete data, and that is obviously not an ideal way to
    make decisions.

    The IRS Is Paying More Attention to Taxpayer Services, But Significant
            Challenges Remain
        In 2006, Congress directed the IRS to prepare a Taxpayer Assistance
    Blueprint (TAB), which was released last April.\22\ The TAB was
    intended to serve as a strategic plan for taxpayer service and lead to
    the development of taxpayer-centric, research-based models to help the
    IRS make decisions about taxpayer service and the delivery of face-to-
    face service. Because of the TAB and my own office's research, we know
    more than ever about taxpayers' needs and preferences, and their
    willingness to try new methods of service delivery.\23\
    ---------------------------------------------------------------------------
        \22\ H. Rep. No. 109-307, at 209 (2005). The Senate Committee
    Report provides further detail on the content of the 5-year plan,
    directing the IRS to: ``. . .  undertake a comprehensive review of its
    current portfolio of taxpayer services and develop a 5-year plan that
    outlines the services it should provide to improve services for
    taxpayers. This plan should detail how it [IRS] plans to meet the
    service needs on a geographic basis (by State and major metropolitan
    area), including any proposals to realign existing resources to improve
    taxpayer access to services, and address how the plan will improve
    taxpayer service based on reliable data on taxpayer service needs. As
    part of this review, the Committee strongly urges the IRS to use
    innovative approaches to taxpayer services, such as virtual technology
    and mobile units. The IRS also should expand efforts to partner with
    State and local governments and private entities to improve taxpayer
    services. S. Rep. No. 109-109, at 134 (2005).
        \23\ See National Taxpayer Advocate 2006 Report to Congress, vol. 2
    (Research Study: Study of Taxpayer Needs, Preferences, and Willingness
    to Use IRS Services).
    ---------------------------------------------------------------------------
        Over the last 2 years, the IRS has begun to reverse its trend in
    recent years of limiting the types of services and methods of delivery.
    I applaud the IRS for creating a Services Committee--the counterpart to
    the Enforcement Committee--thereby enabling the entire IRS senior
    leadership to consider and coordinate taxpayer service initiatives. The
    IRS currently is undertaking many initiatives to assist taxpayers in
    claiming economic stimulus payments, including keeping the IRS's walk-
    in sites--known as Taxpayer Assistance Centers, or TACs--open on more
    Saturdays during the filing season. I am also pleased that IRS
    management has indicated a willingness to consider reinstating Problem
    Solving Days and taking a geographic approach to determining which
    topics to designate as ``out-of-scope'' (e.g., the IRS should not treat
    farm-related questions as ``out-of-scope'' in TACs located in areas
    where there is a significant amount of farming activity). The IRS has
    also recently relaxed its stringent rules that generally prevented
    taxpayers from obtaining copies of their tax return transcripts at the
    TACs.\24\
    ---------------------------------------------------------------------------
        \24\ Previously the IRS required taxpayers to obtain transcripts of
    their accounts through the toll-free service, which would mail a
    transcript within seven to ten days. Taxpayers could only obtain
    transcripts at TACs in ``emergency'' situations. It was TAS's
    experience that the TACs almost never acknowledged an emergency
    situation. In fact, since that policy was in place, TAS transcript
    cases have increased sharply. The IRS's more flexible transcript policy
    should result in fewer TAS cases in this area.
    ---------------------------------------------------------------------------
        It remains to be seen, however, whether the IRS will dedicate the
    resources--both in terms of personnel, dollars, and priorities--
    necessary to make the TAB a reality. I discuss a few of my concerns
    below.

                Sustained Funding for Taxpayer Services Is Crucial to
                        Meeting Taxpayer Needs

        Any reduction in the IRS's taxpayer service budget presents a
    significant challenge to implementation of the TAB. In fact, taxpayer
    service funding should be increased so that, while the IRS continues to
    deliver its traditional services, programs developed by the TAB team
    are not just piloted but are instead fully implemented. For example,
    this filing season the IRS is piloting an approach in the TACs called
    ``Facilitated Self Assistance.'' Under this model, taxpayers who come
    to certain TACs for assistance may carry out designated service tasks
    on IRS.gov or the IRS phone system with the help of a live IRS
    assistor. Preliminary feedback from the 15 TACs offering Facilitated
    Self-Assistance has been positive. Without sufficient funding, however,
    the IRS will be unable to expand the pilot testing, let alone fully
    implement the program, no matter how successful it might be. If the
    financial support for taxpayer service is not sufficient, the TAB
    process will have been for naught--having produced many interesting
    ideas and important research that simply cannot be implemented or
    applied.
                Internet Services Are Important, But They Cannot Be the
                        Only Game in Town

        Insufficient funding increases the temptation for the IRS to put
    all its eggs in one basket when it comes to taxpayer service--namely,
    self-assisted Internet services. The Internet may be adequate for
    taxpayers who are comfortable handling financial transactions online,
    but the TAB's research studies showed that a certain percentage of
    taxpayers, and particular types of tax issues, require personal
    interaction--by telephone, face-to-face, or both.
        For example, we now know that nearly 25 percent of taxpayers do not
    have Internet access.\25\ Additionally, more than 25 percent of
    taxpayers stated that they are unwilling to use the IRS website for any
    service activities in the future.\26\ Among taxpayers who used IRS
    services between mid-2004 and mid-2006, about 45 percent of those who
    called the IRS and more than 75 percent of those who visited the IRS
    stated they would not use the IRS website. When probed further as to
    why they would not use the website, more than half gave a reason that
    suggests they could not use the website due to lack of computer
    equipment, Internet access or computer savvy.\27\ Approximately 75
    percent of taxpayers stated they do not feel comfortable sharing
    personal information via the Internet.\28\ Approximately 12 percent of
    taxpayers have some type of disability, \29\ and about 6 percent of
    taxpayers speak a language other than English at home.\30\
    ---------------------------------------------------------------------------
        \25\ W&I Research, Opinion Survey of Taxpayer Resources and
    Services, 2006--Question 7--22.5 percent-24.6 percent.
        \26\ W&I Research, Opinion Survey of Taxpayer Resources and
    Services, 2006--Question 8--25.3 percent-27.4 percent.
        \27\ IRS Oversight Board, 2006 Service Channels Survey, Questions
    17, 19 & 20: About 50 percent (42.5 percent-57.5 percent) of taxpayers
    who called or visited the IRS are unwilling to use IRS.gov (i.e., 37.2
    percent-52.7 percent of those who called and 60.5 percent-92.7 percent
    of those who visited the IRS stated they would not use the IRS Internet
    site). More than 23 percent of taxpayers called or visited the IRS
    between mid-2004 and mid-2006, which translates to roughly 32 million
    taxpayers (based on a filing population of slightly less than 135
    million). About half of taxpayers who use IRS phone or TAC services,
    approximately 16 million taxpayers, are unable or unwilling to use the
    Internet. IRS, 2006 Filing Season Statistics, Cumulative Through 10/27/
    06, Individual Income Tax Returns total receipts = 134,919,000.
        \28\ IRS Oversight Board, 2006 Service Channels Survey, Question
    11: 70.2 percent-76.2 percent do not feel comfortable sharing personal
    information over the Internet. Reasons include privacy concerns (33.4
    percent-40.8 percent) and Internet security issues (41.9 percent-49.6
    percent).
        \29\ W&I Research, Opinion Survey of Taxpayer Resources and
    Services, 2006, Question 19: 87.2 percent-88.7 percent of taxpayers do
    not have a disability.
        \30\ W&I Research, Opinion Survey of Taxpayer Resources and
    Services, 2006, Question 20: 5.4 percent-6.8 percent of taxpayers speak
    a language other than English.
    ---------------------------------------------------------------------------
        The IRS has an obligation to provide services through methods that
    will assist all taxpayers. The IRS must therefore maintain and improve
    its telephone and face-to-face services for as long as there is a
    segment of the population that needs it--which, given the complexity of
    the tax law and IRS procedures, will be as far into the future as I can
    see.

                The IRS Should Expand and Improve the Services Provided by
                        Taxpayer Assistance Centers

        For several years I have highlighted problems with the IRS's
    delivery of face-to-face taxpayer services in the TACs.\31\ In my 2007
    Annual Report to Congress, I identified several problems that limit the
    usefulness of the TACs, including the insufficient number and staffing
    of TACs and the significant conditions for obtaining return preparation
    assistance that have the effect of deterring taxpayers from seeking
    service.
    ---------------------------------------------------------------------------
        \31\ See National Taxpayer Advocate 2007 Annual Report to Congress
    162-182 (Most Serious Problem: Service at Taxpayer Assistance Centers),
    see also National Taxpayer Advocate 2006 Annual Report to Congress xi-
    xiv (Taxpayer Assistance Blueprint: The National Taxpayer Advocate's
    Perspective); National Taxpayer Advocate 2005 Annual Report to Congress
    2-24 (Most Serious Problem: Trends in Taxpayer Service); National
    Taxpayer Advocate 2004 Annual Report to Congress 8-66 (Most Serious
    Problem: Customer Service in a Complex and Changing Tax Environment).
    ---------------------------------------------------------------------------
                The Location and Number of TACs May Not Be Adequate

        In 2001, the IRS committed to opening 118 new TACs in the following
    seven to 8 years.\32\ Unfortunately, none of these new TACs was opened,
    and the IRS even initiated an unsuccessful effort to close 68 TACs.\33\
    The TAB concluded that TAC offices were adequately serving only 60
    percent of the United States population.\34\ In order to make better
    decisions about the location, number, and staffing of TACs, the IRS
    developed a decision tool about TAC operations. However, that tool only
    includes the present TAC locations. It is not clear whether the IRS
    will use this program to consider adding TAC locations, even though TAB
    research demonstrates that TAC coverage across the United States is
    insufficient. Thus, we recommend that the IRS conduct additional
    research of population segments to determine the volume, scope, and
    type of services that taxpayers require by geographical location, and
    utilize its TAC decision tool to identify the most appropriate number
    and placement of TACs.
    ---------------------------------------------------------------------------
        \32\ National Taxpayer Advocate 2001 Annual Report to Congress 49.
        \33\ IRS News Release, IRS to Create Efficiencies with Taxpayer
    Assistance Centers, IR-2005-63 (June 27, 2005).
        \34\ Internal Revenue Service, Taxpayer Assistance Blueprint: Phase
    2, at 116 (Apr. 17, 2007).
    ---------------------------------------------------------------------------
                TAC Staffing and the Availability of Services Are
                        Inadequate To Meet Taxpayer Needs

        Only 55 percent of TACs are open for 36 to 40 hours per week, and
    during the last 3 years, the IRS reduced TAC staffing by 9 percent,
    leaving most TAC offices with staffing shortages.\35\ Although the IRS
    is now hiring seasonal workers to ease the staffing crunch, I believe
    the IRS should make a firm commitment to providing TACs with the level
    of staffing necessary to meet taxpayer needs.
    ---------------------------------------------------------------------------
        \35\ Information obtained from IRS Wage & Investment Division
    (Field Assistance function) (September 2007).
    ---------------------------------------------------------------------------
                The IRS Should Meet its Fundamental Tax Administration
                        Responsibility To Provide Tax Return Preparation
                        Assistance for Low Income Taxpayers

        I am concerned that the IRS imposes too many barriers and
    limitations on tax preparation. I am pleased that the IRS heeded our
    earlier criticism and has changed its position on requiring taxpayers
    to visit a TAC twice in order to obtain return preparation services--
    once to make the appointment and once to have the return prepared.
    However, the IRS continues to downplay its own role in tax preparation.
        To my mind, tax preparation is a core service for the tax
    administrator. The tax administrator cannot look to the nonprofit
    sector alone to meet the needs of the millions of low income taxpayers,
    including many elderly taxpayers, who cannot afford to pay a return
    preparer. Yet the IRS continues to straddle the line--it prepares
    enough returns to allow it to claim it is providing the service but
    makes it very difficult in some cases for taxpayers to obtain
    assistance. For example, the IRS has declared returns involving
    cancellation of debt income ``out of scope'' both for the TACs and for
    volunteer preparation sites, \36\ even though those subjects are highly
    likely to impact the very taxpayers who are eligible for TAC services
    (whether because of credit card debt forgiveness or home foreclosures).
    Thus, these low income taxpayers have no alternative but to pay for
    return preparation, something they generally cannot afford to do.
    ---------------------------------------------------------------------------
        \36\ IRS Small Business/Self-Employed Division, Response to TAS
    Information Request (Oct. 30, 2007).
    ---------------------------------------------------------------------------
        It is not just individual taxpayers who suffer from this
    restriction on preparation services in the TACs. Today, organizations
    exempt from tax under IRC  501(c)(3) are generally required to file an
    e-postcard annually if their gross receipts are normally $25,000 or
    less, providing the IRS with basic contact information and informing
    the IRS whether the organization is still a going concern.\37\ Failure
    to file for 3 consecutive years will result in automatic revocation of
    the organization's exempt status.\38\
    ---------------------------------------------------------------------------
        \37\ IRC  6033(i); IRC  6033(a)(3)(B); Announcement 82-88, 1982-
    25 I.R.B. 23.
        \38\ IRC  6033(j).
    ---------------------------------------------------------------------------
        Approximately half of exempt organizations have all-volunteer
    staffs and another third have fewer than 10 employees.\39\ These
    smaller nonprofits frequently lack professional tax guidance and rely
    on their volunteers to deal with the IRS.\40\ Yet the TACs have agreed
    to assist exempt organizations with filing the e-postcard on the
    condition that the IRS not publicize the availability of this
    assistance. Thus, the only way a small exempt organization will know
    whether the IRS will help it is if it happens to visit a TAC on its own
    initiative. This ``we will provide you service but we won't tell you
    about it'' approach falls well short of the level of service the public
    has a right to expect from its Government.
    ---------------------------------------------------------------------------
        \39\ IRS, TE/GE Fiscal Year 2005 Strategic Assessment 3 (Feb. 2,
    2005).
        \40\ Id.
    ---------------------------------------------------------------------------
                The IRS Should Explore Alternative Methods of Delivering
                        Face-to-Face Services

        In 2003, the IRS committed to providing alternative methods of
    service to taxpayers.\41\ Among the ideas proposed were alternative
    locations to brick-and-mortar TACs and mobile units specifically
    tailored to the needs of the communities they serve.\42\ I support
    these ideas, and I strongly encourage the IRS to pursue them and to
    explore other service methods as well. For example, the IRS should
    partner with State tax agencies, or other service-oriented Government
    agencies such as the Social Security Administration, to provide one-
    stop shopping for taxpayers. Additionally, the IRS could co-locate with
    other agencies, both State and Federal, to offer services targeting a
    specific taxpaying population (e.g., co-locate with Departments of
    Motor Vehicles to offer excise fuel tax assistance to truck drivers).
    ---------------------------------------------------------------------------
        \41\ National Taxpayer Advocate 2003 Annual Report to Congress 149.
        \42\ Id.
    ---------------------------------------------------------------------------
        I commend the IRS's recent coordination of ``Super Saturday'' to
    assist taxpayers in filing economic stimulus payment returns. The IRS
    should replicate that approach in similar efforts targeted at other
    groups of taxpayers. The IRS previously sponsored ``Problem Solving
    Days,'' where taxpayers could receive assistance on any tax issue and
    potentially have their problems resolved with one contact. The IRS
    should bring back Problem Solving Days using Super Saturday as a model
    and aggressively market the effort to taxpayers. Other initiatives
    could include National Filing Days, which I recommended in my 2007
    Annual Report to Congress, where taxpayers who are currently not in
    compliance with their tax obligations could come to the IRS and be
    brought into compliance.\43\
    ---------------------------------------------------------------------------
        \43\ National Taxpayer Advocate 2007 Annual Report to Congress 257.
    ---------------------------------------------------------------------------
                The IRS Should Expand Outreach and Education in the Exempt
                        Organization Sector

        If the IRS is to increase compliance by exempt organizations (EOs),
    more resources must be devoted to outreach to, and education of, these
    organizations. I commend the Tax Exempt and Government Entities (TE/GE)
    Division's Customer Education and Outreach (CE&O) office for its
    existing efforts to address the needs of EOs. CE&O has done much with
    few resources, but it cannot adequately carry out its mission without
    better funding. TE/GE allocated only approximately $1.2 million or 1.4
    percent of its $85.4 million fiscal year 2007 EO budget to education
    and outreach.\44\ The number of EO education and outreach full-time
    equivalents (FTEs) has stagnated at approximately 12 for the last three
    fiscal years \45\ while the number of EOs has grown by more than 70,000
    per year.\46\ Twelve FTEs are simply not enough to carry on the
    important work of EO education and outreach, regardless of how cost-
    effective and innovative the IRS's outreach methods may be.
    ---------------------------------------------------------------------------
        \44\ Information received from Tax Exempt/Government Entities
    Division (Nov. 7, 2007).
        \45\ Information received from Tax Exempt/Government Entities
    Division (Nov. 6, 2007); IRS, Tax Exempt and Government Entities
    Business Performance Review 21 (May 9, 2007).
        \46\ Remarks of Steven T. Miller, Commissioner, IRS Tax Exempt and
    Government Entities Division, before the Philanthropy Roundtable (Dec.
    10, 2007).
    ---------------------------------------------------------------------------
        TE/GE has leveraged its limited EO education and outreach resources
    through increased use of electronic means. Electronic education and
    outreach is an excellent tool that should be used in conjunction with,
    but not supplant, face-to-face and non-electronic outreach. For
    example, the Charities and Non-Profits page of the IRS website contains
    many useful materials, but the IRS needs to proactively distribute hard
    copies of those materials through partners and outreach sessions rather
    than wait for EOs to find and view them online. Moreover, the IRS must
    obtain better data on EOs' access to the Internet, how EOs use the
    Internet, and EOs' willingness and ability to change how they use the
    Internet before investing further in electronic education and outreach.
        IRS Daily Delinquency Penalty (DDP) abatement rates reveal that
    there is great potential to reduce noncompliance with more education
    and outreach. The IRS may assess a DDP when an EO files an information
    return with missing or incorrect information \47\ but will abate the
    DDP if the penalized organization later supplies the missing
    information or corrects the error and shows reasonable cause for the
    mistake.\48\ Between 2000 and 2005, the IRS abated almost 62 percent of
    all assessed DDPs and nearly 68 percent of all assessed DDP dollars
    (nearly $857 million).\49\ A study conducted by the IRS in 2003 found
    that most assessed DDPs were attributable to organizations' failure to
    include Schedules A and B with their returns.\50\
    ---------------------------------------------------------------------------
        \47\ IRC  6652(c)(1)(A).
        \48\ IRC  6652(c)(4).
        \49\ IRS Enforcement Revenue Information System (ERIS) and
    Statistics of Income (SOI) for EO Returns, 2000-2005 DDP assessments
    and abatements. See also National Taxpayer Advocate 2006 Annual Report
    to Congress 491 (Legislative Recommendation: Increase the Exempt
    Organization Information Return Filing Threshold).
        \50\ Ogden Form 990 Study, Attachment to Memorandum for Director,
    Exempt Organization SE:T:EO, EO Correspondence Review and Timeframes
    (Oct. 2003).
    ---------------------------------------------------------------------------
        The annual cycle of DDP assessment and abatement is not good for
    anyone. EOs that receive DDP assessments due to curable errors must use
    their resources to get the IRS to abate the penalty. Alternatively,
    they may simply pay the penalties to avoid dealing with the IRS but are
    likely to be penalized again if they do not work with the IRS to find
    out why the penalties were assessed. The DDP assessment/abatement cycle
    also wastes IRS resources. When more than 60 percent of all assessed
    DDP penalties are abated, IRS employees are spending significant time
    determining whether the mistakes that gave rise to the assessments were
    attributable to reasonable cause.

                To Reduce the Tax Gap, the IRS Should Place More Emphasis
                        on Combating Noncompliance in the Cash Economy
        As you know, the gross ``tax gap''--the amount of tax that is not
    voluntarily and timely reported and paid--stood at an estimated $345
    billion in 2001 and remains a serious problem.\51\ As a result,
    households that comply with their tax obligations effectively pay a
    ``surtax'' averaging about $2,680 per year to subsidize noncompliance
    by others.\52\ Where taxable payments are reported to the IRS by third
    parties, taxpayers generally report well over 90 percent of their
    income.\53\ By contrast, where taxable payments are not reported to the
    IRS by third parties, reporting compliance drops below 50 percent.\54\
    Therefore, it should come as no surprise that underreported income from
    the ``cash economy''--which, for tax administration purposes, we define
    as taxable income from legal activities that is not subject to
    information reporting or withholding--is probably the single largest
    component of the tax gap, likely accounting for over $100 billion per
    year.\55\
    ---------------------------------------------------------------------------
        \51\ The gross tax gap is the amount of tax that is imposed by law
    for a given tax year, but not voluntarily and timely paid. The net tax
    gap is the portion of the gross tax gap that remains uncollected after
    taking into account late payments and IRS enforcement actions for a
    given tax year. The 2004 IRS National Research Program study estimated
    the 2001 gross tax gap at $345 billion and the net tax gap at $290
    billion. IRS, Tax Gap Map for Year 2001 (Feb. 2007), available at
    http://www.irs.gov/pub/irs-utl/tax_gap_update_070212.pdf. These figures
    do not include unpaid tax on income from illegal activities.
        \52\ If we divide the estimated 2001 net tax gap of $290 billion by
    the estimated 108,209,000 U.S. households in 2001, we see that each
    household was effectively assessed an average ``surtax'' of about
    $2,680 to subsidize noncompliance. See U.S. Census Bureau, Population
    Division (data as of Mar. 2001).
        \53\ See IRS News Release, IRS Updates Tax Gap Estimates, IR-2006-
    28 (Feb. 14, 2006) (accompanying charts), available at http://
    www.irs.gov/newsroom/article/0,,id=154496,00.html.
        \54\ Id.
        \55\ Id. Underreporting makes up about 83 percent of the tax gap
    ($285 billion of the $345 billion gap). Underreporting of business
    income by individuals--from sole proprietors, rents and royalties, and
    pass-through entities--accounted for about $109 billion. Associated
    underreporting of self-employment taxes by unincorporated businesses
    accounts for another $39 billion. Id.
    ---------------------------------------------------------------------------
        Noncompliance in the cash economy merits special attention because
    the IRS's traditional enforcement tools such as document matching and
    audits are less effective when there is no third-party reporting, and
    also because it is growing. According to one study, the percentage of
    all income subject to third-party information reporting fell from 91.3
    percent in 1980 to 81.6 percent in 2000.\56\ The IRS's filing
    projections suggest that the cash economy and the amount of unreported
    income may continue to grow.\57\
    ---------------------------------------------------------------------------
        \56\ Kim Bloomquist, Trends as Changes in Variance: The Case of Tax
    Noncompliance, presented at the 2003 IRS Research Conference (June
    2003) (citing growth in capital gains, partnership, and small business
    income).
        \57\ The IRS expects the number of individual returns from small
    business or self-employed taxpayers to grow by about 33 percent between
    2006 and 2014, while the number of individual returns from other
    taxpayers is expected to decline by about 2 percent over the same
    period. IRS Office of Research, Research, Analysis and Statistics,
    Document 6292, Fiscal Year Return Projections for the United States,
    2007-2014 (Sept. 2007), available at http://www.irs.gov/pub/irs-soi/
    d6292.pdf.
    ---------------------------------------------------------------------------
                The IRS Should Establish a Cash Economy Program Office To
                        Increase the Effectiveness of its Efforts

        In my 2007 Annual Report to Congress, I proposed a comprehensive
    strategy to address the cash economy portion of the tax gap that
    consisted of 15 administrative recommendations and seven legislative
    recommendations.\58\ As a threshold matter, I believe the IRS should
    establish a Cash Economy Program Office. The office would have
    responsibility for coordinating efforts to improve compliance in the
    cash economy. At present, there is no single unit or executive within
    the IRS with responsibility for ensuring that enforcement, research,
    and educational activities aimed at the cash economy are implemented in
    a coordinated fashion. The IRS uses a coordinated approach to address
    certain other issues--an example being the EITC Program Office--and I
    believe a program office would help the IRS address the cash economy as
    well. Such an office would bring accountability to the effort because
    it could measure its success based on the impact of IRS initiatives on
    compliance by cash economy participants.\59\ Absent a strategic,
    coordinated approach, the IRS is less likely to make progress in
    reducing noncompliance in the cash economy.
    ---------------------------------------------------------------------------
        \58\ See National Taxpayer Advocate 2007 Annual Report to Congress
    35-65 (Most Serious Problem: The Cash Economy), 490-502 (Legislative
    Recommendation: Measures to Address Noncompliance in the Cash Economy),
    and vol. 2, at 1-43 (Research Study: A Comprehensive Strategy for
    Addressing the Cash Economy).
        \59\ The Treasury Inspector General for Tax Administration and the
    Government Accountability Office both generally agree that measures
    that promote accountability would help the IRS reduce the tax gap. See,
    e.g., Government Accountability Office, GAO-06-208T, Multiple
    Strategies, Better Compliance Data, and Long-Term Goals Are Needed to
    Improve Taxpayer Compliance (Oct. 26, 2005); Written Statement of
    Russell George, Treasury Inspector General for Tax Administration,
    Hearing Before the Senate Committee on Appropriations Subcommittee on
    Transportation, Treasury, the Judiciary, Housing and Urban Development,
    and Related Agencies on the Internal Revenue Service's Fiscal Year 2006
    Budget Request (Apr. 7, 2005).
    ---------------------------------------------------------------------------
                The IRS Should Research the Most Effective Use of Its Audit
                        Resources

        In addressing the cash economy, the IRS should also leverage its
    limited audit resources by investing in research to identify the most
    effective uses of these resources after taking into account the direct
    and indirect effects of IRS activities on tax revenue. In addition to
    the direct revenue that audits generate from the taxpayer for the
    period(s) under audit, as discussed above, economists estimate the
    indirect effects or ``ripple effects'' of an audit on voluntary
    compliance by other taxpayers or by the same taxpayer in future periods
    provide even greater revenue gains.\60\ The IRS needs more and better
    research on how best to use limited audit resources to improve
    compliance in the cash economy. For example:
    ---------------------------------------------------------------------------
        \60\ See, e.g., Alan H. Plumley, Pub. 1916, The Determinants of
    Individual Income Tax Compliance: Estimating The Impacts of Tax Policy,
    Enforcement, and IRS Responsiveness 35-36 (Oct. 1996).
    ---------------------------------------------------------------------------
      --Should the IRS use more correspondence examinations or face-to-face
            examinations in cash economy industries? Does the answer depend
            on the industry?
      --To achieve the greatest impact, should audits be clustered either
            geographically or within industries, so as to generate maximum
            publicity and possibly change local or industry norms, or
            should audits be more spread out in a dispersed pattern of
            ``touches''?
      --Do audits have an even greater ``ripple'' effect on compliance when
            coupled with outreach and education targeted at unaudited
            members of the same community?
        My other recommendations fall into four broad categories: (1)
    making compliance easier, (2) increasing income visibility and the
    productivity of audits, (3) increasing the focus on preparers, and (4)
    identifying areas where additional research is needed to help the IRS
    understand how it can efficiently improve voluntary compliance.\61\
    ---------------------------------------------------------------------------
        \61\ See National Taxpayer Advocate 2007 Annual Report to Congress
    35-65 (Most Serious Problem: The Cash Economy), 490-502 (Legislative
    Recommendation: Measures to Address Noncompliance in the Cash Economy),
    and vol. 2, at 1-43 (Research Study: A Comprehensive Strategy for
    Addressing the Cash Economy).
    ---------------------------------------------------------------------------
    The Private Debt Collection Initiative Will Cost the Federal Government
            at Least $81 Million in Foregone Revenue Annually and Should Be
            Terminated
        In my Annual Reports to Congress and in prior testimony, I have
    expressed serious concerns about many aspects of the private debt
    collection (PDC) initiative, including the potential for violations of
    taxpayer rights, the fact that private collection agency (PCA)
    procedures are less transparent to the public--and to congressional
    oversight--than IRS procedures, and the evidence that the so-called
    ``simple'' cases on which the program was initially promoted do not
    exist in significant numbers.\62\
    ---------------------------------------------------------------------------
        \62\ See National Taxpayer Advocate 2007 Annual Report to Congress
    411-431 (Status Update: Private Debt Collection); National Taxpayer
    Advocate 2006 Annual Report to Congress 34-61 (Most Serious Problem:
    True Costs and Benefits of Private Debt Collection) and 458-462
    (Legislative Recommendation: Repeal Private Debt Collection
    Provisions); IRS Private Debt Collection: Hearing Before the H. Comm.
    on Ways and Means, 110th Cong. (May 23, 2007) (statement of Nina E.
    Olson, National Taxpayer Advocate).
    ---------------------------------------------------------------------------
        I now add to these concerns the issue of foregone revenue. Very
    simply, the PDC initiative will cost the Government more than $81
    million in foregone revenue this year, and the cost is likely to reach
    nearly a half billion dollars over the next 6 years. I explain below
    how I arrive at this conclusion.
        The IRS projects that it will use $7.65 million in appropriated
    funds in fiscal year 2008 to administer the PDC program, and it
    anticipates relatively steady costs in future years.\63\ At the same
    time, the IRS estimates that the program will generate gross revenue
    averaging about $23 million this year and next, \64\ and it is unlikely
    that gross revenue will increase in future years unless the nature of
    the program changes significantly. By these calculations and after
    subtracting the direct costs of the program ($7.65 million) and
    commissions payable to the PCAs (about $4.60 million), the program can
    be expected to yield annual net revenue of about $11 million. Thus, an
    annual IRS expenditure of $7.65 million will produce annual net revenue
    of about $11 million, which translates to about a 1.45:1 net return on
    investment (ROI).\65\
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        \63\ E-mail from Director, PDC Program Office, to TAS Attorney
    Advisor (Feb. 29, 2008).
        \64\ Id.
        \65\ As discussed in the text below, the data I have cited actually
    overstate the likely ROI because the IRS's cost estimates are not
    comprehensive (e.g., they do not include the time that Taxpayer
    Advocate Service case advocates spend assisting taxpayers who request
    our help with PDC cases or the time senior IRS executives must devote
    to studying, monitoring, and answering continual questions about the
    program) and the IRS's revenue estimates include funds that the IRS
    collects on the basis of its initial letter--before the PCAs make any
    contact with the taxpayers.
    ---------------------------------------------------------------------------
        If the PDC program did not exist and the IRS instead allocated
    $7.65 million in appropriated funds to its Automated Collection System
    (ACS) function, the ROI would be substantially higher. IRS data shows
    that the average ROI for the ACS program is about 20:1, which means an
    expenditure of $7.65 million would generate annual revenue of $153
    million.\66\ In testimony before the House Ways and Means Committee
    last May, Acting Commissioner Kevin Brown placed the ACS ROI somewhat
    lower, at about 13:1.\67\ Even accepting the lower figure, a 13:1 ROI
    on an expenditure of $7.65 million would produce gross revenue of
    $99.45 million and net revenue (after subtracting the $7.65 million
    expenditure) of $91.8 million.
    ---------------------------------------------------------------------------
        \66\ We have computed the full cost of an average ACS employee at
    slightly less than $75,000 (assuming GS-8, step 5). The current average
    amount collected by an ACS employee per year is about $1.53 million.
    That volume of collection translates to a return-on investment on the
    average ACS employee of about 20:1.
        \67\ IRS Private Debt Collection: Hearing Before the H. Comm. on
    Ways and Means, 110th Cong. (May 23, 2007) (testimony of Kevin M.
    Brown, Acting Commissioner of Internal Revenue).
    ---------------------------------------------------------------------------
        Thus, the IRS's expenditure of $7.65 million in appropriated funds
    is generating about $11 million in net revenue when applied to the PDC
    program but should generate at least $91.8 million if applied to its
    ACS collection function. In other words, the opportunity cost of
    spending $7.65 million of appropriated funds on the PDC program each
    year is $81 million, and possibly much more.
        Since the purpose of private debt collection is to raise revenue,
    the fact that it is costing the Government $81 million or more each
    year destroys whatever thin rationale might remain for its existence.

                The $7.65 Million Cost Estimate for the PDC Program Fails
                        to Capture Significant Costs
        In addition to consuming $7.65 million in annual operating costs,
    the PDC program required $70 million in start-up costs. The IRS
    previously estimated that it would recoup these ``sunk'' costs in
    fiscal year 2008 but now acknowledges that fiscal year 2010 is the
    earliest point at which the initiative is likely to ``break even.''
    \68\ Moreover, as of September 2007, the IRS had 54 employees (and this
    total does not include Modernization & Information Technology Services
    (MITS) infrastructure or TAS case working employees) working on the
    initiative and overseeing 62 employees from the PCAs.\69\
    ---------------------------------------------------------------------------
        \68\ The 2008 Filing Season: Hearing Before the H. Comm. on Ways
    and Means, 110th Cong. (Mar. 13, 2008) (testimony of Linda E. Stiff,
    Acting Commissioner of Internal Revenue).
        \69\ IRS Response to Information Request on PDC Initiative (Sept.
    2007).
    ---------------------------------------------------------------------------
        The annual expenditure of $7.65 million is significant for an
    initiative that is failing in most respects. Additionally, we have
    learned that the $7.65 million cost estimate provided by the IRS does
    not include numerous expenses. The $7.65 million cost estimate includes
    PDC-related costs incurred by the IRS referral unit and most IRS
    headquarters staff as well as costs incurred by MITS for support and by
    TAS to cover the cost of one employee assigned to work with the PDC
    Project Office. However, the $7.65 million cost estimate does not
    include the PDC-related costs incurred by the IRS Office of Chief
    Counsel, which is periodically consulted for legal advice; the IRS
    Office of Legislative Affairs, which has spent considerable time
    presenting the program to Members and Committees of the Congress and
    responding to inquiries; by TAS for working with more than 1,500
    taxpayers who have sought our assistance on PCA-related cases; or by
    other IRS functions that have helped to support the program.\70\ We
    have been unable to obtain a complete estimate of the costs of the
    program.
    ---------------------------------------------------------------------------
        \70\ IRS Response to TAS Request for Information (April 10, 2008).
    ---------------------------------------------------------------------------
                The IRS's Own Collection Actions Account for a Significant
                        Portion of the PDC Program's Full-Paid Accounts
        Almost half--specifically, 46 percent--of the fully paid
    liabilities included in PDC gross revenue has been collected through
    offsets or direct payments made by the taxpayer after receiving a
    letter from the IRS informing the taxpayer that his or her account
    would be placed with a PCA but before the PCA made contact with the
    taxpayer.\71\ These fully paid liabilities are a direct result of IRS
    action--not action taken by a PCA.
    ---------------------------------------------------------------------------
        \71\ The 46 percent of fully paid liabilities includes payments
    received by the IRS through the following means: (a) dollars received
    by the government 10 calendar days or less after the IRS transferred
    the account to the contractor; (b) unidentified payments (i.e.,
    payments that cannot be matched and posted to a debtor's account within
    the contractor's inventory of accounts); (c) dollars collected in
    excess of an individual's balance, resulting in overpayment by the
    debtor; (d) dollars received on any account 11 calendar days or more
    after the account was returned to the IRS except as specifically
    described by contract; and (e) dollars received through Federal, State
    or local administrative, tax refund, salary, Treasury offset, Federal
    Levy payment or other type of offset or other administrative action
    which results in the reduction or elimination of the debt in a manner
    beyond the scope of the contractor's performance. IRS, Request for
    Quotation, Request No. TIRNO-05-Q-00187, at 22 ( A.4.1). The National
    Taxpayer Advocate's 2006 Annual Report to Congress reported that, while
    the IRS would not send accounts to private collectors that were already
    subject to levy under the Federal Payment Levy Program (FPLP), the IRS
    would not recall accounts already assigned to a PCA if the account
    becomes subject to an FPLP levy after assignment. National Taxpayer
    Advocate 2006 Annual Report to Congress 43. When the IRS first
    described its vision of the PDC program to Congress, the IRS maintained
    that cases under enforcement action were not the types of cases that
    would be referred to private collectors. Private Debt Collection:
    Hearing Before the Subcomm. on Oversight of the House Comm. on Ways and
    Means, 108th Cong. (May 13, 2003) (testimony of Commissioner Mark W.
    Everson). As a consequence of the IRS's decision to leave FPLP cases
    with private collectors, private collectors are contacting taxpayers
    whose Social Security payments are already under active FPLP levies and
    are demanding full payment of the tax liability.
    ---------------------------------------------------------------------------
        Moreover, more than half of the payments received by the PDC
    initiative are fully paid liabilities.\72\ In many of these cases, the
    IRS had taken no action on the accounts after its standard ``notice
    stream'' had run its course. However, these data seem to indicate that
    if the IRS were to spend 41 cents on a letter to taxpayers sometime
    after the end of the standard notice stream to say, in effect, ``Hello,
    we're back,'' the IRS could obtain a meaningful return.
    ---------------------------------------------------------------------------
        \72\ IRS, Filing Payment Compliance Advisory Council (April. 14,
    2008) at 3.
    ---------------------------------------------------------------------------
                The Inventory of ``Easy'' Cases for PCAs To Work Has
                        Largely Dried Up

        The PDC initiative has taken several steps to address the lower
    than expected revenue, which are deviations from the original intent of
    the initiative.\73\ Because the number of ``easy'' cases was also
    smaller than expected, the IRS began to include older inventory which
    is more difficult to resolve.\74\ The IRS is still searching for other
    types of cases to hand over to the PCAs, many of which are complex,
    require discretion, and are already being worked by the IRS's own
    collection function. For example, the IRS is studying the feasibility
    of assigning cases in which the taxpayer has not agreed to the entire
    outstanding tax liability.\75\ The IRS is also considering placing with
    the PCAs cases that ACS is currently working, and it is studying 1,500
    modules to identify cases that it can move from actual IRS ACS
    inventory to the PCAs.\76\ Thus, the IRS is now proposing to give the
    PCAs the types of cases that the IRS itself is already working and
    could continue to work at a greater rate in the future. Placing these
    types of cases with the PCAs is precisely the opposite of the premise
    on which the program was sold--namely, giving PCAs only the easy cases
    the IRS itself otherwise would not work.\77\
    ---------------------------------------------------------------------------
        \73\ Former Commissioner Mark Everson testified: ``Private
    collectors will work the easy cases, thereby ensuring that they will
    not engage in `inherently governmental' activities and that the IRS
    will be able to focus on more complex work.'' Private Debt Collection:
    Hearing Before the Subcomm. on Oversight of the H. Comm. on Ways and
    Means, 108th Cong. (May 13, 2003) (statement of Commissioner Mark W.
    Everson). I also testified to that point: ``The IRS has stated that it
    will only send to PCAs those cases that meet the following criteria:
    (1) the taxpayer has either agreed to the tax debt and/or has made
    three or more payments toward that debt; and (2) the taxpayer appears
    to have the ability to pay this debt in full immediately or within 36
    months. It is vital to the success of this proposal that only those
    cases that fit these parameters are selected and referred to the
    PCAs.'' IRS Use of Private Debt Collection Agencies by the IRS: Hearing
    Before the Subcomm. on Oversight of the H. Comm. Ways and Means, 108th
    Cong. (May 13, 2003) (statement of Nina E. Olson, National Taxpayer
    Advocate).
        \74\ The IRS had to remove 15,500 cases from the initial inventory
    of 42,800 cases that would possibly have been assigned to private
    collectors. These cases were removed because the taxpayer had previous
    shelved delinquencies. IRS, Filing & Payment Compliance Advisory
    Council Presentation 9 (July 31, 2006).
        \75\ IRS, Filing and Payment Compliance Advisory Council (Jan. 14,
    2008) at 7.
        \76\ IRS, Filing and Payment Compliance Advisory Council (Feb. 11,
    2008) at 10.
        \77\ Private Debt Collection: Hearing Before the Subcomm. on
    Oversight of the H. Comm. on Ways and Means, 108th Cong. (May 13, 2003)
    (testimony of Commissioner Mark W. Everson).
    ---------------------------------------------------------------------------
                The IRS Has Left Cases in the Control of PCAs for Much
                        Longer Than It Originally Intended

        The IRS's concern about the PDC initiative's low revenue might have
    influenced the IRS decision to extend the timeframe for which
    unresolved cases from the initial stage of the PDC program (known as
    Release 1.1) will remain with the PCAs.\78\ Initially, the IRS planned
    to recall taxpayer accounts after 12 months.\79\ However, the IRS
    extended the recall to 18 months and now has extended it until the
    collection curve on these cases declines, but it is not clear how
    significant the decline must be for the recall to begin.\80\ Nor is it
    clear how frequently the PCAs attempt to collect on these cases or
    whether the taxpayers would be better off if their cases were sent back
    to the IRS.
    ---------------------------------------------------------------------------
        \78\IRS, Filing and Payment Compliance Advisory Council (Mar. 10,
    2008) at 12.
        \79\IRS, Request for Quotation, Request No. TIRNO-05-Q-00187, at 22
    ( A.4.5). Taxpayer accounts will be automatically recalled after 12
    months unless the account condition warrants continued work efforts by
    the Contractor assigned the case. Conditions that would warrant an
    extension of the placement period may include acceptable payment within
    60 calendar days prior to recall date or approval from the Contracting
    Officer's Technical Representative (COTR). The IRS can request the
    return of a case at any time upon notice to the PCA.
        \80\ IRS, Filing and Payment Compliance Advisory Council (Mar. 10,
    2008) at 12.
    ---------------------------------------------------------------------------
                To Evaluate the Cost Effectiveness of the PDC Program, an
                        ``Apples-to-Apples'' Comparison Between IRS
                        Employees and PCA Employees Is Needed

        As I have recommended in my reports to Congress, to determine the
    true efficiency and effectiveness of PCAs to the IRS collection
    function, I believe the IRS should design and implement a true apples-
    to-apples comparison of IRS and PCA collection.\81\ The version of the
    IRS fiscal year 2008 funding bill reported by this Committee last year
    directed the IRS to conduct a test to make such a comparison.\82\
    Although this mandate was not contained in the final funding
    legislation, the IRS has taken steps toward implementing an apples-to-
    apples test. In January of 2008, the IRS created a team, which included
    TAS, to design such a test. The test would use IRS employees with
    similar skill sets as the PCA employees and limit IRS enforcement
    powers so their authority to take action on a case would mirror that of
    the PCAs, thereby creating an apples-to-apples comparison. In addition,
    it would create an entry-level bridge position for IRS employees who
    would like to obtain collection experience. These employees could work
    these easy cases that only require a phone call or could help locate
    taxpayers. This would be an opportunity for the IRS to train new
    collection employees and address the IRS's challenge to fill behind an
    aging workforce. Now that the test has been designed, it is time to put
    it into action so the IRS can honestly evaluate who can do this work
    better.
    ---------------------------------------------------------------------------
        \81\ See National Taxpayer Advocate 2007 Annual Report to Congress
    416-418, and National Taxpayer Advocate 2006 Annual Report to Congress
    34-61.
        \82\ Financial Services and General Government Appropriations Act,
    2008, H.R. 2829, 110th Cong.  113 (as reported by S. Comm. on
    Appropriations, July 13, 2007).
    ---------------------------------------------------------------------------
    The IRS Should Reassess Its Approach to e-filing to Ensure That the
            Needs of All Taxpayers Are Addressed and that All Taxpayers May
            Prepare Their Returns and File Directly with the IRS Without
            Charge
        While the IRS has made impressive progress in increasing the rate
    of electronic filing, it is still far from reaching the congressionally
    mandated goal of 80 percent.\83\ During the 2007 filing season, almost
    57 percent of all individual returns were filed electronically.\84\ As
    the tax administrator, the IRS has the authority to determine the
    policies and criteria that entities must meet to participate in the e-
    file program. In important respects, however, it appears that the IRS
    has historically relinquished control of the electronic filing program
    to private industry and faces difficulty in re-asserting ownership of
    the program. Considering the significant benefits e-filing affords to
    both the IRS and taxpayers, we are pleased that the IRS is currently
    evaluating its role in the e-file program in order to increase the rate
    of e-file and to properly align its policies and procedures to meet the
    best interests of taxpayers and the agency itself. We encourage the IRS
    to consult with the Office of the Taxpayer Advocate on this important
    matter, and we look forward to lending support in any manner possible.
    ---------------------------------------------------------------------------
        \83\ The IRS Restructuring and Reform Act of 1998 directed the IRS
    to set a goal of having 80 percent of all returns filed electronically
    by 2007. See Internal Revenue Service Restructuring and Reform Act,
    Pub. L. No. 105-206,  2001(a)(2), 112 Stat. 685 (1998). The 80 percent
    e-filing goal was not achieved by 2007. However, we believe Congress
    should reiterate its commitment to requiring the IRS increase the e-
    filing rate as quickly as possible.
        \84\ IRS News Release, IRS E-File Opens for 2008 Filing Season for
    Most Taxpayers, IR-2008-5 (Jan. 10, 2008).
    ---------------------------------------------------------------------------
        The IRS has an incentive to increase the rate of electronic filing
    to the highest level possible. Electronic filing of tax returns brings
    benefits to both taxpayers and the IRS.\85\ From a taxpayer
    perspective, e-filing improves accuracy by eliminating the risk of IRS
    transcription errors, pre-screens returns to ensure that certain common
    errors are fixed before returns are accepted, and speeds the delivery
    of refunds. From an IRS perspective, e-filing eliminates the need for
    data transcribers to input return data manually (which permits the IRS
    to shift resources to other areas), allows the IRS to capture return
    data electronically, and enables the IRS to process and review returns
    more quickly.\86\
    ---------------------------------------------------------------------------
        \85\ See S. Rep. No. 105-174, at 39-40 (1998).
        \86\ See IRS Fact Sheet, 2008 IRS E-File, FS-2008-4 (Jan. 2008).
    ---------------------------------------------------------------------------
        Nearly one-third of all individual returns processed by the IRS
    through October 2007--or 43 million returns--were prepared using
    software yet mailed rather than submitted electronically.\87\ These
    taxpayers could have e-filed their returns once they were prepared
    using computer software, but for some reason, the taxpayers chose to
    file paper returns. If the IRS successfully converts a significant
    portion of these taxpayers to electronic filing, it would approach, and
    perhaps surpass, the 80 percent e-filing goal.
    ---------------------------------------------------------------------------
        \87\ IRS Tax Year 2006 Taxpayer Usage Study (through Oct. 26,
    2007).
    ---------------------------------------------------------------------------
        I have advocated for years for the IRS to place a basic, fill-in
    template on its website to permit taxpayers to self-prepare their tax
    returns and file directly with the IRS for free.\88\ There is no reason
    why taxpayers should be required to pay transaction fees to file their
    returns electronically. A free template and direct filing portal would
    address some taxpayers' cost and security concerns and would result in
    a greater number of e-filed tax returns. For those taxpayers who are
    comfortable preparing their returns without assistance, the Government
    should provide the means for them to do so without charge. For those
    taxpayers who do not find a basic template sufficient and would prefer
    to avail themselves of the additional benefits of a sophisticated
    software program, they would remain free to purchase one.
    ---------------------------------------------------------------------------
        \88\ See, e.g., National Taxpayer Advocate 2004 Annual Report to
    Congress 471-477. We have proposed that the IRS create an electronic
    tax return that is analogous to the paper environment, but that also
    incorporates the benefits of electronic technology. Specifically, the
    return should be fill-in, with math checking and number-transfer
    capability. The fill-in return should link to line-by-line IRS
    instructions for each form, and where the IRS instructions reference a
    publication, there should be active links to specific sections of the
    forms. Where the instructions or publications have worksheets embedded
    in them, these worksheets should be fill-in, with math-checking and
    number-transfer capability. These capabilities are important, since
    they will substantially reduce the number of ``math error'' notices the
    IRS must issue each year.
    ---------------------------------------------------------------------------
        During a visit to the Australian Taxation Office (ATO) last month,
    I had the opportunity to learn first-hand about Australia's e-file
    program. The ATO built e-tax, a direct filing program, completely in-
    house and officially launched the program in 1999. The resulting e-file
    (e-tax) rates are impressive.\89\ For the 2005-2006 tax period,
    approximately 49 percent of all individuals who self-prepared filed
    their returns through e-tax, while only 7.5 percent of U.S. taxpayers
    who self-prepared their returns used Free File for tax year 2006 (and
    only 2.9 percent of all individual income tax returns filed in tax year
    2006 were prepared using Free File).\90\ Further, only tax agents (the
    Australian equivalent to tax return preparers) use commercial software
    to prepare and file returns.\91\ It is our understanding that the IRS
    is currently evaluating the Australian taxation system. We hope the IRS
    can apply lessons learned from Australia's experience to our own e-file
    program, especially with regard to ATO's direct filing program, e-tax.
    ---------------------------------------------------------------------------
        \89\ Unlike Free File, e-tax is available to taxpayers at all
    income levels. For information on e-tax, see http://www.ato.gov.au/
    corporate/content.asp?doc=/content/83847.htm&pc=001/001/001/
    005&mnu=&mfp=&st=&cy=1 (last visited April 7, 2008).
        \90\ Australian Taxation Office, Taxation Statistics 2005-06,
    available at http://www.ato.gov.au/content/downloads/
    00117625_2006CH2PER.pdf (last visited April 7, 2008); E-Gov, IRS Free
    File Performance Measures--Summary View, available at http://
    www.whitehouse.gov/omb/egov/c-7-3-irs.html (last visited April 7,
    2008). Specifically, 1,521,780 individual self-preparers filed through
    Australia's e-tax program in tax year 2005/2006 out of a total of
    3,132,230 self-preparers. The remaining 8,378,729 individual taxpayers
    used tax agents (return preparers). In the United States, 3.9 million
    individual taxpayers self-prepared for tax year 2006 on Free File out
    of 49 million total self-preparers. Approximately 135 million U.S.
    individual returns were filed for tax year 2006. IRS Document 6149,
    Calendar Year Return Projections by State, CY 2007-2014 (Rev. 12.2007),
    Table 1.
        \91\ Tax agents are regulated by the statutorily created Tax Agent
    Boards located in every state. For more information on the relationship
    between tax agents and tax administration in Australia, see http://
    www.ato.gov.au/corporate/content.asp?doc=/content/66215.htm (last
    visited March 27, 2008).
    ---------------------------------------------------------------------------
        Recent, highly publicized phishing schemes confirm the need for the
    IRS to develop a free fill-in template and direct filing portal. During
    the 2007 filing season, for example, an Internet tax scam lured
    taxpayers into entering confidential tax return information on sites
    masquerading as Free File sites, and these taxpayers became victims of
    identity theft.\92\ It is understandable that some potential Free File
    users fall victim to scams, especially when taxpayers wishing to
    prepare their returns pursuant to an IRS sanctioned program visit the
    official IRS website only to be directed to one of 19 potentially
    unfamiliar commercial websites. All taxpayers should have the option to
    prepare and file their Federal income tax returns on the IRS's own
    website.\93\ Although Free File is accessible through the official IRS
    website, not all taxpayers are eligible to use the program.
    Approximately 30 percent of individual taxpayers--which amounts to more
    than 40 million taxpayers--are ineligible for IRS Free File.\94\
    Moreover, the IRS exerts little control over the content of each Free
    File program. As a consequence, each of the programs has its own
    eligibility requirements, capabilities and limitations, and the
    complexity is confusing to taxpayers.
    ---------------------------------------------------------------------------
        \92\ See IRS News Release, Late Tax Scam Discovered; Free File
    Users Reminded to Use IRS.gov, IR-2007-87 (April 13, 2007). The IRS is
    also aware of several phishing schemes during the 2008 filing season.
    See IRS News Release, IRS Warns of New E-Mail and Telephone Scams Using
    the IRS Name; Advance Payment Scams Starting, IR-2008-11 (Jan. 30,
    2008).
        \93\ Congress contemplated the IRS developing a basic electronic
    template in the IRS Restructuring and Reform Act of 1998, Pub. L. No.
    105-206, 112 Stat. 685 (1998). The RRA 98 conference report states that
    ``the conferees also intend that the IRS should continue to offer and
    improve its Telefile program and make available a comparable program on
    the Internet.'' H.R. Rep. No. 105-599, at 235 (1998) (Conf. Rep.).
        \94\ Taxpayers must have adjusted gross income of $54,000 or less
    to be eligible. See IRS Fact Sheet, 2008 IRS E-File, FS-2008-4 (Jan.
    2008); Free Online Electronic Tax Filing Agreement Amendment (2005),
    available at http://www.irs.gov/pub/irs-efile/free_file_agreement.pdf
    (last visited on April 7, 2008). Ironically, some members of the Free
    File Alliance provided free services to 100 percent of taxpayers under
    the initial term of the Free File Agreement and wanted to continue to
    do so, but the Treasury Department agreed with the Free File Alliance
    to place a cap on the number of taxpayers who would qualify for free
    tax preparation and filing services. As a consequence, Free File
    members are now restricted in the number of taxpayers to whom they may
    offer their services.
    ---------------------------------------------------------------------------
        Despite the IRS's best efforts, some paper filers will refuse to
    convert to e-file. For those cases, the IRS should develop 2-D bar code
    technology, which would provide taxpayers and the IRS with many of the
    same benefits as electronic filing.\95\ It is my understanding that the
    IRS has already incorporated this technology into other functions.
    ---------------------------------------------------------------------------
        \95\ To utilize 2-D bar code technology, a taxpayer or preparer
    uses software to complete the return. Once printed, the return has a
    horizontal and vertical bar code containing tax return information. The
    IRS scans the return, captures the data, decodes it, and processes the
    return as if it had been sent electronically.
    ---------------------------------------------------------------------------
        Pursuant to an Appropriations directive, the IRS Office of
    Electronic Tax Administration and Refundable Credits (ETA) is
    developing a comprehensive strategic plan to meet the 80 percent e-file
    goal.\96\ ETA has commissioned MITRE to conduct the Advancing E-File
    Study, and we are pleased that the study will determine or review the
    following items:
    ---------------------------------------------------------------------------
        \96\ Staff of H. Comm. on Appropriations, 110th Cong., H.R. 2764,
    Consolidated Appropriations Act, 2008, Pub. L. 110-161, Explanatory
    Statement at 871 (Comm. Print 2007); Staff of H. Comm. on
    Appropriations, 110th Cong., Financial Services and Government
    Appropriations Bill, 2008, at 28 (Comm. Print July 2007). Although the
    deadline for submission of the study was March 1, 2008, the IRS Office
    of Electronic Tax Administration and Refundable Credits has faced
    considerable challenges during the current filing season, and it is
    planning to complete the study later this year.
    ---------------------------------------------------------------------------
      --The characteristics of paper and e-filers as well as potential
            barriers to e-file;
      --The current third-party model of tax administration and current
            trends in State and foreign governments; and
      --Potential strategies to increase the rate of e-file or any other
            means to receive return information electronically. This will
            entail a review of direct filing with the IRS, 2-D bar coding,
            and Telefile.\97\
    ---------------------------------------------------------------------------
        \97\ Information Provided by Electronic Tax Administration (Jan.
    30, 2008); Diane Freda, IRS to Study Direct Filing Portal, 2-D Bar
    Coding to Boost E-Filing, BNA Daily Tax Report (Jan. 29, 2008); MITRE
    IRS FFRDC, Center for Enterprise Modernization, IRS Advancing E-File
    Study: Draft Overview of Findings to Date (Jan. 31, 2008) (on file with
    the Office of the Taxpayer Advocate).
    ---------------------------------------------------------------------------
        I believe this study represents an important first step in the
    Government's fulfilling its core responsibility to taxpayers in a
    secure and straightforward fashion, without competing with the private
    sector. The Appropriations directive states that this strategic plan
    should be developed in consultation with me and other stakeholders, and
    I look forward to continuing to work with the IRS on this study.
        Finally, I believe that the IRS should take a more proactive role
    in the electronic filing arena by setting the policies and standards
    for participation in the IRS e-file program. Such policies and
    procedures should align with the needs of both taxpayers and tax
    administration. All high quality return preparation and filing products
    should have equal access to the market, reflect the latest tax law
    changes, and be compatible with filing season peaks in demand as well
    as IRS's computer and processing needs. Moreover, all programs should
    meet IRS established minimum standards for data and identity security,
    and these standards should apply to both for-profit and free tax
    preparation offerings.\98\ Unless the IRS takes corrective action, the
    IRS remains in a reactive position at the whim of private industry and
    is forced to devote scarce resources to address the downstream
    consequences of potentially avoidable problems. We are encouraged that
    the IRS is currently evaluating its role in the e-file program as part
    of the Advancing E-File Study and look forward to lending support to
    the study as well as to receiving periodic briefings of research
    findings as the study progresses.
    ---------------------------------------------------------------------------
        \98\ At the time of this writing, it is not clear how many of the
    programs listed on the IRS e-file partner webpage would meet IRS-
    developed data or identity security specifications.
    ---------------------------------------------------------------------------
    Taxpayer Advocate Service Case Receipts Have Risen by 47 Percent Since
            Fiscal Year 2004 While the Number of Case Advocates Available
            To Work Taxpayer Cases Has Declined by 13 Percent
        I will close with a brief report on my own organization, the
    Taxpayer Advocate Service (TAS), and its role in identifying and
    mitigating the downstream consequences of IRS actions and programs, and
    improving taxpayers' attitudes toward the tax system. Since I became
    the National Taxpayer Advocate in 2001, I am pleased to say that TAS
    has grown up as an organization and substantially improved its ability
    to assist taxpayers. In fiscal year 2001, our quality measures showed a
    performance level of 71.6 percent. In fiscal year 2007, TAS's talented
    and dedicated employees managed to achieve a quality rating of 90.5
    percent. The performance of TAS employees since fiscal year 2004 has
    been particularly commendable--TAS case receipts rose an overwhelming
    47 percent from fiscal year 2004 to fiscal year 2007,\99\ while the
    number of case advocates available to work those cases declined by 13
    percent over the same period. Yet we have managed to handle this
    increased workload while maintaining consistent case quality over these
    3 years.
    ---------------------------------------------------------------------------
        \99\ In fiscal year 2007, TAS received a total of 247,839 cases. In
    fiscal year 2004, TAS received a total of 168,856 cases.
    ---------------------------------------------------------------------------
        The increase in TAS cases is not surprising. The IRS has
    substantially increased the number of its compliance actions in recent
    years,\100\ and about 65 percent of TAS's cases are classified as
    ``compliance'' related.\101\ Increasing the number of compliance cases
    inevitably produces a corresponding increase in TAS cases. Thus, the
    greater IRS emphasis on enforcement has resulted in a greater need for
    TAS services. Economic downturns also contribute to increases in TAS
    inventory, as taxpayers who lose their jobs and become unable to pay
    their tax bills get into trouble with the IRS and seek assistance.\102\
    ---------------------------------------------------------------------------
        \100\ On the Examination side, the number of individual return
    closures increased by 37 percent and the number of business return
    closures increased by 102 percent from fiscal year 2004 to fiscal year
    2007. On the Collection side, the number of levies increased by 85
    percent, the number of liens increased by 28 percent, and the number of
    seizures increased by 54 percent over the same period. See Internal
    Revenue Service, fiscal year 2007 Enforcement and Services Results
    (Jan. 17, 2008) (accompanying fiscal year 2007 Enforcement and Services
    Tables), available at http://www.irs.gov/pub/irs-news/
    irs_enforcement_and_service_tables_fy_2007.pdf.
        \101\ In fiscal year 2007, TAS classified 160,131 case receipts as
    compliance-related and 87,708 as service-related, for a total of
    247,839 case receipts.
        \102\ TAS received 86,261 economic burden case receipts in fiscal
    year 2007 compared with 34,653 in fiscal year 2004--a 149 percent
    increase.
    ---------------------------------------------------------------------------
        TAS is able to assist most taxpayers who seek our help. Overall,
    TAS was able to obtain full relief for the taxpayer in 69 percent of
    the cases we closed in fiscal year 2007 and partial relief in an
    additional 4 percent of our cases.
        TAS Customer Satisfaction surveys provide some evidence that the
    quality and nature of taxpayer service has an impact on taxpayer
    attitudes toward the tax system. When a taxpayer brings an eligible
    case to TAS, he is assigned a case advocate who works with him
    throughout the pendency of the case. Taxpayers have a toll-free number
    direct to that case advocate, and each TAS office has a toll-free fax
    number. TAS employees are required to spot and address all related
    issues and to educate the taxpayer about how to avoid the problem from
    occurring again, if possible. This level and quality of service drives
    TAS's high taxpayer satisfaction scores, as evidenced by the results
    for the last 2 years. In fiscal year 2006 and fiscal year 2007, the
    percentage score for overall satisfaction of the taxpayers who came to
    TAS was 85 percent and 83 percent, respectively. Equally important, 50
    percent of taxpayers stated that they felt better about the IRS as a
    whole after coming to TAS. Even among taxpayers who did not obtain the
    result they sought, an impressive 34 percent reported that they had a
    more positive opinion of the IRS because of their experience with
    TAS.\103\
    ---------------------------------------------------------------------------
        \103\ For fiscal year 2006, the Gallup Organization collected the
    customer satisfaction data for the Taxpayer Advocate Service. In fiscal
    year 2007, TAS began using a new vendor, Macro International, to
    conduct its surveys.
    ---------------------------------------------------------------------------
        However, I am concerned that with the increasing volume,
    complexity, and urgency of TAS's caseload, the cycle time for our cases
    has begun to increase. Closed case cycle time was 71.1 days in fiscal
    year 2004 but has risen to 80.6 days in fiscal year 2008.\104\ These
    results are hardly surprising. If you increase the workload of a
    customer service organization by 47 percent and reduce the number of
    employees available to assist customers by 13 percent, you are
    essentially increasing the average workload of each employee by nearly
    70 percent. And because TAS generally assists taxpayers only where they
    face an imminent economic burden because of an IRS collection action or
    where normal IRS procedures have failed, TAS does not have much
    flexibility to turn away cases. Indeed, TAS expects to receive more
    than 250,000 cases in fiscal year 2008, and our case inventory
    continues to rise. If the balance between TAS staffing and the number
    of cases we handle does not improve, I am concerned that TAS is in
    jeopardy of becoming part of the IRS problem rather than the advocate
    for the solution, as Congress intended.
    ---------------------------------------------------------------------------
        \104\ Fiscal Year 2008 data reflects case closures from October 1,
    2007 through March 31, 2008 (six months).
    ---------------------------------------------------------------------------
        Lastly, I provide a brief report on the Low Income Taxpayer Clinic
    (LITC) program, which is administered by my office. For fiscal year
    2008, the IRS's Taxpayer Services appropriation included $9 million for
    LITC grants. This appropriation represented an increase of $1 million
    compared with the 2007 grant cycle.\105\ The LITC program currently
    funds 154 clinics in all 50 States, the District of Columbia, Puerto
    Rico, and Guam, thus meeting my goal of having at least one LITC in
    each State. The increased appropriation allows us to provide funding
    for new clinics as well as to provide increased funding for existing
    clinics that have expanded or plan to expand their services to
    underserved areas and populations. This additional funding also has
    enabled the LITC Program to work toward its goal of funding at least
    one controversy and at least one English as a Second Language (ESL)
    clinic in every State. The LITC Program Office, in conjunction with TAS
    Research, has identified locations where there are significant
    populations of low income and ESL taxpayers who are not currently
    served by a clinic. Recently, we announced a supplemental grant period
    to solicit qualified organizations willing to address the needs of
    these identified areas.\106\
    ---------------------------------------------------------------------------
        \105\ Although appropriations are made on a fiscal-year basis,
    grants for the LITC program are awarded on a calendar-year basis (which
    we refer to as the ``grant cycle'').
        \106\ Low Income Taxpayer Clinic Grant Program; Availability of
    2008 Supplemental Grant Application Period, 73 Fed. Reg. 15,841-42
    (Mar. 25, 2008).
    ---------------------------------------------------------------------------
    Conclusion
        Compared to the IRS of 10 years ago, the IRS of today is a more
    responsive and effective organization. On the customer service side,
    the IRS Restructuring and Reform Act of 1998 and the IRS response have
    brought about fairly dramatic improvements, and the Taxpayer Assistance
    Blueprint, created in response to an Appropriations directive, provides
    a useful roadmap to maintain and improve the delivery of taxpayer
    services. On the enforcement side, the IRS has been ramping up its
    enforcement of the tax laws, particularly with regard to corporate tax
    shelters and high-income individuals, and the results have generally
    been positive.
        But the IRS can, and should, do better. To increase voluntary
    compliance, the IRS should incorporate an ongoing taxpayer-centric
    assessment of taxpayer service needs into its strategic plans. It
    should consider whether it can meet taxpayer service needs adequately
    when it devotes only 6 percent of its budget to taxpayer assistance and
    education. It should conduct research (including applied research) into
    the causes of noncompliance and apply the resulting knowledge to IRS
    enforcement strategies, including those pertaining to the cash economy.
    Finally, the IRS must have sufficient resources to move forward with
    its technological improvements, which are critical to its ability to
    improve both its Taxpayer Services and Enforcement functions.

                            PRIVATE DEBT COLLECTION

        Senator Durbin. What a loser this private debt collection
    is. I mean, it just seems like we are stuck on this. Not to say
    anything negative about our colleagues, but my guess is that it
    is just a nice, little business with a bunch of employees in
    several places in America that the Senator and Congressmen want
    to keep open, but it sounds like it is a bad deal. This is
    privatization that is costing us more than if we used the
    public employee. Is that your conclusion?
        Ms. Olson. Well, I think that it originated in a concern
    that there was a pool of taxpayers that the IRS was not
    currently touching and that we were not going to get additional
    appropriations to hire employees to touch those taxpayers. And
    what has turned out is that, first, that pool of cases, the
    ones that are easy to work, do not exist. We are running out of
    those cases and we are reaching into cases that the IRS is
    actually scheduled to work, and we are stretching the bounds of
    what PCAs can do efficiently.
        The second thing we have found is what I highlighted in my
    testimony, that a lot of these cases, if the IRS sent a
    letter--we get a return that a lot of these cases have just
    been sitting there----
        Senator Durbin. You said 46 percent.
        Ms. Olson. For a 41-cent stamp, we would get the taxpayer
    going, oh, they are back on the scene. We need to respond to
    them instead of our other creditors.
        Senator Durbin. Of course, if the private debt collector
    gets in, they get what? Twenty-five cents on $1?
        Ms. Olson. Well, up to 25 cents on $1? Yes, correct.
        Senator Durbin. So that seems like a loser.
        Mr. George, about this brain drain, do you know what the
    IRS is doing to use student loan forgiveness to either recruit
    or retain talented people?
        Mr. George. Actually I do not, Mr. Chairman. Allow us to
    get back to you on that.
        Senator Durbin. Would you?
        Mr. George. But if I may, though, could I briefly address
    the private debt collection issue?
        Senator Durbin. Sure.
        Mr. George. Because TIGTA recently conducted an audit and
    there are a couple of facts that I would like to share with
    this subcommittee for your appreciation.
        As of February 23 of this year, the total cases assigned to
    the private debt collection agencies are approximately 98,000
    with the dollars assigned of just under $900 million. The
    actual payments received as a result of this program are $46.19
    million. Out of this, the commissions paid to the private debt
    collectors has been just over $7 million. The number of
    accounts paid. Again, out of approximately 98,000, the total
    number of accounts fully paid is just over 12,000. The number
    of accounts entering into installment agreements is just over
    5,000, and the number of accounts referred to, as we call them,
    taxpayer account services is just over 1,300.
        We really do not know whether or not a simple letter would
    achieve these results. We have not done the research to give
    you a definitive answer in that regard. But Senator Brownback
    may recall that when he was on the Government Reform
    Subcommittee, chaired by Congressman Stephen Horn, over 10
    years ago, we worked on this very issue. Back then the program,
    the pilot that was established, was an abject failure. No one
    would disagree with that point. Here we just simply do not know
    whether the startup costs are those that the private sector
    would simply assume are a part of doing business as the startup
    costs.
        So the bottom line is I am saying I want to make sure that
    this tax gap is addressed somehow and if turning to a project
    such as a private debt collection would help address it----
        Senator Durbin. It sounds objective and valid, but it is
    not working. How long have we been trying this now?
        Ms. Olson. The program started in September 2006, and in
    fact, the way it is structured is any payments that come in the
    first 10 days in response to the first letter the IRS sends to
    the taxpayer saying, hello, we are back, we are going to send
    your case out to the private debt collectors if you do not
    respond to us, are non-commissionable payments. And we do have
    those numbers. In 2007, out of the $32 million--is that how
    much we collected? And $31 million in 2007. About $5 million
    came in the first 10 days.
        So you can see it is about 19 percent of the collections
    were in response to the IRS letter, and I maintain that if we
    sent a letter saying, hello, we are back and we could levy on
    your bank account, on your pay stub, all the things that we
    could do, we would get a response.
        Senator Durbin. I am going to go over time here.
        Senator Brownback. I will not tax you.
        Senator Durbin. Thanks. No penalties, no interest.

                         BUSINESS SYSTEMS MODERNIZATION

        Mr. Cherecwich, my experience has been that the Federal
    Government is not very darned good when it comes to business
    modernization systems. And I have some personal experience
    since 9/11 trying to get the FBI to have an updated computer
    system. I cannot tell you how much money we have wasted in that
    effort and still are not where we ought to be.
        There are similar efforts that have been made in trying to
    verify visas coming in and out of this country. For more than
    10 years, we have failed to come up with what appears to be a
    pretty simple task.
        So what kind of confidence do you have if more money is
    funneled into the IRS for business modernization systems and
    technology that it is going to be well spent?
        Mr. Cherecwich. A couple of responses to that, Senator.
    Typically with high-tech projects, you have a little bit of
    risk going into them, and delays and failure to meet schedules
    are to be expected. Any business that tries to install a
    massive computer system like we are talking about, a massive
    information system, will expect to have hiccups along the road.
    What happens in business when you get a hiccup along the road
    is not that you cut the funding because they are bad boys. You
    turn around and you provide the support in the manner in which
    you feel that they can deal with that.
        Now, how do I feel comfortable that they can deal with
    that? The IRS in the last few years has developed something
    they call a modernization and visions strategy for their
    computer systems, their information structures. And this
    modernization and visions strategy is a tool in which projects
    can be prioritized and the appropriate management assigned to
    make them work. It is an overall program that gives me a great
    deal of comfort that the IRS is on a proper path to properly
    manage this.
        Where we will run into difficulty is this ramped-down stuff
    where we start losing all the skilled people. We need to have
    good, steady, level funding and keep moving forward.
        Senator Durbin. I am going to ask my ranking member a favor
    here. I have to take a phone call, and if he would be kind
    enough to ask questions and recess the subcommittee meeting. I
    want to personally thank the panel and others who have been
    here today to help us.
        Senator Brownback.
        Senator Brownback [presiding]. Thank you very much.
        All those in favor of a flat tax?
        I have got to wait until he gets out of the room.

                               TAX SIMPLIFICATION

        I want to look at tax complexity. You guys are very
    familiar with this Code. I think the difficulties of
    enforcement are interesting.
        I presume all of you would agree with me that if Congress
    provided a simpler Code, that there would be more compliance
    with the tax system.
        Mr. Cherecwich. It is hard to argue with that one.
        Mr. George. I agree, Senator Brownback.
        Senator Brownback. Have you studied or looked at other
    countries that have simplified codes--other industrialized
    countries that have a similar system and know of compliance
    rates? Nina?
        Ms. Olson. Well, I think that some of them are--although
    the IRS might not like this heard--comparable to us. Some of
    them have divided their tax systems between a modest income tax
    and then a value-added tax or a goods and services tax.
        I think that some of the directions talking about a return-
    free system, some of the systems like Sweden where they have so
    much information on their individuals, that they have a very
    high compliance rate, but they know more about their citizens--
    --
        Senator Brownback. Yes. Well, our folks do not really go
    for that.
        Ms. Olson [continuing]. Than United States people would
    want.
        Senator Brownback. But are there other industrialized
    countries that have simplified systems that are not thoroughly
    penetrated into a person's personal information?
        Ms. Olson. I was just in Australia this past month for a
    tax conference, and they have a system that has income tax, has
    a pay as you earn essentially system, so that many people just
    like the United Kingdom do not have to file taxes because the
    taxes are paid by the employer and you pay what you pay each
    paycheck and you do not do a return reconciling. You only file
    a return when you have sole proprietorship income or capital
    gains, you know, transactions that the tax system would not
    know about. And then the rest of the tax is made up by either a
    goods and services or a value-added tax, which is paid along
    the way and is invisible to the individual taxpayer at least.
        Senator Brownback. What would you like to see us do to
    simplify the system?
        Obviously, up here in Congress we use the Tax Code to try
    to manipulate the economy, to try to stimulate the economy, to
    try to get people to do certain things. And each attempt adds a
    layer of complexity, and we are all guilty of it. Every
    lobbyist in town is hired by somebody to do something in this
    Tax Code, and they are very good. So you have got an incredibly
    complex Tax Code.
        But what would you like to see us do? What should we do on
    tax simplification?
        Ms. Olson. Well, let me hedge my comments by saying I do
    not do tax policy. I look at this from the taxpayer's
    perspective in terms of being asked to comply with the laws and
    the difficulty there. And so I will not go into whether it
    needs to be a flat tax or what kind of tax. But whatever tax
    system we have it has to be intuitive to the basic taxpayer and
    not impose arcane rules like the alternative minimum tax that
    confuses people.
        I think that the President's reform panel made some really
    interesting proposals, and I would like to see some of them
    revisited.
        I think that, as well, we do need to look around the world
    and see what other industrial nations are doing and what the
    differences are with their population and our population. We
    have to keep the taxpayer's perspective in mind and say what is
    it that taxpayers can handle so that we do not set them up for
    problems.
        Senator Brownback. I have studied some on the flat tax
    systems in different countries, and the countries I have gone
    to are generally second world countries. But they substantially
    lowered their rate. They simplified their system. They
    increased Government revenue substantially in those places and
    they increased compliance. Currently, with high rates and
    complexity, a lot of people just said, I am out of here. I am
    going to figure a way around you guys, and did. But if it got
    down to a rate that was fairly simple, a lot more people will
    say, well, rather than trying to skip around this, I will pay
    it. That is that intuitive piece, I think, of what you are
    saying.
        Ms. Olson. Yes. Well, and I think also that goes to
    something else we have been recommending which is that IRS do
    more research into the reasons that taxpayers do not comply
    because once you learn that, you can incorporate that into not
    only just how do you do your outreach and your education and
    your enforcement initiatives, but also into your system design.
    If you know what causes taxpayers to not comply, whether it is
    attitude or the sheer complexity of the laws, they get
    confused, that informs how your system should look.
        Senator Brownback. Do we know the answer to that, Mr.
    George?
        Mr. George. Well, I have to, at the outset, say, Senator
    Brownback that, as Nina indicated, tax policy is not my
    bailiwick and actually under directives within the Department,
    I am not in a position to advocate a particular policy.
        That stated, there is no question that if there were a
    simplified tax system, more people would easily or more readily
    comply with their requirements. For example, I note that if the
    legislation that is before Congress helping to determine the
    cost basis of stocks were enacted, that would most definitely,
    I think, help in terms of the overall compliance with people
    acknowledging what they paid and what they owe after stock
    transactions. I actually had an opportunity to raise this issue
    with Jim Cramer of CNBC and he readily acknowledged that that
    would be a very helpful device and that it would not be too
    burdensome on the financial industry.
        Senator Brownback. It would seem like all you guys could
    help us quite a bit if, as we are proposing tax changes, which
    happen every year in the Congress, you had some sort of
    complexity index or rating of what this is going to do on
    making the Tax Code more complex. Our focus is the policy
    initiative we are trying to hit with the money we have. That is
    the whole game. We want to go green and we have got this pool
    of money. So how do we get this policy into that amount of
    money? But we never really look at the complexity issue of what
    it is going to do to the complexity of the code and its impact.
        It would be a helpful exercise actually, particularly
    because I think right now what people are most fed up with is
    the complexity of the Code. I would like to see the rates
    lower. I think most people would like to see the rates lower.
    But what really drives them nuts is how complex this thing is.
        Mr. Cherecwich. Senator, our Board conducts an annual
    attitude survey among taxpayers, which I referred to earlier.
    Among the findings of that survey is most Americans think it is
    inappropriate to try to cheat on their taxes. They think it is
    appropriate to pay the taxes as required.
        Given the complexity of the Tax Code, we feel that it is
    very important to balance the combination of services with
    enforcement. We have a tax gap and we cannot audit our way out
    of the tax gap. We have to have this balance with services and
    enforcement. And that is the reason why our recommended budget
    for fiscal year 2009 has that balance in recognition of the
    complexity that you talk about.
        Senator Brownback. I think you also note in there if it was
    not as complex, you would not have quite as big a tax gap. That
    is a feature of it as well. That is our role here in Congress,
    and I think we need to do a lot better on that.
        Thank you all very much for being here.

                         ADDITIONAL COMMITTEE QUESTIONS

        The record will remain open for a period of 1 week for
    people to be able to submit additional questions or for
    panelists to submit statements into the record.
        [The following questions were not asked at the hearing, but
    were submitted to the Department for response subsequent to the
    hearing:]

                Questions Submitted by Senator Mary L. Landrieu

        Question. Last year, I sent a letter to Acting Commissioner Stiff,
    suggesting several ways to alleviate some of the financial burdens on
    individuals who are being taxed on these grants. In Commissioner
    Stiff's December 27, 2007 letter to me, she responded that all but one
    of my suggestions required a legislative fix. The one suggestion she
    did not address--providing families more time to pay back any tax
    attributable to their grant--would have provided short term relief and
    would have allowed us more time to craft a legislative solution to the
    problem.
        Why didn't Commissioner Stiff address this solution?
        Answer. I understand that then-Acting Commissioner Stiff intended
    the response to indicate the mitigation you requested, extending the
    time to pay back tax attributable to a Road Home grant, requires
    legislative action. We apologize for not being clearer in this regard.
        Question. Could the IRS have allowed for an extension of time?
        Answer. No, there is no legal basis to extend the time period for
    affected taxpayers to pay the tax due. Legislation would be required in
    order to provide additional time to pay the tax due in this case,
    either by extending the payment date or providing for a payment of tax
    over a number of years.
        Question. What was the basis for concluding that the IRS could not
    provide additional time for hurricane victims to pay back any tax
    attributable to a Road Home grant?
        Answer. The IRS does not have the discretion applicable to provide
    taxpayers with an extension of time to pay taxes due.
        Question. Are there other administrative steps that the IRS can
    implement to mitigate the effects of its decision to tax Road Home
    grants?
        Answer. Because, as discussed above, our administrative flexibility
    is limited under the law, the IRS has focused on providing information
    to keep taxpayers well-informed on this issue. Representatives from the
    IRS met with tax professionals and others to provide tax assistance on
    Road Home grant issues (among other tax issues relating to the
    hurricane). The IRS continues to keep an open dialogue with local tax
    professionals to identify and address emerging filing issues, including
    issues involving Louisiana Recovery Authority (LRA) Grants and the
    effect of the taxpayer reporting a casualty loss in a prior tax year.
    The IRS website has a page dedicated to providing information on
    disaster relief, which includes detailed responses to frequently asked
    questions for hurricane victims concerning the tax implications of Road
    Home grants, including the tax-benefit rule.
                                     ______

                  Questions Submitted by Senator Wayne Allard

        Question. Can you please provide me with an accurate and detailed
    account outlining where the IRS audit process involving conservation
    easements currently stands in Colorado?
        Answer. The status of the audit process is as follows:
      --We have issued 183 private offer letters. These private letter
            offers are similar to settlement proposals. The letters address
            over 400 tax years and over 103 easements. They concern over
            $38,900,000 in claimed easement donation value.
      --Of the 183 offer letters, 64 (35 percent) have been accepted, 91
            (50 percent) have been rejected, and 28 (15 percent) are
            pending.
      --We expect to send a small number of additional offer letters within
            the next several weeks.
      --Audits are continuing for 316 taxpayers, 489 tax years, and 159
            easements.
      --Audits have concluded for 356 taxpayers, 667 tax years, and 168
            easements.
        Question. Does the IRS have any intention of refocusing its
    investigation off of legitimate easements and focus solely on those who
    have been targeted by the state?
        Answer. The IRS strives to avoid focusing its investigations on
    legitimate easements. Our efforts have focused on two approaches.
    First, we attempted to resolve through our settlement offer program
    those cases in which the sole issue was valuation of the easement.
    Although this approach resolved many cases, we will need to do further
    work with respect to those taxpayers who declined to accept the
    settlement offer. Second, we have been investigating some of the
    organizations that have been targeted by the state of Colorado as
    promoters of questionable or abusive easements. We intend to pursue our
    work with respect to these cases as we complete our work on
    conservation easements in Colorado and elsewhere across the United
    States.
        Question. In mid-November, the IRS began making settlement offers
    to a significant number of conservation easement donors under audit in
    Colorado. According to the IRS, the settlements were only offered in
    those cases where the sole issue between the donor and the IRS is
    valuation.
        The offers generally fell into a ``bucket'' where the IRS stated
    only 30 percent, 60 percent, or 75 percent of the original value of the
    charitable donation was allowed.
        What were the criteria the IRS used to place different taxpayers
    into these various ``buckets''? Did the IRS indicate in writing to the
    donor how or why the IRS arrived at their decision? If not, why?
        Answer. The IRS established the three separate categories after
    reviewing factors that affected the strength of the taxpayers'
    appraisals and other substantiation of the deductions claimed, with the
    highest allowance percentage being provided to those taxpayers the IRS
    believed had the strongest cases, taking into account the hazards of
    litigation. A 30 percent allowance offer was made to those taxpayers
    that had subdivided their properties into small parcels, such as 35
    acre parcels, in connection with making a contribution of an easement.
        The primary difference between the 60 percent and 75 percent
    categories was the extent of the taxpayer's appraisal process; 75
    percent was offered to those identified as having undergone an
    appraisal process that was identical or similar to Colorado's ``Great
    Outdoors Colorado'' (GOCO) process; and 60 percent was offered to all
    other taxpayers. GOCO is a state program intended to encourage
    conservation and preservation, including through conservation
    easements.
        We attached as Appendix A a copy of the standard form of letter
    that was sent to the taxpayers, as well as one of its attachments--a
    letter from the state of Colorado concerning the resolution of state
    income tax liability. The standard letter invites taxpayers to contact
    the IRS with any questions they may have. Many taxpayers who received
    this letter have done so, and have discussed their offers and the
    reasons for them with Revenue Agents and Engineers.
        Question. Since the IRS investigations began into the 2003
    easements how much money has the IRS recuperated and how much taxpayer
    money has been spent on the blanket audit of conservation easements in
    Colorado?
        Answer. Our information systems do not track costs in this fashion.
    To date in Colorado we have assessed $6.9 million in tax, penalties,
    and interest in these cases.
        We respectfully note that decisions on administering the tax laws
    generally are not guided exclusively by a cost-benefit approach as
    contemplated by the question. Other considerations, including
    requirements of the tax law, the deterrent effect on taxpayers, and the
    interests of justice, must be taken into account.
        Question. Wouldn't the IRS be more successful in recuperating tax
    dollars if it investigated the same fraud the state uncovered rather
    than auditing good easements that have been shown to meet rigorous
    state and national standards?
        Answer. The IRS commenced this examination program because of
    problems reported and discovered in conservation easement donations
    generally, but initially focused on Colorado after the State of
    Colorado expressed its concerns regarding valuation and other issues
    involving donations made in Colorado. The State initiated its actions
    after our work elsewhere had begun. We have and will continue to work
    collaboratively with the State of Colorado and will focus on what we
    believe are the more egregious cases.
        Question. How much money does the IRS expect to spend defending its
    settlement offers in court? Do you find this to be a good way of using
    taxpayer's dollars?
        Answer. No reliable estimate of such costs is possible until we
    know better the number of cases involved. However, as we choose how to
    audit and resolve cases, we always take into account limited resources
    and long-term strategies. We experience such choices in virtually every
    examination initiative.
        Question. Does the IRS have appraisers or other professionals that
    are experts in conservation easements? If not, why?
        Answer. Yes, the IRS does have a number of appraisers and other
    specialists who are experts in valuing various forms of property, and
    who have valued conservation easements for federal income tax purposes.
        Question. Has the IRS used the experts in conservation easement
    valuation or tax law that have offered their expertise? If not, why?
        Answer. Yes, and we will be using more. The IRS is currently
    working to hire additional experts to work Colorado cases, including
    cases involving potentially abusive promotions of easements.
        Question. The longer these cases remain pending, the more impact
    they can have on land conservation in Colorado. When does the IRS
    expect to conclude their investigation?
        Answer. The IRS understands the need to be expeditious in
    attempting to resolve these cases. The IRS has already completed
    examination work in Colorado easement cases involving 168 easements.
    Cases involving 159 easements remain open at this time. The IRS
    continues to work toward completing its examinations involving Colorado
    easements, and we recently dedicated additional resources to complete
    them as quickly as possible. Although the IRS expects to conclude many
    of its examinations of the existing open Colorado conservation easement
    cases by December 2008, we expect that the balance of the examinations
    work will not be completed until as late as June 2009. This timeframe
    does not include the time required for cases to work their way through
    the Appeals and litigation processes.

                                   APPENDIX A

    Internal Revenue Service
    (IRS Address)
    Date:

    (Taxpayer name)
    (Address        )

    Department of the Treasury

    Refer Reply to:
    Group:
    Person to Contact:

    Employee Identification Number:
    Contact Telephone Number:

        Dear (Taxpayers name):
        This letter is to inform you that Appeals has considered the
    federal tax implications of a group of returns reflecting charitable
    contributions of conservation easements in the state of Colorado.
    Because your conservation easement is within that group, the Internal
    Revenue Service proposes to resolve the issue(s) related to the
    conservation easement contribution claimed on your federal income tax
    return for XXXX(tax year) under Delegation Order 4-25, as described
    below. This proposed offer must be accepted within 30 days of the date
    of this letter.
        This resolution reflects Appeals' assessment of the hazards of
    litigation. Appeals has concluded the settlement proposed in this
    letter is an equitable resolution of the issue(s). Absent atypical
    facts and circumstances, you (investor or investor partner) should not
    expect a resolution of the tax issue on terms that are more favorable
    than the terms offered in this letter. If you do not accept this offer,
    the resolution of your case in Appeals will be based on the merits of
    the issues presented and may in fact be less favorable than the terms
    of this letter.
        If you accept this offer, the Service will resolve your
    conservation easement on the following terms. For purposes of this
    settlement:
          1. The government will treat the easement you donated during the
            year 20xx as a qualified conservation easement contribution.
          2. The allowed amount of the conservation easement contribution
            is based upon the amount of the value of the easement
            originally claimed and the hazards of litigation. Please see
            the attached Form 4549A.
          3. If you sold or transferred the Colorado state tax credit
            resulting from the donation of the conservation easement, the
            amount you received in exchange for the sale or transfer will
            be subject to tax as ordinary income. Please see the attached
            Form 4549A.
          4. If the settlement results in an adjustment for a period(s)
            other than the period(s) listed in the first paragraph of this
            letter, you will file amended returns reflecting the settlement
            and furnish copies of same to the person named above.
          5. You are liable for interest as provided by law.
        You are not eligible for this settlement offer if the conservation
    easement in question involves:
          1. An appraisal that determines the highest and best use for the
            property is the extraction of natural resources where such
            resources have not been shown to exist or to be economically
            feasible to extract.
          2. A quid pro quo arrangement.
          3. Property which was purchased or sold within 18 months of the
            contribution of the conservation easement.
          4. A contribution made to a donee organization that either does
            not qualify under section 501(c) (3) of the Internal Revenue
            Code or is under active consideration for termination of its
            exempt status.
          5. An appraisal from a participant or individual who was involved
            in the promotion or marketing of conservation easements or
            under investigation for inflated valuations.
          6. Conservation land easement on property outside the state of
            Colorado.
          7. The legal issue of whether the contribution is a qualified
            conservation contribution under section 170(h) of the Internal
            Revenue Code.
        In addition, you are not eligible for this settlement offer if you
    are:
          A. A party to a court proceeding (individual or as a partner in a
            TEFRA partnership) in which the determination of the tax
            treatment of the conservation easement is at issue.
          B. A partner, owner, promoter, or advisor in the business of
            developing real estate.
          C. A promoter, partner of a promoter, or employee of a promoter
            of a conservation easement transaction.
          D. A person under criminal tax investigation. This includes a
            person under related criminal tax investigation by the Service
            or the Department of Justice, or a person who has been notified
            before the date of execution of the Form 906, closing
            agreement, that the Service or the Department of Justice
            intends to commence a tax related criminal investigation of
            that person.
        If any of the above exclusions applies, you are not eligible for
    this settlement offer.
        If you are eligible for this settlement offer and wish to resolve
    your Colorado conservation easement issue on the terms set forth above,
    you must sign and return the enclosed Forms 870-AD (triplicate original
    signatures) and Forms 906 (triplicate original signatures) to the
    person whose name is listed above within 30 days of the date of this
    letter.
        You must thereafter cooperate with the Service to resolve your case
    expeditiously. In addition if the Service requests additional
    information, or documents necessary to effect this settlement, you must
    provide those documents within 20 calendar days of the request. The
    Service will grant an extension of the 20 day period only in
    exceptional circumstances and at its discretion.
        The settlement is not binding until both you and the Service sign a
    specific matters closing agreement (Form 906) and Form 870-AD resolving
    the issues for all taxable years affected by this transaction in
    accordance with the above terms. When the Service signs the specific
    matters closing agreement, the one-year period of limitations on
    assessment will begin under section 6229(f) of the Internal Revenue
    Code for investor partners.
        Full payment of the liabilities under this offer is expected by the
    date the closing agreement and Form 870-AD are returned to the Service.
    If you are unable to make full payment, you must submit complete
    financial statements (Form 433-A or Form 433-B, as appropriate) and
    return them to the person whose name is listed above.
        If you choose not to accept this proposed settlement or you are not
    eligible for this settlement, development of the issue will continue.
    If the issue is still in dispute at completion of the examination, you
    may request an Appeals conference.
        This settlement is solely a settlement of civil tax matters. No
    statement contained herein shall be deemed to be an admission by the
    Service. Nothing herein shall preclude the Service from asserting a
    position on the merits that is different from this settlement in
    contexts other than those concerning the civil tax liability of the
    taxpayer-parties whose cases are settled under this offer.
        If you choose to have a representative you must authorize such
    representation by completing a Form 2848, Power of Attorney and
    Declaration of Representative. You can obtain this form from a local
    IRS office, through our website at www.irs.gov or by calling 1-800-829-
    3676.
        Also, enclosed is a letter from the state of Colorado which
    provides instructions on resolving your state income tax liability
    involving this issue provided that you resolve your federal tax matter
    at this time.
        If you have any questions, please contact the person whose name and
    telephone number appear at the top of this letter.
                Sincerely,
                                  Name of Person Issuing Letter
                                         Title of Person Issuing Letter
    Enclosures:
        Form 906
        Form 870-AD
        Form 4549A
        Form 433-A
        Form 433-B
        State of Colorado letter

                                 State of Colorado,
                             Taxpayer Service Division,
                                         Department of Revenue,
                              Denver, Colorado 80261, November 1, 2007.

                COLORADO DEPARTMENT OF REVENUE SETTLEMENT OFFER

        Taxpayers who participate in the Internal Revenue Service's
    conservation easement donation settlement offer will also be eligible
    for a settlement offer from the Colorado Department of Revenue
    according to the terms set forth below. The IRS will advise the
    Colorado Department of Revenue of the identity of taxpayers who qualify
    for their offer as allowed through our information sharing agreement.
        In order to accept the Colorado offer, the taxpayer must file an
    amended return for all affected tax years within 30 days of the
    acceptance and execution of the IRS' settlement offer. The amended
    return(s) will include:
      --Adjustments to federal taxable income matching the federal
            settlement adjustments;
      --Adjustment to Colorado's federal charitable contribution deduction
            addback to the extent applicable to the federal settlement
            adjustments;
      --Repayment by the easement donor of 50 percent of the gross
            conservation easement tax credit that would have been
            disallowed under the federal settlement adjustments. The donor
            may pay this amount rather than having the transferees
            assessed.
        Questions regarding this offer should be referred to Richard
    Giardini at the Colorado Department of Revenue at 303-866-3900.
                                              Richard Giardini,
             Colorado Department of Revenue, Taxpayer Service Division.

                              SUBCOMMITTEE RECESS

        Senator Brownback. The hearing is recessed.
        [Whereupon, at 4:13 p.m., Wednesday, April 16, the
    subcommittee was recessed, to reconvene subject to the call of
    the Chair.]

      FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL
                                   YEAR 2009

                                  ----------

                           WEDNESDAY, APRIL 30, 2008

                                           U.S. Senate,
               Subcommittee of the Committee on Appropriations,
                                                        Washington, DC.
        The subcommittee met at 3:02 p.m., in room SD-192, Dirksen
    Senate Office Building, Hon. Richard J. Durbin (chairman)
    presiding.
        Present: Senators Durbin and Brownback.

                       CONSUMER PRODUCT SAFETY COMMISSION

    STATEMENTS OF:
            NANCY A. NORD, ACTING CHAIRMAN
            THOMAS H. MOORE, COMMISSIONER

                 OPENING STATEMENT OF SENATOR RICHARD J. DURBIN

        Senator Durbin. Good afternoon. I am pleased to welcome you
    to this hearing today before the Financial Services and General
    Government Appropriations Subcommittee.
        Today we will discuss the President's fiscal year 2009
    budget request for the Consumer Product Safety Commission
    (CSPC). Testifying before us will be Acting Chairman Nancy Nord
    and Commissioner Thomas Moore.

                                  THEN AND NOW

        Last year, thanks to investigative reporting by the Chicago
    Tribune, which won a Pulitzer Prize for its work, I became
    concerned about toy safety issues. With the spotlight shining
    on some deadly toys, America became much more aware of the
    dangers of toys on store shelves, often ones coming from China.
        At this time last year, we were reviewing the budget of an
    agency that had been neglected and underfunded for years. We
    acted together on a bipartisan basis last year to boost funding
    from a level of $63 million to $80 million, a dramatic increase
    by today's budget standards. The House and Senate both passed
    reauthorization bills to improve CPSC's abilities to protect
    the public.
        So now, with the 28 percent increase in funding last year
    and an expected final reauthorization that will, if the Senate
    prevails, give the CPSC new tools, we will be able to prevent
    dangerous products from reaching stores, ensure faster recalls,
    and allow families access to information on existing safety
    complaints. I think the Consumer Product Safety Commission has
    the potential to become an exemplary watchdog agency.
        The Commission has gone from a high of 978 full-time
    employees in 1980 to a low of 380 employees in January of this
    year. Now that it is turning around, because CPSC has the
    funding we provided to replace the key staff it has lost over
    the years, I hope the Commission will swiftly hire all the
    needed technical experts and investigators to get the agency
    back to better fulfill its mission.
        We discussed last year in detail the dilapidated laboratory
    that CPSC uses to test toys. I understand that Bob, one of the
    toy testers, has since retired. Bob became a very famous figure
    in America, as we talked about his workbench and his testing
    laboratory.
        But soon CPSC will move to a new and improved testing
    laboratory. We provided funding last year to enable that
    timetable to be accelerated, and with funds requested in fiscal
    year 2009, the Commission will be able to move into the space a
    year earlier than expected.

                      FISCAL YEAR 2009 PRESIDENT'S BUDGET

        While good things are being done with funding provided last
    year, unfortunately, the President did not join in the cheer.
    The President froze funding for this agency for the next fiscal
    year at the $80 million level. So while the agency is hiring
    new staff, the fiscal year 2009 budget proposal by the
    President would just maintain the staff and not continue to
    build the professional staff that is needed to protect
    consumers across America. I do not agree with the President.
    There has been a dramatic upsurge in imports into the United
    States, a dramatic increase in products that have to be
    reviewed by this Commission to make sure that American families
    are safe.

                 MISINFORMED APPROACHES TO CONSUMER PROTECTION

        At this point, I hope that we can move forward. I hope that
    we can understand that some of the challenges are very obvious.
    A CPSC engineer was asked to design a new study of the
    mechanics and stability of all-terrain vehicles (ATVs). He
    proposed a cursory review of the latest ATV's on a budget of
    about $40,000. He was turned down because it cost too much, he
    was told. How can $40,000 be too much to study a vehicle that
    literally is responsible for the deaths of hundreds of people
    and sends hundreds of thousands to emergency rooms each year?
    It is clearly a case of penny-wise and pound-foolish.
        In 2001, CPSC issued an administrative complaint, a first
    step in litigation leading to a recall, against Daisy
    Manufacturing Company about their Powerline Airguns. Airgun's
    BBs were getting stuck in the gun, so children thought the guns
    were empty and began aiming and shooting at each other. Due to
    the high velocity BBs, this resulted in deaths and serious
    injuries among kids. Daisy alleged there was a misuse of the
    product and an education campaign would solve the problem.
        The Commission alleged a defect, which caused the BB to
    lodge in the gun so that an administrative complaint was
    issued, but it was then dismissed by the CPSC in 2003 under a
    new administration. One of the factors leading to the
    settlement action was that Daisy Company could have gone out of
    business if there had been a recall.
        Mr. Moore, at the time, your statement took issue with that
    settlement action, and I quote. ``The bottom line is that we
    are not the business protection agency. We are the Consumer
    Product Safety Commission. Our responsibility is to protect the
    public from dangerous consumer products. If we lose sight of
    that, we will get entangled in endless discussions of company
    finances while consumers are being put at risk of death or
    serious injury.''
        These are clearly issues and many others that we will have
    to consider, and we will talk about them as we get into this
    hearing. But at this point, let me turn to my ranking member,
    Senator Brownback of Kansas.

                       STATEMENT OF SENATOR SAM BROWNBACK

        Senator Brownback. Thank you, Mr. Chairman.
        The hearing we did last year on the Consumer Product Safety
    Commission was an excellent hearing. I thought it was a ground-
    breaking hearing, and I am pleased to see progress is being
    made.
        I would like to thank Acting Chairman Nord and Commissioner
    Moore. I will begin by commending you for the steps you have
    taken to improve the agency and the work and the safety of
    imported consumer products since our September 12, 2007
    hearing. I understand that you used the additional resources we
    appropriated to improve your import surveillance activities,
    modernize your product testing, and hire additional product
    safety inspectors. It is unfortunate that such advances were
    not made until after all the toy recalls, bad press, and
    congressional hearings.
        We discussed the issue of imported products from China at
    great length in our earlier hearing, so I will be briefer on
    that today. But clearly, China is our biggest regulatory
    challenge since 70 percent of all defective products are coming
    from that country--70 percent. We must continue to focus our
    efforts on stopping dangerous and even lethal products from
    reaching American consumers. This is where the problem is and
    this is where our focus, I believe, should be. It is hoeing
    where the weeds are.
        I am glad to hear the continuing dialogue with the Chinese
    and the enhanced ways your agency is communicating with them,
    but I am concerned that dialogue just is not enough. The
    memorandum of understanding (MOU) that you have signed with the
    Chinese must be honored and you must verify--verify--that the
    Chinese are holding up their end of the bargain. I would
    recommend that you hold annual, rather than biennial, product
    safety summits with the Chinese. I still believe that we cannot
    merely trust China to do what is right.
        Certainly regarding product safety, they have given us
    every reason not to trust them. In fact, just yesterday a Food
    and Drug Administration (FDA) official testified before a House
    subcommittee that FDA's working hypothesis is that the
    contamination of heparin was intentional. Although FDA has not
    proven this yet, it speaks volumes about the grave concerns we
    must have about all products coming from China.
        I hope that during today's hearing you will be able to
    identify specific ways you intend to hold China accountable.
    Again, this is where the problem is and this is where our focus
    should be. It is a totalitarian system. It does not have a free
    press. It has graft and corruption that operate within the
    political system. I think by looking at the exterior factors
    you would expect a series of problems to probably arise.
        So Ms. Nord and Mr. Moore, I thank you for your commitment
    to protect America's consumers. I look forward to hearing your
    detailed testimony and what we can do to particularly address
    the issue of the products that we are seeing coming in from
    China.
        Thank you, Mr. Chairman.
        Senator Durbin. Thanks, Senator Brownback.
        I now invite testimony from Chairman Nord and Commissioner
    Moore. Please proceed.
        Ms. Nord. Thank you, Mr. Chairman, Senator Brownback.
        A lot has happened at the CPSC since the last time I
    appeared before you, thanks in large measure to the leadership
    of this subcommittee and to you personally, Chairman Durbin and
    Senator Brownback.
        The CPSC received a nearly 28 percent increase in our
    fiscal year 2008 appropriation, and I can report to you that we
    are putting these new funds to very good use this year and are
    building a foundation for further growth in 2009.
        The consumer product landscape is changing with
    globalization and a surge in imported products, more
    technologically complex products, and a dramatic increase in
    Internet sales. As this landscape changes, so must we.
        This afternoon I want to highlight changes we are making
    with the increase in our 2008 funding and discuss our 2009
    budget proposals which are built on this foundation.
        The first change is staffing. We started fiscal year 2008
    anticipating a staffing level for the year of around 400.
    Instead, for the first time in many years, the CPSC will end
    the fiscal year with more people on staff than at the beginning
    of the year. Our ambitious goal is to begin fiscal year 2009,
    this October, with the full complement of staff requested for
    the entire year, an increase of over 50 people since this past
    January.
        While we are staffing up throughout the agency, we are
    making a special effort to increase our compliance and field
    staff who are part of CPSC's new Import Surveillance Division,
    which is a centerpiece of our new import safety initiative. For
    the first time we will have a team of permanent full-time
    personnel at selected key ports, supported by a team of
    technicians, scientists, and lawyers at headquarters, with full
    access to Customs' technology that will give our team real-time
    information on consumer product shipments bound for the United
    States. When a suspect shipment warrants inspection, we will be
    using the newly acquired XRF technology to screen for violative
    products.
        The second change is in our laboratory. Our lab team tests
    products sent from our field staff to identify defects and
    violations, and they provide the scientific backbone to support
    our rulemakings such as the one we are pushing forward now on
    upholstered furniture. With more field inspectors and
    compliance officers, the work of the lab will grow
    significantly. As you know very well, the laboratory is housed
    in a substandard facility. The fiscal year 2008 funding you
    provided allowed us to begin the modernization a year earlier
    than we had anticipated, and our fiscal year 2009 budget
    request allows us to plan to move into a new modern laboratory
    by the end of 2009. It is anticipated that the new facility
    will increase our efficiency by accommodating not only our lab
    staff, but also other technical and scientific staff who work
    closely with them.
        The third change concerns our data management and
    information technology (IT). The CPSC receives an enormous
    amount of information, close to half a million individual
    product incident reports each year. And I have here a couple of
    samples of a 1-day's run of data of product reports from two
    different databases. Processing, investigating, and responding
    to this information is an enormously complex undertaking. Yet
    it is in this data that we find the clues that point to
    possible emerging hazards.
        Unfortunately, due to the age and limitations of our IT
    infrastructure, this data is entered in numerous systems that
    are not integrated with each other. These two databases which
    have consumer complaints and product incident reports are not
    integrated. They do not talk to each other. Thus, we have to
    rely on the keen eyes and the institutional memories of our
    experienced staff to pick up trends and patterns, an inadequate
    approach as the agency grows and as our more seasoned staff
    retires.
        Our IT improvement plan will connect these data systems to
    allow staff to more effectively identify patterns and flag
    hazards as they emerge. The recently launched early warning
    system, which initially is focusing on nursery products in the
    sleep environment, is a pilot program for this data integration
    project.
        Our fiscal year 2009 budget request proposes to build a
    more comprehensive plan on the foundation provided by the early
    warning system. We will keep the subcommittee informed of the
    progress of this work since we do anticipate that additional
    funding will be needed in fiscal year 2010 to bring the new
    system online.
        Before concluding, I would like to reference two
    legislative developments that will impact our funding needs.
        First, Congress passed the Virginia Graeme Baker Pool and
    Spa Safety Act after our budget plans were finalized this past
    December. That law directs us to undertake a number of new
    enforcement and education requirements and to administer a new
    grant program. We anticipate returning with an amendment to our
    budget request for additional funds.

                               PREPARED STATEMENT

        We also anticipate that the CPSC reauthorization bill will
    be finalized soon. In addition to giving us needed new
    authorities, it appears that the final bill will include many
    new mandates for the agency, including as many as 40 new
    rulemaking requirements. When it is enacted, we undoubtedly
    will need additional resources above our 2009 budget proposal.
    In this regard, I look forward to continuing to work with the
    members and staff to make sure that we have those resources
    that we need to continue to serve our most important
    stakeholder, the American consumer.
        Thank you.
        Senator Durbin. Thank you, Chairman Nord.
        [The statement follows:]

               Prepared Statement of the Honorable Nancy A. Nord

        Thank you for this opportunity to present to you the appropriation
    request for the U.S. Consumer Product Safety Commission (CPSC) for
    fiscal year 2009. As the Committee members know, the CPSC is a small,
    independent and bipartisan agency created by Congress. Our mission is
    to protect the public from unreasonable risks of injury and death
    associated with more than 15,000 types of consumer products.
        Last December, the appropriations committees significantly
    increased CPSC's fiscal year 2008 budget by over 27 percent above the
    previous year. I want to begin my testimony by thanking the Committee,
    and specifically the Chairman, for your strong support of our agency
    and our safety mission. The funds that you have provided are helping us
    lay the necessary groundwork for the agency's expanded initiatives that
    are presented in the agency's fiscal year 2009 budget request.

                        FISCAL YEAR 2009 BUDGET REQUEST

        For fiscal year 2009, the CPSC is requesting $80 million to carry
    out our various safety missions for America's families. While the
    agency's final appropriation for fiscal year 2008 was also $80 million,
    there are significant expenditures in 2008 that do not recur in 2009.
    Therefore, an additional $11,800,000 is available in the agency's 2009
    budget request compared to the 2008 funding level. With these fiscal
    year 2008 and 2009 funds, the CPSC will be able to complete the
    modernization of our testing laboratory, begin to overhaul our
    information technology (IT) infrastructure, and hire more staff.
        The facilities, staff and IT systems provided by this funding will
    combine to create the foundation we need to begin to build the agency's
    newest safety programs, including the Early Warning System that I
    initiated last year to enhance our ability to identify emerging hazards
    and the Import Safety Initiative that will allow the agency, for the
    first time in its history, to have a full-time presence at the Nation's
    ports. These expenditures for laboratory facilities, workspace and IT
    infrastructure are critical capital investments that must be made now
    to accommodate current and expected future growth of the agency,
    especially in tandem with our projected staff increase.

                   MEETING THE CHALLENGE OF IMPORTED PRODUCTS

        Since the CPSC's inception in 1973, the agency's work has
    contributed substantially to the decline in the rate of deaths and
    injuries related to hazardous consumer products. Today, the American
    home environment has never been safer. However, the international
    marketplace is dynamic, and there is always more work to be done and
    new challenges to be met.
        Perhaps the greatest of these is the import safety challenge. Most
    of the consumer products that we use today are no longer manufactured
    in the United States. For example, over 85 percent of toys and 59
    percent of electrical products are manufactured in other countries,
    notably in China. The number of products imported into the United
    States showed a 200 percent increase from 1997 to 2006.
        The Commission has taken aggressive steps to meet this challenge,
    including ongoing dialogue and initiatives with the Chinese Government;
    working with the private sector, including Chinese manufacturers
    directly; and increased surveillance and enforcement activities at the
    borders and within the marketplace.
        To provide a comprehensive and coordinated effort to ensure greater
    import compliance with recognized American safety standards, the
    Commission in 2004 created the Office of International Programs.
    Through this Office we have established a formal relationship between
    the CPSC and the General Administration of Quality Supervision,
    Inspection and Quarantine (AQSIQ), our counterpart agency in China.
    Formal working groups and action plans with the Chinese Government were
    set up to focus on key product areas, and they continue to make
    progress on their immediate goals of developing strategies to address
    safety problems and to respond quickly to urgent product safety issues.
        Last autumn, the CPSC sponsored the U.S.-Sino Product Safety Summit
    where significant agreements were signed with AQSIQ to strengthen these
    working groups. China has pledged to increase pre-export inspections,
    improve compliance with mandatory and consensus standards, and crack
    down on repeat violators of U.S. safety standards. While we recognize
    that China is a huge country with thousands of manufacturing facilities
    and that implementation of these agreements cannot be accomplished
    overnight, we have begun to see positive results. The CPSC will
    continue to work with the Chinese to assure that they fully implement
    their commitments.
        The initial steps that the CPSC has taken to assure the safety of
    imported goods are an important beginning to our goal of maximizing
    Chinese industry compliance with U.S. product safety requirements. In
    this regard, it is essential to convey to them a full understanding of
    U.S. regulatory requirements. Summaries of provisions of nearly 300
    U.S. mandatory and consensus consumer product safety standards are now
    available in Chinese. We are posting timely information briefs on our
    website in Chinese, and our plans include links to full Chinese texts
    and audio-visual products. The agency is also participating in
    industry-specific safety seminars and retail and vendor training
    seminars on-site in China.

                  BUILDING A NEW IMPORT SURVEILLANCE DIVISION

        The CPSC is hiring new staff in the areas of hazard identification
    and reduction, as well as in compliance and field operations. CPSC's
    number of actual FTEs at the start of calendar year 2008 was under 390;
    our aggressive goal is to increase that number to 439 by October 1,
    2008--a 13 percent increase with more than 50 new employees.
    Additionally, increased staff training and performance initiatives will
    enhance retention of CPSC's experienced and skilled employees.
        These personnel will enable the agency to expand its monitoring,
    inspection and testing of products, and especially children's products,
    as part of our Import Safety Initiative. Our new Import Surveillance
    Division is designed to be the front line of defense working to prevent
    dangerous toys and other hazardous products from entering the country
    and reaching American consumers.
        These employees will be specialists trained specifically in import
    surveillance procedures and will work closely with other Government
    agencies and with CPSC's compliance officers, technical staff,
    attorneys, and laboratory personnel. CPSC's new port investigators will
    track cargo and, with Customs' officials, stop and inspect suspect
    shipments. High impact ports will be targeted and new measures of
    import compliance will be established to better assess progress.

                     MODERNIZING CPSC'S TESTING LABORATORY

        When our import surveillance and compliance officers find suspect
    products, those products are sent to our laboratory to determine if
    they violate standards or are defective. Therefore, our laboratory is
    an integral and critical part of our operation. As you know, and as
    your staff has witnessed first-hand, CPSC's testing laboratory needs to
    be modernized to create efficiencies and to better support CPSC's
    product safety work, including the new work generated by the Import
    Safety Initiative. As presently configured, the laboratory space is
    inefficient to say the least, though our staff there do an incredible
    job with the tools that they have at hand.
        Our new funding has allowed the agency in 2008 to begin to
    implement plans that not only address the needs of the laboratory but
    also anticipate critical and immediate workspace issues for a growing
    staff. The Commission has been able to move forward with site selection
    and will make a substantial payment to the General Services
    Administration of $8 million in fiscal year 2008 so that we can move
    into the new laboratory a year earlier than otherwise expected. An
    additional payment of $6 million is requested in CPSC's fiscal year
    2009 budget proposal to complete the laboratory project.
        By accelerating our laboratory modernization plan, we will provide
    not only a modern facility for our engineers and scientists to conduct
    their testing and investigations but also office space for an
    additional 70 employees to be relocated from CPSC's headquarters
    office. These employees will be those who work closely with the
    laboratory staff. This action will allow further efficiencies and
    improvements in office space at our headquarters site.

                       IMPROVING CPSC'S IT INFRASTRUCTURE

        Per the Committee's interest, the agency is also spending new
    funding on important improvements to our information technology (IT)
    infrastructure. The need for increased funding for IT has been a
    constant in CPSC's budget proposals over the years. Our IT systems have
    not been fully modernized since 1993 when the agency last relocated its
    headquarters. As directed by the Committee, CPSC's 2009 budget request
    includes a report on our information technology modernization
    requirements.
        Achieving the agency mission is dependent on our IT systems because
    our work requires electronic accessibility of information to maintain
    productivity. The increased emphasis on import safety demands greater
    reliance than ever before on integrating CPSC databases and accessing
    other agencies' databases, such as those of U.S. Customs and Border
    Protection, in a seamless fashion.
        With new funding in fiscal year 2008, the CPSC has permanently
    established a long-sought capital fund to replace aging and outdated IT
    equipment on a systematic basis and a fund to support development of
    more advanced electronic applications. Additionally, a one-time
    expenditure of $2.3 million is allowing the agency to replace its
    resource management information system which is so outmoded that vendor
    support is being withdrawn.
        Funding in fiscal year 2009 will continue this modernization effort
    and include the development of our IT improvement plan to convert our
    current data systems from a client-server environment to a web-based
    environment; full integration of the Document Management System;
    updating current, outdated database platforms to one, mainstream
    platform; and converting current, disparate data systems to one data
    system.
        These IT improvements are essential to the agency's Import Safety
    Initiative. Improved electronic data exchanges with Customs' databases
    in the future will enhance the Government's capabilities to identify,
    track and stop hazardous products from entering the United States. Our
    IT plan will also include a new system that can track historical
    changes of addresses and names for foreign companies which will provide
    for more rapid identification of hazardous imported products. The new
    system will also integrate several third party sources of information
    that will yield improved monitoring. Finally, it will potentially give
    us, for the first time, an effective tool to flag and guard against
    foreign suppliers who repeatedly ignore our product safety
    requirements.

                    ESTABLISHING A NEW EARLY WARNING SYSTEM

        The new IT improvements will also support our new Early Warning
    System (EWS) which I initiated last year to enhance our current hazard
    identification systems. The goal of the EWS is to systematically
    identify and respond to children's product safety hazards starting with
    cribs, bassinets and playpens. This initiative is important because it
    is designed to address emerging hazards more quickly and effectively.
    Through an enhanced identification system, the agency will be able to
    detect product hazard patterns more promptly as they emerge.

                            ONGOING CPSC ACTIVITIES

        While I have discussed CPSC's new systems, programs and
    infrastructure at length, it is also important to recognize the
    critical ongoing work of the agency in standards setting, domestic
    enforcement and public education.
        Though the Commission was without a quorum for the better part of
    2007, I am pleased to report that the agency was able to make progress
    on a number of fronts. As a result of last year's staff work, the
    Commission was able to vote earlier this year, before the quorum again
    expired, on a final rule to update our clothing textile flammability
    standard and on a notice of proposed rulemaking on upholstered
    furniture flammability.

    Reducing Carbon Monoxide Poisonings
        Additionally, the Commission completed a great amount of work to
    reduce carbon monoxide (CO) poisonings.
        First, the Commission issued a mandatory rule last year for a new
    danger label for portable generators to warn consumers about CO
    poisoning and to encourage safe use. The regulation became effective on
    May 14, 2007, for all portable generators manufactured or imported
    after that date.
        Second, the Commission issued an advance notice of proposed
    rulemaking in December 2006 to initiate a multi-faceted proceeding that
    includes as its goal reducing consumer exposure to CO through technical
    means and performance standards that will enable and encourage proper
    generator placement outdoors.
        Third, the CPSC awarded a contract to develop a prototype generator
    engine with reduced CO in the exhaust.
        Fourth, CPSC staff has an interagency agreement with the National
    Institute of Standards and Technology (NIST) to conduct physical
    testing and indoor air quality modeling of in-home CO infiltration in
    various styles of homes when a generator is used in various locations.
        Finally, CPSC staff conducted a proof-of-concept demonstration of a
    remote CO sensing automatic shut-off device, as well as an interlock
    concept in which a CO sensor was located in the generator. The results
    of these investigations will help determine practical and effective
    performance requirements for portable generators and provide the basis
    for subsequent rulemaking activity.
    Implementing a New Mattress Flammability Standard
        In 2007, the CPSC's new mattress flammability standard became
    effective. The staff estimates that the new standard, when fully
    effective, will prevent as many as 270 deaths and 1,330 injuries
    annually.
        In implementing the new standard, CPSC staff has sponsored and
    participated in education seminars for manufacturers and retailers.
    Staff has also developed a dedicated mattress information webpage and
    prepared and distributed several reference documents and informational
    brochures.
        In addition to the progress the agency has made on these
    rulemakings, the CPSC is continuing its work in the voluntary standards
    process by providing expert advice, technical assistance, and
    information based on data analyses of how deaths and injuries occurred.
    Staff is currently supporting the development or revision of over sixty
    voluntary standards, including those to reduce fires related to
    candles, batteries, appliances and other electrical products.
    Enforcement and Compliance Efforts
        CPSC's Office of Compliance completed 473 cooperative recalls in
    2007 involving approximately 100 million product units. While those 473
    recalls in 2007 were heavily publicized in the media, they were only
    marginally above the 467 cooperative recalls that were completed in
    2006, and in fact, they involved fewer than the 120 million product
    units in 2006. The increased media attention on the CPSC in 2007 did,
    however, have the salutary effect of raising both public awareness of
    the agency's safety mission and its effectiveness in removing products
    from the marketplace that violate mandatory standards or present a
    substantial risk of injury to the public.
        To assist industry in recalling products and complying with our
    regulations easily and quickly, the agency relies on Fast Track product
    recalls to streamline the process for firms that are willing and
    prepared to recall their products promptly. Because every defective
    product presents a risk of injury or death, removing hazardous products
    from the marketplace faster can prevent more injuries and save more
    lives. Recalls under the Fast Track program are conducted without the
    need for a time-consuming hazard analysis and, over 90 percent of the
    time, are implemented within 20 days of a firm's report to the CPSC.
    For non-Fast Track corrective actions, we also established new
    efficiency goals to complete key actions within a specified time
    period.

    Educating the Public
        CPSC's Office of Public Affairs is very active in educating the
    public and informing consumers of recalls and emerging hazards. In
    2007, that Office issued more than 350 press releases on product
    recalls and safety information and completed more than 20 safety
    campaigns on such topics as all-terrain vehicles; mattress safety;
    stove, television and furniture tipovers; portable generator dangers;
    and outdoor and indoor drowning prevention. American consumers viewed
    safety information announced by the CPSC more than a half billion times
    through television interviews, video news releases, free publications,
    and the Neighborhood Safety Network.
        I am especially proud of that Office's work on outreach to the
    Spanish-speaking community. In 2007, we translated the Neighborhood
    Safety Network Toolkit into Spanish, as well as several safety
    publications and three times the number of press releases as in the
    previous year. The CPSC coordinated a Lead Poisoning Prevention Web
    site in cooperation with other Federal agencies and the National
    Council of La Raza.
        Before concluding, I should note that the House and the Senate have
    passed different versions of reauthorization legislation for the CPSC.
    CPSC's fiscal year 2009 budget request does not include funding
    increases in the event that Congress finalizes this legislation and the
    President signs it. Since it is clear that the final legislation would
    impose substantial new regulatory, enforcement and other mandates on
    the CPSC, we will, of course, be in further contact with the
    appropriations Committees in that regard at the appropriate time.
        The CPSC is an agency that is undergoing change, like no other
    agency of Government, with significant budget increases, comprehensive
    reauthorization, and national attention unlike ever before in its
    history. As we make the transitions that accompany this change, I look
    forward to continuing to work closely with the Committee. Our common
    goal is to assure the safety of the products that American families
    bring into their homes, schools and recreation areas. I am honored to
    serve the American public as Acting Chairman of the Consumer Product
    Safety Commission at this time of great challenge and great
    opportunity, and I look forward to answering your questions.
        Thank you.

        Senator Durbin. Commissioner Moore.

                      SUMMARY STATEMENT OF THOMAS H. MOORE

        Mr. Moore. Mr. Chairman, Mr. Ranking Member, thank you for
    providing me with this opportunity to present testimony before
    you today on the U.S. Consumer Product Safety Commission's
    fiscal year 2009 appropriations request.
        For our current fiscal year 2008, Congress, led by this
    subcommittee, took up the cause of the American consumer by
    focusing on, and addressing, the serious deficiencies at the
    Commission resulting from our most recent years of shrinking
    resources. Our agency was appropriated $80 million, a $16.75
    million increase over the administration's request.
        For fiscal year 2009, the President's funding request for
    the agency is $80 million, which is equal to the level of
    funding provided by Congress for fiscal year 2008. With this
    amount of funding, we propose to hire up to a level of 444
    full-time employees. Additionally, we propose to continue our
    efforts to acquire a modern, state-of-the-art laboratory
    facility and to acquire additional office space, which we will
    need to accommodate some of our new hires.
        The fiscal year 2009 request on its face is a request for
    level funding from 2008. However, there are a number of one-
    time expenses occurring in 2008 that are not anticipated in
    2009. Not having those expenses in 2009 provides the Commission
    with $5.8 million to direct toward activities which would give
    indications of growth as opposed to stagnation or movement in
    the negative direction.
        Most important to me is our now present ability to rebuild
    our staff. CPSC is a staff-intensive organization, as I have
    said previously. At the heart of CPSC's operation is its staff,
    without question our greatest and most important asset.
        In addition to Congress' focus on Commission appropriation
    issues, both Chambers, the House and the Senate, have passed
    reauthorization legislation. Both bills provide significant
    increases in our authorization levels for future years at the
    Commission. The bills would require the Commission to undertake
    a number of activities that I am not taking into consideration
    as I present this statement. I cannot say at this time what
    resources we would need to fully implement any new
    requirements. When a final package is agreed upon and signed
    into law, we certainly intend to communicate with this
    subcommittee with respect to any future requirements and their
    effect on Commission resources.
        Also, last December, the President signed into law the Pool
    and Spa Safety Act. For fiscal year 2009, the act authorizes $7
    million for the Commission to carry out its requirements. Our
    staff has done an estimate of the cost of carrying out the
    requirements of the act and has advised the Commission that for
    fiscal year 2009, we would need an additional--an additional--
    $7.887 million. The President's request of $80 million does not
    include this funding and Congress would have to include
    additional funds above the President's request for the
    Commission to carry out the act's requirements.
        Mr. Chairman, I want to thank this subcommittee for your
    recognition of the importance of our agency with respect to
    product safety for American consumers. The sale of unsafe
    consumer products remains a major national problem. Because of
    your attention and assistance, we are now on the way back to
    firm footing in preventing unsafe, potentially harmful consumer
    products from causing deaths and injuries to American
    consumers. The continued support of this subcommittee is
    essential to a successful fulfillment of our mission.

                               PREPARED STATEMENT

        I thank you again, and I am now available to respond to
    questions that you may have. Thank you.
        Senator Durbin. Thank you, Mr. Commissioner.
        [The statement follows:]

                     Prepared Statement of Thomas H. Moore

        Mr. Chairman, Ranking Member, and members of the subcommittee,
    thank you for providing me with this opportunity to present testimony
    before you today on the U.S. Consumer Product Safety Commission's
    (CPSC) fiscal year 2009 appropriations request.
        In summary, for fiscal year 2009, the President's funding request
    for the agency is $80,000,000 which is equal to the level of funding
    provided by Congress for fiscal year 2008. With this level of funding,
    we propose to hire up to 444 Full Time Equivalents (FTEs) from our
    budget submission level of approximately 380 FTEs. Additionally, we
    propose to continue our efforts to acquire a modern laboratory facility
    and to acquire additional office space, which we will need to
    accommodate some of our new hires.
        However, it must be noted that the fiscal year 2009 funding request
    does not take into consideration the cost of implementing the
    requirements of the ``Virginia Graeme Baker Pool and Spa Safety Act''
    nor does the 2009 funding request address the cost of implementing
    possible requirements of any final passage of a conference agreement on
    the ``Consumer Product Safety Commission Reform Act'' as passed by the
    Senate and the ``Consumer Product Safety Modernization Act'' as passed
    by the House.
        On December 19, 2007, the President signed into law the Virginia
    Graeme Baker Pool and Spa Safety Act which is aimed at reducing the 260
    pool and spa drownings each year involving children younger than 5 and
    reducing suction entrapment deaths and injuries. The act addresses pool
    and spa safety issues by specifying requirements that would make pools
    and spas safer. The act also authorizes the Commission to establish an
    incentive-based grant program for States, subject to the availability
    of appropriations. Additionally, the act requires the Commission to
    ``establish and carry out an education program to inform the public of
    methods to prevent drowning and entrapment in swimming pools and
    spas.''
        For fiscal year 2009, the act authorizes $7 million for the
    Commission to carry out these requirements. Our staff has done an
    estimate of the cost of carrying out the requirements of the act and
    advised the Commission that, for fiscal year 2009, we would need an
    additional $7.887 million--which would provide for start-up cost,
    contract cost, the cost of an additional 6 FTEs, and other costs
    associated with implementing the requirements of the act. As I have
    indicated, the President's request of $80 million does not include
    funding for these activities and Congress would have to include
    additional funds, above the President's request, for the Commission to
    carry out these requirements.

                       IMPACT OF FISCAL YEAR 2008 FUNDING

        In order to fully understand our fiscal year 2009 request, we must
    first look at what is transpiring for us in fiscal year 2008. In fiscal
    year 2008, the administration's budget contemplated funding the
    Commission at $63,250,000 which would have resulted in an all-time low
    funded staffing level of 401 FTEs; a decrease of 19 FTEs from the
    fiscal year 2007 funded level. As I indicated in my written statement
    to this subcommittee last year, such a funding level would have had a
    devastating effect on the agency's ability to maintain the broad range
    of skilled staff we need to address the full scope of the 15,000 types
    of consumer products under our jurisdiction. Congress, led by this
    subcommittee, took up the cause of the American consumer by focusing
    on, and addressing, the serious deficiencies at the Commission
    resulting from our most recent years of shrinking resources by
    appropriating $80 million, a $16.75 million increase over the
    administration's request.
        With the additional resources, the Commission has been able to
    start the process of reversing the effects of the Commission's downward
    spiral in staffing. The Commission is now able to begin filling
    critical vacancies, moving our staff level in the positive direction
    toward 420 FTEs. We have also started a process to reacquire
    headquarters office space that we forfeited in order to reduce our
    operating cost.
        Part of our staffing increase has been directed to an import safety
    initiative through the creation of a new Import Surveillance Division
    in the Office of Compliance and Field Operations. For the first time,
    CPSC will have permanent, full-time product safety investigators at key
    ports of entry throughout the United States. Initially, we have
    identified up to 10 ports where we will assign personnel.
        We are also implementing an Early Warning System (EWS) initiative
    which is designed to identify emerging product safety hazard patterns
    more quickly and effectively in children's products such as cribs,
    bassinets and play yards (playpens). Fiscal year 2008 funding will
    allow staff to continue to develop and implement processes and
    procedures to evaluate and characterize hazard scenarios and failure
    modes which should alert the Commission staff that a product hazard may
    exist and quick action to address it must ensue.
        The additional resources for fiscal year 2008 will also allow the
    Commission to move in the direction of expediting the acquisition of a
    new state-of-the-art laboratory facility and equipment. We will commit
    $8 million of fiscal year 2008 funding toward this effort. The
    Commission is taking the approach of acquiring a new facility as
    opposed to modernizing the present laboratory site based on current
    projections by CPSC staff, GSA, and OMB that acquiring a new facility
    would be a more cost effective, more expeditious, and more efficient
    process for the Commission than rehabilitating the present laboratory
    site.
        Our laboratory situation is well known to most people who have
    focused on the problems presented by the Commission's limited resource
    allocations in recent budgets. We have been trying, through various
    avenues, to remodel or rebuild our existing facility for many years. We
    now appear to be getting closer to the reality of a new testing
    laboratory. The process with GSA has been frustrating, with their
    stated deadlines to us slipping again and again. Last year when GSA
    gave us the preliminary estimate of how much they were going to raise
    the rent at the current laboratory facility (with no improvements) it
    seemed the last straw. (They have since backed off substantially from
    the threatened initial rent increase.)
        Finally, after much discussion, GSA was willing to start the
    process of looking at what other facilities might be available to see
    if the option of moving the lab was more cost effective than rebuilding
    the present one. Perhaps, by the end of this fiscal year we will have a
    much better handle on that option, but given the fits and starts of
    this process I am not as confident as I would like to be about the
    outcome. The cost estimates we are operating on are numbers from OMB
    and GSA, based on the assumption that we will indeed find appropriate
    new space for all of our current and future testing needs as well as
    office space for perhaps as many as 70 of our other employees. I am
    hopeful that at the end of this process we will have a clear picture of
    the efficiency and cost effectiveness of moving in this direction. For
    now, I must simply go on what information staff is presenting to me on
    this issue and I have consented to fully exploring this option.
        We are also able, for the first time, to establish in our base
    funding, a capital fund to replace aging and outdated Information
    Technology (IT) equipment and we are able to dedicate funds to further
    the process of developing more advanced electronic applications for our
    IT system. These advanced electronic applications will be essential to
    the Commission's Import Safety and EWS initiatives as well as an
    important element in converting our current, disparate database systems
    to a one-stop data acquisition system. Moreover, we are able to replace
    our outmoded resource management information system, for which vendor
    support was withdrawn due to the age of the system. Not included in
    this budget are resources to integrate and modernize our various
    database systems into one larger searchable format, an improvement to
    our data analysis capabilities that we have wanted for a long time. If
    Congress requires the agency to create additional publicly accessible
    databases--a move I strongly support--being able to do that in the
    context of improving our overall data capabilities would be especially
    helpful.
        The fiscal year 2008 increase will additionally provide for other
    important product safety related activities such as a modest increase
    in our contract funds for our rulemaking, research, and project
    support. And, because we need to be able to compete with other
    governmental agencies and the private sector for qualified candidates
    to fill our vacancies, the budget increases funds for our staff
    training and staff performance incentives.
        Most important to me in our fiscal year 2008 increase is our now
    present ability to begin rebuilding our staff. CPSC has been under a
    glaring spotlight for the last year. While it is not always a
    comfortable position for the agency to be in, for me, it has been
    welcomed and much needed attention. It brought to light, especially for
    Congress, the woeful state of the agency's resources, from its
    declining staffing levels to its aging and inadequate laboratory
    facilities. For too many years the agency had been forced to put a
    brave face on its situation by claiming it could do more with less.
    When we stopped getting enough resources to meet our basic needs that
    claim began to ring hollow and the agency was left without the
    necessary tools to properly police the consumer product marketplace.
        Now, not only has Congress shown a willingness to give us the
    resources we so desperately need, but it has also positioned itself to
    increase our authorities and responsibilities. I am very thankful for
    Congress' efforts on our behalf. I do hope, however, that any final
    authorization bill that Congress passes gives the Commission the
    necessary time it will need to rebuild to meet our current
    responsibilities. Once we reach that point, then we can give full
    concentration to tackling the many new responsibilities that are
    projected to be part of a final reauthorization package.
        Our fiscal year 2009 budget assumes that we will have 444 staff on
    board for the beginning of fiscal year 2009. This requires us to add
    nearly 65 new employees, a 17 percent increase over our budget
    submission level. That will bring us almost back to our fiscal year
    2005 staffing level of 446 FTEs. When I first came to the agency in
    1995, we had final FTE authority of 487 FTEs and averaged 474 FTEs on
    board for the year. So we still will need to hire another 30 people in
    fiscal year 2010 just to get us back up to our 1995 staffing level, a
    staffing level at which we handled that year's existing
    responsibilities fairly comfortably.
        Over time we hope to be able to hire and train capable replacements
    for those that have left, but the experience that we have lost due to
    their departure will take years to recover. I am very optimistic that
    now, with the change in attitude about the Commission's importance that
    has manifested itself in our increased funding levels, we will be able
    to reverse the negative perceptions about the Commission and move in a
    positive direction on our staffing issues and, therefore, on product
    safety.
              cpsc's safety work can continue in fiscal year 2009
        By most measures, CPSC provides both tremendous service and
    tremendous value to the American people and we are very proud of our
    staff's accomplishments. Our agency is the major factor in the
    substantial decline in the rate of deaths and injuries related to
    consumer products since 1974. During that time, through our standards
    work, compliance efforts, industry partnerships, and consumer
    information, there has been a 43 percent reduction in residential fire
    deaths, a 74 percent reduction in consumer product-related
    electrocutions, a 41 percent reduction in consumer product-related
    carbon monoxide deaths, an 83 percent reduction in poisoning deaths of
    children younger than 5 years of age, an 88 percent reduction in baby
    walker injuries and an 84 percent reduction in crib-related deaths.
        The fiscal year 2009 request, on its face, is a request for level
    funding from fiscal year 2008. What we really have, however, amounts to
    a $5.8 million increase. Assuming the projections on the lab are
    accurate, we will spend $2 million less on the lab in 2009 and we have
    another $3.8 million in other non-recurring, one-time costs that we are
    funding in 2008 that we don't fund in 2009 for a total of $5.8 million
    in additional funds for 2009.
        Of that, $2.457 million will go to maintaining the costs of the 420
    employees we anticipate having on board in fiscal year 2008, along with
    increases in other fixed costs such as rent. Another $3.218 million
    will go to hiring 24 new employees to supplement and to provide support
    for the Import Safety Initiative. We have also targeted $125,000 for
    travel for the U.S.-Sino Product Safety Summit. While I note that both
    the pending reauthorization bills anticipate the Commission receiving
    additional funding for the modernization of our testing and research
    laboratory, our budget requests for both fiscal year 2008 and fiscal
    year 2009 are constructed to utilize a large portion of the funding
    increases provided by Congress for the laboratory modernization,
    certainly a greatly needed improvement. The rest of the increases begin
    the crucial staff rebuilding and the acquisition of additional office
    space to accommodate the additional staff. Those concentrations leaves
    us little for anything else.
        Now, there are certainly many questions remaining unanswered at
    this time concerning reauthorization legislation requirements. I know
    that there are many questions about what should be included as part of
    our request for our fiscal year 2009 budget. At this particular moment,
    it is extremely difficult to determine what additional staff and funds
    we will need to meet the new responsibilities that Congress may give
    us. We have made no attempt to do that in the fiscal year 2009 budget
    request as that would have been premature. The Acting Chairman's office
    in a response to a question presented by House appropriators had staff
    prepare estimates as to what those resources might be (some of those
    estimates are already going through second revisions), but we are all
    flying somewhat blindly until we have a final bill with definite
    requirements and timelines for Commission action. I hope that the
    deadlines in the final bill will take into account the time needed to
    hire and train new employees, to find them adequate office space and to
    integrate them and their skills into our existing workforce. The
    Commission hasn't had to hire at this pace since it was first
    established back in the 1970s.
        We at the Commission strongly feel that many, many deaths and
    injuries have been prevented as a result of the heightened attention
    given to safety issues by manufacturers and consumers due to CPSC's
    leadership. However, we are very mindful that the product safety
    landscape is ever evolving because of more technologically complex
    products as well as an ever growing emphasis on imports. Last year's
    heightened activities with respect to imported toys, in particular,
    clearly illustrate the benefits of a strong CPSC Federal presence in
    today's consumer product marketplace and therefore provide substantial
    justification for present and future funding to keep our safety
    programs intact.

                                   CONCLUSION

        As I have indicated, Congress is poised to come to agreement on a
    final reauthorization package. Both bills under consideration provide
    significant increases in our authorization levels for future years at
    the Commission. The authorization levels reflect my own views on how
    growth should be contemplated for the Commission, and I am hoping that
    future appropriations will be in line with the House and Senate final
    agreed upon authorization levels.
        As I have previously discussed, the bills would also require the
    Commission to undertake a number of activities that I am not taking
    into consideration as I present this statement. The final legislative
    package will most certainly contain some significant new regulatory,
    enforcement and other mandates that could have some effect on what
    resources we would need to fully implement all of the requirements.
    When a final determination is made, we certainly intend to communicate
    with this subcommittee with respect to future requirements and their
    effect on Commission resources.
        Mr. Chairman, I want to thank this subcommittee for your
    recognition of the importance of our agency with respect to product
    safety for American consumers. The sale of unsafe consumer products
    remains a major national problem. Because of your attention and
    assistance, we are now on the way back to firm footing in preventing
    unsafe, potentially harmful consumer products from causing deaths and
    injuries to American consumers. The continued support of this
    subcommittee is essential to a successful fulfillment of our mission.

                                STAFFING LEVELS

        Senator Durbin. Chairman Nord, if I recall, it was in
    December when it was clear that we were sending you this pretty
    substantial increase in your appropriation to $80 million, and
    I was asking the staff here what kind of staffing levels you
    had last year at this time. We think it was around 400 million
    FTE's. Pardon me. 400 FTE's.
        Ms. Nord. You have been dealing with other agencies way too
    long.
        Senator Durbin. I am not sure there is any agency with 400
    million. But 400 FTE's.
        Now, historically we have talked about where this agency
    has been. 980 is the high watermark and now apparently at 380,
    the low watermark. So the question I have is that in the 4-or
    5-month period of time that we have sent you the new resources
    to staff up, it appears you are staffing down. It appears you
    are losing ground. Some 5 percent of your employees have left
    and not been replaced, instead of an additional 10 percent
    being hired. So can you give us an indication of why the trend
    line is moving in the wrong direction?
        Ms. Nord. Well, we see attrition on a regular basis. You
    generally see one or two every month leave, and those people
    have to be replaced to keep you even. But since January, we
    have brought on 21 new hires. We have got 12 offers out right
    now. We have got well over 30, almost 40 new positions that are
    in the mix for being put out for advertisement. So we are
    working really very, very aggressively to get up to that goal
    of starting the fiscal year with 444 FTE's.
        Senator Durbin. So are the 21 that you have hired included
    in the 380 number?
        Ms. Nord. If they are on board, they would be included in
    our current staffing.
        Senator Durbin. What is your current staffing? What number?
        Ms. Nord. It is approximately 385 to 390. I will have to
    give you the precise number.
        Senator Durbin. Well, I do not want you to go out and pick
    the first person off the street, and I am sure you would not
    want to.
        Ms. Nord. No.
        Senator Durbin. But we sure want to make certain that you
    understand the sense of urgency. I will tell you why, and I
    think you know it better than I do.
        The biggest scandal last year involved toys. We know that
    the design for toys for this coming holiday season in
    December--those were all agreed on last year, and they are
    currently under manufacture and currently being shipped to the
    United States. So the new dolls, the new games, whatever they
    happen to be are on their way. Clearly, we have to be ready to
    make sure that the American families do not go through the same
    thing next holiday season that they did the last one.
        Ms. Nord. I do understand your sense of urgency and I share
    that, Senator.
        The thing that I would like to point out is that the type
    of people we are seeking to hire are statisticians, scientists,
    toxicologists, human factors, engineers. These people are
    essential to our operations, but they are also in demand in
    other Government agencies who are also now trying to staff up,
    as well as in the private sector. So this is something we are
    committed to doing. We are working full out right now to get
    ourselves up to the 444. That is our goal and we are working
    very hard to reach it.
        Senator Durbin. We are going to keep in touch with you to
    monitor your progress----
        Ms. Nord. Good.
        Senator Durbin [continuing]. And hope that you can reach
    the 444 with competent individuals as quickly as possible.

                          NEW IMPORT SAFETY INITIATIVE

        Let me ask you about the import safety initiative, which
    will allow you to put permanent, full-time product safety
    investigators at key ports. How many ports will be part of this
    initiative and how many investigators will be placed at these
    ports?
        Ms. Nord. We are going to be putting people at 10 different
    ports. Our overall division is going to be approximately, I
    believe, 12 people, and I would prefer to give your staff
    privately the locations of those ports, if I could.
        Senator Durbin. May I ask, if you are talking about one
    person or slightly more than one person per port, what kind of
    workload will that person face?
        Ms. Nord. Well, they will certainly face a very heavy
    workload, but the thing that needs to be remembered here is,
    first, we have to start someplace.
        And second, we do anticipate that this is a program that
    will grow based on our experiences this year.
        Third, these people are not out there standing alone. They
    are supported by technical staff back at headquarters and also,
    very, very importantly, they are going to be working hand in
    glove with their colleagues from Customs. And that relationship
    between CPSC and Customs has grown wonderfully well over this
    past year, and I am very encouraged by the support that we are
    getting.
        Senator Durbin. Are you considering any new technology in
    these ports for the detection of lead or other dangerous
    substances?
        Ms. Nord. Yes. Because of the increased funding that we
    were able to receive from you, we have now acquired what is
    known as XRF technology. This is important because it allows us
    to screen for potential violations. What we had to do before is
    if the inspector's eye saw something that they thought was
    suspicious, that product had to be sent back to Washington for
    testing, and that was a process that took a great deal of time.
    So this allows us to screen it right there quickly. We can then
    separate out the things that pass from the things that need a
    further look.

                    WILL THERE BE A CPSC PRESENCE IN CHINA?

        Senator Durbin. My last question. Do you expect to place
    any staff in China?
        Ms. Nord. If I have my way, we will.
        Senator Durbin. You are the Acting Chairman.
        Ms. Nord. Yes. We have been having conversations with the
    Beijing Embassy and with the State Department about having a
    foreign service national assigned to us over there. If we are
    to send CPSC staff there and put them there, that is a big
    undertaking for our agency. I believe it requires a vote of the
    Commission, and at this point, you know, we do not have a
    quorum. But I think that would be a good thing to do. So I will
    certainly be voting for it.
        Senator Durbin. I am going to turn this over to Senator
    Brownback. I have to step out while he questions, but I will be
    returning.
        Senator Brownback. Thank you, Mr. Chairman.
        Are you conducting any surprise inspections in China now?
        Ms. Nord. We do not do inspections per se in China as, for
    example, the FDA does. What we are doing is all our recall
    notices go directly to our counterpart agency in China, and
    they investigate them. We are now getting very detailed reports
    back from them as to their findings. We have monthly video
    conferences where we go over each of the recalls and what their
    investigations found.
        Senator Brownback. What about doing surprise inspections in
    China? You were talking about putting personnel or somebody at
    the Embassy there. What about doing surprise inspections?
        Ms. Nord. It is clear actually that under our statute we
    only regulate American product sellers. So we would not have
    the legal authority to go into a Chinese-owned plant with an
    American inspector and do an inspection. What will happen is
    that the Chinese Government does that, and if we have people in
    China, then they could certainly participate in those
    inspections, but they would have to be done by the Chinese
    since they would be inspecting Chinese factories.
        Senator Brownback. Therein lies the rub, if you will,
    because we are getting so much from China and we are having so
    many problems and their system is so different from ours. That
    is the problem. You could kind of say, well, okay, China has a
    free press and so they are going to kind of track these issues
    or get some light on them. Well, they do not. If they had an
    open political system where you would have different political
    parties batting this around, well, okay, maybe that would be
    something that would produce it. They do not. It is well known
    the corruption and graft that is taking place at local levels
    in China. The national level of the Chinese Government is
    trying to get some competitiveness at a local level because of
    primarily dealing with graft and corruption that they are
    trying to get out of the system but is there.
        So I do not know how we depend upon the Chinese Government
    to assure that we get a decent product without us being there
    and in on surprise inspections.
        Ms. Nord. We cannot look to the Chinese Government to
    enforce American safety laws, and we do not intend to. But what
    we can do is put in place a number of different kinds of
    processes that will push toward an ultimate result of safer
    products, and that is what we were trying to do with the
    agreements that we signed last September that created a
    framework for this ongoing activity. That is what we are trying
    to do with our monthly meetings with the Chinese. That is what
    we are trying to do with the training sessions that go on in
    China.
        But having said all that, it is very, very important that
    we also understand that we have got to be looking at layers of
    protection. We can do all that with China, but we have got to
    make sure that we are vigilant at the ports, that we have got
    police on the beat, that is to say, that we recall products
    when we find violations, and that we put penalties in place.
        But one of the things that I think is important for you to
    know, Senator, is that, first of all, the number of toy recalls
    and lead paint violations is going way down. And also it is
    important and I think very good news that we have not yet seen
    any products manufactured after the point of our agreements
    that have been recalled for lead paint violations.
        Senator Brownback. If I could before my time is up, have
    the total number of consumer product recalls on imported items
    from China increased or decreased since September 2007, and not
    just the lead-based products?
        Ms. Nord. I am sorry. I did not have that statistic. The
    number of recalls that we have done in fiscal year 2008 is
    going up, but those are products that were already in the
    marketplace. They are not new products that have entered the
    marketplace since September. So they are things from 2005,
    2006, that kind of thing.
        Senator Brownback. Just to conclude on this, when you catch
    it, the horse is already out of the barn. It is in the consumer
    marketplace here and that is where we catch it when we ought to
    be backing up a lot earlier on this. I do not have confidence
    that, with whatever kind of cooperation we get from the Chinese
    Government, that they are going to catch this. And at the point
    at which we catch it, it has already entered the consumer
    marketplace.
        Ms. Nord. That is why the layers of protection is such an
    important concept. Obviously, consumers are better off if the
    product is manufactured safely in the first place, and that is
    what we have to be shooting for.
        Senator Brownback. Thank you.
        Thank you, Mr. Chairman.

                              CPSC REAUTHORIZATION

        Senator Durbin. Chairman Nord, when the Consumer Product
    Safety Commission Reform Act was pending, Commissioner Moore
    and you sent letters to Chairman Inouye about it, and you have
    alluded to it in your testimony today. Now, of course, this
    bill, having passed the Senate, is subject to conference with
    the House in terms of its outcome.
        I just want to make sure that I understand what you have
    said today. If this bill as passed in the Senate was enacted
    into law, would this give you more tools and more authority to
    do your job?
        Ms. Nord. It would certainly give us more tools and more
    authority.
        Senator Durbin. Is there any way that you think provisions
    of this bill would make your job more difficult?
        Ms. Nord. There are a number of new mandates in the
    legislation and they have very, very short time deadlines on
    them. So we will either have to come back to you with a plan
    for staffing up, to the extent we can, or reallocating existing
    resources, taking things off existing projects and putting them
    on what is there.
        Senator Durbin. Can you give me any examples of those
    mandates as you are sitting there?
        Ms. Nord. Oh, gosh. The bill set out a whole schedule for
    doing rulemakings on children's products, durable infant
    products.
        Senator Durbin. Like tracking labels for children's
    products?
        Ms. Nord. Well, no, doing rulemakings on putting in place
    rules dealing with durable children's products.
        Senator Durbin. Such as a comprehensive ban on lead?
        Ms. Nord. Well, that certainly is there as well, but I was
    speaking of something else.
        Senator Durbin. I am trying to get down to what you are
    speaking of. I am not trying to misstate you.
        Ms. Nord. The bill tells us on a schedule we are to
    finalize two rulemakings every year on durable children's
    products. It also, as you point out, has the ban on lead, and
    we are working very hard with the authorizers' staff to----
        Senator Durbin. I hope you do not disagree with that
    mandate.
        Ms. Nord. Oh, of course, not.

                          CONSUMER COMPLAINT DATABASE

        Senator Durbin. What about the online product safety
    database enhancing public access to product safety information?
    Does that exist today?
        Ms. Nord. No, it does not.
        Senator Durbin. Do you know what it would take to put that
    database in operation? Have you considered that?
        Ms. Nord. Yes. I have asked our information technology
    people to give us some estimates, and they have advised me that
    to do what is described in the Senate bill as it passed would
    take approximately $20 million in startup costs and about $2.5
    million to $3.5 million annual maintenance cost.
        If I may expand, the database is a very good example of why
    we really need to get a better handle overall on our
    information technology needs. Unfortunately, because the agency
    has been short funded, we have put together databases on an as-
    needed basis. They are stovepiped. They do not communicate with
    each other, and for our staff to have the tools it really needs
    to do its work, we have got to modernize our IT resources.

              SENATE CPSC REAUTHORIZATION BILL AND COST ESTIMATES

        Senator Durbin. I would like to ask you, if you would, to
    take a look at the bill that passed the Senate.
        Ms. Nord. Yes.
        Senator Durbin. And if you would give us your best estimate
    from your staff of where you consider to be the most expensive
    and the most challenging elements of that bill, I would like to
    know because I want to get this bill passed. We have been
    working hard to get the conference committee to go to work on
    it, and I want to be thinking in terms of next year's
    appropriation as to what will be needed. For example, this
    database requirement here. If people can come up with a
    reasonable estimate of what that might cost, I want to be
    thinking ahead about what that might require in the next
    appropriation bill.
        I believe in this bill. I introduced an earlier bill which
    was very similar to it. Senator Pryor improved on it and did a
    great job leading it through the floor on a bipartisan basis.
    But I want to think ahead to what these new challenges might be
    and what their costs might be. It certainly is not going to be
    served with a remake of the $80 million fiscal year
    appropriation for this year. It is going to take more.
        Ms. Nord. We will need an amendment, and I will be happy to
    do that.
        Senator Durbin. If you would, please, I would appreciate
    that very much.

              MOST IMPORTANT ELEMENTS OF CPSC REAUTHORIZATION BILL

        Commissioner Moore, your letter in reference to this bill
    was much more supportive in terms of the tools that it would
    give to your Commission. As you reflect on that, were there any
    specifics that you had in mind that you think could really make
    a difference in the way you do your job?
        Mr. Moore. Certainly given the increase in the number of
    products coming in through our ports, the ability to expand our
    study and our interest in products as we meet them at the
    ports, at the docks, I think is very important. To the extent
    that we can turn products around if they are violative--they do
    not meet standards--I think the more effective we can be in
    controlling product safety problems.
        Senator Durbin. Mr. Moore, I think we all understand what
    happened last year. It was a troubling time for many American
    families. There were questions raised about toys in particular
    but other products as well. And a lot of people came up to me
    in my State and to other Senators and said, what is safe? What
    is it safe to buy? And I could not tell them. I really did not
    know the answer to that question. I could not make a
    recommendation of what to do.

                             ARE WE BETTER OFF NOW?

        Do you feel that there is anything happening at the
    Commission today which gives you confidence that the next
    holiday season will be any different or any better?
        Mr. Moore. Well, I think one of the most risky elements of
    products out there most recently has been lead in children's
    toys, and I think there has been enough publicity and enough
    vocal concerns raised about that, that I think the public is
    very much aware. Also manufacturers are very much aware. And, I
    think to the extent that we can eliminate that particular
    problem, that is a major consideration.
        Senator Durbin. It is.
        Chairman Nord, let me ask you the same question. Can you
    tell me with any degree of certainty that the next holiday
    season, that families can have more peace of mind in the toys
    and products that they are purchasing, that we will have done a
    better job or that the process will be any safer?
        Ms. Nord. Last Christmas, the toys, because of what
    happened, were the most tested and examined in the history of
    our country. We need to build on that. I think that the toy
    industry safety initiative is a really interesting proposal
    because, to Senator Brownback's concern, it really does force
    an examination of the Chinese factories. I think that if I
    could have one thing only from the authorization bill--this is
    something I asked for last summer--it is to have certification
    authority. That would do so much to help us. It would drive
    testing. It would give us another tool for imports. That simple
    thing.

                            CERTIFICATION AUTHORITY

        Senator Durbin. Certifying laboratories?
        Ms. Nord. No. Certify that toys meet all relevant
    standards.
        Senator Durbin. Where would the certification take place?
        Ms. Nord. The importer and the product seller would have to
    get it certified.
        Senator Durbin. Where?
        Ms. Nord. If it was manufactured in China, they would have
    to have it tested there.
        Senator Durbin. So there would be laboratories doing this
    work.
        Ms. Nord. Absolutely.
        Senator Durbin. That we would certify.
        Ms. Nord. Absolutely.
        Senator Durbin. And that would, obviously, mean that some
    CPSC employees would have to be traveling to these
    laboratories.
        Ms. Nord. Well, we would certainly be traveling to these
    laboratories, but I think we would be setting up a structure
    that would make sure that the quality control is in place, but
    that all flows from that simple certification requirement.
        Senator Durbin. Is there any effort underway now, even
    absent this new reform bill, to establish these laboratories in
    China, not Government laboratories, but private laboratories,
    the names of which we might recognize?
        Ms. Nord. There are many ongoing efforts. I think the
    community has anticipated that the bill will pass, and that
    sets out a very full third party, independent testing and
    certification requirement. And so they are gearing up for that
    now.
        Senator Durbin. And are you involved at all in that current
    undertaking?
        Ms. Nord. Yes.
        Senator Durbin. What does the CPSC do?
        Ms. Nord. Well, our staff is working very closely with the
    other Government players who have experience doing this in
    other areas. I mean, we have an ongoing relationship with all
    the testing and certification accreditation bodies. You know
    them as well as I, UL, ANSI, ASTM, and there are many others
    that have a role to play here, and we work daily with them.

                                 ENDING REMARKS

        Senator Durbin. I do not have any further questions. I want
    to thank Commissioner Moore and Chairman Nord for being here
    today.
        We are looking forward to receiving your best estimate of
    what impact the new reform bill might have on your agency. I
    encourage you as quickly as possible in a professional way to
    try to get staffed up to make sure that we have the technical
    staff and investigators, both here in the United States and
    overseas. If there is any need of this subcommittee or Congress
    to be involved to help you locate your people in other places,
    I hope you will turn to us because I hope I made it clear that
    I do not want to live through what we did last year, and I am
    sure you do not either.
        Ms. Nord. You can be assured of that, Senator.
        Senator Durbin. We learned from that experience, and we owe
    it to the American people, all of us in Congress and in the
    executive branch, to do a better job.

                         ADDITIONAL COMMITTEE QUESTIONS

        So the record will be open if my colleagues have questions
    that they might submit for your consideration. We have made a
    couple of requests of you here, and I thank you for joining us
    today.
        [The following questions were not asked at the hearing, but
    were submitted to the Commission for response subsequent to the
    hearing:]

                      Questions Submitted to Nancy A. Nord
                Questions Submitted to Senator Richard J. Durbin

                          NEW IMPORT SAFETY INITIATIVE

        Question. How will this initiative change your stated goal for
    fiscal year 2008 for Import Surveillance, which was for staff to
    conduct port-of-entry surveillance for 1 product for which fire safety
    standards are in effect?
        With the funding increase from fiscal year 2008 and knowing of the
    limited goals listed in your fiscal year 2008 budget justification,
    will any of your fiscal year 2009 stated goals for import safety and
    interaction with China be able to be accelerated into this year?
        I know you are using XRF technology. Are there other functional
    technologies being considered for inspection?
        Answer. The 2008 stated goal for one port-of-entry surveillance for
    fire safety contemplated a focus on compliance with CPSC's new mattress
    flammability standard. That important initiative is underway. While the
    stated goals in the Consumer Product Safety Commission's (CPSC)
    Performance Budget and Operating Plan cannot be changed without a vote
    of the Commission (and the Commission currently lacks a quorum), the
    CPSC has been able to use the additional funds provided for fiscal year
    2008 to strengthen its import surveillance activities. A substantial
    portion of the new funds have been used to create the new Import
    Surveillance Division within the Office of Compliance. This new
    division includes, for the first time in CPSC history, personnel who
    work at the ports-of-entry on a full-time basis. The new division
    already has a staff of 11 employees, most of whom are new to the agency
    (although all have had significant prior experience in import safety).
    This increased presence at the ports is yielding a larger number of
    import samples to be evaluated for conformity with mandatory safety
    standards.
        CPSC staff is currently using our new XRF technology at the ports,
    and it has proven to be a very efficient and effective screening system
    in identifying products that may contain lead or be coated with lead
    paint. CPSC staff is exploring whether there are other functional
    technologies that could be used for inspection at the ports.

                         UPDATE ON U.S.-CHINA AGREEMENT

        Question. Last year, you announced an agreement between the United
    States and China on lead paint and consumer product safety.
        Can you give me an update on any progress? Do you believe that
    you'll soon be signing a specific follow up agreement to the framework
    agreement you announced last year?
        What do you see as the tangible benefits of finishing a formal
    agreement?
        Have you observed improvements in China's capacity and willingness
    to perform compliance and enforcement activities regarding product
    safety?
        What outreach has been conducted as a result of the U.S.-China
    agreement?
        Do you expect any such agreements with other countries?
        Answer. The work plans that the CPSC agreed to at the U.S.-Sino
    Consumer Product Safety Summit held in September 2007 were outcomes of
    our Memorandum of Understanding (MOU) with the Peoples' Republic of
    China (PRC) which established the framework for cooperation and
    outreach. The work plans called for cooperative work in four product
    categories: toys, lighters, electrical products, and fireworks.
    Technical experts are now working on exchanges of standards
    information, training for product testing, and sharing information on
    best practices in those four product categories.
        Since September, CPSC staff has met eight times, either in person
    or via video conference, with staff of China's General Administration
    for Quality Supervision, Inspection and Quarantine (AQSIQ) to review
    recalls and safety issues.
        The CPSC has begun a Chinese language service on our web site,
    where Chinese suppliers and government officials can get updated
    compliance information in Chinese. We are translating many product
    safety requirements and posting them on the web site, as well as
    providing summary descriptions in Chinese that link to full texts in
    English.
        Regarding Chinese cooperation, first it should be stressed that the
    CPSC does not rely on the Chinese government to enforce U.S.
    requirements. The CPSC enforces our requirements with American
    importers. That said, the PRC offered to use its export quality control
    system to target Chinese-made products that would be recalled if they
    entered the United States. The CPSC singled out lead paint on toys as a
    problem and the Chinese agreed to take that on.
      --The PRC says it has inspected thousands of factories and revoked
            hundreds of export licenses for lead paint violations. As we
            send them case reports, they now send us the results of their
            investigations, and their reports frequently cite specific
            remedial action that they have required the Chinese factory to
            take.
      --The Chinese government has stated that no export permit is granted
            for a painted toy unless the paint on the toy came from an
            approved lead-free suppliers list.
      --The PRC has sponsored numerous high-profile standards and
            compliance seminars aimed at getting the product safety message
            to Chinese manufacturers. The CPSC participated in one of these
            in November.
      --CPSC staff has noticed that the Chinese government shows an
            increased interest in promoting industry best practices for
            compliance assurance, compared to simply increasing its factory
            inspections.
        Nothing the Chinese government promises and no amount of export
    control inspection can take the place of major systemic changes in
    Chinese manufacturing. CPSC staff is working with Chinese suppliers to
    hasten that change, but it is the U.S. importer that must ensure its
    product complies with U.S. laws.
        At CPSC's invitation, product safety officials from the European
    Union will join us in China during September for a joint outreach
    program directed to consumer product exporters. The Chinese government
    has enthusiastically endorsed this project and has agreed to facilitate
    access to the appropriate audiences for the compliance outreach
    seminars.
        Because we have found the formal work plan to be an effective
    mechanism for articulating priorities and specific outcomes, CPSC staff
    will focus on revising the work plan to capture new priorities rather
    than creating new formal agreements. New work plan priorities will be
    the subject of discussions with the Chinese over the coming months.
    These will be formalized during the U.S.-Sino Safety Summit now being
    planned for 2009.
        With regard to other nations, CPSC staff is negotiating a work plan
    under a new 2008 MOU with Vietnam which is designed to maximize success
    in priority product areas, with textiles as a strong candidate for a
    product area. The CPSC will do a training outreach in Vietnam this
    year, as well as a joint training outreach in China with the European
    Union.

                             NEW IMPROVEMENTS IN IT

        Question. You plan to spend a significant amount of the fiscal year
    2008 funding we provided ($4.3 million) on information technology
    enhancements.
        What are the improvements you are making and what practical results
    will be achieved?
        How will these upgrades improve the quality of injury and hazard
    data received by CPSC and the targeting of inspection and compliance
    activities?
        Answer. With the additional funding provided in fiscal year 2008,
    the CPSC has established both a long-sought permanent capital fund to
    be used to replace aging and outdated equipment on a systematic basis
    as well as a second fund to support development of more advanced
    electronic applications. Additionally, a one-time expenditure of $2.3
    million is allowing the agency to replace its resource management
    information system which is so outdated that vendor support is being
    withdrawn.
        These IT improvements are essential to the agency's new Import
    Safety Initiative and Early Warning System Initiative (EWS). These
    improvements lay the foundation for improved electronic data exchanges
    with Customs and Border Patrol's databases and enhance our capabilities
    to identify, track and stop hazardous products from entering the United
    States. Development and implementation of our EWS will enhance our
    current hazard identification systems. The goal of the EWS is to
    systematically identify and respond to hazards, quickly and
    effectively. Through an enhanced identification system, the agency will
    be better able to quickly detect and initiate action on emerging
    product-associated hazards.

                           STATUS OF CPSC LABORATORY

        Question. I was pleased to have been helpful in discussions with
    the General Services Administration about securing a proper laboratory
    for testing, investigations, and other staffing purposes. I'm glad with
    the funding we provided, that CPSC will be able to move staff to the
    laboratory a year earlier than expected.
        What is the latest on the laboratory move and expected timetable?
        What are the most significant improvements in performance you'll be
    able to demonstrate as a result of moving to the new laboratory?
        Answer. The General Services Administration (GSA) is currently
    working with those who made offers in the Best and Final Offer stage of
    the process. GSA has estimated a July/August completion of this stage
    of the project. We expect a lease award to be made in early fiscal year
    2009, with the occupancy date dependent on build-out requirements.
        The new facility will improve the efficiency of CPSC's technical
    and testing operations by allowing the CPSC to consolidate technical
    staff currently located at our headquarters in Bethesda and at our
    laboratory in Gaithersburg, Maryland, in one location and to expand
    testing and evaluation capacity in support of our Import Surveillance
    Initiative. The new laboratory will allow for a more efficient use of
    space through the proper integration of offices and laboratories and is
    expected to reduce the time currently required to set-up and conduct
    various tests. The new laboratory will be designed to be more flexible
    and will permit CPSC staff to adapt the layout to future changes in
    operational requirements.
        Plans also include the design and construction of a Human Factors
    laboratory within the new facility. This laboratory will provide the
    CPSC with the capability to perform studies of children's and adults'
    interaction with various consumer products such as toys.

                      WHAT ELSE WILL CPSC STUDY THIS YEAR?

        Question. Yesterday, I cosponsored legislation to ban bisphenol A
    (BPA), a chemical found in plastics, from all products made for infants
    and children up to age 7. I understand that in 2002, the CPSC studied
    rattles, teething rings, and pacifiers and found BPA in 5 of 13 plastic
    samples.
        Given the growing evidence from new studies that have linked the
    chemical to cancer, diabetes, behavioral disorders and productive
    problems, do you now plan to study BPA further, particularly with
    regard to toys and other items children may put into their mouths?
        With the increased resources that you now have, what other issues
    do you expect to begin to focus on and study?
        Nanotechnology?
        Answer. Bisphenol A (BPA) is a chemical used in the manufacture of
    polycarbonate plastics and epoxy resins. The greatest potential for
    human exposure to BPA is from food contact items. The recent in-depth
    peer review conducted by the National Toxicology Program (NTP) Center
    for the Evaluation of Risk to Human Reproduction (CERHR) stated that
    diet accounts for the vast majority, 99 percent, of human exposure. If
    BPA migrates out of a food contact surface into food, it is considered
    an unintentional food additive and would be under the jurisdiction and
    expertise of the Food and Drug Administration (FDA).
        Polycarbonate is used in consumer products where there is a need
    for a very hard, clear, unbreakable and sturdy plastic. Polycarbonate
    is used in helmets, pacifier shields, protective gear such as goggles
    and shin guards, as well as other products, that fall under the
    jurisdiction of the CPSC.
        Polycarbonate is used in some pacifier shields (that prevent the
    nipple from being swallowed) so that when a child falls, the shield
    does not shatter, breaking into small parts and exposing the child to a
    possible choking or laceration injury. Any potential exposure from this
    product would result from mouthing the shield. In 2000 and 2001, CPSC
    staff conducted a behavioral observation study on mouthing related to
    the agency's investigation of exposure to diisononyl phthalates; the
    results of this study are instructive with regard to BPA. In the
    behavioral observation study, trained observers monitored the behavior
    of 169 children between the ages of 3 and 36 months. The study found
    that the daily mouthing times of children's toys and related products
    were much lower than expected. Based on these findings, the potential
    exposure from the pacifier shield would be negligible. As with adults,
    the preponderant exposure route for children would be through food.
        There would be no exposure to BPA expected from compact disks,
    electronics, helmets, goggles, other protective gear, and related
    consumer products. It should be noted that polycarbonate plays a very
    important role in its use in helmets and other protective gear,
    preventing children from receiving serious head injuries, eye injuries
    or other bodily injuries while engaging in sports and play.
        With respect to nanotechnology, CPSC staff is actively
    participating in a number of interagency initiatives or initiatives by
    other groups addressing the production, use, and potential health
    effects and safety of nanomaterials. These groups include: Nanoscale
    Science, Engineering and Technology (NSET) subcommittee of the National
    Science and Technology Council (NSTC) and its working groups such as
    the Nanotechnology Environmental and Health Implications (NEHI);
    American National Standards Institute (ANSI); International Life
    Sciences Institute (ILSI); National Toxicology Program (NTP); ASTM
    International (ASTM); and International Council on Nanotechnology
    (ICON).
        Participation in these groups and activities fosters communication
    between CPSC staff and the staff of various federal agencies and other
    groups. CPSC staff learns about health effects data and the best
    available practices for the regulation of nanomaterials. These
    interactions also promote responsible research and development of
    nanomaterials that can be used in consumer products.
        A contractor for the CPSC has completed a literature review of
    nanomaterials that may be used as flame-retardant (FR) chemicals. The
    report focuses on the physico-chemical properties of the FR chemicals
    and also reviews potential exposure and health effects of these
    compounds.
        CPSC staff has met with staff at NIST, EPA, FDA, and NIOSH to
    identify areas of mutual interest and collaboration. For example, CPSC
    staff has signed a memorandum of understanding (MOU) with NIST to
    review nano-flame retardants in various products. CPSC staff is also
    developing an interagency agreement (IAG) with the National Institute
    for Occupational Safety and Health (NIOSH) to conduct laboratory
    investigations of emissions of nanomaterials from selected consumer
    products.
        The increased resources for the CPSC are primarily devoted to three
    purposes in fiscal year 2008: new laboratory facilities, information
    technology modernization and additional field staff. However, CPSC
    staff will continue chemical-related activities focusing on lead in
    consumer products; nanotechnology; strong sensitizers; ozone-generating
    air cleaners; the use of flame retardant chemicals in upholstered
    furniture and mattresses; implementation of the Globally Harmonized
    System (GHS) for Classification and Labeling; and participation in
    interagency and international workgroups and committees. Additionally,
    the staff has begun to investigate phthalate substitutes.
        In 2009 all of these current activities are expected to continue.
    In addition, the staff plans to begin new projects looking at potential
    health effects on issues that may include the use of aerosol products
    (such as leather waterproofing sprays) and the presence of stabilizers
    in plastics.
        Question. Is CPSC Collecting Data on Fire-Related Injuries and
    Deaths?
        Your fiscal year 2008 budget justification indicates that you began
    an evaluation of a new system for collecting data on fire-related
    injuries and deaths but that additional data collection and
    investigation for this new system was being suspended pending a review,
    resulting in temporary cost savings.
        Where does this effort stand today? Have you resumed collection and
    analysis of fire death data and will you continue to collect and
    evaluate fire injury data?
        Answer. Two preliminary studies, one on fire fatalities and the
    other on fire injuries, have been completed. The preliminary study
    results are currently undergoing agency review, evaluation and
    clearance procedures; further work is pending completion of those
    procedures. The CPSC continues to utilize data provided by the U.S.
    Fire Administration's National Fire Incident Reporting System and the
    National Fire Protection Association's Survey of Fire Departments to
    generate fire loss estimates (fires, death, injuries, and property loss
    damage) for products within CPSC's jurisdiction.

             DATA ANALYSIS--NEW EARLY WARNING SYSTEM PILOT PROGRAM

        Question. I understand that with the additional funds provided last
    year, you will implement a pilot program; an early warning system that
    will facilitate rapid identification of and action on emerging product-
    associated hazards.
        How will this program work and what products will you focus on?
        Answer. The goal of the Early Warning System (EWS) is to enhance
    CPSC's current hazard identification systems by decreasing the time
    required to identify and initiate action on emerging product-associated
    hazards, and increasing accountability for decisions.
        In November 2007, CPSC staff initiated an EWS pilot program that
    targets products found in the sleeping environments of children--cribs,
    bassinets, and play yards (play pens). The agency's current focus is on
    mechanical and structural hazards that have the potential to entrap or
    otherwise fatally injure a child.
        A multidisciplinary team of subject matter experts meets weekly to
    evaluate and characterize the hazard scenarios and failure modes of
    product-associated incidents received during the previous week. An
    electronic database has been developed to capture these hazard
    scenarios, failure modes, and the investigative status.
        The automated system that is being developed will include the
    ability to: consolidate incident information from CPSC's many databases
    into one incident record, associate records that have like incident
    scenarios, identify hazard patterns and trends, apply a set of decision
    rules based on specific hazard characteristics and frequency of
    occurrence, and assign decision rule-based outcomes.
        The next stage in the development of our EWS, currently underway,
    is proof of concept. Concepts that are developed to automate the
    program requirements identified in the pilot program will be tested to
    ensure that system outputs meet the needs of system users and satisfy
    the project objective.

            WHY ARE CPSC GOALS FOR CUSTOMER SATISFACTION DECREASING?

        Question. Your fiscal year 2009 budget justification lists annual
    goals for customer satisfaction. Categories include, but are not
    limited to: responding to voicemail messages by the next business day;
    processing incident reports within 8 working hours; and mailing
    incident information for verification to consumers within 2 business
    days. In almost every category listed, your goals for 2008 and 2009 are
    lower than your actual rates for years 2004 through 2007.
        Why is that?
        Answer. The staff of the National Injury Information Clearinghouse
    (NIIC) was reduced over the last several years from six full time
    technical information specialists to the current staff level of three
    full time technical information specialists. As the agency continues to
    hire more staff as a result of increased appropriations, the number of
    staff resources devoted to the NIIC will increase, and pending the
    restoration of a quorum, the Commission will be reassessing these
    performance goals when developing the agency's fiscal year 2009
    operating plan.

                              ALL-TERRAIN VEHICLES

        Question. I understand that you've collected reports on fatal
    crashes.
        Have you recorded that information in your database so it can be
    studied?
        Have you performed any tests on ATVs to see whether the companies
    are abiding by agreements on lateral (side) stability?
        ATVs used to be mostly three-wheeled vehicles. Moving to more
    stable, four-wheel models was an improvement, but a side effect was to
    shift the safety debate to rider behavior and away from ATV design.
        Have you challenged manufacturers on the design of four-wheel ATVs
    or done any meaningful stability testing of four-wheel ATVs in the past
    decade?
        Are most of these ATVs coming from China?
        Now that you are hiring more staff, will this be an area of focus?
        Answer. CPSC staff collects information on fatalities associated
    with the use of all-terrain vehicles (ATVs) and records that
    information in a CPSC ATV database (ATVD) so that the information can
    be retrieved, reviewed, and analyzed. The ATVD is available to the
    public on request. The fatality data are gathered from a variety of
    sources, including news clips; reports submitted to CPSC staff from
    medical examiners and coroners; consumer reports received via telephone
    or the Internet; and death certificates received from state and city
    vital registries.
        ATV fatalities generally are assigned for in-depth investigation by
    CPSC Field Operations staff, who attempt to gather any available
    information about the:
      --incident (date, location, number of deceased persons, a description
            of the circumstances surrounding the incident and how the
            incident occurred, number of riders on the ATV when the
            incident occurred);
      --decedent (date of death, age, gender, helmet use, cause of death);
      --driver (age, gender, height, weight, alcohol use at time of
            incident, drug use at time of incident, how the driver learned
            to operate an ATV);
      --ATV (type, manufacturer, brand, model, and engine size);
      --environment (type of terrain being traveled at the time of the
            incident, type of road being traveled at the time of the
            incident); and
      --hazard pattern (e.g., did the ATV overturn? Did the ATV land on the
            victim?).
        CPSC staff uses these fatality data in preparing its annual report
    of ATV-related deaths and injuries, in special studies requested by the
    Commission, in support of education initiatives by CPSC's Office of
    Public Affairs, and in support of voluntary standard and rulemaking
    activities.
        In August and September 2007, Office of Compliance staff requested
    lateral stability values for all current ATV models from all of the
    firms with Letters of Understanding (LOUs) with the CPSC. All reported
    lateral stability values met the requirements that were agreed to when
    the consent decrees were in effect.
        Currently, CPSC Engineering Sciences (ES) staff is examining the
    current generation of ATVs to become familiar with the static and
    dynamic testing of ATVs using the latest available technologies. As a
    part of this effort, ES staff recently tested nine youth ATVs at the
    U.S. Army Automotive Test Center in Aberdeen, Maryland. This testing
    consisted of gathering baseline measurements of the vehicles' static
    stability and preliminary measurements of the vehicles' dynamic
    performance. In addition, CPSC staff has been developing the capability
    to perform dynamic testing of ATVs, has been consulting with vehicle
    dynamic experts at Aberdeen, plans to test adult ATVs in fiscal years
    2008 and 2009, and has been developing a robotic steering system to
    test ATV stability under a variety of operational conditions, some of
    which would be too dangerous to perform with a test operator.
        In the time since the consent decrees, vehicle technology has
    evolved in terms of brake systems, suspension systems, and engine
    horsepower. CPSC staff believes that the exploration of a lateral
    stability requirement for ATVs, while potentially very useful, is an
    exceedingly complex task. This is because ATVs are rider-interactive
    vehicles used in many types of off-road terrains. The effort to address
    lateral stability issues requires extensive test and evaluation with
    the cooperation of CPSC staff, industry and other private sector
    entities.
        With regard to ATVs imported from China, a recently-released trade
    press report indicates that for 2007 about 42 percent of the ATVs sold
    in the United States were from ``nontraditional'' companies. Nearly all
    of these units were from Chinese companies. A report, with a chart
    showing Chinese ATVs as a proportion of the ``nontraditional'' ATVs
    sold in the United States for the years 1997 through 2007, can be found
    at: http://www.dealernews.com/dealernews/article/
    articleDetail.jsp?id=512838&searchString=nontraditi.
        CPSC staff intends to continue its ATV rulemaking and other
    activities in 2008 and 2009, as directed by the Commission. Other
    activities include continued testing of ATVs with the goal of better
    understanding vehicle stability; information and education activities
    (see ATVsafety.gov); completion of the next annual report of ATV-
    related deaths and injuries; and conducting focus groups to address the
    issue of maximum speed for youth ATVs.

                          NEW POOL AND SPA SAFETY ACT

        Question. Your budget justification indicates that this year, you
    will begin an education program associated with the Pool and Spa Safety
    Act, enacted last year.
        What specific activities will you undertake?
        Answer. On May 21, 2008, the CPSC launched its 2008 media and
    education campaign on pool safety and drowning prevention by hosting a
    pre-Memorial Day Weekend news conference. CPSC's news conference and
    news release focused on new death and injury data, building layers of
    protection in and around the pool and spa, the importance of constant
    supervision, and the requirements for public pool and spa owners/
    operators under the new federal law.
        The news conference, the issuance of a video news release, and
    proactive communication with the media, resulted in: a segment on ``The
    Today Show'', a news reader on ``Good Morning America'', citation of
    our data on ``CBS Evening News'' reader, an ABCNews.com story on a CPSC
    employee who lost her son in a pool drowning, and stories on ``CBS
    Radio'', ``CNN Radio'', ``Telemundo'', Washingtonpost.com, the
    Associated Press wire, and in Parenting Magazine. Current data
    collected by the CPSC shows more than 25 million TV viewers and radio
    listeners were reached.
        In addition, the CPSC is working with two respected companies in
    the Washington, DC area to disseminate nationally and locally, our TV
    and Radio Public Service Announcement (PSA) on pool safety, which is
    entitled ``Quickly and Quietly.''
        The CPSC, in partnership with Safe Kids USA and the American Red
    Cross, also produced a safety poster on drowning prevention that was
    specifically designed for our 5,300 Neighborhood Safety Network
    members, who provide safety information to disadvantaged families.
        The agency continues to provide consumers, pool owners, pool
    operators and others with free copies of our ``Guidelines for
    Entrapment Hazards: Making Pools and Spas Safer'' and ``Safety Barrier
    Guidelines for Home Pools'' publications.
        During the summertime, the CPSC will work closely with Safe Kids
    USA to respond to news reports of child drownings and will provide
    critically important safety information and PSAs to media in the
    affected community.
        The CPSC is working hard to educate families on pool and spa safety
    this year and, pending the availability of appropriations, is preparing
    to carry out a significantly expanded information and education
    campaign in fiscal year 2009. This effort, combined with our commitment
    to effectively implement the new Pool and Spa Safety Act, is aimed at
    reducing the tragic number of child drownings which occur each year.

                                YO-YO WATER BALL

        Question. In 2003, CPSC announced the results of an investigation
    into the ``Yo-Yo Water Ball'', a plastic toy with a stretchy cord, for
    which CPSC had received 186 reports of incidents in which the toy's
    cord wrapped around a child's neck. CPSC determined that there was a
    low but potential risk of strangulation and that the toy did not meet
    the standards for a recall. I understand that as of mid-December 2007,
    CPSC has received more than 400 injury reports related to this toy. And
    the State of New Jersey has now banned the sale of Yo-Yo Water Balls.
        Is CPSC considering taking any action with regard to this dangerous
    product?
        Answer. The CPSC has not received 400 injury reports related to
    this toy. Incident reports provided to the CPSC do not necessarily
    involve an injury. For example, many of the incident reports regarding
    yo-yo water balls were concerns about odors, leaking or possible
    flammability. The majority of these reports were received before the
    CPSC issued a public advisory on the product on September 24, 2003.
    Since that time, incident reports have dropped precipitously. In
    calendar year 2006 the CPSC received 10 incident reports, four of which
    were complaints about the product's odor.
        When CPSC's professional staff investigated this product in 2003,
    they decided not to recommend that the Commission ban yo-yo water
    balls. Staff did not believe that the product met the banning
    requirements under section 15 of the Federal Hazardous Substances Act.
    Subsequently, the CPSC worked with ASTM International in their
    development of a voluntary safety standard for yo-yo water balls. That
    standard was published in the March 2007 version of ASTM F963.

                                  CPSC QUORUM

        Question. CPSC's quorum expired in early February. The CPSC
    Reauthorization, in conference negotiations right now, and which may be
    completed in May, would temporarily permit two members of the
    Commission, if they are not affiliated with the same political party,
    to constitute a quorum for the transaction of business.
        What rulemakings and other items requiring a vote of the Commission
    do you foresee this year?
        What items are pending right now and ready for a vote?
        Answer. The Commission's official Regulatory Agenda sets forth the
    status of all CPSC rulemakings currently underway. A copy of the
    current Regulatory Agenda is attached. If a CPSC reauthorization bill
    is enacted into law that reflects the language currently being
    considered by the Senate/House conference committee, the Regulatory
    Agenda will have to be very substantially revised to reflect
    redeployment of Commission personnel resources to address new statutory
    mandates. In that case, during the remainder of calendar year 2008, the
    Commission may take official action on project changes to the fiscal
    year 2008 and 2009 Operating Plans and the CPSC fiscal year 2009 budget
    submission.

                                                AGENCY RULE LIST--SPRING 2008--CONSUMER PRODUCT SAFETY COMMISSION
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                   Agency                  Agenda Stage of Rulemaking                                Title                                        RIN
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    CPSC................................  Proposed Rule Stage........  Flammability Standard for Upholstered Furniture..................  3041-AB35
    CPSC................................  Proposed Rule Stage........  Possible Revocation or Amendment of Standard for the Flammability  3041-AC27
                                                                        of Mattresses and Mattress Pads (Cigarette Ignition).
    CPSC................................  Proposed Rule Stage........  All-Terrain Vehicles.............................................  3041-AC28
    CPSC................................  Long-Term Actions..........  Amendment of Safety Regulations for Cribs........................  3041-AB67
    CPSC................................  Long-Term Actions..........  Portable Bed Rails...............................................  3041-AB91
    CPSC................................  Long-Term Actions..........  Safety Standard for Baby Bath Seats..............................  3041-AC03
    CPSC................................  Long-Term Actions..........  Petition CP 03-1/HP 03-1 Requesting a Standard for Bunk Bed        3041-AC10
                                                                        Corner Posts.
    CPSC................................  Long-Term Actions..........  Petition CP 04-1/HP 04-1 Requesting Mandatory Fire Safety          3041-AC22
                                                                        Standards for Candles and Candle Accessories.
    CPSC................................  Long-Term Actions..........  Mandatory Safety Standard for Cigarette Lighters.................  3041-AC25
    CPSC................................  Long-Term Actions..........  Proposed Standard To Address Open-Flame Ignition of Bedclothes...  3041-AC26
    CPSC................................  Long-Term Actions..........  Regulatory Options for Infant Pillows............................  3041-AC30
    CPSC................................  Long-Term Actions..........  Regulatory Options for Table Saws................................  3041-AC31
    CPSC................................  Long-Term Actions..........  Fireworks Devices................................................  3041-AC35
    CPSC................................  Long-Term Actions..........  Portable Generators..............................................  3041-AC36
    CPSC................................  Long-Term Actions..........  Civil Penalty Factors............................................  3041-AC40
    CPSC................................  Long-Term Actions..........  Regulatory Options for Lead Toy Jewelry..........................  3041-AC41
    CPSC................................  Completed Actions..........  Amendment of the Standard for the Flammability of Clothing Tex-    3041-AB68
                                                                        tiles.
    --------------------------------------------------------------------------------------------------------------------------------------------------------

                                   VIEW RULE

        CPSC     RIN: 3041-AB35 Publication ID: Spring 2008
        Title: Flammability Standard for Upholstered Furniture
        Abstract: On October 23, 2003, the Commission issued an ANPRM to
    expand the scope of the ongoing upholstered furniture flammability
    proceeding to include both cigarette and small open flame-ignited
    fires. The staff developed a draft standard addressing both cigarette
    and small open flame ignition, and held public meetings in 2004 and
    2005 to present and discuss the draft. In January, 2006, the staff sent
    a briefing package containing a revised draft standard and describing
    regulatory options to the Commission and provided follow-up status
    reports on various technical research efforts in November 2006 and
    December 2006. The staff forwarded another options package to the
    Commission in November 2007. The Commission voted to propose a rule
    based on the 2007 draft standard. The Commission's proposed standard
    would not require FR chemicals in fabrics or fillings.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Economically Significant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Proposed Rule Stage
        Major: Yes
        Unfunded Mandates: No
        CFR Citation: 16 CFR 1640 (To search for a specific CFR, visit the
    Code of Federal Regulations.)
        Legal Authority: 15 USC 1193, Flammable Fabrics Act; 5 USC 801
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    ANPRM.............................  06/15/1994.......  59 FR 30735
    Commission Hearing May 5 & 6, 1998  03/17/1998.......  63 FR 13017
     on Possible Toxicity of Flame
     Retardant Chemi-  cals.
    Meeting Notice....................  03/20/2002.......  67 FR 12916
    Notice of September 24 Public       08/27/2003.......  68 FR 51564
     Meeting.
    ANPRM.............................  10/23/2003.......  68 FR 60629
    ANPRM Comment Period End..........  12/22/2003.......  .................
    Staff Held Public Meeting.........  10/28/2004.......  .................
    Staff Held Public Meeting.........  05/18/2005.......  .................
    Staff Sends Status Report to        01/31/2006.......  .................
     Commission.
    Staff Sends Status Report to        11/03/2006.......  .................
     Commission.
    Staff Sends Status Report to        12/28/2006.......  .................
     Commission.
    Staff Sends Options Package to      12/22/2007.......  .................
     Commission.
    Commission Votes to Direct Staff    12/27/2007.......  .................
     to Prepare Draft NPRM.
    Staff Sends Draft NPRM to           01/22/2008.......  .................
     Commission.
    Commission Decision to Publish      02/01/2008.......  .................
     NPRM.
    NPRM..............................  03/04/2008.......  73 FR 11702
    NPRM Comment Period Ends..........  05/19/2008.......  .................
    ------------------------------------------------------------------------

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: Undetermined
        Federalism: Undetermined
        Included in the Regulatory Plan: Yes
        RIN Data Printed in the FR: No
        Agency Contact: Dale R. Ray, Project Manager, Consumer Product
    Safety Commission, Directorate for Economic Analysis, 4330 East-West
    Highway, Bethesda, MD 20814-4408. Phone: 301 504-7704. Email:
    dray@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC27 Publication ID: Spring 2008
        Title: Possible Revocation or Amendment of Standard for the
    Flammability of Mattresses and Mattress Pads (Cigarette Ignition)
        Abstract: The Commission published an advance notice of proposed
    rulemaking (ANPRM) in the Federal Register on June 23, 2005, requesting
    comments on a rulemaking proceeding that could result in revoking or
    amending its existing flammability standard that includes a test for
    cigarette ignition of mattresses and mattress pads (16 CFR part 1632).
    On January 13, 2005, the Commission issued a proposed flammability
    standard for mattresses and mattress and foundation sets that
    prescribes an open flame ignition test. Some commenters to that
    rulemaking stated that they believe that once the new mattress standard
    is in effect the cigarette ignition test currently required in 16 CFR
    1632 will not be necessary and conducting both tests will be burdensome
    for industry. The Commission issued this ANPRM to begin consideration
    of whether the existing mattress standard should be revoked or amended.
    The staff is analyzing the public comments. A research project
    examining the criteria for self-sustained smoldering began in late
    2006.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Proposed Rule Stage
        Major: Undetermined
        Unfunded Mandates: Undetermined
        CFR Citation: 16 CFR 1632 (To search for a specific CFR, visit the
    Code of Federal Regulations.)
        Legal Authority: 15 USC 1193, Flammable Fabrics Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    ANPRM.............................  06/23/2005.......  70 FR 36357
    ANPRM Comment Period End..........  08/22/2005.......  .................
    Research Project Begins...........  09/30/2006.......  .................
    Research Project Completed........  09/00/2008.......  .................
    Staff Sends Briefing Package to     ( \1\ )..........  .................
     Commission.
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: Undetermined
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact: Patricia K. Adair, Project Manager, Consumer
    Product Safety Commission, Directorate for Engineering Sciences, 4330
    East-West Highway, Bethesda, MD 20814-4408. Phone: 301 504-7536. Email:
    padair@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC28 Publication ID: Spring 2008
        Title: All-Terrain Vehicles
        Abstract: On October 14, 2005, the Commission published an advance
    notice of proposed rulemaking (ANPRM) concerning all terrain vehicles
    (ATVs). Issuance of the ANPRM initiated a rulemaking proceeding under
    the Consumer Product Safety Act (CPSA) and the Federal Hazardous
    Substances Act (FHSA). After reviewing the regulatory alternatives and
    the comments submitted in response to the ANPRM, the staff developed a
    May 31, 2006, briefing package recommending that the Commission issue a
    notice of proposed rulemaking (NPRM) that would formally ban three-
    wheeled ATVs and mandate performance, training, labeling, and
    information requirements for four-wheeled ATVs. Other non-regulatory
    activities also were recommended, including the launch of an ATV safety
    Web site and a two-phase information and education effort. A Commission
    briefing was held on June 15, 2006. On July 12, 2006, the Commission
    voted 3-0 to approve publication of the draft NPRM with changes in the
    Federal Register. The NPRM was published on August 10, 2006, with a
    comment closing date of October 24, 2006. Seven ATV manufacturers and
    distributors requested a 60-day extension of the comment period. The
    Commission granted their request, and the comment closing date was
    extended to December 26, 2006. Staff is conducting research as directed
    by the Commission in its vote on July 12, 2006. On February 13, 2008,
    staff sent a report to the Commissioners summarizing the status of the
    staff's research activities.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Proposed Rule Stage
        Major: Undetermined
        Unfunded Mandates: Undetermined
        CFR Citation: 16 CFR 1307; 16 CFR 1410; 16 CFR 1500; 16 CFR 1515
    (To search for a specific CFR, visit the Code of Federal Regulations.)
        Legal Authority: Consumer Product Safety Act; 15 USC 1261; Federal
    Hazardous Substances Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Staff sends draft ANPRM to          09/15/2005.......  .................
     Commission.
    Commission Decision...............  10/05/2005.......  .................
    ANPRM.............................  10/14/2005.......  70 FR 60031
    ANPRM Comment Period Closes.......  12/13/2005.......  .................
    Staff Sends Briefing Package to     05/31/2006.......  .................
     Commission.
    Commission Decision...............  07/12/2006.......  .................
    NPRM..............................  08/10/2006.......  71 FR 45903
    NPRM Comment Period Extended......  10/20/2006.......  71 FR 61923
    NPRM Comment Period Closes........  10/24/2006.......  .................
    NPRM Comment Period Closes........  12/26/2006.......  .................
    Staff Sends Status Report to        02/13/2008.......  .................
     Commissioners.
    Staff Send Second Status Report to  06/00/2008.......  .................
     Commission.
    Staff Sends Briefing Package to     ( \1\ )..........  .................
     Commission.
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: Undetermined
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact: Elizabeth W. Leland, Project Manager, Consumer
    Product Safety Commission, Directorate for Economic Analysis, 4330
    East-West Highway, Bethesda, MD 20814-4408. Phone: 301 504-7706. Email:
    eleland@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AB67 Publication ID: Spring 2008
        Title: Amendment of Safety Regulations for Cribs
        Abstract: On December 16, 1996, the Commission published an advance
    notice of proposed rulemaking (ANPRM) to begin a proceeding that could
    result in amendment of the safety regulations for full-size and non-
    full-size cribs, 16 CFR parts 1508 and 1509. Among the regulatory
    alternatives under consideration is amendment of the regulations to add
    tests to assure that slats will not disengage from the side panels of
    cribs. The Commission began this proceeding after considering
    information about incidents in which crib slats disengaged from the
    side panels of cribs, creating a risk that children may become
    entrapped between the remaining slats or fall out of the crib. At the
    urging of CPSC staff, in April 1999, the voluntary standard for cribs
    designated, ``Specification for Full Size Baby Cribs (ASTM F1169-99),''
    and published by ASTM International was revised to include performance
    requirements for crib slats. CPSC staff is currently assessing the
    adequacy of and conformance with the voluntary standard. Following this
    assessment, the staff will prepare a briefing package for Commission
    consideration as to whether to continue the rulemaking.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: No
        CFR Citation: 16 CFR 1508 to 1509 (To search for a specific CFR,
    visit the Code of Federal Regulations.)
        Legal Authority: 5 USC 553, Administrative Procedure Act; 15 USC
    1261, Federal Hazardous Substances Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Staff Recommended Revisions to      09/30/1996.......  .................
     Voluntary Standard.
    ANPRM.............................  12/16/1996.......  61 FR 65996
    ANPRM Comment Period End..........  02/14/1997.......  .................
    Revisions to Voluntary Standard     04/10/1999.......  .................
     Approved.
    Voluntary Certification Program     03/01/2000.......  .................
     Begins.
    Staff Began Monitoring Adequacy of  03/27/2001.......  .................
     and Conformance with Revised
     Voluntary Standard.
    Staff Completes Monitoring          ( \1\ )..........  .................
     Adequacy and Conformance.
    Staff Sends Briefing Package to     ( \1\ )..........  .................
     Commission.
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: Undetermined
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact: Patricia L. Hackett, Project Manager, Consumer
    Product Safety Commission, Directorate for Engineering Sciences, 4330
    East-West Highway, Bethesda, MD 20814-4408. Phone: 301 504-7577. Email:
    phackett@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AB91 Publication ID: Spring 2008
        Title: Portable Bed Rails
        Abstract: The Commission is considering whether certain portable
    bed rails present an unreasonable risk of injury that should be
    regulated. A portable bed rail is a device intended to be installed on
    an adult bed to prevent a child from falling out of the bed. Such bed
    rails may be constructed in a manner that allows children to become
    entrapped between the portable bed rail and the bed. This entrapment
    can result in serious injury or death. In October 2000, the Commission
    issued an advance notice of proposed rulemaking (ANPRM) addressing this
    issue. The ASTM International standard for bed rails has since been
    revised and staff is evaluating the adequacy of, and conformance to,
    the revised standard. Following this evaluation, the Commission staff
    will prepare a briefing package for Commission consideration as to
    whether to continue the rulemaking.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: No
        CFR Citation: Not Yet Determined (To search for a specific CFR,
    visit the Code of Federal Regulations.)
        Legal Authority: 15 USC 1261, Federal Hazardous Substances Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Staff Sent Briefing Package to      06/28/2000.......  .................
     Commission.
    Commission Decision...............  09/21/2000.......  .................
    ANPRM.............................  10/03/2000.......  65 FR 58968
    ANPRM Comment Period End..........  12/04/2000.......  .................
    Staff Sent Briefing Package to      10/01/2001.......  .................
     Commission.
    Commission Decision...............  10/30/2001.......  .................
    Staff Begins Evaluating             10/01/2005.......  .................
     Conformance to Voluntary Standard.
    Staff Sends Briefing Package to     ( \1\ )..........  .................
     Commission.
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: Undetermined
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact: Patricia L. Hackett, Project Manager, Consumer
    Product Safety Commission, Directorate for Engineering Sciences, 4330
    East-West Highway, Bethesda, MD 20814-4408. Phone: 301 504-7577. Email:
    phackett@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC03 Publication ID: Spring 2008
        Title: Safety Standard for Baby Bath Seats
        Abstract: An advance notice of proposed rulemaking (ANPRM),
    published in the Federal Register on August 1, 2001, requested comments
    on a rulemaking proceeding that could result in a mandatory rule
    addressing baby bath seats. These are consumer products used to hold an
    infant in a bathtub while the child is being bathed. The staff briefed
    the Commission on July 28, 2003, and the Commission received oral
    comments from the public on the same date. The staff evaluated the
    comments received at the hearing and sent a briefing package to the
    Commission. In October of 2003, the Commission voted to direct the
    staff to prepare a notice of proposed rulemaking (NPRM) for the
    Commission's consideration. On December 29, 2003, the NPRM was
    published in the Federal Register. The comment period closed on March
    15, 2004. Since the NPRM, staff worked with ASTM International to
    revise the voluntary standard for bath seats (ASTM F1967). The standard
    was revised in 2004 and again in 2007. Staff is currently evaluating
    the adequacy of the revised standard. Following this evaluation, staff
    will prepare a briefing package for Commission consideration as to
    whether to continue the rulemaking.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: Undetermined
        CFR Citation: Not Yet Determined (To search for a specific CFR,
    visit the Code of Federal Regulations.)
        Legal Authority: 15 USC 1261, Federal Hazardous Substances Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    ANPRM.............................  08/01/2001.......  66 FR 39692
    ANPRM Comment Period End..........  10/01/2001.......  .................
    Staff Sends Briefing Package to     05/08/2003.......  .................
     Commission.
    Staff Briefed Commission..........  07/28/2003.......  .................
    Hearing...........................  07/28/2003.......  .................
    Commission Decision...............  10/16/2003.......  .................
    NPRM..............................  12/29/2003.......  68 FR 74878
    NPRM Comment Period End...........  03/15/2004.......  .................
    Staff Begins Monitoring Progress    10/01/2005.......  .................
     of Voluntary Standard.
    Staff Completes Monitoring          ( \1\ )..........  .................
     Progress of Voluntary Standard.
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: None
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Related RINs: Related to 3041-AB93
        Agency Contact: Patricia L. Hackett, Project Manager, Consumer
    Product Safety Commission, Directorate for Engineering Sciences, 4330
    East-West Highway, Bethesda, MD 20814-4408. Phone: 301 504-7577. Email:
    phackett@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC10 Publication ID: Spring 2008
        Title: Petition CP 03-1/HP 03-1 Requesting a Standard for Bunk Bed
    Corner Posts
        Abstract: A petition from the Danny Foundation requests that the
    Commission establish a standard to address an alleged hazard of
    strangulation posed by bunk bed corner posts. The petitioner asserts
    that due to the height of bunk beds, corner posts on bunk beds pose a
    substantial risk to children when the children's clothing, bedding, or
    other items become caught on the corner posts. On November 8, 2002, the
    Commission published a notice in the Federal Register to solicit
    comments on the petition from all interested persons. The comment
    period closed on January 7, 2003. On April 13, 2004, the staff sent a
    briefing package to the Commission on this issue. On July 30, 2004, the
    Commission voted to defer action on the petition while the staff
    continues to work with the ASTM International bunk bed subcommittee on
    this issue. A revised voluntary standard for bunk beds was published in
    October 2004 that incorporates warning language about hangings
    associated with bunk beds and attaching items to the bed. CPSC staff
    worked with the subcommittee to develop requirements to address
    strangulation hazards with vertical protrusions. A revised standard was
    approved on July 15, 2007. Staff is currently evaluating the adequacy
    of the revised standard.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: No
        CFR Citation: Not Yet Determined (To search for a specific CFR,
    visit the Code of Federal Regulations.)
        Legal Authority: 5 USC 553(e), Administrative Procedure Act; 15 USC
    1262(j), Federal Hazardous Substances Act; 15 USC 2058(i), Consumer
    Product Safety Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Petition Docketed.................  10/23/2002.......  .................
    Notice............................  11/08/2002.......  67 FR 68107
    Comment Period End................  01/07/2003.......  .................
    Staff Sends Briefing Package to     04/13/2004.......  .................
     Commission.
    Commission Votes To Defer Action..  07/30/2004.......  .................
    Staff Sends Briefing Package to     ( \1\ )..........  .................
     Commission.
    Staff Begins Evaluating             ( \1\ )..........  .................
     Conformance to Voluntary Standard.
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: None
        Federalism: No
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact: Susan Bathalon, Project Manager, Consumer Product
    Safety Commission, Directorate for Engineering Sciences, 4330 East-West
    Highway, Bethesda, MD 20814-4408. Phone: 301 504-7566. Email:
    sbathalon@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC22 Publication ID: Spring 2008
        Title: Petition CP 04-1/HP 04-1 Requesting Mandatory Fire Safety
    Standards for Candles and Candle Accessories
        Abstract: The National Association of State Fire Marshals requests
    that the Commission issue mandatory safety standards for candles and
    candle accessories such as candleholders. The request was docketed as a
    petition for rulemaking on March 10, 2004. A notice requesting comment
    on the petition was published in the Federal Register on April 6, 2004.
    The comment period closed on June 7, 2004. On July 10, 2006, CPSC staff
    sent a briefing package to the Commission for consideration and
    recommended that the Commission defer action on the petition. On July
    19, 2006, the Commission voted 3-0 to defer the petition and directed
    the staff to provide updates on the progress of voluntary standards
    activities. Staff provided a status report to the Commissioners on June
    6, 2007.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: Undetermined
        CFR Citation: Not Yet Determined (To search for a specific CFR,
    visit the Code of Federal Regulations.)
        Legal Authority: 5 USC 553(e), Administrative Procedure Act; 15 USC
    2051, Consumer Product Safety Act; 15 USC 1261, Federal Hazardous
    Substances Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Petition Docketed.................  03/10/2004.......  .................
    Notice............................  04/06/2004.......  69 FR 18059
    Comment Period End................  06/07/2004.......  .................
    Staff Sends Briefing Package to     07/10/2006.......  .................
     Commission.
    Commission Votes to Defer Action..  07/19/2006.......  .................
    Staff Sends Update on Progress of   06/06/2007.......  .................
     Voluntary Standards Activities to
     Commissioners.
    Staff Sends Briefing Package to     ( \1\ )..........  .................
     Commission.
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: None
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact:, Allyson Tenney, Project Manager, Consumer Product
    Safety Commission, Directorate for Engineering Sciences, 4330 East-West
    Highway, Bethesda, MD 20814-4408. Phone: 301 504-7567. Email:
    atenney@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC25 Publication ID: Spring 2008
        Title: Mandatory Safety Standard for Cigarette Lighters
        Abstract: In November 2001, a petition from the Lighter
    Association, Inc. requested that the Commission issue a rule to adopt
    an ASTM International voluntary safety standard for cigarette lighters.
    In November 2004, the Commission voted to grant the petition and
    initiate a rulemaking proceeding. An advance notice of proposed
    rulemaking (ANPRM) was published in April 2005 and the comment period
    closed on June 10, 2005. Staff completed monitoring conformance of
    lighters with the voluntary standard, and sent a status report to the
    Commission for consideration in October 2006. On January 23, 2008,
    staff provided a review of applicable law, decision factors, and
    pertinent information to assist the Commission in considering whether
    to formally rely upon the voluntary standard for cigarette lighters.
    The Commission did not agree on this approach.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: No
        CFR Citation: Not Yet Determined (To search for a specific CFR,
    visit the Code of Federal Regulations.)
        Legal Authority: 5 USC 553(e); Administrative Procedure Act; 15 USC
    2051; Consumer Product Safety Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Staff Sent Draft ANPRM to           03/25/2005.......  .................
     Commission.
    Commission Decision...............  03/31/2005.......  .................
    ANPRM.............................  04/11/2005.......  70 FR 18339
    ANPRM Comment Period End..........  06/10/2005.......  .................
    Staff Begins Monitoring of          10/01/2005.......  .................
     Conformance with Voluntary
     Standard.
    Staff Completes Monitoring of       05/15/2006.......  .................
     Conformance with Voluntary
     Standard.
    Staff Sent Status Report to         10/10/2006.......  .................
     Commission.
    Staff Sent Briefing Package to      01/23/2008.......  .................
     Commission.
    Commission Decision...............  02/01/2008.......  .................
    Next Action Undetermined..........  ( \1\ )..........  .................
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: Undetermined
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact: Rohit Khanna, Project Manager, Consumer Product
    Safety Commission, Directorate for Engineering Sciences, 4330 East-West
    Highway, Bethesda, MD 20814-4408. Phone: 301 504-7546. Email:
    rkhanna@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC26 Publication ID: Spring 2008
        Title: Proposed Standard To Address Open-Flame Ignition of
    Bedclothes
        Abstract: On January 13, 2005, the Commission published an advance
    notice of proposed rulemaking (ANPRM) to begin a proceeding for
    development of a flammability standard to address risks of death,
    injury, and property damage from fires associated with open-flame
    ignition of bedclothes. Bedclothes are a major contributor to mattress
    ignition. Commission staff reviewed research indicating that mattresses
    and bedclothes operate together as a system in fires involving
    mattresses. Research has suggested that improved flammability
    performance of some bedclothes can reduce the fire hazard. The
    Commission staff will review public comments received on the ANPRM and
    consider how information derived from implementation of the new open
    flame mattress standard impacts bedclothes flammability. Staff will
    prepare a decision package for Commission consideration.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Economically Significant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: No
        CFR Citation: 16 CFR 1634 (To search for a specific CFR, visit the
    Code of Federal Regulations.)
        Legal Authority: 15 USC 1193; Flammable Fabrics Act; 5 USC 801
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    ANPRM.............................  01/13/2005.......  70 FR 2514
    ANPRM Comment Period End..........  03/14/2005.......  .................
    Staff Sends Briefing Package to     ( \1\ )..........  .................
     Commission.
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: Undetermined
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact: Allyson Tenney, Project Manager, Consumer Product
    Safety Commission, Directorate for Engineering Sciences, 4330 East-West
    Highway, Bethesda, MD 20814-4408. Phone: 301 504-7567. Email:
    atenney@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC30 Publication ID: Spring 2008
        Title: Regulatory Options for Infant Pillows
        Abstract: On July 13, 2006, the Commission voted 3-0 to grant a
    petition requesting that the Commission amend the ban on infant pillows
    under 16 CFR 1500.18(a)(16)(i). The staff prepared a draft advance
    notice of proposed rulemaking (ANPRM) concerning infant pillows to
    initiate a rulemaking proceeding under the Federal Hazardous Substances
    Act (FHSA) to identify the product and the risk of injury associated
    with infant pillows, summarize regulatory alternatives, and invite
    comments from the public. On September 27, 2006, the Commission issued
    the ANPRM. Staff reviewed public comments and prepared an options
    briefing package for Commission consideration. On February 1, 2008, the
    Commission voted 2-0 to exempt certain nursing pillows from the ban on
    infant pillows and to terminate rulemaking.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: No
        CFR Citation: 16 CFR 1500.18(a)(16)(i)
        Legal Authority: 5 USC 553, Administrative Procedure Act; 15 USC
    1261, Federal Hazardous Substances Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Staff sends Draft ANPRM to          09/07/2006.......  .................
     Commission.
    Commission Decision...............  09/14/2006.......  .................
    ANPRM.............................  09/27/2006.......  71 FR 56418
    ANPRM Comment Period Ends.........  11/27/2006.......  .................
    Staff Sends Briefing Package to     01/24/2008.......  .................
     Commission.
    Commission Decision...............  02/01/2008.......  .................
    Staff Drafts FR Notice............  ( \1\ )..........  .................
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: Undetermined
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact: Suad Wanna-Nakamura, Ph.D., Project Manager,
    Consumer Product Safety Commission, Directorate for Health Sciences,
    4330 East-West Highway, Bethesda, MD 20814-4408. Phone: 301 504-7252.
    Email: swanna-nakamura@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC31 Publication ID: Spring 2008
        Title: Regulatory Options for Table Saws
        Abstract: On July 11, 2006, the Commission voted 2-1 to grant a
    petition requesting that the Commission issue a rule prescribing
    performance standards for a system to reduce or prevent injuries from
    contacting the blade of a table saw. The Commission also directed the
    staff to prepare an advance notice of proposed rulemaking (ANPRM)
    initiating a rulemaking proceeding under the Consumer Product Safety
    Act (CPSA) to identify the product and the risk of injury associated
    with table saw blade contact injuries, summarize regulatory
    alternatives, and invite comments from the public. A draft advance
    notice of proposed rulemaking will be prepared for Commission
    consideration.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: No
        CFR Citation: Not Yet Determined (To search for a specific CFR,
    visit the Code of Federal Regulations.)
        Legal Authority: 5 USC 553(e), Administrative Procedure Act; 15 USC
    2051, Consumer Product Safety Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Staff Sends ANPRM to Commission...  ( \1\ )..........  .................
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: Undetermined
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact: Caroleene Paul, Project Manager, Consumer Product
    Safety Commission, Directorate for Engineering Sciences, 4330 East-West
    Highway, Bethesda, MD 20814-4408. Phone: 301 504-7540. Email:
    cpaul@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC35 Publication ID: Spring 2008
        Title: Fireworks Devices
        Abstract: The staff prepared a draft advance notice of proposed
    rulemaking (ANPRM) concerning fireworks devices requesting comments on
    whether there is a need for the agency to update and strengthen its
    regulation of fireworks devices and sent it to the Commission for
    consideration on June 26, 2006. On June 30, 2006, the Commission voted
    3-0 to issue an advance notice of proposed rulemaking. The ANPRM was
    issued on July 12, 2006. The comment period on the ANPRM closed on
    September 11, 2006. Commission staff is evaluating comments received.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: Undetermined
        CFR Citation: 16 CFR 1500; 16 CFR 1507 (To search for a specific
    CFR, visit the Code of Federal Regulations.)
        Legal Authority: 15 USC 1261, Federal Hazardous Substances Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Staff sends draft ANPRM to          06/26/2006.......  .................
     Commission.
    Commission Decision...............  06/30/2006.......  .................
    ANPRM.............................  07/12/2006.......  71 FR 39249
    Comment Period Closes.............  09/11/2006.......  .................
    Staff Sends Briefing Package to     ( \1\ )..........  .................
     Commission.
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: Undetermined
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact:, James Joholske, Compliance Officer, Office of
    Compliance, Consumer Product Safety Commission, 4330 East-West Highway,
    Bethesda, MD 20814. Phone: 301 504-7527. Email: jjoholske@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC36 Publication ID: Spring 2008
        Title: Portable Generators
        Abstract: On December 5, 2006, the Commission voted 2-0 to issue an
    advance notice of proposed rulemaking (ANPRM) under the Consumer
    Product Safety Act (CPSA) concerning portable generators. The ANPRM
    discusses regulatory options that could reduce portable generator-
    related deaths and injuries, particularly those related to carbon
    monoxide poisoning. The ANPRM was published in the Federal Register on
    December 12, 2006. Staff reviewed public comments and is conducting
    technical activities. Staff awarded a contract to develop a prototype
    generator engine with reduced CO in the exhaust and entered into an
    interagency agreement (IAG) with the National Institute of Standards
    and Technology (NIST) to model the buildup and concentration of CO in
    various locations. NIST will also verify the efficacy of the prototype
    generator in reducing CO. In addition, staff conducted a proof-of-
    concept demonstration of a remote CO sensing automatic shutoff device
    for a portable generator, as well as an interlock concept in which a CO
    sensor was located on the generator.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: Undetermined
        CFR Citation: Not Yet Determined (To search for a specific CFR,
    visit the Code of Federal Regulations.)
        Legal Authority: 15 USC 2051, Consumer Product Safety Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Staff Sends ANPRM to Commission...  06/29/2006.......  .................
    Staff Sends Supplemental Material   10/12/2006.......  .................
     to Commission.
    Commission Decision...............  10/26/2006.......  .................
    Staff Briefs Commission...........  10/26/2006.......  .................
    Staff Sends Draft ANPRM to          11/21/2006.......  .................
     Commission.
    ANPRM Published...................  12/12/2006.......  71 FR 74472
    Comment Period Ends...............  02/12/2007.......  .................
    Staff Sends NPRM Briefing Package   ( \1\ )..........  .................
     to Commission.
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: Undetermined
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact: Janet L. Buyer, Project Manager, Consumer Product
    Safety Commission, Directorate for Engineering Sciences, 4330 East-West
    Highway, Bethesda, MD 20814. Phone: 301 504-0508. Email:
    jbuyer@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC40 Publication ID: Spring 2008
        Title: Civil Penalty Factors
        Abstract: Section 20(b) and (c) of the Consumer Product Safety Act,
    15 USC 2069(b) and (c), require certain factors to be considered in
    assessing and compromising civil penalties. The Commission proposed a
    new interpretive rule that identifies and explains related factors that
    may be considered by the Commission and staff in evaluating the
    appropriateness and amount of a civil penalty. On July 12, 2006, the
    Commission solicited comments on a proposed new interpretive rule. The
    comment period closed on August 11, 2006. CPSC staff will prepare a
    briefing package for Commission consideration concerning the content of
    a possible final interpretive rule.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: No
        CFR Citation: 16 CFR 1119 (To search for a specific CFR, visit the
    Code of Federal Regulations.)
        Legal Authority: 15 USC 2069(b) and (c), Consumer Product Safety
    Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Notice of Proposed Interpretive     07/12/2006.......  71 FR 39248
     Rule.
    Comment Period End................  08/12/2006.......  .................
    Staff Sends Briefing Package to     ( \1\ )..........  .................
     Commission.
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: Undetermined
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact:, John Gibson Mullan,, Assistant Executive Director,
    Compliance and Field Operations, Consumer Product Safety Commission,
    4330 East-West Highway, Bethesda, MD 20814. Phone: 301 504-7626. Email:
    jmullan@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AC41 Publication ID: Spring 2008
        Title: Regulatory Options for Lead Toy Jewelry
        Abstract: On December 11, 2006, the Commission voted 2-0 to grant a
    petition requesting a ban on toy jewelry containing more than 0.06
    percent lead by weight. On December 27, 2006, the Commission approved
    an advance notice of proposed rulemaking (ANPRM), which was published
    in the Federal Register on January 9, 2007. The public comment period
    ended March 12, 2007. CPSC staff is reviewing public comments and will
    prepare a briefing package for Commission consideration as to whether
    to continue with rulemaking.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Long-Term Actions
        Major: Undetermined
        Unfunded Mandates: No
        CFR Citation: Not Yet Determined (To search for a specific CFR,
    visit the Code of Federal Regulations.)
        Legal Authority: 5 USC 553, Administrative Procedure Act; 15 USC
    1261, Federal Hazardous Substances Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Commission Decision on Draft ANPRM  12/27/2006.......  .................
     FR Notice.
    ANPRM Published...................  01/09/2007.......  72 FR 920
    Comment Period Ends...............  03/12/2007.......  .................
    Staff Sends Briefing Package to     ( \1\ )..........  .................
     Commission.
    ------------------------------------------------------------------------
    \1\ To Be Determined.

        Regulatory Flexibility Analysis Required: Undetermined
        Government Levels Affected: None
        Federalism: Undetermined
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact:, Kristina Hatlelid, Ph.D., Project Manager,
    Consumer Product Safety Commission, Directorate for Health Sciences,
    4330 East-West Highway, Bethesda, MD 20814-4408. Phone: 301 504-7254.
    Email: khatlelid@cpsc.gov.

                                   VIEW RULE

        CPSC     RIN: 3041-AB68 Publication ID: Spring 2008
        Title: Amendment of the Standard for the Flammability of Clothing
    Textiles
        Abstract: The Standard for the Flammability of Clothing Textiles
    prohibits the manufacture, importation, or sale of clothing and fabrics
    and related materials intended for use in clothing, which are
    dangerously flammable because of rapid and intense burning. The
    standard prescribes the apparatus, procedure, and criteria to be used
    for testing to determine compliance with that standard. The standard
    was made mandatory by the Flammable Fabrics Act of 1953 (Pub. L. 83-88,
    67 Stat. 111; June 30, 1953). Some of the equipment and procedures
    specified by the standard, particularly those for laundering and
    cleaning of test specimens, have become obsolete, unavailable, or
    unrepresentative of current practices. The staff prepared a briefing
    package describing modifications of the standard that may be needed to
    assure that the test in the standard is conducted with equipment and
    procedures representative of conditions to which garments currently are
    exposed. After consideration of the briefing package, the Commission
    decided to begin a proceeding for amendment of the standard. An advance
    notice of proposed rulemaking (ANPRM) was published in the Federal
    Register on September 12, 2002. The staff reviewed public comments and
    proposed amendments for Commission consideration. On January 12, 2007,
    the Commission voted to publish a notice of proposed rulemaking (NPRM)
    in the Federal Register. The comment period closed on May 14, 2007. The
    staff evaluated the comments and prepared a final rule briefing package
    for Commission consideration. On February 1, 2008, the Commission voted
    to approve the final rule amending the standard for the Flammability of
    Clothing Textiles.
        Agency: Consumer Product Safety Commission (CPSC)
        Priority: Substantive, Nonsignificant
        RIN Status: Previously published in the Unified Agenda
        Agenda Stage of Rulemaking: Completed Actions
        Major: No
        Unfunded Mandates: No
        CFR Citation: 16 CFR 1610 (To search for a specific CFR, visit the
    Code of Federal Regulations.)
        Legal Authority: 15 USC 1191, Flammable Fabrics Act
        Legal Deadline: None

                                    TIMETABLE
    ------------------------------------------------------------------------
                  Action                       Date             FR Cite
    ------------------------------------------------------------------------
    Staff Sent Briefing Package to      06/11/2002.......  .................
     Commission.
    Commission Decision...............  08/28/2002.......  .................
    ANPRM.............................  09/12/2002.......  67 FR 57770
    ANPRM Comment Period End..........  11/12/2002.......  .................
    Staff Sends Briefing Package to     11/30/2006.......  .................
     Commission.
    Commission Decision...............  12/08/2006.......  .................
    Draft NPRM to Commission..........  01/10/2007.......  .................
    Commission Decision on Draft NPRM.  01/12/2007.......  .................
    NPRM..............................  02/27/2007.......  72 FR 8843
    NPRM Comment Period End...........  05/14/2007.......  .................
    Staff Sends Briefing Package to     12/27/2007.......  .................
     Commission.
    Staff Sends Draft FR Notice with    01/22/2008.......  .................
     Draft Final Rule to Commission.
    Commission Decision...............  02/01/2008.......  .................
    Final Action......................  03/25/2008.......  73 FR 15636
    ------------------------------------------------------------------------

        Regulatory Flexibility Analysis Required: No
        Government Levels Affected: None
        Federalism: No
        Included in the Regulatory Plan: No
        RIN Data Printed in the FR: No
        Agency Contact:, Patricia K. Adair, Project Manager, Consumer
    Product Safety Commission, Directorate for Engineering Sciences, 4330
    East-West Highway, Bethesda, MD 20814-4408. Phone: 301 504-7536. Email:
    padair@cpsc.gov.
           why does it take so long for cpsc to publish a final rule?
        Question. For seven regulations that CPSC has worked on for the
    past 4 years--some of which date back to the 1990s--the average length
    of time from initiation of a regulation to a final rule has been almost
    6 years, which is a long time to wait when the public has the potential
    of being injured or killed by a product. Your own statute states that,
    with certain exceptions, a rule shall be issued within one year of
    publication of an advance notice of proposed rulemaking.
        How can the length of time between initiation of a rule and
    finalization of it be accelerated?
        Answer. Under its statutes, to issue a final rule, the Commission
    must prepare thorough responses to substantive public comments (which
    can lead to the need to conduct complex research and testing) and
    develop a record to support its findings concerning ``unreasonable
    risk,'' costs and benefits, the basis for why the rule is the ``least
    burdensome alternative,'' and the inadequacy of any voluntary standards
    addressing the risk. The findings must be sufficiently robust to
    withstand judicial challenge, generally against a ``substantial
    evidence'' review standard.
        Additionally, in rulemakings under the Consumer Product Safety Act
    or the Federal Hazardous Substances Act that address chronic risks of
    cancer, birth defects or genetic mutations, the Commission is required
    to appoint a panel of scientific experts from a list of nominees
    provided by the National Academy of Sciences, allow the panel to
    deliberate, and receive the panel's expert opinion concerning the
    potential harm to human health that could result from exposure to the
    substance, before the rulemaking may commence with an Advance Notice of
    Proposed Rulemaking (ANPR). Also, of course, loss of quorum can
    materially impact rulemaking schedules.
        In addition to the requirements of the Commission's statutes noted
    above, there are numerous other federal government-wide statutory
    requirements and treaty obligations that impose constraints on the
    rulemaking process and the rate at which it can be accomplished,
    including the Regulatory Flexibility Act, the Paperwork Reduction Act,
    the Small Business Regulatory Enforcement Fairness Act, the National
    Environmental Policy Act, and public comment period duration
    requirements under the North American Free Trade Agreement, among
    others.
        All of these statutorily mandated complexities and checks and
    balances on the Commission's rulemaking authorities and procedures of
    necessity constrain the rate at which the deliberative process leading
    to a final rule can be accomplished.
        Last year, I submitted a proposal to Congress to make optional the
    statutory requirement to commence all standard or ban rulemakings with
    an ANPR, and I am hopeful that this reform will be included in CPSC's
    reauthorization when it is passed.
        A March 2008 report by Public Citizen criticized the CPSC for not
    completing work on the seven rules that are referred to in your
    question. The report is grossly misleading, and information on a few of
    the examples cited by the Public Citizen report follow:
        The upholstered furniture rulemaking activity has been
    exceptionally complex, with many diverse stake holders providing input
    into the process. Upholstered furniture components include such varied
    materials as cover fabrics, loose fillings, barriers, wood, plastic and
    resilient foams. Each reacts differently to open flame and smoldering
    ignitions. The components interact with each other during a fire
    depending on the materials involved and the construction and geometry
    of the product. In some cases, potential solutions that would mitigate
    open flame ignitions may not address, or could even reduce, the
    effectiveness of measures addressing smoldering ignitions and vice-
    versa. Solving these complex fire science problems has been critical to
    developing an effective standard that complies with the agency's
    governing statutes. Nonetheless, the CPSC has proposed a new
    flammability standard for residential upholstered furniture and
    published it in the Federal Register on March 4, 2008, for public
    comment. Finalization of this very important rulemaking is one of my,
    and the Commission's, highest priorities.
        The rulemaking on bedclothes (e.g., quilts, blankets, bedspreads)
    flammability is closely related to the Commission's recently issued
    rule on open flame ignition of mattresses, a rule that when fully
    effective is estimated to prevent over 200 deaths each year. As we
    enforce the new rule that became effective on July 1, 2007, we gain
    important information that is relevant to bedclothes flammability.
    Before proceeding with the development of testing methodology and
    performance requirements related to bedclothes, CPSC staff will need to
    evaluate this critical data. It should also be noted that, like
    upholstered furniture, the fabrics and contents of bedclothes vary
    enormously in the market, and so development of a single flammability
    standard would be a very difficult and complex undertaking.
        The amendments to the Clothing Textile Standard are technical
    clarification and work was delayed so that CPSC's flammability experts
    could concentrate on the important mattress flammability standard
    (referred to above). This work is now complete and a final rule was
    published on March 25, 2008.
        After the CPSC initiated a rulemaking activity on baby bath seats,
    the voluntary standard was revised so that it was essentially the same
    as the mandatory requirements proposed by the CPSC. As noted above, the
    Commission is prohibited from issuing a mandatory rule if there is a
    voluntary standard in place that adequately addresses the hazard and
    there is likely to be substantial compliance with that standard. In
    that regard, staff is monitoring and evaluating the adequacy of the
    revised standard and will prepare a formal briefing package for
    Commission consideration as to whether to continue rulemaking. In the
    interim, CPSC staff participation in the development of revisions to
    the voluntary standard has been ongoing and significant.

                          ILLINOIS--LEAD IN KEYCHAINS

        Question. It has come to my attention that Illinois Attorney
    General Lisa Madigan has contacted you about the sale of some keychains
    in the State of Illinois that far exceeded lead standards through
    independent testing. One of these keychains resulted in the injury of a
    9-month old baby from Decatur, Illinois. Part of the Attorney General's
    letter raised concerns about CPSC's response to this report of
    independent testing.
        Will you provide me with your response to this injury report?
        Have you responded to the Attorney General's letter?
        Answer. The keychains were first brought to CPSC's attention by a
    professor of chemistry whose class conducted testing of these keychains
    along with a number of children's jewelry items. There are no standards
    for lead content of keychains, and at that time, CPSC staff focused on
    the jewelry items, which are subject to a specific enforcement policy,
    and obtained recalls as appropriate. Like the CPSC, the State of
    Illinois also considered the keychains a product for adults, but it
    became aware of lead exposure caused by one of the keychains given to
    an infant by its mother. As soon as CPSC staff learned of this
    exposure, a recall quickly ensued.
                                     ______

                  Questions Submitted by Senator Sam Brownback

        Question. Since our toy safety hearing last September, what
    specific ways have Chinese manufacturing plants changed their
    operations to ensure toy safety?
        What specifically has the Chinese government done to ensure that
    toys and other consumer products manufactured for export are meeting
    safety standards?
        How would you characterize your agency's relationship with the
    Chinese government? Has China been willing to work with you?
        Answer. During the past year of CPSC outreach to Chinese
    manufacturers and Chinese government export inspectors, we have
    detected a shift of attitudes toward adoption of modern, end-to-end
    best practices to ensure compliance with safety standards. This shift
    can be seen in toy industry publications, in seminars for manufacturers
    hosted by the Chinese government, and in recall case reports to the
    CPSC from the Chinese regulator.
        The work plans that were agreed to at the U.S.-Sino Consumer
    Product Safety Summit held in September 2007 were outcomes of our
    Memorandum of Understanding (MOU), which established the framework for
    cooperation. The work plans called for cooperative work in four product
    categories: toys, lighters, electrical products, and fireworks.
    Technical experts are now working on exchanges of standards
    information, training for product testing, and sharing information and
    best practices in those four product categories.
        Since September, CPSC staff has met eight times, either in person
    or via video conference, with staff of China's General Administration
    for Quality Supervision, Inspection and Quarantine (AQSIQ) to review
    recalls and safety issues.
        The CPSC has begun a Chinese language service on our web site,
    where Chinese suppliers and government officials can get the latest
    information in Chinese (we are translating requirements and posting
    them) and descriptions in Chinese that link to the full texts of
    English language requirements.
        At CPSC's invitation, product safety officials from the European
    Union will join us in China during September for a joint outreach
    program to consumer product exporters. The Chinese government has
    enthusiastically endorsed this project and has agreed to facilitate
    access to the appropriate audiences for the compliance outreach
    seminars.
        Regarding Chinese compliance cooperation, first it should be
    stressed that the CPSC does not rely on the Chinese government to
    enforce U.S. requirements. The CPSC enforces our requirements with
    American importers. That said, the Peoples' Republic of China (PRC)
    offered to use its export quality control system to target Chinese-made
    products that would be recalled if they entered the United States. We
    singled out lead paint on toys as a problem and they agreed to take
    that on.
      --The Chinese government investigates recall causes at the factory
            and mandates specific changes, such as a change of supplier or
            more frequent testing. It reports those case-specific outcomes
            to CPSC. The PRC says it has inspected thousands of factories
            and revoked hundreds of export licenses for product safety
            violations.
      --The PRC has sponsored numerous high-profile standards and
            compliance seminars aimed at getting the product safety message
            to Chinese manufacturers. The CPSC participated in one of these
            in November.
        However, nothing the Chinese government promises and no amount of
    export control inspection can take the place of major systemic changes
    in Chinese manufacturing. We are working with Chinese suppliers to
    hasten that change, but it is the U.S. importer that must ensure that
    its product complies with our laws.
        Question. We cannot merely trust the Chinese. What specifically is
    your agency doing to verify that the Chinese are adhering to the MOU
    that we have entered into with them? Have the Chinese resisted your
    efforts to verify their agreements with us?
        Answer. CPSC officials are in China frequently meeting with Chinese
    industry representatives and government officials to witness their
    implementation of the policies and practices that we have been
    encouraging. During the past year, CPSC staff participated in training
    seminars in China for thousands of Chinese suppliers and we have
    visited several factories. We also work closely with State Department
    officials in China, who also visit factories and report on product
    safety issues. We have not experienced resistance to any of our
    requests for access or cooperation. Notably, when the CPSC requested an
    immediate visit to the factory producing the recalled toy ``Aqua
    Dots,'' we were provided access to the property (which was not
    sanitized for us) within 24 hours, as well as an opportunity to speak
    to the toy designer.
        Question. Have the number of consumer product recalls of imported
    items increased or decreased since September 2007?
        Have the number of consumer product recalls of imported items from
    China increased or decreased since September 2007?
        Answer. As a result of heightened industry awareness and aggressive
    enforcement activities by the CPSC, the number of consumer product
    recalls of imported items has increased since September 2007, relative
    to earlier years, and specifically, the number of consumer product
    recalls of imported items from China has increased since that time. It
    should be noted that the recalled products from China in this time
    frame were manufactured and exported to the United States before the
    U.S.-Sino Consumer Product Safety Summit in September 2007.
        Question. Frankly, I worry that the Chinese are unwilling or unable
    to implement productive changes in their manufacturing processes. How
    are we to be assured that safety standards will be met and that
    inspectors will monitor production facilities?
        Answer. Regarding Chinese cooperation, it must be stressed that the
    CPSC does not rely on the Chinese government to enforce U.S.
    requirements. The CPSC enforces our requirements with American
    companies that import consumer products. This is the essential purpose
    of CPSC's new Import Safety Initiative. We have already seen that
    recalls by the CPSC provide a significant economic incentive to promote
    change in China.
        As noted at the hearing, I would welcome funding for a CPSC
    Regional Product Safety Officer, supported by a Foreign Service
    National (FSN), to be stationed at the U.S. Embassy in Beijing to cover
    Asia and to help us coordinate with Chinese authorities--as a first
    step in a CPSC overseas presence. Since we are beginning to work with
    Vietnam and other countries in the region, there would be extended
    benefits to such a presence.
        Question. Ms. Nord, I would like to commend you for your new
    surveillance initiatives and your plan to hire employees to staff your
    new Import Surveillance Division. Do you think this increased presence
    is enough to stem the tide of defective imports flowing into the
    country? In your estimation what more should be done by the CPSC to
    help protect American consumers?
        Answer. The new CPSC presence at U.S. ports-of-entry is an
    important advance in our efforts to reduce the number of defective
    products entering the country. However, because of the sheer volume of
    consumer products imported into the nation annually, port inspection
    activity alone is not sufficient. That is the reason that the CPSC has
    implemented a multi-pronged approach to meet this challenge. In
    addition to increased dialogue and initiatives with China and other
    nations to encourage systemic change in their manufacturing processes,
    the CPSC is working with the private sector and reaching out to foreign
    manufacturers to establish product safety systems as an integral part
    of their manufacturing process. Additionally, I have requested a number
    of new enforcement tools, some of which are included in the CPSC Reform
    Act that is currently awaiting final action by a Senate/House
    conference committee. For example, I proposed that it be unlawful to
    fail to furnish a certificate of compliance with a mandatory standard
    under any statute administered by the CPSC or to issue a false
    certificate of compliance. As I mentioned at the hearing, this would be
    an extremely effective enforcement tool for the CPSC, and although this
    provision was not in the Senate-passed bill, I am hopeful that the
    final legislation will include it.
        Question. With the increased surveillance at the nation's high
    impact ports, do you expect there to be any ``port shopping'' of
    shipping vessels unloading at the docks with a lower federal presence?
    If so, how do you plan to tackle this problem?
        Answer. It is probably inevitable that some unscrupulous importers
    will try to find ways to bypass CPSC's fulltime presence at certain
    ports. It is important to recognize, however, that CPSC's field staff
    can visit any of the 300 U.S. ports-of-entry and sample products at
    those locations on an as-needed basis. In addition, the CPSC is now a
    participating agency in the International Trade Data System (ITDS)
    Automated Commercial Environment (ACE), which will give us much better
    information with which to target imports.
        Question. Commissioner Nord, Wichita and El Dorado happen to be
    hubs of the largest latex balloon manufacturing operation in America,
    and I'm very proud that we continue to have this kind of domestic
    manufacturing presence in Kansas and in the United States.
        I understand that the Balloon industry, Pioneer Balloon in
    particular, voluntarily put cautionary statements on their packaging as
    early as 1992. They also worked closely and cooperatively with the CPSC
    to develop standardized cautionary statements for all balloon packages
    that were implemented in 1994. These efforts have been effective, with
    fatal incidents associated with balloons dropping dramatically.
        As you may know, there is a provision in the CPSC reauthorization
    legislation that deals with extending the mandate for cautionary
    statements on a class of products, including balloons, from the labels
    of those products to advertising, including Internet and Catalog
    advertising, for these products. These efforts appear to be intended to
    ensure that consumers who would see the cautionary statement in a brick
    and mortar store would also be aware of the hazard if they were to buy
    balloons online.
        While the Balloon Industry wants to safeguard consumers as much as
    they can, they want to make sure they can continue to do business
    without a huge chilling effect on commerce or on their business-to-
    business practices. To that end:
        By your understanding of the bill, would the provision affect
    business to business advertising, in catalogues or the Internet?
    Because balloons are generally sold from manufacturers to distributors
    and retailers, I want to be sure that this provision would not be
    misconstrued to affect business-to-business advertising or catalogs
    that balloon companies send to their distributors that never make it
    into the hands of consumers?
        Answer. As written, section 11 of S. 2663 does not make a
    distinction between business-to-business advertisements and business-
    to-consumer advertisements. Rather, it requires an appropriate
    cautionary statement in any advertisement on the internet or in a
    catalogue or other distributed material ``that provides a direct means
    of purchase.'' The provision does not specify who is making the
    purchase.
        Question. While conferees still have work to do on a final bill, if
    the provision were to become law, would the CPSC work cooperatively
    with the Balloon Industry in a way that befits previous cooperation so
    that we can be sure that only consumers who buy online or from a
    catalog are affected, and that business to business practices can
    continue as they exist today?
        Answer. The CPSC works cooperatively with affected industries to
    assure that they understand their requirements under the law as it is
    written by Congress.
                                     ______

                     Questions Submitted to Thomas H. Moore
                  Questions Submitted by Senator Sam Brownback

        Question. Numerous states have either passed or are considering
    passing their own product safety laws. In some cases, the states would
    be imposing standards, for lead content for example, which are
    considerably more restrictive than the contemplated federal standards.
    How does S. 2663 guard against states creating what would in effect
    become a patchwork of different material content standards across the
    country?
        Answer. It is unclear the extent to which either S. 2663 or the
    express preemption provisions of the Federal Hazardous Substances Act
    would sufficiently address this problem. Regardless of the language
    used in the final version of the federal statute, in all likelihood
    these issues will ultimately be resolved in the courts by resort to
    judicial principles concerning preemption.
        Question. While S. 2663 defines ``children's product'' to mean
    products designed or intended for use by consumers aged seven or
    younger, certain state statutes have a higher age threshold. How does
    S. 2663 avoid a situation in which products destined for very young
    children are subject to the federal standard while products intended
    for older children face more restrictive material content standards
    imposed by the states?
        Answer. S. 2663 contains no provision which would avoid such a
    situation.
        Question. How does S. 2663 guard against states passing their own
    children's product safety laws which encompass specific products, such
    as jewelry, or a broader array of materials than does the federal law,
    thus, effectively creating special restrictions for products or
    materials which Congress did not feel compelled to regulate?
        Answer. S.2663 contains no provision which would avoid such a
    situation.
        Question. In the State of Washington, a new product safety law will
    go into effect in July of 2009. Senate bill 2663 will probably not
    become effective until after that time; likely the end of 2009. Thus,
    retailers may face a situation in which they are forced to comply with
    a very restrictive state standard for several months before the new
    federal standards take effect. How can S. 2663 be modified to avoid
    this problem?
        Answer. This situation is essentially impossible to prevent in the
    absence of enactment of a federal law addressing the same scope of
    products and very clearly stating Congressional intent to preempt the
    Washington law prior to the effective date of the Washington law.

                              SUBCOMMITTEE RECESS

        Senator Durbin. The meeting of the subcommittee will stand
    recessed.
        [Whereupon, at 3:46 p.m., Wednesday, April 30, the
    subcommittee was recessed, to reconvene subject to the call of
    the Chair.]

      FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL
                                   YEAR 2009

                                  ----------

                             WEDNESDAY, MAY 7, 2008

                                           U.S. Senate,
               Subcommittee of the Committee on Appropriations,
                                                        Washington, DC.
        The subcommittee met at 3:02 p.m., in room SD-192, Dirksen
    Senate Office Building, Hon. Richard J. Durbin (chairman)
    presiding.
        Present: Senators Durbin, Brownback, and Allard.

                      COMMODITY FUTURES TRADING COMMISSION

    STATEMENT OF HON. WALTER L. LUKKEN, ACTING CHAIRMAN

                 OPENING STATEMENT OF SENATOR RICHARD J. DURBIN

        Senator Durbin. I call to order this meeting of the Senate
    Appropriations Committee Subcommittee on Financial Services and
    General Government. The hearing this afternoon will consider
    funding requests for two Federal regulatory agencies that are
    part of the jurisdiction of our subcommittee. My colleagues
    will be joining me a little bit later.
        I am pleased to welcome Acting Chairman Walter Lukken of
    the Commodity Futures Trading Commission (CFTC), and I am told
    that CFTC Commissioners Mike Dunn--please indicate, Mike, where
    you are. Mike, good to see you again. Bart Chilton; is Bart
    here? Bart, thank you for joining us. Jill Sommers, present.
    Jill, thank you for attending. I also understand that Chairman
    Chris Cox of the Securities and Exchange Commission, if he's
    not here--he's enroute.
        I'm going to waive the reading of my opening statement in
    the interest of having more time to ask questions, and ask
    consent that it be put in the record. Without Senator
    Brownback's objection, it will be. So, Senator, if you would
    like to make any kind of an opening statement, you're welcome
    to.
        Senator Brownback. Before I start, Senator Shelby has
    submitted a statement that he would like to be included in the
    record.
        [The statements follow:]

                Prepared Statement of Senator Richard J. Durbin

        Good afternoon. I am pleased to welcome you to this hearing to
    consider the funding requests of two Federal regulatory agencies within
    the jurisdiction of the Appropriations Subcommittee on Financial
    Services and General Government.
        I welcome my colleagues who have joined me on the dais today and
    others who may arrive.
        I am pleased to welcome Acting Chairman Walter Lukken of the
    Commodity Futures Trading Commission (CFTC). I also note that CFTC
    Commissioners Mike Dunn, Bart Chilton, and Jill Sommers are present.
    Thank you for attending and for your service.
        I welcome Chairman Chris Cox of the Securities and Exchange
    Commission (SEC), and members of his staff. Thank you all for being
    here.
        The CFTC and the SEC enjoy unique histories, hold specialized and
    independent responsibilities, and take different approaches to markets
    that serve differing purposes. Yet the CFTC and the SEC both occupy
    pivotal positions at the forefront of stimulating and sustaining
    economic growth and prosperity in our country. Through their vigilance,
    the United States is better equipped to compete in today's evolving
    global marketplace.
        As the subcommittee prepares to make difficult funding decisions
    for the next fiscal year, I look forward to hearing from our witnesses
    about the particular challenges their respective agencies face in
    today's tumultuous economic environment. I welcome input on how we can
    best address those needs.
        Before hearing from our panelists, I'd like briefly outline the
    missions of these agencies and their budget proposals:
        First, the CFTC: It is charged with protecting the public and
    market users from manipulation, fraud, and abusive practices. It is
    also responsible for promoting open, competitive, and financially sound
    markets for commodity futures. The CFTC regulates the activities of
    nearly 70,000 registrants--from sales people to trading advisors to
    floor traders.
        The CFTC helps ensure that the futures markets are equipped to
    better perform their vital function in the U.S. economy--providing a
    mechanism for price discovery and a means of offsetting price risks.
        The CFTC's oversight and enforcement mission becomes tangible when
    you consider that futures prices impact what we pay for the basic
    necessities of our daily lives: Our food, clothing, shelter, fuel in
    our vehicles, and heat in our homes.
        We have witnessed a remarkable transformation in the nature and
    type of products listed by exchanges since the CFTC was established in
    1976. Thirty-two years ago, the vast majority of futures trading
    occurred in the agricultural sector--cattle, grains and crops, and the
    proverbial pork bellies.
        Today, novel and highly complex financial contracts are emerging,
    based on such things as foreign currencies, interest rates, Treasury
    bonds, weather, real estate and economic derivatives, and stock market
    indices. These now surpass agricultural contracts in trading volume.
    And the ever-expanding complexities pose ever-demanding challenges as
    new futures products emerge.
        For the CFTC, the President's budget requests funding of $130
    million, representing an increase of $18.7 million--a 17 percent hike--
    over the fiscal year 2008 enacted level of nearly $111.3 million.
        Of the $18.7 million in increased funding for next year, $3.2
    million is slated for increased compensation and benefit costs for a
    staff of 465; $13.6 million will be devoted to increased operating
    costs for information technology modernization, lease of office space,
    and other services; and $1.9 million will support the salary and
    expenses of 10 additional full-time staff.
        Currently, with the $111.3 million provided for fiscal year 2008 (a
    14 percent increase over the $98 million in fiscal year 2007), CFTC is
    beginning an intensive hiring process to boost staffing from 447 up to
    465 and is making some initial investments to upgrade its information
    technology to keep pace with the rapidly-evolving technology-driven
    futures markets.
        In the past decade, trading volume has increased more than ten-
    fold--reaching well over 3 billion trades in 2007, and actively traded
    contracts have quintupled--from 258 in 1997 to 1,540 in 2007. CFTC
    oversees $4.2 trillion of daily trades. But despite this phenomenal
    surge in activity, staffing levels have not kept pace, and in fact,
    have dropped 21 percent. As I pledged last year, I am committed to
    addressing this resource deficiency.
        I also understand that various components of the CFTC
    reauthorization, included as part of the farm bill, would impose new
    responsibilities for the CFTC. Among these elements are regulation of
    energy derivatives markets and increased penalty authorities for market
    manipulation violations, which may require additional resources not
    contemplated in the fiscal year 2009 request.
        I look forward to hearing more about CFTC's budgetary needs today,
    and the opportunity to discuss with Chairman Lukken a variety of
    issues, including the oversight and regulatory challenges and
    opportunities presented by rising commodity prices, particularly for
    agricultural items and oil.
        Turning to the SEC, its three-prong mission is to protect
    investors; maintain fair, orderly, and efficient markets; and
    facilitate capital formation.
        The SEC is responsible for overseeing more than 12,000 publicly
    traded companies, over 10,000 investment advisers that manage more than
    $38 trillion in assets, nearly 1,000 fund complexes, 6,000 broker
    dealers with 172,000 branches, and close to $44 trillion worth of
    trading conducted each year on America's stock and option exchanges.
        The strength of the American economy and our financial markets
    depends on investors' confidence in the financial disclosures and
    statements released by publicly traded companies. Investors expect the
    SEC to be the vigilant ``cop on the beat.'' This subcommittee wants to
    make certain that the SEC has the necessary resources to effectively
    fulfill its obligatory singular mission: protecting shareholders.
        Crucial to the SEC's effectiveness is its enforcement authority.
    Each year the SEC brings hundreds of civil enforcement actions for
    violations of the securities laws. Typical infractions include insider
    trading, accounting fraud, and providing false or misleading
    information. Serious, thoughtful questions have been raised about
    whether the proposed enforcement budget is adequate to keep pace with
    the growing demands.
        The SEC's budget request for fiscal year 2009 totals $913 million,
    a slight $7 million (0.8 percent) increase over the agency's fiscal
    year 2008 enacted level of $906 million. Part of the $913 million will
    be provided through $42 million of prior year balances, resulting in an
    appropriated level of $871 million. These funds are offset by
    registration and transaction fees. The fiscal year 2009 budget would
    fund 3,409 permanent staff, a reduction of 94 staff (a 2.7 percent cut)
    below the SEC's fiscal year 2008 level.
        What is troubling about the paltry increase is that it is
    insufficient to sustain the agency's salary needs at SEC's authorized
    personnel level and will actually require cutting nearly 100 staff.
    This reduction of personnel comes at a time when developments and
    trends in the market call for more, not less, vigilance to protect
    investors. Resources devoted to enforcement are declining in both
    dollar terms and proportionality.
        I am concerned this bare-bones budget will hinder the SEC's ability
    to accomplish its mission. I look forward to exploring this topic more
    fully with Chairman Cox. In addition, I also plan to delve into other
    issues including the recent SEC-CFTC Memorandum of Understanding, Sudan
    divestment disclosure, SEC's role with subprime mortgage markets,
    expediting Fair Fund disbursements to investor-victims, plans for
    greater oversight of credit rating agencies, and how availability of
    interactive data is simplifying investor understanding and access to
    corporate filings and financial information.
        I look forward to hearing from our witnesses about the resources
    they require to keep pace with change and achieve success in a 21st
    century world, while responsibly managing taxpayer dollars.
                                     ______

                Prepared Statement of Senator Richard C. Shelby

        Chairman Cox, in your testimony today you state your support for
    providing dedicating funding for the SEC's Consolidated Supervised
    Entities (CSE) program. However, this program has never been explicitly
    authorized by Congress. Rather, it was created by the SEC. Unlike the
    Fed's regulation of bank holding companies and the OTS's regulation of
    thrift holding companies, the SEC's regulation of investment bank
    holding companies under the CSE program is not authorized by statute.
    The CSE program is entirely the SEC's creation.
        Normally, Congress is responsible for making policy, while the SEC
    implements that policy. In this case, however, the SEC decided that the
    CSE program was needed and then took it upon itself to create the
    program. Before the SEC now decides that a CSE program needs dedicated
    funding, I believe the SEC needs to take a step back and let Congress
    decide how investment banks should be regulated.

                       STATEMENT OF SENATOR SAM BROWNBACK

        Senator Brownback. I appreciate your way and means of doing
    this, and I'm going to do similarly because I've got a lot of
    questions.
        I would like to, though, point out two things very quickly
    if I could. First, welcome, Chairman Lukken. I appreciate you
    being here. And Securities and Exchange Commission (SEC)
    Chairman Cox is on his way.
        We put these in the record last week at the Joint Economic
    Committee on ending stocks of wheat and rice. I think it's
    important to get some factual basis out there. We are at a 27-
    year low on ending stocks of wheat, I believe. We had a
    terrible crop last year in the Midwest. You guys don't grow any
    wheat, but we do, and we didn't grow much last year. And then
    they didn't in Australia and a number of other places. A
    similar thing happened on the rice markets as well.
        But you can look at other markets that didn't have much of
    a problem, and yet you've seen this huge rise in prices. I want
    you particularly to address some of that if you would, because
    it strikes me that we do have people taking resources and
    putting them into commodities which drives up some commodities,
    not based on the fundamentals. There are crop movements that
    are based on the fundamentals; there are some that are not
    based on it.
        I really hope we can look at that particular issue and the
    potential manipulation of the market by large hedge funds or
    index funds, of taking money that they would normally put in
    other places, maybe even put it in commercial real estate, but
    with the declining value of the dollar shifting into the
    commodity markets, and then driving up those market prices
    above what the fundamental would support. I want to ask you
    what you anticipate doing to try to address that issue.
        Mr. Chairman, thanks for the hearing.
        Senator Durbin. Thanks.
        Chairman Lukken, your opening statement. We'll put whatever
    you like officially in the record and invite you now to give us
    a few minutes of the introduction to your statement.

                     SUMMARY STATEMENT OF WALTER L. LUKKEN

        Mr. Lukken. Thank you, Mr. Chairman and other Senators of
    the subcommittee. I am pleased to be here to testify on behalf
    of the Commodity Futures Trading Commission. The CFTC is the
    agency charged with overseeing and regulating the U.S.
    commodity futures and options markets. These markets play a
    critical role in the U.S. economy by providing important risk
    management tools for market participants. The futures markets
    also serve to discover prices that accurately reflect supply,
    demand, and other economic factors.
        These are extraordinary times for our markets, with
    commodity futures prices at unprecedented levels. In the last 3
    months the agricultural staples of wheat, corn, soybeans, rice,
    and oats have hit all-time highs. We've also witnessed record
    prices in crude oil, gasoline, and other related energy
    products. Broadly speaking, the falling dollar, strong demand
    from the emerging world economies, global political unrest,
    detrimental weather, and ethanol mandates have driven up
    commodity futures prices across the board.
        On top of these trends, the emergence of the subprime
    crisis last summer led investors to increasingly seek portfolio
    exposure in commodity futures. As the Federal regulator of
    these products, the CFTC is closely monitoring these growing
    markets to ensure they are working properly for farmers,
    investors, and consumers.
        To date, CFTC staff analysis indicates that the current
    higher futures prices generally are not a result of
    manipulative forces. That said, we continue to probe,
    investigate, and gather information from the entire marketplace
    and welcome outside analysis and perspectives so that we can
    ensure that we have an accurate and full view.
        For example, the agency convened an industry agricultural
    forum 2 weeks ago to have a full public airing of views as to
    the driving forces in these markets. The comment period for
    that event ends today and we hope to announce in the near
    future agency initiatives to address the concerns we heard at
    that forum.
        The CFTC also recently announced the creation of an energy
    markets advisory committee and scheduled its first meeting for
    June 10 to review the functioning of the energy markets.
        Despite this tumultuous time in our markets, the agency
    continues to make advancements on important policy initiatives.
    Last fall, the Commission delivered an extensive report to
    Congress recommending additional authorities for the agency in
    overseeing exempt energy trading. Through bipartisan efforts,
    these recommendations became a part of the CFTC reauthorization
    bill, which is contained in the farm bill conference report.
    The enactment of that legislation will improve our oversight of
    the energy markets with the addition of new authorities at the
    agency. The President's fiscal year 2009 budget does not take
    into account these new powers.
        The U.S. futures and options markets of today bear little
    resemblance to the industry of 1976, the Commission's first
    year of operation, in terms of complexity, globalization,
    volume, and economic importance. Yet, staff resources and
    operating funds over time have not kept pace.
        Figure 1 on the monitor shows the growth in trading volume
    on the U.S. futures exchanges from 1996 to present. Trading
    volume has increased sixfold during the last decade, while at
    the same time Commission staffing levels have fallen to 447
    full-time employees. That's 50 fewer staff today than the
    agency had 30 years ago.
        Figure 2 lists many of the different components of the
    futures industry. As you can see from the chart, the growth of
    these categories from 1976 to present is stunning. For
    instance, total contract volume has increased more than 8,000
    percent in 30 years, compared to CFTC's staffing and overhead
    expenses, which have decreased 12 percent and 5 percent
    respectively.
        On behalf of the entire Commission, I would like to express
    my appreciation for the support provided to the CFTC in the
    fiscal year 2008 budget. The $111 million appropriated by
    Congress for the current calendar year is already being put to
    good use to address critical needs in two major areas:
    personnel and technology. That focus will continue with the
    fiscal year 2009 budget.
        The Commission employs highly trained individuals who work
    within three program divisions: market oversight; clearing and
    intermediary oversight; and enforcement. The Division of Market
    Oversight ensures that the markets are operating efficiently
    and free from manipulation and fraud. The Commission's staff
    economists utilize the Commission's Large Trader Reporting
    System and one of the Commission's main technology systems, the
    Integrated Surveillance System (ISS), to detect and deter
    market manipulation. As you can see in figure 3, the current
    atmosphere of rising futures prices across a wide range of
    products makes these anti-manipulation efforts ever the more
    important.
        The Division of Clearing and Intermediary Oversight ensures
    the financial integrity of the futures industry as a whole. The
    amount of funds handled by clearinghouses has increased
    significantly of late. During this time, all exchanges have
    experienced record settlements, including one day in January
    2008 in which the Chicago Mercantile Exchange cleared and
    settled more than $12 billion worth of transactions in 1 day,
    nearly six times its normal load. Despite these spikes in cash
    flow, the clearing system has worked well.
        When a manipulation or fraud occurs in the futures markets,
    it is the job of the Enforcement Division to prosecute the
    offenders. Since the collapse of Enron, CFTC has brought 39
    cases involving energy markets and charged 64 entities or
    persons with manipulation, attempted manipulation, and false
    reporting. The collective civil monetary penalties levied in
    these energy market enforcement cases has exceeded $444
    million.
        Unfortunately, these programs have felt the effects of
    turnover at the agency. The Commission lost 58 experienced
    employees in fiscal year 2006, 49 in 2007, and 15 in 2008.
    Replenishing these losses is critical if this agency is to
    continue to meet its responsibilities in overseeing the futures
    markets.
        The fiscal year 2009 President's budget request, as seen in
    figure 5, is an appropriation of $130 million and 475 full-time
    staff, an increase of approximately $18.7 million and 10 staff
    over the fiscal year 2008 appropriation. Key changes in the
    fiscal year 2009 budget are: $3.2 million to provide increased
    compensation and benefits for current employees; $1.9 million
    to provide for salary and expenses of 10 additional full-time
    employees. This increase, although modest, will allow us to
    build on current key hiring efforts. And $13.6 million to
    provide for increased operating costs for technology
    modernization, office space, and all other services.
        In fiscal year 2009, the requested increased funding will
    continue to target technology upgrades and staffing increases.
    It would permit the Commission to improve existing critical
    technology systems, such as the ISS and E-Law systems. The
    funds requested would also permit the development of the new
    Trade Surveillance System, or TSS. Soon, with these
    investments, we will have the capability to more quickly
    monitor and analyze traders' intraday trading activity.
        In conclusion, I am very proud of the agency and our highly
    skilled staff. Every day they carry out the agency's mission of
    protecting the public and market users from manipulation,
    fraud, and abusive practices. If the futures markets fail to
    work properly, all Americans are impacted. Accordingly, it is
    critical that the CFTC have sufficient resources to hire and
    maintain skilled talent as well as to provide a steady stream
    of technology investment commensurate with the agency's
    expanding and evolving global mission.

                               PREPARED STATEMENT

        Thank you for this opportunity to appear today and I
    welcome any questions.
        [The statement follows:]

                     Prepared Statement of Walter L. Lukken
        Thank you, Mr. Chairman and members of the subcommittee. I am
    pleased to be here to testify before you on behalf of the Commodity
    Futures Trading Commission.

                      BACKGROUND AND CURRENT MARKET EVENTS

        The CFTC is the agency charged with overseeing and regulating the
    U.S. commodity futures and options markets. These markets play a
    critical role in the U.S. economy by providing risk management tools
    that producers, distributors, and commercial users of commodities use
    to protect themselves from unpredictable price changes. The futures
    markets also play a price discovery role as participants in related
    cash and over-the-counter markets look to futures markets to discover
    prices that accurately reflect information on supply, demand, and other
    factors.
        As you are well aware, these are extraordinary times for our
    markets with commodity futures prices at unprecedented levels. In the
    last 3 months, the agricultural staples of wheat, corn, soybeans, rice,
    and oats have hit all-time highs. We have also witnessed record prices
    in crude oil, gasoline and other related energy products. Both macro-
    economic factors as well as micro fundamentals for specific markets are
    at play in these prices. Broadly speaking, the falling dollar, strong
    demand from the emerging world economies, Mideast political unrest,
    detrimental weather and ethanol mandates have driven up commodity
    futures prices across-the-board.
        On top of these trends, the emergence of the sub-prime crisis last
    summer led investors to increasingly seek portfolio exposure in
    commodity futures. As the Federal regulator of these products, the CFTC
    is monitoring these growing markets to ensure they are working properly
    for farmers, investors, and consumers. To date, CFTC staff analysis
    indicates that the current higher futures prices are generally not a
    result of manipulative forces. That said, we continue to gather
    information from the entire marketplace--and welcome outside analysis
    and perspectives--so that we can ensure that we have an accurate and
    full view.
        For example, the agency recently convened an agriculture forum 2
    weeks ago in which we brought together a diverse group of market
    participants to have a full airing of views and opinions as to the
    driving forces in these markets. The comment period for that event ends
    today and we hope to announce in the near future agency initiatives to
    address the concerns we heard at the forum. The CFTC also recently
    announced the creation of an Energy Markets Advisory Committee and
    named the public members of the Committee just last week. Our first
    meeting is scheduled for June 10th to look at issues related to the
    energy markets and the CFTC's role in these markets under the Commodity
    Exchange Act. I am confident that these public forums will benefit our
    ability to make informed decisions as we strive to improve our
    oversight of these important markets.
        Despite this tumultuous time in our markets, the agency continues
    to make advancements on several important policy initiatives. Last
    September, the Commission held a public hearing on the regulation of
    exempt markets, resulting in an extensive Report to Congress
    recommending additional authorities for the agency in overseeing this
    type of trading. Through bipartisan efforts, these recommendations
    became a part of the CFTC's reauthorization legislation, which is
    contained in the Farm Bill conference report now being debated. The
    enactment of that legislation will mean increased responsibilities for
    the agency--and accordingly, will mean a need for additional CFTC staff
    to carry out the new authorities. The President's fiscal year 2009
    budget for the $130 million funding level does not take into account
    the new authorities included in the Farm Bill. The legislation would
    also raise penalties for market manipulation violations and close a
    legal loophole that has developed due to adverse court decisions that
    are hindering the CFTC's efforts to combat retail off-exchange foreign
    currency fraud.
        The CFTC has also worked to strengthen its relationship with the
    Securities and Exchange Commission (SEC) over the last year, given our
    shared responsibilities over certain products that affect the
    regulatory interests of both agencies. In March, our respective
    agencies entered into a memorandum of understanding (MOU) that will
    help the agencies share information as well as coordinate our review of
    novel derivative products that have attributes of both securities and
    futures. Two Chicago exchanges, the Chicago Board Options Exchange and
    OneChicago, are the first beneficiaries of this new framework as both
    seek to list for trading derivative products based on gold ETF
    products.
        Last year was busy on the enforcement front as well with the agency
    assessing record penalties against those seeking to manipulate the
    markets and defraud the public, culminating in the CFTC and Department
    of Justice reaching a record settlement against British Petroleum for
    manipulating the propane market. I am confident that the CFTC's
    dedicated staff will continue this productive effort in the coming
    year.

                            EVOLUTION OF THE MARKETS

        Congress created the CFTC in 1974 as an independent agency. The
    CFTC's primary mission under our governing statute, the Commodity
    Exchange Act, is to ensure that the commodity futures and options
    markets operate in an open and competitive manner, free of price
    distortions. In December 2000, Congress reauthorized the Commission
    with passage of the Commodity Futures Modernization Act of 2000 (CFMA).
    This landmark legislation established a flexible, principles-based
    regulatory regime. Today, the CFTC is the only U.S. principles-based
    financial regulator. This flexible approach has allowed the regulated
    futures industry to flourish. The same flexibility also allows alert
    and responsive oversight by the CFTC to fulfill the agency's mission.
        The U.S. futures and options markets of today bear little
    resemblance to the industry of 1976 in terms of complexity,
    globalization, volume, and economic importance--and these differences
    will continue in fiscal year 2009. Yet, staff resources and operating
    funds over time have not kept pace.
        For example, Figure 1 shows the growth in trading volume on U.S.
    futures exchanges from 1996 to present. Trading volume has increased
    six-fold during the last decade, while at the same time, Commission
    staffing levels have fallen to 447 full-time employees. That's 50 fewer
    staff today than the agency had 30 years ago in 1976--the Commission's
    first year of operation.

      Figure 1.--Growth in Volume of Futures & Option Contracts Traded &
                                     FTEs.

        Figure 2 lists the many different components of the futures
    industry, including the number of contracts traded, the volume of
    trading, the number of futures industry participants, the number of
    exchanges and other trading facilities, and the overall notional value
    of these markets.

        ----------------------------------------------------------------

    ----------------------------------------------------------------------------------------------------------------
                                Indicator                                  1976            2007       Percent change
    ----------------------------------------------------------------------------------------------------------------
    CFTC Staff......................................................             497             437             -12
    Overhead Expenses as a Percentage of Budget.....................              34              29              -5
    Total Contract Volume...........................................             37M          3.085B          +8,238
    Types of Contracts Traded.......................................              66           1,365          +1,968
    Commodity Trading Advisors......................................             447           2,601            +482
    Commodity Pool Operators........................................             544           1,416            +160
    Floor Brokers...................................................           2,591           8,038            +210
    Associated Persons (Sales Persons)..............................          25,579          53,844            +110
    CFTC--Regulated Exchanges.......................................              10              12             +20
    CFTC--Registered Clearing Organizations.........................  ..............              11         ( \1\ )
    Exempt Boards of Trade..........................................  ..............               9         ( \1\ )
    Exempt Commercial Markets.......................................  ..............              20         ( \1\ )
    Notional Value of Contracts Traded (Per Day)....................             $4B      \2\ $4.78T         119,400
    Customer Funds in FCM Accounts..................................           $577M           $155B         26,763
    ----------------------------------------------------------------------------------------------------------------
    \1\ Not available.
    \2\ Estimate.

        ----------------------------------------------------------------

                   Figure 2.--Indicators of Industry Growth.

        As you can see from the chart, the growth in these categories from
    1976 to present is stunning--with percentage increases in the triple,
    quadruple, and quintuple digits. For instance, total contract volume
    has increased more than 8,000 percent in 30 years. Contrast that with
    the CFTC staffing and overhead expenses over time, which have decreased
    -12 percent and -5 percent, respectively. Looking at the growth in all
    sectors, it's clear that CFTC is doing a lot more with a lot less.

                            FISCAL YEAR 2008 BUDGET

        On behalf of the entire Commission, I would like to express my
    appreciation for the support provided to the CFTC in the fiscal year
    2008 budget. The $111 million appropriated by Congress for the current
    calendar year was the first substantial increase for the Commission in
    recent years and is already being put to good use. It is important to
    explain how the CFTC is using the fiscal year 2008 funding to address
    critical needs in two major areas--experienced professionals and a
    modern technology infrastructure--because the fiscal year 2009 funding
    will build on that foundation.
    Additional Staff Hires
        The Commission is implementing an intensive hiring program for the
    first time since October 2005. This program seeks to fill the loss of
    experienced, long-time Commission employees, as well as address new
    skill sets required by the rapidly evolving industry we regulate. The
    Commission employs highly-trained, expert staff who works within three
    major program divisions--Market Oversight, Clearing and Intermediary
    Oversight, and Enforcement. These divisions are complemented and
    supported by the Offices of the Executive Director, General Counsel,
    Chief Economist, International Affairs, and External Affairs.
        The Division of Market Oversight ensures that the markets are
    operating efficiently and without manipulation and fraud. One of the
    keys to Market Oversight is market surveillance. The Commission's staff
    economists utilize the Commission's large trader reporting system and
    one of the Commission's main technology systems, the Integrated
    Surveillance System (ISS), to detect and deter market manipulation and
    disruption. As you can see in Figure 3, the current atmosphere of
    rising futures prices across a wide range of products makes these anti-
    manipulation efforts all the more important.

          Figure 3.--Recent Commodity Price Changes by Percent Change.

        The Division of Clearing and Intermediary Oversight ensures the
    financial integrity of the futures industry as a whole. Futures and
    options trading on U.S. contract markets increased by approximately 27
    percent in 2007 over the prior year and remains at consistently high
    levels. Not only has the volume of trading increased and the futures
    prices of some commodities increased to record levels, the amount of
    funds handled by the clearing houses has increased as well. In this
    regard, all exchanges have experienced record settlements during this
    time period, including one day in January 2008 in which the Chicago
    Mercantile Exchange cleared and settled more than $12 billion of
    transactions--nearly six times its normal load. Despite these spikes in
    cash flow, the clearing system has worked extraordinarily well.
    Nevertheless, with the rising need for risk management by businesses
    and the rising importance of futures markets to the Nation's economy,
    the Commission's financial integrity programs must be continually
    strengthened. A key component of the Commission's financial integrity
    program is the required segregation of all customer funds from those
    funds of Futures Commission Merchants (FCM). As shown in Figure 4, the
    level of required segregated customer funds has more than doubled since
    the end of 2000.

                     Figure 4.--Segregated Funds Required.

        When a manipulation or fraud occurs in the marketplace, it is the
    job of the Enforcement Division to gather information, build a case and
    prosecute the offenders. In the foreign currency or FOREX markets, the
    CFTC has filed 98 cases involving 374 entities or persons with more
    than $562 million in civil monetary penalties levied and more than $453
    million in restitution awarded. Since the collapse of Enron, CFTC has
    brought 39 cases involving energy markets and charged 64 entities or
    persons with manipulation, attempted manipulation, and/or false price
    reporting. The collective civil monetary penalties levied in these
    energy market enforcement actions exceed $444 million.
        As our financial markets become more complex, global, and
    interwoven, the Commission is increasingly called upon to co-ordinate
    and co-operate with other agencies domestically and world wide.
    Internationally, these activities involve the Commission's
    participation in multilateral bodies, such as the International
    Organization of Securities Commissions (IOSCO), as we strive to raise
    global regulatory standards. This is complemented with specific
    bilateral information sharing arrangements with other nations as we try
    to coordinate our enforcement and oversight efforts. Domestically, the
    Commission staff works with several Federal and State agencies,
    including USDA, FERC, and DOJ, to harmonize our mutual regulatory
    efforts. The Commission recently signed an MOU with the SEC to further
    co-ordinate our efforts, given the additional convergence of the
    futures and equities markets. In addition, our agency has an
    information sharing MOU with FERC to enhance cooperation in the
    policing of the energy markets.
        All of these important responsibilities and priorities require
    qualified personnel in their execution. Unfortunately, recent turnover
    at the agency has been significant. Throughout the agency and its
    divisions, the Commission lost 58 experienced employees in fiscal year
    2006, 49 in fiscal year 2007 and 15 to date in fiscal year 2008. The
    Commission currently has 447 full-time employees onboard and with the
    recent increased funding, we are actively recruiting toward a target of
    465 FTEs for fiscal year 2008. Such personnel additions are critical if
    this agency is to continue to meet its responsibilities in overseeing
    the futures markets.

    Technology Investments
        The other focus of the fiscal year 2008 budget allocation is
    technology. The CFTC primarily uses technology in the surveillance of
    the markets and the monitoring of the financial integrity of the
    clearing organizations and firms. The Commission's fiscal year 2008
    appropriation enables the agency to undertake a long-delayed
    modernization of capital investments in Information Technology (IT)
    software and hardware, such as computers, servers, routers, switches
    and other critical communications components. The modernization of our
    surveillance systems will pay off with enhanced transparency and
    detection tools for the oversight of our markets.
        The CFTC receives and analyzes millions of data points everyday
    that come in from the exchanges and firms, which allow us to monitor
    the marketplace. Once aggregate position levels are determined, CFTC
    staff not only monitors daily positions of all large traders, but also
    has the ability to analyze the minute-by-minute trades of these market
    participants, including hedge funds and other speculators, during times
    when there is a heightened risk of manipulation. To do this job, the
    CFTC's market surveillance staff uses its ISS system to organize and
    group the information into meaningful categories.
        With the exponential growth of these global electronic markets, the
    CFTC must continue to devote significant portions of its budget to
    technology in order to stay on top of this sector. This year the agency
    will increase its technology budget by almost 37 percent with the hope
    of almost doubling the overall technology budget by fiscal year 2009.
    These resources will be primarily used to enhance the agency's
    surveillance tools--making these programs faster, more functional and
    better able to detect wrongful activities across markets and
    jurisdictional borders.
        Clearly, technology and personnel investments are keys to the
    agency's success and the fiscal year 2009 budget builds on the
    foundation that has been enhanced this year. I am grateful for the
    administration's and appropriators' recognition of the need for
    increased funding for our agency in these two key areas.

                            FISCAL YEAR 2009 BUDGET

        The fiscal year 2009 President's budget request, as seen in Figure
    5, is for an appropriation of $130 million and 475 full-time staff, an
    increase of approximately $18.7 million and 10 staff over the fiscal
    year 2008 appropriation.

    Figure 5.--Fiscal Year 2009 Budget Request Provides for an Increase of
                     $18.7 Million and Additional 10 FTEs.

        Compared to the fiscal year 2008 appropriation, key changes in the
    fiscal year 2009 budget are:
        --$3.2 million to provide for increased compensation and benefit
            costs for a staff of 465 full-time employees;
        --$1.9 million to provide for salary and expenses of 10 additional
            full-time employees. This portion of the budget also includes
            $200,000 to establish a student loan program that is designed
            to help with retention and recruitment of young, qualified
            professionals. The agency has not had the resources in previous
            years to be able to support this program and we're pleased to
            have this program planned for in our budget.
        --$13.6 million to provide for increased operating costs for
            information technology modernization, lease of office space,
            and all other services.
        This funding increase provides the Commission with the financial
    wherewithal to build on the fiscal year 2008 investments by continuing
    to hire additional staff and make critical investments in technology.
    Additional Staff Hires
        For fiscal year 2009 the Commission is requesting ten additional
    positions. This increase--although modest compared to industry growth--
    will allow us to build on the hiring we are undertaking as a result of
    the fiscal year 2008 appropriation. The ten positions requested for
    fiscal year 2009 are spread throughout the Commission because our needs
    cut across all of our responsibilities. For example, in the Division of
    Market Oversight, we will allocate an additional surveillance economist
    to focus principally on the complex issues and changing practices in
    the energy cash and derivatives market. In the Division of Clearing and
    Intermediary Oversight, we will allocate two additional staff to
    enhance the expanding financial and risk surveillance functions. In the
    Enforcement program, two additional staff will focus mainly on
    allegations of manipulation, trade practice violations, and false
    reporting, but the additional staff will also enhance our ability to
    address a wide range of violations of Federal commodities law. One
    additional staff is planned for the Office of the Chief Economist to
    conduct market research and analysis commensurate with the growth in
    new types of exchanges, new trading execution methods, and the role of
    speculators in our markets. For the Office of Proceedings, we are
    requesting one addition position to fill the long vacant directorship.
    For the Office of General Counsel, we are seeking one additional
    position to replace a loss in expertise among senior staff in areas
    such as bankruptcy and anti-trust law. Finally, in the Office of
    Information Technology, we are requesting two additional positions to
    enhance in-house expertise to assist the major program Divisions in
    monitoring, auditing, and investigating increasingly sophisticated
    technologically driven markets.

    Technology Investments
        In fiscal year 2009, additional funding would permit the Commission
    to upgrade telecommunications systems and to expand and improve
    existing critical systems, such as the Integrated Surveillance System
    and eLaw. Also in fiscal year 2009, funds requested would permit
    continued development of the new Trade Surveillance System (TSS), which
    will be used for trade practice surveillance on all exchanges,
    including new and emerging electronic exchanges. TSS will use state-of-
    the-art, commercially available software to enhance both intra-exchange
    and inter-exchange trade practice surveillance. We can now obtain and
    analyze the trading activity of our large traders in a mere fraction of
    the time it used to take--minutes instead of days. Soon, with these
    investments, we will have the capability to monitor and analyze even
    more quickly and efficiently a trader's intraday trading activity.
        The Commission's ability to fulfill its mission depends on the
    collection, analysis, communication and presentation of information in
    forms useful to Commission employees, the regulated industry, other
    Federal, State, and international agencies, the Congress, and the
    American public. The resources allocated in fiscal year 2008 and fiscal
    year 2009 to Information Technology will permit a secure modern
    information technology infrastructure and the development of a Document
    Management System to modernize, centralize and automate the management
    of the Commission's information resources. These comprehensive
    enhancements will enable the Commission to serve these stakeholders
    effectively.
        The fiscal year 2009 budget, if approved, will largely enable
    completion of the CFTC's technology modernization initiative--barring
    unforeseen industry developments or new statutory requirements. The
    Commission is making a concerted effort to use commercial best
    practices in developing and maintaining its IT systems and ensuring
    that our IT staff is focused on increasing efficiency and controlling
    costs.
        All of the technology improvements have one commonality; they help
    increase the availability of one of our most critical resources--time.
    That is, technology allows our growing staff to become more productive
    by spending additional time on qualitative analysis rather than
    quantitative processing and compilation.

                                   CONCLUSION

        I am very proud of the agency and our highly-skilled staff.
    Everyday, they carry out the agency's mission of protecting the public
    and market users from manipulation, fraud, and abusive practices and
    promoting open, competitive and financially sound markets. If the
    futures markets fail to work properly, all Americans are impacted.
        When looking at the increased volume of activity across all areas
    of the CFTC mission and the scope of the industry changes, the
    resulting increase in specialized workload is demonstrable.
    Accordingly, it is critical that the CFTC have sufficient resources to
    hire and maintain skilled talent, as well as provide a steady stream of
    technology investment commensurate with the agency's expanding and
    evolving global mission.
        Thank you for the opportunity to appear before you today on behalf
    of the CFTC. I would be happy to answer any questions you may have.

                   ADEQUATE STAFFING TO MEET VOLUME INCREASES

        Senator Durbin. Chairman Lukken, your graphs tell the story
    about a dramatic increase in trading that you are responsible
    to oversee. As I understand it, if you're able to replace
    employees that have left, the President's new budget request
    will give you an additional 10 employees over the 465 that
    you're targeting. I can't imagine that gets close to matching
    the volume increase that this agency faces in terms of the
    markets that you supervise. Does it?
        Mr. Lukken. Well, our fighting weight as an agency
    historically has been in the mid-500s, and we're trying to
    build up over a series, a period of years, to get to those
    levels, and we're hopeful to reach that. I think the 10 that
    we've requested in 2009 is the minimum we need to ensure our
    responsibilities at the agency. The technology is very
    important in ensuring that we're productive in those 10
    individuals.
        So we're looking over a long-term horizon to make sure that
    we get to where we need to be, but we think 10 is a good start
    in that venture.

                      SPECULATION IMPACT ON ENERGY FUTURES

        Senator Durbin. So let me try to be more specific in the
    next question about another issue. As I understand your
    testimony and your agency's responsibility, you look for
    illegal conduct, market manipulation, evidence of corruption,
    and obviously do your best to keep transparency and
    credibility, integrity in the marketplace, and that is an
    important part of your role.
        But you've also initiated several discussions that relate
    to the overall market and the role it has in our economy as it
    relates to specific commodities. Now being more specific, when
    it comes to energy contracts, that's one that's in the news.
    And there are a lot of people, including some of my colleagues
    that I respect very much, who think that the speculation and
    trading in energy futures has driven up the price of oil, for
    example. One of my colleagues today said he thought that of the
    $120 a barrel, maybe $30 of it or more was attributable just to
    speculators driving up the price of the commodity.
        There's also a question about margin requirements when it
    comes to these energy futures.
        Let me throw in the third element, of course: global
    competition. In London, ICE is selling many of these same
    contracts or contracts similar to them.
        That's as soft a pitch as I could throw you on this, but
    I'd like your feedback on the speculation on this issue.
        Mr. Lukken. Well, certainly we closely follow the market
    participants and track what speculators may be doing in our
    markets. As I mentioned, we receive every day the trade
    positions of all traders in our markets above a certain
    threshold. That ensures that we can see what sort of
    controlling positions they may have as traders on a given
    market.
        Our economists also closely follow fundamentals of those
    markets to ensure that those types of traders aren't using
    their positions in order to manipulate or cause some sort of
    illegal behavior in our markets. So we closely follow that.
    Like I said, every day we're looking at who the large traders
    might be and whether they're either themselves or colluding
    with others to try to manipulate the markets.
        Senator Durbin. Do you think that that's happening now? Do
    you think that the observation that $20 or $30 on a barrel of
    oil can be attributed to speculation is a valid observation?
        Mr. Lukken. Well, I think as far as illegal behavior, where
    an individual or a set of individuals are trying to manipulate
    the market, I can say with a high degree of confidence that we
    are not seeing that. With regard to speculation, we also have
    controls in place for speculators. Each month as the contract
    is about to expire, they have to get down to certain positions
    in agricultural markets and other, energy contracts so that
    there's a less chance that they may be able to manipulate the
    markets, and those controls are currently in place.
        So between seeing the transparency of the reporting that we
    receive, plus the controls, the position limits we have in
    place, we have a high degree of confidence that people are not
    manipulating the markets.

                              MARGIN REQUIREMENTS

        Senator Durbin. And what are the margin requirements on
    these energy contracts?
        Mr. Lukken. The margin requirements--as you know, in the
    futures industry, margin is set based on a risk modeling that
    the exchanges perform, and this is meant to cover a 1-day price
    move, so that the losers can pay the winners every day, and the
    markets mark to market at least twice a day. This wrings the
    risk, credit default risk, out of the marketplace, so that
    losses can't accumulate over a period of days. So every day
    everybody starts afresh.
        So this has worked very well to----
        Senator Durbin. Is there a margin requirement?
        Mr. Lukken. For?
        Senator Durbin. Energy futures.
        Mr. Lukken. Yes, there is. There is to cover a potential 1-
    day price move. Again, this is based on statistical, historical
    and statistical evidence of what that might be.
        Senator Durbin. How does that compare with other
    commodities, the actual margin requirement?
        Mr. Lukken. It's based on volatility. I'll have to ask our
    staff whether we can get you figures on percentages. But oil, I
    think, is sort of middle of the pack as far as volatility
    compared to some of the other commodities. But we can give you
    specific numbers.
        Senator Durbin. The last question--I'm sorry to go over a
    minute, but I didn't get my entire opening statement, so I can
    have an extra minute here. So if we passed a law calling on you
    to substantially increase the margin requirements on energy
    futures, particularly as they relate to crude oil, what impact
    would that have in your estimation on migration to another
    marketplace, like ICE in London, as an alternative market to
    pursue the same type of future?
        Mr. Lukken. I think there would be migration off exchanges.
    It would be a tax on a type of trader. These traders--I know
    that there's a lot of people who have disparaging remarks about
    speculators, but they do provide liquidity for a lot of these
    markets and have for years, and that's necessary to make sure
    that the commercial participants in the markets, the producers,
    the farmers, and everybody, has a buyer for every seller and a
    seller for every buyer.
        Senator Durbin. What percentage of those who trade, for
    example, in these energy commodities actually take possession?
        Mr. Lukken. Very few. Very few actually ever deliver. The
    vast majority of the contracts never deliver the physical
    commodity. The futures markets are not a marketing tool for
    product. It is a risk management tool and people utilize it as
    a risk management tool. There has to be delivery as part of the
    mechanism to ensure that the cash price and the futures price
    eventually converge, but the truth is that most people get out
    of these contracts way before delivery ever occurs.
        Senator Durbin. Senator Brownback.
        Senator Brownback. Thank you, Mr. Chairman.

                         MONITORING MARKET FUNDAMENTALS

        Years ago when I was a farm broadcaster, I thought I was
    really smart on these markets, so I speculated a little bit,
    lost my shirt. My dad would not listen to anything I ever said
    again from that point. He farms and he said: All right, we're
    just going to keep it in the bin now; I'm not listening to you
    any more.
        So I know those things move on you. I was long in the wheat
    futures when the Soviets invaded Afghanistan, if anybody
    remembers that period, and we lock-limited down the markets for
    3 days. I'll never forget it. It was quite an experience for a
    young man.
        You mentioned, though, earlier, Chairman, that your
    economists track the fundamentals and what the market should
    be. What should the price of oil be now, according to what your
    economists are saying?
        Mr. Lukken. Well, we make sure that the markets are
    reflecting as best they can and they are functioning
    efficiently and performing. We can't predict what prices may
    be. That's the function of a free market.
        Senator Brownback. Do you do a range? Do you do a range and
    say, on these fundamentals, this supply, this demand, there is
    a range that this price should in normal circumstances trade
    in? Do you do any historical view of that?
        Mr. Lukken. We do not.
        Senator Brownback. There's been a number of articles out
    lately thinking that these markets are being driven heavily.
        Mr. Lukken. We do closely follow what the Department of
    Energy and the U.S. Department of Agriculture, the numbers that
    they're putting out, looking at a holistic approach to make
    sure the fundamentals are supporting the general prices that
    are being put out by the markets. And if we see----
        Senator Brownback. Well then, answer that question: Do the
    fundamentals support the general prices being put out by this
    oil market?
        Mr. Lukken. I think, based on supply and demand that we're
    seeing--and a lot of people in the markets agree--that yes, the
    fundamentals do support largely what the prices are at today.
        Senator Brownback. So you disagree with what the chairman
    said, that there's as much as $30 in these markets that's based
    on speculation?
        Mr. Lukken. Well, I have not seen that study, so we'd have
    to look at that. But we have not seen that speculators again
    are driving--are a major factor in setting these prices.
        Senator Brownback. You're familiar, and I'll enter into the
    record, there's a Barron's article that cites that they believe
    that they are.
        [The information follows:]

                    [From Barron's, Monday, March 31, 2008]

                      Commodities: Who's Behind the Boom?
                               (By Gene Epstein)

        China, as everyone knows, is a big force in the extraordinary boom
    in commodities. Its voracious appetite for everything from corn and
    wheat to copper and oil has helped push up U.S. commodities prices by
    some 50 percent over the past 12 months.
        But China is by no means the whole story. Speculators--including
    small investors--are also playing a huge role. Thanks to the
    proliferation of mutual funds and exchange-traded funds tied to
    commodities indexes, speculative buying has gone way beyond anything
    the domestic commodities markets have ever seen. By one estimate, index
    funds right now account for 40 percent of all bullish bets on
    commodities. The speculative juices are even more plentiful--nearly 60
    percent of bullish positions--if you count the bets placed by
    traditional commodity ``pools.''
        Here's the problem: The speculators' bullishness may be way
    overdone, in the process lifting prices far above fair value. If the
    speculators were to follow the commercial players--the farmers, the
    food processors, the energy producers and others who trade daily in the
    physical commodities--they'd be heading for the exits. For right now,
    the commercial players are betting on price declines more heavily than
    ever before, says independent analyst Steve Briese.
        For example, in the 17 commodities that make up the Continuous
    Commodity Index, net short positions by the commercials have been
    running more than 30 percent higher than their previous net-short
    record, in March 2004.
        Briese, author of the recent book The Commitments of Traders Bible
    and editor of the Website CommitmentsOfTraders.org, was one of the
    first to recognize that information on the bets made by the commercials
    could provide rare insights into how the ``smart money'' views the
    price outlook. These days, the data suggest, the smart money clearly
    believes that the market's exuberance has turned irrational.
        Indeed, the great commodities bubble started springing its first
    leaks two weeks ago: Oil, gold and other major commodities posted their
    steepest weekly drop in half a century. Though prices have since
    firmed, they could eventually drop 30 percent as speculators retreat.
    The only real question is when.
        It's not easy to size up the influence of the index funds. But
    based on their known cash commitments in certain commodities, and the
    commodity indexes their prospectuses say they track, it is possible to
    estimate the size of their commitments in all commodities they buy.
    Using this method, analyst Briese (pronounced ``breezy'') estimates
    that the index funds hold about $211 billion worth of bets on the buy
    side in U.S. markets.
        Applying a similar method, but with slightly different assumptions
    for indexes tracked, Bianco Research analyst Greg Blaha puts that
    figure at $194 billion. Either figure is enough to turn the index funds
    into the behemoths of the commodity pits, where total bullish positions
    now stand at $568 billion.
        Commodities index funds, which arrived on the scene in the late
    1990s, have come into their own in the past several years. The biggest
    index fund, Pimco Real Return (ticker: PRTNX), has seen its assets
    swell to $14.3 billion from $8 million since its inception in January
    1997.
        Index funds offer investors an easy, inexpensive way to gain
    exposure to a segment of the commodities markets or a broad-based
    basket of commodities. Result: The funds have drawn many private
    investors who have never ventured into futures, along with pension
    funds and other institutional players looking to diversify. But for all
    the virtues that the funds hold as a way of spreading bets across
    commodity markets, they take only long, or bullish, positions, avoiding
    short-selling. In other words, they trade on the naive and potentially
    fatal assumption that commodities have the same tendency as stocks to
    rise over the long run.
        That this large, bullishly oriented group of funds is flourishing
    is partly a result of a regulatory anomaly. In recognition of the fact
    that the commodity markets are too small to absorb an excess of
    speculative dollars, the Commodity Futures Trading Commission, in
    conjunction with exchanges, imposes position limits on speculators. But
    the agency has effectively exempted the index funds from position
    limits.
        The dislocations caused by allowing so much money into markets that
    have limited liquidity is now causing alarm in the trading pits. That,
    in turn, is prompting the CFTC to call for an industry gathering April
    22 at its Washington headquarters ``to hear firsthand from participants
    to ensure that the exchanges are functioning properly.'' On this and
    related issues, CFTC Acting Chairman Walter Lukken declined to comment
    to Barron's.

        Unless regulators clamp down, the index funds could become an even
    bigger force in the markets. In the midst of the recent sell-off,
    commodity bull Jim Rogers made that very point in an interview with
    Bloomberg News. Referring to the ``over 70,000 mutual funds in the
    world'' compared with the ``fewer than 50'' that now invest in
    commodities, he held out the prospect of a speculative bubble that
    could last for years.
        In Rogers' view, the bull market is in the ``fourth inning'' of a
    ``nine-inning baseball game.'' To which commodity bear Steve Briese
    counter-quips, ``Maybe, but can't the game be called for a year or two,
    on account of rain?''
        In the organized commodity markets, trading is in futures and
    options, which are essentially two-way bets on the outlook for prices.
    For every buyer (a ``long'') of a future or options contract betting on
    a price rise, there is a seller (a ``short''), taking the other side of
    the contract by betting on a price decline. Since speculators and
    commercials as a group can be either short or long, the charts (see the
    last page) track the net position--longs minus shorts--held by either
    group. Courtesy of Briese, the charts track net long or short positions
    in dollars, based on the dollar value of the commodity each futures or
    options contract covers.
        The speculators, now so bullish, are mainly the index funds. To see
    how their influence on the market has become outsized, just look at how
    they operate. Nearly $9 out of every $10 of index-fund money is not
    traded directly on the commodity exchanges, but instead goes through
    dealers that belong to the International Swaps and Derivatives
    Association (ISDA). These swaps dealers lay off their speculative risk
    on the organized commodity markets, while effectively serving as market
    makers for the index funds. By using the ISDA as a conduit, the index
    funds get an exemption from position limits that are normally imposed
    on any other speculator, including the $1 in every $10 of index-fund
    money that does not go through the swaps dealers.
        The purpose of position limits on speculators, which date back to
    1936, is clearly stated in the rules: It's to protect these relatively
    small markets from price distortions. An exemption is offered only to
    ``bona fide hedgers'' (not to be confused with ``hedge funds''), who
    take offsetting positions in the physical commodity.
        The basic argument put forward by the CFTC for exempting swaps
    dealers is that they, too, are offsetting other positions--those taken
    with the index funds.
        Position limits on speculators, in some commodities specified by
    CFTC rules and in others by the exchanges, are generally quite liberal.
    For example, the position limit on wheat traded on the Chicago Board of
    Trade is set at 6,500 contracts. At an approximate value of $60,000
    worth of wheat per contract, a speculator could command as much as $390
    million of wheat and still not exceed the limit.
        But at least one index fund that does trade the organized commodity
    markets directly and must therefore abide by the rules--PowerShares DB
    Multi-Sector Commodity Trust (DBA)--recently informed investors that it
    was bumping up against position limits and therefore would change its
    strategy.
        No such information is available from individual swaps dealers. But
    based on CFTC data on their total position in a commodity like wheat,
    together with the fact that only four dealers account for 70 percent of
    all the trading from the ISDA, it is quite clear that if the exemption
    were ever rescinded, the dealers' trading in these markets would no
    longer be viable.
        Speculators also use the older commodity pools, whose position is
    likewise tracked on the charts. The pools, open to sophisticated
    investors, are flexible enough to sell short as well as buy long and
    are subject to position limits. But since they are generally trend-
    followers, they will almost always go long in bull markets. Through
    most of the recent period, then, the pools have been adding to the
    price distortions caused by the index funds. Add the pools' bets to
    those of the index funds, and speculative money forms 58 percent of all
    bullish positions.
        To get a further idea of the impact of these speculative bets,
    Barron's asked Briese to measure them against production in the
    underlying markets. He calculates that in soybeans, the index funds
    have effectively bought 36.6 percent of the domestic 2007 crop, and
    that if you add the commodity pools, the figure climbs to 59.1 percent.
    In wheat, the figures are even higher--62.3 percent for the index funds
    alone, and the figure jumps to a whopping 83.6 percent if you add the
    pools. Betting against them as never before are the commercials, who
    deal in the physical commodity.
        The CFTC provides these figures on index trading for only 10
    commodities. Why are such major commodities as crude oil, gold, and
    copper excluded? The agency's rationale, which even certain insiders
    question, is that it would be hard to get reliable information on these
    other commodities from the swaps dealers.
        What might finally trigger the bursting of the commodities bubble?
        One possible trigger was cited in a Barron's interview with Carl
    Weinberg of High Frequency Economics, published last week. Weinberg
    anticipated a break ``some time this year'' in industrial commodities,
    including crude oil, copper and natural gas once there is news of
    ``even the slightest slowdown in the Chinese economy,'' the country
    whose insatiable demand, together with that of India, has been a
    rallying cry of the bullish speculators. When industrial commodities
    prove vulnerable, speculative money could start fleeing agricultural
    commodities, also.
        Societe Generale analyst Albert Edwards goes much further. Based on
    his view that the ``Commodity bubble is nonsense on stilts,'' Edwards
    holds the ``very strong conviction that before the end of this year,
    commodity prices . . . will be unraveling.'' He believes the triggering
    events will be the ``unfolding U.S. consumer recession'' and likelihood
    of ``negative CPI [consumer price index] inflation rates.''
        A sudden turnaround in the dollar could be another trigger, notes
    Briese. By making dollar-denominated commodities ever cheaper in terms
    of other currencies, the collapsing dollar has been a legitimate
    bullish factor. ``But the buck won't go down forever,'' Briese argues.
    ``The same cycles that coincided with the dollar's major bottom in 1992
    are due to make a low later this year. A rebounding dollar would pinch
    demand for dollar-denominated commodities.''
        Alternatively, to borrow a quip from the late humorist Art
    Buchwald--who once explained that his candidate lost the election owing
    to ``not enough votes''--the bubble could burst from not enough buying.
    Brokerage houses have been advising their clients to allocate part of
    their portfolios to commodities, compared with allocations of zero
    several years ago. Even a shift of five percentage points would have
    been more than enough to account for the dollars that have fueled the
    ``nonsense on stilts.''
        But what if the U.S. economy proves more resilient than currently
    thought, doesn't fall into recession, and instead starts growing again?
    The resulting rally in the stock market could send the allocation share
    back to zero and the bubble could burst, not with a bang, but with a
    whimper.
        The CFTC could also prick the bubble by enforcing its own rules. If
    the agency were to rescind the exemption on position limits given to
    the index funds (say, on a phased basis, so that the funds could make
    an orderly retreat), prices would probably fall back to reflect their
    true supply-demand fundamentals.
        Briese's analysis of commercial hedger positions leads him to
    believe that commodities in general were fully valued in terms of the
    fundamentals as of early September 2007. Based on the 24-commodity S&P
    Goldman Sachs Commodity Index, that would mean about a 30 percent
    collapse from present levels. But, he adds, ``Given the tendency for
    prices to overshoot, commodity values could be cut in half before they
    stabilize.''
        Maybe it's time to start listening to the smart money.

                         LIMITATIONS ON OPEN POSITIONS

        Senator Brownback. I would ask you as well: You have
    limitations on what one individual can control as far as the
    number of open positions in a commodity; is that correct?
        Mr. Lukken. That is correct.
        Senator Brownback. Does that same limitation apply to a
    hedge fund?
        Mr. Lukken. It does.
        Senator Brownback. To an index fund? To a hedge fund?
        Mr. Lukken. Well, a hedge fund is in our terms somebody who
    is a speculative trader. An index fund is somebody like Goldman
    Sachs or AIG, which is a fund that brings in passive long-only
    investments into our markets. We typically call speculators
    those that are buying and selling over a short-term horizon.
    These are long-term investments in which pension funds such as
    CALPERS or retirement funds and endowment funds come into our
    markets in a buy and hold type strategy.
        Senator Brownback. And there is no limitation on the amount
    of open positions they can maintain?
        Mr. Lukken. They receive an exemption from us for those
    position limits.
        Senator Brownback. Now, in one article that I read--only
    long position?
        Mr. Lukken. Only long.
        Senator Brownback. But in one of the articles I read, that
    they were holding as much as 40 percent of some of the near-
    term long positions in these index funds.
        Mr. Lukken. Well, they normally never get into the spot
    month. They roll before the spot month occurs. So they again
    are seeking long-term exposure.
        But in our analysis--and this is something that was
    discussed quite a bit at the agricultural forum we held 2 weeks
    ago--we've seen evidence where the largest percentage of index
    fund trading is in live cattle right now, about 45 percent of
    the market, and yet live cattle is down 6 percent, 8 percent on
    the year. So we have not seen high levels of correlation. In
    fact, Minneapolis wheat contract has no index fund trading----

                           INDEX FUNDS IN OIL MARKETS

        Senator Brownback. What about oil?
        Mr. Lukken. Unfortunately, because of the way that index
    funds enter into the oil markets, we're not able to pull out
    that data separately. But it's something we're looking into
    trying to drill down to find out how the index funds enter into
    those markets.
        Senator Brownback. It sure seems like that's one you really
    ought to be, as you say, no pun intended, drilling down into.
        Mr. Lukken. Well, it's something we want to look into
    further, how we can do it. It's a resource question because
    many of these index funds do a variety of types of trading.
    They don't separate the two, and so for us to try to find out
    that type of data, it would be very resource-intensive. But
    it's something we're interested in finding out.
        Senator Brownback. Why wouldn't you want to limit the
    number of open positions, open long positions, that an index
    fund could maintain? I mean, it seems to me, and maybe I'm
    looking at this too simply, but that people are parking money
    in these areas, which is fine, but you're taking a bunch of
    product off the market then and you're letting one entity
    control it, which you would not let an individual do. But an
    individual runs this fund and so you've got an individual
    sitting on top of a big hedge fund that's controlling a lot of
    positions.
        Mr. Lukken. Yes.
        Senator Brownback. I think back to when somebody was trying
    to capture the silver market two or three decades ago. It seems
    like you could get very much in the same spot, just only now
    the name's an index fund rather than an individual, but it's
    still a person that controls it.
        Mr. Lukken. Our markets are risk management markets.
    Financial institutions who are selling these products to
    pension funds and others have a risk. They have risks that
    they're trying to offlay in the futures markets. They are
    exposed to a long or short position when they do sell these
    products. Our markets try to help them to offset that risk.
        That's why I think there's been some discussion of whether
    we should call them a hedger, such that a producer or a grain
    elevator is a hedger. But they are hedging some type of
    financial risk, and it's been the position of the Commission
    for 20-plus years to allow them to have that type of an
    exemption.
        But I think this is something that came out in this ag
    forum and something that we're closely looking at to make sure
    that we're categorizing them correctly.
        I would point out that, even though they are not subject to
    these position limits, we still see all the positions. We see
    who they are. The transparency is complete for us. So we're
    able, if we think they have a position that's going to
    manipulate the markets, we as regulators can see that. They
    just don't have hard limits as they do maybe with the position
    limits. But we certainly can see and exercise judgment on
    whether they're trying to control the marketplace.
        Senator Brownback. It seems to me that you could see where
    this could happen, where they could drive the market up just by
    having a big quantity of open positions on long positions. I
    mean, it just seems, on its face, something that really we
    ought to be deeply concerned about. I hope you do look at the
    amount of positions you let them hold, long positions in those
    months.
        Mr. Chairman, thank you for being generous with my time.
        Senator Durbin. Senator Allard.
        Senator Allard. Thank you, Mr. Chairman. I do have a
    statement I'd like to put in the record, with unanimous consent
    to do that.
        Senator Durbin. Without objection.
        [The statement follows:]

                   Prepared Statement of Senator Wayne Allard

        I would like to thank Chairman Durbin and Ranking Member Brownback
    for holding this hearing to examine the fiscal year 2009 budget
    requests of the Commodities Futures Trading Commission (CFTC) and the
    Securities and Exchange Commission (SEC). I appreciate the opportunity
    to more closely examine the regulation of our securities and futures
    markets.
        American capital markets are predicated on openness and fairness,
    and that fairness is only assured though careful, prudent, consistent
    regulation. The SEC and CFTC are at the heart of the effort to protect
    market participants and investors and to ensure market integrity.
        The financial markets have seen a great deal of growth and
    evolution during recent years. Regulation is becoming all the more
    challenging as the agencies must not only adapt to changing times, but
    try to anticipate future trends. The SEC and CFTC budget requests for
    fiscal year 2009 are an important part of helping the agencies meet
    those challenges.
        I place a strong emphasis on outcomes, particularly in the area of
    budgeting. Budgets are not, or at least should not, be simply a sign of
    how much we like a particular program. Rather, it should be tied to
    need and the results that are being achieved with past funding.
        I am concerned that neither budget before us today strikes the
    right balance. The CFTC is requesting a very large funding increase,
    yet according to the PART assessment is demonstrating no results. By
    contrast, the SEC, at least in some of its programs, has been shown to
    be effective. We have also heard repeated testimony in the authorizing
    committee about the need for a stronger SEC presence, yet, this budget
    actually proposes reduced staffing levels.
        I will be eager to hear from the chairmen to see how they square
    their budget requests with the facts on the table.
        Thank you, Mr. Chairman.

        Senator Allard. Just for the record of this subcommittee, I
    think if we were ever to look at a place where there is some
    market control it would be the OPEC countries. Obviously, we're
    not going to be able to control them, but you know, they
    produce oil, I'm told, in Iran for $15 to $17 a barrel. In
    Saudi Arabia they produce it out of the ground for $1 to $3 a
    barrel. We're paying $115 a barrel.
        I think that has more to do with the OPEC cartel and what
    they're doing, their markup. I think that's where the real
    problem is. So I just wanted to make that point for the record.

                           PROGRAM ASSESSMENT RATING

        One thing that you're doing that does concern me in a big
    way, and that is that I don't see you having a satisfactory
    score on the PART program. If you refer to the PART program,
    you understand which program I'm referring to? Well, you need
    to know about it. The PART program is where the administration
    measures objectives and results.
        You are scored as not making any effort--your score on that
    is that you haven't done anything to measure results and
    outcomes. Many of the agencies have. The SEC, which we'll be
    hearing from, has a good PART score. You have ``no results
    demonstrated.''
        Why is that?
        Mr. Lukken. I have to admit, Senator, this is something--I
    just got handed a note. This is dealing with the enforcement
    program?
        Senator Allard. Well, it's ``CFTC.'' That's the way it's
    listed, I think, on the PART program. How is it listed?
        Mr. Lukken. ``CFTC?''
        Senator Allard. It's listed as ``CFTC'' in general, a line
    item, ``CFTC.''
        Your evaluation comes from the Office of Management and
    Budget (OMB). As a policymaker, we look at that to see whether
    the taxpayer dollars or the fees that you're collecting are
    being put into an efficient and effective program. If we look
    at yours, where ``no results demonstrated,'' what is this? I
    mean, it's the CFTC; they're supposed to be a good business.
    They're not even practicing good business. Most good-managed
    businesses use management by objectives. That's what we're
    talking about.
        I see from ``no results demonstrated,'' which tells me
    you're not even bothering to set goals and objectives and
    trying to reach those. Those are measurable goals and
    objectives.
        If you go onto the Internet on expectmore.gov, enforcement
    of commodity futures and options, your rating is ``not
    performing, results not demonstrated; the program lacks
    performance measures that illustrate whether the program meets
    its overall objectives. The program demonstrates through the
    existing performance measures that it brings substantive cases
    in a timely manner. The program is well-designed to meet its
    objectives and examine the use''--those are the three
    classifications.
        You're classified as ``results not demonstrated.'' So a
    question I have is, why aren't you doing this?
        Mr. Lukken. Well, that's something I'll commit to you to
    look further into. I just got handed a note that we rated 80
    out of 100. But this is something----
        Senator Allard. Well, it's not showing up on
    expectmore.gov.
        Mr. Lukken. It's my understanding that we did score, and on
    the enforcement program I know there was something we were
    trying to get a line item in the budget on so we can try to
    find measurable outcomes for the enforcement program. It's
    something I know we want to look into, but I commit to you
    today that this is something we'll try to improve on.
        Senator Allard. I've pulled into the second page. It's
    commodity futures trading--it's ``Enforcement of commodity
    futures and options markets,'' and that's where the ``results
    not demonstrated'' is. That's the way it comes up on the
    report.
        Mr. Lukken. Well, we'll make this a priority.
        Senator Allard. You know, I think it's important. You know,
    if you can't demonstrate results and effectiveness, maybe you
    ought to be combined with the SEC, where they know how to do
    that. I served on the Agriculture Committee and I know you
    don't want to hear that suggestion. But I've tried to say
    something that catches your attention.
        Mr. Lukken. I understand.
        Senator Allard. I think things need to change there and
    it's something that I watch very closely. Whenever you show
    up--you've never had an opportunity to show up before me, but
    whenever you show up before me you can always expect me to have
    looked at your PART score to see what you're doing, because
    it's something I think that's quite helpful as policymakers for
    us to review.
        I served on the Agriculture Committee. I've been pretty
    impressed actually with your programs, and I understand why you
    have speculators there and how important they are. I understand
    that most of your dealings that you have on commodities futures
    and trading are, they're hedging. They're buying and selling in
    a timely way so that they reduce their risk. And I think you
    serve a good and valuable function in that way and you help our
    markets a lot.
        You want to increase your fees. Have you looked at how a
    fee increase might impact your global marketing?
        Mr. Lukken. A fee increase has been suggested by OMB to try
    to help us with raising money. This is not something, a
    position that the Commission has taken, whether it's in support
    or not in support of a fee. I think we believe, and different
    Commissioners can talk about this, their own personal view,
    that this is something that Congress and OMB should have a
    discussion about, how to raise the money.
        From my point of view, I'm here to describe how we spend
    the money, the types of programs we need to ensure illegal
    activity is not occurring on the marketplace.
        Senator Allard. You're the only regulatory agency that
    doesn't collect a fee.
        Mr. Lukken. That's my understanding, we're the only agency
    that does not have a fee.
        Senator Allard. And I think your input is important. I
    wouldn't just leave it up to the OMB and Congress, because we
    don't understand the world markets. You're out there dealing in
    the world markets. You're dealing with other exchanges
    throughout the world and you understand, I think, the impact,
    how the impact would be on your customers and whether you
    continue to do business in a competitive way. So I hope you
    don't back away on that.
        Thank you, Mr. Chairman.
        Senator Durbin. Senator Allard, I'm going to pass down this
    performance and accountability report. I had not seen it
    before, but the staff shared it with me. And we'll let you take
    a look at it. It may address some of your earlier questions,
    and see if it does.
        Senator Allard. We just pulled this off the Internet before
    I came here to the subcommittee meeting. So maybe it's not
    updated there.
        Senator Durbin. Okay. Thank you.
        Senator Allard. It's probably the same as what we've got in
    here.

                 IMPACT OF BIOFUELS MANDATE ON PRICE INCREASES

        Senator Durbin. Chairman Lukken, last month you had a
    roundtable at CFTC to talk about changes in the marketplace.
    I'm glad you did it. In your opening remarks you said: ``During
    the last year the price of rice has increased 118 percent,
    wheat 95 percent, soybeans 88 percent, corn 66 percent, cotton
    and oats by 47 percent. These price levels, combined with
    record energy costs, have put a strain on consumers as well as
    many producers and commercial participants that utilize the
    futures market to manage risk and discover prices.''
        Now, the big question we're facing is the impact of the
    biofuels mandate on this phenomenon. I wonder if you could tell
    me whether or not you considered that element and have an
    opinion as to whether this biofuels mandate can be linked to
    any of these price increases?
        Mr. Lukken. I think the economists that follow those
    markets very closely, our agricultural markets, believe ethanol
    is a factor that is affecting the price of not only corn, but
    other commodities around that may substitute acreage from corn.
    So this is something that we closely--I can't comment on the
    mandate itself, but certainly when nearly one-third of corn
    production is going now for biofuels, that's going to have an
    impact on corn, on wheat, on soybeans and others that may be
    involved or be interrelated to the price of corn.
        Senator Durbin. Have you considered--I'm told that there's
    still more American corn exported than converted to ethanol.
    Have you considered why that element is still there if in fact
    we have a short domestic market in corn?
        Mr. Lukken. I'm not sure if that's something we've studied
    intensively or not. But it's something we can get back to you
    on later.
        Senator Durbin. Would you, please.
        Mr. Lukken. Yes.
        [The information follows:]

                             CFTC-SEC COORDINATION

        Senator Durbin. The last question I have relates to the
    next panel and that is the memorandum of understanding (MOU)
    that I understand that you and SEC Chairman Cox have worked on.
    Could you comment on that and how you are trying to coordinate
    the activities of your two agencies?
        Mr. Lukken. I think both Chairman Cox and I recognize how
    our agencies have to collaborate more as our markets become
    more intertwined. So this was the fruits of that labor, to sign
    an MOU that allows for information-sharing and for us to
    discuss the possibility of allowing novel derivative products
    to get to market quickly.
        So we've taken it out for a test ride. There's a couple of
    Chicago exchanges, in fact, that have submitted products to us
    that we are--that are out for comment, on ETF gold products. We
    hope that those are finalized in the coming months. But we also
    hope to tackle other big issues, such as portfolio margining.
    To allow more efficient use of margin between the two
    marketplaces I think would be enormously helpful, and allowing
    more product choices to consumers.
        Senator Durbin. Have you run into any conflicts with the
    SEC trying to figure out where a new product coming to market
    should be regulated?
        Mr. Lukken. Well, certainly we have differing missions.
    Theirs is capital formation. They have insider trading
    provisions that they have to think about. Ours are risk
    management markets. So we come at this from different angles.
    Certainly we have to discuss our mandates and make sure that we
    can align those mandates properly.
        Certainly we have differences of opinion, but we try to
    work through them, and understanding that collaboration is the
    way forward for both of our agencies.
        Senator Durbin. Thank you.
        Senator Brownback.
        Senator Brownback. Thank you.

                       LONG CONTRACTS HELD BY INDEX FUNDS

        What percentage of open long contracts are held by index
    funds? Do you have that number?
        Mr. Lukken. I think it's about 30 percent across, 30
    percent across the agricultural sector.
        Senator Brownback. Do you know about it in other sectors as
    well?
        Mr. Lukken. Again, we only break this out for agricultural
    products at the moment. We're looking into whether we can do
    that, given resources, for energy complex.
        Senator Brownback. I really want to urge you to do that in
    the energy complex. But it's 30 percent of the positions across
    agriculture. Does that vary substantially based on what it is
    in--corn or wheat or beef?
        Mr. Lukken. We do have a graph that we can give to your
    staff, but it ranges anywhere from about 45 percent in live
    cattle, which again I mentioned actually was in negative
    territory this year, down to around 15 percent in other
    commodities.
        But they typically are somewhere in the range of 25 to 30
    percent in the agricultural commodities.
        Senator Brownback. And what were they several years ago, if
    you'd know? Do you know any of those historic numbers?
        Mr. Lukken. I think when we started tracking this they were
    about 27 percent, 27 to 28 percent. So they've grown slightly
    over the last couple years, but not significantly. We haven't
    seen a huge uptick in growth since we started tracking this in
    the agricultural area.

                          ETHANOL IMPACT ON GAS PRICES

        Senator Brownback. You've noted that you think the price of
    corn is being impacted by ethanol, and certainly the ethanol
    consumption of corn would have an impact on corn prices. I
    don't know if you've tracked the impact of ethanol on gasoline
    prices. Do you track that at all?
        Mr. Lukken. I'm not sure this is something--no, I don't
    think so.
        Senator Brownback. Just for the record, I would put this
    out, and I've got a couple of charts and articles, Mr.
    Chairman, I would like to put in the record.
        Senator Durbin. Without objection.
        [The information follows:]

                                     ______

                 [From The Wall Street Journal, Mar. 24, 2008]

    As Biofuels Catch on, Next Task is to Deal With Environmental, Economic
                                     Impact
                               (By Patrick Barta)

        The world's economy is acquiring a new energy addiction: biofuels.
        Crop-based fuels such as ethanol and biodiesel are quietly becoming
    a crucial component of the global energy supply, despite growing
    concerns about their impact on the environment and world food prices.
        Biofuels production is rising rapidly, while other fuel sources are
    failing to keep pace with demand. As a result, biofuels are making up a
    larger portion of the world's energy-supply gap than many analysts
    expected. That means the debate over biofuels probably will shift from
    whether they are good or bad to the more difficult question of how to
    make sure their production keeps growing--without wreaking economic and
    environmental havoc.
        Global production of biofuels is rising annually by the equivalent
    of about 300,000 barrels of oil a day. That goes a long way toward
    meeting the growing demand for oil, which last year rose by about
    900,000 barrels a day.
        Without biofuels, which can be refined to produce fuels much like
    the ones made from petroleum, oil prices would be even higher. Merrill
    Lynch commodity strategist Francisco Blanch says that oil and gasoline
    prices would be about 15 percent higher if biofuel producers weren't
    increasing their output. That would put oil at more than $115 a barrel,
    instead of the current price of around $102. U.S. gasoline prices would
    have surged to more than $3.70 a gallon, compared with an average of a
    little more than $3.25 today.
        Biofuels are playing ``a critical role'' in satisfying world
    demand, says Fatih Birol, chief economist of the Paris-based
    International Energy Agency. Without them, ``it would be much more
    difficult to balance global oil markets,'' he said.
        The implications are huge. After an initial burst of enthusiasm in
    2005 and 2006, environmentalists and some economists now blame biofuels
    for a host of global problems. These include a sharp jump in the price
    of corn and other biofuel crops, which has triggered a rise in global
    inflation and protests in poor nations.
        Many environmentalists now believe biofuels contribute
    substantially to greenhouse gases--those responsible for global
    warming--instead of reducing them, as was previously believed, in part
    because farmers clear forest land to grow biofuel crops. Scientists say
    deforestation causes a large, quick release of carbon into the
    atmosphere when existing plant life is destroyed.
        International agencies, including the Food and Agriculture
    Organization of the United Nations, have called on governments to deal
    with problems caused by biofuels, and some countries have started to
    rethink their support for the fuels. But cutting back on them won't be
    easy. Just as developing nations continue to gobble up coal, despite
    the high environmental cost, Western consumers seem to want whatever it
    takes to ensure enough fuel for their cars.
        As global energy consumption grows, ``there will be pressure to
    continue relying on these sources regardless'' of their negative
    impacts, says Jeff Brown, a Singapore-based economist at consulting
    firm FACTS Global Energy Group. ``The only other choice is higher [oil]
    prices.''
        It's possible newer biofuels will be developed that pose fewer
    problems. In India and Africa, farmers are expanding production of
    jatropha, an inedible shrub that is grown on marginal land and requires
    relatively little water. There also is rising interest in miscanthus, a
    perennial grass grown in Britain and elsewhere that can be used to
    generate energy without driving up the cost of crops needed for human
    consumption.
        Still, most farmers prefer to grow biofuel crops they are familiar
    with, such as corn. And most ``second-generation'' biofuels are coming
    on more slowly than many experts had hoped, meaning it might be several
    years, if ever, before they are viable on a large scale.
        It is also possible that ``first-generation'' biofuels like palm
    oil-derived biodiesel will run into constraints that would make it
    difficult to boost their production. The cost of raw materials like
    palm oil has shot up over the past year, cutting into profits for
    biofuel producers and forcing some to idle refineries or cancel new
    ones. It is also unclear whether there is enough land or water left to
    keep boosting biofuels' production at their current rate of increase.
        But a slowdown in biofuel production would only tighten world
    energy markets--and further highlight the world's dependence on the
    fuels, especially as producers of traditional crude oil struggle to
    crank up their supply.

        Earlier this month, Exxon Mobil Corp. said it planned to boost
    capital spending by several billion dollars in 2008 to roughly $25
    billion, and yet production levels will likely stay about the same this
    year. Mr. Blanch at Merrill Lynch says he expects new oil from
    producers outside the Organization of Petroleum Exporting Countries to
    taper off to as little as 300,000 barrels a day by 2011--about the
    equivalent of today's annual increase in biofuels production.
        Production from OPEC is tougher to forecast, in part because of the
    unpredictable political forces that shape the group's decisions. Last
    year, however, the cartel's output, including that of new members
    Angola and Ecuador, declined by about 400,000 barrels a day, according
    to the IEA. OPEC has lately decided to hold production at its current
    levels despite oil prices in excess of $100 a barrel.
        All of that can only mean one thing: With so many challenges ahead
    for increasing oil supplies, the world will have to get used to relying
    on biofuels--or find yet another alternative, at a time when there
    aren't many.
                                     ______

       The Relative Impact of Corn and Energy Prices in the Grocery Aisle
             (John M. Urbanchuk, Director, LECG LLC, June 14, 2007)

        Retail food prices measured by the Consumer Price Index (CPI) for
    food have begun to accelerate and are beginning to approach rates of
    increase last seen in mid-2004. Critics of renewable fuels are blaming
    the recent increases on high prices for corn caused by increasing
    ethanol production. They fail to point out that corn prices are only
    one of many factors that determine the CPI for food, and in fact,
    directly affect a small share of retail food prices. Increases in
    energy prices for example exert a greater impact on food prices than
    does the price of corn. A 33 percent increase in crude oil prices--
    which translates into a $1.00 per gallon increase in the price of
    conventional regular gasoline--results in a 0.6 percent to 0.9 percent
    increase in the CPI for food while an equivalent increase in corn
    prices ($1.00 per bushel) would cause the CPI for food to increase only
    0.3 percent.
        The purpose of this study is to examine and compare the impact on
    consumer food prices resulting from increases in petroleum and corn
    prices.
    Background
        The ethanol and corn industries are under attack by a wide range of
    critics for causing everything from sharply higher food prices for
    American consumers to shortages of and high prices for Mexican
    tortillas and even potentially higher tequila prices. Expansion of the
    ethanol industry to meet clean air standards and reduce dependence on
    imported petroleum has boosted demand for corn, the primary feedstock
    for U.S. ethanol. This increased demand has caused corn prices to rise
    to their highest levels since the drought of 1995. Critics contend that
    the recent increase in retail food prices measured by the CPI for food
    is the direct result of higher corn prices caused by ethanol demand and
    that an even larger increase in food prices is in store for American
    consumers.
        The actual record on the relationship between ethanol, corn, and
    retail food prices is less clear. Over the past 5 years, ethanol
    production has more than doubled, increasing from 2.14 billion gallons
    in 2002 to 4.86 billion gallons in 2006. Over this same period, the
    demand for corn to produce ethanol has grown from 996 million bushels
    to 2.2 billion bushels. Over most of this period, cash market corn
    prices were relatively stable. From January 2002 through September
    2006, corn prices averaged $2.18 per bushel. However, between September
    2006 and May 2007, corn prices jumped 61 percent to $3.56 per bushel in
    May 2007.
        During this same period, the CPI for food averaged a year-over-year
    increase of 2.4 percent. In fact, the inflation rate for food declined
    from a 5-year peak of 4.1 percent in May 2004 to a 2.5 percent year-
    over-year rate in September 2006. However, since September 2006 the CPI
    for food has accelerated to a year-over-year rate of 3.7 percent in
    April 2007, an increase of 1.2 percent. During this same period, cash
    market corn prices increased $1.15 per bushel. While it is tempting to
    blame the entire increase in food price inflation over the past 8
    months on higher corn prices, most of the increase in food prices was
    the result of foods not impacted by corn such as fish, fruits and
    vegetables, sugar and sweeteners, and food away from home. Meat,
    poultry, eggs, and dairy products--the foods where corn is a major
    input and are most affected by rising corn prices--accounted for about
    0.2 percent of the 1.2 percent acceleration in food price inflation
    between September 2006 and April 2007. Rising energy prices had a more
    significant impact on food prices than did corn.
        Year-over-year increases in the CPI for all items, CPI for food and
    selected components are shown in Table 1.

                                                                   TABLE 1.--CPI URBAN WORKERS
                                                                [Percent change, year-over-year]
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                   Cereals and     Meat,
                                          All items     All food      bakery      poultry,     Beef and       Pork       Poultry        Eggs        Dairy
                                                                     products       fish         veal
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    2002...............................          1.6          1.8          2.2          0.5          0.1         -0.4          1.3          1.3          0.6
    2003...............................          2.3          2.2          2.4          4.0          9.0          1.9          1.3         13.8         -0.1
    2004...............................          2.7          3.4          1.6          7.4         11.5          5.6          7.5          6.2          7.3
    2005...............................          3.4          2.4          1.5          2.4          2.6          2.0          2.0        -13.7          1.2
    2006...............................          3.2          2.4          1.8          0.8          0.8         -0.2         -1.8          4.9         -0.5
                                        --------------------------------------------------------------------------------------------------------------------
    January 2007.......................          2.1          2.4          2.7          1.7          0.2          1.4          0.2         11.8         -0.1
    February 2007......................          2.4          3.1          4.1          1.7          1.4          0.5          1.0         29.1          0.2
    March 2007.........................          2.8          3.3          3.6          2.8          2.3          2.2          2.1         20.8          1.5
    April 2007.........................          2.6          3.7          4.5          3.7          4.7          0.7          4.6         18.6          2.5
    --------------------------------------------------------------------------------------------------------------------------------------------------------

        Annual average and recent monthly average market prices for corn,
    soybean meal, Distiller's grains, and regular gasoline are shown in
    Table 2. The shift in corn prices that occurred in late 2006 is clearly
    evident and has been mirrored by soybean meal and Distiller's grains.
    During this same period energy price also accelerated rapidly. For
    example, the national average price of conventional regular gasoline
    increased 89 cents per gallon (39 percent) between October 2006 and May
    2007.

                                      TABLE 2.--MARKET PRICES FOR FEED AND GASOLINE
    ----------------------------------------------------------------------------------------------------------------
                                                                   Corn No. 2
                                                                     Yellow      SBM High                  Regular
                            Calendar year                           central    Pro decatur   DDG L'burg    gasoline
                                                                  Illinois ($/    ($/cwt)     ($/cwt)     ($/gallon)
                                                                    bushel)
    ----------------------------------------------------------------------------------------------------------------
    2002........................................................        $2.17      $167.36       $81.55        $1.38
    2003........................................................         2.29       200.00        91.66         1.60
    2004........................................................         2.39       237.01       105.18         1.89
    2005........................................................         1.90       188.08        75.71         2.31
    2006........................................................         2.41       175.85        89.01         2.62
                                                                 ---------------------------------------------------
    January 2007................................................         3.66       190.56       118.00         2.29
    February 2007...............................................         3.90       208.81       129.00         2.32
    March 2007..................................................         3.76       205.26       130.88         2.61
    April 2007..................................................         3.36  ...........  ...........         2.89
    May 2007....................................................         3.56  ...........  ...........         3.19
    ----------------------------------------------------------------------------------------------------------------

        Livestock and poultry producers are beginning to respond to higher
    feed costs by slowing the growth in animal numbers and market prices
    are reflecting these changes. However, corn prices are only one of
    several factors that impact livestock and meat production.
      --Heavy cow and calf slaughter and early placement of feeder cattle
            in feedlots have combined with poor fall and winter pasture
            conditions and higher grain prices to set the stage for slower
            growth in cattle numbers through early 2008. This will in turn
            slow growth in beef production in 2008 and support higher beef
            prices.
      --Growth in hog inventories are expected to be constrained by higher
            feed costs. However, this will be offset by growth in domestic
            demand supported by a stronger consumer economy and increases
            in exports as China turns to the U.S. to offset sharply reduced
            domestic pork production.
      --Higher feed costs will dampen broiler producer's zest to sharply
            expand production. However, producers will respond to higher
            prices for red meat and growth in real disposable income that
            will support demand growth. This will moderate any potential
            sharp increases in broiler prices in 2008.
        Recent data for beef, pork, and broiler production and market
    prices are summarized in Table 3.

                                                  TABLE 3.--SELECTED LIVESTOCK, POULTRY PRODUCTION, AND PRICES
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                     Beef and                                                                      Broiler
                                                       Cattle on       veal     Steer price      Pork     Barrows and  Hog and pig    Broiler     price 12-
                                                          feed      production     Omaha      production     gilts      inventory    production      city
                                                       (thousands   (millions    direct ($/   (millions     national    (thousands   (millions   average  ($/
                                                        of head)    of pounds)      cwt)      of pounds)      base       of head)    of pounds)      cwt)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    2002............................................        9,910       27,090       $67.04       19,664       $34.91       59,722       32,240       $55.52
    2003............................................        9,124       26,238        84.69       19,945        39.45       59,554       32,749        62.00
    2004............................................       11,253       24,547        84.75       20,511        52.48       60,444       34,063        74.10
    2005............................................       11,299       24,682        87.28       20,685        50.01       60,975       35,365        70.80
    2006............................................       11,726       26,071        85.41       20,999        47.28       61,449       35,752        64.30
                                                     -------------------------------------------------------------------------------------------------------
    January 2007....................................       11,974        2,178        86.75        1,898        44.04       62,149        3,015        70.43
    February 2007...................................       11,726        1,965        88.68        1,636        48.60  ...........        2,656        75.89
    March 2007......................................       11,599        2,131        96.39        1,861        46.00  ...........        2,903        78.66
    April 2007......................................       11,644        2,027        98.04        1,711        48.43  ...........        2,905        78.63
    May 2007........................................  ...........        2,279        95.90        1,759        54.00  ...........        3,259        80.50
    --------------------------------------------------------------------------------------------------------------------------------------------------------

    Analysis
        Retail food prices are not likely to accelerate significantly in
    2008 and beyond, even as ethanol production continues to expand. In
    fact, consumers will be more severely affected by rising gasoline and
    energy prices than by increases in corn prices.
        Increasing petroleum prices have about twice the impact on consumer
    food prices as equivalent increases in corn prices. A 33 percent
    increase in crude oil prices--the equivalent of $1.00 per gallon over
    current levels of retail gasoline prices--would increase retail food
    prices measured by the CPI for food by 0.6 to 0.9 percent. An
    equivalent increase in corn prices--about $1.00 per bushel over current
    levels--would increase consumer food prices only 0.3 percent.
        The reason for the larger impact on food prices from petroleum and
    energy prices stems from the relative importance of energy in food
    production, packaging, and distribution compared to that of a single
    ingredient. While petroleum and energy prices affect virtually all
    aspects of agricultural raw material transportation, processing, and
    distribution of all finished consumer food products, corn prices affect
    only a segment of consumer foods--livestock, poultry, and dairy. Corn
    is an important feed ingredient for livestock and poultry producers and
    changes in corn prices can have significant impacts on profitability
    and production. However, meat, poultry, fish, eggs, and dairy products
    account for only one-fifth of the CPI for food which, in turn, is only
    15 percent of the overall CPI.
        Crude oil and refined petroleum prices have increased sharply over
    the past several years and have put considerable pressure on consumers.
    Energy plays a significant role in the production of raw agricultural
    commodities, transportation and processing, and distribution of
    finished consumer food products. Several studies have looked at the
    impact of increased energy prices on food prices.
      --Reed, Hanson, Elitzak and Schluter utilized three different model
            structures to examine the impact of a doubling of crude oil
            prices on the CPI for food.\1\ They conclude that the short run
            impact of a doubling (e.g., 100 percent increase) in crude oil
            prices would cause a 1.82 percent rise in average food prices
            in the short run and 0.27 percent in the long run.
    ---------------------------------------------------------------------------
        \1\ A.J. Reed, Kenneth Hanson, Howard Elitzak, and Gerald Schluter.
    ``Changing Consumer Food Prices: A User's Guide to ERS Analyses''. USDA
    Economic Research Service. Technical Bulletin 1862. June 1997.
    ---------------------------------------------------------------------------
      --A more recent analysis published by Chinkook Lee examined the
            impact of energy price increases as an intermediate input for
            food processing and concluded that a 10 percent increase in
            energy prices results in a 0.2709 percent increase in the
            purchase (consumer) price of food and kindred products
            prices.\2\
    ---------------------------------------------------------------------------
        \2\ Lee, Chinkook. ``The Impact of Intermediate Input Price Changes
    on Food Prices: An Analysis of ``From-the-Ground-Up'' Effects.''
    Journal of Agribusiness 20, 1 (Spring 2002).
    ---------------------------------------------------------------------------
        As pointed out, earlier corn prices also have increased
    significantly over the past year as the markets have recognized the
    impact of increasing ethanol production on corn demand. The price of
    No. 2 Yellow corn at Central Illinois averaged $3.56 per bushel in May
    2007, nearly 60 percent higher than year ago levels. The USDA and many
    private sector forecasters project ethanol production to exceed 15
    billion gallons by 2017, utilizing more than 4 billion bushels of corn
    and maintaining corn prices well above $3.00 per bushel for most of the
    decade.
        We evaluated the impact of an increase in petroleum prices on
    consumer prices food prices by applying the impact elasticities
    summarized above to an assumed 33 percent increase in crude oil (the
    equivalent of a $1.00 increase in retail gasoline prices from current
    levels). To determine the impact of an increase in corn prices on
    livestock, poultry, dairy and consumer food prices we imposed a 33
    percent increase in corn prices (about $1.00 per bushel from current
    levels) on the current LECG agricultural sector baseline forecast over
    the 5-year period 2007 through 2012. This is consistent with the
    increase in corn prices that has occurred over the past year.
        The analyses by Reed and Lee indicate that a 33 percent increase in
    oil/energy prices would increase retail food prices by 0.6 percent and
    0.9 percent. Reed indicates that a 100 percent increase in crude oil
    prices results in a short-term increase of 1.82 percent in consumer
    food prices while Lee reports that a 10 percent increase in energy
    prices provides a 0.2709 percent increase in retail food prices.
    Restating these on an equivalent 33 percent basis (1.82 percent times
    .33 and 0.2709 times 3.3) provides the 0.6 to 0.9 percent range.
        As shown in Table 4, the equivalent 33 percent increase in corn
    prices over the 5-year period is expected to reduce beef, pork, and
    broiler production by 2.6 percent between 2008 and 2012 and increase
    prices by 2.4 percent. Combined with higher turkey, egg, and dairy
    prices, the CPI for food is projected to increase an additional 0.3
    percent. This result is consistent with the 0.2 percent contribution to
    food price inflation between September 2006 and April 2007 from meat,
    poultry, fish, and dairy and the $1.15 per bushel increase in cash
    market corn prices.

             TABLE 4.--IMPACT OF A $1.00 CORN PRICE INCREASE ON LIVESTOCK, POULTRY, AND CONSUMER FOOD PRICES
                                                   [Average 2008-2012]
    ----------------------------------------------------------------------------------------------------------------
                                                                                                        Percentage
                                                                         Baseline        Scenario         change
    ----------------------------------------------------------------------------------------------------------------
    Corn Price, Average Farm ($/bu).................................           $3.10           $4.10            33.0
    Beef and Veal Production (millions of pounds)...................          25,778          25,749            -0.1
    Pork Production (millions of pounds)............................          21,057          20,696            -1.7
    Broiler Production (millions of pounds).........................          35,530          33,740            -5.0
    Steer Price, Omaha Direct ($/cwt)...............................          $98.41          $98.59             0.2
    Barrows and Gilts, Market ($/cwt)...............................          $49.95          $50.99             2.1
    Broilers, 12-City Average (cents/lb)............................          $77.90          $82.09             5.4
    CPI, Food (percent).............................................             2.3             2.6             0.3
    CPI, Food at Home (percent).....................................             1.9             2.2             0.3
    CPI, Meats, Poultry, Eggs (percent).............................             1.4             2.1             0.7
    ----------------------------------------------------------------------------------------------------------------

    Conclusion
        The days of cheap corn are more likely than not over. Livestock and
    poultry producers who enjoyed low and relatively stable corn (and other
    feed) prices over most of the past decade are now faced with the
    challenge of adjusting to an environment of higher feed prices. The new
    reality is that corn prices are likely to remain nearer to the $3.00
    per bushel than the $2.00 per bushel mark for an extended period. The
    good news is that prices may be more stable as corn production expands
    to meet ethanol requirements and new ethanol feedstocks and
    technologies emerge. Livestock and poultry producers also will have an
    incentive to increase use of the ethanol coproduct Distiller's grains
    in order to control feed costs. This medium protein feed component can
    be used in place of corn in a substantial portion of the feed ration.
    As ethanol production expands, so will production of Distiller's grains
    and thus putting downward pressure on prices.
        Corn and energy prices both affect consumer food prices. However,
    since increases in corn prices are limited to a relatively small
    portion of the overall CPI for food, an increase in corn prices
    resulting from higher ethanol demand or a supply disruption such as a
    major drought is expected to have about half the impact of the same
    percentage increase in petroleum and energy prices.

                                                                                APPENDIX TABLE 1.--CPI ALL URBAN WORKERS
                                                                                   [Percent change from previous year]
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                              Cereals and
                                                                     All items     All food      bakery        Beef         Pork       Poultry        Eggs        Dairy      Fruits and   Fats, oils
                                                                                                products                                                         products    vegetables
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
    January 2004..................................................          1.9          3.5          2.1         20.4          5.4          5.5         30.5          3.6          2.3          3.1
    February 2004.................................................          1.7          3.3          1.3         16.1          3.6          4.1         31.2          2.9          2.9          2.3
    March 2004....................................................          1.7          3.2          1.3         12.8          5.5          6.1         33.2          2.9          2.9          5.5
    April 2004....................................................          2.3          3.4          1.8         13.2          4.8          5.9         26.4          4.9          3.2          6.5
    May 2004......................................................          3.1          4.1          1.5         15.9          6.6          9.5         19.0         12.4          2.4          7.5
    June 2004.....................................................          3.3          3.7          1.5         16.0          6.3          8.9         10.1         15.2         -0.3          9.5
    July 2004.....................................................          3.0          4.0          1.3         15.4          7.0          9.5          6.3         14.0         -0.9         10.0
    August 2004...................................................          2.7          3.5          1.3         14.2          7.4         10.5         -1.0         10.4         -0.4          7.6
    September 2004................................................          2.5          3.3          1.4         12.2          6.2          9.8         -9.6          6.6          0.7          8.1
    October 2004..................................................          3.2          3.4          1.9          7.4          5.3          8.3        -12.4          6.0          6.1          6.6
    November 2004.................................................          3.5          3.2          2.1          0.6          5.2          6.3        -21.1          5.7          9.1          6.7
    December 2004.................................................          3.3          2.7          1.7         -0.9          4.7          5.1        -19.9          4.1          7.9          6.2
                                                                   ---------------------------------------------------------------------------------------------------------------------------------
    January 2005..................................................          3.0          2.9          1.8          1.5          5.5          5.3        -23.0          6.3          4.5          6.0
    February 2005.................................................          3.0          2.6          2.0          3.5          6.3          4.5        -21.5          5.6          2.2          4.3
    March 2005....................................................          3.1          2.5          1.8          6.0          4.5          4.0        -27.0          5.5          1.6          0.5
    April 2005....................................................          3.5          3.1          1.8          5.3          7.0          3.4        -25.9          4.7          5.2          1.9
    May 2005......................................................          2.8          2.4          1.7          5.0          2.8          1.2        -18.6         -1.4          5.6         -0.9
    June 2005.....................................................          2.5          2.2          1.3          3.3          1.8          1.3        -17.3         -4.1          5.2         -4.0
    July 2005.....................................................          3.2          2.1          1.1          0.8          0.1          0.5        -11.9         -3.2          7.0         -2.7
    August 2005...................................................          3.6          2.2          1.4          0.8         -0.7          0.1        -12.2         -1.1          5.6         -1.2
    September 2005................................................          4.7          2.5          0.9          0.5         -1.0          1.3          1.4          0.1          6.5         -0.6
    October 2005..................................................          4.3          2.2          1.2          1.4         -0.8         -0.2         -0.6          0.3          2.4         -0.9
    November 2005.................................................          3.5          2.2          1.1          1.2         -0.2          2.3          5.3          1.4         -0.8         -1.0
    December 2005.................................................          3.4          2.3          1.0          2.2         -0.1          0.3          1.4          1.7          0.6         -1.3
                                                                   ---------------------------------------------------------------------------------------------------------------------------------
    January 2006..................................................          4.0          2.6          1.4          2.8         -1.7         -1.3          8.3          0.2          6.4         -0.3
    February 2006.................................................          3.6          2.8          0.9          1.3         -1.7         -0.3         -3.1          0.9          7.9          0.6
    March 2006....................................................          3.4          2.6          1.2          1.2         -1.0         -1.6          5.5          0.9          6.3          0.9
    April 2006....................................................          3.5          1.8          0.9          0.7         -1.9         -2.0          8.7         -0.5          2.7         -2.6
    May 2006......................................................          4.2          1.9          1.0         -1.7         -0.8         -2.0          2.4         -1.3          1.3          0.5
    June 2006.....................................................          4.3          2.2          1.6         -1.9         -1.0         -1.4          8.9         -0.8          4.0          1.7
    July 2006.....................................................          4.1          2.2          2.5         -0.5          0.2         -2.7          0.5         -0.4          3.7         -0.2
    August 2006...................................................          3.8          2.4          2.1          1.4          1.1         -1.7          6.0         -1.6          5.3         -0.1
    September 2006................................................          2.1          2.5          2.5          1.6          1.3         -2.6         -0.8         -1.0          7.2         -0.9
    October 2006..................................................          1.3          2.6          2.5          2.0          1.6         -1.9          1.5         -0.3          6.5          0.3
    November 2006.................................................          2.0          2.3          2.6          2.4          0.1         -3.1          6.6         -1.6          4.2          1.1
    December 2006.................................................          2.5          2.1          3.1          0.5          0.7         -0.7         14.1         -1.2          1.9          0.9
                                                                   ---------------------------------------------------------------------------------------------------------------------------------
    January 2007..................................................          2.1          2.4          2.7          0.2          1.4          0.2         11.8         -0.1          1.7          0.2
    February 2007.................................................          2.4          3.1          4.1          1.4          0.5          1.0         29.1          0.2          6.0          0.8
    March 2007....................................................          2.8          3.3          3.6          2.3          2.2          2.1         20.8          1.5          6.2          1.4
    April 2007....................................................          2.6          3.7          4.5          4.7          0.7          4.6         18.6          2.5          6.2          2.9
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

                                     ______

     The Impact of Ethanol Production on U.S. and Regional Gasoline Prices
           and on the Profitability of the U.S. Oil Refinery Industry

                                    ABSTRACT

        Using pooled regional time-series data and panel data estimation,
    we quantify the impact of monthly ethanol production on monthly retail
    regular gasoline prices. This analysis suggests that the growth in
    ethanol production has caused retail gasoline prices to be $0.29 to
    $0.40 per gallon lower than would otherwise have been the case. The
    analysis shows that the negative impact of ethanol on gasoline prices
    varies considerably across regions. The Midwest region has the biggest
    impact, at $0.39/gallon, while the Rocky Mountain region had the
    smallest impact, at $0.17/gallon. The results also indicate that
    ethanol production has significantly reduced the profit margin of the
    oil refinery industry. The results are robust with respect to
    alternative model specifications.
        Keywords: crack spread, crude oil prices, ethanol, gasoline prices.

    Introduction
        Fuel ethanol production in the United States increased from 1.63
    billion gallons in 2000 to 7.22 billion gallons in 2007 (RFA). In
    comparison, the United States consumed approximately 146 billion
    gallons of petroleum in 2007 (EIA). The purpose of this paper is to
    estimate the impact of this increase in ethanol supply on the U.S.
    gasoline market.
        Ethanol is blended with gasoline to improve octane and performance
    in about 50 percent of the Nation's gasoline supply. Typically, a
    gallon of ethanol blend will have 10 percent ethanol and 90 percent
    gasoline. This gallon of ethanol blend will contain approximately 97
    percent of the energy of a gallon of gasoline (Tokgoz et al. 2007) and
    will use approximately one-tenth as much fuel energy to produce as it
    contains (Wang et al. 2007). Therefore, ethanol has essentially added
    to U.S. gasoline supplies by utilizing solar energy to grow the crop,
    coupled with energy from natural gas and coal to manufacture the farm
    equipment and fertilizer used in crop production.
        In order to identify the separate impact of ethanol on gasoline
    prices, we need to separate the impact of ethanol from the other forces
    driving gasoline prices. We do so by examining the price of gasoline
    relative to the price of crude oil. We also estimate the impact of
    ethanol on the profits made by refiners. Both estimates are calculated
    for the United States as a whole and for each of five regions within
    the United States. The motivation for conducting the regional analysis
    is that if ethanol is affecting gasoline prices, then we hypothesize
    that this impact will be largest in the Midwest where regional ethanol
    production and utilization is at its maximum.
        The paper proceeds as follows. First, background information
    regarding previous work, relative gasoline prices, and the use of the
    crack spread as a measure of industry profitability are introduced. We
    then describe the five regional ``Petroleum Administration for Defense
    Districts'' (PADDs) that are the basis for the analysis. Next, we
    present a detailed description of and motivation for the explanatory
    variables. We also provide a description of and motivation for the
    three estimation methods that are used. The last section summarizes the
    results.

    Previous Work
        Quantitative analysis of the effect of ethanol on gasoline prices
    and on the profitability of the refinery industry has been largely
    neglected in the literature. Eidman (2005) points out that ethanol
    largely acts as a fuel extender. He also shows that there has been a
    strong positive correlation between ethanol and gasoline prices.
    Employing an international ethanol model consisting of behavioral
    equations for production, consumption, and trade, Tokgoz and Elobeid
    (2007) analyze the price linkage between ethanol and gasoline markets.
    They conclude that ethanol is mainly used as an additive to gasoline
    and that the complementary effect of ethanol dominates the substitution
    effect on gasoline prices. Szklo, Schaeffer, and Delgado (2007)
    conclude that by replacing methyl tertiary butyl ether (MTBE), which is
    a traditional additive used as an oxygenate to raise the octane number,
    ethanol blending will not reduce gasoline use until flexible fuel
    vehicles become widely available. Vedenov et al. (2006) apply a
    continuous-time option pricing method to calculate the decision
    threshold of switching to ethanol. Their empirical analysis suggests
    that blending ethanol into gasoline would generate lower gasoline price
    volatility and that switching from conventional gasoline to an ethanol
    blend is an economically sound decision.
        The ``3:2:1 crack spread'' is used as one of the significant
    indicators of refinery profitability. It is a term used in the oil
    industry and futures trading as a proxy for the profitability of
    refineries. Although there is some qualitative description of its
    determinants, formal quantitative analysis is limited in the
    literature. Asche, Gjolberg, and Volker (2003) examine the price
    relationships among crude oil and refined products. They find that the
    crude oil price is weakly exogenous and that the spread is constant
    among some of the prices. Girma and Paulson (1998) examine the crack
    spread of daily futures prices of crude oil and heating oil. Girma and
    Paulson (1999) investigate the long-run relationship among crude oil,
    gasoline, and heating oil futures prices and find the prices are co-
    integrated. They also find a stationary relation between crude oil and
    its end products.
        In the literature on mergers in the refinery industry, several
    studies rely on analysis of the price margin, which is defined as
    wholesale prices of gasoline less crude oil prices. The Government
    Accounting Office (GAO 2004) models the price margin as a function of
    the crude oil price, inventory ratio, utilization rate, and dummy
    variables representing a merger and acquisition event. Geweke (2003)
    provides a comprehensive survey on this subject.
        The degree of market concentration has been long recognized and
    analyzed in the literature seeking to explain price changes and
    adjustment in the wholesale gasoline market. Focusing on Gulf Coast,
    Los Angeles, and New York whole spot gasoline markets, Oladunjoye
    (2007) investigates the effects of market structure on the pattern of
    price adjustment and finds that market concentration has a significant
    asymmetric effect on gasoline price changes responding to crude price
    shocks. The GAO (2004) concludes that mergers and increased market
    concentration generally led to higher wholesale gasoline prices in the
    United States from the mid-1990s through 2000. Examining wholesale
    price responses in 188 gasoline markets in the United States,
    Borenstein and Shepard (2002) find that refinery firms with market
    power generally choose a different adjustment rate and adjust prices
    more slowly than do competitive firms.

    Background
        The 3:2:1 crack spread is defined as

    where PG, PH, and PO are the prices of regular gasoline, no. 2 heating
    oil, and crude oil, respectively.
        The 3:2:1 crack spread has been institutionalized over the years as
    a way to measure the refinery margin. The use of the 3:2:1 crack spread
    is justified by the fact that among all finished products converted
    from crude oil in the refinery process, gasoline and distillate fuel
    oil are the two primary product classes. The relative proportion of
    these two products is approximately two barrels of gasoline to one
    barrel of distillate fuel. Together, gasoline and distillate fuel
    comprise about 80 percent of the refinery yield. The average refinery
    yield of finished motor gasoline is about 46 percent and has been
    stable over the 1993-2007 sample period (DOE).
        The West Texas Intermediate (WTI) crude oil price, which is priced
    at Cushing, Oklahoma, is chosen to represent the crude oil price in
    this study. The reason is that WTI-Cushing is one of the most widely
    traded and price-transparent crude oils in the U.S. crude oil market.
        We use the Petroleum Administration for Defense Districts (PADDs)
    to define refinery product markets. This market definition was formed
    during World War II for the purpose of administering oil allocation.
    The PADDs are still used by the Department of Transportation (DOT) and
    Energy Information Administration (EIA) for statistical and reporting
    purposes. The five regions are East Coast (PADD I), Midwest (PADD II),
    Gulf Coast (PADD III), Rocky Mountain (PADD IV), and West Coast (PADD
    V). These five geographically distinct regions are also very different
    in terms of their economic conditions, oil and petroleum
    characteristics, oil-related pipeline infrastructure, and local product
    supply and demand conditions.
        Because of its high population density, the East Coast PADD I has
    the highest demand for refined products in the country, but it has very
    limited refinery capacity. Its regional demand is largely satisfied by
    the Gulf Coast and by foreign imports. The Midwest PADD II is distinct
    in its coexistence of a highly industrialized section and a rural
    agricultural section. It also leads the Nation in ethanol production,
    mainly because of its leading role in corn production, the primary
    feedstock for ethanol production. For example, Iowa had 30 ethanol
    plants in operation by the end of 2007 and produces nearly 2.1 billion
    gallons of ethanol annually. Much of the crude oil used in the Midwest
    is piped in from the Gulf Coast and Canada. One place worth mentioning
    in this region is Cushing, Oklahoma, which is the major crude oil
    transportation hub for the Midwest.
        The Gulf Coast region, including Texas, Louisiana, New Mexico,
    Arkansas, Alabama, and Mississippi, produces over 50 percent of the
    Nation's crude oil and 47 percent of its final refined products. This
    region also serves as a national hub for crude oil and is the center of
    the pipeline system. The Rocky Mountain region, or PADD IV, has the
    smallest and fastest-growing oil market in the United States, with only
    3 percent of national petroleum product consumption. The West Coast
    region, PADD V, is the largest oil-producing and consuming region. This
    region's oil supply is independent of
        other regions since it is geographically separated by the Rocky
    Mountains. In addition, the refinery market of this region is highly
    concentrated.

    Data
        The gasoline price relative to that of crude oil is used as a
    dependent variable to measure ethanol's possible substitution effect on
    the gasoline price, while the 3:2:1 crack spread is employed as a
    dependant variable to quantify the effect of ethanol on the refinery
    profit margin. Figure 1 presents the relative gasoline to crude oil
    price over the 1995-2007 period. Figure 2 is for the 3:2:1 crack spread
    deflated by Producer Price Index (PPI) for crude energy material for
    five PADD regions over the same sample period. The PPI data are
    obtained from the U.S. Bureau of Labor Statistics.

        The relative gasoline price is similar to crack spread in the sense
    that both are measurements of profitability of the refinery industry.
    The difference is that relative gasoline prices only account for the
    contribution of gasoline to the profit margin. It is employed in this
    study to quantify the substitution effect of ethanol production on
    gasoline prices. Relative gasoline prices and the refinery profit
    margin are mainly determined by similar explanatory variables. The
    explanatory variables included in this study are market demand and
    supply conditions, refinery capacity and utilization rate, market
    concentration and structure, unexpected supply disruptions, gasoline
    imports, seasonality, and ethanol production. Each of these chosen
    variables and its relationship with the relative gasoline price and
    refinery profitability is discussed in greater detail in this section.
                Crude and Product Market Conditions
        The gasoline price and refinery profitability are affected by the
    supply and demand balances of the crude market and product market. When
    the crude oil market has ample stocks, refinery profit should increase
    because of lower crude oil prices. Alternatively, when there are large
    stocks of gasoline and other refinery products, refinery profits should
    fall because of lower product prices. A tight product market will
    generate upward pressure on product prices even when there is an ample
    supply of crude oil. That is, product prices are bid up by more than
    any underlying cost increases. This upward movement relative to crude
    oil prices will be seen as an increase in the relative price and crack
    spread. We use monthly crude oil inventory and gasoline inventory data
    collected by the EIA to represent the conditions in these two markets.
    The gasoline stock and crude oil stock data for the East Coast region
    from 1995 to 2007 are shown in Figures 3 and 4, respectively.

                Refinery Capacity and Capacity Utilization Rate
        Refinery capacity is a critical factor influencing the
    profitability of the refinery industry. Figure 5 presents the operable
    crude oil distillation capacity in the five PADD regions from 1995 to
    2007. In this figure, refinery capacity is represented by monthly data
    of atmospheric crude oil distillation units (barrels per calendar day).
    Total refinery capacity increased by 13 percent over the past 12 years,
    with PADD III, the Gulf Coast, having the highest growth of 19 percent.
    The lowest increase in capacity occurred in the Midwest, with a 4
    percent growth over the same period.

        The monthly percent refinery capacity utilization rates for 1995 to
    2007 for PADDs II, III, and V are shown in Figure 6. Here, refinery
    capacity utilization is based on gross input to atmospheric crude oil
    distillation units divided by the refinery operable distillation
    capacity. The average rate over five regions is 92 percent, which means
    that capacity utilization has increased significantly and refineries
    are running at high rates of utilization. Refinery capacity and its
    utilization rate are variables that will affect gasoline price and
    refinery profits via higher prices for products and possible increases
    in marginal costs.

    Market Concentration
        Mergers and acquisitions among refinery firms may potentially
    further reduce the competition in the refinery market, thus possibly
    leading to a higher refinery margin. To measure the level of market
    concentration, the Herfindahl-Hirschman Index (HHI) is commonly applied
    in the literature. The HHI of a market is calculated by summing the
    squares of the percentage market shares held by the respective firms as

    where Sit is the market share of a specific firm in the corresponding
    production market with total firms of Nt at year t. A market with an
    HHI less than 1,000 is considered to be a competitive market; 1,000-
    1,800 to be a moderately concentrated market, and greater than 1,800 to
    be a highly concentrated market.
        We constructed an HHI for the five PADD regions over the period
    1995 to 2007, and we present this information in Figure 7. The HHI for
    the refinery market in PADD I increased from 1,558 to 2,335 from 1995
    to 2007 and changed from a moderately concentrated to a highly
    concentrated market using Department of Justice definitions. Since much
    of this region's refinery product supply is from other regions, the
    impact of this increased concentration may be small. The refinery
    market in PADD II, the Midwest, suggests that this is a competitive
    market, although its HHI increased to 960 in 2007. Similar to the
    Midwest region, PADD III, the Gulf Coast, also has a competitive
    refinery market as of the end of 2007. The HHI for PADD IV, the Rocky
    Mountain region, decreased from 1,025 to 930, which suggests that its
    refinery market became less concentrated than before. The HHI for the
    PADD V, the West Coast region, increased from 914 to 1,155, and this
    refinery market changed its definition to a moderately concentrated
    market by 2007.

                Unexpected Supply Disruptions
        On August 29, 2005, Hurricane Katrina hit the U.S. Gulf Coast at
    New Orleans. On September 24, 2005, Hurricane Rita hit at the border
    between Texas and Louisiana. Both were category four storms when they
    did significant damage to the refineries' facilities and pipeline in
    the Gulf Coast region. Refinery operations were reduced by 1.8 million
    barrel/day in September and October 2005. Retail gasoline prices jumped
    by $0.50 to over $3.00 per gallon on a national average basis after
    Hurricane Rita. Prices were distinctly higher than before. In order to
    control for the effect of this event on the gasoline and refinery
    profit margin, we include dummy variables for September and October in
    2005, when the disruptions were most severe.
                Gasoline Imports
        A significant share of total gasoline demand in the United States
    is met by imports. The net import share of total gasoline consumption
    in 2007 is 14 percent. Figure 8 presents U.S. finished motor gasoline
    imports from all countries over the period 1995 to 2007. Imports
    reached their highest level in October 2005, the month after Hurricanes
    Katrina and Rita. Major sources of gasoline imports include Canada,
    Europe, and the Virgin Islands. A structural surplus in gasoline
    production in Europe means that gasoline production costs are lower
    when derived from foreign sources than they would be if the United
    States built and operated additional refinery capacity domestically.
    Growth in imports is expected to be tempered because of the increased
    use of domestically produced ethanol. Also, with increases in imported
    gasoline, refinery profitability is expected to be negatively affected.

                Ethanol Production
        Figure 9 presents the monthly ethanol production over the 1995-2007
    period. There are 68 ethanol plants under construction or expanding.
    Iowa leads the Nation with about 2 billion gallons of ethanol
    production capacity. Our hypothesis is that this additional production
    has had a negative impact on gasoline prices and on the margins of
    crude oil refiners.

                Seasonality
        The gasoline market is highly seasonal due to stronger demand in
    spring and summer. Gasoline price tends to gradually rise before and
    after summer. Demand for distillate fuel including heating oil and
    diesel fuel typically peaks in winter and thus has a counter-cyclical
    price pattern from gasoline. We include a set of monthly dummies to
    account for the seasonal pattern.
    Estimation Method
        The regression model is specified as follows:

    where pit it is the price of gasoline divided by the price of crude oil
    or the 3:2:1 crack spread of region i at month t, and Xit is the K-
    dimensional vector of explanatory variables described earlier.
        There are several options for estimating equation (1), including
    pooled OLS regression and panel data models. The pooled OLS regression
    simply pools together data series for all PADD regions and applies the
    ordinary least squares method. The OLS estimates of the standard errors
    may be highly inaccurate if the data exhibits heteroskedasticity and/or
    cross-sectional and serial correlation. The panel data models increase
    precision of estimates and allow us to control for an unobservable
    individual region's heterogeneity and temporal effects without
    aggregation bias.
        The Hausman test for misspecification (Greene 2003, p. 301) is
    employed to help us select from two principal types of panel data
    models: the fixed effect model and the random effect model. Under the
    null hypothesis, the random effects estimator is consistent and
    efficient, while under the alternative, it is inconsistent. The random
    effect model is chosen if we fail to reject the null hypothesis. In the
    case of relative gasoline price (3:2:1 crack spread), the x\2\ test
    statistic was calculated at 26.92 (48.99) and significant at the 5
    percent (1 percent) significance level. This suggests that the fixed
    effect estimator is consistent and asymptotically efficient in both
    cases.
        Different specification tests are applied on the data set to better
    specify the panel data model. Applying the Wooldridge test for
    autocorrelation in panel data for the relative gasoline price (or crack
    spread) (Wooldridge 2002, p. 282), we get an F-test statistic of 917
    (1,708), which is highly significant, and the null hypothesis of no
    first-order autocorrelation is rejected. Tests developed by Pesaran
    (2004) and Frees (1995) of cross-sectional independence are applied and
    both null hypotheses are rejected; this confirms the existence of
    cross-sectional correlation across regions.
        Based on these diagnostic results, we used a fixed effect panel
    data model with correction for first-order serial correlation. We also
    estimated a feasible generalized least squares (FGLS) model with
    generalized error structure to allow for the presence of AR(1)
    autocorrelation within panels, as well as for heteroskedasticity and
    cross-sectional correlation across panels. By using three alternative
    model specifications we hope to provide information on the robustness
    of the results.
        The fixed effect model is specified as

    where ai represents the individual regional effect. The fixed effect
    model is typically estimated by the least squares dummy variable (LSDV)
    method (Greene 2003, p. 287).
        The FGLS estimation method takes into account heteroskedasticity,
    and cross-sectional and serial correlation. The error terms can be
    written as

        An FGLS panel data model is also called the Parks-Kmenta method
    (Kmenta 1986). This method consists of the following steps. Estimate
    equation (1) by regular OLS. Then use the estimation residuals to
    estimate assumed error AR(1) serial correlation coefficient r. Use this
    coefficient to transform the model to eliminate error serial
    correlation. Substitute V for V using estimated r and s\2\ then obtain
    the FGLS estimator of b as

    Analysis of Estimation Results
        Using the relative gasoline price as the dependent variable, we get
    estimation results for the pooled OLS regression, a fixed effect panel
    data model, and a panel FGLS method; these are shown in Table 1. The
    corresponding estimation results for 3:2:1 crack spread are shown in
    Table 2.
        In the case of the relative gasoline price, three estimation
    methods generate similar results. The only difference is that standard
    errors of coefficient estimates get bigger after taking into account
    cross-sectional and temporal autocorrelation, which in turn lead to a
    comparatively lower significance level for corresponding variables.
    Crude oil and gasoline inventories, refinery capacity, short-run supply
    disruption, and dummy variables for some summer months all
    significantly influence the relative gasoline price. Ethanol production
    has a considerably negative impact on the gasoline price, which is
    highly significant at the 1 percent level in all three estimation
    results. This indicates that over the sample period, ethanol has a
    significant substitution effect on gasoline. Evaluating at the sample
    mean, we find that the gasoline price is lowered by 39.50 cents,
    28.70 cents, and 34.10 cents per gallon because of the substitution
    effect of ethanol.
        For the 3:2:1 crack spread, the estimation results of the fixed
    effect and panel FGLS models are quite different from that of the
    pooled OLS regression. In addition, the pooled OLS regression model
    generates highly significant estimates for all explanatory variables
    except the dummy variables for January, February, and November. As
    previously mentioned, ignoring cross-sectional and serial correlation
    as well as individual heterogeneity typically leads to highly
    inaccurate standard error estimation; i.e., the significance estimation
    results are not reliable. Hence, we focus on the fixed effect and panel
    FGLS estimation results.
        From these two sets of estimates, all the explanatory variables
    have intuitively correct signs. First, the profitability represented by
    the 3:2:1 crack spread presents a strong seasonal pattern. This is
    reflected by the fact that the dummy variables for months in the second
    and third quarters are all significant at the 1 percent significance
    level in the panel FGLS model and at the 5 percent level in the fixed
    effect model. Second, crude oil and refinery product market conditions,
    refinery capacity, ethanol production, and unexpected supply disruption
    significantly affect profit margins. For all five PADD regions,
    unexpected supply disruption, measured by dummies for Hurricanes
    Katrina and Rita, considerably increased profits in the months right
    after the occurrence. Gasoline imports and the HHI are found not to
    have statistically significant effects on crack spread nationally.
    Finally, we find that ethanol production generates negative pressure on
    crack spread over the sample period. For the fixed effect and panel
    FGLS models, the marginal effect of ethanol production on the crack
    spread is estimated to be -0.000073 and -0.000077, respectively.

    Regional Analysis
        Pooling cross-sectional and time-series information provides more
    accurate estimation results. However, it is instructive to analyze the
    time-series data of each region individually. Each PADD region has
    unique supply and demand conditions of crude oil and refinery products,
    different market structures, and different ethanol production and
    usage. The effects of explanatory variables may differ considerably
    because of region-specific factors.
        We apply regular OLS regression on individual region's monthly data
    series over the period 1995 to 2007. The estimation results for the
    relative gasoline price and 3:2:1 crack spread are summarized in Tables
    3 and 4, respectively.
        From the estimation results for the relative gasoline price,
    ethanol production has a significant negative effect on gasoline prices
    in all regions. And the magnitude of the effect varies with PADD
    regions, ranging from -0.000041 to -0.000095. As expected, in PADD II,
    the Midwest region, ethanol production has the largest impact on the
    gasoline price with a coefficient of -0.000095. The substitution effect
    is highly significant and reduces the gasoline price by 39.5 cents on
    average over the sample period. The West Coast and East Coast
    experience similar negative ethanol impacts with estimates of
    -0.000056, which means that the corresponding gasoline price is lowered
    by 23.3 cents. The Gulf Coast region, PADD III, has a slightly higher
    coefficient estimate of -0.000059, or, equivalently, a 24.6 cents
    reduction in gasoline prices. The Rocky Mountain region, or PADD IV,
    experienced the smallest downward gasoline price change, at 17.1 cents,
    probably because of its comparatively low total gasoline consumption.
    These results tell us what would have happened had we removed the
    entire ethanol industry at the mean of the data set, and they are not
    marginal effects of removing one unit of ethanol capacity in each
    region.
        From the estimation results of the profit margin for individual
    regions, effects of some explanatory variables differ considerably
    across regions. In PADD regions III and V, the HHI has a significant
    positive effect on refinery profit. This result suggests that higher
    market concentration in these two regional markets results in refinery
    profits. We did not find this pattern in our panel data model.
    Similarly, gasoline imports have a significant negative effect on the
    profit margin in both East Coast and Midwest regions, possibly because
    these two regions are more heavily dependent on imported refinery
    products to meet their regional demand. Ethanol production has a
    significant negative effect on the refiner's profit margin in all five
    PADD regions.

    Conclusions
        We employ pooled OLS regression, a fixed effect panel data model,
    and a panel FGLS estimation method to quantify the possible impact of
    ethanol on regular gasoline in the United States as a whole and in five
    regions of the United States. The models control for gasoline imports,
    refinery capacity, capacity utilization rate, hurricanes, market
    concentration in the refinery industry, stocks, and seasonality.
        Estimation results show that over the period 1995 to 2007, ethanol
    production had a significant negative effect of $0.29 to $0.40 per
    gallon on retail gasoline prices. The results suggest that this
    reduction in gasoline prices came at the expense of refiners' profits.
    These results are statistically significant across a range of model
    specifications and across all regions.
        Results for individual U.S. regions indicate that the largest
    impact of ethanol on gasoline is found in the Midwest region where
    gasoline prices were reduced by 39.5 cents per gallon. The Gulf Coast
    region is found to have experienced a 24.6 cents reduction in the
    retail gasoline price, while for the West Coast and East Coast, the
    average price drop is about 23.3 cents. The smallest impact, a
    17.1 cents reduction, is found in the Rocky Mountain region, mainly
    because of its comparatively low gasoline consumption.
        These reductions in retail gasoline prices are surprisingly large,
    especially when one considers that they are calculated at their mean
    values over the sample period. The availability of ethanol essentially
    increased the ``capacity'' of the U.S. refinery industry and in so
    doing prevented some of the dramatic price increases often associated
    with an industry operating at close to capacity. Because these results
    are based on capacity, it would be wrong to extrapolate the results to
    today's markets. Had we not had ethanol, it seems likely that the crude
    oil refining industry would be slightly larger today than it actually
    is, and in the absence of this additional crude oil refining capacity
    the impact of eliminating ethanol would be extreme. In addition, the
    impact of the first billion gallons of ethanol on this capacity
    constraint would intuitively be greater than the billions of gallons
    that came later. We did try a quadratic term to pick up this effect,
    and it was not significant.

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                   TABLE 1.--REGRESSION RESULTS FOR POOLED OLS, THE FIXED EFFECT MODEL, AND THE PANEL FGLS METHOD ON RELATIVE GASOLINE PRICES
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                              Pooled OLS Regression         Fixed effect model with AR(1)           Panel FGLS method
                         Variable                      -----------------------------------------------------------------------------------------------------
                                                            Estimate      Standard error      Estimate      Standard error      Estimate      Standard error
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Oil stock.........................................     \1\ 3.88e-6          8.42e-7      \2\ 1.97e-6          9.28e-7      \1\ 5.71e-7          2.19e-7
    Gasoline stock....................................    \1\ -5.03e-6          1.11e-6      \1\ 0.000010         2.70e-6      \2\ 1.03e-6          5.24e-7
    Refinery capacity.................................    \1\ -0.000099         0.000029    \2\ -0.00038          0.00019     \3\ -0.00040          8.94e-6
    Utilization rate..................................        -0.0019           0.0028           0.00095          0.0015           0.00048          0.00041
    Ethanol production................................    \1\ -0.000095         3.96e-6     \1\ -0.000069         0.000012    \1\ -0.000082         0.000012
    Supply disruption.................................     \1\ 0.32             0.11         \1\ 0.20             0.055        \2\ 0.20             0.099
    Gasoline import...................................    \1\ -0.000037         3.89e-6      \1\ 7.37e-6          2.75e-6          6.22e-6          4.78e-6
    HHI...............................................     \1\ 0.00028          0.000062        -0.00019          0.00019         -0.000037         0.000025
    January...........................................        -0.030            0.054       \2\ -0.047            0.022            0.015            0.035
    February..........................................        -0.083            0.054       \2\ -0.058            0.028            0.00061          0.046
    March.............................................         0.013            0.055           -0.0079           0.031            0.031            0.053
    April.............................................     \2\ 0.12             0.055            0.055            0.035            0.069            0.058
    May...............................................     \1\ 0.19             0.056        \2\ 0.089            0.036        \3\ 0.099            0.060
    June..............................................     \1\ 0.17             0.055        \1\ 0.10             0.037        \3\ 0.10             0.060
    July..............................................     \2\ 0.11             0.055            0.046            0.036            0.020            0.059
    August............................................         0.046            0.055            0.029            0.034           -0.0084           0.056
    September.........................................        -0.0077           0.054           -0.012            0.031           -0.060            0.052
    October...........................................        -0.014            0.054           -0.014            0.026           -0.069            0.046
    November..........................................        -0.032            0.053           -0.0063           0.019           -0.05             0.034
    Constant..........................................     \1\ 3.12             0.29         \1\ 3.20             0.076        \1\ 2.46             0.12
    R \2\.............................................         0.6014    ...............     r = 0.87      ...............  ...............  ...............
    Adjusted R \2\....................................         0.5914    ...............    F test                9.42      ...............  ...............
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    \1\ 1 percent significance.
    \2\ 5 percent significance.
    \3\ 10 percent significance level.

                  TABLE 2.--REGRESSION RESULTS FOR THE POOLED OLS, THE FIXED EFFECT MODEL, AND THE PANEL FGLS METHOD ON THE 3:2:1 CRACK SPREAD
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                              Pooled OLS Regression         Fixed effect model with AR(1)           Panel FGLS method
                         Variable                      -----------------------------------------------------------------------------------------------------
                                                            Estimate      Standard error      Estimate      Standard error      Estimate      Standard error
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Oil stock.........................................     \1\ 4.61e-6          9.53e-7      \1\ 7.27e-7          3.19e-7          1.7e-6           1.18e-6
    Gasoline stock....................................    \1\ -4.56e-6          1.26e-6          1.13e-6          7.55e-7      \1\ 0.000011         3.48e-6
    Refinery capacity.................................    \1\ -0.000015         0.000032    \1\ -0.000063         0.000012    \3\ -0.00039          0.00022
    Utilization rate..................................    \1\ -0.015            0.00032         -0.000066         0.00073         -0.00087          0.0019
    Ethanol production................................    \1\ -0.000091         4.49e-6     \1\ -0.000073         0.000011    \1\ -0.000077         0.000014
    Supply disruption.................................     \1\ 0.32             0.12         \3\ 0.23             0.13         \3\ 0.13             0.071
    Gasoline import...................................    \1\ -0.000062         4.41e-6         -3.3e-6           6.0e-6           5.19e-6          3.53e-6
    HHI...............................................     \1\ 0.00026          0.000069        -0.000027         0.000036         0.000079         0.00024
    January...........................................        -0.058            0.06             0.00099          0.046       \1\ -0.075            0.028
    February..........................................        -0.075            0.06             0.022            0.059           -0.036            0.036
    March.............................................     \2\ 0.13             0.062        \2\ 0.14             0.067        \2\ 0.095            0.039
    April.............................................     \1\ 0.30             0.063        \1\ 0.22             0.072        \1\ 0.18             0.044
    May...............................................     \1\ 0.39             0.063        \1\ 0.23             0.07         \1\ 0.19             0.046
    June..............................................     \1\ 0.36             0.063        \1\ 0.24             0.074        \1\ 0.20             0.046
    July..............................................     \1\ 0.31             0.062        \2\ 0.17             0.073        \1\ 0.15             0.045
    August............................................     \1\ 0.28             0.062        \2\ 0.16             0.07         \1\ 0.18             0.043
    September.........................................     \1\ 0.23             0.061        \3\ 0.12             0.066        \1\ 0.18             0.039
    October...........................................     \1\ 0.19             0.061        \3\ 0.099            0.059        \1\ 0.18             0.034
    November..........................................         0.0022           0.060           -0.03             0.044            0.02             0.025
    Constant..........................................     \1\ 4.04             0.33         \1\ 2.06             0.13         \1\ 2.53             0.10
    R \2\.............................................         0.6196    ...............     r = 0.87      ...............  ...............  ...............
    Adjusted R \2\....................................         0.6101    ...............    F test                3.98      ...............  ...............
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    \1\ 1 percent significance.
    \2\ 5 percent significance.
    \3\ 10 percent significance level.

                                                   TABLE 3.--RESULTS FOR OLS REGRESSION ON RELATIVE GASOLINE PRICE WITH INDIVIDUAL PADD REGIONAL DATA
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                             PADD I                    PADD II                  PADD III                   PADD IV                   PADD V
                                                                   ---------------------------------------------------------------------------------------------------------------------------------
                               Variable                                            Standard                  Standard                  Standard                  Standard                  Standard
                                                                      Estimate      error       Estimate      error       Estimate      error       Estimate      error       Estimate      error
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
    Oil stock.....................................................  \3\ .000025      .000015  \1\ .000012      2.11e-6  \1\ 3.89e-6     9.38e-7     -7.88e-6       .000018     2.84e-6      5.62e-6
    Gasoline stock................................................  \1\ .000031     6.48e-6       .000011      8.16e-6  \1\ .000024     7.36e-6   \1\ .00015       .000055      .000029      .000019
    Refinery capacity.............................................     0.0048       0.00032       .00054        .00047     -.00012       .00021   \1\ -.0062       .0023    \1\ -.0032       .00074
    Utilization rate..............................................     0.0051       0.0046       -.012          .0073   \3\ .010         .0056       -.010         .0086        .0037        .011
    Ethanol production............................................  \1\ -.00005      .000014  \1\ -.00009      8.45e-6  \1\ -.00005      .000014  \1\ -.00004      .000020  \1\ -.00005      .000015
                                                                       6                         5                         9                         1                         6
    Supply disruption.............................................  \2\ .47          .20          .19           .19     \1\ .54          .20          .23          .26         -.069         .29
    Gasoline import...............................................  \1\ -.00004     7.58e-6      -.000012      9.59e-6    -5.07e-6      8.18e-6      -.000013      .000014    -9.37e-6       .000014
                                                                       4
    HHI...........................................................  \3\ -.00029     0.00017      -.00029        .00037      .00037      -.0030        .00051       .00053   \1\ .0019        .00046
    January.......................................................     -.10          .097        -.047          .10        -.0057        .0084       -.14          .13         -.067         .15
    February......................................................     -.11          .098        -.11           .10        -.024         .088        -.17          .13         -.0060        .15
    March.........................................................      .0079        .099        -.12           .11        -.006         .079        -.063         .12          .12          .14
    April.........................................................      .060         .10         -.013          .10        -.0044        .080         .15          .13          .22          .14
    May...........................................................      .023         .11          .11           .11         .019         .080     \3\ .26          .13          .22          .14
    June..........................................................      .000052      .10          .17           .11         .0097        .078     \2\ .35          .14          .22          .14
    July..........................................................      .018         .10          .065          .10        -.0013        .078     \2\ .33          .15          .16          .14
    August........................................................      .072         .10          .093          .10         .017         .079     \2\ .32          .15          .11          .15
    September.....................................................     -.037         .10          .053          .098       -.047         .076         .23          .14          .074         .14
    October.......................................................      .035         .10         -.012          .099       -.056         .077         .18          .13          .096         .14
    November......................................................     -.029         .097        -.025          .096       -.052         .075         .09          .12          .046         .14
    Constant......................................................  \1\ 0.17         .67          .31          1.79         .048        1.20      \1\ 5.56        1.49      \1\ 8.87        2.79
    R \2\.........................................................      .7109    ...........      .7119    ...........      .8229    ...........      .6610    ...........      .6415    ...........
    Adjusted R \2\................................................      .6705    ...........      .6717    ...........      .7981    ...........      .6136    ...........      .5915    ...........
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
    \1\ 1 percent significance.
    \2\ 5 percent significance.
    \3\ 10 percent significance level.

                                                      TABLE 4.--RESULTS FOR OLS REGRESSION ON 3:2:1 CRACK SPREAD WITH INDIVIDUAL PADD REGIONAL DATA
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                             PADD I                    PADD II                  PADD III                   PADD IV                   PADD V
                                                                   ---------------------------------------------------------------------------------------------------------------------------------
                               Variable                                            Standard                  Standard                  Standard                  Standard                  Standard
                                                                      Estimate      error       Estimate      error       Estimate      error       Estimate      error       Estimate      error
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
    Oil stock.....................................................      .000012      .000018      .000014      2.3e-6   \1\ 4.9e-6      1.0e-6        .000017      .000019  \3\ .000012     6.2e-6
    Gasoline stock................................................  \1\ .000038     7.8e-6    \3\ .000015      8.7e-6   \1\ .000029     7.9e-6    \1\ .000023      .000058      .000025      .000021
    Refinery capacity.............................................    -0.000079     0.000038     -.00017        .00050     -.00028       .00023   \1\ -.012        .0025    \1\ -.0029       .000082
    Utilization rate..............................................  \2\ -.01         .0055    \1\ -.031         .0078   \3\ -.012        .0063       -.013         .0091       -.0065        .012
    Ethanol production............................................  \1\ -.00005      .000017  \1\ -.00009      9.e-6    \2\ -.00003      .000016    -4.2e-6        .000021  \1\ -.00004      .000016
                                                                       1                                                   9                                                   7
    Supply disruption.............................................  \2\ .59          .24          .23           .21         .10          .21          .079         .27         -.24          .32
    Gasoline import...............................................  \1\ -.00006     9.1e-6    \1\ -.00002       .00001  \2\ -.00001     8.8e-6       -.000023      .000015     -.000019      .000016
                                                                       5                         9                         9
    HHI...........................................................     -.00033       .24         -.00042        .00039  \1\ -.0023       .000078      .00033       .00056   \1\ .0016        .00050
    January.......................................................     -.098         .12         -.053          .11        -.13          .090        -.19          .13         -.11          .16
    February......................................................     -.023         .12         -.098          .11        -.12          .10         -.17          .14         -.025         .16
    March.........................................................      .16          .12         -.069          .11         .05          .085         .044         .14          .22          .16
    April.........................................................  \3\ .22          .12          .16           .11         .14          .086     \2\ .34          .14      \2\ .41          .16
    May...........................................................      .17          .13      \1\ .33           .12     \3\ .16          .086     \1\ .46          .14      \2\ .36          .16
    June..........................................................      .11          .12      \1\ .41           .11     \3\ .15          .084     \1\ .59          .15      \2\ .36          .16
    July..........................................................      .16          .13      \2\ .28           .11     \3\ .15          .084     \1\ .62          .16      \2\ .36          .16
    August........................................................  \2\ .25          .12      \1\ .37           .11     \2\ .21          .085     \1\ .68          .16      \2\ .38          .16
    September.....................................................      .14          .12      \1\ .32           .10     \3\ .14          .081     \1\ .63          .15      \2\ .40          .16
    October.......................................................      .20          .12      \3\ .18           .10         .065         .083     \1\ .53          .14      \2\ .34          .16
    November......................................................      .01          .12          .017          .10        -.053         .081         .21          .13          .068         .15
    Constant......................................................  \1\ 2.10         .81      \1\ 3.76         1.91     \1\ 3.52        1.29      \1\ 7.22        1.58      \1\ 8.04        3.07
    R \2\.........................................................      .7017    ...........      .7419    ...........      .8299    ...........      .7216    ...........      .6592    ...........
    Adjusted R \2\................................................      .6600    ...........      .7058    ...........      .8061    ...........      .6827    ...........      .6116    ...........
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
    \1\ 1 percent significance.
    \2\ 5 percent significance.
    \3\ 10 percent significance level.

                                     ______

                                                         November 2007.
         Analysis of Potential Causes of Consumer Food Price Inflation

                  PREPARED FOR: THE RENEWABLE FUELS FOUNDATION
            PREPARED BY: INFORMA ECONOMICS, AN AGRA INFORMA COMPANY

                              I. EXECUTIVE SUMMARY
    A. Introduction
        Since fall 2006, public debate has intensified over the extent to
    which the expansion of the ethanol industry has resulted in higher
    agricultural commodity prices and, more importantly, whether and to
    what extent there has been an impact on consumer food prices. To date,
    this debate has been fueled mainly by anecdotal information. Given that
    this issue has bearing on major policy decisions with respect to
    agriculture and renewable energy, it is imperative that an objective,
    fact-based assessment be available to public policymakers. The
    Renewable Fuels Foundation (RFF) commissioned Informa Economics, Inc.
    (Informa) to conduct such an assessment, and the results are contained
    in this report.
    B. Key findings
        The ``farm value'' of commodity raw materials used in foods
    accounts for 19 percent of total U.S. food costs, a proportion that has
    declined significantly from 37 percent in 1973. For food products where
    corn is only one of several farm-produced inputs, the proportion of the
    total product cost attributable to the cost of corn is even less than
    19 percent. The remaining portion of total retail food costs is known
    as the marketing bill. The marketing bill includes the costs of labor,
    packaging, transportation, energy, profits, advertising, depreciation,
    rent, interest, repairs, business taxes, and other costs not
    attributable to basic agricultural commodities. The marketing bill has
    a higher correlation with the consumer price index (CPI) for food than
    does corn, although there is a notable long-term upward trend to both
    the marketing bill and the food CPI. Within the overall marketing bill,
    the costs of energy and transportation have increased considerably over
    the last several years, with crude oil prices surging from just under
    $60 per barrel in fall 2006 to nearly $100 per barrel in November 2007,
    the same period during which corn prices have increased.
        An analysis was performed to quantify the historical price
    relationships between corn prices and livestock, poultry, egg, and milk
    prices, and the results showed weak correlations. With these low
    correlations, it is statistically unsupported to suggest that high and/
    or rising corn prices are the causative reason behind high and rising
    retail meat, egg, and milk product prices. Moreover, the upward trend
    in cattle, hog, and poultry prices began in the late 1990s, well before
    the corn price began to increase significantly. Notably, dairy and egg
    prices have been driven higher mainly by strong export demand.
        More generally, there has historically been very little
    relationship between corn prices and consumer food prices. Statistical
    relationships are weak even when corn price data are lagged to allow
    time for them to work their way through the food supply chain. The corn
    price would be considered a statistically insignificant variable in
    determining what drives the food CPI.
        To provide context to an analysis of consumer food prices, it is
    useful to consider the role of food expenditures in the average
    American's budget. The proportion of the average American's disposable
    income that is spent on food has declined steadily over the last half-
    century, from 21 percent of disposable income in 1950 to below 10
    percent in 2006. Additionally, the share of total food expenditures
    accounted for by at-home food consumption has been declining relative
    to away-from-home consumption. In 1950, 83 percent of total food
    expenditures were for at-home consumption, but by 2006 this share had
    declined to 58 percent.
        Consumer food prices have been increasing at a relatively steady
    pace over the last two decades. The annual increase in the food CPI has
    averaged 2.96 percent since 1985, with food price inflation peaking at
    5.84 percent in 1989 and falling to 1.2 percent in 1992. Since 1992,
    the rate of increase in the food CPI has averaged a slightly lower 2.57
    percent. By comparison, the annualized growth rate during the first
    three-quarters of 2007 has been 3.40 percent. While growth rates in the
    CPI sub-index for food consumed away from home have been slowly
    trending upward since about 1994, the CPI for food consumed at home is
    significantly more volatile and is currently growing more rapidly than
    away-from-home food prices.
        The United States harvested a record corn crop of 11.8 billion
    bushels in 2004, but production fell to 11.1 billion bushels in 2005
    and dropped further to 10.5 billion bushels in 2006. Over the same time
    period, encompassing crop-marketing years 2004-2005 through 2006-2007,
    the usage of corn in ethanol production expanded to 2.1 billion bushels
    from 1.3 billion bushels. Yet, the ethanol industry was not the only
    source of additional demand for corn. U.S. corn exports, which were 1.8
    billion bushels in 2004-2005, rose to 2.1 billion bushels in both 2005-
    2006 and 2006-2007--a level that was at the top of the range
    experienced over the previous decade. Thus, the combination of a
    reduction in supply and an increase in demand from both the ethanol
    industry and the export market led to corn prices moving higher
    starting in fall 2006.
        Sub-indices of the food CPI are reported for the major food product
    categories. It was investigated whether the price of corn has a greater
    influence on these sub-indices than the overall food CPI. However,
    similar to the case with the overall food CPI, the relationship with
    the product sub-indices is generally weak.
        Given the weak correlation between corn prices and consumer food
    prices, it can be hypothesized that a considerable proportion of the
    impact of corn price changes is absorbed by participants in the value
    chains for meats, poultry, and other corn-based food products. This
    does not necessarily mean that margins within the value chain are low
    or negative, but rather that they are lower than they would be in the
    absence of higher corn prices.
        In summary, the statistical evidence does not support a conclusion
    that the growth in the ethanol industry is driving consumer food prices
    higher. This is demonstrated by the fact that the R-squared statistic
    between nearby corn futures prices on the Chicago Board of Trade (CBOT)
    and the food CPI is only 0.04, which means that only 4 percent of the
    change in the food CPI is ``explained'' by fluctuations in nearby corn
    futures prices. Even when the corn price is lagged to allow for the
    effects to work their way through the food supply chain, the
    statistical results do not improve. It can be concluded that no single
    factor is the driver of consumer food prices over time--or the
    moderately higher-than-average inflation during the first three
    quarters of 2007--but rather there is a complex and interrelated set of
    factors that contribute to food prices.

                                II. INTRODUCTION

        Since fall 2006, public debate has intensified over the extent to
    which the expansion of the ethanol industry has resulted in higher
    agricultural commodity prices and, more importantly, whether and to
    what extent there has been an impact on consumer food prices. To date,
    this debate has been fueled mainly by anecdotal information. Given that
    this issue has bearing on major policy decisions with respect to
    agriculture and renewable energy, it is imperative that an objective,
    fact-based assessment be available to public policymakers. The RFF
    commissioned Informa to conduct such an assessment, and the results are
    contained in this report.
        As a result of the confluence of several factors that are explained
    in Section VIII of this report, corn prices received by farmers
    increased to an average of $3.03 per bushel during the crop-marketing
    year that began in September 2006 and ended in August 2007, which was a
    substantial increase from the $2.09 per bushel that farmers received in
    August 2006, just before the start of the 2006-2007 crop year.
    Similarly, it was considerably higher than the $2.00 per bushel average
    experienced during the 2005-2006 crop year. However, other costs
    incurred in the production and distribution of food products were
    moving higher as well.
        The price of crude oil (West Texas Intermediate) hovered just below
    $60 per barrel in fall 2006, then increased to the $60-$70 per barrel
    range in the spring and early summer of 2007 and further to the $70-$80
    per barrel range in the late summer and early fall of 2007; in November
    2007, the price surged to near $100 per barrel. Additionally,
    transportation costs have been surging in recent years, propelled
    higher partly by increasing fuel prices and partly by capacity
    tightness relative to strengthening demand for transportation services.
        As will be shown in this report, no single factor is the driver of
    consumer food prices over time--or the moderately higher-than-average
    inflation during the first three quarters of 2007--but rather there is
    a complex and interrelated set of factors that contribute to food price
    inflation. In addition to the analysis contained in this report,
    Appendix A provides background on media coverage of the ``food versus
    fuel'' debate and on other studies that have looked into whether
    ethanol industry growth and changes in corn prices are contributing to
    food price inflation.

                            II. CONSUMER FOOD PRICES

        Consumer food prices have been increasing at a relatively steady
    pace over the last two decades. Specifically, the annual increase in
    the food CPI has averaged 2.96 percent since 1985, with food price
    inflation peaking at 5.84 percent in 1989 and falling to 1.2 percent in
    1992 (see Figure 1). Since 1992, the rate of increase in the food CPI
    has averaged a slightly lower 2.57 percent. In comparison, the
    annualized growth rate during the first three-quarters of 2007
    (January-September) has been 3.40 percent--a rate of growth that was
    matched only one other time in the last 15 years (in 2004).

        The ``core CPI,'' which excludes food and energy prices, is viewed
    as a more accurate reflection of underlying inflationary pressures in
    the general economy than the overall CPI (at least in the short term),
    since the core CPI excludes food and energy prices, which tend to be
    significantly more volatile from month-to-month than other sectors of
    the economy. Over the 1985-2007 time period, the average annual
    inflation rate of the core CPI has been 3.09 percent, which is very
    close to the 2.96 percent average food CPI growth rate (see Figure 2).
    Whether inflation in the core CPI or the food CPI is higher varies
    almost from year to year.

        If only the period since 1992 is considered, core CPI inflation has
    on average been 0.17 percent below food CPI inflation. Essentially,
    this again indicates food CPI inflation has been similar to the core
    inflation rate over the long run. During this time period, the greatest
    differential between the two CPI inflation rates was in 2004, when food
    CPI inflation was higher than core CPI inflation by 1.69 percent.
    Similarly, from January to September 2007, the food CPI inflation rate
    has been running 1.32 percent above the core CPI inflation rate.
        Not only is the overall CPI composed of major expenditure
    categories such as food and energy, but the food CPI is composed of two
    main sub-indices: food consumed at home and food consumed away from
    home. While growth rates in the away-from-home food CPI have been
    slowly trending upward since about 1994, the at-home food CPI is
    significantly more volatile and is currently growing more rapidly than
    away-from-home food prices (see Figure 3). However, both are currently
    growing at rates exceeding the core CPI.

        Importantly, the USDA's Economic Research Service (ERS) and the
    Bureau of Labor Statistics (BLS) have noted that the at-home food CPI
    statistic likely overestimates actual inflation in prices consumers pay
    for food. This is due in part to the impact of emerging ``big-box
    stores'' (e.g., Wal-Mart and Costco) on the food at-home CPI. Data from
    previous studies have shown that food prices from these ``big-box
    stores'' are, on average, 7 percent to 8 percent lower than those found
    in large supermarket chains. The problem is that such stores might not
    be fully represented in the sample of stores surveyed for price data.
    Furthermore, when a ``big-box store'' acquires a store that is included
    in the surveyed group, the BLS has an aligning procedure which assumes
    that quality-adjusted prices at these stores are equal to the prices at
    the large supermarket chains. In essence, this procedure equates the
    prices of these alternative food retailers. A study by Hausman and
    Leibtag \1\ concluded that this phenomenon confers an upward bias of
    0.32 percent to 0.42 percent in the at-home food CPI.
    ---------------------------------------------------------------------------
        \1\ Hausman, J. and E. Leibtag. 2004. ``CPI Bias from Supercenters:
    Does the BLS Know that Wal-Mart Exists?'' NBER Working Paper #20712
    (Aug). National Bureau of Economic Research, Cambridge, MA.
    ---------------------------------------------------------------------------
        The at-home food CPI is further categorized into additional sub-
    indices, broken down into product categories with increasing levels of
    specificity. An evaluation of relevant first-level product categories
    further demonstrates which categories are largely responsible for
    changes in the overall food CPI. Among products that have a direct or
    indirect linkage to corn as an input, egg prices have recently been
    exhibiting the strongest inflation, while other livestock, dairy, and
    poultry markets exhibit similar, but much milder, trends (see Figure
    4). In contrast, the CPI for cereals and bakery products has avoided
    the large, volatile swings that have occurred in the egg market. In
    general, the more value added in the manufacture of the product, the
    more consolidated the market, and the more price elastic the demand
    (i.e., costs cannot be passed along to consumers without lowering
    demand), the less volatile end-product prices will be.

                 iv. perspective on consumer food expenditures
        In providing context to the food-versus-fuel debate, in addition to
    examining how the CPI has changed over time it is also useful to
    consider the role of food expenditures in the average American's
    budget. To start with, the proportion of the average American's
    disposable income that is spent on food has declined steadily over the
    last half-century. In 1950, approximately 21 percent of disposable
    income was spent on food; by 2006, the share had broken below 10
    percent (see Figure 5).

        Interestingly, the proportion of disposable income spent on food
    away from home has remained relatively stable over time. Away-from-home
    food consumption has remained in the range of 4.0 percent to 4.3
    percent of total disposable income since 1976. Given the increase in
    consumers' disposable income over time, this means that in nominal
    terms the total amount spent on food away-from-home has increased
    substantially. In fact, per capita away-from-home food expenditures
    have increased 44 percent between 2000 and 2006, increasing from an
    average $971 to $1,402.
        Another trend within food expenditures is that the share accounted
    for by at-home food consumption has been declining relative to away-
    from-home consumption. Again, this is the share of food expenditures,
    whereas the previous paragraph addressed the share of disposable
    income. In 1950, 83 percent of total food expenditures were for at-home
    food consumption (see Figure 6). By 2006, this share had declined to 58
    percent, and according to the USDA, it is predicted to fall to 51
    percent by 2016.

        Increases in food prices in 2007 have been showing up more in the
    at-home food CPI than the away-from-home food CPI, which is to be
    expected since at-home food prices historically have been more volatile
    than away-from-home food prices (refer back to Figure 3). However,
    given that the at-home food category has been a declining component of
    total food expenditures, and that food expenditures have accounted for
    a declining proportion of consumer incomes, the effect of any increase
    in at-home food prices on the average American's financial condition
    will be considerably muted relative to what it would have been in the
    past.
        In the Center for Agricultural and Rural Development (CARD) study
    referenced in the appendix to this study, long-run general food prices
    were predicted to increase by as much as 1.8 percent above the ``no
    ethanol'' scenario. This was the most extreme scenario of the reviewed
    research publications, as the USDA forecasts long-run food price
    inflation equal to or less than the general inflation rate, the AFBF
    found no short- or long-term relationship, and the consulting firm AES
    only reported inflationary increases for individual products. However,
    even though the inflation rates estimated by AES were only examined for
    individual products, for most product categories the rates were less
    than those estimated by the CARD study. Therefore, it can be said that
    this average retail food price inflation estimation of 1.8 percent
    above the ``no ethanol'' control is the highest inflation rate
    estimation of those referenced.
        What would the scenario of 1.8 percent higher food price inflation
    mean for consumers? In 2006, the average disposable income was $32,114,
    with 9.9 percent of this being spent on food. This would mean that a
    1.8 percent increase in the price food would increase the total annual
    food expenditures of an average household by about $57 a year. With 58
    percent of this being spent on at-home food expenditures, this means
    that the average American household can be expected to spend an extra
    $34 a year on their groceries.
        However, to understand the net impact on consumers' financial
    condition, changes in expenditures on not only food but also fuel would
    have to be considered. Specifically, if more abundant supplies of
    ethanol were to result in a measurable reduction in retail fuel prices,
    this would have to be compared to any food price increase in
    determining the net impact to consumers. The effect of ethanol on
    retail fuel prices is not addressed in this study.

    V. RELATIONSHIP BETWEEN CORN PRICES AND OTHER AGRICULTURAL COMMODITIES
                                     PRICES

        This section analyzes the relationships among the prices of corn,
    other commodities and consumer food prices. It examines whether there
    is a sufficient relationship between corn prices and other commodity
    and food prices to substantiate whether an increase in corn prices--
    regardless of the reason for the increase in corn prices--would cause
    an increase in the prices consumers pay for food.
    A. Historical relationships among corn and other commodity prices
                1. Grain and oilseed prices
        Grain and oilseed prices have always been highly volatile. In
    Figure 7, historical monthly nearby futures averages are shown for
    corn, soybeans, and wheat, the three major row crops grown in the
    United States.\2\ Until recently, domestic demand for these commodities
    generally grew at a relatively steady rate, while changes in supply
    (usually due to weather) have been the main determinants of price
    volatility.
    ---------------------------------------------------------------------------
        \2\ ``Nearby'' futures refer to the futures contract closest to
    expiration. For example, March futures would serve as the nearby corn
    contract during January and February of any given year, since contracts
    are not traded with delivery during those months.

        While these three commodities have only limited substitutability
    for each other, conditions in one market can influence the prices in
    another--often caused by the common denominator of weather. Recent
    increases in corn prices are no exception. While a record corn crop is
    being harvested in the fall of 2007, there is concern that increased
    demand will bring soybean supplies down to low levels by the end of the
    crop year, and weather problems in Australia and other wheat-growing
    nations have caused wheat prices to reach record levels. As a result,
    corn prices have not been able to fall as would have been expected
    given the size of the crop. This section provides a brief overview of
    the complex historical relationships among these three markets.
        The Corn Price.--Over the historical time period extending from
    January 1985 to August 2007, the average nearby corn futures price has
    averaged $2.46/bu. Weather had a substantial impact on corn futures
    prices in the 1988-1989 crop year, when poor crops resulted in high
    prices. (The crop year for corn begins in September, when harvest gears
    up on a large scale, and ends in August of the following calendar
    year.) In 1995-1996 record high corn prices were reached when a drop in
    production coincided with very strong export demand, resulting in
    record corn futures prices as high as $5.00/bu.
        Following record corn production in the 2004-2005 crop year of 11.8
    billion bushels and another crop over 11 billion bushels in 2005-2006,
    corn futures prices declined to $2.23/bu in the 2005-2006 crop year.
    However, driven by a significant decrease in corn acreage harvested in
    2006, corn production fell to 10.5 billion bushels, while corn usage in
    ethanol production increased and exports rebounded strongly to the top
    end of the range experienced during the prior decade; as a result,
    nearby corn futures in 2006-2007 increased to an average $3.56/bu, with
    spring prices approaching the $4.50/bu range.
        A fundamental driver of the price of corn is the level of
    inventories at the end of the crop-marketing year. Ending stocks are
    viewed by the industry as the ``cushion'' or ``buffer'' stocks
    available to incorporate increases in demand or reductions in supply in
    the following crop year. The larger the level of ending stocks, the
    more comfortable the market will be with a given level of demand. In
    particular, the ratio of year-end stocks to total consumption during
    the year is a key price determinant. Corn prices tend to weaken when
    supplies are plentiful relative to usage, whereas they strengthen when
    stocks are drawn down compared to demand. The level of stocks is market
    driven, as the U.S. Government no longer carries large stocks as part
    of its corn support programs.
        Price Relationships Among Corn, Wheat, and Soybeans.--As was shown
    above in Figure 7, a general price relationship exists among these
    three crops. In 1995, the early frost that affected corn production
    also led to spikes in soybean and wheat prices. Just as the corn price
    increases were compounded by strong export demand, the wheat price
    increase was also compounded by other factors. These included low
    stocks that year and world supply issues, as production and export
    subsidies in the United States and EU were curtailed under the Uruguay
    Round of the General Agreement on Tariffs and Trade (now called the
    World Trade Organization, WTO).
        However, a weather problem for one crop does not necessarily always
    mean a supply problem for the other. A prime example of this is the
    drought of 2003, which affected the soybean crop but left the other two
    crops relatively unscathed. While weather plays a key role in
    explaining the relationship between these three commodities, it is not
    the only factor. Each market has its own set of supply and demand
    factors that can either exacerbate the problems in another market or
    help to mitigate potential price increases.
        Higher corn prices can influence wheat prices, but typically the
    reverse has not been true. This is because as corn prices move higher,
    wheat prices will be pulled higher to keep wheat from being used as a
    feed. However, the record wheat prices of 2007 are very much a result
    of supply-side issues. U.S. wheat supplies were reduced by adverse
    weather, including a spring freeze and unseasonably heavy rainfall
    around harvest. To add to the global supply problems, Australia's wheat
    production has fallen significantly due to drought. Eastern Europe,
    Ukraine, and to some extent Canada--all of which are large-scale wheat
    producers--have also been having supply issues.
        In general, the demand bases for wheat and corn are quite different
    since the crops' end-product uses are generally different, with corn
    mainly used as a feed grain and wheat mainly used as a food grain.
    Usually, the global wheat supply has a modest impact on corn exports,
    although for countries where wheat and barley are the primary feed
    grains, a weather problem can necessitate increased usage of other feed
    grains, including imported corn. Although there can be some linkage
    between the wheat and corn markets in such a case, corn futures prices
    are remaining at high levels in fall 2007 in order for corn to
    ``compete'' against high-priced soybeans for acres to be planted in
    spring 2008; this competition is mainly with soybeans as opposed to
    wheat, since wheat is typically grown in areas that are not necessarily
    best suited for corn.
        This competition between corn and soybean acres has affected the
    price relationship between these two commodities over the last couple
    of years. In the spring of 2006, futures prices provided a net revenue
    premium to grow soybeans compared to corn, and soybean acres expanded
    at the expense of corn. In 2007, the reverse was true, and corn acreage
    increased substantially. After the 2007 crop was made, the market
    realized that the pace of usage would bring soybean inventories to low
    levels at the end of the 2007-2008 crop year, and if a larger soybean
    crop were not realized next year, the inventory situation would become
    particularly acute by the end of the 2008-2009 crop year. This has led
    to inflation in the corn price over what it would have been had it not
    had to compete with soybean acreage.
        While part of the increase in soybean prices can be attributed to
    the shift of some soybean acres to corn in 2007, it can be argued that
    the price of soybeans would not have gone quite so high had it not been
    for the price of crude oil (petroleum), which has driven soybean oil
    prices higher due to the growth of the biodiesel industry.
                2. Livestock, poultry, egg, and milk prices
        Figure 8 provides a visual indication that there is not a strong
    correlation between corn prices and livestock or poultry prices. It is
    also evident that the upward trend in cattle, hog, and poultry prices
    began in the late 1990s, well before the corn price began to increase
    significantly in 2005-2006.

        Cattle prices have been on an upswing since the mid-to-late 1990s,
    resulting from declining cattle supplies and increasing demand. Cattle
    inventories declined from 103.5 million head in 1996 (January 1
    inventories) to just under 95 million head by 2004, and there has been
    only a modest 2-million-head rebound since then. In conjunction with
    declining cattle inventories was an increase in beef demand that became
    evident in the late 1990s. Consumer preferences began to take a
    detectable turn; the previously held belief that beef was a health
    detriment began to moderate as consumers adopted diets that placed more
    emphasis on protein and less on carbohydrates. These shifts in supply
    and demand have been the main driving forces behind the increasing
    cattle prices, which have been rising at an average annual growth rate
    of about 3.6 percent since 1998. Previous (1985-1998) cattle price
    increases averaged just less than 1 percent.
        In contrast to the strong growth in cattle prices, the growth in
    hog and poultry prices has been more moderate, although there have
    still been increases. Similar to cattle prices, an upward trend in hog
    prices can be detected beginning near the turn of the millennium. In
    recent years, annual productivity gains have continued at trend levels,
    even as industry structure has matured. The breeding herd has held
    relatively steady, at or slightly above 6 million head since 2000, with
    minor deviations from year to year. From the demand side, pork demand
    at the wholesale level has remained stagnant in the United States,
    while export demand has increased dramatically. In general, there
    appears to be very little relation between corn prices and hog prices,
    with the possible exception being in the 1996-1997 crop year when hog
    prices spiked following the large corn price spike in 1995-1996. While
    most of this increase is attributed to constrained supplies of pork
    that year, the large increase in corn prices the previous year
    (exceeding the recent corn price spike in 2006-2007) may have partially
    motivated these supply reductions.
        Poultry prices remained relatively flat across the 1985-1986 to
    1999-2000 time period, averaging $54.50/cwt. Since then, poultry prices
    have been trending upward at an average annual growth rate of 4 percent
    (averaging $67.86/cwt). Such price increases can be largely explained
    by increasing per capita poultry consumption. Further demand increases
    have been seen following the Avian Influenza found within Asia and
    Europe in 2003. Such demand increases, along with tight supplies,
    resulted in the record-high prices recorded during the 2003-2004 crop
    year. Then in 2005-2006, prices dropped back down as exports backed off
    as a result of the record prices.
        Egg prices, on the other hand, have been relatively more responsive
    to corn prices. There are several reasons for this tighter
    relationship. First, while the egg industry supply chain is not as
    concentrated as the broiler industry, it is still relatively integrated
    and consolidated. These larger, integrated operations are able to make
    supply decisions and respond more quickly to changing input prices than
    small, independent laying operations. Second, demand for eggs is
    relatively inelastic, as they are a cheaper source of protein than
    meats or other livestock products and are used in a range of processed
    food products. This enables price changes to be passed on to consumers
    without affecting overall consumption severely.
        Egg values have been extremely high in 2007. With production
    margins extremely poor during 2005 and into 2006, producers cut their
    laying flocks considerably. Consequently, egg production has fallen.
    The total number of eggs produced up to this point in 2007 is about 1.5
    percent fewer than the number of eggs produced during the same time
    period in 2006.
        Along with a diminished U.S. egg supply, export trade of both eggs
    and egg products has risen strongly during 2007 (see Table 1). There
    has been a significant increase in exports of both shell eggs and egg
    products during the first 9 months of 2007 compared to recent years.
    Even though exports of shell eggs still account for less than 2 percent
    of all U.S. egg production, the increase in exports combined with
    diminished egg production was enough to skim necessary supplies from an
    already tight domestic market for eggs and has been a contributing
    factor to higher egg prices in 2007.
        Similarly, inelastic demand for milk leads to a moderately tighter
    relationship between corn and milk prices than with other livestock and
    poultry prices (see Figure 9). That being said, recent milk price
    increases have been driven primarily by substantial increases in world
    dairy product demand and tight world supplies that resulted from major
    droughts in leading milk-producing countries, such as Australia (see
    Figure 10).

                   TABLE 1.--U.S. EXPORTS OF SHELL EGGS AND EGG PRODUCTS, JANUARY-SEPTEMBER, 2003-2007
    ----------------------------------------------------------------------------------------------------------------
                                                                                                          All egg
                                                                                                         products,
                                  Year                                  Table eggs      Shell eggs        liquid
                                                                       (1,000 dozen)   (1,000 dozen)    equivalent
                                                                                                        (1,000 lbs)
    ----------------------------------------------------------------------------------------------------------------
    2003 (January-September)........................................          33,523          68,816          70,603
    2004 (January-September)........................................          36,123          73,157          61,195
    2005 (January-September)........................................          47,216          82,250         110,308
    2006 (January-September)........................................          37,838          75,478         114,536
    2007 (January-September)........................................          62,170         107,057         125,603
    ----------------------------------------------------------------------------------------------------------------
    Note: Since only January-September data are available for 2007, data for the same time periods in previous years
      are shown for purposes of comparison.

                Correlation analysis
        An analysis was performed to quantify the historical price
    relationships between corn prices and livestock, poultry, egg, and milk
    prices, and the results showed rather weak correlations. With these low
    correlations, it is statistically unsupported to suggest that high and/
    or rising corn prices are the causative reason behind high and rising
    retail meat, egg, and milk product prices.
        Quarterly average nearby corn futures prices were analyzed relative
    to quarterly average nearby cattle and nearby hog prices and quarterly
    cash price averages for broilers, milk, and eggs (January 1985-
    September 2007). Direct quarter to quarter correlations were calculated
    as were lagged correlations for one, two, three, and four quarters to
    identify if there was a lagged impact from corn prices on meat, egg,
    and milk prices. The results are presented below.
                    Cattle and beef
        In the cattle-and-beef sector, the correlation coefficients were
    weak over short periods of time and even negative over longer periods
    of time, which indicates that there is no discernible strong
    relationship between corn prices and cattle prices (see Table 2). Based
    on this analysis, it can be concluded that high corn costs do not
    automatically result in higher cattle prices, either in the short term
    or over a 12-16 month period. The higher costs of producing beef result
    in a negative impact on cattle feeders' margins, and this ultimately
    would have a negative impact on feeder cattle prices (i.e., the prices
    paid animals entering feedlots). Irrespective of the price of corn, the
    price of fed cattle and beef might be higher or lower, with such prices
    determined by the supply/demand conditions in the beef market.

              TABLE 2.--CORN/CATTLE PRICE CORRELATION COEFFICIENTS
    ------------------------------------------------------------------------
                                                                Correlation
    ------------------------------------------------------------------------
    Current.................................................           +0.18
    One quarter lag.........................................           +0.15
    Two quarter lag.........................................           +0.06
    Three quarter lag.......................................           -0.06
    Four quarter lag........................................           -0.21
    ------------------------------------------------------------------------

        The cattle and beef industry has a rather complex supply chain, as
    numerous independent entities participate in the production of cattle
    as they progress from the core cow-calf production operation through
    backgrounding activities and then on through commercial cattle-feeding
    activities. In the production process for grain-fed beef, it can take
    anywhere from 16 to 24 months for an animal to move from birth to
    slaughter. Multiple buy/sell transactions occur in this process, as
    young calves are typically sold to operations that put these animals on
    forage programs and then eventually sell the animals to feedlot
    operations that feed out the animals to slaughter weights. The
    complexity of this process has a tendency of disrupting the supply
    response to changing cattle prices and changes in feed costs, which is
    likely reflected in the weak correlations between cattle and corn
    prices.
                    Hogs and pork
        Within a single quarter there is virtually no correlation between
    corn prices and hog prices, as measured by nearby futures prices. Given
    the length of the breeding and production process (10-12 months), a lag
    of at least four quarters between high feed costs and any possible
    impact on hog prices would be anticipated. Historically, producers
    endured losses for at least two quarters prior to adjusting breeding
    inventories; if that behavior pattern still holds, there would
    theoretically be a relationship between corn prices lagged five or six
    quarters and hog prices. However, the correlations between corn prices
    and hog prices for all lagged time periods are very weak (see Table 3).

                TABLE 3.--CORN/HOG PRICE CORRELATION COEFFICIENTS
    ------------------------------------------------------------------------
                                                                Correlation
    ------------------------------------------------------------------------
    Current.................................................           +0.15
    One quarter lag.........................................           +0.19
    Two quarter lag.........................................           +0.18
    Three quarter lag.......................................           +0.17
    Four quarter lag........................................           +0.22
    Five quarter lag........................................           +0.19
    Six quarter lag.........................................           +0.06
    Seven quarter lag.......................................           -0.01
    ------------------------------------------------------------------------

        Even with a four-quarter lag on corn prices, the correlation of
    +0.22 is so weak that it cannot be concluded that higher corn prices
    result in higher hog prices. Once again, if higher corn prices were
    going to have an impact on pork supply and prices, such impacts would
    be expected at least a year from when corn prices rise. However, when
    further lags are considered (five, six, and seven quarters), the
    correlation actually begins to decline.
                    Broilers
        In the broiler (chicken) sector, there does appear to be a slightly
    higher degree of linkage between broiler prices and corn prices. Still,
    correlation coefficients below 0.75 (actually, between -0.75 and 0.75)
    are considered tenuous at best, and the highest correlation coefficient
    between corn and the Georgia dock broiler price is only 0.3 (see Table
    4).

              TABLE 4.--CORN/BROILER PRICE CORRELATION COEFFICIENTS
    ------------------------------------------------------------------------
                                                                Correlation
    ------------------------------------------------------------------------
    Current.................................................           +0.25
    One quarter lag.........................................           +0.31
    Two quarter lag.........................................           +0.23
    Three quarter lag.......................................           +0.12
    Four quarter lag........................................           +0.03
    ------------------------------------------------------------------------

        The coefficient of 0.25 within a single quarter indicates a weak
    relationship between corn and broiler prices. The fact that the
    coefficient with a one-quarter lag is a little higher does suggest that
    there is a very weak price relationship; however, over time the
    correlation coefficients get smaller (weaker), which indicates that
    there is little relationship between the cost of corn and the price of
    broilers.
                    Eggs
        While correlations between corn and egg prices were the strongest
    observed for any of the livestock/poultry markets, the correlation
    coefficients would still be considered statistically weak. Again, a
    correlation between -0.75 and 0.75 is generally considered
    statistically insufficient to be used in modeling or predictions (for
    an equation with a single explanatory variable). Within a single
    quarter, or with up to a two-quarter lag in corn prices, the
    correlation coefficient between corn and eggs is gravitates around 0.5
    (see Table 5). When a further lag in corn prices is considered, the
    correlations worsen.

                TABLE 5.--CORN/EGG PRICE CORRELATION COEFFICIENTS
    ------------------------------------------------------------------------
                                                                Correlation
    ------------------------------------------------------------------------
    Current.................................................           +0.51
    One quarter lag.........................................           +0.49
    Two quarter lag.........................................           +0.51
    Three quarter lag.......................................           +0.39
    Four quarter lag........................................           +0.13
    ------------------------------------------------------------------------

        Egg producers have the capability of adjusting short-term
    production volumes, which in turn can have fairly immediate impacts on
    egg prices. If corn prices were the driver of either ``high'' or
    ``low'' egg prices, the correlation coefficients would be substantially
    higher than those found and presented above. It would appear that other
    factors besides corn prices contribute to egg price changes. For
    example, egg-product exports have increased to 126 million pounds
    during the first 9 months of 2007, compared to 115 million pounds
    during the same period in 2006, which has resulted in high egg prices;
    the role of high corn prices appears to have been, at most, a secondary
    contributor.
                    Dairy and milk
        Again, there is only a moderate degree of correlation between corn
    prices and milk prices (stronger than the broiler market but weaker
    than the egg market). The correlation coefficients for nearby corn
    futures prices and milk prices are shown in Table 6.

               TABLE 6.--CORN/MILK PRICE CORRELATION COEFFICIENTS
    ------------------------------------------------------------------------
                                                                Correlation
    ------------------------------------------------------------------------
    Current.................................................           +0.27
    One quarter lag.........................................           +0.41
    Two quarter lag.........................................           +0.44
    Three quarter lag.......................................           +0.31
    Four quarter lag........................................           +0.13
    ------------------------------------------------------------------------

         vi. relationship between corn prices and consumer food prices
    A. Historical relationship between corn prices and consumer food prices
        The first question to be asked in determining whether statements
    that higher corn prices are causing higher consumer food prices is:
    Have corn prices shown a strong relationship with consumer food prices
    in the past? In fact, this section shows there has historically been
    very little relationship between corn prices and consumer food prices.
    This is not surprising, given the results of the last section--if
    correlations between corn prices and livestock, poultry, egg, and milk
    prices at the wholesale level are weak, than correlations to further
    processed products at the retail level should be at least as weak.
        Relationships between corn prices and consumer food prices were
    evaluated by running a simple regression of corn prices against food
    CPI index values. Crop year averages since 1985-1986 were utilized. The
    resulting R-squared \3\ value was only 0.04, indicating that variations
    in the corn price ``explain'' only 4 percent of the variations in the
    food CPI index (see Figure 11). Thus, the corn price would be
    considered a statistically insignificant variable in determining what
    drives the food CPI.
    ---------------------------------------------------------------------------
        \3\ The R-squared value represents the proportion of the total
    variation in the food CPI (the ``y'' variable) that can be explained by
    the corn price (the ``x'' variable).

        In reality, it would be expected that a change in the corn price
    would take time to work its way through the value chain before the food
    CPI is affected, so that the impact might not be instantaneous.
    However, the R-squared values do not improve when quarterly prices are
    used and the corn price is lagged by as many as four quarters (see
    Table 7).

             TABLE 7.--FOOD CPI AS A FUNCTION OF LAGGED CORN PRICES
    ------------------------------------------------------------------------
                                                                 R-squared
                   Corn price                   Correlation        value
    ------------------------------------------------------------------------
    Current.................................          0.2010          0.0404
    One quarter lag.........................          0.1749          0.0306
    Two quarter lag.........................          0.1351          0.0183
    Three quarter lag.......................          0.0558          0.0031
    Four quarter lag........................         -0.0078          0.0001
    ------------------------------------------------------------------------

        Given that a general upward trend in the food CPI is prevalent,
    another regression was run using crop-year changes in corn prices
    against the crop-year changes in the food CPI. Again, very little of
    the food CPI inflation rate can be directly explained by year-to-year
    movements in the corn price, as reflected in an R-squared of 0.002 (see
    Figure 12). The corn price variable is statistically insignificant in
    the regression equation.

        While movements in the overall food CPI are not explained well by
    the price of corn, it was investigated whether the price of corn has a
    greater influence on sub-categories within the food CPI. Similar to the
    case with the overall food CPI, the relationship with the product sub-
    indices is generally weak, with only eggs having an R-squared over 0.1
    (see Table 8 and Table 9). This is true even if lagged corn prices are
    used.

                    TABLE 8.--CORRELATION BETWEEN FOOD CPI SUB-INDICES AND CURRENT/LAGGED CORN PRICES
    ----------------------------------------------------------------------------------------------------------------
                                                                                            Dairy and    Cereals and
             Corn prices            Beef and      Pork CPI     Poultry CPI    Eggs CPI       related       bakery
                                    veal CPI                                              products CPI  products CPI
    ----------------------------------------------------------------------------------------------------------------
    Current.....................        0.1968        0.1701        0.2164        0.4163        0.1413        0.2186
    One quarter lag.............        0.1534        0.1830        0.2286        0.0064        0.1435        0.2006
    Two quarter lag.............        0.0947        0.1689        0.2078        0.3782        0.1243        0.1660
    Three quarter lag...........       -0.0068        0.0939        0.1243        0.2936        0.0491        0.0919
    Four quarter lag............       -0.0798        0.0370        0.0427        0.1427       -0.0186        0.0321
    ----------------------------------------------------------------------------------------------------------------

          TABLE 9.--R-SQUARED VALUES FOR FOOD CPI SUB-INDICES REGRESSED AGAINST CURRENT AND LAGGED CORN PRICES
    ----------------------------------------------------------------------------------------------------------------
                                                                                            Dairy and    Cereals and
             Corn prices            Beef and      Pork CPI     Poultry CPI    Eggs CPI       related       bakery
                                    veal CPI                                              products CPI  products CPI
    ----------------------------------------------------------------------------------------------------------------
    Current.....................        0.0387        0.0289        0.0468        0.1733        0.0200        0.0478
    One quarter lag.............        0.0235        0.0335        0.0523  ............        0.0206        0.0402
    Two quarter lag.............        0.0090        0.0285        0.0432        0.1431        0.0154        0.0276
    Three quarter lag...........  ............        0.0088        0.0155        0.0862        0.0024        0.0084
    Four quarter lag............        0.0064        0.0014        0.0018        0.0204        0.0003        0.0010
    ----------------------------------------------------------------------------------------------------------------

        The value chain for eggs is relatively more consolidated than other
    product value chains, as there are fewer handlers; eggs also generally
    have less value added than other food categories, and their price
    elasticity of demand is highly inelastic. These are all potential
    reasons to explain the slight but notable correlation between the eggs
    CPI and the corn price. Still, this relationship is too weak to be
    statistically significant. Despite the fact that milk is also
    considered to be a highly price-inelastic product, a very weak
    correlation with corn prices (lagged or current) is exhibited.
        Considering that there are trends in some food CPI sub-indices, an
    attempt was again made to determine whether there would be a more
    notable relationship between the annual crop-year percent change in the
    corn price and the annual crop-year percent change in the food CPI sub-
    indices. Again, the eggs CPI had the strongest correlation with corn
    prices, but the R-squared value was only 0.30; the corn price variable
    was statistically significant at the 5 percent level (the first
    regression where this was the case), but it still suggests that only 30
    percent of the yearly movements in the eggs CPI can be attributed to
    yearly corn price changes (see Table 10). Other correlation and
    regression results indicate very weak price relationships--in some
    cases negative.

    TABLE 10.--RELATIONSHIP BETWEEN ANNUAL CROP-YEAR CHANGES IN FOOD CPI SUB-
                         INDICES AND CORN PRICE CHANGES
    ------------------------------------------------------------------------
                                                Correlation      R-squared
    ------------------------------------------------------------------------
    Annual crop year percentage change in            -0.1078          0.0116
     meats (beef and pork) CPI..............
    Annual crop year percentage change in            -0.0228          0.0005
     beef and veal CPI......................
    Annual crop year percentage change in            -0.1901          0.0361
     pork CPI...............................
    Annual crop year percentage change in             0.0835          0.0070
     poultry CPI............................
    Annual crop year percentage change in             0.5505          0.3031
     eggs CPI...............................
    Annual crop year percentage change in             0.2756          0.0760
     cereals and bakery products CPI........
    ------------------------------------------------------------------------

    B. Price spreads among different levels of the value chain
        There are several segments in the value chain between the farm and
    the consumer. For grains and oilseeds, there are grain elevators, bulk
    processors (e.g., flour millers and soybean crushers), further
    processors (e.g., packaged food manufacturers), wholesale distributors,
    and retail grocery and foodservice establishments that take basic
    commodities, transform them and deliver them to the consumer. For
    livestock and poultry, there are slaughterhouses and sometimes separate
    first-stage and further processors that produce in-tray meat cuts/
    poultry and packaged food products containing meats/poultry;
    distributors and retailers bring these products to consumers, while
    foodservice establishments prepare the meats/poultry before they are
    served.
        There are various economic factors (supply/demand and costs) and
    industry structure issues that determine the margins at each of these
    value-chain segments and the degree to which they can pass along cost
    increases. The historical price spreads from farm to wholesale and from
    wholesale to retail are shown in Figure 13 to Figure 15.

    C. Role of margins as shock absorbers
        Given the weak correlation between corn prices and livestock,
    poultry, egg, and milk prices (at the farm level), it can be
    hypothesized that a considerable proportion of the impact of corn price
    changes is being absorbed in the value chain in the form of reduced
    margins to livestock producers. Importantly, this does not necessarily
    mean margins for livestock producers are low or negative, but rather
    that they are lower than they would be in the absence of higher corn
    prices. This section will look at the historical relationships between
    corn prices and production margins, as well as evaluate the impact of
    recent corn price changes.
                1. Beef cattle
                    Cow-calf and cattle-feeding margins
        Calf-crop levels have been declining steadily since about 1996,
    dropping from a level of 40.3 million head to 37.6 million head in
    2007. During this same time period, a string of profitable years has
    been achieved in the cow-calf sector. Such strong profitability has not
    been experienced in the cattle feeding sector, where imputed margins
    have been negative since early 2004 (see Figure 16). This followed
    uncharacteristically high margins in 2003, which resulted mainly from
    the large increase in cattle prices during the last half of that
    year.\4\ In fact, over the long term from January 1985 to August 2007,
    average cattle feeding margins were negative, by an amount of -$15.42/
    head. However, this does not necessarily mean that cattle feeders have
    experienced sustained losses over the time period, since there are many
    cost markups associated with feedlot operations that are already
    included in their margin calculations.
    ---------------------------------------------------------------------------
        \4\ Trade disruptions in the aftermath of the first domestic case
    of BSE in Canadian cattle helped boost United States fed cattle prices
    to record levels in the fall of 2003.

        While total feed costs are undeniably affected by changes in the
    corn price, overall margins are not mirror-reflections of corn price
    changes. For one, there is often a lagged affect. The corn purchased in
    one period does not directly affect the profitability of the feeder
    steers being sold that period, but rather those that are being fed to
    be sold at a later date. Furthermore, cattle feeders anticipating
    higher corn prices will make operational adjustments. They will
    purchase fewer feeder cattle or only buy them at reduced prices; they
    can make ration adjustments to a degree; and/or they can decrease the
    number of days each animal is on feed (reducing total yardage costs and
    perhaps total feed consumption). The latter option is achieved by
    placing heavier-weight feeder cattle into the feedlot, or selling
    fattened cattle at a lower finished weight. There are also many other
    factors, such as beef demand, that affect the sales price of finished
    cattle but have nothing to do with the corn price.
        Another mitigating factor has been the ability of feedlots to
    incorporate distillers grains into their feed rations. For each bushel
    of corn ground to make ethanol, almost one-third of the material ends
    up as distillers grains, and according to industry sources,
    approximately 42 percent of the distillers grains consumed in the
    United States in 2006 were used in beef cattle rations. Distillers
    grains are a high-energy, high-protein feed source that can be used as
    a feed substitute for corn. In fact, many recent feeding trials suggest
    that feeding wet distillers grains with solubles actually increases
    feed efficiency relative to corn.
        Table 11 provides cost and revenue data for the U.S. cattle-feeding
    industry based on a proprietary feedlot production cost model developed
    by Informa. Annual data for calendar years 2004, 2005, and 2006 are
    presented. The key assumptions made are that feeder cattle are
    purchased and enter the feedlot at 750 pounds and are fed to a
    marketing weight of 1,200 pounds live, equivalent to 756 pounds carcass
    weight. The cost per head for feeder cattle entering the feedlot over
    this 3-year timeframe ranged from $774 in 2004 to $841 in 2006, with
    the 2005 cost very similar to 2006.

                                    TABLE 11.--INFORMA FEEDLOT PRODUCTION COST MODEL
                                        [Feedlot production cost model ($/head)]
    ----------------------------------------------------------------------------------------------------------------
                                          Market                           Total      Market
                                         cost on                Total     cost of    value of                Steer
              Marketing year              750 lb   Feed cost   costs in   1,200 lb   1,200 lb  Difference   carcass
                                          feeder               feedlot     feeder     feeder                 weight
                                          steer                            steer      steer
    ----------------------------------------------------------------------------------------------------------------
    2004..............................     774.40     167.92     270.00   1,044.40   1,012.97      -31.43        807
    2005..............................     838.98     135.77     247.16   1,086.14   1,054.46      -31.68        816
    2006..............................     840.99     150.92     268.72   1,109.71   1,035.62      -74.09        833
                                                   1,200 lb liveweight fed steer yields an average carcass weight of
                                                                                756 lbs
    ----------------------------------------------------------------------------------------------------------------
    Source: Informa Economics, Inc.

        Feed costs per head for 450 pounds of gain vary primarily with the
    cost of corn. Feed costs per head were about $168 in 2004, dropped to
    $136 in 2005 as corn prices declined, and then rebounded to about $151/
    head in 2006 as corn prices turned higher. Total costs per animal
    during the feeding period are also provided; most changes are directly
    related to the cost of corn. For the 3 years analyzed, the feed cost as
    a percent of total costs ranged from a low of 54.9 percent in 2005 to a
    high of 62.2 percent in 2004.
        For information purposes, a calculation of the total cost of a
    1,200 pound fed steer is provided along with the average market value
    for that same animal. As can be seen, margins for feeding these animals
    were negative in each year under study, with 2004 and 2005 losses
    amounting to just over $31/head while 2006 losses were more than double
    that at an estimated $74/head. Of note is the fact that even with a
    $32/head lower feed cost per head in 2005 relative to 2004, per-head
    production losses were the same in both years which, once again
    reflects the disconnect that exists between the cost of corn and the
    price of cattle.
                    Packer margins
        Packers have been experiencing the largest sustained losses of any
    of the beef supply chain participants. This has been a result of excess
    capacity chasing relatively tight supplies. Declining margins in the
    early 1990s forced plant shutdowns, and while margins improved in the
    mid-1990s, they have declined to historically low levels within the
    last 2 years. Figure 17 shows net packer margins since 2002.

                2. Hogs
        The hog industry has a much more integrated production system than
    the cattle industry, and as a result, pork production growth tends to
    be relatively stable, increasing at an average pace of 2 percent
    annually since 2000. Unlike cattle, hogs can not utilize forages, thus
    feed costs tend to account for a relatively large percentage of
    variable input costs.
        Hog production margins remained high but volatile throughout most
    of the 1990s. However, in the late 1990s, producers expanded rapidly at
    the same time as the packing industry was reducing capacity, resulting
    in a huge price collapse in late 1998 and poor production margins for
    the next year. Production margins recovered in 2000 and 2001 only to
    turn negative during much of 2002 and 2003, as per capita pork supplies
    increased to burdensome levels once again (see Figure 18).

        Beginning in late 2003, the U.S. pork industry began to experience
    an unprecedented boom in exports, which helped drive demand for pork
    and propel prices and margins to much higher levels. Since then, hog
    margins have remained mostly in the $20 to $30/head range, peaking
    periodically into the $40/head range and dropping down into the teens
    in early 2006. The run of profitability since 2004 has been the best on
    record. Then, starting in early 2007, as corn prices had begun to
    increase significantly, hog margins took a slight decrease down into
    the $5-$25/head range, as the higher cost of gain offset hog prices,
    which remained favorable up through the summer of 2007. In the fall of
    2007, on large production increases, hog production margins finally
    began to turn negative, ending the longest uninterrupted run of profits
    on record for the industry.
        In Table 12, the total production cost per hog is calculated and
    converted to a total cost per cwt lean; it then is compared to the
    annual average market value per cwt lean to give an indication of
    production margins. The 2004-2006 time period was the best ever in
    terms of profitability for the hog production sector. Given that the
    long-term average margin for producers would fall somewhere in the $7-
    $8/cwt lean range, the United States industry headed into 2007 with a
    strong equity and financial condition fully able to withstand potential
    margin pressures arising from higher corn costs.

                                          TABLE 12.--HOG PRODUCTION COST MODEL
                                       [Farrow to finish cost of production model]
    ----------------------------------------------------------------------------------------------------------------
                                                                          Total    Market
                                                         Feed    Total     cost    value    Margin
                                                       cost $/  cost $/   per $/   per $/  per cwt    Live   Carcass
                                                         head     head     cwt      cwt      lean    weight   weight
                                                                           lean     lean
    ----------------------------------------------------------------------------------------------------------------
    2004.............................................    49.00   114.00    57.41    71.74    14.33   262.00   199.30
    2005.............................................    37.00   103.00    51.09    68.28    17.19   264.00   200.70
    2006.............................................    40.00   105.00    52.03    64.41    12.38   265.00   201.10
                                                                                Butcher hog fed to 265 pounds
    ----------------------------------------------------------------------------------------------------------------
    Source: Informa Economics, Inc.

                3. Poultry: broilers and eggs
                    Broilers
        The broiler industry is a highly integrated and concentrated
    industry with the top 25 production operations accounting for a large
    percentage of industry output. Since the decision making at the
    production level is consolidated into few hands, the broiler industry
    has the capability of making rather quick and meaningful production
    adjustment decisions.
        There appears to be very little correlation between historical
    poultry margins and the price of corn (see Figure 19). In fact, when
    corn prices were at their lowest in early 2006, poultry margins were
    negative, and as corn prices began to take off, poultry margins climbed
    (although they took a brief dip when corn prices peaked in early 2007).
    In early 2003, poultry margins took a swing from negative to positive,
    despite relatively stagnant corn prices. This was a direct result from
    a cutback in production taken after the margin losses in 2002 and 2003.
    This cutback in production along with record high prices in late 2003
    and early 2004 led to record high margins by mid-2004. Then, as exports
    dropped off due to the high poultry prices, margins began to decline.
    Corn prices throughout all of this have had relatively little effect.
    In fact, the record-high margins in mid-2004 directly followed a corn
    price spike in the preceding months.

        As of November 2007, nearby CBOT corn futures were about $4/bushel,
    while soybean meal has been averaging near $220/ton. Based on these
    feed input prices, the feed cost per pound of broiler meat produced has
    risen to 25 cents compared to an average of 20.6 cents in 2006. This
    appreciation in feed costs has raised total production costs to nearly
    56 cents per pound. Even with this advance in feed costs, sales values
    for both whole birds and broiler parts are providing a weighted
    industry return of nearly 14 cents per pound (see Table 13).
        With financial returns of this magnitude, odds favor the industry
    increasing production rather than maintaining the slight reductions
    that started last fall and lasted through the first quarter of 2007.
    The industry did initiate a production rollback in the fall of 2006 due
    to poor margins; the weak margin situation was due to weak product
    prices in combination with rising feed costs. The production declines
    were large enough to raise product prices, and now that sales values
    have recovered so too have margins.

                                               TABLE 13.--BROILER PRODUCTION COSTS AND IMPACT OF HIGHER CORN PRICE
                                                                         [U.S. broilers]
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                    Weighted
                                                                                                                                                      net
                                                                                                                                                    returns
                                                                                                                                 Whole    Cutout      (80
                                                                                      Average      Feed      Other     Total    broiler     net     percent
                                                                          Average   eviscerated  cost per  cost per  cost per     net     returns   cutout,
                                                                        liveweight     weight       RTC       RTC       RTC     returns   per RTC      20
                                                                                                   pound     pound     pound    per RTC    pound    percent
                                                                                                                                 pound               whole
                                                                                                                                                   broilers)
                                                                                                                                                    per RTC
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    2004..............................................................       5.27         3.82      22.58     30.84     53.43     21.24     16.45      17.41
    2005..............................................................       5.38         3.90      19.52     30.84     50.36     22.46     10.21      12.66
    2006..............................................................       5.47         3.96      20.60     30.84     51.45     16.80      0.00       3.36
    2007 ($4.00/bu corn)..............................................       5.45         3.95      25.00     30.84     55.85     18.30     12.92      13.99
    2007 ($4.50/bu corn)..............................................       5.41         3.92      27.49     30.84     58.33      7.06     -4.05      -1.83
    --------------------------------------------------------------------------------------------------------------------------------------------------------

                    Eggs
        Table 14 provides estimates of shell egg production costs. The feed
    cost per dozen eggs produced has varied from a low of 23.95 cents per
    dozen in 2005 to a high of 27.54 cents in 2004. Costs in 2006 for the
    feed component of production costs averaged 25.49 cents per dozen.
    Based on shell egg selling prices in the past 3 years, margins have
    been rather variable. In 2004, margins averaged over 18 cents per dozen
    even though feed costs were high, helped by very firm egg prices. Lower
    feed costs in 2005 were accompanied by weak egg prices and margins
    slipped to 5.41 cents before recovering to 10 cents per dozen in 2006.
    As with other livestock sectors, changes in feed costs have not been
    correlated with producer margins.

                                         TABLE 14.--EGG COST OF PRODUCTION MODEL
                                          [Table egg cost of production model]
    ----------------------------------------------------------------------------------------------------------------
                                                                                                      Urner Barry MW
                                                       Feed cost per  Total cost per    Margin per       shell egg
                                                           dozen           dozen           dozen           price
    ----------------------------------------------------------------------------------------------------------------
    2004............................................          $27.54          $49.80          $18.04          $86.54
    2005............................................           23.95           45.72            5.41           68.80
    2006............................................           25.49           47.37           10.00           75.44
    $4.00 corn......................................           32.61           55.25           20.90           92.71
    $4.50 corn......................................           34.75           57.75           18.40           92.71
    ----------------------------------------------------------------------------------------------------------------

        Despite the highest feed costs in over 10 years, margins for the
    industry are the best in many years due to very strong egg prices. With
    average shell egg prices projected to be near 93 cents per dozen,
    production margins are very strong and this suggests the potential for
    expanding production rather than production declines.
                4. Milk
        Estimated milk production margins have averaged $9.35/cwt over the
    time period from January 2000 to September 2007. Milk margins declined
    in 2002-2003 when corn prices increased, but margins climbed as corn
    prices spiked in 2003-2004 (see Figure 20). Both corn prices and milk
    margins declined during the latter part of 2004 and most of 2005.
    Despite current corn prices taking off, beginning in early 2007, milk
    margins have climbed to record high levels. This suggests that corn
    prices are a very minor determinant of milk production margins and are
    not a primary driver of milk prices.

        Milk margins have been strong the past year largely as a result of
    rising milk prices, which have been driven by demand increases. U.S.
    milk consumption is increasing, and world dairy demand is also
    increasing. This world demand increase follows strong economic growth
    in many developing countries, and it is compounded by the fact that
    many major milk-producing countries, such as Australia, have been
    experiencing drought, thus tightening world milk and dairy supplies.
    Due to this strong global demand, U.S. exports of dairy products have
    increased significantly, and this has supported domestic price
    increases of milk and milk products.

                      VII. DRIVERS OF FOOD PRICE INFLATION

        Given that historical data shows little relationship between corn
    prices and consumer food prices, the question arises: What does drive
    consumer food prices? This section will explore various factors
    affecting consumer food price inflation. In summary, food price
    inflation is caused by a complex set of factors.
    A. Summary of usda models of the food CPI
        USDA-ERS periodically forecasts the food CPI, and it is frequently
    asked to evaluate the impact of input price changes. The agency has
    three different models it uses to analyze the food CPI, with the choice
    of model depending on whether or not the objective calls for an
    analysis of short-run or long-run impacts. The ERS price-spread model
    and input-output model are used to analyze short-run impacts, while the
    variable proportions model is used in long-run analyses.
        The price-spread model uses a weighted sum of percent changes in
    input prices from 16 food industries to estimate input price change
    effects on at-home food prices, where each input change is weighted by
    its respective cost share. It is assumed that each firm in each of the
    16 food industries produces a single end-product; accordingly, the
    model combines a farm commodity with a set of non-farm inputs in fixed
    proportions.
        Alternatively, the input-output model, while similar to the price-
    spread model, considers the indirect effects of changing input costs.
    For example, an increase in energy will not only affect the cost of
    producing the food item, but it will also impact the costs of producing
    other food production inputs. This model uses a system of equations
    from 50 food industries and 430 nonfood industries. Both of the short-
    run models assume that consumers do not respond to retail price changes
    and that food producers do not alter their input proportions.\5\
    ---------------------------------------------------------------------------
        \5\ This may be a rather strong assumption, especially for certain
    food products in which demand is elastic, there are multiple substitute
    products available to consumers, or for which there are substitute
    products available within the production process.
    ---------------------------------------------------------------------------
        However, the long-run model, the variable proportions model,
    relaxes these short-run restrictions. This eight-market food model uses
    a system-of-equations approach: (1) the first equation relates the
    industry's retail price to the price of one marketing or non-farm
    input, the exogenous farm supply, and the shift in consumer demand; and
    (2) the second equation relates the industry's farm price with the same
    three variables. Analyses using the variable proportions model have
    shown that changes in input prices do not always lead to food price
    increases. This effect is mitigated by firms altering their input
    proportions and by changing consumer demand.\6\
    ---------------------------------------------------------------------------
        \6\ Reed, A.J., K. Hanson, H. Elitzak, and G. Schluter. 1997.
    ``Changing Consumer Food Prices: A User's Guide to ERS Analyses.''
    Technical Bulletin #1862. Economic Research Service, Washington, DC.
    ---------------------------------------------------------------------------
        The ERS lists four key factors as influencing how input cost
    increases affect food prices.\7\ The first is the share of total costs
    accounted for by the input (this is discussed in detail below). The
    second is whether or not the input has adequate substitutes in the
    production process. the third is whether or not consumers have good
    substitutes for the food product. Last is the time period considered.
    In the short run, producers and consumers might not be able to adjust
    to price changes. If the price change is permanent, such adjustments
    can be made, but on the other hand, this might cause some firms to go
    out of business, causing the price increase to be greater in the long
    run.
    ---------------------------------------------------------------------------
        \7\ Economic Research Service. 2007. ``Food CPI, Prices, and
    Expenditures: How Changes in Input Costs Affect Food Prices.''
    Retrieved from www.ers.usda.gov/Briefing/CPIFoodAndExpenditures/
    howchangesininputcostsaffectf.
    ---------------------------------------------------------------------------
    B. Food marketing costs
                1. Composition of the retail food dollar
        The share of the final food product price accounted for by the cost
    of commodities purchased from producers has declined over the years.
    According to consumer expenditure data collected by the BLS and
    reported by the USDA, the ``farm value'' accounts for 19 percent of
    total food costs. This proportion has declined significantly from 37.2
    percent in 1973 (see Figure 21).
        The remaining portion of total retail food costs (i.e., in addition
    to the farm value) is known as the marketing bill. The marketing bill
    includes labor, packaging, transportation, energy, profits,
    advertising, depreciation, rent, interest, repairs, business taxes, and
    other costs.
        With the decrease in the share of the food dollar accounted for by
    the farm value of raw materials, corn price changes have a declining
    impact on the overall food retail price. Furthermore, within many food
    items, corn constitutes only a portion of the farm value. Thus, in
    items where corn is only one of several farm inputs, total food costs
    attributable to the cost of corn will be on average even less than 19
    percent.
        While 19 percent represents the average share of farm value in the
    retail food dollar, this percentage varies considerably among food
    items. Table 15 provides the most current annual average data available
    for food categories for which the USDA estimates the farm value share
    of the retail food price.\8\
    ---------------------------------------------------------------------------
        \8\ The most recent annual average data available for cereals and
    bakery products, fats and oils, and dairy were for 2005. Annual
    averages were available for 2006 for meat product data.

        TABLE 15.--FARM VALUE SHARE OF RETAIL FOOD PRICE BY FOOD CATEGORY
    ------------------------------------------------------------------------
                                                               Farm value as
                      Food product category                    percentage of
                                                               retail price
    ------------------------------------------------------------------------
    Cereals and bakery items................................               6
    Beef....................................................              47
    Pork....................................................              30
    Chicken.................................................              36
    Dairy products..........................................              36
    Fats and oils...........................................              17
    ------------------------------------------------------------------------

        The farm value share of the food dollar is provided for specific
    food products rather than categories in Table 16. The product examples
    that were selected for the table either are derived from corn or are
    commodities affected by the corn market (e.g., livestock, poultry,
    wheat, and soybeans). Again, total farm-based input costs are shown,
    not only the cost of corn.

              TABLE 16.--EXAMPLES: COST OF FARM INPUTS AS A SHARE OF PRICES OF SELECT RETAIL FOOD PRODUCTS
    ----------------------------------------------------------------------------------------------------------------
                                                                                                          Cost of
                                                                        Farm value    Example retail     input(s)
                              Food product                               share of      prices (price  purchased from
                                                                       retail price     per pound)      farm (price
                                                                       (percentage)                     per pound)
    ----------------------------------------------------------------------------------------------------------------
    Milk, \1/2\ gal.................................................              34           $3.84           $1.31
    Flour, wheat, 5 lbs.............................................              19            0.36            0.07
    Bread, 1 lb.....................................................               5            1.21            0.06
    Margarine, 1 lb.................................................              15            1.26            0.19
    Corn flakes, 18 oz. box.........................................               4            1.65            0.07
    Corn syrup, 16 oz. bottle.......................................               3            1.57            0.05
    Ground beef, 1 lb...............................................              47            2.37            1.11
    Bacon, sliced...................................................              28            3.78            1.06
    Chicken, fresh whole............................................              47            1.14            0.54
    ----------------------------------------------------------------------------------------------------------------
    Sources: USDA, ERS (utilizing most current data available for each food product category, as of October 2007)

                 VIII. PERSPECTIVE ON COMMODITY PRICE INFLATION

        Although it has been shown in the preceding sections of this report
    that corn price changes have, at most, a weak correlation with changes
    in the food CPI, additional context can be provided to this report by
    examining not only the higher corn prices that have occurred since fall
    2006 but also the environment of general commodity price inflation in
    which this has been occurring.
    A. Corn prices
        The ``conventional wisdom'' expressed in the media is that a
    dramatic increase in the use of corn in ethanol production caused corn
    prices to increase substantially, particularly since the fall of 2006.
    However, even the reason for the increase in corn prices is more
    complex than indicated by the media.
        Fueled by a record yield, the United States harvested a record corn
    crop of 11.8 billion bushels in 2004. In 2005, acreage remained steady,
    but a more historically consistent yield led production to fall to 11.1
    billion bushels. Then, in the spring of 2006, price signals in the
    futures markets gave farmers the incentive to plant more soybeans, and
    the acreage planted to corn fell by 3.5 million acres. Combined with
    relatively flat yields, corn production fell for the second year in a
    row, to 10.5 billion bushels.
        Thus, corn production fell by 1.3 billion bushels over 2 years,
    even though the usage of corn in ethanol production expanded from 1.3
    billion bushels in 2004-2005 to 2.1 billion bushels in 2006-2007 (see
    Figure 22). Yet, the ethanol industry was not the only source of
    additional demand. U.S. corn exports, which were 1.8 billion bushels in
    2004-2005, rose to 2.1 billion bushels in both 2005-2006 and 2006-
    2007--a level that was at the top of the range experienced over the
    previous decade. So, it was basic supply and demand--a reduction in
    supply and an increase in demand from both ethanol and exports--that
    led to prices moving higher in the fall of 2006.

        Then, in 2007, U.S. farmers proved that they could respond to the
    market's need for more corn. In the 1996 and 2002 Farm bills, producers
    had been relieved of the base-acre and set-aside systems that had
    previously restricted what they could plant, and they now had ``freedom
    to farm''--the ability to allocate their crop acreage as they saw fit,
    with few remaining constraints. With this freedom and corn prices that
    provided a significant net revenue premium per acre over soybeans,
    farmers planted 93.6 million acres of corn in 2007--the highest level
    since the 1940s. As of November 2007, the USDA estimates the crop at a
    record 13.2 billion bushels (see Table 17).
        As was mentioned earlier in this report, the level of corn stocks
    at the end of the crop year relative to the volume of corn consumed
    during the year is a key factor in the pricing of corn. At the end of
    2004-2005, when the previous record crop was harvested, the stocks-to-
    use ratio was nearly 20 percent, which is plentiful by recent
    historical standards. However, with lower production and rising ethanol
    usage and exports, the stocks-to-use ratio was cut almost in half, to
    just under 12 percent, in 2006-2007. This was reflected in
    substantially higher prices.
        Despite Informa's projections of an almost 800-million-bushel
    increase in the corn grind for ethanol and an additional 250 million
    bushels of exports, the record crop of 2007 is forecast to allow stocks
    to build to over 2.1 billion bushels by the end of the crop year,
    allowing the stocks-to-use ratio to rebound to 17.1 percent. Normally,
    this would be expected to allow prices to ease significantly. However,
    soybean oil prices have been lifted by rising crude oil (petroleum)
    prices, and as a result the pace of soybean consumption is expected to
    bring stocks to meager levels by the end of the 2007-2008 crop year,
    and if there is not a rebound in soybean acres planted in 2008 stocks
    could reach unsustainably low levels. This has led to upward pressure
    on soybean prices, and in order for corn acreage not to fall too far in
    the face of continued ethanol industry expansion--and likely continued
    strength in exports given weakness in the U.S. Dollar--the market has
    maintained relatively high corn futures prices.
        Based on futures prices as of November 2007, farmers would be
    expected to plant nearly 89 million acres of corn in 2008. If this were
    to occur, Informa's forecast of the stocks-to-use ratio for 2008-2009
    would be 16.5 percent, which is ample but not burdensome. The national
    average farm price for corn, which Informa forecasts to be $3.25/bu in
    2007-2008 would be forecast to fall to $2.85/bu in 2008-2009 under this
    scenario.
        However, absent a very favorable soybean yield in 2008, such a high
    level of corn plantings would likely not allow soybean production to be
    sufficient to prevent stocks from falling to an unsustainable level,
    and prices would have to rise even further to ration demand.
    Accordingly, it is expected that by the spring of 2008 the market will
    anticipate this imbalance, and corn acres will be reduced further, with
    balance perhaps occurring at roughly 86 million acres of corn. In this
    case, even with no change in the demand forecast, the stocks-to-use
    ratio for corn would be forecast to recede to 12.7 percent in 2008-
    2009, which would be sufficient and would allow corn prices to come
    down.

                                                               TABLE 17.--U.S. CORN BALANCE SHEET
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                   97/98    98/99    99/00    00/01    01/02    02/03    03/04    04/05    05/06    06/07    07/08    08/09
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Planted acres...............................     79.5     80.2     77.4     79.6     75.7     78.9     78.6     80.9     81.8     78.3     93.6     88.9
    Harvested acres.............................     72.7     72.6     70.5     72.4     68.8     69.3     70.9     73.6     75.1     70.6     86.1     81.8
    Yield.......................................    126.7    134.4    133.8    136.9    138.2    129.3    142.2    160.4    148.0    149.1    153.0    160.0
                                                 ===========================================================================================================
    Beginning inventories (September 1).........      883    1,308    1,787    1,718    1,899    1,596    1,087      958    2,114    1,967    1,304    2,117
    Production..................................    9,207    9,759    9,431    9,915    9,503    8,967   10,089   11,807   11,114   10,535   13,168   13,083
    Imports.....................................        9       19       15        7       10       14       14       11        9       12       10       10
                                                 -----------------------------------------------------------------------------------------------------------
          Total supply..........................   10,099   11,085   11,232   11,639   11,412   10,578   11,190   12,776   13,237   12,514   14,482   15,209
                                                 ===========================================================================================================
    Feed and residual...........................    5,479    5,469    5,665    5,842    5,864    5,563    5,795    6,158    6,155    5,598    5,700    5,400
    Food/seed/industrial........................    1,805    1,846    1,913    1,957    2,047    2,340    2,537    2,686    2,981    3,488    4,290    5,500
        Of which: ethanol for fuel..............      481      526      566      628      706      996    1,168    1,323    1,603    2,117    2,900    4,100
                                                 ===========================================================================================================
        Domestic use............................    7,284    7,316    7,578    7,799    7,911    7,903    8,332    8,844    9,136    9,086    9,990   10,900
    Exports.....................................    1,507    1,983    1,937    1,941    1,905    1,588    1,900    1,818    2,134    2,124    2,375    2,150
                                                 -----------------------------------------------------------------------------------------------------------
          Total use.............................    8,791    9,298    9,515    9,740    9,815    9,491   10,232   10,662   11,270   11,210   12,365   13,050
                                                 ===========================================================================================================
    Ending inventories (August 31)..............    1,308    1,787    1,718    1,899    1,596    1,087      958    2,114    1,967    1,304    2,117    2,159
                                                 ===========================================================================================================
    Stocks/use (percent)........................     14.9     19.2     18.1     19.5     16.3     11.4      9.4     19.8     17.5     11.6     17.1     16.5
                                                 ===========================================================================================================
    Futures price ($/bu)........................     2.57     2.16     2.10     2.09     2.15     2.37     2.64     2.12     2.23     3.54     3.55     3.25
    Farm price ($/bu)...........................     2.43     1.94     1.82     1.85     1.97     2.32     2.42     2.06     2.00     3.03     3.25     2.85
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Sources: USDA, CBOT (History); Informa Economics.

        Thus, producers have demonstrated their ability to respond swiftly
    to market conditions in making their acreage decisions. Assuming normal
    weather, this ability and willingness to shift acres is expected to
    mitigate any further inflationary pressures on corn prices through at
    least the 2008-2009 crop year, despite expectations for continued rapid
    growth in the ethanol industry. As a final note, there is evidence that
    the biotech corn traits that were first introduced in the United States
    in 1996 and have been gaining broader adoption in recent years have led
    to the potential for above-trend yields to be achieved; to the extent
    that this occurs or technology developments accelerate, this would
    further mitigate any upward pressure on corn prices.
    B. General commodity and macroeconomic inflation
        The increase in corn prices since the fall of 2006 is not occurring
    in a vacuum, and in fact the Reuters/Jeffries CRB index, an index of
    commodity prices, has more than doubled since 2001 (see Figure 23). The
    index is a weighted average of the prices of 19 commodities in three
    categories: energy, agriculture, and metals.

        Crude oil, heating oil, and unleaded gasoline carry one-third of
    the overall weighting of the index. Therefore, it is not surprising
    that the index has been on a prolonged run as crude oil prices have
    surged from around $20/barrel in November 2001 to almost $100/barrel in
    November 2007 (see Figure 24).

        However, the weighting of energy commodities in the index masks the
    fact that the prices of metals and, more recently, agricultural
    commodities have been increasing. There is some interrelation of the
    price increases, as the demand for basic materials that has been
    generated by the strong economic growth in developing countries,
    especially China and India, encompasses not only energy but also
    metals. Higher energy prices have been a contributor to higher
    agricultural commodity prices as well, since they have fostered higher
    prices for ethanol and biodiesel and the expansion of those industries.
    Moreover, the depreciation of the U.S. Dollar, which has been
    particularly acute in the fall of 2007, has affected the prices of
    multiple commodities, making U.S. corn more affordable and thereby
    increasing export demand, and contributing to the rise in oil prices
    (see Figure 25).

        In summary, corn has been one of several commodities that have
    experienced upward price pressure in recent years. Historically, rising
    prices for commodities in general--not corn in isolation--have
    contributed to overall macroeconomic inflation (see Figure 26). This
    was particularly the case during and after the oil price shocks of the
    1970s. However, as the U.S. economy has become more service oriented
    and the manufacturing sector has accounted for a declining share of
    gross domestic product, there has been less of a direct impact of
    higher commodity prices on general inflation. Productivity gains have
    also helped dampen inflation.

                                IX. CONCLUSIONS

        While there have been a number of stories in the media over the
    last year indicating that consumer food prices are being driven higher
    by an ethanol-induced increase in corn prices, there is little evidence
    of such a simplistic cause-and-effect linkage. In reality, a complex
    set of factors drives the food CPI. In fact, the marketing bill,
    defined as the portion of the food dollar that is not related to the
    farm value of raw materials, has a stronger relationship with the food
    CPI than does the cost of corn. While an increase in corn prices will
    affect certain industries--for example, causing livestock and poultry
    feeding margins to be lower than they otherwise would have been--the
    statistical evidence does not support a conclusion that there is a
    strict ``food-versus-fuel'' tradeoff that is automatically driving
    consumer food prices higher.

             APPENDIX A: BACKGROUND ON THE ``FOOD VS. FUEL'' DEBATE

    A. Media coverage
        There has been no shortage of media attention given to the food-
    versus-fuel debate since late 2006. Major news sources such as The
    Washington Post, Los Angeles Times, CBS News, U.S. News & World Report,
    and The Wall Street Journal have run stories indicating that rising
    corn demand is causing an increase in consumer food prices. The
    following quotes are representative of stories and editorials that have
    been carried by the media:
      --``Corn prices in America have spiked. And since corn is also a
            prime ingredient for animal feeds and sweeteners, prices
            likewise are rising for poultry, beef and everything from soft
            drinks to candy.'' (The Washington Post; June 30, 2007)
      --``While we worry about gas prices, the cost of milk, meat, and
            fresh produce silently skyrockets. So like the end of cheap
            energy, is the era of cheap food also finally over?''
            (Washington Times; June 30, 2007)
      --``. . . rising food prices are threatening the ability of aid
            organizations to help the world's hungriest people . . .''
            (Christian Science Monitor, quoted by CBS News; July 29, 2007)
      --``Food prices were up 3.9 percent in April over a year ago. The
            overall inflation rate in the same period: 2.6 percent. Over
            the past 5 years, food prices have risen 12.2 percent
            nationwide. . . . Fuel costs and rising demand for corn are
            helping to drive the higher prices, experts said. Corn, for
            instance is in growing demand to make ethanol. Because it's
            used so much in cattle feed, that's pushing up prices for meat,
            milk, and eggs.'' (Chicago Sun Times; June 6, 2007)
      --``Ethanol already consumes so much corn that signs of strain on the
            food supply and prices are rippling across the marketplace.''
            (U.S. News & World Report; February 4, 2007)
      --``Further, there's only so much farmland to go around. To meet the
            Senate's 2022 renewable-fuels mandate of 35 billion gallons
            using corn would take 96 million acres. Last year, the entire
            corn crop, most of which went to food, was grown on 80 million
            acres. The only source of unused farmland is 37 million acres
            in the Federal Conservation Reserve Program, under which the
            Government rents cropland from farmers for wetlands and
            wildlife.'' (L.A. Times; August 20, 2007)
        However, not all mainstream media reports have drawn a simplistic
    link between ethanol production and food prices. Bad weather,
    increasing export demand for certain food products, and high
    transportation costs resulting from rising fuel prices also have been
    cited as being additional drivers of recent food price increases.
    Additionally, the declining cost of corn as a proportion of total food
    prices has been used as a counter-argument, particularly regarding the
    prices of higher value-added products. Recently, the U.S. Department of
    Agriculture (USDA) acting Secretary Chuck Conner was noted as saying,
    ``Ethanol fuel is getting too much of the blame for what's happening in
    grocery store aisles'' (Food and Fuel America; October 5, 2007).
        While the statements made in the mainstream media are what reach
    the general public, there is not necessarily much analytic rigor behind
    them. Given all the claims and counter-arguments in the media, and
    given the importance of the policy debate occurring regarding renewable
    fuels, it is useful to look at more in-depth, analytically oriented
    research on whether there is a connection between ethanol production
    and consumer food prices.
    B. Research publications
        Despite the considerable amount of attention given to this topic by
    the media, relatively few studies have been conducted to provide
    evidence supporting one side or the other on this issue.
                1. Center for Agricultural and Rural Development
        A study entitled ``Emerging Biofuels: Outlook of Effects on U.S.
    Grain, Oilseed, and Livestock Markets'' (May 2007) was conducted by the
    Center for Agricultural and Rural Development (CARD) at Iowa State
    University. This study utilized a multi-product, multi-country,
    deterministic partial-equilibrium model to evaluate the impacts of
    ethanol production on planted acreage, crop prices, livestock
    production and prices, trade, and retail food costs. The analysis
    assumes current tax credits and trade policies are maintained.
    Essentially, the study authors customized the modeling system of the
    Food and Agricultural Policy Research Institute (FAPRI), which models
    supply and demand for all important temperate-climate agricultural
    products. This model was then utilized to analyze long-run equilibrium
    prices under several ethanol outlook scenarios.
        The CARD study concluded that ethanol expansion will cause long-run
    crop, livestock, and retail food price increases. The study predicted
    that in the long run, general food prices (food at home and food away
    from home) will increase 0.7 percent to 1.8 percent more than they
    otherwise would have.
        There were two basic ethanol scenarios considered. Under the
    baseline oil-price assumption, model results indicate a 0.7 percent
    increase in food prices due to ethanol production. If oil prices were
    $10/barrel higher than the baseline assumption, the ethanol impact on
    food prices increases to 1.8 percent. The highest increases are
    predicted for at-home food prices (0.9 percent-2.2 percent), whereas
    away-from-home food-price increases are slightly more modest (0.6
    percent-1.5 percent).
        The study then deconstructs the predicted increase in prices of
    food consumed at home into more specific food item categories,
    predicting that the greatest inflationary pressure will be evident in
    the eggs market. The range in consumer egg price inflation as a result
    of ethanol production is estimated between 5.4 percent and 13.5
    percent. Additional consumer price inflation is estimated to range
    between 2.5 percent and 6.3 percent for meats, between 1.4 percent and
    3.5 percent for dairy, and 0.5 percent to 1.2 percent for cereal and
    bakery products.
                2. National Corn Growers Association/Advanced Economics
                        Solutions
        The National Corn Growers Association (NCGA) released a report in
    March 2007 addressing the impact of higher corn prices on consumer food
    prices. They compiled the analyses/reports of the USDA, the Bureau of
    Labor Statistics (BLS), and Advanced Economics Solutions (AES, a
    consulting firm commissioned by the NCGA to analyze the impact of
    increased corn prices on retail food prices). Given USDA estimates of
    food input costs as a percentage of retail food prices and hypothetical
    corn prices of $3.50 to $4.00 per bushel (bu), AES estimated that
    retail prices for meat, poultry, fish, and eggs would be 4 percent to
    11 percent higher than they otherwise would have been during the 2007-
    2009 period. As for consumer dairy prices, increases in the range of
    4.3 to 8.3 percent were predicted. The study predicts a much lower
    increase in price inflation levels for cereal/bakery items of 0.67
    percent to 1 percent annually. However, an important assumption behind
    the study is that while food-processing margins might be compressed in
    the short run due to higher corn prices, in the long run all of the
    increase in corn prices will be passed on to consumers.
                3. U.S. Department of Agriculture
        The publication ``USDA Agricultural Projections'' (February 2007),
    which was also incorporated into the NCGA report, projected market
    impacts related to ethanol supply; corn production, prices, and usage;
    other crop production and prices; livestock production and prices
    (including the impact of distiller's grains); and farmland values. The
    study concluded:
      --Consumer price inflation rates for red meats, poultry, and eggs
            will exceed the general inflation rate between 2008 and 2010,
            raising the inflation rate of food prices (all food) above the
            general inflation rate by as much as about 0.5 percent;
      --Despite this initial period of higher food price inflation, on
            average, retail food prices will increase less than the general
            inflation rate over the next 10 years (the food-price inflation
            rate is predicted to fall below the general inflation rate
            after 2010); and
      --Highly processed foods, such as cereals and bakery products, will
            rise at a rate near the general inflation rate.\9\
    ---------------------------------------------------------------------------
        \9\ Since the USDA projections were released in February 2007, some
    of the assumptions are now out of date. For instance, study authors did
    not foresee 93 million acres planted to corn in 2007, or wheat supply
    issues that have caused a spike in wheat prices.
    ---------------------------------------------------------------------------
                4. American Farm Bureau Federation
        The American Farm Bureau Federation published an article (July
    2007) in which it indicated that while meat and dairy consumer price
    indices (CPI) have increased more than the ``core CPI'' (i.e., the
    average rate of inflation in the general economy, excluding food and
    energy prices), these increases are not related to corn prices. The
    analysis illustrates that recent corn price increases are not related
    to meat and dairy prices (on-farm). The point is made in the article
    that meat prices were increasing long before corn prices started to
    increase. It concludes that with little relationship between corn
    prices and meat and dairy prices, very little of the increase in food
    costs--particularly for meat and dairy products--can statistically be
    attributed to increased corn prices.

        Senator Brownback. The figure that I've seen is that it
    reduces the price 15 percent; the gasoline price in the country
    would be 15 percent higher if not for ethanol. So I think we've
    got to look at this thing as an overarching supply and demand
    situation. While you take corn out of the market to make
    ethanol, it doesn't go in the trash can; it goes in the gas
    tank; and that there's a supply and demand there that has a
    positive impact.
        Plus, I was looking at the prices. In this country we don't
    eat that much corn directly. We do some, but mostly it's fed to
    livestock. So it has an indirect impact on the overall food
    prices in this country. You can escalate corn prices 40 percent
    with having minimal, less than 1 percent, impact on overall
    food prices in the country.
        Do you chart that number or look at that number?
        Mr. Lukken. Yes, we look at all sorts of fundamental
    numbers like that, yes.
        Senator Brownback. I hope you can supply that one to us as
    well.
        Thank you, Mr. Chairman.
        [The information follows:]

        Senator Durbin. Chairman Lukken, thank you very much. We
    appreciate your testimony today. We look forward to sending you
    some questions in writing, myself and other members of the
    subcommittee, and hope you can give us some timely answers.
        Mr. Lukken. Thank you for allowing me to testify.
        Senator Durbin. You bet.
                       SECURITIES AND EXCHANGE COMMISSION

    STATEMENT OF HON. CHRISTOPHER COX, CHAIRMAN
        Senator Durbin. Chairman Cox, welcome to the subcommittee.
    Senator Brownback and I are minimizing our opening statements
    so that we'll have a few more moments to ask questions and not
    take too much of your own time. If you would like to summarize
    your opening statement, the entire written statement will be
    made part of the record.

                               SUMMARY STATEMENT

        Mr. Cox. Thank you very much, Mr. Chairman, Senator
    Brownback, and members of the subcommittee. Thank you for the
    opportunity to testify today about the President's fiscal year
    2009 budget request for the SEC.
        I'll begin by saying that, in return for the SEC's not
    quite $1 billion budget, the taxpaying public is getting
    significant value. The SEC oversees the nearly $44 trillion in
    securities trading annually on U.S. equity markets, the
    disclosures of about 13,000 public companies, and the
    activities of about 11,000 investment advisers, 1,000 fund
    complexes, and 5,700 broker-dealers.
        The Commission is active on a number of fronts working to
    protect investors, promote capital formation, and foster
    healthy markets. The failure of Bear Stearns has brought to the
    fore the regulatory gap in the supervision of investment banks.
    Although Federal law provides for supervision of commercial
    banks, no such scheme exists for the largest investment banks.
    The Commission created the voluntary Consolidated Supervised
    Entities (CSE) Program to partly fill this gap. Without this
    voluntary program, there would have not been any consolidated
    information available to regulators, including the New York
    Fed, when Bear Stearns precipitously lost liquidity in mid-
    March 2008.
        While the CSE program is at present voluntary and receives
    no dedicated funding from the Congress, we understand that
    Congress may be acting to fill this gap. I strongly support
    this because of the fact that even today the SEC has no
    explicit statutory mandate to supervise the Nation's investment
    banks on a consolidated basis. It is a statutory no-man's-land
    that should not be tolerated indefinitely.
        For the meantime, I have prepared information for the
    subcommittee concerning the SEC's proposed increases to the
    staffing in the CSE Program that I have submitted along with my
    testimony.
        In addition to the important work of investment bank
    supervision, the Congress recently gave the Commission
    significant new statutory authority over credit rating
    agencies. That has permitted us to register credit rating
    agencies with the SEC beginning last fall. As of the end of
    September 2007, seven credit rating agencies, including those
    that are most active in rating subprime securities, became
    subject to the Commission's new oversight authority.
        In the 6\1/2\ months since the Commission's authority over
    these credit rating agencies went into effect, two additional
    ratings agencies have registered with the Commission, so that
    now there are nine nationally recognized statistical rating
    organizations registered with the SEC and in competition in the
    marketplace.
        We have aggressively used our new examination authority
    under the new law to evaluate whether credit rating agencies
    are adhering to their published methodologies for determining
    ratings and managing conflicts of interest. We will shortly
    publish the findings of these examinations, which have focused
    on the three largest firms most active in rating subprime-
    related securities, and we will soon propose significant new
    rules governing credit rating agencies that build on the
    lessons learned from the recent subprime market turmoil.
        Through the SEC's broader inspection and examination
    program, the SEC is focusing on securities firms and the
    adequacy of their controls over valuation, their controls to
    prevent insider trading, the level of protection they provide
    to seniors in our markets, and the adequacy of their compliance
    programs to prevent, detect, and correct violations of the
    securities laws.
        The SEC is also working closely with our fellow regulators
    to promote the fairness and stability of the markets. Under the
    recently concluded MOU with the CFTC to which you just
    referred, Mr. Chairman, and Mr. Chairman Lukken has just talked
    to you about, we have established what we hope will be a
    durable process to better regulate today's increasingly
    interconnected markets.
        To better anticipate future problems across all areas of
    the securities markets, we are more than doubling the size of
    the SEC's Office of Risk Assessment. The newly expanded office
    will help throughout the Commission to look around the corners
    and over the horizon in order to identify potentially dangerous
    practices before they impact large numbers of investors and the
    economy as a whole.
        From both a budget and a policy standpoint, the SEC is
    first and foremost a law enforcement agency. The budget
    submission for fiscal 2009 would represent the largest amount
    of money ever devoted by the agency to pursuing wrongdoers in
    all corners of the securities markets. To lever the
    effectiveness of that investment, we are using new technology,
    including a new agency-wide enforcement database called the
    Hub, along with improved management of resources to focus our
    enforcement efforts on the areas of greatest risk for
    investors.
        The Enforcement Division is aggressively investigating
    possible fraud, market manipulation, and breaches of fiduciary
    duty in the subprime area through our subprime working group.
    It's also pursuing significant investigations of insider
    trading, wrongdoing in the municipal bond market, Internet and
    microcap fraud, and scams against seniors. We've taken
    additional steps to safeguard investors and protect the
    integrity of the markets by redoubling our efforts to stamp out
    abusive naked short selling, including recently proposing a
    rule that would explicitly target naked short selling as fraud.
        The SEC is also building upon its growing success in
    returning funds to harmed investors. Since the agency first
    received authority from Congress under the Sarbanes-Oxley Act
    to use FAIR funds, we have returned a total of more than $3.7
    billion to harmed investors. We expect to distribute another
    three-quarters of $1 billion in the next 6 months alone, aided
    by the establishment of a dedicated Office of Distributions and
    Collections and a new computer tracking system for investor
    funds from penalties and other sources called Phoenix.
        The SEC's efforts in the international arena have by
    necessity been a key focus of my chairmanship. The world's
    regulatory and enforcement authorities are finding that we have
    to collaborate if we are to protect our own investors.
    Accordingly, the SEC is working closely with our international
    counterparts to monitor the markets and pursue fraudsters
    wherever they run.
        We're also exploring the idea of mutual recognition among a
    very few high standards countries with robust regulatory and
    enforcement regimes in order to strengthen our level of
    cooperation.
        In recognition of the interconnectedness of global markets,
    the SEC is continuing to expand our own expertise in
    international financial reporting standards and to explore
    additional ways that U.S. investors might benefit from the
    increased comparability of investments in the marketplace that
    would result from using a truly global high-quality standard.
        This year, after years of experience through the SEC's
    voluntary interactive data pilot program, the Commission will
    consider beginning to migrate public company filing with the
    SEC to interactive data. That would allow investors to have far
    easier access to information from the paper forms and financial
    statements that companies have filed since the 1930s. In
    addition, they would be able to use computers to easily and
    instantly compare information about the companies and funds in
    which they invest.
        There are other investor-friendly improvements in store for
    mutual fund disclosure. In the coming months the SEC will
    consider allowing investors to have access to a summary
    prospectus for mutual funds that would succinctly present key
    facts about their funds up front and, with progressively more
    detailed information available in layers, give them an
    opportunity to exploit the Internet's easy search capabilities.

                               PREPARED STATEMENT

        Mr. Chairman, these are only some of the highlights of what
    the agency has recently been focused on and what we have
    planned for the coming year. The SEC's mandate is as broad as
    it is important to America's investors and to our markets. On
    behalf of the agency, let me thank you for the support that you
    and this subcommittee have so well provided for these vital
    efforts. I want to thank you for this opportunity to discuss
    the SEC's appropriation for fiscal 2009, and I look forward to
    working with you to meet the needs of our Nation's investors.
    I'll be happy to answer your questions.
        [The statement follows:]

                     Prepared Statement of Christopher Cox

        Chairman Durbin, Ranking Member Brownback, and members of the
    subcommittee: Thank you for the opportunity to testify today about the
    President's fiscal year 2009 budget request for the Securities and
    Exchange Commission.
        As you know, until this year the Congress had not increased the
    SEC's budget for 3 years. If the President's budget request for another
    increase next year is approved, then after years of flat budgets, the
    SEC will have received a roughly four percent increase over 2 years.
    After taking inflation and pay increases into account, this budget for
    fiscal year 2009 would permit the SEC to keep staffing on par with
    levels in fiscal year 2007--at about 3,470 full-time equivalents.
        In return for the SEC's not-quite $1 billion budget, the tax-paying
    public gets significant value. The SEC oversees the nearly $44 trillion
    in securities trading annually on U.S. equity markets; the disclosures
    of almost 13,000 public companies; and the activities of about 11,000
    investment advisers, nearly 1,000 fund complexes, and 5,700 broker-
    dealers. By way of illustration, let me outline some of what the agency
    achieved during fiscal year 2007.

                           REVIEW OF FISCAL YEAR 2007

        For the SEC's Enforcement Division, which polices the markets and
    helps keep investors' money safe, fiscal year 2007 was truly a notable
    year. The Division's results are impressive both in the number of cases
    filed--the second highest in Commission history--and in their
    substance, covering a range of topics of critical importance to
    investors.
        Among many highlights, the Commission brought one of the most
    significant insider trading cases in 20 years. We filed options
    backdating cases against executives at companies in a range of
    industries, to stamp out that notorious abuse. Even non-investors
    benefited from the Commission's efforts: our anti-spam initiative was
    credited with a 30 percent reduction in the volume of stock market spam
    emails in an independent industry review. In all, the SEC forced
    wrongdoers to give up more than $1 billion in illegal profits and pay
    more than $500 million in financial penalties. In the 17 years since
    the Congress gave the SEC authority to collect penalties against
    companies, this is the fifth highest penalties and disgorgement total
    ever, and $1 billion above the pre-Enron average of the 1990s.
        The SEC also continued to aggressively combat scams targeting the
    retirement savings of America's senior citizens. In fiscal year 2007,
    the Enforcement Division brought 30 enforcement actions involving
    investment fraud, abusive sales practices, and other schemes aimed
    against seniors. In addition, our examination and investor education
    programs joined with other regulators, law enforcement agencies, the
    Financial Industry Regulatory Authority, and others to conduct
    examination sweeps and sponsor events to educate seniors across the
    country.
        The Commission also reached an important new agreement to share
    enforcement and examination information with the Financial Crimes
    Enforcement Network (FINCEN), to assist in the identification,
    deterrence, and interdiction of terrorist financing and money
    laundering. The agreement will help ensure that SEC-regulated firms
    have robust anti-money laundering programs and identify financial
    institutions that are in violation of the Bank Secrecy Act.
        The SEC's examination program also worked to identify compliance
    issues at brokerage firms and investment advisers and correct such
    problems before they could harm investors. In fiscal year 2007, the SEC
    conducted more than 2,400 examinations of investment advisers and
    investment companies, broker-dealers, transfer agents, and self-
    regulatory organizations. Overall, 75 percent of investment adviser and
    investment company examinations and almost 82 percent of broker-dealer
    examinations revealed some type of deficiency or control weakness.
    Importantly, most examinations resulted in improvements in the firms'
    compliance programs. Where appropriate, inspection results were
    referred for enforcement action.
        In fiscal year 2007, we also initiated a new program for broker-
    dealer chief compliance officers that seeks to help them improve their
    compliance programs, called the CCOutreach BD program. This program has
    been a great success, involving hundreds of participants.
        On the regulatory front, the Commission reformed the implementation
    of Section 404 of the Sarbanes-Oxley Act, to fulfill the congressional
    intent that the law's objectives be achieved without waste and
    inefficiency. These reforms included Commission approval of a new
    auditing standard to ensure that 404 audits are conducted in a more
    cost-effective way, and that they focus on areas that truly matter to
    investors. The Commission also adopted Section 404 guidance for
    management, who previously had to rely on the rules intended for
    auditors. Currently, the staff is undertaking a study to determine
    whether as a result of these reforms Section 404 is in fact being
    implemented in a manner that is efficient and that will be cost-
    effective for smaller reporting companies. The study will be completed
    before small companies are required to have their first audit under
    Section 404. In addition, during 2007 the Commission approved a series
    of reforms to help smaller companies gain faster and easier access to
    the financial markets when they need it.
        One of the most significant disclosure initiatives in the
    Commission's history was our new comprehensive disclosure regime for
    executive compensation, which took effect in 2007. These new rules
    require every public company to provide a single number stating total
    compensation for their top officers. For the first time, all forms of
    compensation are in one place for investors to analyze, and companies
    are required to provide plain English statements of their compensation
    policies. The complete and readily accessible information about
    executive pay that this initiative has opened up to investors has
    provided a valuable new insight into corporate governance in the
    Nation's public companies.
        Also in 2007, the SEC broke an 8-year logjam by publishing final
    rules to implement the Gramm-Leach-Bliley Act's bank-broker provisions.
    This will benefit investors who utilize banks as well as brokers to
    help achieve their financial objectives. And we approved the merger of
    the NYSE and NASD's regulatory arms, with the goal of creating a single
    set of rules and eliminating the regulatory gaps between markets that
    often made enforcement difficult.
        The Commission also significantly intensified its contacts with its
    counterparts across the globe. As Chairman, I executed agreements with
    the College of Euronext Regulators, the German Federal Financial
    Supervisory Authority, and the UK's Financial Services Authority and
    Financial Reporting Council, all aimed towards enhancing information-
    sharing on enforcement and supervisory matters. The Commission also
    approved the merger of the New York Stock Exchange and Euronext;
    streamlined the deregistration requirements for foreign private
    issuers, removing a significant deterrent to listing on U.S. exchanges;
    and authorized foreign firms to use IFRS as published by the
    International Accounting Standards Board in preparing their disclosures
    in the United States. These important steps have helped facilitate
    cross-border capital formation and helped our market better integrate
    with the rest of the world.
        Administratively, we undertook major reforms to improve the
    effectiveness of the SEC's operations. In 2007, the SEC significantly
    augmented its investor education and advocacy functions. To
    reinvigorate the agency's emphasis on the needs of retail investors, we
    created the Office of Policy and Investor Outreach which will assess
    the views of individual investors and help inform the agency's
    policymaking. The new Office of Investor Education is focused
    exclusively on promoting financial literacy and helping investors gain
    the tools they need to make informed investment decisions.
        In 2007, the SEC took major steps to foster the widespread use of
    interactive data in corporate disclosures. Interactive data will
    empower investors to obtain and compare information about their
    investments far more easily than ever before. This initiative will
    completely remake financial disclosure. Instead of an electronic filing
    cabinet for 1930s-style forms, which was the SEC's EDGAR system, every
    item within an income statement or a balance sheet will be individually
    searchable and downloadable. Investors and the entire marketplace will
    be able to compare any information they choose for thousands of
    companies in an instant. RSS feeds will send the latest SEC filings to
    investors' desktops or handhelds, without their even having to know a
    form was filed.
        Overall in fiscal year 2007, the SEC had one of the most productive
    years in its history, aggressively pursuing wrongdoing and tackling
    fundamental reforms in the securities markets, all on behalf of
    America's investors.

                            FISCAL YEAR 2008 TO DATE

        Already in fiscal year 2008, the Commission has been active on a
    number of fronts working to protect investors, promote capital
    formation, and foster healthy markets. And our agenda in the coming
    months is no less ambitious.
    Oversight of the Markets
        The failure of Bear Stearns has brought to the fore the regulatory
    gap in the supervision of investment banks. Although Federal law
    provides for supervision of commercial banking by bank regulatory
    agencies, no such scheme exists for the largest investment banks.
    Because the law fails to provide for supervision of even the largest
    globally active firms on a consolidated basis, the Commission created
    the Consolidated Supervised Entities (CSE) program to fill this gap,
    beginning in 2004. Without this voluntary program there would not have
    been any consolidated information available to regulators, including
    the Federal Reserve Bank of New York, when Bear Stearns precipitously
    lost liquidity in mid-March 2008. This program, which is necessary to
    monitor for, and act quickly in response to, any financial or
    operational weaknesses that might place regulated entities or the
    broader financial system at risk, is providing the basis for
    significant new collaboration with the Federal Reserve.
        Building on the new statutory authority from Congress that enabled
    the SEC to register and examine credit rating agencies, as nationally
    recognized statistical rating organizations, beginning in late
    September 2007, the SEC has launched a new program to oversee credit
    rating agencies. This is also a vitally important topic in light of
    recent market events. Under this new authority, the Commission is
    conducting inspections of rating agencies to evaluate whether they are
    adhering to their published methodologies for determining ratings and
    managing conflicts of interest. Given the recent problems in the
    subprime market, the SEC has been particularly interested in whether
    the rating agencies' involvement in bringing mortgage-backed securities
    to market impaired their ability to be impartial in their ratings. We
    will shortly propose additional rules building on the lessons learned
    from the subprime market turmoil. These proposals may include, among
    other things, requiring better disclosure of past ratings, so as to
    facilitate competitive comparisons of rating accuracy; enhancing
    investor understanding of the differences in ratings among different
    types of securities; regulating and limiting conflicts of interest;
    reducing reliance on ratings per se, as opposed to the underlying
    criteria that ratings are thought to represent; and disclosing the role
    of third-party due diligence in assigning ratings. This will continue
    to be an area of emphasis for the Commission in the coming fiscal year.
        Currently neither the CSE nor the credit rating agency programs
    receive dedicated funding from the Congress. We understand that
    Congress may be acting to fill this gap, and I believe such a move
    would help formalize and strengthen these two critical programs. We
    have prepared some information about this proposal that I have
    submitted along with my testimony.
        The SEC is also working closely with our fellow regulators to
    promote the fairness and stability of the markets. Under a recently
    concluded Memorandum of Understanding with the Commodity Futures
    Trading Commission, we have established a durable process to better
    address the regulatory issues that in today's increasingly
    interconnected markets don't respect regulatory boundaries drawn up
    decades ago. The agreement that I signed with Acting Chairman Lukken
    establishes a permanent regulatory liaison between the two agencies,
    provides for enhanced information sharing, and sets forth several key
    principles guiding their consideration of novel financial products that
    may reflect elements of both securities and commodity futures or
    options.
        To anticipate future problems, I announced in February 2008 a
    program to more than double the size of the SEC's Office of Risk
    Assessment, created under the leadership of my predecessor, Chairman
    Bill Donaldson. With additional staff experts and the right
    surveillance tools, the newly expanded Office will help staff
    throughout the Commission look around the corners and over the horizon
    to identify potentially dangerous practices before they impact large
    numbers of investors and the economy as a whole.
    Enforcement
        The SEC is continuing to pursue wrongdoers in all corners of the
    securities markets, while also applying enforcement resources to the
    areas that pose the greatest risks to investors.
        The Enforcement Division's subprime working group is aggressively
    investigating possible fraud, market manipulation, and breaches of
    fiduciary duty. Among the issues we are looking at is whether financial
    firms made proper disclosures about their holdings and their
    valuations, whether insiders used non-public information to gain from
    the recent market volatility, and whether naked short sellers illegally
    manipulated the market.
        The Enforcement Division is also investigating insider trading
    among large institutional traders; wrongdoing in the municipal bond
    market; Internet and microcap fraud; and scams against seniors.
        In fiscal year 2008, the SEC is building upon its growing success
    in returning funds to harmed investors. Since the agency first received
    authority under the Sarbanes-Oxley Act of 2002 to use Fair Funds to
    compensate victims, we have returned a total of more than $3.7 billion
    to wronged investors. We expect to distribute another $750 million in
    the next 6 months alone. To further professionalize the agency's
    execution in this area, I have created the Office of Collections and
    Distributions, which is led by a Director who reports to the Executive
    Director and the Chairman. As part of this initiative, the agency has
    deployed a new computer tracking system, called Phoenix, which with
    additional enhancements this year will help to speed the return of
    investors' money and maintain appropriate internal controls.
        Another major productivity enhancement in the Enforcement Division
    is ``The Hub,'' an agency-wide database that gives all enforcement
    staff access to the entire inventory of investigations. By giving line
    staff a window into this deep knowledge base, and permitting senior
    management to direct the resources of the national enforcement program
    quickly and effectively when necessary, The Hub is significantly
    increasing the effectiveness of our enforcement dollars. Additional
    features being rolled out in the coming months will help Division staff
    more readily access performance information, coordinate more
    effectively with our examination staff, and better manage their
    investigative documents throughout the enforcement lifecycle.
    International Enforcement and Regulatory Issues
        The SEC's efforts in the international arena, which have markedly
    increased in recent years, have by necessity been a key focus of my
    Chairmanship. The time is long past when the SEC, or any financial
    regulator, can feel safe that by scrutinizing just the activities
    within its national borders, it can comprehend all the potential
    dangers ahead. In a world where capital flows freely across borders,
    problems or issues in one corner of the globe rarely stay there. The
    world's regulatory and enforcement authorities are finding that we have
    to collaborate if we hope to protect our own investors. Accordingly,
    the SEC is working closely with our international counterparts to
    monitor the markets and pursue fraudsters wherever they may run. We are
    also exploring the idea of mutual recognition among a very few high-
    standards countries with robust regulatory and enforcement regimes.
        In recognition of the interconnectedness of global markets, the SEC
    will continue to expand our own expertise in IFRS, and explore
    additional ways that U.S. investors might benefit from increased
    comparability using a high-quality international standard. The
    continued integration of our own domestic accounting standards and IFRS
    will enhance the quality of both, while improving the reliability,
    clarity, and comparability of financial disclosure for American
    investors.

    Disclosure
        The SEC is committed to making public company disclosure more
    useful to investors. Under the leadership of the Office of Interactive
    Disclosure, the SEC is building upon our recent successes in
    constructing a foundation for the widespread use of interactive data.
    After years of experience through the SEC's voluntary pilot program,
    the Commission will consider a rule in 2008 that requires the use of
    interactive data by reporting companies, as well as other proposals to
    expand interactive data reporting by mutual funds and other market
    participants. These efforts will be aimed at giving investors the
    ability to easily find and compare key data about the companies and
    funds in which they invest.
        There are other investor-friendly improvements in store for mutual
    fund disclosure. Too many investors today throw away their mutual fund
    disclosures instead of reading them. Too often, the prospectuses are
    laden with legalese that makes them nearly impenetrable for the average
    person. In the coming months, the SEC will consider authorizing mutual
    funds to issue a summary prospectus that will be more user-friendly for
    investors. If adopted, the summary document would succinctly present
    key facts about the fund up front, with more detailed information
    available for investors on the Internet or in paper upon request. The
    agency also is preparing help for investors at the time they buy a
    mutual fund to learn about fees, expenses, and conflicts of interest.
        Another important initiative relates to the $2.5 trillion worth of
    municipal securities currently outstanding, about two-thirds of which
    is owned either directly or indirectly by retail investors. Despite its
    size and importance, this market has many fewer protections for
    investors than exist in the corporate market. For example, investors
    often find it difficult even to get their hands on the disclosure
    documents for the municipal securities they own. To address this
    shortcoming, the Commission is working to authorize the creation of an
    online computer database, which would give investors in municipal
    securities electronic access to disclosures filed in connection with
    their investments. I have also urged our authorizing committees in the
    House and in the Senate to update the SEC's authority in this area.

    Investor Protection
        The Commission has very recently taken additional steps to
    safeguard investors and protect the integrity of the markets during
    short selling transactions by proposing a rule that would specify that
    abusive ``naked'' short selling is a fraud. In a naked short sale, the
    seller does not borrow or arrange to borrow the securities in time to
    make delivery to the buyer within the standard 3-day settlement period
    for trades. As a result, the seller fails to deliver stock to the buyer
    when delivery is due. This is known as a ``failure to deliver.'' When
    sellers intentionally fail to deliver securities to the buyer as part
    of a scheme to manipulate the price of a security, or possibly to avoid
    borrowing costs associated with short sales, they should be subject to
    enforcement action by the Commission for violation of the securities
    laws.
        The Commission is also working to protect Americans' pension fund
    investments. In March 2008, the Commission issued a special report
    reminding public pension funds of their responsibilities under the
    Federal securities laws, and warning them that they assume a greater
    risk of running afoul of anti-fraud and other provisions if they do not
    have adequate compliance policies and procedures in place to prevent
    wrongdoing in their money management functions.
        To protect investor privacy and to help prevent and address
    security breaches at the financial institutions the SEC regulates, the
    Commission proposed new rules that provide more detailed standards for
    information security programs. The proposed rules provide more specific
    requirements for safeguarding information and responding to information
    security breaches. The Commission also extended these privacy
    protections to other entities registered with the Commission.
        The Commission has also proposed an expedited process to speed up
    the availability to the investing public of exchange-traded funds
    (ETFs). ETFs are similar to traditional mutual funds, but issue shares
    that trade throughout the day on securities exchanges. The proposed
    rules would eliminate a barrier to entry for new participants in this
    fast-growing market, while preserving investor protections. The
    Commission also proposed enhanced disclosure for ETF investors who
    purchase shares in the secondary markets.
        Mr. Chairman, these are only some of the highlights of what the
    agency has recently been focused on, and what we have planned for the
    coming year. The SEC's mandate is as broad as it is important to
    America's investors and our markets. On behalf of the agency, let me
    thank you for the support that you and this Committee have so well
    provided for these vital efforts.

                                   CONCLUSION

        The budget request for fiscal year 2009 will allow the SEC to
    continue to aggressively pursue each of these ongoing initiatives on
    behalf of investors, as well as to address new risk areas as they
    emerge. As I mentioned, the request will allow the SEC to fully
    maintain our current program of strong enforcement, examinations and
    inspections, disclosure review, and regulation.
        The request also will cover merit raises for SEC staff, as the
    agency transitions to a new performance evaluation system. This new
    five-level rating system has been developed in conjunction with the
    National Treasury Employees' Union to provide more individualized
    feedback to staff, based on clear performance criteria. The system has
    been piloted in our Office of Human Resources, and will next be
    extended to the agency's senior managers. The rest of the agency's
    employees are scheduled to transition into the program next year.
        I want to thank you for this opportunity to discuss the SEC's
    appropriation for fiscal year 2009. I look forward to working with you
    to meet the needs of our Nation's investors, and I would be happy to
    answer any questions you may have.

                                STAFFING LEVELS

        Senator Durbin. Thank you very much, Chairman Cox.
        Let me try to reconcile budget request with some of the
    policy statements you've made. If I understand the President's
    budget request for 2009, it calls for 3,409 permanent staff at
    the SEC, which would be a reduction anywhere between 94 and 100
    employees, and over the last 3 or 4 years you've had about an
    11 percent reduction in your enforcement activities. Does that
    sound about right?
        Mr. Cox. All the way up to the 11 percent reduction in
    enforcement activities. We have within our overall budget,
    which is----
        Senator Durbin. Staffing reduction. I'm sorry, staffing
    reduction of 11 percent since 2005.
        Mr. Cox. Yes, we have had budget freezes, as you know, from
    Congress through continuing resolutions in 2006 and 2007. So
    holding at the same dollar figure for two fiscal years in a
    row, combined with the fact that we have a built-in ratchet of
    about 5 percent just standing steady because of cost-of-living
    allowances, merit pay, and promotions within the agency and an
    historically low turnover rate, means that, with two-thirds of
    the total budget going to personnel, it is impossible to
    maintain even the same staffing numbers year to year at higher
    dollar levels.
        But what we have done within the overall budget number is
    to prioritize enforcement and also the Division of Trading and
    Markets and its market supervisory responsibilities, so that in
    the last fiscal year we have brought the second highest number
    of enforcement actions in the agency's 74-year history.
    Likewise, we have the highest number of respondents in actions
    in years by quite a wide margin.

                         OVERSIGHT OF INVESTMENT BANKS

        Senator Durbin. So I want to applaud your efficiencies and
    what you have achieved. But if you continue to reduce the
    number of staff that are working in some of these sections,
    some of these divisions within the SEC, it clearly would have
    an impact on your future activity. One of the things that you
    raise is something that I'm concerned about. You mentioned the
    Bear Stearns situation, in which the head of the Federal
    Reserve as well as the Secretary of the Treasury decided to
    step in and to help Bear Stearns through a rough patch.
        Without judging the wisdom of that decision, and I think it
    was necessary personally, it seems to have opened up a new area
    of concern and responsibility. You talked about the gap in
    enforcement for investment banks. I don't know what the most
    current figure is, but I heard at one time that we have opened
    our discount window to the tune of about $200 billion in
    borrowing by these investment banks.
        The obvious question is, the entities that are borrowing
    the money now from the Federal taxpayers through the discount
    window, what kind of oversight and supervision we have of these
    entities. I think what I heard in your opening statement is the
    suggestion that the SEC may play a role in that or could or
    should play a role in that.
        Reconcile these two things--reducing the number of staffers
    in your budget and expanding your responsibilities to include
    investment banks to make sure that at the end of the day the
    taxpayers of America don't end up holding the bag as investment
    banks use the discount window.
        Mr. Cox. Well, Mr. Chairman, you're absolutely right about
    the importance of that function of overseeing and supervising
    investment banks. In addition, I would add to that, the SEC
    also has been given very recently a significant new function
    related to subprime issues and that is oversight and regulatory
    authority over credit rating agencies. Both of these functions
    are prioritized within the SEC's budget, but something has to
    give. It has to come from some place.
        So, if the SEC's budget were to be frozen on a continued
    basis, we would run out of potential savings. The largest area
    of potential savings I have been able to find thus far is the
    agency's historical function of maintaining a filing and
    information service that was essentially related to the 1930s-
    era idea of having paper forms. We had people walk into the SEC
    and inspect documents. With the Internet we didn't need that
    any longer, and so we were able to free up about 100 positions
    within the agency and put those slots to better use.
        But the opportunity to find efficiencies like that is a
    very steep declining curve.
        Senator Durbin. Historically, the SEC has relied on fees
    and collections to defer their costs of operation to some
    extent; is that not the case?
        Mr. Cox. Well, it is partly true, but in a way that
    concerns me some days, not entirely true, because, while we do
    collect a good deal in the way of fees, all of our funds are
    appropriated.
        Senator Durbin. All of your funds----
        Mr. Cox. We cannot live off of the fees we collect.

                            IMPOSITION OF USER FEES

        Senator Durbin. I understand that part. But what I'm
    driving at is, I'm trying to reconcile the earlier question:
    Where will you find some future SEC Chairman, where will they
    find the resources to now keep a close eye on investment banks
    using the discount window, borrowing from American taxpayers?
    It seems that there should be, and it may not exist today, some
    fee collection that would fund that Government responsibility.
    Has that been proposed by the administration or anyone to your
    knowledge?
        Mr. Cox. Well, indeed, were this subcommittee willing to do
    so, taking the existing stream of fees that the SEC already
    collects and dedicating it to SEC operations would provide a
    good deal of consistency to the budget.
        Senator Durbin. But those fees are not collected from
    investment banks currently, are they?
        Mr. Cox. No, they are not, and we could, I suppose--I
    should say, Congress could--fashion a new kind of fee. But in
    any case, the difference between the fees that the SEC's
    responsible for collecting and our appropriation is already
    significant. There's a big delta there.
        Senator Durbin. But it would seem, in fairness, that if
    this branch of our economy is going to be reviewed, there's
    oversight, that the cost of that oversight shouldn't be borne
    by another sector of the economy, collection of fees from some
    other entity. That doesn't seem to track. At least, I don't
    know in this detail, but it would seem that collecting a fee
    from the supervised entity is more reasonable.
        Mr. Cox. Well, I think at least in the SEC's experience we
    have subsisted entirely on the basis of appropriated funds, and
    so there has been no effort with respect to any of the agency's
    programs to match some form of fee collection with our
    function.
        Senator Durbin. Thank you.
        Senator Brownback.
        Senator Brownback. Thank you very much, Mr. Chairman.

                            SUBPRIME MORTGAGE CRISIS

        Welcome, Chairman Cox. I want to look at what led up to the
    subprime debacle that we've had. You can go back after these
    crises are over and look at how did all this occur and you hope
    to learn lessons from that.
        I went and met with my realtors in Kansas and different
    bankers and they said: Oh, yeah, yeah, we knew this was going
    on; we weren't making any of the loans, but people were out
    trolling and originating subprime mortgages to people we had
    never lent to. I even had one banker say to me: Yes, I
    originated one of the loans that I would never have made, but
    then put it into the pool for the subprime fund. And I thought,
    well, at least he admitted it, I guess, but he would never have
    made it, but it got into then the securitized overall fund.
        I want to enter into the record, Mr. Chairman, an article
    in the New York Times magazine from April 27, 1996, Thomas
    Friedman, a New York Times columnist, remarked in the ``News
    Hour with Jim Lehrer'' that: ``There are two superpowers in the
    world, the United States and Moody's bond rating service, and
    it is sometimes unclear which is more powerful.''
        [The information follows:]

                   [From The New York Times, April 27, 2008]

                                Triple-A Failure
                             (By Roger Lowenstein)
    The Ratings Game
        In 1996, Thomas Friedman, the New York Times columnist, Thomas
    Friedman, the New York Times columnist, remarked on ``The NewsHour With
    Jim Lehrer'' that there were two superpowers in the world--the United
    States and Moody's bond-rating service--and it was sometimes unclear
    which was more powerful. Moody's was then a private company that rated
    corporate bonds, but it was, already, spreading its wings into the
    exotic business of rating securities backed by pools of residential
    mortgages.
        Obscure and dry-seeming as it was, this business offered a certain
    magic. The magic consisted of turning risky mortgages into investments
    that would be suitable for investors who would know nothing about the
    underlying loans. To get why this is impressive, you have to think
    about all that determines whether a mortgage is safe. Who owns the
    property? What is his or her income? Bundle hundreds of mortgages into
    a single security and the questions multiply; no investor could begin
    to answer them. But suppose the security had a rating. If it were rated
    triple-A by a firm like Moody's, then the investor could forget about
    the underlying mortgages. He wouldn't need to know what properties were
    in the pool, only that the pool was triple-A--it was just as safe, in
    theory, as other triple-A securities.
        Over the last decade, Moody's and its two principal competitors,
    Standard & Poor's and Fitch, played this game to perfection--putting
    what amounted to gold seals on mortgage securities that investors swept
    up with increasing elan. For the rating agencies, this business was
    extremely lucrative. Their profits surged, Moody's in particular: it
    went public, saw its stock increase sixfold and its earnings grow by
    900 percent.
        By providing the mortgage industry with an entree to Wall Street,
    the agencies also transformed what had been among the sleepiest corners
    of finance. No longer did mortgage banks have to wait 10 or 20 or 30
    years to get their money back from homeowners. Now they sold their
    loans into securitized pools and--their capital thus replenished--wrote
    new loans at a much quicker pace.
        Mortgage volume surged; in 2006, it topped $2.5 trillion. Also,
    many more mortgages were issued to risky subprime borrowers. Almost all
    of those subprime loans ended up in securitized pools; indeed, the
    reason banks were willing to issue so many risky loans is that they
    could fob them off on Wall Street.
        But who was evaluating these securities? Who was passing judgment
    on the quality of the mortgages, on the equity behind them and on
    myriad other investment considerations? Certainly not the investors.
    They relied on a credit rating.
        Thus the agencies became the de facto watchdog over the mortgage
    industry. In a practical sense, it was Moody's and Standard & Poor's
    that set the credit standards that determined which loans Wall Street
    could repackage and, ultimately, which borrowers would qualify.
    Effectively, they did the job that was expected of banks and government
    regulators. And today, they are a central culprit in the mortgage bust,
    in which the total loss has been projected at $250 billion and possibly
    much more.
        In the wake of the housing collapse, Congress is exploring why the
    industry failed and whether it should be revamped (hearings in the
    Senate Banking Committee were expected to begin April 22). Two key
    questions are whether the credit agencies--which benefit from a unique
    series of government charters--enjoy too much official protection and
    whether their judgment was tainted. Presumably to forestall criticism
    and possible legislation, Moody's and S.&P. have announced reforms. But
    they reject the notion that they should have been more vigilant.
    Instead, they lay the blame on the mortgage holders who turned out to
    be deadbeats, many of whom lied to obtain their loans.
        Arthur Levitt, the former chairman of the Securities and Exchange
    Commission, charges that ``the credit-rating agencies suffer from a
    conflict of interest--perceived and apparent--that may have distorted
    their judgment, especially when it came to complex structured financial
    products.'' Frank Partnoy, a professor at the University of San Diego
    School of Law who has written extensively about the credit-rating
    industry, says that the conflict is a serious problem. Thanks to the
    industry's close relationship with the banks whose securities it rates,
    Partnoy says, the agencies have behaved less like gatekeepers than gate
    openers. Last year, Moody's had to downgrade more than 5,000 mortgage
    securities--a tacit acknowledgment that the mortgage bubble was abetted
    by its overly generous ratings. Mortgage securities rated by Standard &
    Poor's and Fitch have suffered a similar wave of downgrades.
    Presto! How 2,393 Subprime Loans Become a High-Grade Investment
        The business of assigning a rating to a mortgage security is a
    complicated affair, and Moody's recently was willing to walk me through
    an actual mortgage-backed security step by step. I was led down a
    carpeted hallway to a well-appointed conference room to meet with three
    specialists in mortgage-backed paper. Moody's was fair-minded in
    choosing an example; the case they showed me, which they masked with
    the name ``Subprime XYZ,'' was a pool of 2,393 mortgages with a total
    face value of $430 million.
        Subprime XYZ typified the exuberance of the age. All the mortgages
    in the pool were subprime--that is, they had been extended to borrowers
    with checkered credit histories. In an earlier era, such people would
    have been restricted from borrowing more than 75 percent or so of the
    value of their homes, but during the great bubble, no such limits
    applied.
        Moody's did not have access to the individual loan files, much less
    did it communicate with the borrowers or try to verify the information
    they provided in their loan applications. ``We aren't loan officers,''
    Claire Robinson, a 20-year veteran who is in charge of asset-backed
    finance for Moody's, told me. ``Our expertise is as statisticians on an
    aggregate basis. We want to know, of 1,000 individuals, based on
    historical performance, what percent will pay their loans?''
        The loans in Subprime XYZ were issued in early spring 2006--what
    would turn out to be the peak of the boom. They were originated by a
    West Coast company that Moody's identified as a ``nonbank lender.''
    Traditionally, people have gotten their mortgages from banks, but in
    recent years, new types of lenders peddling sexier products grabbed an
    increasing share of the market. This particular lender took the loans
    it made to a New York investment bank; the bank designed an investment
    vehicle and brought the package to Moody's.
        Moody's assigned an analyst to evaluate the package, subject to
    review by a committee. The investment bank provided an enormous
    spreadsheet chock with data on the borrowers' credit histories and much
    else that might, at very least, have given Moody's pause. Three-
    quarters of the borrowers had adjustable-rate mortgages, or ARMs--
    ``teaser'' loans on which the interest rate could be raised in short
    order. Since subprime borrowers cannot afford higher rates, they would
    need to refinance soon. This is a classic sign of a bubble--lending on
    the belief, or the hope, that new money will bail out the old.
        Moody's learned that almost half of these borrowers--43 percent--
    did not provide written verification of their incomes. The data also
    showed that 12 percent of the mortgages were for properties in Southern
    California, including a half-percent in a single ZIP code, in
    Riverside. That suggested a risky degree of concentration.
        On the plus side, Moody's noted, 94 percent of those borrowers with
    adjustable-rate loans said their mortgages were for primary residences.
    ``That was a comfort feeling,'' Robinson said. Historically, people
    have been slow to abandon their primary homes. When you get into a
    crunch, she added, ``You'll give up your ski chalet first.''
        Another factor giving Moody's comfort was that all of the ARM loans
    in the pool were first mortgages (as distinct from, say, home-equity
    loans). Nearly half of the borrowers, however, took out a simultaneous
    second loan. Most often, their two loans added up to all of their
    property's presumed resale value, which meant the borrowers had not a
    cent of equity.
        In the frenetic, deal-happy climate of 2006, the Moody's analyst
    had only a single day to process the credit data from the bank. The
    analyst wasn't evaluating the mortgages but, rather, the bonds issued
    by the investment vehicle created to house them. A so-called special-
    purpose vehicle--a ghost corporation with no people or furniture and no
    assets either until the deal was struck--would purchase the mortgages.
    Thereafter, monthly payments from the homeowners would go to the S.P.V.
    The S.P.V. would finance itself by selling bonds. The question for
    Moody's was whether the inflow of mortgage checks would cover the
    outgoing payments to bondholders. From the investment bank's point of
    view, the key to the deal was obtaining a triple-A rating--without
    which the deal wouldn't be profitable. That a vehicle backed by
    subprime mortgages could borrow at triple-A rates seems like a trick of
    finance. ``People say, `How can you create triple-A out of B-rated
    paper?' '' notes Arturo Cifuentes, a former Moody's credit analyst who
    now designs credit instruments. It may seem like a scam, but it's not.
        The secret sauce is that the S.P.V. would float 12 classes of
    bonds, from triple-A to a lowly Ba1. The highest-rated bonds would have
    first priority on the cash received from mortgage holders until they
    were fully paid, then the next tier of bonds, then the next and so on.
    The bonds at the bottom of the pile got the highest interest rate, but
    if homeowners defaulted, they would absorb the first losses.
        It was this segregation of payments that protected the bonds at the
    top of the structure and enabled Moody's to classify them as triple-A.
    Imagine a seaside condo beset by flooding: just as the penthouse will
    not get wet until the lower floors are thoroughly soaked, so the
    triple-A bonds would not lose a dime unless the lower credits were
    wiped out.
        Structured finance, of which this deal is typical, is both clever
    and useful; in the housing industry it has greatly expanded the pool of
    credit. But in extreme conditions, it can fail. The old-fashioned
    corner banker used his instincts, as well as his pencil, to apportion
    credit; modern finance is formulaic. However elegant its models,
    forecasting the behavior of 2,393 mortgage holders is an uncertain
    business. ``Everyone assumed the credit agencies knew what they were
    doing,'' says Joseph Mason, a credit expert at Drexel University. ``A
    structural engineer can predict what load a steel support will bear; in
    financial engineering we can't predict as well.''
        Mortgage-backed securities like those in Subprime XYZ were not the
    terminus of the great mortgage machine. They were, in fact, building
    blocks for even more esoteric vehicles known as collateralized debt
    obligations, or C.D.O.'s. C.D.O.'s were financed with similar ladders
    of bonds, from triple-A on down, and the credit-rating agencies' role
    was just as central. The difference is that XYZ was a first-order
    derivative--its assets included real mortgages owned by actual
    homeowners. C.D.O.'s were a step removed--instead of buying mortgages,
    they bought bonds that were backed by mortgages, like the bonds issued
    by Subprime XYZ. (It is painful to consider, but there were also third-
    order instruments, known as C.D.O.'s squared, which bought bonds issued
    by other C.D.O.'s.)
        Miscalculations that were damaging at the level of Subprime XYZ
    were devastating at the C.D.O. level. Just as bad weather will cause
    more serious delays to travelers with multiple flights, so, if the
    underlying mortgage bonds were misrated, the trouble was compounded in
    the case of the C.D.O.'s that purchased them.
        Moody's used statistical models to assess C.D.O.'s; it relied on
    historical patterns of default. This assumed that the past would remain
    relevant in an era in which the mortgage industry was morphing into a
    wildly speculative business. The complexity of C.D.O.'s undermined the
    process as well. Jamie Dimon, the chief executive of JPMorgan Chase,
    which recently scooped up the mortally wounded Bear Stearns, says,
    ``There was a large failure of common sense'' by rating agencies and
    also by banks like his. ``Very complex securities shouldn't have been
    rated as if they were easy-to-value bonds.''
    The Accidental Watchdog
        John Moody, a Wall Street analyst and former errand runner, hit on
    the idea of synthesizing all kinds of credit information into a single
    rating in 1909, when he published the manual ``Moody's Analyses of
    Railroad Investments.'' The idea caught on with investors, who
    subscribed to his service, and by the mid-20s, Moody's faced three
    competitors: Standard Statistics and Poor's Publishing (which later
    merged) and Fitch.
        Then as now, Moody's graded bonds on a scale with 21 steps, from
    Aaa to C. (There are small differences in the agencies' nomenclatures,
    just as a grande latte at Starbucks becomes a ``medium'' at Peet's. At
    Moody's, ratings that start with the letter ``A'' carry minimal to low
    credit risk; those starting with ``B'' carry moderate to high risk; and
    ``C'' ratings denote bonds in poor standing or actual default.) The
    ratings are meant to be an estimate of probabilities, not a buy or sell
    recommendation. For instance, Ba bonds default far more often than
    triple-As. But Moody's, as it is wont to remind people, is not in the
    business of advising investors whether to buy Ba's; it merely publishes
    a rating.
        Until the 1970s, its business grew slowly. But several trends
    coalesced to speed it up. The first was the collapse of Penn Central in
    1970--a shattering event that the credit agencies failed to foresee. It
    so unnerved investors that they began to pay more attention to credit
    risk.
        Government responded. The Securities and Exchange Commission, faced
    with the question of how to measure the capital of broker-dealers,
    decided to penalize brokers for holding bonds that were less than
    investment-grade (the term applies to Moody's 10 top grades). This
    prompted a question: investment grade according to whom? The S.E.C.
    opted to create a new category of officially designated rating
    agencies, and grandfathered the big three--S.&P., Moody's and Fitch. In
    effect, the government outsourced its regulatory function to three for-
    profit companies.
        Bank regulators issued similar rules for banks. Pension funds,
    mutual funds, insurance regulators followed. Over the 1980s and 1990s,
    a latticework of such rules redefined credit markets. Many classes of
    investors were now forbidden to buy noninvestment-grade bonds at all.
        Issuers thus were forced to seek credit ratings (or else their
    bonds would not be marketable). The agencies--realizing they had a hot
    product and, what's more, a captive market--started charging the very
    organizations whose bonds they were rating. This was an efficient way
    to do business, but it put the agencies in a conflicted position. As
    Partnoy says, rather than selling opinions to investors, the rating
    agencies were now selling ``licenses'' to borrowers. Indeed, whether
    their opinions were accurate no longer mattered so much. Just as a
    police officer stopping a motorist will want to see his license but not
    inquire how well he did on his road test, it was the rating--not its
    accuracy--that mattered to Wall Street.
        The case of Enron is illustrative. Throughout the summer and fall
    of 2001, even though its credit was rapidly deteriorating, the rating
    agencies kept it at investment grade. This was not unusual; the
    agencies typically lag behind the news. On Nov. 28, 2001, S.&P. finally
    dropped Enron's bonds to subinvestment grade. Although its action
    merely validated the market consensus, it caused the stock to collapse.
    To investors, S.&P.'s action was a signal that Enron was locked out of
    credit markets; it had lost its ``license'' to borrow. Four days later
    it filed for bankruptcy.
        Another trend that spurred the agencies' growth was that more
    companies began borrowing in bond markets instead of from banks.
    According to Chris Mahoney, a just-retired Moody's veteran of 22 years,
    ``The agencies went from being obscure and unimportant players to
    central ones.''
    A Conflict of Interest?
        Nothing sent the agencies into high gear as much as the development
    of structured finance. As Wall Street bankers designed ever more
    securitized products--using mortgages, credit-card debt, car loans,
    corporate debt, every type of paper imaginable--the agencies became
    truly powerful.
        In structured-credit vehicles like Subprime XYZ, the agencies
    played a much more pivotal role than they had with (conventional)
    bonds. According to Lewis Ranieri, the Salomon Brothers banker who was
    a pioneer in mortgage bonds, ``The whole creation of mortgage
    securities was involved with a rating.''
        What the bankers in these deals are really doing is buying a bunch
    of I.O.U.'s and repackaging them in a different form. Something has to
    make the package worth--or seem to be worth--more that the sum of its
    parts, otherwise there would be no point in packaging such securities,
    nor would there be any profits from which to pay the bankers' fees.
        That something is the rating. Credit markets are not continuous; a
    bond that qualifies, though only by a hair, as investment grade is
    worth a lot more than one that just fails. As with a would-be immigrant
    traveling from Mexico, there is a huge incentive to get over the line.
        The challenge to investment banks is to design securities that just
    meet the rating agencies' tests. Risky mortgages serve their purpose;
    since the interest rate on them is higher, more money comes into the
    pool and is available for paying bond interest. But if the mortgages
    are too risky, Moody's will object. Banks are adroit at working the
    system, and pools like Subprime XYZ are intentionally designed to
    include a layer of Baa bonds, or those just over the border. ``Every
    agency has a model available to bankers that allows them to run the
    numbers until they get something they like and send it in for a
    rating,'' a former Moody's expert in securitization says. In other
    words, banks were gaming the system; according to Chris Flanagan, the
    subprime analyst at JPMorgan, ``Gaming is the whole thing.''
        When a bank proposes a rating structure on a pool of debt, the
    rating agency will insist on a cushion of extra capital, known as an
    ``enhancement.'' The bank inevitably lobbies for a thin cushion (the
    thinner the capitalization, the fatter the bank's profits). It's up to
    the agency to make sure that the cushion is big enough to safeguard the
    bonds. The process involves extended consultations between the agency
    and its client. In short, obtaining a rating is a collaborative
    process.
        The evidence on whether rating agencies bend to the bankers' will
    is mixed. The agencies do not deny that a conflict exists, but they
    assert that they are keen to the dangers and minimize them. For
    instance, they do not reward analysts on the basis of whether they
    approve deals. No smoking gun, no conspiratorial e-mail message, has
    surfaced to suggest that they are lying. But in structured finance, the
    agencies face pressures that did not exist when John Moody was rating
    railroads. On the traditional side of the business, Moody's has
    thousands of clients (virtually every corporation and municipality that
    sells bonds). No one of them has much clout. But in structured finance,
    a handful of banks return again and again, paying much bigger fees. A
    deal the size of XYZ can bring Moody's $200,000 and more for
    complicated deals. And the banks pay only if Moody's delivers the
    desired rating. Tom McGuire, the Jesuit theologian who ran Moody's
    through the mid-90s, says this arrangement is unhealthy. If Moody's and
    a client bank don't see eye to eye, the bank can either tweak the
    numbers or try its luck with a competitor like S.&P., a process known
    as ``ratings shopping.''
        And it seems to have helped the banks get better ratings. Mason, of
    Drexel University, compared default rates for corporate bonds rated Baa
    with those of similarly rated collateralized debt obligations until
    2005 (before the bubble burst). Mason found that the C.D.O.'s defaulted
    eight times as often. One interpretation of the data is that Moody's
    was far less discerning when the client was a Wall Street securitizer.
        After Enron blew up, Congress ordered the S.E.C. to look at the
    rating industry and possibly reform it. The S.E.C. ducked. Congress
    looked again in 2006 and enacted a law making it easier for competing
    agencies to gain official recognition, but didn't change the industry's
    business model. By then, the mortgage boom was in high gear. From 2002
    to 2006, Moody's profits nearly tripled, mostly thanks to the high
    margins the agencies charged in structured finance. In 2006, Moody's
    reported net income of $750 million. Raymond W. McDaniel Jr., its chief
    executive, gloated in the annual report for that year, ``I firmly
    believe that Moody's business stands on the `right side of history' in
    terms of the alignment of our role and function with advancements in
    global capital markets.''
    Using Weather in Antarctica To Forecast Conditions in Hawaii
        Even as McDaniel was crowing, it was clear in some corners of Wall
    Street that the mortgage market was headed for trouble. The housing
    industry was cooling off fast. James Kragenbring, a money manager with
    Advantus Capital Management, complained to the agencies as early as
    2005 that their ratings were too generous. A report from the hedge fund
    of John Paulson proclaimed astonishment at ``the mispricing of these
    securities.'' He started betting that mortgage debt would crash.
        Even Mark Zandi, the very visible economist at Moody's forecasting
    division (which is separate from the ratings side), was worried about
    the chilling crosswinds blowing in credit markets. In a report
    published in May 2006, he noted that consumer borrowing had soared,
    household debt was at a record and a fifth of such debt was classified
    as subprime. At the same time, loan officers were loosening
    underwriting standards and easing rates to offer still more loans.
    Zandi fretted about the ``razor-thin'' level of homeowners' equity, the
    avalanche of teaser mortgages and the $750 billion of mortgages he
    judged to be at risk. Zandi concluded, ``The environment feels
    increasingly ripe for some type of financial event.''
        A month after Zandi's report, Moody's rated Subprime XYZ. The
    analyst on the deal also had concerns. Moody's was aware that mortgage
    standards had been deteriorating, and it had been demanding more of a
    cushion in such pools. Nonetheless, its credit-rating model continued
    to envision rising home values. Largely for that reason, the analyst
    forecast losses for XYZ at only 4.9 percent of the underlying mortgage
    pool. Since even the lowest-rated bonds in XYZ would be covered up to a
    loss level of 7.25 percent, the bonds seemed safe.
        XYZ now became the responsibility of a Moody's team that monitors
    securities and changes the ratings if need be (the analyst moved on to
    rate a new deal). Almost immediately, the team noticed a problem.
    Usually, people who finance a home stay current on their payments for
    at least a while. But a sliver of folks in XYZ fell behind within 90
    days of signing their papers. After six months, an alarming 6 percent
    of the mortgages were seriously delinquent. (Historically, it is rare
    for more than 1 percent of mortgages at that stage to be delinquent.)
        Moody's monitors began to make inquiries with the lender and were
    shocked by what they heard. Some properties lacked sod or landscaping,
    and keys remained in the mailbox; the buyers had never moved in. The
    implication was that people had bought homes on spec: as the housing
    market turned, the buyers walked.
        By the spring of 2007, 13 percent of Subprime XYZ was delinquent--
    and it was worsening by the month. XYZ was hardly atypical; the entire
    class of 2006 was performing terribly. (The class of 2007 would turn
    out to be even worse.)
        In April 2007, Moody's announced it was revising the model it used
    to evaluate subprime mortgages. It noted that the model ``was first
    introduced in 2002. Since then, the mortgage market has evolved
    considerably.'' This was a rather stunning admission; its model had
    been based on a world that no longer existed.
        Poring over the data, Moody's discovered that the size of people's
    first mortgages was no longer a good predictor of whether they would
    default; rather, it was the size of their first and second loans--that
    is, their total debt--combined. This was rather intuitive; Moody's
    simply hadn't reckoned on it. Similarly, credit scores, long a mainstay
    of its analyses, had not proved to be a ``strong predictor'' of
    defaults this time. Translation: even people with good credit scores
    were defaulting. Amy Tobey, leader of the team that monitored XYZ, told
    me, ``It seems there was a shift in mentality; people are treating
    homes as investment assets.'' Indeed. And homeowners without equity
    were making what economists call a rational choice; they were
    abandoning properties rather than make payments on them. Homeowners'
    equity had never been as high as believed because appraisals had been
    inflated.
        Over the summer and fall of 2007, Moody's and the other agencies
    repeatedly tightened their methodology for rating mortgage securities,
    but it was too late. They had to downgrade tens of billions of dollars
    of securities. By early this year, when I met with Moody's, an
    astonishing 27 percent of the mortgage holders in Subprime XYZ were
    delinquent. Losses on the pool were now estimated at 14 percent to 16
    percent--three times the original estimate. Seemingly high-quality
    bonds rated A3 by Moody's had been downgraded five notches to Ba2, as
    had the other bonds in the pool aside from its triple-A's.
        The pain didn't stop there. Many of the lower-rated bonds issued by
    XYZ, and by mortgage pools like it, were purchased by C.D.O.'s, the
    second-order mortgage vehicles, which were eager to buy lower-rated
    mortgage paper because it paid a higher yield. As the agencies endowed
    C.D.O. securities with triple-A ratings, demand for them was red hot.
    Much of it was from global investors who knew nothing about the U.S.
    mortgage market. In 2006 and 2007, the banks created more than $200
    billion of C.D.O.'s backed by lower-rated mortgage paper. Moody's
    assigned a different team to rate C.D.O.'s. This team knew far less
    about the underlying mortgages than did the committee that evaluated
    Subprime XYZ. In fact, Moody's rated C.D.O.'s without knowing which
    bonds the pool would buy.
        A C.D.O. operates like a mutual fund; it can buy or sell mortgage
    bonds and frequently does so. Thus, the agencies rate pools with assets
    that are perpetually shifting. They base their ratings on an extensive
    set of guidelines or covenants that limit the C.D.O. manager's
    discretion.
        Late in 2006, Moody's rated a C.D.O. with $750 million worth of
    securities. The covenants, which act as a template, restricted the
    C.D.O. to, at most, an 80 percent exposure to subprime assets, and many
    other such conditions. ``We're structure experts,'' Yuri Yoshizawa, the
    head of Moody's' derivative group, explained. ``We're not underlying-
    asset experts.'' They were checking the math, not the mortgages. But no
    C.D.O. can be better than its collateral.
        Moody's rated three-quarters of this C.D.O.'s bonds triple-A. The
    ratings were derived using a mathematical construct known as a Monte
    Carlo simulation--as if each of the underlying bonds would perform like
    cards drawn at random from a deck of mortgage bonds in the past. There
    were two problems with this approach. First, the bonds weren't like
    those in the past; the mortgage market had changed. As Mark Adelson, a
    former managing director in Moody's structured-finance division,
    remarks, it was ``like observing 100 years of weather in Antarctica to
    forecast the weather in Hawaii.'' And second, the bonds weren't random.
    Moody's had underestimated the extent to which underwriting standards
    had weakened everywhere. When one mortgage bond failed, the odds were
    that others would, too.
        Moody's estimated that this C.D.O. could potentially incur losses
    of 2 percent. It has since revised its estimate to 27 percent. The
    bonds it rated have been decimated, their market value having plunged
    by half or more. A triple-A layer of bonds has been downgraded 16
    notches, all the way to B. Hundreds of C.D.O.'s have suffered similar
    fates (most of Wall Street's losses have been on C.D.O.'s). For Moody's
    and the other rating agencies, it has been an extraordinary rout.
    Whom Can We Rely On?
        The agencies have blamed the large incidence of fraud, but then
    they could have demanded verification of the mortgage data or refused
    to rate securities where the data were not provided. That was, after
    all, their mandate. This is what they pledge for the future. Moody's,
    S.&P. and Fitch say that they are tightening procedures--they will
    demand more data and more verification and will subject their analysts
    to more outside checks. None of this, however, will remove the conflict
    of interest in the issuer-pays model. Though some have proposed
    requiring that agencies with official recognition charge investors,
    rather than issuers, a more practical reform may be for the government
    to stop certifying agencies altogether.
        Then, if the Fed or other regulators wanted to restrict what sorts
    of bonds could be owned by banks, or by pension funds or by anyone else
    in need of protection, they would have to do it themselves--not farm
    the job out to Moody's. The ratings agencies would still exist, but
    stripped of their official imprimatur, their ratings would lose a
    little of their aura, and investors might trust in them a bit less.
    Moody's itself favors doing away with the official designation, and it,
    like S.&P., embraces the idea that investors should not ``rely'' on
    ratings for buy-and-sell decisions.
        This leaves an awkward question, with respect to insanely complex
    structured securities: What can they rely on? The agencies seem utterly
    too involved to serve as a neutral arbiter, and the banks are sure to
    invent new and equally hard-to-assess vehicles in the future. Vickie
    Tillman, the executive vice president of S.&P., told Congress last fall
    that in addition to the housing slump, ``ahistorical behavorial modes''
    by homeowners were to blame for the wave of downgrades. She cited
    S.&P.'s data going back to the 1970s, as if consumers were at fault for
    not living up to the past. The real problem is that the agencies'
    mathematical formulas look backward while life is lived forward. That
    is unlikely to change.

        Senator Brownback. It goes through how these rating
    agencies rated these subprime mortgages with an AAA score. I'm
    trying to piece all this together in hindsight. So, people are
    originating these loans that locals would not make because it
    isn't up to their standards. And when you put them all
    together, it somehow magically transforms into an AAA-rated
    bond entity that is cited in this article.
        I go back on it, Chris, and ask: What should we be doing
    differently to keep this from happening again? Obviously, we're
    in a credit crunch and so we're not going to have a lot of
    money flowing at the moment. Are there things we should be
    doing to either oversee or rank the bond raters? Should we
    provide greater oversight on the mortgage originating entities,
    to make sure that data is there and that the loan is worthy? I
    think that this whole system is a series of bad practices,
    trying to get people into loans that they shouldn't have and
    then catching them in the net.
        What's the lesson learned here?
        Mr. Cox. Well, first, yes to both of your questions. These
    are both areas that Congress and regulators should take very
    serious interest in and make big changes in. We are not the
    front-line regulators for the mortgage industry, but I feel
    comfortable as Chairman of the SEC commenting on this because
    of the big impact that it has had in the securities markets,
    and focusing on proper oversight of mortgage origination is of
    vital importance for regulators and for lawmakers.

                      OVERSIGHT OF CREDIT RATING AGENCIES

        With respect to credit rating agencies, the Congress has
    done a very important and wise thing very recently in the
    Credit Rating Agency Act, giving the SEC brand new authority to
    regulate and oversee credit rating agencies that presently we
    are exercising vigorously. Up until a few months ago, until the
    end of September last year, the credit rating agency industry
    was essentially unregulated. Now that is completely changed. We
    are in the midst of a very broad investigation of the three
    largest credit rating agencies that rated most of the subprime-
    related securities. We will report publicly our findings from
    that examination very soon. The findings of that examination
    will also inform our ongoing rule-writing that we expect to
    complete this year. We expect to propose very, very soon new
    rules to govern, for example, conflicts of interest in that
    industry, to prohibit certain practices, to make sure that
    there is full disclosure of things like due diligence in
    preparation of these ratings, that there's full understanding
    and disclosure of the various methodologies, and that there's
    healthy competition in that industry.
        None of this existed before. These are big changes and they
    are very, very necessary.

                    FINANCIAL SERVICES REGULATORY STRUCTURE

        Senator Brownback. Would you mind commenting on the
    Secretary's comments about the need for changes due to new
    business structures? He's saying we need to consolidate several
    of these agencies and remove blind spots. Just your thoughts on
    that.
        Mr. Cox. Modernization of financial services regulation,
    which is the general topic that was broached by the Treasury
    blueprint, is I think very high on everybody's agenda, in the
    Congress, certainly for all of us at the SEC and for other
    regulatory agencies, but also around the world, and in
    international fora such as the Financial Stability Forum and
    IOSCO.
        The reason is that our regulatory structure is old. It's
    got quite a pedigree, a distinguished one, but the major
    regulatory agencies go back to the first part of the 20th
    century. Our agency is going to turn 75 years old in just a few
    months. This is already the 75th anniversary of the 1933 act.
        So as markets have changed, as the products that Walt
    Lukken and the CFTC regulate have morphed in such dramatic ways
    in the 21st century into competitors for products that the SEC
    regulates, our system has to take that into account. It's very
    hard to do that, I understand, because of both constituencies
    in the marketplace who've become accustomed to the existing
    regulatory structure, because of difficulties in Congress
    related to different jurisdictions and different committees,
    and because of some very difficult substantive choices that
    would have to be made about which model to pick and how to
    integrate it.
        So it's surpassingly difficult. But I think the topic is
    the right one to focus on because we have to do a better job of
    integrating regulatory responsibilities if we're going to keep
    abreast of what's going on, not only in our own country but in
    interconnected ways around the world.
        Senator Brownback. Thank you, Mr. Chairman.

                            BROKER-DEALER RULEMAKING

        Senator Durbin. Mr. Chairman, on March 19, 2007, the SEC
    published a proposed rule on amendments to financial
    responsibility rules for broker-dealers. In the notice the SEC
    asked for comments on changes to the rules on net capital,
    customer protection, books and records, notification rules. I
    understand that some of these proposed amendments have been
    sought by the financial services community for a number of
    years.
        Among the changes proposed are reduction in capital
    charges, haircut for money market mutual funds, and the
    inclusion of certain money market mutual funds as qualified
    securities eligible for deposit in the special reserve account.
        It's my understanding that the comment period closed last
    June, and since it will soon be a full year since the comment
    period on the proposed rule elapsed, what is the current status
    of this rulemaking?
        Mr. Cox. Mr. Chairman, we are very interested in this
    subject. We have taken a fresh look at it in light of all the
    market turmoil to make sure that this is the right time to be
    embarking on these kinds of changes. But the comment that we
    have received has included much favorable comment, and so this
    is very much on the rulemaking agenda of the Commission at this
    time.
        Senator Durbin. Since it's been a year, what is the
    anticipated release date for your final rule?
        Mr. Cox. We don't have a calendar date right now for
    further action on this proposal. But I would be happy, Mr.
    Chairman, to report back to you in real time about what the
    prognosis for that is.
        Senator Durbin. If you would, please.
        Are you soliciting additional comments?
        Mr. Cox. No, I believe the comment period is closed. Let me
    check and make sure that's the case.
        Yes, that is the case.
        Senator Durbin. Is there a plan to reissue a new proposal
    or are you going to stick with the original proposal?
        Mr. Cox. I think that the opportunity to fashion a final
    rule based not only on the proposal but the questions that were
    asked and the comments that were received should be sufficient
    so that it would not be required that we repropose it.
        Senator Durbin. If you'd kind of let me know just in
    general terms when that might happen.

                          SECURITIES LITIGATION REFORM

        Last August, a group of law professors asked your agency to
    convene a series of roundtables on the topic of securities
    litigation reform, and the ``Wall Street Journal'' reported
    that the forums would occur early next year, implying this
    year, 2008. Can you tell me if such roundtables are planned or
    under way?
        Mr. Cox. Mr. Chairman, this was a suggestion in chief from
    academics led by, among others, Professor Langwood at
    Georgetown. It is one that I think for a variety of reasons
    many people agree the Commission should act upon. There are a
    variety of reasons across the ideological spectrum and across
    the markets that people have interest and concerns with this
    general topic.
        My own interest in this topic and experience with it
    suggests to me that it is best taken up in a bipartisan way. We
    have currently a short-handed Commission comprised only of
    Republican commissioners and so I have wanted to wait before we
    had any such roundtable, even though of course we could always
    have a balanced panel, to make sure we also had a balanced
    Commission that can give the public confidence that we're
    handling this very important issue with great care and not in
    any political way.

                             DIVESTMENT DISCLOSURES

        Senator Durbin. Last question I have. Two weeks ago the SEC
    adopted rules requiring a registered investment company
    disclose when it divests from securities of issuers that the
    fund determines conduct or have direct investments in certain
    business operations in Sudan. These rules were mandated under
    the Sudan Accountability Investment Act signed into law on
    December 31 of last year.
        How will the SEC track these particular divestment
    disclosures?
        Mr. Cox. Mr. Chairman, as you know, we acted with great
    alacrity to do what was required by the statute, and we are
    energetically going to implement it as well, through the
    Division of Corporation Finance and our Office of Risk
    Assessment.
        Senator Durbin. So how would an investor be able to quickly
    determine that a particular company has made such a disclosure,
    for example?
        Mr. Cox. I'm sorry?
        Senator Durbin. How would an individual investor be able to
    determine that a particular company has made such a disclosure?
        Mr. Cox. Well, all of these filings will be made public and
    we have taken some very recent measures to provide for full
    text search capability of filings that are available on our
    EDGAR online disclosure system.
        Senator Durbin. Good. Thank you.
        Senator Brownback, any further questions?
        Senator Brownback. No questions.
        Senator Durbin. Chairman Cox, thanks. We appreciate your
    coming by. We're glad you're working with the CFTC on a
    memorandum of understanding and how that you'll continue that
    cooperative arrangement. I asked when they formed this
    subcommittee to bring these two agencies under the
    subcommittee's jurisdiction. There are so many things that you
    do have in common, at least in terms of the integrity of the
    marketplace. I hope that that conversation continues outside
    this room.
        Thank you for being here today.
        Mr. Cox. Thank you very much, Mr. Chairman.

                         ADDITIONAL COMMITTEE QUESTIONS

        Senator Durbin. Any questions for the record will be
    submitted to those who have testified, in the hopes that there
    will be prompt replies so we can complete our work.
        [The following questions were not asked at the hearing, but
    were submitted to the Commission for response subsequent to the
    hearing:]

                Questions Submitted by Senator Richard C. Shelby

                                  CRA PROGRAM

        Question. Chairman Cox, in your testimony you indicated that the
    SEC's credit rating agency program's costs are approximately $2.2
    million. Would you please discuss how these funds would be allocated
    within the program? How would having a dedicated funding source for the
    program improve the SEC's ability to administer the program?
        Answer. The SEC created the credit rating agencies program in
    September 2007 as a result of the enactment of the Credit Rating Agency
    Reform Act, to ensure that rating agencies are adhering to their
    published methodologies for determining ratings and managing conflicts
    of interest. The Act also provides the Commission with authority to
    write new regulations in this area and inspect the nationally
    recognized statistical rating organizations for compliance with
    applicable rules and policies. The SEC's proposed budget for fiscal
    year 2009 would increase the number of staff responsible for
    implementing the Credit Rating Agency Reform Act from 7 to 20 positions
    for oversight and inspections of credit rating agencies. This would
    nearly triple the number of staff dedicated to the program. Having
    dedicated funding would give the credit rating agency program more
    legislative structure and formality and ensure that the agency's
    allocation of resources was in line with the intent of Congress.

                                  CSE PROGRAM

        Question. Chairman Cox, over the past several months our economy
    has been plague by a liquidity crisis triggered by poorly underwritten
    subprime loans and structured finance products. The investment banks
    the SEC regulates as part of the CSE program were among the most active
    players in both the subprime and structured finance markets. They
    structured and underwrote many of the financial instruments now causing
    so many problems for our economy.
      --If the SEC was properly monitoring the CSE firms, why did it fail
            to raise the alarm about the decline in underwriting and
            lending standards?
      --How much responsibility does the SEC bear for the deterioration of
            lending and underwriting standards by CSE firms and their
            subsidiaries?
        Answer. The President's Working Group noted in their March report
    to the President that a principal underlying cause of the turmoil in
    financial markets was ``a breakdown in underwriting standards for
    subprime mortgages'' which then rippled through the system as these
    substandard mortgages were securitized. However, the SEC has no
    authority over mortgage underwriting standards. The consolidated
    supervised entities program does not change this reality. Under the
    Commission's new authority to supervise credit rating agencies, the
    Commission has recently proposed new rules designed to increase
    accountability and competition among credit rating agencies, as their
    ratings may have played a significant role in the market acceptance of
    subprime-related securities.

                                  ENFORCEMENT

        Question. Chairman Cox, earlier today at a hearing of the Banking
    Committee, former SEC Chairmen Arthur Levitt stated that the SEC needs
    substantial increases in its enforcement budget and that it does not
    have the manpower to properly enforce our securities laws.
      --How many personnel are presently employed by the Division of
            Enforcement, and how has that figured changed over the past 10
            years?
        Answer. In fiscal year 2008, the Enforcement program has over 1,100
    permanent FTE which is more than 30 percent higher than the size of the
    enforcement program since 1998.

                              [Dollars in millions]
    ------------------------------------------------------------------------
                                                                Enforcement
                                                                  Program
                                                Enforcement    Salaries and
                                                Program FTE      Benefits
                                                                Obligations
    ------------------------------------------------------------------------
    1998....................................             852         ( \1\ )
    1999....................................             811         ( \1\ )
    2000....................................             824         ( \1\ )
    2001....................................             904         ( \1\ )
    2002....................................             925         ( \1\ )
    2003....................................             935         ( \1\ )
    2004....................................           1,144          $168.8
    2005....................................           1,232           195.4
    2006....................................           1,157           200.6
    2007....................................           1,111           197.8
    2008 (Budget)...........................           1,124           210.0
    ------------------------------------------------------------------------
    \1\ Not available.

        Question. Also, how do the number of SEC enforcement actions and
    the amount disgorgements orders during your tenure compare to the
    levels seen when Chairmen Levitt was at the Commission?
        Answer. In fiscal year 2007, the Commission brought the second
    highest number of cases in the Commission's history including the
    largest number of corporate penalties cases ever. The chart below,
    provides the requested information on the nearly seven full fiscal
    years of Chairman Levitt's tenure and the two full fiscal years of my
    tenure.

                              [Dollars in millions]
    ------------------------------------------------------------------------
                                                                  Average
                                              Average Number   Disgorgements
                                              of Enforcement   and Penalties
                                                Actions Per     Ordered Per
                                                   Year            Year
    ------------------------------------------------------------------------
    Arthur Levitt, Chairman, July 1993-Feb.              490            $608
     2001...................................
    Christopher Cox, Chairman, August 2005-              615           2,483
     present................................
    ------------------------------------------------------------------------
    Note: Figures for Chairman Levitt are totals for fiscal year 1994-fiscal
      year 2001. Figures for Chairman Cox are totals for fiscal year 2005-
      fiscal year 2007.

        The following table shows the specific figures for each fiscal year
    during Chairman Levitt's and my tenures:

                              [Dollars in millions]
    ------------------------------------------------------------------------
                                                               Disgorgements
                                                Enforcement    and Penalties
                                                  Actions         Ordered
    ------------------------------------------------------------------------
    Under Chairman Levitt:
        1994................................             497            $764
        1995................................             486           1,028
        1996................................             453             392
        1997................................             489             263
        1998................................             477             477
        1999................................             525             841
        2000................................             503             488
    Under Chairman Cox:
        2006................................             574           3,365
        2007................................             655           1,601
    ------------------------------------------------------------------------

                              SUBCOMMITTEE RECESS

        Senator Durbin. This meeting of the subcommittee will stand
    recessed. Thank you.
        [Whereupon, at 4:12 p.m., Wednesday, May 7, the
    subcommittee was recessed, to reconvene subject to the call of
    the Chair.]

      FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL
                                   YEAR 2009

                                  ----------

                            WEDNESDAY, MAY 14, 2008

                                           U.S. Senate,
               Subcommittee of the Committee on Appropriations,
                                                        Washington, DC.
        The subcommittee met at 3:35 p.m., in room SD-192, Dirksen
    Senate Office Building, Hon. Richard J. Durbin (chairman)
    presiding.
        Present: Senators Durbin and Brownback.

                            FEDERAL TRADE COMMISSION

    STATEMENT OF HON. WILLIAM E. KOVACIC, CHAIRMAN
    ACCOMPANIED BY HON. JON LEIBOWITZ, COMMISSIONER

                 OPENING STATEMENT OF SENATOR RICHARD J. DURBIN

        Senator Durbin. Good afternoon. I'm pleased to welcome you
    to this hearing today before the Financial Services and General
    Government Appropriations Subcommittee.
        I apologize for the late start. We had a rollcall vote on
    the floor, and Senator Reid was called to a funeral service in
    Arlington for a fallen soldier from Nevada, and I had to fill
    in for a few minutes there. I thank Senator Brownback as well
    for his patience in waiting for my arrival.
        Today's hearing focuses on the President's fiscal year 2009
    budget request for the Federal Trade Commission (FTC).
    Testifying before us this afternoon is Chairman William Kovacic
    and Commissioner Jon Leibowitz.
        I welcome my colleagues to the dais and those who will
    appear in short order.
        The FTC, Federal Trade Commission, has two important and
    related missions: to protect consumers and to preserve
    competition in the marketplace. These missions really hit home
    when it comes to American consumers as they face skyrocketing
    prices at gasoline pumps, struggle with home mortgages they may
    not be able to pay back, and worry about identity theft and
    privacy in our increasingly intrusive world. The FTC pursues
    both of its consumer protection and competition missions by
    identifying illegal practices, stopping them through law
    enforcement, and preventing them through consumer and business
    education. It also adds to the public knowledge and dialogue by
    conducting research, advocating for consumers, and representing
    American consumer interests.
        I am pleased to see the FTC has a strong record on these
    missions. The agency has received numerous awards for its
    consumer education programs. Its implementation of the Do Not
    Call program has enjoyed success in curbing most unwanted
    telemarketing calls. There are still some of them getting
    through we will have to talk about. And last year, the FTC
    received a clean audit opinion for the 11th straight year in a
    row. Congratulations. With these and other accomplishments, I
    think the FTC has much to be proud of.
        The President's budget requests $256.2 million for fiscal
    year 2009, increased $12.3 million, or about 5 percent, over
    current year funding. This request will provide additional
    funding for consumer protection, including three additional
    FTE's dedicated to financial services. I am glad you are
    looking in this area. We are all too familiar with the fraud
    and deception in the mortgage industry, so this is certainly a
    good idea.
        This request also would provide additional funding for the
    FTC's Competition Bureau, including eight additional FTEs. Your
    role as consumer watchdog for anticompetitive behavior is
    especially crucial in today's market for gasoline, diesel fuel,
    and jet fuel.
        As you know, based on a letter I recently sent to you, I am
    very concerned about the spike in fuel prices. Drivers across
    America are paying higher and higher prices at the pump. Air
    travelers and consumers are also feeling the heat. Projections
    suggest the situation could get worse. Yet, somehow these
    record-breaking prices are coming at a time when the oil
    industry is reporting record-breaking profits.
        This chart points out something that an executive from an
    airline told me just a couple weeks ago when we talked about
    the increasing cost of jet fuel and what it was doing to the
    airline industry across America. He had made a phone call to a
    chief executive officer (CEO) of the same airline who had his
    job about 15 to 20 years ago, and this former CEO said, I do
    not understand how you can even operate with the so-called
    crack spreads today, crack spread being the difference between
    the crude oil and the refined product.
        That differential used to be in the $1 to $5 range. Now it
    is in the $40 range. And so as you see the price of a barrel of
    oil going up--I do not know what it is today. I think yesterday
    it was $127--you have to know that ultimately the consumer will
    pay even more because the spread between crude oil and refined
    product just continues to grow exponentially, making it
    increasingly difficult to be competitive for all users of
    refined oil products. That would include families, businesses,
    farmers, truckers, airlines, transit agencies, and all of the
    above.
        I am happy that you will be here to testify about this and
    other issues, perhaps commenting on the letter that I sent
    requesting an inquiry. And before turning it over to you for
    presentation, I would like to invite my colleague, Senator
    Brownback, to speak.

                       STATEMENT OF SENATOR SAM BROWNBACK

        Senator Brownback. Thank you, Mr. Chairman, for holding the
    hearing. I look forward to the presentation that is going to be
    coming up from our colleagues and to our question and answer
    session. I think this is an important hearing on some very
    substantive issues.
        I have worked with the FTC over many years on a number of
    topics, and I have found the Commission very good to work with.
    I appreciate their mission. I think it is crucial and a
    delicately balanced one of protecting consumers from fraud and
    predatory scams, while at the same time not interfering with
    legitimate business activities. Protecting consumers from
    identity theft and credit fraud, enforcing the Do Not Call
    Registry, and prohibiting the marketing of media violence to
    children, the Commission has a valuable role in our Government.
        To carry out its mission, the FTC must look carefully at
    the facts to guide its efforts. It cannot rely on anecdotes or
    speculation. It is a difficult function. It requires objective
    inquiry, analysis, and deliberation. It is not a function that
    can be exercised properly by a rush to judgment that is based
    on a theory or popular opinion.
        Mr. Chairman, all of us are very concerned and troubled by
    the exorbitant prices that consumers are paying at the pump. In
    my State and across the country, farmers, truck drivers, and
    all working families are facing painfully high prices to put
    gas in their cars and trucks and to put food on their tables. I
    would say, Mr. Chairman, if oil companies have acted in an
    anticompetitive fashion that has harmed consumers, then throw
    the book at them. I have no qualms about doing that whatsoever,
    and it should be done and it should be the function of the
    Government to do it.
        Now, let us make sure that they are not colluding and
    engaging in anticompetitive activities. We must do that. But
    let us base those claims on facts and not anecdotes and let us
    find answers and not excuses. And we must pursue real solutions
    rather than political gain.
        In the same way that we admonish our colleagues not to
    scapegoat ethanol for rising food prices here in the United
    States and abroad, we need to examine carefully the data and
    facts surrounding higher gasoline prices. As you and I know,
    Mr. Chairman, if it were not for the increased use of ethanol
    and the blending of gasoline, prices at the pump would be some
    29 cents to 40 cents higher per gallon. That may explain in
    part why crude oil prices have risen faster and further than
    prices at the pump, and we have a chart that I wanted to show
    on this.
        Since January of this year, crude prices are up 21 percent,
    while gasoline prices are up 19 percent. Since January 2007,
    the difference is even more pronounced. Crude prices are up 106
    percent while gasoline prices are up 94 percent.
        The latest data from the Energy Information Administration
    (EIA) in March 2008 shows that 71.8 percent of the price of a
    gallon of gasoline is attributable to the raw crude oil input.
    In March 2007, crude oil accounted for only 52.3 percent of the
    cost of a gallon of gasoline. In March 2000, crude oil
    accounted for 44.6 percent of a gallon of gasoline. And that is
    on the charts.
        Crude oil costs are the unmistakable driving force behind
    the rise in gasoline prices, and for that we need to look in
    part at our own body here. We have made choices to refuse to
    allow drilling off the continental shelf and in Arctic National
    Wildlife Refuge (ANWR). We have chosen to allow antidevelopment
    and, I believe, antigrowth activists to block any attempt to
    expand our Nation's refining capacity. We need to revisit those
    decisions just as much as we need to examine the behavior of
    private enterprises.
        It is unfortunate the Government is not called to task for
    its own role in distorting markets and placing increased costs
    on consumers. Decisions that our Government has made regarding
    energy policy have contributed to the higher prices that
    consumers are now paying. And even though the percentage of
    retail gasoline prices and taxes represent a decline from 32.1
    percent in January 2000 to 12.3 percent in March 2008, the
    actual amount of the tax has not. In January 2000, taxes
    accounted for 41.4 cents per gallon. In March 2008, they
    accounted for 39.9 cents per gallon.
        I urge the FTC to use its resources to examine diligently
    and thoroughly all aspects of this issue. In the past, FTC has
    determined, except in a few isolated cases, that market forces
    were responsible for large changes in gasoline prices, not
    anticompetitive actions by the industry. But if you find those
    anticompetitive actions, we want to know about it and we want
    them pursued. Let us not think that we need to change the rules
    or alter the objectivity of scientific analysis and facts just
    to get the answer we want.
        I want to thank you, Mr. Chairman, for holding this
    hearing. I look forward to the testimony of the witnesses and a
    chance to question them.
        Senator Durbin. Thank you, Senator Brownback.
        As you can tell, we have a slightly different view of the
    world, and luckily the Federal Trade Commission is here to be
    the ultimate arbiter.
        We want to thank Chairman Kovacic, who will be allowed to
    make an opening statement, followed by Commissioner Leibowitz.
    Mr. Chairman.

                    SUMMARY STATEMENT OF WILLIAM E. KOVACIC

        Mr. Kovacic. Thank you, Chairman Durbin and Ranking Member
    Brownback. You could not have put the arbitration position in
    better hands.
        We are delighted to have the opportunity to speak to the
    budget request and to give you a sense of how we would use the
    funds that have been sought. To divide the labor today, I would
    like to talk a bit about the competition mission, and my
    colleague, Commissioner Leibowitz, will address the consumer
    protection mission.
        I want to talk about several areas that are examples of the
    respects in which I think this true modern success story in
    public administration provides an excellent return to consumers
    for the resources you have entrusted us with. Our basic
    philosophy in competition policy, I think, truly matches the
    intuition that motivates both of your comments about what we
    should be doing. We try to use our resources in areas that are
    of the greatest concern to consumers, and we have tried to
    address them by using the varied tools you put at our disposal.
    You not only made us, nearly a century ago, a law enforcement
    agency, but you entrusted us with research capabilities to get
    underneath the surface, to understand more fundamentally what
    is going on in our industries, and to not simply use the
    prosecution of lawsuits, but the formulation of rules, consumer
    education, and publicity as tools for formulating adjustments
    that we can control ourselves, but advising you as well about
    what policies should do.
        Let me single out several areas of principal concern to us,
    the areas, among others, in which we will devote our efforts in
    the competition area with the proposed budget of $256 million.
        First and foremost, energy. I share your view that there is
    no single field of endeavor for us that is more important to
    the American public, and we expect to approach it, among other
    areas, in two ways.
        As you know, earlier this month we issued an advance notice
    of proposed rulemaking to explore approaches for applying the
    market manipulation authority that this body gave us in
    December. We anticipate that the rulemaking process will be
    concluded in this calendar year, and there is nothing that my
    colleagues and I will devote more effort to see addressed as
    expeditiously and effectively within our agency.
        At the same time, we are deeply concerned with structural
    changes in this sector that can affect the price at which
    petroleum products, natural gas, other energy products are
    delivered to consumers. Within the past 12 months, we
    challenged a natural gas distribution merger in Pittsburgh,
    which ultimately resulted in the abandonment of the
    transaction. We brought a case against a combination of two
    refiners in the southwestern United States involving Western
    refining and Giant industries. In this we were unsuccessful in
    obtaining a preliminary injunction. But both matters are
    indicative of our willingness in all areas to scrutinize very
    carefully structural adjustments or proposed changes in the
    industry that would affect competition in this sector.
        The second area that is certainly close behind is health
    care. Two priorities I want to flag for you. The first is our
    continuing commitment to monitor and to challenge
    anticompetitive pay-for-delay settlements. Our prosecution of
    the Cephalon case is the latest in our efforts to ensure that
    the arrangements that Congress set in place with the Hatch-
    Waxman Act and the promise of lower prices through the
    provision of generic drugs to consumers are not lost. And even
    though we have suffered setbacks in a couple of these matters
    in the courts of appeals, we will continue to press as
    effectively as we can for successful judicial resolution of
    these matters. Cephalon is part of our commitment in that area.
        We are here also examining structural changes in the
    sector. Only recently we filed a challenge to a merger in
    northern Virginia that involves hospital providers, INOVA and
    the Prince William County Health Care System, again an
    indication of our commitment to monitor structural changes in
    this and other important sectors that would affect the price
    that consumers pay for healthcare.
        In the real estate area, we have brought cases involving
    what we feel are inappropriate arrangements involving multiple
    listing services.
        In the area of standards setting, we were unsuccessful in
    our Rambus case, but within the past couple of years, our
    successful challenge to an effort by Unocal to distort the
    process by which the State of California sets standards for
    gasoline to be sold in that State, resulted in a settlement
    that has yielded, we believe, benefits of at least $500 million
    a year to consumers.
        And the last item I want to mention is the very generous
    allotment that this subcommittee and the Congress as a whole
    gave us to pursue international matters. We have extended our
    efforts to work more effectively with our counterparts abroad
    to provide technical assistance to new competition systems,
    China, India, among others, and to pursue effective
    international cooperation under the framework of the SAFE WEB
    legislation that Congress also enacted in 2006.

                               PREPARED STATEMENT

        Last, I want to mention that we are undertaking a basic
    self-assessment. We are looking ahead to our centennial in
    2014, and we are going to be asking ourselves, with respect to
    all areas of our operations, are we the agency that Congress
    intended us to be, what steps can we take to get there? This
    will fold well into other areas in which Congress has directed
    us: to examine ourselves, to identify our possibilities for
    greatness, and to allow no power persuasion to deter us from
    that mission.
        Thank you.
        Senator Durbin. Thank you, Mr. Chairman.
        [The statement follows:]

                 Prepared Statement of Hon. William E. Kovacic

                                  INTRODUCTION

        Chairman Durbin, Ranking Member Brownback, and members of the
    subcommittee, thank you for inviting us to testify today in support of
    the Federal Trade Commission's (FTCs) fiscal year 2009 appropriation
    request and to discuss some of the work we will be doing next year. The
    Commission looks forward to working with you to further the interests
    of American consumers.
        The FTC, though small, is the one Federal agency with both consumer
    protection and competition jurisdiction across broad sectors of the
    economy. It enforces, among a broad range of other laws, Section 5 of
    the Federal Trade Commission Act, which prohibits business practices
    that are harmful to consumers because they are anticompetitive,
    deceptive, or unfair.
        The Report attached to this testimony, ``The FTC in 2008: A Force
    for Consumers and Competition'' provides a detailed overview of the
    scope of our work. The FTC has pursued a vigorous and effective law
    enforcement program in a dynamic marketplace that is increasingly
    global and characterized by changing technologies. Through the efforts
    of a dedicated staff, the FTC continues to handle a growing workload.
    This testimony summarizes the FTC's budget request for fiscal year
    2009, and describes some of its major activities. To meet the
    challenges of our Consumer Protection and Maintaining Competition goals
    in fiscal year 2009, the FTC requests $256,200,000 and 1,102 FTE. The
    fiscal year 2009 request represents an increase of $12,336,000 and 18
    FTE over the fiscal year 2008 enacted levels.
        Looking further into the future our success will require continued
    efforts to improve the institutional mechanism through which we execute
    our responsibilities. In the coming months we will undertake a program
    to identify the way ahead. Our focus will extend beyond the next few
    years, and we will ask what the Agency should look like when our
    centennial arrives in 2014, and beyond. This self-assessment will
    include a combination of internal deliberations and external
    consultations in the United States and overseas with the community of
    Government and non-Government bodies that have an interest in
    competition and consumer protection policy.

                          CONSUMER PROTECTION MISSION

        In the consumer protection area, the Commission is active in a
    variety of efforts to protect the public from unfair, deceptive, and
    fraudulent practices in the marketplace, including law enforcement
    targeting telemarketing fraud, deceptive marketing of health care
    products, consumer fraud against Hispanics, and business opportunity
    and work-at-home schemes. The Commission also has an active program of
    consumer and business education and outreach. This testimony highlights
    seven key priorities for the FTC in fiscal year 2009: financial
    practices; technology (spyware, spam, and behavioral advertising); Do
    Not Call; privacy and data security; green claims; food marketing to
    children; and entertainment industry marketing to children.

    Financial Practices
        The Commission will continue its important work to protect
    consumers of financial services, focusing on every stage of the
    consumer credit life cycle, from the advertising and marketing of
    financial products to debt collection and debt relief. The Commission
    is particularly concerned at this time about the rise in mortgage
    foreclosures and delinquencies in the subprime market and its impact on
    communities.
        In the past decade, the Agency has brought 22 actions focused on
    the mortgage lending industry, with particular attention to the
    subprime market, alleging that lenders and servicers have engaged in
    unfair and deceptive advertising and mortgage servicing practices.
    Through these cases, the FTC has recovered more than $320 million for
    consumer redress. In addition, these cases serve as notice to the
    industry generally not to engage in the practices identified as unfair
    or deceptive. Most of these mortgage cases are complex and take
    considerable resources to investigate and prosecute, often requiring
    considerable litigation, in order to obtain adequate redress for
    consumers and other remedies. The Commission continues its important
    work in this area.
        The Agency is currently investigating the ads of a dozen companies
    for improperly promoting mortgage products, such as ads that announce
    low ``teaser'' rates without explaining that those rates apply for a
    short period of time and can increase substantially after the loan's
    introductory period. Commission staff has reviewed hundreds of mortgage
    advertisements and sent warning letters to 200 mortgage lenders because
    their ads did not appear to comply with laws the Commission enforces.
    Staff is examining these companies' more recent advertisements and,
    where they are noncompliant, the Commission will follow up by bringing
    cases.
        With the rapid increase in mortgage delinquencies and foreclosures,
    the FTC has also intensified its efforts to protect consumers from
    mortgage foreclosure rescue scams. Most of these cases involve
    allegations of scammers who falsely promise that they can save
    consumers' homes from foreclosure.\1\ Since February of this year, the
    Commission has announced four cases targeting such foreclosure rescue
    scams.\2\ Commission staff also continues to conduct outreach and to
    share enforcement resources with State and local authorities through
    seven regional task forces in cities with high foreclosure rates.
    ---------------------------------------------------------------------------
        \1\ In testimony on February 13, 2008 before the Senate Special
    Committee on Aging on foreclosure rescue fraud, the Commission set
    forth a more complete description of the FTC's efforts to address such
    fraud. The FTC's testimony is available at http://www.ftc.gov/os/
    testimony/P064814foreclosure.pdf.
        \2\ FTC v. Safe Harbour Foundation, No. 08 C 1185 (N.D. Ill. filed
    Feb. 25, 2008), available at http://www.ftc.gov/os/caselist/0823028/
    index.shtm; FTC v. Mortgage Foreclosure Solutions, Inc., No. 8:08 CV-
    00388 (M.D. Fla. filed Feb. 26, 2008) available at http://www.ftc.gov/
    os/caselist/0823021/index.shtm; FTC v. National Hometeam Solutions,
    Inc., No. 4:08-CV-00067 (E.D. Tex. filed Feb. 26, 2008), available at
    http://www.ftc.gov/os/caselist/0823076/index.shtm. FTC v. Foreclosure
    Solutions, LLC, No. 1-08-CV-01075 (N.D. Ohio filed Apr. 28, 2008),
    available at http://www.ftc.gov/os/caselist/0723131/index.shtm. Last
    month, The Bear Stearns Companies, Inc. (``Bear Stearns'') disclosed
    that FTC staff has notified its mortgage servicing subsidiary, EMC
    Mortgage Corporation (``EMC''), that the staff believes EMC and its
    parent Bear Stearns have violated a number of Federal consumer
    protection statutes in connection with its servicing activities. Bear
    Stearns further disclosed that FTC staff offered an opportunity to
    resolve the matter through consent negotiations before seeking approval
    from the Commission to proceed with the filing of a complaint.
    According to the disclosure, EMC expects to engage in such discussions
    with Commission staff. Form 10-K, Bear Stearns Mortgage Funding Trust
    2007-AR4 (CIK No. 1393708), at Item 1117 of Reg AB, Legal Proceedings
    (filed Mar. 31, 2008), available at www.sec.gov/Archives/edgar/data/
    1393708/000105640408001164/0001056404-08-001164.txt. The FTC cannot
    comment further on this ongoing law enforcement investigation.
    ---------------------------------------------------------------------------
        The Commission's actions to protect consumers of financial services
    extend beyond mortgage lending to a wide range of non-mortgage
    financial services. Earlier this year, the Commission announced that
    three payday lenders agreed to settle FTC charges that their
    advertising violated the Truth in Lending Act by failing to provide
    interest information required by Federal law. This information helps
    consumers compare the costs of these payday loans to other payday loans
    and to alternative forms of short-term credit.\3\ The settlements have
    been accepted for public comment.
    ---------------------------------------------------------------------------
        \3\ CashPro, File No. 072-3203 (Feb. 2008); American Cash Market,
    Inc., File No. 072-3210 (Feb. 2008); Anderson Payday Loans, File No.
    072-3212 (Feb. 2008) (all available at http://www.ftc.gov/opa/2008/02/
    amercash.shtm).
    ---------------------------------------------------------------------------
        In this economy, consumers with high levels of debt are
    particularly vulnerable to debt collection abuses, as well as debt
    negotiation and debt consolidation scams. Last November, the Commission
    announced its largest civil penalty in a debt collection case $1.375
    million.\4\ In addition, the Commission has prosecuted more than 60
    companies engaged in deceptive debt negotiation, debt consolidation,
    and credit repair practices. The Commission plans to continue its
    important work in this area in fiscal year 2009.
    ---------------------------------------------------------------------------
        \4\ United States v. LTD Financial Services, Inc., Civ. No. H-07-
    3741 (S.D. Tex. filed Nov. 5, 2007), available at http://www.ftc.gov/
    os/caselist/0523012/index.shtm.
    ---------------------------------------------------------------------------
    Technology (Spyware, Spam, and Behavioral Advertising)
        The Commission has been at the forefront of protecting consumers
    from such technological threats as spam and spyware. The Agency has
    brought more than 100 spam and spyware cases. Earlier this year, the
    Agency announced its largest civil penalty in a spam case $2.9 million
    against a company allegedly using deceptive email to offer ``free''
    gifts that were not, in fact, free.\5\
    ---------------------------------------------------------------------------
        \5\ United States v. Valueclick, No. CV08-01711 MMM (rzx) (C.D.
    Cal. filed Mar. 13, 2008), available at http://www.ftc.gov/os/caselist/
    0723111/index.shtm.
    ---------------------------------------------------------------------------
        In addition, the Agency identifies and studies potential consumer
    protection issues raised by new technologies. For example, last week,
    the Commission hosted a town-hall meeting on mobile marketing, which
    examined such topics as consumers' ability to control mobile
    applications; the challenges presented by small screen disclosures;
    practices targeting children and teens; evolving security threats and
    solutions; and next-generation products and services.
        The Commission also continues to examine behavioral advertising,
    the practice of collecting information about consumers' online habits
    in order to deliver targeted advertising.\6\ Following a workshop on
    behavioral advertising last fall, the Commission staff released a set
    of proposed principles to guide the development of self-regulation in
    this area and sought comment on these principles.\7\ The deadline for
    comments was April 11; the Agency received numerous detailed and
    thorough comments, which it is currently reviewing.
    ---------------------------------------------------------------------------
        \6\ See http://www.ftc.gov/bcp/workshops/ehavioral/index.shtml.
        \7\ See Press Release, FTC Staff Proposes Online Behavioral
    Advertising Privacy Principles (Dec. 20, 2007), available at http://
    www.ftc.gov/opa/2007/12/principles.shtm.
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    Do Not Call
        The Commission continues aggressively to implement and enforce the
    National Do Not Call Registry. The Commission is grateful that Congress
    made participation in the Do Not Call Registry permanent so that
    consumers will continue to enjoy its benefits without having to re-
    register. In November 2007, the Commission announced six new
    settlements and one new Federal court action against companies that
    violated the Do Not Call provisions of the Telemarketing Sales Rule.
    The six settlements resulted in $7.7 million in civil penalties for Do
    Not Call violations.\8\
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        \8\ See Press Release, FTC Announces Law Enforcement Crackdown On
    Do Not Call Violators, Nov. 7, 2007, available at http://www.ftc.gov/
    opa/2007/11/dncpress.shtm.
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    Privacy and Data Security
        Privacy and data security continue to be high priorities for the
    Commission. In the past 6 months, the Commission announced six new data
    security cases,\9\ bringing the total number of FTC data security cases
    to 20. Most recently, the Commission announced cases against TJX and
    Reed Elsevier, the parent company of Lexis Nexis, alleging that the
    companies engaged in unfair practices by failing to employ reasonable
    and appropriate security measures to safeguard sensitive data. The
    settlements have been accepted for comment, and would require the
    companies to implement comprehensive data security programs and third-
    party assessments biennially for 20 years.\10\
    ---------------------------------------------------------------------------
        \9\ United States v. American United Mortgage Company, No. 07C 7064
    (N.D. Ill. filed Dec. 17, 2007), available at http://www.ftc.gov/opa/
    2007/12/aumort.shtm; Life is good, Inc., Docket C-4216 (Apr. 2008),
    available at http://www.ftc.gov/os/caselist/0723046/index.shtm; In the
    Matter of Goal Financial, LLC., Docket No. C-4216 (Mar. 2008),
    available at http://www.ftc.gov/os/caselist/0723013/index.shtm
    (settlement accepted for public comment); United States v. Valueclick,
    No. CV08-01711 MMM (rzx) (C.D. Cal. filed Mar. 13, 2008), available at
    http://www.ftc.gov/os/caselist/0723111/index.shtm; The TJX Companies,
    File No. 072-3055 (Mar. 2008), available at http://www.ftc.gov/os/
    caselist/0723055/index.shtm (settlement accepted for public comment);
    Reed Elsevier, Inc. and Seisint, Inc., File No. 052-3094 (Mar. 2008),
    available at http://www.ftc.gov/os/caselist/0523094/index.shtm
    (settlement accepted for public comment).
        \10\ The TJX Companies, File No. 072-3055 (Mar. 2008), available at
    http://www.ftc.gov/os/caselist/0723055/index.shtm; In the Matter of
    Reed Elsevier, Inc. and Seisint, Inc., File No. 052-3094 (Mar. 2008),
    available at http://www.ftc.gov/os/caselist/0523094/index.shtm.
    ---------------------------------------------------------------------------
        The FTC has also been active on data security education. It has
    distributed more than 3 million copies of its consumer education
    publication ``Take Charge: Fighting Back Against ID Theft.'' The FTC
    also published a guide for businesses on data security, Protecting
    Personal Information: A Guide for Business, and launched an
    interactive, online video tutorial designed to educate businesses using
    real-life scenarios. The Agency has also begun to hold regional
    workshops for businesses on how to plan and manage data security. The
    first workshop took place April 15 in Chicago.

    Green Marketing
        In response to a virtual explosion of green marketing over the past
    year, the Commission has accelerated its review of its environmental
    marketing guidelines, also known as the Green Guides.\11\ In November
    2007, the FTC published a Federal Register Notice seeking public
    comment on the Guides. Given the importance of green marketing and the
    proliferation of new claims, the Commission also announced that it
    would hold a series of workshops in aid of the Guide review. The
    Commission hosted the first of these events on January 8, 2008,
    addressing the marketing of carbon offsets and renewable energy
    certificates. The second workshop, on green packaging, took place on
    April 30, 2008, and a third workshop, on green claims related to
    textiles and building materials, is planned for this July. The
    Commission will use the information it receives at these workshops to
    inform its review of the Green Guides, conduct enforcement actions, and
    educate consumers.
    ---------------------------------------------------------------------------
        \11\ See Press Release, FTC Reviews Environmental Marketing Guides,
    Announces Public Meetings (Nov. 26, 2007), available at http://
    www.ftc.gov/opa/2007/11/enviro.shtm.
    ---------------------------------------------------------------------------
    Food Marketing to Children
        The Commission continues its efforts to combat childhood obesity.
    In early August, the Commission issued compulsory process orders to 44
    food and beverage companies and quick-service restaurants, asking for
    information on their expenditures and activities targeted toward
    children and adolescents. All of the targeted companies have submitted
    their responses, and staff is analyzing the submissions. Staff will
    prepare a report, submit it to Congress, and release it publicly this
    summer. The report will be an important tool for tracking the
    marketplace's response to childhood obesity and identifying where more
    action is needed.

    Entertainment Marketing to Children
        The Commission continues to monitor the marketing of violent
    entertainment to children and encourage industry self-regulation in
    this area. Since 2000, the FTC has issued six reports on the marketing
    of movies, music, and video games containing content that may not be
    appropriate for children.\12\ The Commission's reports generally
    document improvement by all three industries in providing rating or
    labeling information in advertising. The Commission has also conducted
    five ``undercover shops,'' in which underage teenagers try to purchase
    media rated or labeled as containing inappropriate content. These
    undercover shops have demonstrated steady improvement in retail
    enforcement of the age ratings.
    ---------------------------------------------------------------------------
        \12\ Moreover, in 2006, the Commission initiated and settled an
    action against Take-Two Interactive Software, Inc. and Rockstar Games,
    Inc., the creators and distributors of the popular Grand Theft Auto:
    San Andreas video game, because they advertised the Entertainment
    Software Rating Board (``ESRB'') rating for the game but failed to
    disclose that the game discs contained potentially viewable sexually
    explicit content that was unrated by the ESRB. Take-Two Interactive
    Software, Inc., No. C-4162 (July 21, 2006), available at http://
    www.ftc.gov/os/caselist/0523158/0523158.shtm.
    ---------------------------------------------------------------------------
        Last week, the Commission released the results of its fifth
    undercover shop. These results show improvement, particularly by the
    video game industry, which denied sales of Mature-rated games to our
    underage shoppers 80 percent of the time. This is a dramatic
    improvement from where the industry started 8 years ago, when nearly 9
    out of 10 underage shoppers were able to buy these games. There are,
    however, still areas for improvement. For example, roughly half of our
    undercover shoppers were able to purchase R-rated or unrated DVDs and
    explicit content music. The Commission will continue to monitor self-
    regulatory efforts in this area.

                              COMPETITION MISSION

        The Commission has an active enforcement agenda to promote and
    protect competition, focusing on areas that are highly important to
    consumers, such as health care, energy, real estate, and high
    technology and standard setting. The Commission scrutinizes mergers in
    many industries, filing actions to enjoin those that are likely to be
    anticompetitive and ordering divestitures where appropriate to preserve
    competition while allowing the beneficial aspects of the merger to
    proceed. The Commission also polices anticompetitive conduct, with a
    particular focus on competitor collaboration and exclusionary conduct.
    Additionally, the Commission promotes sound competition policy through
    myriad research and reports, studies, hearings, workshops, advocacy
    filings, and amicus briefs. The Commission is also very active on the
    international front, developing strong working relationships with
    foreign antitrust agencies, cooperating on cross-border cases,
    promoting convergence on competition policies, and offering technical
    assistance to countries with relatively new competition laws.
        This portion of the testimony highlights several important recent
    developments in the Commission's competition agenda.
    Health Care (Pay-For-Delay Settlements and Hospital Mergers)
        In the health care area, the Commission is continuing its efforts
    to prevent brand name drug companies from paying generic competitors to
    stay out of the market, thereby depriving consumers and other payers of
    significant savings. In February 2008, the Commission filed a case
    charging that Cephalon, a pharmaceutical manufacturer, engaged in
    illegal conduct to prevent competition for its branded drug,
    Provigil,\13\ by paying four competing firms to refrain from selling
    generic versions of the drug until 2012.\14\ The Commission's complaint
    alleges that Cephalon's conduct constituted an abuse of monopoly power
    that is unlawful under Section 5 of the FTC Act. The Commission also
    has several other exclusion payment (``pay-for-delay settlement'')
    investigations ongoing.
    ---------------------------------------------------------------------------
        \13\ Provigil is used to treat excessive sleepiness in patients
    with sleep apnea, narcolepsy, and shift-work sleep disorder.
        \14\ FTC v. Cephalon, Inc., No. 1:08-cv-00244 (D.DC. filed Feb. 13,
    2008), available at http://www.ftc.gov/os/caselist/0610182/
    080213complaint.pdf.
    ---------------------------------------------------------------------------
        These deals are a growing problem due to two court decisions taking
    a lenient view of the practice. Between 2000 and 2004, there were no
    patent settlements in which the generic received compensation and
    agreed to stay off the market, but after the two court decisions in
    2005, there were 3 such agreements in fiscal year 2005 and 14 in fiscal
    year 2006. The Commission strongly supports legislation to address
    competitive problems with pay-for-delay settlements. We note that bills
    have been introduced in both chambers, and thank you, Mr. Chairman, for
    your sponsorship of the bipartisan Senate bill.\15\
    ---------------------------------------------------------------------------
        \15\ Preserve Access to Affordable Generics Act, S. 316, 110th
    Cong. (2007) (as reported by S. Comm. on the Judiciary).
    ---------------------------------------------------------------------------
        Last week the Commission voted to challenge the Inova Health
    System's proposed acquisition of the Prince William Health System. The
    proposed merger would combine Inova, the largest hospital system in
    Northern Virginia, with the Prince William Hospital in Prince William
    County, Virginia. The Commission alleges that the merger would
    eliminate the existing, significant price and non-price competition
    between these hospitals, particularly in the fast-growing western
    suburbs of Northern Virginia, leading to higher health care costs for
    the employers and residents of Northern Virginia.

    Energy
        The Commission shares the concerns of lawmakers, businesses, and
    American consumers about rapidly increasing prices for crude oil,
    gasoline,\16\ diesel fuel, jet fuel, and natural gas, and currently
    engages in a wide range of activities to prevent improper industry
    conduct causing such price rises. Under new authority to promulgate
    regulations provided in Section 811 of the Energy Independence and
    Security Act of 2007 (EISA), this month the Commission issued an
    Advance Notice of Proposed Rulemaking (ANPR) regarding manipulation of
    wholesale crude oil, gasoline, or petroleum distillate markets. The
    ANPR, available on the Commission's website and in the Federal
    Register, solicits public comments on determining whether and in what
    ways the Commission should develop a rule defining and prohibiting
    market manipulation in the petroleum industry.\17\ The 30-day public
    comment period runs through June 6, 2008, and the Commission
    anticipates concluding the rulemaking process this year. In addition,
    Section 812 of that act prohibits knowingly reporting false data to a
    Federal agency under a mandatory reporting requirement, with the
    intention of affecting the Agency's data compilations for statistical
    or analytical purposes. The section provides for Commission enforcement
    with substantial penalties.
    ---------------------------------------------------------------------------
        \16\ The Commission actively and continuously monitors retail and
    wholesale prices of gasoline and diesel fuel, looking for ``unusual''
    price movements and then examining whether any such movements might
    result from anticompetitive conduct that violates Section 5 of the FTC
    Act. FTC economists have developed a statistical model for identifying
    such movements. The Agency's economists regularly scrutinize price
    movements in 20 wholesale regions and approximately 360 retail areas
    across the country.
        \17\ FTC Seeks Public Comment on Rulemaking to Prohibit Market
    Manipulation in the Petroleum Industry, Press Release, May 1, 2008,
    available at: http://www.ftc.gov/opa/2008/05/anpr.shtm, 73 Fed. Reg.
    25614 (May 7, 2008).
    ---------------------------------------------------------------------------
        To protect and promote competition in the energy industry, the
    Commission reviews mergers and investigates pricing and other
    conduct.\18\ Over the past several years, the Commission has challenged
    many mergers in this industry, obtaining significant divestitures to
    preserve competition.\19\
    ---------------------------------------------------------------------------
        \18\ In 2005, the Commission settled an enforcement action charging
    that Unocal deceived the California Air Resources Board (``CARB'') in
    connection with regulatory proceedings to develop the reformulated
    gasoline standards that CARB adopted. We believe the settlement
    continues to result in an estimated $500 million of consumer savings at
    the pump each year. See the discussion in Section III.D below.
        \19\ These include Mobil/Exxon, British Petroleum/Amoco, Chevron/
    Texaco, and Phillips Petroleum/Conoco.
    ---------------------------------------------------------------------------
        In the past year, we have acted to block acquisitions in the
    natural gas and petroleum industries that we believed could raise
    prices to consumers. In January 2008, Equitable Resources abandoned its
    proposed acquisition of the Peoples Natural Gas Company, a subsidiary
    of Dominion Resources, after the Third Circuit took the unusual step of
    granting the Commission's motion for an injunction pending appeal, and
    vacated the District Court's ruling dismissing the Commission's
    complaint.\20\ The Commission alleged that parties were each others'
    sole competitors in the distribution of natural gas to non-residential
    customers in the Pittsburgh area and the transaction would have
    resulted in a monopoly for many customers. Moreover, in May 2007, the
    Commission brought an enforcement action in the oil and gasoline
    industry when it issued an administrative complaint and initiated a
    Federal court action to block Western Refining, Inc.'s $1.4 billion
    proposed acquisition of rival energy company Giant Industries, Inc. The
    Commission brought the action in an effort to preserve competition in
    the supply of bulk light petroleum products, including motor gasoline,
    diesel fuels, and jet fuels, in northern New Mexico. After a week-long
    trial, the Federal district court denied the Commission's motion for a
    preliminary injunction.\21\ The Commission is continuing to examine and
    address a wide range of issues in the energy markets.\22\
    ---------------------------------------------------------------------------
        \20\ See FTC v. Equitable Resources, Inc., No. 07-2499 (3rd Cir.
    2008), available at http://www.ftc.gov/os/caselist/0610140/
    080204ftcmovacateequitabledecision.pdf.
        \21\ The Commission subsequently dismissed its administrative
    complaint, concluding that further prosecution would not be in the
    public interest.
        \22\ For example, in November 2007, the Commission issued its third
    annual report on the state of ethanol production in the U.S. The report
    noted that, as of September 2007, 13 firms had entered into the
    production of ethanol during the preceding year, bringing the total
    number of U.S. producers to 103. As new firms have entered, the market,
    which is unconcentrated by any measure of capacity or production, has
    become even more unconcentrated. 2007 Federal Trade Commission Report
    of Ethanol Market Concentration (Nov. 2007) available at http://
    www.ftc.gov/reports/ethanol/2007ethanol.pdf.
        Additionally, the Commission is preparing its first report for the
    Committees on Appropriations summarizing the Commission's activities
    relating to ongoing reviews of mergers, acquisitions, and other
    transactions in the oil and natural gas industries, the investigation
    of pricing behavior or any potential anticompetitive actions in those
    industries, and the resources that the Commission has devoted to such
    reviews and investigations during the 6-month period.
    ---------------------------------------------------------------------------
    Real Estate
        In another area critical to consumers, the Commission continues to
    challenge realtor board rules that restrain competition and hinder
    consumer choice in markets throughout the country. The Commission's
    cases allege that associations of competing real estate agents have
    adopted rules that limit competition from non-traditional and discount
    brokers by restricting these brokers from, in part, placing listings on
    MLS Internet sites, thus harming consumers who may prefer to list with
    less expensive or non-traditional brokers. Six of our cases were
    resolved by consent order requiring each realtor board to discontinue
    enforcing the policies that, the Commission alleged, kept
    nontraditional brokers from competing. A seventh investigation led to
    an administrative complaint against a realtor group, which after a full
    administrative trial and dismissal of the complaint against the
    realtors by the ALJ is on appeal before the Commission. Oral arguments
    were held in April, and a Commission opinion is expected in the next
    months. The Commission also settled an action raising similar concerns
    with a Milwaukee-based realtor group in the past year.\23\
    ---------------------------------------------------------------------------
        \23\ Press Release, FTC Charges Milwaukee MLS with Illegally
    Restraining Competition (Dec. 12, 2007), available at http://
    www.ftc.gov/opa/2007/12/mls.shtm.
    ---------------------------------------------------------------------------
    High Technology and Standard Setting
        The Commission continues to remain vigilant against mergers and
    conduct that would distort competition in the high technology industry.
    One such enforcement case that the Commission has brought is the case
    against Rambus. In June 2002, the Commission charged Rambus with
    unlawfully monopolizing four computer memory technologies that were
    incorporated into industry standards for dynamic random access memory
    chips, widely used in personal computers, servers, printers, and
    cameras. In July 2006, the Commission found that Rambus had illegally
    acquired monopoly power through exclusionary acts, and issued an order
    limiting the royalty rates Rambus may collect under its licensing
    agreements.\24\ On April 22, 2008, the D.C. Circuit Court of Appeals
    set aside the Commission's Order and remanded the case for further
    proceedings before the Commission. The Commission is reviewing the
    Court of Appeals opinion and will decide in the next few weeks whether
    to appeal the decision to the full D.C. Circuit or the Supreme Court.
    ---------------------------------------------------------------------------
        \24\ Press Release, FTC Issues Final Opinion and Order in Rambus
    Matter (Feb. 5, 2007), available at http://www.ftc.gov/opa/2007/02/
    070502rambus.htm.
    ---------------------------------------------------------------------------
        The Commission has previously addressed the substantial consumer
    harm, including higher prices, that can result from the alleged abuse
    of standard-setting processes. In 2003, the Commission successfully
    challenged Unocal's alleged illegal acquisition of monopoly power in
    the technology market for producing Phase 2 ``summer-time'' gasoline a
    formulation of low- emissions gasoline mandated for sale and use in
    California for up to 8 months of the year by misrepresenting that
    certain information was non-proprietary and in the public domain, while
    at the same time pursuing patents that would enable it to charge
    substantial royalties if the information was incorporated into
    California Air Resources Board (``CARB'') standards. The complaint
    alleged that Unocal induced CARB to adopt standards for this gasoline
    that substantially overlapped with Unocal's patent rights. The
    Commission's success is estimated to have saved California consumers
    over $500 million per year at the pump.
    Other
        The Commission's efforts to maintain competition are not limited to
    high profile industries. In January 2008, the U.S. Court of Appeals for
    the Fifth Circuit upheld a Commission order requiring Chicago Bridge &
    Iron Co., N.V. and its United States subsidiary (CB&I) to divest assets
    acquired from Pitt-Des Moines, Inc. used in the business of designing,
    engineering, and building field-erected cryogenic storage tanks.\25\
    The Commission had ruled in 2005 that CB&I's acquisition of these
    assets in 2001, would likely result in a substantial lessening of
    competition or tend to create a monopoly in four markets for industrial
    storage tanks in the United States. The court endorsed the Commission's
    findings that the merged firms controlled over 70 percent of the
    market, and that new entry was unlikely given the high entry barriers
    and based on the incumbents' reputation and control of skilled crews.
    ---------------------------------------------------------------------------
        \25\ FTC v. Chicago Bridge & Iron Co., No. 05-60192 (5th Cir. 2008)
    available at http://www.ftc.gov/os/adjpro/d9300/
    080125opinion.pdf.http://www.ftc.gov/opa/2008/01/cbi.shtm
    ---------------------------------------------------------------------------
        The Commission continues to appeal its case against Whole Foods
    Market, Inc.'s acquisition of its chief rival, Wild Oats Markets, Inc.,
    on the grounds that the district court failed to apply the proper legal
    standard that governs preliminary injunction applications by the
    Commission in Section 7 cases. The Court of Appeals for the District of
    Columbia Circuit heard oral arguments on this case on April 23, 2008.

                     NEEDED RESOURCES FOR FISCAL YEAR 2009

        To meet the challenges of its Consumer Protection and Maintaining
    Competition goals in fiscal year 2009, the FTC requests $256,200,000
    and 1,102 FTE. The fiscal year 2009 request represents an increase of
    $12,336,000 and 18 FTE over the fiscal year 2008 enacted levels.
        The Commission seeks these additional resources to continue to
    build on its record of accomplishments in enhancing consumer protection
    and protecting competition in the United States and, increasingly,
    abroad. The increase of $12,336,000 that the Commission is seeking in
    fiscal year 2009 includes:
      --$7,989,000 in mandatory cost increases associated with contract
            expenses (CPI adjustment) and personnel (salaries and with-in-
            grade increases);
      --$2,847,000 for 18 additional FTE;
        --10 FTE for Consumer Protection to protect consumers from unfair
                and deceptive practices in the financial services
                marketplace; protect consumers' privacy; improve compliance
                with FTC orders; pursue foreign-located evidence of fraud
                perpetrated against U.S. consumers; advocate the adoption
                of foreign data privacy laws and procedures that are
                compatible with American law; and provide support for the
                effective operation of this program; and
        --8 FTE for Maintaining Competition to meet the increased workload
                required to challenge anticompetitive mergers and assure
                that the marketplace is free from anticompetitive business
                practices in the health care, pharmaceutical, energy, and
                technology sectors; promote convergence in competition
                policy of foreign enforcement practices; and provide
                support for the effective operation of this program;
      --$1,500,000 for non-FTE program needs;
        --$1,100,000 for Consumer Protection;
          -- $500,000 for ``Green'' marketing research, education campaign,
                and enforcement;
          -- $250,000 for high-tech tools to stop fraudsters;
          -- $250,000 for marketing and advertising of food to children;
          -- $100,000 for privacy and identity theft and deceptive and
                unfair practices in mobile marketing; and
          -- $400,000 for Maintaining Competition to meet the challenges of
                an increased enforcement agenda and associated litigation
                and outreach efforts.
        The majority of the funding for the FTC's fiscal year 2009 budget
    request will be derived from offsetting collections; HSR filing fees
    and Do Not Call fees will provide the Agency with an estimated
    $189,800,000 in fiscal year 2009. The FTC anticipates that the
    remaining funding needed for the Agency's operations will be through a
    direct appropriation of $66,400,000 from the General Fund in the U.S.
    Treasury. The FTC appreciates the strong support it has received from
    Congress to serve its critical mission of protecting the American
    consumer and ensuring competition in the marketplace. With the
    increased funding made available to the FTC in the fiscal year 2008
    appropriation for high priority activities including subprime lending,
    identity theft, the U.S. SAFE WEB Act, market manipulation of
    petroleum, maintaining competition, and training and technical
    assistance for developing nations, the FTC will be able to address
    critical consumer problems at present and anticipate, adapt, and
    mitigate the challenges of the future.

                                   CONCLUSION

        We appreciate the opportunity to appear before you today to discuss
    the Commission's work and our fiscal year 2009 budget request, and look
    forward to continuing to work together.

        Senator Durbin. Commissioner Leibowitz.

                    SUMMARY STATEMENT OF HON. JON LEIBOWITZ

        Mr. Leibowitz. Thank you, Mr. Chairman, Ranking Member
    Brownback. Let me begin by speaking briefly about the
    Commission generally before I turn to the FTC's consumer
    protection efforts.
        From my perspective, the Commission's biggest challenge is
    that we are a small agency--we have fewer than 1,100 full-time
    equivalents (FTEs)--but we are tasked with a big mission:
    protecting competition and consumers across broad swaths of the
    economy. The constant challenge for us is not only to
    effectively leverage our limited resources--I think we do that
    quite well--but also to ensure that the quality of our work is
    not strained by the quantity of demands placed upon us.
        In the past few years, Congress has enacted new laws,
    several very important ones, that the FTC is charged with
    enforcing: CAN-SPAM, the Fair and Accurate Credit Transactions
    Act (FACT), the Children's Online Privacy Protection Act
    (COPPA), to name just a few.
        Put simply, implementing and enforcing these laws takes
    resources. For that reason, we deeply appreciate your efforts
    to ensure that we have the budget we need. Speaking for myself,
    I am enormously grateful for the $3 million your subcommittee
    authorized last year above the administration's request. That
    enabled us to hire additional employees to bolster our
    enforcement efforts, especially in the areas of financial fraud
    and anticompetitive behavior by pharmaceutical companies, which
    Chairman Kovacic talked about.
        Mr. Chairman, the rest of my remarks will focus on some of
    our consumer protection priorities. I am going to try to do six
    priorities in 3 minutes.
        First, financial services. Chairman Durbin, you mentioned
    mortgages, and we currently have multiple investigations
    underway in the subprime market, including two that the targets
    themselves have made public: investigations of Bear Stearns,
    for servicing subprime mortgage loans; and of CompuCredit, a
    leading provider of subprime credit cards. We also are
    investigating mortgage brokers whose advertising, for example,
    touted preposterously low interest rates without disclosing
    that they would increase substantially after a short
    introductory period. In the past decade, we have brought 22
    actions against the mortgage lending industry and obtained more
    than $320 million in consumer redress.
        Indeed, if you combine all the consumer redress,
    disgorgement, and fines we collect with our Hart-Scott-Rodino
    and Do Not Call fees, the agency brings back more money to
    American consumers than it costs.
        Second, Do Not Call. The great American philosopher, Dave
    Barry, has called the Do Not Call Registry the most popular
    Government program since the Elvis stamp. It has helped
    preserve the sanctity of the American dinner hour, and we are
    grateful that Congress made Do Not Call permanent last year.
    There are nearly 160 million phone numbers registered on Do Not
    Call and----
        Mr. Kovacic. How many?
        Mr. Leibowitz. 160 million registered, and to date we have
    brought 36 cases against violators.
        Third, technology. The Commission has initiated more than
    100 spam and spyware actions, and has helped to substantially
    reduce the nuisance adware problems that have caused literally
    billions of unwanted pop-up ads on Americans' computers.
        We have also held hearings on emerging technologies and
    practices such as behavioral marketing; that is, the monitoring
    of consumers' online behavior to deliver targeted advertising.
    Commission staff recently issued a set of proposed behavioral
    advertising principles for public comment designed to push
    self-regulation in the right direction.
        Fourth, privacy and data security. Safeguarding consumers'
    sensitive personal information remains a priority for us. To
    date, the FTC has brought 20 enforcement actions challenging
    data breaches and inadequate data security practices.
        Fifth, so-called green claims. In the past year or two,
    there has been an explosion of environmental advertising claims
    like ``sustainable'', ``renewable'', and ``carbon neutral''. In
    response, we are holding a series of workshops and updating our
    environmental marketing guidelines, better known as the Green
    Guides.
        Sixth and finally, an issue I know both of you are
    interested in, marketing to children. The Commission continues
    its efforts to combat childhood obesity and foster appropriate
    food marketing to kids. Last August, the Commission subpoenaed
    44 food and beverage companies seeking information on their
    activities targeted to children. Staff is preparing a report
    based on what we have learned, and we expect to release it this
    summer.
        The Commission also continues to monitor entertainment
    industry marketing practices. Since 2000, the FTC has issued
    six reports on the marketing of movies, music, and video games
    containing violent content. And last week we released the
    results of our fifth undercover shopping survey in which
    underage teenagers tried to buy media labeled as containing
    inappropriate content. These reports and surveys generally show
    industry improvement, although further progress would be
    helpful, especially in the growing marketing of unrated DVDs.
    Our efforts are designed to encourage further self-regulation
    in this area. We believe they have been helpful.
        With that, I will exercise some self-regulation of my own
    and stop talking. And I am happy to answer questions.
        Senator Durbin. Thank you, and I think we will have a few.

                            TRENDS IN THE OIL MARKET

        Chairman Kovacic, I wrote you a letter on April 23 urging
    the FTC to investigate trends in the oil market. We have seen a
    sudden widening of the difference between crude oil and certain
    refined petroleum product prices, the so-called crack spread.
    This crack spread for middle distillate fuels like diesel, home
    heating oil, and jet fuel has spiked recently, leading to two
    trends I wrote you about.
        First, while gasoline has typically been more expensive
    than diesel fuel, we have recently seen that trend dramatically
    reversed. The national average for retail gas, $3.72; the
    average for diesel fuel, $4.33 a gallon, a difference of 61
    cents.
        Second, we are seeing a spike in jet fuel costs having a
    major impact on struggling airlines. Yesterday CNN quoted the
    CEO of a consumer airline ticket web site as expecting ``at
    least two more price increases before the end of May.''
        These trends are not linked to changes in crude oil prices
    or taxes. The crude feedstock for diesel and gasoline is
    identical, about $3 a gallon, and Federal gas and diesel taxes
    have not changed for almost 15 years.
        I would like to just make a comment. First, I do not think
    these charts are inconsistent. What Senator Brownback has shown
    us is that as crude oil prices have gone up, so too has the
    cost of the refined product, in this case I believe gasoline. I
    do not quarrel with that.
        But this one tells you that the difference between the two
    is much wider than it once was, and that difference is the
    refining add-on cost to the basic crude product. And within
    that add-on cost for refining, the so-called crack spread,
    turns out to be a world of profit for the oil companies now
    registering and reporting not only record oil company profits,
    but record profits for American businesses. No one has ever
    been quite this successful in our capital system.
        So the question I have is this. Has the FTC been monitoring
    these trends? Do you plan to initiate a comprehensive
    investigation or inquiry? And what is driving this?
        Mr. Kovacic. Thank you, indeed, for your letter, Chairman
    Durbin.
        For about the past 3 or 4 years, we have had a program in
    place to monitor on a retail and wholesale basis price changes
    concerning gasoline and diesel. The program has not covered jet
    fuel as well. But we have been examining anomalies as they
    appear in the pricing and distribution of these products. With
    your letter in hand, we are expanding our examination of these
    issues and we are taking a look very closely at both trends in
    diesel and jet fuel.
        I do not have specific results to report to you at the
    moment, although I do make the offer to meet with you and with
    my staff as we do learn more from the results of this
    examination, and I make myself, along with my staff, available
    to discuss this with you.
        What we are seeing in part is that this is an international
    pattern. That is, from our quick examination to date, these are
    trends that characterize practice in global markets, Singapore,
    Europe.
        We are also noticing that one notable feature has been a
    dramatic increase in demand for diesel in recent years. That
    is, in Europe, in Asia, in a number of areas where we have been
    able to examine very closely and compare with our own
    experience, there has been a significant increase in the demand
    for diesel. We see that as one factor that has probably made
    the two lines cross that you were referring to before.
        Another relationship we are looking at quite carefully is
    that in the stratum of the refining process, the barrel that is
    being produced--there is a very close interaction between
    production capacity and the production of both jet fuel and
    diesel, kerosene and diesel together. We are looking very
    carefully at how adjustments in production process and capacity
    allocation decisions have affected that.
        But let me emphasize that your inquiry and others that we
    have received from your colleagues in this body and across the
    Capitol--we are looking at this very carefully. I make myself
    at your disposal to report to you on what we see as the
    consequence of this deeper look at both diesel and jet fuel.
        Senator Durbin. Thank you. I am glad that the FTC is going
    to initiate this inquiry, and I am sure it will expand even
    beyond the questions that I have asked. I hope that it will
    include questions about refinery capacity and unused capacity.
    I find it hard to imagine why we are still dealing with about
    85 percent use of refinery capacity in a country where the
    prices are so high.
        Second, I hope you will at least explore the question as to
    whether and, if so, how much the United States is exporting in
    terms of refined product or even crude product for that matter.
    There have been calls for us to drill in the Arctic National
    Wildlife Refuge and other places offshore that are
    controversial from an environmental viewpoint, and I certainly
    hope that before we would even consider such a thing, that we
    would look at other alternatives that would spare these areas
    from creating any kind of environmental hardship.
        Let me turn it over to my colleague and I will return with
    some more questions.
        Senator Brownback. Thank you, Mr. Chairman.
        Examining the data, I think we are using similar charts. It
    looks like the crack spread has flipped between 2007 to 2008. I
    have somebody who understands and analyzes this more, but if
    you look at what has happened on the spot oil price, this chart
    goes from 2001 to 2008. Yours goes from 2002 to 2007. There has
    been substantial movement. But I would just point out over a
    longer period of time, these two track together and you are
    going to see an increase in gasoline prices.
        If there has been market manipulation, I want us to
    absolutely go after people with hammer and tong on it so that
    we can get at the bottom of this.
        I understand the FTC has recently announced an advance
    notice of proposed rulemaking on market manipulation of oil and
    gas prices. How do you see this rule helping the American
    consumer? What are you targeting? And I know you cannot talk on
    some of the specifics of this from our previous discussion, but
    can you give us any thought of what the American consumer can
    see out of the FTC as a result of this?
        Mr. Kovacic. What I am going to do, Senator, is to give you
    a snapshot of what was in that notice as an indication of what
    we will be looking at and, as you mentioned, to be enormously
    cautious in offering any specific views about what we might do
    to avoid a possibility of prejudgment.
        We intend to examine very carefully a variety of scenarios
    that are laid out in the advance notice. Among the scenarios
    for which we have sought comment involves the possibility that
    there has been fraud with respect to the reporting of
    information to public authorities, or fraud or
    misrepresentation with respect to the reporting of information
    to private bodies that collect and report information on
    pricing and transactions.
        We intend to look very carefully at a collection of
    scenarios that are closely related to those that our other
    Federal agencies, the Federal Communication Commission (FCC),
    Federal Energy Regulatory Commission (FERC), and Commodity
    Futures Trading Commission (CFTC) have examined in the course
    of applying manipulation authority. Have there been deliberate
    efforts in specific instances to exploit shortage conditions as
    an opportunity to raise prices? Have there been traditional
    forms of manipulation that would fit within a conventional
    antitrust or competition context, that is, including the
    possibility of collusion, improper behavior to exclude other
    firms?
        As laid out in the notice, this range of possibilities,
    some of them familiar to the concepts that you were alluding to
    before, Senator, involving outright collusion, traditional
    antitrust actionable behavior, but not antitrust behavior in
    many instances examined by our fellow Federal agencies in
    different settings. Those are the scenarios in the notice that
    we have asked others to comment upon, and we do welcome the
    comments before the comment period closes in early June.
        Mr. Leibowitz. Yes. And let me just echo what the Chairman
    has said. We put out, I think, a 38-page advance notice of
    proposed rulemaking. I think that is the right approach to take
    because, after all, we have a lot of experience with antitrust,
    but we do not have a lot of experience with manipulation beyond
    the antitrust laws.
        And in the ANPR--and again, I do not want to talk in too
    much detail because we do not want to be accused of prejudging;
    we do not want to be asked to be recused--we show other
    examples, examples that we want commented on, like very public
    announcements or pre-announcements of refinery shutdowns, or
    moving product away from an area where there is a shortage to
    drive up prices. And so those are the things we want comments
    on, and we are committed to, I think, completing--we certainly
    anticipate completing the rulemaking process by the end of the
    year.
        Senator Brownback. Good. I think that is good and I think
    it is going to be very useful to be able to see that kind of
    information. As you may know from last week's hearing, we had
    the CFTC here, and we were talking about market manipulation by
    large hedge funds, index funds on commodity prices overall. And
    I think there is more to be looked at there.

                           FOOD MARKETING TO CHILDREN

        On another area, Senator Harkin and I have been working
    closely together over the last year examining the effects of
    food marketing to kids. I am very interested in the
    comprehensive analysis the FTC has undertaken on the types and
    amounts of food marketing directed at children. It is my
    understanding the report is due to be released this summer. You
    have worked on these topics. I have worked with you on these
    topics before, as you mentioned, Mr. Leibowitz, and on target
    marketing of violent entertainment to children.
        What kind of information should we expect to see in this
    report that you are going to be putting out on target marketing
    of food to children?
        Mr. Kovacic. Jon?
        Mr. Leibowitz. Well, we hope to complete our report this
    summer. We did a workshop on this issue. We sent out a number
    of subpoenas to the major fast food restaurants and food
    companies.
        Maybe we can come in and brief your staff about this. But
    we are trying to figure out exactly how the targeting is being
    done and what effect it may have on children. And as you know,
    because I know you are involved in the FCC task force,
    childhood obesity has gone up dramatically in the last
    generation. What used to be called adult-onset diabetes cannot
    be called that anymore because so many children have it. We
    think part of that may be due to the foods that they are
    eating, and so we are taking a look at this marketing and we
    hope to have something useful to say in the report in the next
    couple of months. But we will come in and talk to you about it
    beforehand.
        Mr. Kovacic. I think, Senator, what you certainly can
    expect to see is what probably will be the best empirical view
    that a public agency has had to date about some of the
    phenomena that are being addressed. We are undertaking a very
    careful effort to gather data company by company to give you
    and the larger public a clear view of the advertising trends at
    issue. This study will be based, again related to a point that
    both of you made before, as much as possible, on a carefully
    developed empirical foundation and not simply on hunches.
        Senator Brownback. Thank you.

                         SPECULATION IN THE OIL MARKET

        Senator Durbin. Chairman Kovacic, last week the Wall Street
    Journal's Market Watch quoted an industry analyst as estimating
    that about $25 to $30 of price per barrel of crude oil may be
    attributed solely to speculation. Have you looked into how the
    futures market is influencing the price of gasoline or other
    energy products? And if so, what steps do you think should be
    taken to protect consumers from any excessive speculation?
        Mr. Kovacic. To this point, we have not examined that in a
    detailed way, Mr. Chairman. What we have seen from our work in
    the past, looking at the links between futures trading activity
    and current prices, is that efforts on the part of individual
    investors to anticipate future developments and make
    investments unmistakably play some role in setting current
    prices. What we are not certain of is how much. That is, is it,
    in the case of the individual quoted in the article, $25 or $30
    a barrel? Is it $5 or $10 a barrel? Is it $1 a barrel? That is
    something we do not know.
        I would anticipate pursuing two avenues on this issue. One
    is in the course of the rulemaking process; one possible avenue
    identified in the advance notice is to devote closer attention
    as part of the authority. That is, one possible application of
    our authority might be to examine these issues in much closer
    detail.
        A second one that I detect in your questioning of Walt
    Lukken from the CFTC and to some extent with Chris Cox is a
    concern that whatever we do, we make the best possible use of
    knowledge that already resides in other public authorities that
    have been examining this. So in addition to our consultation
    with them as part of the rulemaking process, we are separately
    going to work as carefully as possible with the CFTC, with the
    SEC, and indeed, with FERC, though they do not deal with
    petroleum prices as such, to see the extent to which we can
    explore these issues together and to make sure that as our own
    research program is formulated and, as an enforcement program
    is developed, that we take the fullest possible advantage of
    what they have learned. I have met with Chairman Lukken on this
    point. I have met with Chairman Kelleher, and I anticipate
    meeting with Chairman Cox as well to ensure that whatever we do
    builds on the foundation they have already constructed.
        Senator Durbin. It is no secret that Chicago, which I
    represent, is very interested in the futures markets.
        Mr. Kovacic. There are futures markets in Chicago, yes.
        Senator Durbin. So I am trying my best to look at this in
    an honest fashion, and when I ask the industry, they say do not
    forget we are one player, and there are other markets that
    people can choose to use outside of the United States. And if
    we take action in the hopes of having impact on speculation, it
    may just drive the futures activities to other countries. I
    assume that will be taken into consideration?
        Mr. Kovacic. Indeed. As a consequence of the augmentation
    of resources that you provided us last year for international
    matters, we have a much better platform today than we did 2
    years ago to work with our foreign counterparts. I suspect it
    would surprise neither of you that the issue of energy prices,
    both with respect to current prices and futures markets, is an
    acute matter of concern to our counterparts at the Office of
    Fair Trading in London, to our counterparts in the
    Bundeskartellamt in Bonn, to our counterparts at the ACCC in
    Canberra, and to Canada's Competition Bureau in Ottawa. There
    is no issue, I would suspect, that is more important or
    compelling to all of us.
        And we do have increasingly effective means to cooperate
    with each other. So the international dimension of this problem
    will be a crucial element of what we do. Again, by way of
    thanking you for looking over the horizon to think of the kinds
    of resources that provide a better basis for us for doing that
    work and taking that into account, we are in a much better
    position to do that now than we were previously.
        Mr. Leibowitz. Yes. And if I can just add, I agree with
    everything that the Chairman just said, and we are also going
    to be reaching out in the rulemaking process to buyers, to
    customers, and to consumer groups because we really need to
    learn about this area as we go forward with our manipulation
    authority.

                                  DO NOT CALL

        Senator Durbin. Commissioner Leibowitz, you mentioned the
    Do Not Call Registry that Dave Barry had just kind things to
    say in reference to. And it is my understanding that there are
    now some 145 million active telephone number registrations in
    our country, maybe even higher.
        Mr. Leibowitz. It is up to 160 million now. It grows every
    day.
        Senator Durbin. I also understand the FTC has received over
    1.2 million consumer complaints alleging violations of the
    registry. How are you responding? What remedies or relief do
    you have available when you find violations?
        Mr. Leibowitz. Well, that is a really good question. We do
    collect complaints and that is how we prioritize, in a large
    way, the law enforcement actions that we take. We have actually
    brought 36 cases against violators thus far. I think last year,
    we recovered $7.7 million in fines.
        We are fortunate that when we have violations of Do Not
    Call, we are able to fine malefactors. For most violations of
    the FTC Act, however, we do not have fining authority. That is
    an issue that is being discussed in the context of the
    reauthorization that is going through the Commerce Committee.
        But we take Do Not Call very, very seriously. We think it
    is a wonderful program and an unequivocally successful one, and
    we spend a lot of resources to make sure that we go after
    people who are in violation of it.
        Senator Durbin. Thank you.
        Senator Brownback.

                MARKETING ADULT-RATED ENTERTAINMENT TO CHILDREN

        Senator Brownback. Gentlemen, I want to look at the FTC
    study that previously done on target marketing of adult-rated
    entertainment material for children. I appreciate you handing
    me your FTC press release about undercover shoppers finding it
    more difficult to buy ``M'' rated games.
        You may recall some of the ground-breaking studies and work
    that were done as the Commerce Committee was pushing on this
    issue. Mr. Leibowitz, you were working with Herb Kohl. I have
    worked on it with Senator Lieberman. John McCain was chairing
    the Commerce Committee when we moved into this area.
        Are you looking still at the target marketing of the adult
    material? This is on the ability to purchase, but not the
    target marketing of this.
        I want to suggest that what you studied in the target
    marketing of entertainment to underage consumers may be the way
    you want to study the comparable target marketing of material
    in the food consumption area. Are you updating the target
    marketing survey on the entertainment material?
        Mr. Leibowitz. Yes. We will be doing another report. We
    have done six in the last 8 years, I believe, and so we will be
    doing another entertainment industry marketing report probably
    sometime toward the end of this year or next year.
        And we do look at targeted marketing. In the context of our
    food marketing to children report, we will be looking at, for
    example, Internet advertising to kids and the propriety of it
    and the types of advertising we are seeing. I think in our last
    report on entertainment industry marketing, we saw that ratings
    were not as well associated with Internet advertising as they
    were with, for example, print advertising.
        Senator Brownback. I think this is a key area for us. You
    have correctly identified that we are all seeing this huge
    onslaught on obesity, particularly in children. We are looking
    at a possibility of a generation that may not live as long as
    their parents did and this would be a first for this country, a
    lot of the problem is just based upon a lack of healthy eating
    habits.
        We are seeing target marketing taking place here, which we
    saw in the entertainment industry. You guys doing that survey
    and putting the information out was something that was very
    helpful to the Congress, and I think it would be very helpful
    to the country to expose the problem of target marketing of
    food to children, if it is what is taking place here. This is
    why it is so hard for mom or dad to go for the Healthy Choice
    when they are taking the kids to the grocery store or to the
    fast food restaurant. And the kids say no, as they pull back
    the other way. We can try to help the parents in that
    situation. I think it would be very beneficial.
        Might I make a suggestion to both of you? I have recently
    met with the head of the National Institute of Mental Health.
    The understanding of how the mind works is getting much better.
    Now, we are a long ways from understanding the most complex
    physical entity in the entire cosmos. It is the human mind. And
    then there is a subset of that, the child's mind, even maybe
    more difficult to understand.
        Mr. Leibowitz. And I have two young children, so I know
    exactly what you are talking about.
        Senator Brownback. And it is not fully developed until--I
    think they are saying now--the age of 23 on average.
        But I found it very interesting what we do know. By meeting
    with them, I might suggest that you bring out some of the
    experts from the National Institute of Mental Health or you
    yourself go there and have them tell you what do we know and
    what do we not know because I think you will find it
    interesting to your own perspective about regulating
    advertising or looking at advertising. To ask the question of
    what is really happenning within this mind, and what do we know
    and what do we not know, what are we unlikely to know. I think
    it would be advantageous.
        One quick final comment. I hope when you do the gasoline
    study, which I think can be very helpful, you will look at
    overall supply and demand situations globally and the effects
    of transportation because in any sort of global commodity
    business is effected by supply and demand. The big differential
    is transportation cost of that commodity. While we may have
    disputes about domestic production of oil, it does have a
    significant impact and a more pronounced impact domestically.
    And I hope you would look into this.
        I do not want anything left off the table on this as we
    look at this very key area and an area of deep concern to us
    and to the country. I think you guys can provide some overall
    data to use in this tough time of increasing energy costs.
        Mr. Kovacic. Senator, your comment about the consultation
    with the authorities at the National Institute of Mental Health
    fits very well into an approach that we have taken to heart on
    consultations with others. Indeed, one line of research that we
    have been spending more time on is the larger question about
    how people absorb information, what do they understand, adults
    and children, from the downpour of information that swamps each
    of us every day. When they see a mandated disclosure, what do
    they take away from it? We had a very good workshop on what is
    called behavioral economics, which really goes to this question
    in many ways, of how people understand images or messages that
    are being brought to them. So that fits very well--your thought
    about how to approach that--with other things we are doing, and
    I will certainly bring that back to my colleagues.
        On the point about energy, I think it is our responsibility
    within the sphere of work we do to be as active and effective
    as we possibly can. And we cannot possibly shed responsibility
    by saying the problem lies elsewhere. In the full scope of
    authority we have, our principal duty is to use that authority
    as effectively as we possibly can.
        I think another part of our responsibility that you have
    touched on--and I think it is really implicit in larger
    discussion we have had--is our obligation to participate in
    larger discussions about what energy policy should be, larger
    discussions about how we live from what we see in our consumer
    protection and competition side, how we consume, how our lives
    are structured in a way that drives demand in certain
    directions, how people can make adjustments from existing
    lifestyles in ways that could affect consumption patterns, and
    indeed, on the supply side, what challenges we face in ensuring
    that there are adequate supplies.
        And I think beyond the narrow niche of competition and
    consumer protection, as important as those are to both of us,
    we would like to be part of that larger discussion about
    looking ahead as a country, what bigger challenges we must face
    in order to resolve these and related problems. We would
    eagerly enjoy being part of that discussion as well.
        Senator Brownback. Thank you, Mr. Chairman.

                             CREDIT CARD PRACTICES

        Senator Durbin. So you identified one of your concerns with
    financial services as subprime lenders and the like. I would
    like to ask you whether you have initiated any kind of
    inquiries or investigation into credit card practices.
        Mr. Leibowitz. Credit card practices are tricky for us
    because they are mostly done through banks, and we do not have
    jurisdiction over banks. It is one of the carve-outs, like
    common carriers and insurers, that we do not have jurisdiction
    over.
        We do have a major investigation going on of a large
    subprime credit card non-bank company, CompuCredit, and I can
    make that public because they have made it public in, I think,
    their Securities and Exchange Commission (SEC) filings. So yes.
    The answer is yes. We are looking at this.
        Senator Durbin. I would think that the credit card aspect
    of this might come up in the identity theft investigations.
        Mr. Leibowitz. Of course, it does.

                                 IDENTITY THEFT

        Senator Durbin. And that is your number one complaint. I
    think one out of three consumer complaints relate to identity
    theft.
        Mr. Leibowitz. That is right.
        Senator Durbin. Having been personally victimized a few
    years ago and my wife just recently--thank goodness, it was not
    any great damage to us. Tell me what you are finding. Are there
    things that we should be considering in terms of new
    legislation or new policies that might protect the privacy of
    American consumers?
        Mr. Leibowitz. Well, identity theft is a very major problem
    in America. Roughly 10 million people, according to our
    surveys, are victims of some sort of identity theft every year.
        We are mostly an information clearinghouse on identity
    theft because, after all, a lot of identity theft is criminal.
    But we do a lot of education on this, and we have some identity
    theft brochures, and I believe 3 million people have copies of
    them.
        Do I think that there is a need for more legislation? I
    would like to think about that and get back to you.
        But I certainly think it is an area--and I think our staff
    certainly thinks it is an area--that we need to keep in the
    forefront because it affects so many Americans. And so we spend
    a lot of time on the education side, on the compiling of
    statistics side, and we are going to stay on top of it.
        Mr. Kovacic. I want to underscore Commissioner Leibowitz's
    observation about the importance of your support for our
    efforts to do education. This is an area where we think that
    with greater precaution-taking, many Americans can avoid
    circumstances in which they are going to be vulnerable. We
    should begin the process of education at the earliest possible
    stages of our education system. That is, imagine building into
    grade school education equivalence of the precepts that I think
    many of us--well, of a certain age at least--tended to learn as
    school children. Do not take a ride home with a stranger. If
    someone approaches you that you do not know, you do not follow
    them around. Basic precepts that might be identified for an
    electronic age today. If it is someone you do not know that is
    reaching out to you, far more often than not, nothing good is
    going to come from that. To tell adults about how to be
    discreet in the way in which they disclose information about
    themselves. If you receive a telephone solicitation--we will
    assume it is a legitimate one seemingly--or if you receive
    solicitations over the Internet and you know that you do not
    have a bank account with the State National Bank and they are
    asking you to verify account information, that is certain to be
    a fraud.
        So your continuing support for efforts both for us and for
    related public institutions to carry on that education function
    would be helpful, along with your support for our continuing
    efforts to work more extensively with other public
    institutions.
        As my colleague mentioned, the serious wrongdoers I think
    will only be deterred in this area when we take their freedom
    away. That means prison sentences. That means criminal
    prosecution. And your encouragement and continuing assistance
    in our efforts to prepare matters for prosecution by the
    Department of Justice, by State prosecutors, by Assistant U.S.
    attorneys would be most valuable in this respect.
        Mr. Leibowitz. And I absolutely agree with that.

                                GREEN MARKETING

        Senator Durbin. If I could just have one last question, I
    think there is one area we have not touched on in the consumer
    side, and that is the so-called green marketing that you
    mentioned in your summary.
        The FTC has been working to review environmental marketing
    guidelines, also known as Green Guides. What is the most common
    type of problem that you are finding when it comes to green
    advertising?
        Mr. Leibowitz. Well, what we are beginning to see with the
    proliferation of green advertising--of course, if it is
    accurate, that is very good. It is good for the environment,
    and it is good for consumers to have that option. What we are
    beginning to see--and we started this with a workshop process--
    is that some of the advertisements are sometimes exaggerated,
    and if an advertisement is deceptive, then we are going to do
    an investigation and perhaps bring a prosecution. We are just
    starting to look at this issue. We think most of the
    advertisements we are seeing are good and they are well-
    intended, but we are going to police this area. That is what we
    are supposed to be doing.
        Mr. Kovacic. If I can mention, Mr. Chairman, our recent
    workshop on packaging and green claims related to packaging I
    think underscored an issue that lies ahead which is in popular
    discourse in advertising you see common use of terms like
    ``sustainable,'' ``green,'' ``green-friendly.'' I suppose in
    some way we have a general hunch about what these things mean,
    but there could be a source of confusion for consumers as a
    whole. What is a sustainable product?
        Senator Brownback. Or what does ecoshaped mean? A very
    handsome shape, too.
        Mr. Kovacic. That is right.
        And one of the things we saw in our workshop was--I think
    our workshop will help be a catalyst for further efforts by a
    variety of private and not-for-profit associations to provide
    better definitions for these things, to help establish
    standards and focal points for providing meaningful
    definitions. That, in turn, is going to assist us in framing
    the revision of our guidelines themselves. And as my colleague
    mentioned, we are keenly attuned to instances in which someone
    says, give me $50, I will plant a tree in the rainforest, to
    focus more and more attentively on whether that tree gets
    planted.
        Senator Durbin. Thank you.
        Senator Brownback.
        Senator Brownback. I have no further questions.
        Senator Durbin. Thank you. It has been a great hearing. You
    have a fascinating agency which has received high marks for its
    performance for America's taxpayers and our economy, and you
    should be proud to be part of it. And we are glad to have you
    as part of our appropriation. I thank you for your preparation
    for this hearing and your comments.

                         ADDITIONAL COMMITTEE QUESTIONS

        We may send some written questions your way, and I hope you
    will have a chance to respond to them in a careful and
    expedient way. The hearing record is going to remain open for
    about 1 week until Wednesday, May 21, for other subcommittee
    members if they would care to submit questions as well.
        [The following questions were not asked at the hearing, but
    were submitted to the Commission for response subsequent to the
    hearing:]

                Questions Submitted by Senator Richard J. Durbin

                                MERGER ACTIVITY

        Question. During economic downturns like we're experiencing today,
    analysts have reported that merger activity tends to increase.
        Has the FTC observed that trend in the past, and if so, does the
    fiscal year 2009 budget include an increase to accommodate the increase
    in anticipated workload?
        Answer. The FTC's data show that the number of merger filings with
    the FTC and the Department of Justice tends to grow with increased
    merger and acquisition activity during strong economic times. The FTC
    has not observed that merger notifications tend to increase during
    economic downturns. Notwithstanding the current economic downturn,
    however, the FTC budget request for fiscal year 2009 includes an
    increase in resources devoted to reviewing mergers--resources that will
    be used to address the growing complexity of the transactions that the
    agency reviews and the increased need for sophisticated economic
    analysis of those transactions.

                                FRAUD COMPLAINTS

        Question. The number of fraud complaints reported to the FTC grew
    by almost 30 percent in 2007.
        What was the cause of the increase, and how will the fiscal year
    2009 request address this problem?
        Answer. This increase is due, in large part, to better data
    collection and specifically due to a substantial increase in complaints
    shared by the Better Business Bureaus (``BBBs''). We received 169,887
    complaints from the BBBs in 2007, compared to 20,265 complaints in
    2006.
        The FTC maintains a broad range of consumer complaint data in
    Consumer Sentinel, which is a secure online database of millions of
    complaints that we make available to more than 1,700 law enforcement
    agencies. Numerous consumers complain directly to the FTC. At the same
    time, for many years, the agency has undertaken significant efforts to
    obtain complaints from other law enforcers combating fraud, such as the
    FBI, U.S. Postal Inspection Service, National Association of Attorneys
    General, and Australian Competition and Consumer Commission, as well as
    non-governmental entities, such as the BBBs. Pooling consumer complaint
    data from multiple sources enhances their utility for law enforcement,
    that is, bringing cases, and related purposes. For this reason, each
    year we strive to encourage new entities to share data with us and to
    increase the amount of data shared by existing contributors.
        During fiscal year 2009, we will continue our efforts to increase
    complaint data sharing from our partners and, through outreach,
    encourage consumers to complain directly to the FTC. Our fiscal year
    2009 budget request provides funds to support these important efforts.

                                SUBPRIME LENDING

        Question. The FTC's fiscal year 2009 budget request includes an
    increase for protecting consumers from unfair and deceptive practices
    in the financial services marketplace.
        What tools does the FTC have to investigate predatory lending
    practices? What specific steps has the FTC taken in the past year?
        Answer. The FTC has effective tools for investigating lending
    practices that might violate any of the laws it enforces, which include
    the Truth in Lending Act (``TILA''),\1\ the Home Ownership and Equity
    Protection Act (``HOEPA''),\2\ and the Equal Credit Opportunity Act.\3\
    The Commission also enforces Section 5 of the Federal Trade Commission
    Act (``FTC Act''), which more generally prohibits unfair or deceptive
    acts or practices in the marketplace.\4\ The FTC has jurisdiction over
    nonbank financial companies, including nonbank mortgage companies,
    mortgage brokers, and finance companies.
    ---------------------------------------------------------------------------
        \1\ 15 U.S.C. Sec. Sec. 1601-1666j (requiring disclosures and
    establishing other requirements in connection with consumer credit
    transactions).
        \2\ 15 U.S.C. Sec. 1639 (providing additional protections for
    consumers who enter into certain high-cost refinance mortgage loans).
    HOEPA is a part of TILA.
        \3\ 15 U.S.C. Sec. Sec. 1691-1691f (prohibiting creditor practices
    that discriminate on the basis of race, religion, national origin, sex,
    marital status, age, receipt of public assistance, and the exercise of
    certain legal rights).
        \4\ 15 U.S.C. Sec. 45(a).
    ---------------------------------------------------------------------------
        The full range of investigative tools available to the Commission
    in its other consumer protection investigations are available in its
    lending investigations. Most significantly, the FTC has the authority
    under Section 20 of the Federal Trade Commission Act to issue civil
    investigative demands to compel the recipient to provide documents,
    testimony, and other information to be used in determining whether the
    law has been violated and whether to commence a law enforcement action.
        The Commission has been very active in investigating mortgage
    lending practices in the past year.\5\ Among other things, in June
    2007, the agency staff conducted a nationwide review of ads, including
    some in Spanish, featuring claims for very low rates or monthly payment
    amounts without adequate disclosure of other important loan terms. The
    FTC staff reviewed the ads to determine whether they may be deceptive
    in violation of Section 5 of the FTC Act or may violate TILA.\6\ The
    Commission staff then commenced investigations of or sent warning
    letters to advertisers whose ads raised concerns. This included warning
    letters that FTC staff sent in September 2007 to more than 200 mortgage
    brokers and lenders, and media outlets that carry their advertisements
    for home mortgages, informing them that their ads may be unlawful. The
    agency staff recently reviewed the current advertising of those who
    received warning letters. We will take law enforcement action where
    appropriate if this review or other monitoring of mortgage advertising
    claims reveals that an advertiser has violated the law.
    ---------------------------------------------------------------------------
        \5\ The Commission's April 29, 2008 testimony before the
    Subcommittee On Interstate Commerce, Trade, and Tourism of the
    Committee On Commerce, Science, and Transportation, United States
    Senate provides a comprehensive description of the FTC's law
    enforcement, policy, and consumer education work in the subprime
    mortgage market in recent years. The testimony is available at http://
    www.ftc.gov/os/testimony/P064814subprimelending.pdf.
        \6\ See Press Release, FTC Warns Mortgage Advertisers and Media
    That Ads May Be Deceptive (Sept. 11, 2007), available at www.ftc.gov/
    opa/2007/09/mortsurf.shtm.
    ---------------------------------------------------------------------------
        In addition, the FTC plays an important role in preventing unlawful
    mortgage discrimination.\7\ At this time, the Commission is conducting
    several non-public investigations of mortgage originators for possible
    violations of fair lending laws.
    ---------------------------------------------------------------------------
        \7\ The Commission's July 25, 2007 testimony before the
    Subcommittee on Oversight and Investigations of the House Committee on
    Financial Services detailed the Commission's fair lending program. The
    testimony is available at www.ftc.gov/os/testimony/P064806hdma.pdf.
    ---------------------------------------------------------------------------
        The Commission has also been active in investigating unfair or
    deceptive practices by mortgage servicers. Recently, The Bear Stearns
    Companies, Inc. (``Bear Stearns'') disclosed that FTC staff has
    notified its mortgage servicing subsidiary, EMC Mortgage Corporation
    (``EMC''), that the staff believes EMC and its parent Bear Stearns have
    violated a number of federal consumer protection statutes in connection
    with its servicing activities. Bear Stearns further disclosed that FTC
    staff offered an opportunity to resolve the matter through consent
    negotiations before seeking approval from the Commission to proceed
    with the filing of a complaint. According to the disclosure, EMC
    expects to engage in such discussions with Commission staff.\8\ The FTC
    cannot comment further on this ongoing law enforcement investigation.
    ---------------------------------------------------------------------------
        \8\ Form 10-K, Bear Stearns Mortgage Funding Trust 2007-AR4 (CIK
    No. 1393708), at Item 1117 of Reg AB, Legal Proceedings (filed Mar. 31,
    2008), available at www.sec.gov/Archives/edgar/data/1393708/
    000105640408001164/0001056404-08-001164.txt.
    ---------------------------------------------------------------------------
        Previously, in 2003, the Commission, along with HUD, announced a
    settlement of allegations that Fairbanks Capital Corp. (now called
    Select Portfolio Servicing, Inc.) failed to post consumers' payments
    upon receipt, charged unauthorized fees, used dishonest or abusive
    tactics to collect debts, and reported to credit bureaus consumer
    payment information that it knew to be inaccurate.\9\ In late 2007,
    based on a compliance review of the company, the Commission negotiated
    modifications to the 2003 consent order. The modified consent order
    provides substantial benefits to consumers beyond those in the original
    order, including additional refunds of fees paid in certain
    circumstances.\10\
    ---------------------------------------------------------------------------
        \9\ United States v. Fairbanks Capital Corp., No. 03-12219 (D.
    Mass. 2003). The settlement agreement included a $40 million redress
    fund for consumers as well as strong injunctive provisions and specific
    safeguards to prevent the company from foreclosing on consumers without
    cause.
        \10\ United States v. Fairbanks Capital Corp., No. 03-12219 (D.
    Mass. Sept. 4, 2007) (Modified Stipulated Final Judgment and Order).
    ---------------------------------------------------------------------------
        The Commission continues to investigate mortgage servicing
    practices for compliance with the law.
        In an effort to enhance interagency coordination, the FTC, the
    Federal Reserve Board (``FRB''), the Office of Thrift Supervision, and
    two associations of state regulators have combined forces to undertake
    an innovative law enforcement project. The agencies are jointly
    conducting consumer protection compliance reviews and investigations of
    certain nonbank subsidiaries of bank holding companies with significant
    subprime mortgage operations.\11\
    ---------------------------------------------------------------------------
        \11\ See Press Release, FTC, Federal and State Agencies Announce
    Pilot Project to Improve Supervision of Subprime Mortgage Lenders (July
    17, 2007), available at www.ftc.gov/opa/2007/07/subprime.shtm.
    ---------------------------------------------------------------------------
        Finally, the Commission works to protect consumers of subprime
    unsecured loans. In June 2008, for example, the Commission filed a
    lawsuit charging subprime credit card company CompuCredit Corporation
    (``CompuCredit'') and its affiliate with deception in marketing credit
    cards.\12\
    ---------------------------------------------------------------------------
        \12\ FTC v. CompuCredit Corp., No. 1:08cv1976-BBM-RGV (N.D. Ga.
    2008). The FTC's complaint alleges, among other things, that
    CompuCredit marketed to consumers with subprime credit ratings a Visa
    credit card purportedly providing $300 in credit, using solicitations
    that touted in bold headlines that certain up-front fees that did not
    apply. Rather than provide consumers with $300 of available credit,
    CompuCredit allegedly immediately charged consumers as much as $185 in
    fees that it did not disclose adequately in light of the
    representations made. These fees left consumers with as little as $115
    in available credit. The FTC alleges that CompuCredit deceived
    consumers in violation of Section 5 of the FTC Act by misrepresenting
    the amount of credit available.
        With respect to another Visa credit card CompuCredit offered, the
    FTC alleges CompuCredit marketed to consumers with slightly higher
    credit scores its Visa credit card purporting to offer ``up to $3,250''
    in available credit and touted that the card could be used for any
    purpose. The FTC alleges, however, that CompuCredit misrepresented the
    amount of available credit because it withheld 50 percent of that
    credit for 90 days. CompuCredit allegedly also failed to disclose, or
    failed to disclose adequately, that for the first 90 days, the company
    would monitor consumers' purchases, and might reduce their credit limit
    based on an undisclosed ``behavioral'' scoring model. The Commission
    alleges that CompuCredit's misrepresentation as to the amount of
    available credit and its failure to disclose adequately that the types
    of purchases consumers made could reduce their credit limit were
    deceptive acts and practices in violation of Section 5 of the FTC Act.
    The FTC's litigation with CompuCredit is ongoing.
    ---------------------------------------------------------------------------
        Question. Are there steps that the FTC would have liked to have
    taken that it could not because of limits or restrictions in the FTC's
    authorities?
        Answer. The Commission generally believes that the scope of its
    legal authority has not prevented the agency from taking steps to
    address the acts and practices of those within its jurisdiction related
    to subprime mortgage lending, although the Commission currently lacks
    authority to seek civil penalties for HOEPA violations. The FTC,
    however, notes that the FRB recently finalized rules under HOEPA and
    TILA that will prohibit specific mortgage lending and related practices
    the FRB determined were unfair and deceptive under the HOEPA.\13\ Both
    the federal banking agencies and the FTC can enforce the new rules as
    to the entities they regulate. We note, though, that the federal
    banking agencies have the authority to obtain civil penalties against
    entities they regulate who violate the new rules, while the FTC does
    not.\14\ Enacting legislation allowing the FTC to obtain civil
    penalties against entities within the FTC's jurisdiction who violate
    the new rules would allow the FTC to enforce the rules more effectively
    and better protect consumers in the subprime mortgage market, and it
    would level the playing field such that all entities subject to HOEPA
    could be subject to civil penalties. We particularly appreciate the
    inclusion of provisions in the Committee's fiscal year 2009
    appropriations bill that would authorize the FTC to obtain civil
    penalties for violations of rules under HOEPA.
    ---------------------------------------------------------------------------
        \13\ The rules add four protections for a newly defined category of
    ``higher-priced'' mortgage loans: (1) they prohibit a lender from
    making a loan without regard to borrowers' ability to repay the loan;
    (2) they require creditors to verify the income and assets they rely
    upon to determine repayment ability; (3) they restrict prepayment
    penalties; and (4) they require creditors to establish tax and
    insurance escrow accounts for all first-lien mortgage loans. The rules
    also prohibit creditors and mortgage brokers from coercing a real
    estate appraiser to misstate a home's value. And the rules prohibit
    mortgage servicers from engaging in certain practices, such as
    pyramiding late fees. The rules also impose specific advertising
    standards, banning seven deceptive or misleading advertising practices,
    including representing that a rate or payment is ``fixed'' when it can
    change.
        \14\ Under the Federal Deposit Insurance Act, 12 U.S.C. Section
    1818(i)(2), federal banking agencies can obtain civil penalties from
    the entities they regulate who violate the laws they enforce, including
    TILA and its implementing regulations. The FTC has no comparable
    authority to obtain civil penalties from the nonbank entities it
    regulates for violations of TILA and its implementing regulations.
    ---------------------------------------------------------------------------
        Question. FTC testimony states that the agency has sent warning
    letters to 200 mortgage lenders about misleading mortgage
    advertisements--for example, promoting low ``teaser rates'' without
    explanation of long-term rates. Are these warning letters a strong
    enough punishment? Why hasn't the FTC taken enforcement action against
    these lenders?
        Answer. As explained above, the FTC is following up on these
    warning letters with law enforcement, where appropriate. Currently, the
    Commission is investigating a number of mortgage originators for
    potential deceptive advertising.
        Question. To what extent is the FTC coordinating with other
    agencies (such as the FBI, the SEC, and HUD) in pursuing predatory
    lending?
        Answer. The Commission coordinates regularly on financial practices
    matters with federal banking agencies, the Department of Justice, and
    HUD. For more than a decade, the FTC has been a member of the
    Interagency Task Force on Fair Lending, a joint undertaking with DOJ,
    HUD, and the federal banking regulatory agencies. Task Force members
    meet often to share information on lending discrimination, predatory
    lending enforcement, and policy issues. The Commission also has had
    several conversations with SEC representatives about the subprime
    mortgage market, although our law enforcement activities focus on
    different practices in the mortgage industry.
        Further, FTC staff are coordinating with other governmental
    entities to combat foreclosure rescue fraud. Commission staff are
    participating in task forces concerning foreclosure rescue fraud in
    seven geographic areas. Task force members in each local area share
    information about trends in consumer complaints and work to identify
    solutions. For example, the FTC's Southeast Regional Office is working
    with a state attorney general's office to identify, investigate, and
    prosecute cases. These efforts include close coordination on cases
    under investigation. In some cases, the two agencies have divided
    responsibility for law enforcement actions; in other cases, the two
    agencies are working cooperatively on particular targets. The FTC's
    East Central Regional Office is partnering with a local task force to
    implement various consumer education and outreach strategies to help
    consumers. The Southern California Foreclosure Fraud Task Force, in
    which the FTC's Western Region participates, has facilitated the
    coordination of prosecutions by civil and criminal authorities at
    various levels.

                               U.S. SAFE WEB ACT

        Question. The U.S. SAFE WEB Act, enacted in December 2006, expanded
    the FTC's authorities to coordinate with foreign law enforcement
    against spam and other unfair and deceptive practices involving foreign
    commerce. The FTC's fiscal year 2009 budget request includes additional
    funding for staff to pursue foreign-located fraud.
        How many FTE are currently dedicated to implementing the U.S. SAFE
    WEB Act, and how would additional staff enhance that effort?
        Answer. Because the statute provides a wide range of authorities to
    the agency, a number of staff members in a number of offices throughout
    the agency are involved in implementing it. FTC's Office of
    International Affairs (``OIA''), which helped develop the Act and works
    to advance international enforcement cooperation, leads the
    implementation, including chairing an agency-wide steering group of 9
    people and several additional ad hoc members for particular issues. At
    least six attorneys in OIA devote substantial time to implementing the
    Act, including the Act's provisions on information sharing,
    investigative assistance, international agreements, cooperation on
    foreign judgment enforcement and asset recovery, enforcement networks
    and projects, and foreign staff exchange programs (i.e., the FTC's new
    ``International Fellows'' program). In addition, a number of other
    staff members within OIA as well as in the Bureau of Consumer
    Protection, the Office of the General Counsel, the Executive Director's
    Office, and others are involved in implementing and making use of the
    SAFE WEB authority.
        We would use additional staff to enhance our efforts on foreign
    judgment enforcement and asset recovery for American consumers,
    information sharing and investigative assistance, and our International
    Fellows program. We are addressing increasing numbers of requests for
    information sharing and investigative assistance regarding cross-border
    matters that may aid FTC enforcement actions or may halt frauds
    targeting U.S. consumers among others. In addition, we are expanding
    our International Fellows program to provide opportunities for foreign
    officials to learn first-hand how the FTC operates and for FTC staff
    similarly to learn about agencies abroad, thereby improving the ability
    of the agencies to coordinate and cooperate on law enforcement matters.
    We are also working to take advantage of our enhanced ability through
    SAFE WEB to enforce judgments against foreign defendants. With more
    staff, we can manage additional use of these and other SAFE WEB tools
    to protect American consumers from cross-border fraud.
        Question. What are the biggest obstacles to enforce against foreign
    fraud? How is the FTC addressing these obstacles?
        Answer. The biggest obstacle to enforcing against foreign fraud is
    the ability of unscrupulous businesses operating in one jurisdiction to
    evade enforcement by using the Internet and long distance telephone
    technology to victimize consumers globally and hide behind national
    borders and laws. In particular, these actors often exploit the
    inability of many foreign law enforcement agencies to identify schemes
    and targets and share information about them in a timely and effective
    manner because of antiquated laws and regulations.
        As described above, the FTC is using the tools of the SAFE WEB Act
    to address these obstacles. The key to combating cross-border fraud is
    developing better and quicker enforcement cooperation with foreign law
    enforcement agencies, including information sharing and investigative
    cooperation. While the FTC has always acted aggressively to combat
    cross-border fraud, since the Act went into effect at the end of 2006
    and implementing regulations in the spring of 2007 the FTC has been
    able to obtain heightened success by using the tools of the SAFE WEB
    Act. For example, the FTC's enforcement action against Spear Systems,
    Inc., alleging international illegal spamming, was significantly
    enhanced by the agency's use of its information sharing powers under
    SAFE WEB. Information sharing authorized under SAFE WEB assisted
    Canadian law enforcement agencies with regard to several cases
    targeting telemarketing schemes that allegedly defrauded U.S.
    consumers, as part of the FTC's 2008 Telemarketing Sweep--``Operation
    Tele-PHONEY.'' The U.S. SAFE WEB Act has been pivotal in allowing the
    FTC to take the lead globally in combating cross-border fraud and in
    encouraging our foreign law enforcement partners to revise their laws
    in light of the global nature of mass-marketing fraud.

                                   GAS PRICES

        Question. The FTC's 2006 study on nationwide gas prices \15\
    concluded that rising prices could be explained entirely by market
    forces, not illegal anticompetitive behavior or other activity designed
    to increase prices relative to costs or to reduce output.
    ---------------------------------------------------------------------------
        \15\ Federal Trade Commission Report On Spring/Summer 2006
    Nationwide Gasoline Price Increases (August 2007) (available at http://
    www.ftc.gov/reports/gasprices06/P040101Gas06increase.pdf); Dissenting
    Statement of Commissioner Jon Leibowitz Regarding the Federal Trade
    Commission and Department of Justice Antitrust Division Report on
    Spring/Summer 2006 Nationwide Gasoline Price Increases (available at
    http://www.ftc.gov/reports/gasprices06/P010401Gas06dissent.pdf).
    ---------------------------------------------------------------------------
        Commissioner Leibowitz filed a dissent to the 2006 report, writing:
    ``. . . the question you ask determines the answer you get: whatever
    theoretical justifications exist don't exclude the real world threat
    that there was profiteering at the expense of consumers.''
        Is the FTC asking the wrong questions when it comes to
    investigating these high gas prices? And if so, what is the right
    question to ask so that we can get to the heart of what Commissioner
    Leibowitz calls ``profiteering at the expense of consumers?''
        Answer. For the most part the Agency is asking the right questions,
    especially today. But I was hoping that the 2006 gas price
    investigation and the resulting report would cover potential misconduct
    by oil companies. Instead, staff constructed a theoretical model of
    legitimate behavior and attempted to determine whether that model could
    explain gas prices (we could not have uncovered anticompetitive conduct
    by oil companies because we were not looking for it). To be fair, and
    as I noted in my 2007 statement, when we began the investigation for
    the 2006 Report, staff had just finished a major report relating the
    gas price run-up in the wake of hurricanes Katrina and Rita.\16\ In
    that investigation, staff found no antitrust violations but did find
    what in my view was inappropriate profit-taking by the oil companies in
    the wake of a disaster, including price-gouging as that term was
    defined by Congress.
    ---------------------------------------------------------------------------
        \16\ See Dissenting Statement at 1; see also Federal Trade
    Commission Report on the FTC's Investigation of Gasoline Price
    Manipulation and Post-Katrina Price Increases (May 2006) (available at
    http://www.ftc.gov/reports/
    060518PublicGasolinePricesInvestigationReportFinal.pdf).
    ---------------------------------------------------------------------------
        Going forward, the Commission, in its ongoing rulemaking
    proceeding, is considering assessing conduct under a standard set out
    in the Energy Independence Security Act of 2007. To the extent that the
    profiteering was a result of manipulation of gas prices by individual
    oil companies, it is possible that a result of the rulemaking
    proceeding may make it easier to prevent that in the future.\17\
    ---------------------------------------------------------------------------
        \17\ Information on the Commission's rulemaking proceeding is
    available at http://www.ftc.gov/ftc/oilgas/index.html.
    ---------------------------------------------------------------------------
        The report on the 2006 nationwide price increases was not based on
    theoretical justifications. Rather it was an analysis and description
    of the factual evidence of the economic developments actually
    experienced that could account for the price spikes: facts concerning
    upward price pressure stemming from seasonal effects on both the demand
    for and the supply of gasoline, increases in prices for crude oil and
    ethanol, reductions in refining capacity due to the transition to
    ethanol, and other identified market factors. This fact-based analysis
    led to the conclusion that such developments adequately explained the
    2006 price increases and that the price phenomena did not indicate
    anticompetitive conduct.
        With respect to the right question to address ``profiteering at the
    expense of consumers,'' this has to depend on what is meant by
    ``profiteering.'' To the extent it is intended to refer to the sheer
    size of profits, decisions on how to address this, such as through
    fiscal policy or price controls, are very fundamental policy
    determinations that are properly reserved for Congress. The Commission,
    however, must--and does--continue zealously to seek out and prevent any
    violations of the antitrust laws, including those that illegally raise
    prices and profits. Furthermore, Congress has given the Commission
    authority with respect to manipulative or deceptive devices or
    contrivances regarding this industry, and, as Commissioner Leibowitz
    notes above, the Commission is currently engaged in a rulemaking
    proceeding under this authority.
        Question. Commissioner Leibowitz cited that among other things, the
    investigation found ``disturbing conduct by . . . petroleum
    companies.''
        What disturbing conduct did the FTC observe? What action did the
    FTC take, and does the agency continue to see this kind of behavior?
        Answer. As described above, the Katrina Report found that there was
    price gouging (under the Congressional definition) by some oil
    companies in the wake of the disaster. And it is disturbing that oil
    companies made record profits even as many consumers suffered from high
    energy prices in the affected area. The conduct found was not a
    violation of the antitrust laws however. Going forward, the Commission,
    in its ongoing rulemaking proceeding is considering assessing conduct
    under a standard set out in the Energy Independence Security Act of
    2007 and it may ultimately be that we look at certain oil company
    behavior using a broader definition of misconduct.
        Neither the major investigation reported in the Katrina report nor
    the careful analysis the following year of the 2006 price spikes showed
    evidence of behavior inconsistent with competitive responses to market
    conditions. In particular, with respect to the Katrina aftermath, the
    agency's extensive investigation found that the market, including price
    increases for a period of time, functioned appropriately to enable
    increased supply to flow into the affected areas and to reduce prices
    to consumers swiftly. With respect to the ``price gouging'' identified
    in the Commission's post-Katrina report, in fifteen instances prices
    met the statutory definition of ``price gouging'' laid down for the
    study, but all except one were explainable by identifiable market
    factors other than those incorporated into that definition. As noted,
    the agency continues to scrutinize the industry carefully to identify
    possible anticompetitive activity, and to investigate and take
    enforcement action whenever warranted. In addition, as noted, the
    agency is conducting a rulemaking proceeding under its new authority to
    prohibit manipulative or deceptive devices or contrivances and our
    expectation is that this proceeding will be completed this year.

                         RESOURCES FOR PRICE MONITORING

        Question. The President ordered the 2006 study of nationwide gas
    prices in April of 2006, yet the FTC report was published in August
    2007--a full 16 months later.
        If the FTC is conducting real-time monitoring of gas prices for
    anticompetitive behavior, why did it take 16 months to come to a
    conclusion on this study? How can the FTC stop oil companies in their
    tracks if investigations take this long?
        Answer. The inquiry into the 2006 price increases--conducted
    jointly with the Department of Justice and with assistance from the
    Department of Energy's Energy Information Administration--focused on
    the gasoline price increases experienced nationwide in the spring and
    summer of that year. The inquiry identified six broad market factors
    that appeared to contribute to the national average price increases
    during the spring and summer of 2006: seasonal effects, increases in
    crude oil prices, increases in ethanol prices, capacity reductions due
    to the transition to ethanol, reductions in refiners' ability to
    produce gasoline, and increases in demand. It required careful
    financial and economic analysis of price and cost data spanning an
    extended period of time, supplemented by interviews with refiner
    personnel and a review of key company documents, to identify the
    relative contribution of each factor to the price increases and
    conclude that those market factors provided an adequate explanation for
    the price increases without giving rise to an inference of
    anticompetitive behavior.
        In this instance, the FTC Gasoline and Diesel Price Monitoring
    Project was of limited value in explaining the nationwide, average
    increases, because the project's model is designed to focus on a
    different phenomenon--i.e., whether an observed difference between two
    retail or wholesale areas' local gasoline or diesel prices departs from
    the difference that one would expect based on historical statistical
    relationships.
        As you know, the FTC is primarily a law enforcement agency rather
    than a supervisory or regulatory agency. As a law enforcement agency,
    the FTC is empowered to take legal action to challenge suspect behavior
    under the federal laws it enforces. In such proceedings, the FTC must
    meet burdens of proof as determined by the relevant statutes and as
    interpreted by the federal courts. For practices that do violate a
    federal law, the FTC has available a wide variety of remedies to halt
    the practices and reverse their harmful results. I also note that the
    task involved in this investigation is not necessarily the same as that
    of a law enforcement investigation, which may stem, for example, from a
    merger filing, information on specific company acts, or a more
    localized or straightforward pricing anomaly rather than a nationwide
    price movement.
        Question. Does the FTC have sufficient resources to analyze the oil
    and gas markets quickly enough to promptly act and stop anticompetitive
    behavior?
        Answer. The FTC believes that its fiscal year 2009 funding request
    would provide sufficient resources to meet the agency's Consumer
    Protection and Maintaining Competition goals, including those involving
    oil and gas markets. I note, however, that the budgets that serve as
    the basis of the appropriations requests are prepared many months
    before requests are submitted to Congress, and they cannot always
    predict changes to the agency's work that are dictated by emerging
    events or Congressional directives or requests. A recent example of
    this is the new statutory authority Congress gave the FTC to prescribe
    anti-manipulation rules in the energy sector. The Commission will
    continue, as it has in the past, to redistribute existing resources to
    meet these new demands, while assessing the need for additional
    resources.

                                 PRICE GOUGING

        Question. What is the FTC's opinion on federal anti-price gouging
    legislation? On the state level, has the agency observed a deterrent
    effect? Would federal price gouging laws enhance state laws?
        Answer. The Commission has testified on several occasions that
    federal price gouging legislation likely would harm consumers by
    reducing the incentives and increasing the risks for refiners to move
    additional supply into affected areas and take other steps to respond
    to market forces after natural disasters.\18\ After Hurricanes Katrina
    and Rita in 2005, gasoline prices briefly spiked higher in many parts
    of the country. Consumers understandably are upset when they face
    dramatic price increases within very short periods of time, especially
    during a disaster. But price gouging laws--particularly inasmuch as
    they could well deter firms from taking beneficial steps to respond to
    post-disaster shortages--likely will do consumers more harm than good.
    Law enforcement actions premised on a notion of restricting price
    increases essentially are a form of price control, which could produce
    longer lines at the pump and prolong the gasoline crisis. Although no
    consumer likes price increases, such an increase in fact can help to
    make the gasoline shortage less intense and shorter-lived than it
    otherwise would have been.
    ---------------------------------------------------------------------------
        \18\ Commissioner Leibowitz notes that, as he has stated in his
    concurrence to the Commission's report ``Investigation of Gasoline
    Price Manipulation and Post-Katrina Gasoline Price Increases,'' twenty-
    nine states and the District of Columbia have price gouging laws that
    provide for either civil or criminal penalties and, in some situations,
    both. Six of these states and the District of Columbia expressly are
    permitted by their statutes to cap price increases during an emergency.
    Most of these price gouging statutes require an emergency declaration
    and, to the Commissioner's mind, seem entirely unthreatening to the
    operation of the free market--and, indeed they may serve a salutary
    purpose of discouraging outliers from profiteering in the aftermath of
    a disaster.
    ---------------------------------------------------------------------------
        Prices play a critical role in our economy: they signal producers
    to increase or decrease supply, and they also signal consumers to
    increase or decrease demand. In a period of shortage--particularly with
    a product, like gasoline, that can be sold in many markets around the
    world--higher prices create incentives for suppliers to send more
    product into the market, while also creating incentives for consumers
    to use less of the product. For instance, sharp increases in the price
    of gasoline can help curtail the panic buying and ``topping off''
    practices that cause retailers to run out of gasoline. In addition,
    higher gasoline prices in the United States in the wake of the 2005
    hurricanes resulted in the shipment of substantial additional supplies
    of foreign gasoline to the United States.\19\ If price gouging laws
    distort these natural market signals, markets may not function well and
    consumers would be worse off.
    ---------------------------------------------------------------------------
        \19\ Total gasoline imports into the United States for September
    and the first three weeks of October 2005 (after the August hurricanes)
    were approximately 34 percent higher than imports over the same seven-
    week period in 2004. See U.S. Dep't of Energy, Energy Information
    Admin., U.S. Weekly Gasoline Imports (Oct. 26, 2005), available at
    http://www.eia.doe.gov/oil_gas/petroleum/info_glance/gasoline.html.
    ---------------------------------------------------------------------------
        To be sure, there may be situations in which sellers go beyond the
    necessary market-induced price increase. A seller might misjudge the
    market and attempt to charge prices substantially higher than
    conditions warrant or than its competitors are charging. News stories
    of gasoline retailers panicking and setting prices of $6.00 per gallon
    after Katrina are evidence of such misjudgments. But the market--not
    price gouging laws--is the most effective cure for these. Temporary
    prices that are wildly out of line with competitors' prices do not last
    when consumers quickly discover that other stations are charging lower
    prices. A single seller in a market structured like gasoline retailing
    cannot unilaterally raise prices for long above the level justified by
    supply and demand factors. The few retailers who raised prices to the
    $6.00 level reduced them just as quickly when it became apparent that
    they had misjudged the market.
        A price gouging law likely would be difficult to enforce fairly.
    The difficulty for gas station managers, as well as for enforcers,
    often is knowing when the managers have raised prices ``too much,'' as
    opposed to responding to reduced supply conditions. It can be very
    difficult to determine the extent to which any more moderate price
    increases are necessary. Examination of extant state price gouging laws
    and of the federal gasoline price gouging legislation that has been
    introduced indicates that the offense of ``price gouging'' is difficult
    to define. For example, some bills define ``gouging'' as consisting of
    a 10 or 15 percent increase in average prices, while most leave the
    decision to the courts by defining gouging in nebulous terms such as
    ``gross disparity'' or ``unconscionably excessive.'' Some, but not all,
    make allowances for the extra costs that may be involved in providing
    product in a disaster area. Few, if any, proposed federal bills or
    state laws take account of market incentives for sellers to divert
    supply from their usual customers in order to supply the disaster area,
    or incentives for consumers to reduce their purchases as much as
    possible, minimizing the shortage. Ultimately, the inability to agree
    on what should be prohibited indicates the risks in developing and
    enforcing a federal statute that could be counterproductive to
    consumers' best interest. Moreover, much legislation provides
    substantial criminal penalties for those found guilty of ``price
    gouging''--a feature of the legislation that is likely to persuade
    significant numbers of merchants to close down operations rather than
    run the risk of going to prison for raising prices enough to cover
    ongoing costs and maintain adequate supplies.
        For all of these reasons, a majority of the Commission has
    concluded that federal price gouging legislation would harm consumers
    overall.
        The Commission has not studied state price gouging laws in depth to
    determine if they actually have any deterrent effect.\20\ Because of
    the potential overall harm to consumers of price gouging laws, I cannot
    say that a federal law would be likely to enhance the states' ability
    to protect consumers.
    ---------------------------------------------------------------------------
        \20\ The Commission's report following Hurricanes Katrina and Rita
    noted that the prices of nearly all the retailers subjected to state
    enforcement actions were consistent with market trends or other market-
    based factors.
    ---------------------------------------------------------------------------
                          STRATEGIC PETROLEUM RESERVE

        Question. A provision suspending the acquisition of petroleum for
    the Strategic Petroleum Reserve passed the Senate recently. Based on
    the FTC's historical models, would the suspension have significant
    effect on prices a the pump?
        Answer. As noted above, the FTC's Gasoline and Diesel Price
    Monitoring Project--with its focus on historical differences in local
    gasoline or diesel prices in retail or wholesale areas--is not designed
    to predict how changes in crude oil availability might affect crude oil
    prices or gasoline or diesel prices. Accordingly, the Monitoring
    Project model cannot provide any insight into the possible effects on
    prices at the pump of a suspension of additions to the Strategic
    Petroleum Reserve.
                                     ______

                  Questions Submitted by Senator Sam Brownback

                                GASOLINE PRICES

        Question. On May 23, 2007, the FTC testified before the Joint
    Economic Committee that ``mergers of private oil companies have not
    significantly affected worldwide concentration in crude oil. This fact
    is important, because crude oil prices historically have been the chief
    determinant of gasoline prices.'' Given the fact that the share of
    gasoline prices attributable to crude oil costs haves risen to 71.8
    percent from around 50 percent a year ago, would you say that crude oil
    costs are likely an even stronger determinant today?
        Answer. The average spot price of crude oil, as reported by the
    Energy Information Administration, nearly doubled between May 2007 and
    May 2008, from a monthly average of $67 per barrel to approximately
    $125 per barrel. Crude oil prices rose even more after May 2008,
    varying daily between about $130 and $145 per barrel during June and
    the first three weeks of July. This increase in crude oil prices has by
    far outstripped changes in any other element relevant to the production
    of gasoline. Crude oil prices are a stronger determinant of gasoline
    prices today because any given percentage change in crude oil prices
    from current levels will have a greater impact on pump prices than in
    previous years, when crude oil prices were dramatically lower.

                                    ETHANOL

        Question. Has the FTC looked at concentration in the ethanol
    market? Is concentration increasing or decreasing?
        Answer. The FTC has closely scrutinized and reported on production
    and concentration in the United States ethanol market since late 2005.
    In November 2007, the Commission issued its third annual report on the
    U.S. industry. The series of FTC reports shows that concentration in
    the industry has been decreasing. The 2007 report noted that, as of
    September 2007, 13 firms had entered into the production of ethanol
    during the preceding year, bringing the total number of U.S. producers
    to 103.\21\ As new firms have entered, the market, which is
    unconcentrated by any measure of capacity or production, has become
    even more unconcentrated.
    ---------------------------------------------------------------------------
        \21\ Federal Trade Commission, 2007 Report on Ethanol Market
    Concentration (Nov. 2007), available at http://www.ftc.gov/reports/
    ethanol/2007ethanol.pdf.
    ---------------------------------------------------------------------------
                               TELECOMMUNICATIONS

        Question. The proposed Reauthorization bill S. 2831, which is
    currently before the Senate Commerce Committee, proposes a waiver of
    the telecommunications common carrier exemption. This exemption bars
    the agency from reaching certain conduct of telecommunications
    companies. The Commission has testified in favor of the repeal of the
    exemption. However in seeking this new authority, the FTC has never
    cited an instance where the FCC failed to fulfill its responsibilities.
    The Telecommunications Consumers Division within the FCC's Enforcement
    Bureau investigates the practices of companies engaged in various
    telecommunications-related activities. So, the FCC already is
    exercising its statutory authority in the precise areas in which the
    FTC seeks jurisdiction. If this exemption were to be lifted what would
    be the benefit? What could the FTC accomplish or reach that is not
    currently dealt with? Because, to permit two different agencies to
    impose regulations covering the same type of conduct could very easily
    become unduly burdensome on companies, while not providing a
    corresponding benefit to or protection for consumers.
        Answer. The FTC's request that Congress repeal the FTC Act
    exemption for common carriers as applied to providing telecommunication
    services is not a commentary on or reflection of concern about the work
    done by the FTC's sister agency, the Federal Communications Commission.
    Indeed, over the years, the FTC has worked closely with the FCC on
    numerous issues of joint interest. Currently, the two agencies
    coordinate enforcement of their overlapping Do Not Call rules, and the
    FCC is a member of the federal-state law enforcement task force on
    prepaid calling cards that the FTC established last year.
        The two agencies, however, have very different missions and law
    enforcement tools. The FTC is the nation's consumer protection
    authority and, as such, has extensive experience investigating and
    bringing federal court and administrative actions against companies
    engaged in deceptive and unfair practices. As a result, the FTC has
    substantial litigation experience and a robust body of case law to rely
    on in seeking to stop deceptive or unfair acts and practices that harm
    consumers, and to get money back for injured consumers.
        The common carrier exemption dates from a period when
    telecommunications were provided by highly-regulated monopolies. The
    exemption as applied to telecommunications services is now outdated,
    and the FTC has repeatedly found its consumer protection work impeded
    by the exemption in ways that are detrimental to consumers. Most
    recently, the common carrier exemption has been an issue in two FTC
    cases against the distributors of prepaid calling cards. In those
    cases, the FTC has alleged that the distributors engaged in deceptive
    marketing practices by misrepresenting the number of calling minutes
    provided by their cards and failing to disclose or to adequately
    disclose fees and charges associated with their cards. FTC v. Clifton
    Telecard Alliance One LLC, No. 2:08-cv-01480-PGS-ES (D.N.J.) (filed
    March 25, 2008); and FTC v. Alternatel, Inc., No. 08-21433-CIV-Jordan/
    McAliley (S.D. Fla.) (filed May 19, 2008).\22\ In both cases, the FTC
    sought and received temporary restraining orders prohibiting defendants
    from, inter alia, misrepresenting the number of calling minutes
    provided by the cards they distribute, and failing to disclose fees and
    charges that reduce the value of their calling cards. Because of the
    common carrier exemption, the FTC has not pursued the carriers that
    provide the telecommunications services for the cards at issue. As a
    result, in both cases the defendants have moved to dismiss the FTC's
    case on the grounds that the underlying telecommunications carriers are
    necessary parties that cannot be joined by the FTC, because of the
    common carrier exemption. Although the FTC has opposed defendants'
    motions, and is confident that it will win on the merits, the exemption
    has created a litigation issue for the FTC. More fundamentally, the
    exemption directly impedes the FTC's ability to hold carriers
    accountable for their role in allegedly deceptive and unfair practices
    in the calling card industry.
    ---------------------------------------------------------------------------
        \22\ In the Clifton case the Commission has also alleged that
    defendants failed to disclose or to adequately disclose that the value
    of their cards may be reduced even when a call does not connect.
    ---------------------------------------------------------------------------
        The prepaid calling card industry is not an isolated example of an
    area in which the common carrier exemption hampers the FTC's ability to
    protect consumers from deceptive and unfair acts or practices. As
    information, entertainment, and payment systems converge, common
    carriers are providing an increasing number of new services. Now,
    consumers can purchase their voice services bundled with Internet
    access services and video services. Moreover, landline and cellular
    carriers bill consumers for unlimited numbers of services provided by
    third parties. The FTC has brought dozens of cases against companies
    that the FTC alleges have crammed unauthorized charges onto consumers'
    phone bills.\23\ The common carrier exemption, however, has given rise
    to issues that complicate litigation in some of these cases,\24\ and
    has impeded the Commission's ability to consider whether and to what
    extent phone companies should be held responsible for placing those
    charges on their customers' phone bills.
    ---------------------------------------------------------------------------
        \23\ See, e.g., FTC v. Verity International Ltd., 335 F. Supp. 2d
    479 (S.D.N.Y. 2004), aff'd in part, rev'd in part, 443 F.3d 48 (2d Cir.
    2006), cert. denied, 127 S. Ct. 1868 (2007); FTC v. Nationwide
    Connections, Inc., No. 06-80180-CIV-Ryskamp/Vitunack (S.D. Fla. 2006);
    FTC v. Websource Media, LLC., No. H-06-1980 (S.D. Tex. 2006); FTC v.
    Epixtar Corp., No. 03-CV-8511 (DAB) (S.D.N.Y. 2003); FTC v. Sheinkin,
    No. 2-00-363618 (D.S.C., 2000); FTC v. Mercury Marketing of Delaware,
    Inc., No. 00-CV-3281 (E.D. Pa. 2000); FTC v. Int'l Telemedia Assocs.,
    Inc., No. 1-98-CV-1925 (N.D. Ga. 1998); FTC v. Audiotex Connection,
    Inc., No. C-97 0726 (DRH) (E.D.N.Y. 1997).
        \24\ For example, in FTC v. Verity International Ltd., the
    Commission alleged that the defendants orchestrated a scheme whereby
    consumers seeking online entertainment were disconnected from their
    regular ISPs and reconnected to a Madagascar phone number. The
    consumers were then charged between $3.99 and $7.78 per minute for the
    duration of each connection. AT&T and Sprint--which were not parties to
    the FTC enforcement action--had carried the calls connecting the
    consumers' computers to the defendants' servers. The defendants
    therefore argued that the entertainment service in question was
    provided on a common carrier basis and thus outside the FTC's
    jurisdiction. One defendant also claimed to be a common carrier itself
    and hence beyond FTC jurisdiction. Although both the District Court and
    the Court of Appeals rejected those arguments, the FTC had to expend
    substantial time and resources litigating the question of jurisdiction.
    ---------------------------------------------------------------------------
                               MORTGAGE MARKETING

        Question. Could you elaborate for the record on some of the most
    egregious examples of unfair and deceptive advertising that the FTC has
    reviewed in connection with mortgage brokerage activities? What are the
    underlying themes--is it rates that adjust after a month, unclear
    disclosures of what the terms are, failure to disclose that the quoted
    terms didn't include escrow information clearly, or represented a type
    of bait and switch approach? Just give us a flavor of some of the most
    significant aspects of this type of marketing.
        Answer. The Commission has been actively investigating mortgage
    lending practices for many years.\25\ In June 2007, the agency staff
    conducted a nationwide review of mortgage ads, including some in
    Spanish, featuring claims for very low rates or monthly payment amounts
    without adequate disclosure of other important loan terms. The FTC
    staff reviewed the ads to determine whether they may be deceptive in
    violation of Section 5 of the FTC Act or may violate the Truth in
    Lending Act (``TILA'').\26\ The Commission staff then commenced
    investigations of or sent warning letters to advertisers whose ads
    raised concerns. This included warning letters that FTC staff sent to
    more than 200 mortgage brokers and lenders, and media outlets that
    carry their advertisements for home mortgages, informing them that
    their ads may be unlawful. The agency staff recently reviewed the
    current advertising of those who received warning letters. We will take
    law enforcement action where appropriate if this review or other
    monitoring of mortgage advertising claims reveals that an advertiser
    has violated the law.
    ---------------------------------------------------------------------------
        \25\ The Commission's April 29, 2008 testimony before the
    Subcommittee On Interstate Commerce, Trade, and Tourism of the
    Committee On Commerce, Science, and Transportation, United States
    Senate provides a comprehensive description of the FTC's law
    enforcement, policy, and consumer education work in the subprime
    mortgage market in recent years. The testimony is available at http://
    www.ftc.gov/os/testimony/P064814subprimelending.pdf.
        \26\ See Press Release, FTC Warns Mortgage Advertisers and Media
    That Ads May Be Deceptive (Sept. 11, 2007), available at www.ftc.gov/
    opa/2007/09/mortsurf.shtm.
    ---------------------------------------------------------------------------
        Through our deceptive mortgage advertising sweep and other
    monitoring of mortgage ads, the FTC has reviewed many mortgage ads for
    problematic claims. The ads frequently tout the most favorable terms of
    a mortgage without revealing critical facts consumers need to make
    well-informed decisions. We have encountered numerous ads offering low
    rates or monthly payments without disclosing adequately significant
    limitations or conditions. For example, an ad may tout that a mortgage
    is available with only ``1 percent Payments,'' yet fail to disclose
    that 1 percent is not an interest rate or that this payment rate only
    applies during a brief introductory period. We have also encountered
    ads offering loans with ``fixed'' low rates or monthly payments which
    in fact are loans with adjustable rates or payments. For instance, an
    ad may state in large bold print, ``30-Year Fixed, 1.99 percent.'' Only
    at the bottom or reverse side, in tiny print, will it reveal that it is
    only fixed for the first year, and that after that will increase every
    year by as much as 7 percent.

                                  DEBT RELIEF

        Question. Can you outline examples of some of the most egregious
    cases of consumer fraud that you've witnessed in the Debt Relief/Debt
    Counseling arena? Obviously, people are hurting and looking for hope
    when they go to these services. What characteristics delineate the
    legitimate players in the market from those simply looking to prey upon
    desperate people?
        Answer. The Commission has prosecuted about a dozen companies that
    it alleged falsely promised lifelines to consumers overwhelmed with
    credit card debt.\27\ Some examples of egregious alleged conduct
    include the following cases:
    ---------------------------------------------------------------------------
        \27\ FTC v. Debt-Set, No. 07-558 (D. Colo. 2007); FTC v. Select
    Personnel Mgmt., Inc., No. 07-0529 (N.D. Ill. 2007); FTC v. Dennis
    Connelly, No. 06-701 (C.D. Cal. 2006); FTC v. Express Consolidation,
    No. 06-61851 (S.D. Fla. 2006); US v. Credit Found. of Am., No. 06-3654
    (C.D. Cal. 2006); FTC v. Debt Solutions, Inc., No. 06-0298 (W.D. Wash.
    2006); FTC v. Debt Mgmt. Found. Servs., Inc., No. 04-1674 (M.D. Fla.
    2004); FTC v. Integrated Credit Solutions, Inc., No. 06-00806 (M.D.
    Fla. 2006); FTC v. National Consumer Council, Inc., No. 04-0474 (C.D.
    Cal. 2004); FTC v. Better Budget Fin. Servs., Inc., No. 04-12326 (D.
    Mass. 2004); FTC v. Innovative Sys. Tech., Inc., d/b/a Briggs & Baker,
    No. 04-0728 (C.D. Cal. 2004); FTC v. Jubilee Fin. Servs., Inc., No. 02-
    6468 (C.D. Cal. 2002).
    ---------------------------------------------------------------------------
        In its largest case in this area, the FTC sued AmeriDebt, Inc., a
    purported credit counseling organization.\28\ The Commission alleged
    that AmeriDebt deceived consumers with claims that it was a non-profit
    organization that provided bona fide debt counseling services. In fact,
    the FTC alleged, AmeriDebt funneled profits to affiliated for-profit
    entities and individuals. The Commission also alleged that AmeriDebt
    deceived customers by claiming that it did not charge an up-front fee
    when, in fact, AmeriDebt kept its clients' first payments as a fee,
    rather than disbursing the money to their creditors as promised. The
    FTC's settlement with AmeriDebt, which filed for bankruptcy during the
    litigation, bans the company from the industry. Subsequently, on the
    eve of trial, AmeriDebt's founder agreed to a $35 million
    settlement.\29\
    ---------------------------------------------------------------------------
        \28\ FTC v. AmeriDebt, Inc., No. 03-3317 (D. Md. 2003).
        \29\ See FTC v. AmeriDebt, Inc., No. 03-3317 (D. Md. Jan. 9, 2006)
    (Stipulated Final Judgment and Permanent Injunction as to DebtWorks,
    Inc. and Andris Pukke). Subsequently, the court-appointed receiver
    determined that primary defendant Andris Pukke had hidden assets from
    the FTC, and the court entered a judgment requiring him to turn over
    tens of millions of dollars' worth of additional assets. Because he
    resisted turning over his assets even after the court found him in
    contempt of court, the Court ordered his incarceration pending full
    cooperation, lasting almost a month.
    ---------------------------------------------------------------------------
        In another case, the Commission sued a Canadian telemarketer,
    alleging that it preyed on American consumers by falsely promising
    that, for an upfront fee of $700, it would provide interest rate
    reduction services for consumers with high-interest credit cards.\30\
    Although the telemarketer claimed affiliation with consumers' credit
    card companies, the extent of its services consisted of a single call
    to the creditor asking for an interest rate reduction, which was
    routinely denied. The Commission also alleged that the defendant did
    not honor its refund guarantee to consumers who did not experience the
    promised substantial savings.
    ---------------------------------------------------------------------------
        \30\ FTC v. Select Personnel Mgmt., Inc., No. 07-0529 (N.D. Ill.
    2007) (litigation ongoing).
    ---------------------------------------------------------------------------
        The Commission also has brought actions against for-profit debt
    settlement companies, alleging that defendants falsely promised to
    reduce substantially credit card debt.\31\ In those cases, defendants
    allegedly deceived consumers into paying hundreds or thousands of
    dollars in upfront fees by misrepresenting that they would obtain lump
    sum settlements of consumers' credit card debt. In fact, the Commission
    alleged that defendants kept the upfront fees and had little if any
    success in obtaining the promised settlements.
    ---------------------------------------------------------------------------
        \31\ E.g., FTC v. Debt-Set, No. 07-558 (D. Colo. 2007).
    ---------------------------------------------------------------------------
        There are a number of features for consumers to look for when
    assessing the legitimacy of debt relief services being offered. The
    legitimate non-profit credit counseling agencies commonly provide free
    budget analysis for consumers seeking a manageable debt repayment plan.
    They do not charge substantial fees for services. After reviewing a
    consumer's financial condition, the these legitimate agencies explain
    the possible options for the consumer. If consumers have sufficient
    income, the agencies can negotiate a debt consolidation plan (known as
    a ``debt management plan'') directly with the creditors on behalf of
    the consumer. The consumer then pays the agency one monthly amount
    which the agency then disburses to the creditors. The Commission's
    education and outreach program in this area includes a number of
    publications to help consumers who are seeking debt relief
    services.\32\
    ---------------------------------------------------------------------------
        \32\ Consumer education materials on debt relief and credit
    counseling issues are directly accessible from the FTC's webpage,
    Credit and Loans: In Debt?, available at www.ftc.gov/bcp/menus/
    consumer/credit/debt.shtm. In Spanish, the materials are available from
    the FTC's webpage, Credito y Prestamos: oEndeudado?, available at
    www.ftc.gov/bcp/menus/consumer/credit/debt_es.shtm.
    ---------------------------------------------------------------------------
                              REAL ESTATE MARKETS

        Question. Can you discuss for the record any inquiries the FTC has
    made into ``infomercial'' type marketing of ``get rich easy'' real
    estate investment schemes? Have you looked at the role those programs
    may have played in encouraging irresponsible speculation in the real
    estate market, including flipping activities that went bad? Or the
    degree to which those programs included suggestions that participants
    engage in occupancy fraud that led to a high degree of early payment
    defaults?
        Answer. The Commission's testimony emphasized recent law
    enforcement and outreach efforts to tackle deceptive and unfair
    practices involving mortgage lending and servicing, and to halt
    mortgage foreclosure rescue scams, which impact the real estate market.
    As a general matter, we know that scam artists seize upon ``hot''
    areas, such as real estate investment, to promote fraudulent business
    opportunities as ``get rich quick'' schemes. Such scammers promote
    their false promises of wealth through any medium, including
    infomercials.
        The Commission has aggressively targeted the broad range of
    business opportunity frauds. In December 2006, the agency spearheaded
    ``Project FAL$E HOPE$,'' which was a coordinated civil and criminal
    crackdown by federal and state law enforcers targeting more than 100
    bogus business opportunities.\33\ As part of that sweep, the FTC
    announced partial settlements in the Commission's pending case against
    a group of defendants that the FTC alleged telemarketed a product that
    purportedly instructed consumers on how to make easy money buying and
    selling privately held mortgages. In 2007, the Court issued summary
    judgment in the case by against the remaining defendants ordering them
    to pay $17 million in consumer redress.\34\ The agency is generally
    aware that some real estate investment schemes have been promoted
    through infomercials, but it is not aware of any clear connection
    between such investment schemes and irresponsible speculation or
    occupancy fraud in the marketplace.
    ---------------------------------------------------------------------------
        \33\ http://www.ftc.gov/opa/2006/12/falsehopes.shtm.
        \34\ http://www.ftc.gov/opa/2007/05/stefanchik.shtm.
    ---------------------------------------------------------------------------
        The FTC will continue to challenge false ``get rich quick'' claims
    that promote bogus investment opportunities, including those involving
    real estate, and will continue to combat deceptive and unfair practices
    that impact the real estate market.

                             CONCLUSION OF HEARINGS

        Senator Durbin. If there are no further questions, the
    subcommittee stands recessed.
        [Whereupon, at 4:30 p.m., Wednesday, May 14, the hearings
    were concluded, and the subcommittee was recessed, to reconvene
    subject to the call of the Chair.]

                 Material Submitted Subsequent to the Hearings

        [The following agencies were unable to testify and have
    submitted statements for inclusion in the record.]

                         OFFICE OF PERSONNEL MANAGEMENT

        Prepared Statement of the Honorable Linda M. Springer, Director
        Mr. Chairman and members of the subcommittee: I appreciate the
    opportunity to submit for the record a statement addressing the
    appropriations request for the Office of Personnel Management (OPM) for
    fiscal year 2009.
        As you know, OPM provides a variety of products and services to the
    nearly 1.8 million employees in the Federal Government. Some of our
    products and services include managing health insurance for
    approximately 8 million current and former Federal employees and their
    families, administering retirement services for over 2 million retirees
    from all branches of Government, completing 90 percent of background
    investigations for industry and Federal agencies, and administering
    career development programs. As the OPM Director, I am committed to
    successfully delivering on our responsibilities on a timely basis. In
    short, I believe the American citizens and the Federal civilian
    workforce expect us to get things done, and our fiscal year 2009 budget
    request will allow us to do just that.
        We are requesting $20 billion to carry out our mission in fiscal
    year 2009. Of this total, $19.8 billion is requested for mandatory
    programs and $228.9 million for discretionary activities. The
    discretionary request reflects $211 million for Salaries and Expenses--
    including transfers from the Trust Fund Accounts of $118.1 million--and
    $18 million for the Office of the Inspector General. The total
    discretionary request reflects a net decrease of $15.4 million compared
    to the fiscal year 2008 enacted level. I also want to note that OPM
    operates a revolving fund for the administration and operations of a
    number of programs including our Federal investigative services and
    Government-wide training efforts.

               RETIREMENT CLAIMS PROCESSING AND BENEFITS PROGRAMS

        OPM's request includes funding to improve the services it delivers
    to Federal employees, annuitants, and their families through the
    retirement and insurance programs.
        On February 25, 2008, OPM began the rollout of the first ever
    Federal electronic retirement system. The budget requests an additional
    $15.2 million in No-Year Trust funds for continuation of this project.
    These funds will allow OPM to continue the conversion of millions of
    paper retirement records to electronic data and contract for the
    information technology needed for the system so that retirees can
    receive full payments once they separate from service eliminating
    interim payments at reduced amounts. At full rollout, employees will be
    able to model their retirement and initiate the process.

                FEDERAL EMPLOYEES HEALTH BENEFITS PROGRAM (FEHB)

        As the administrator of the FEHBP, OPM will continue to negotiate
    and contract with private insurance companies that offer a broad range
    of health insurance benefits, including high-deductible health plans
    with Health Savings Accounts and consumer-driven health plan options.
    As such, OPM will spend $26 million in fiscal year 2009 to ensure the
    viability of the Program's 283 health care plans covering over 8
    million people. As usual, OPM will continue to carry out tough
    negotiations with health carriers to contain premium hikes. Over the
    years these negotiations have resulted in employee premiums that are
    substantially lower than those of the private sector while maintaining
    benefit levels, and continuing to provide, improve, and expand tools so
    customers can make informed health insurance decisions. In fact, the
    FEHBP increase for 2008 was 2.1 percent, compared to an average 8.7
    percent increase for the private sector and a 6.3 percent increase for
    the California Public Employees' Retirement System during that same
    year.

                           HUMAN RESOURCES MANAGEMENT

        In fiscal year 2009, OPM will pursue policy initiatives that
    continue to reform human resources management in Federal agencies. We
    will work with the Department of Defense to ensure the reforms underway
    link pay to performance in a fair and consistent manner. At the same
    time, OPM will work with other agencies engaged in implementing
    Alternative Personnel Systems to assess the lessons learned from
    various modernization efforts. Mr. Chairman, in the last half-century,
    the Federal workforce has changed significantly, and the old personnel
    system has not kept pace. We are, therefore, striving to modernize the
    systems designed to recruit and retain federal employees.
        The fiscal year 2009 budget will allow OPM to maintain the
    competitiveness of Federal employee compensation and benefits by
    exploring ways to refine market adjustments to Federal pay, and
    providing Federal employees with opportunities, benefits, and service
    delivery that compare favorably with other employers. For instance, OPM
    will continue to develop new workforce recruitment strategies and
    tools, and further improve the hiring process by developing a life-
    cycle reform model for agencies to adopt to streamline the current
    recruitment process. And last but not least, OPM will spend $200,000 to
    continue to support the Nation's returning Veterans by providing
    assistance in finding job opportunities with the Federal Government.

                IMPLEMENTING HUMAN CAPITAL STANDARDS FOR SUCCESS

        OPM will use requested funds to engage Federal agencies in
    implementing the Human Capital Assessment and Accountability Framework,
    and other best practices in human capital management, in keeping with
    the Merit System Principles, veterans' preference, and other standards.
    At the beginning of fiscal year 2008, 17 of the 26 agencies reporting
    under the President's Management Agenda Scorecard have met these
    standards, up from 11 in 2006, eight in 2005, and zero in 2003. As a
    result, more than 99 percent of the Federal civilian workforce is
    employed by agencies that have made significant progress toward meeting
    these standards.
        Through its Compliance Program, OPM will continue to evaluate,
    review, and ensure agencies comply with Merit System Principles and
    veterans' preference, and to ensure whistleblower protection and other
    rights and privileges are honored and protected. OPM will strengthen
    this program through a human capital accountability system that holds
    agencies accountable for adhering to these principles, laws, and rules,
    as well as the human capital best practices referenced above.

                        HUMAN RESOURCES LINE OF BUSINESS

        In 2009, OPM will continue to be a leader in the President's
    Management Initiative for Expanded Electronic Government and has
    included $7,202,000 in its request for this purpose. The requested
    resources will support the Human Resources Line of Business (HR LOB)
    and Enterprise Human Resources Integration (EHRI). HR LOB will continue
    to identify and document common functional, technical, and data
    requirements consistent with Federal human resources policies and will
    work toward the establishment of Federal and private sector Shared
    Service Centers to meet these requirements. During 2009, the EHRI
    project will continue to modernize how the Federal Government
    maintains, stores, protects, and transmits information on human
    resources transactions.

                          SECURITY-RELATED ACTIVITIES

        The fiscal year 2009 request includes funding for a number of
    important security-related activities. OPM will implement Homeland
    Security Presidential Directive 12 (HSPD-12), Policy for a Common
    Identification Standard for Federal Employees and Contractors, which
    was signed by the President on August 27, 2004. This mandates the
    circulation of a Federal standard for a secure and reliable form of
    identification for Federal employees and contractors. HSPD-12
    requirements will enhance OPM's strategic goal of improving security
    and emergency planning actions throughout the agency.

                                 REVOLVING FUND

        OPM also provides a variety of ongoing services that are financed
    by other agencies through our revolving fund. These services include
    providing one-stop access to high-quality e-Training products and
    services; offering professional development and continuous learning for
    Federal managers and executives; providing employment information and
    assessment services; automating other agencies' staffing systems;
    providing examining services when requested by an agency; providing
    technical assistance and consulting services on all facets of Human
    Resources management; testing potential military personnel for the
    Department of Defense where it is cost-effective for OPM to do so;
    managing the selection, coordination, and development of Presidential
    Management Fellows; and conducting investigations for employees to
    determine whether they are suitable for employment, as well as more in-
    depth investigations for employees whose positions require security
    clearances. For those ongoing revolving fund responsibilities, the
    fiscal year 2009 budget includes an estimated $1 billion in obligations
    and 3,131 FTE to be financed through payments for OPM's services by
    other agencies.

                           MANDATORY PAYMENT ACCOUNTS

        The OPM budget request also includes mandatory appropriations to
    fund the Government contributions to the health benefits and life
    insurance programs for Federal annuitants.
        For the approximately 1.9 million annuitants participating in the
    Federal Employees Health Benefits Program, we estimate that about $9.6
    billion will be needed to pay the Government's share of the cost of
    coverage. That represents an increase of $769 million over fiscal year
    2008. We estimate that, for the 500,000 annuitants under age 65 who
    elect post-employment life insurance coverage, an appropriation of $46
    million will be required.
        Also, as mandated by the financing system established in 1969 by
    Public Law 91-93, liabilities resulting from changes (principally pay
    raises) since that year that affect retirement benefits must be
    amortized over a 30-year period. For that purpose, we are requesting a
    ``such sums as may be necessary'' payment to the Civil Service
    Retirement and Disability Fund in the amount of $10.2 billion. This
    represents an increase of $100 million to cover the service cost of the
    Civil Service Retirement System, which is not funded by and for active
    employees.
        Thank you again for the opportunity to provide for the record a
    discussion of OPM's budget request for fiscal year 2009. I would be
    pleased to provide any additional information the subcommittee may
    need.
                                     ______

      Prepared Statement of the Honorable Patrick E. McFarland, Inspector
                                    General

        Mr. Chairman and members of the subcommittee: Thank you for
    providing me this opportunity to discuss the President's fiscal year
    2009 request for appropriations for the Office of the Inspector General
    at the Office of Personnel Management (OPM). The total request for the
    Office of the Inspector General is $18,000,000, which is $600,000 below
    the amount enacted for fiscal year 2008. Of our requested amount,
    $1,538,000 is from the salaries and expenses/general fund and
    $16,462,000 is from the trust funds. These resources are requested to
    perform our core functions which include:
      --Conducting audits, investigations, and evaluations of agency
            programs and operations, including primarily carriers
            participating in the Federal Employees Health Benefits Program
            (FEHBP), the associated information systems, and internal
            agency operations and financial systems; and
      --Issuing administrative sanctions, including debarments and
            suspensions to health care providers who pose a financial risk
            to the FEHBP itself or a health care risk to persons who
            receive health insurance coverage through the FEHBP.
        The Office of the Inspector General recognizes that oversight of
    the retirement, health benefits, and life insurance trust funds
    administered by OPM is, and will remain, its most significant
    challenge. These trust funds are among the largest held by the United
    States Government. Their assets totaled $789.3 billion in fiscal year
    2007, their receipts were $97.1 billion, and their annual outlays were
    $153.7 billion. The amounts of their balances are material to the
    integrity of the Government's financial position. I continue to
    allocate the vast majority of the Office of the Inspector General's
    efforts and resources to trust fund oversight, and we remain fully
    committed to trust fund activities.
        OPM makes outlays from the retirement trust funds in the form of
    payments to millions of Federal annuity recipients. The health
    insurance trust fund provides payments to approximately 270 health
    insurance plans nationwide. In turn, the health insurance carriers pay
    millions of claims for services filed by their enrollees and health
    care providers. We have shown through our audits and investigations
    that such health insurance payments may be at risk through improper,
    inaccurate or fraudulent claims.
        We are obligated to Federal employees and annuitants to protect the
    integrity of their earned benefits. Our audit and criminal
    investigative work reduces losses due to fraud and improper payments
    and recovers misspent funds whenever possible. We have a special
    obligation to the Federal agencies and the American taxpayers, who
    provide the majority of the funding. We also seek to deter future
    occurrences of fraud and abuse within OPM programs, as well as serve to
    protect the health and welfare of beneficiaries of OPM programs and
    services.
        Audits and criminal investigations of the OPM-administered trust
    fund programs have resulted in significant financial recoveries to the
    trust funds and commitments by program management to recover additional
    amounts. From fiscal year 2005 to the present, our office has
    cumulative judicial recoveries and audit recommendations to recover
    funds exceeding $440 million.
        Beginning in 2005, the Office of the Inspector General established
    a nationwide field structure. As of 2008, the office has eighteen
    investigative and two audit field offices in addition to its
    headquarters in Washington, DC. We have determined that the most
    effective deployment of investigative staff is to locate them in areas
    of the country where FEHBP and retirement benefits are more
    concentrated. Experience has shown that criminal investigators located
    in these areas often work in cooperation with other law enforcement
    entities similarly located, resulting in additional criminal leads and
    better protection of OPM programs. In many instances, criminal
    investigators located outside of Washington, DC work exclusively on
    cases referred to them by local authorities. During fiscal year 2007,
    investigative work resulted in 46 arrests, 66 indictments, and 50
    convictions.
        During fiscal year 2009, we will continue to conduct audits of
    pharmacy benefit managers (PBMs), firms contracted by FEHBP carriers to
    administer their prescription drug programs. The premiums paid for
    prescription drug coverage have risen exponentially over the last ten
    years and allegations against PBMs have also increased. It is estimated
    that approximately $9.2 billion was paid during 2007 in prescription
    drug premiums to experience-rated and health maintenance organization
    (HMO) carriers. This represents approximately 28 percent of experience-
    rated and HMO carrier premiums paid for health benefits coverage for
    Federal employees and annuitants. In fiscal year 2007, we settled a
    large civil health care fraud claims case against an FEHBP PBM,
    resulting in $97 million returned to the OPM trust fund. We remain
    steadfast in our efforts to audit and investigate pharmacy benefits and
    pharmaceutical fraud within the FEHBP.
        Also during fiscal year 2009, we will further our development of a
    data warehouse of health benefits claims. The data warehouse offers the
    best opportunity for global detection of erroneous health benefit
    payment transactions by medical providers, insurance carriers and
    subscribers by accumulating all benefit claims for all fee-for-service
    insurance carriers in a single data repository. This effort will
    enhance our current claims reviews by enabling the auditors and
    investigators to target certain types of potential claim payment errors
    on a program-wide rather than on a plan-by-plan basis. This will
    provide a significant improvement in our audit efficiency and
    effectiveness by offering us the opportunity to address significant
    issues of broad concern on a coordinated basis and to recover
    overcharges to the program when appropriate.
        Currently in the data warehouse, we have data for the top three
    experience-rated carriers (Blue Cross Blue Shield, Mail Handlers
    Benefit Plan, and Government Employees Health Association),
    representing 86 percent of experience-rated plans claims payments. We
    are also receiving data from HMO plans with over 500 subscribers. This
    includes 85 plans, representing 87 percent of the HMO plans claims
    payments. The data is being accumulated and used for basic analysis to
    support premium rate calculations. Starting in fiscal year 2009, we
    plan to introduce more advanced claims analyses which recognize
    potential high risk areas for community-rated carriers.
        Our administrative sanctions program has continued to improve its
    effectiveness in protecting the FEHBP and its enrollees against
    untrustworthy health care providers. This program enforces the FEHBP
    sanctions statute, which authorizes suspension or debarment of
    providers on the basis of 18 different categories of violations. The
    most frequently-encountered violations represent criminal convictions
    or loss of professional licensure. The highest priority sanctions cases
    involve providers who are the subject of investigation by our Office of
    Investigations. We select cases for action on the basis of the
    seriousness of the provider's violations and the risks that the
    provider poses to the FEHBP and to the health and safety of its
    subscribers. We currently have over 30,396 active debarments and
    suspensions in effect. We recently completed the conversion and
    digitizing of our debarment and suspension paper files and records to
    an electronic, searchable database.
        Thank you for this opportunity to present our office's resource
    request for fiscal year 2009.
                                     ______

                            SELECTIVE SERVICE SYSTEM

       Prepared Statement of the Honorable William A. Chatfield, Director

                                    FORWARD

        Chairman Durbin and members of this subcommittee, I am honored as
    Selective Service Director to present the President's fiscal year 2009
    appropriations request of $22,000,000 for the agency. The Congress and
    administrations under both parties have acknowledged the wisdom of
    maintaining Selective Service as a hedge against unforeseen threats and
    as a low-cost insurance policy against underestimating any threat our
    Armed Forces might face in a still-dangerous world.
        This agency is as determined as ever to make the necessary
    adjustments to budget realities and the requirements of combating
    terrorism, defending the homeland, and maintaining other priorities
    listed in the President's January 28, 2008, State of the Union Address.
    Personnel reductions at Selective Service have resulted from planned
    attrition and will not involve a reduction-in-force. Meanwhile, the
    agency continues its phased reductions in operational readiness while
    preserving as much customer service as possible. For example, we are
    reducing the number of part-time Reserve Component officers from a
    total of 250 to 200 by the end of fiscal year 2008 and to 150 by the
    end of 2009. Automated registrations are making it possible to
    accomplish our missions without the need for as much face-to-face
    contact at the local level. These innovations have required painful
    choices, but satisfying our goals will assure a Selective Service that
    is beyond reproach, while meeting the needs of its primary customer,
    the Department of Defense. I welcome the challenge and appreciate the
    opportunity to share my vision for Selective Service with you today.

                                WHAT WE DO TODAY

        Selective Service is in business to perform two unique functions.
    Should the Congress and the President authorize a return to military
    conscription, the agency can conduct a draft that is efficient, fair,
    and accepted by the public. It is also ready to administer a program of
    alternative community service for men who are classified as
    conscientiously opposed to military service.
        Additionally, each and every day Selective Service continues its
    close partnership with the Department of Defense by providing direct
    support to Armed Forces recruiting. Specifically, Selective Service
    provides names of registrants to the Secretary of Defense for
    recruiting purposes, in accordance with the Military Selective Service
    Act. Information about Armed Forces opportunities for Active Duty,
    National Guard, and Reserves, along with a business reply card, is
    enclosed routinely with our registration acknowledgment that Selective
    Service sends to each new registrant. For fiscal year 2007, these
    contacts totaled nearly 2.2 million young men. Consequently, the
    Defense Department benefits by ``piggy-backing'' on our routine
    mailings which generate actual recruiting leads. And it reimburses us
    for the additional costs in accordance with the Economy Act.
        Beyond its compliance with the Military Selective Service Act and
    providing these tangible services, the agency also promotes an
    intangible national benefit. For present and future generations of
    America's young men, Selective Service is a very critical link between
    society-at-large and today's volunteer military. It is a reminder that,
    as Americans, every young man is personally responsible to ``provide
    for the common defence'' in the time-honored tradition of preceding
    generations.

                               AREAS OF EMPHASIS

        Air Shows.--I look forward once again in 2008 and continuing in
    2009 what I regard as this agency's most creative innovation in meeting
    its traditional mission in a climate of budget austerity. I refer to
    our success in harnessing the venue, excitement, and patriotism of air
    shows.
        My vision has been to present the agency in huge, open community
    venues across the Nation, highlighting authentic American heroes and
    promoting public service and patriotic themes appealing to multiple
    generations. The value of this effort presented itself after my
    assessment of the agency's capabilities, priorities, and missions. Air
    shows are the second most attended spectator events in America,
    attracting a high concentration of registration-age men. I remain
    convinced that funding this initiative results in a substantial
    increase in registration compliance and represents a positive impact on
    the influencers of young men. We are conducting this effort by
    absorbing the $118,000 expense out of our fiscal year 2008 budget and
    will do so again in fiscal year 2009. No new money is involved.
        Registration Compliance.--As exciting as the air show initiative
    has been, it will not be the only effort to satisfy our statutory
    missions. Our operational readiness to perform our traditional missions
    has been reduced because of world risk assessments. Selective Service
    has always believed only when all eligible young men are in the
    manpower pool and accounted for as equally vulnerable would any future
    draft be considered completely fair and equitable by the public.
        Our latest full year of data collection (CY 2007) indicates 91
    percent of legally eligible men (ages 18 to 25) are registered; this is
    a 2 percentage point drop from the previous year. The compliance rate
    for men who are draft eligible (ages 20 to 25) is 95 percent, a 1
    percentage point decrease from CY 2006. Keeping the rates high is very
    important because a declining compliance rate contributes to a lack of
    public confidence in our ability to administer a fair and equitable
    draft.
        Naturally, this agency is as determined as ever to make
    congressional priorities truly our own. We appreciate the
    subcommittee's support for ensuring that our work continues. To the
    extent that our traditional mission survives, I will use every resource
    to continue to maintain high registration compliance. For example, the
    agency will:
        Carry on routine updating of the interactive Selective Service
    pages on the World Wide Web (www.sss.gov) where online registration,
    registration verification, the ability to file changes of information,
    and a wealth of other agency information are available to anyone with
    access to the Internet. For fiscal year 2007, 83 percent of
    registrations reached Selective Service through electronic means, the
    same percentage as 2006. Electronic registrations are encouraged
    because they are quicker, more cost-effective than processing paper
    registrations, and provide better customer service. We are also placing
    links to our site with other Federal, State, and local agencies,
    schools, and assorted organizations to enhance public education and
    facilitate customer responsiveness.
        Profit from an increasing number of States that link obtaining a
    driver's license or State identification card to the Selective Service
    registration requirement. These State and territorial laws currently
    provide Selective Service with an average of 71,000 registrations per
    month. As of this month, 36 States, 3 territories, and the District of
    Columbia have enacted laws. These jurisdictions represent 70.1 percent
    of the national 18-year-old male registrant population. We continue to
    offer technical expertise to the other States where such legislation is
    pending. Data electronic exchanges are the most cost-effective, timely,
    and user-friendly registrations available. Selective Service is
    committed to aid the remaining 14 States in implementing this easy
    method to protect their young men's eligibility for State and Federal
    benefits and programs. This program has been a valuable tool to reach
    all eligible registrants and is more customer-friendly.
        Remain sensitive to the fact that not every household in your
    district has a computer, so technological innovations will not
    compensate for all resource restraints. The only way for young men in
    those households to register is the old-fashioned, pre-Internet way.
    That means going to the nearest post office. And that is why we must
    devote sufficient resources to printing forms and keeping post offices
    well stocked.
        Alternative Service Program.--Half of the agency's mission during
    any return to conscription is to provide for a supervised term of
    alternative civilian service for all men it classifies as conscientious
    objectors. A key component of this program, therefore, is reaching out
    to employers capable of providing work of ``national importance'' by
    becoming members of the Alternative Service Employer Network, or ASEN.
    We continue to reach out to historic peace church constituencies, non-
    profit organizations, and Government entities. These have, in past
    wars, provided the bulk of the assignments we will need to provide our
    alternative service workers with employment that benefits the national
    health, safety, and welfare.
        We have had negotiations with Christian Aid Ministries, Mennonite
    Voluntary Services, and others who hope to join the ASEN. We also
    continue to have our State Directors visit the projects run by these
    organizations to determine their suitability to become ASEN members. In
    addition to visiting model project sites, our State Directors have
    begun to reach out to our historic conscientious objector
    constituencies across America. These contacts and outreach efforts were
    previously confined to our headquarters staff. In addition to making it
    easier and less expensive for the public to stay in touch with us, this
    field effort facilitates the building of the relationships we will need
    to successfully meet our goals for this program during any return to
    conscription.
        Finally, we continue to work toward obtaining employer agreements
    with the Public Health Service and the Corporation for Community and
    National Service. These two Federal entities will, we hope, play a key
    role in providing suitable employment to conscientious objectors in any
    future conscription.
        Information Technology Modernization.--The agency's Reclassify,
    Compliance, and Verification project is intended to allow Selective
    Service System to leave the Department of Defense's Military Entrance
    Processing Command mainframe and move to a Microsoft Windows system.
    However, it is behind schedule. Selective Service hopes to complete the
    analysis, scope, and requirements definition during fiscal year 2008,
    and we plan to design, code, and test in fiscal year 2009.
    Notwithstanding resources expended so far, if our revised schedule is
    not met, then the entire project will be shelved pending future
    resources and commitment.

                      NATIONAL IN SCOPE, LOCAL IN SERVICE

        While rumors of a future draft will continue to circulate among the
    public, private groups, the media, and academia, Selective Service
    remains focused on missions mandated by Congress. It manages its
    volunteer board members; prepares to administer a program of
    alternative community-based service for men classified as conscientious
    objectors; and, to the extent possible, updates its conscription plans
    and registration procedures. All these efforts are aimed at being ready
    to conduct a fair and equitable classification procedure to determine
    who should serve when not all can serve during an emergency. To ensure
    fairness and equity, each Selective Service board is a gathering of
    civic-minded men and women reflecting the racial, cultural and ethnic
    diversity of the young men in your districts. Through these volunteers,
    a unique bond has been formed at the grass roots with young American
    men, society-at-large, and the U.S. Armed Forces. Through the Selective
    Service structure, local American communities play a positive role in
    providing for the common defense.

                                    CLOSING

        Mr. Chairman, Selective Service stands prepared to perform its
    time-tested responsibilities when directed. The fiscal year 2009
    appropriation request of $22,000,000 will be invested prudently in one
    of the Nation's important security assets in an increasingly dangerous
    and ambiguous world. Maintaining this adequate funding level would: (1)
    provide a compact, cost-efficient civilian structure capable of
    expansion in a crisis; (2) provide manpower to the U.S. Armed Forces as
    required; and (3) do it fairly, equitably, and within the necessary
    timeframes. These outcomes will advance our statutory mandate and
    restore the high registration compliance rates so painstakingly
    achieved over the last decade. Selective Service remains an active
    partner in the national preparedness community, ever watchful for
    opportunities to improve.
        Thank you, Mr. Chairman. I would be pleased to answer your
    questions.
                                     ______

      COURT SERVICES AND OFFENDER SUPERVISION AGENCY FOR THE DISTRICT OF
                                    COLUMBIA

              Prepared Statement of Paul A. Quander, Jr., Director

        The Court Services and Offender Supervision Agency (CSOSA)
    supervises approximately 15,000 men and women offenders on probation,
    parole, or supervised release in the District of Columbia at any given
    time. CSOSA includes the D.C. Pretrial Services Agency, which
    supervises another 5,000 defendants at any given time to ensure that
    they comply with court-imposed release conditions and appear for
    scheduled court dates. These agencies make a vital contribution to
    public safety in Washington, D.C.
        This statement is provided in support of CSOSA's fiscal year 2009
    budget request of $202,490,000 including 1,297 permanent positions and
    1,293 full time equivalents (FTE). Of this amount, $54,838,000 is
    requested for the Pretrial Services Agency (PSA) and $147,652,000 is
    requested for the Community Supervision Program (CSP). The fiscal year
    2009 request for CSOSA represents a $12,147,000, or 6 percent, increase
    over fiscal year 2008 enacted levels.

                                   BACKGROUND

        Since CSOSA was created under the National Capital Revitalization
    and Self-Government Improvement Act of 1997, we have implemented
    significant program enhancements, particularly in post-release
    supervision. Probation and parole caseloads have been lowered
    dramatically--in many cases by 50 percent--to meet or exceed the
    recommended national standard of 50 cases per Community Supervision
    Officer (CSO). Since fiscal year 1999, monthly surveillance drug
    testing has increased 360 percent; last year, over 8,300 offenders were
    tested each month. CSOSA operates six field offices to locate CSOs in
    the neighborhoods were offenders live and work, and over 8,000 joint
    field visits by CSOs and the Metropolitan Police Department occurred in
    those neighborhoods last year. Since fiscal year 2004, CSOSA has placed
    over 2,000 high-risk offenders on Global Positioning System (GPS)
    monitoring to reinforce compliance and track their location; the
    Metropolitan Police Department routinely uses GPS data in crime
    investigation.
        CSOSA has also received resources for contract substance abuse
    treatment to supplement the District's public treatment system. Last
    year, we made over 2,400 offender and over 1,600 pretrial defendant
    placements in our continuum of services, which includes detox,
    residential, transitional housing, and outpatient services. We also
    continue to implement the Reentry and Sanctions Center, a residential
    program that provides intensive assessment and treatment readiness
    services for high-risk offenders and defendants. Since the facility's
    opening in 2006, we have placed 1,188 individuals in the program; 88
    percent have completed it successfully.
        CSOSA recognizes that successful supervision involves both managing
    risk through close supervision and addressing need through the
    provision of treatment and support services. We have implemented many
    enhancements to ensure effective risk management. We work closely with
    a variety of Government, non-profit, and faith-based partners to
    increase offenders' access to existing services and build additional
    capacity in the core need areas of housing, education/training, and
    health care. Through the Criminal Justice Coordinating Council's
    Reentry Steering Committee, we provide leadership of efforts to address
    the needs of supervised offenders, particularly those returning to the
    District from incarceration.
        One of our most significant accomplishments of the past year has
    been the implementation of a new performance management system
    (SMARTStat) that tracks a core set of supervision practices down to the
    individual case level. Through this system, we can determine the extent
    to which cases are being managed effectively. This information is
    available to supervisors and branch chiefs, who are encouraged to use
    it as part of their case audits and team meetings. The information
    forms the basis of regular reviews with the entire CSP executive staff,
    during which action items are assigned and outcomes regularly tracked
    so that problems can be solved quickly.

                            2009 BUDGET INITIATIVES

        CSOSA's fiscal year 2009 budget contains two initiatives, one for
    CSP, which provides information technology resources for post-release
    supervision, and one for PSA, which provides resources for supervision
    of D.C. Misdemeanor and Traffic Court (drunk driving) cases.
    CSP Information Technology Enhancement Initiative
        CSP requests $2,583,000 and ten (10) positions to continue building
    its information technology infrastructure, including enhancements to
    the Supervision Management Automated Records Tracking (SMART) case
    management system.
        Improving the quality, management, and utility of information has
    been a CSP priority since CSOSA's founding. CSP inherited outdated,
    cumbersome legacy systems from its predecessor agencies. In 1997, most
    probation and parole officers relied on paper case files and lacked
    access to personal computers. Developing an automated case management
    system and training staff to use it were essential to successful
    implementation of the agency's program strategy. CSP launched the
    initial version of SMART in 2002, following a remarkably efficient
    requirements gathering and application development process.
        SMART is now in its third release. From its initial core
    supervision tracking functions, the system has expanded to encompass
    modules that capture treatment placement and expenditures, the
    development of Alleged Violation Reports, vocational and education
    assessment, and other critical program functions. We are also
    developing an Enterprise Data Warehouse (EDW) as a repository for
    historical data that can be used for research and performance
    measurement. The EDW is the source of CSP's new performance management
    system, SMARTStat, which provides management and staff with complete
    visibility into offender supervision practices and effectiveness. CSP
    also developed and maintains the District's Sex Offender Registry
    (SOR).
        CSP's Office of Information Technology (OIT) develops and maintains
    the CSP infrastructure, including acquisition, support, maintenance,
    and life-cycle replacement of architecture/design/systems enhancements,
    the EDW, IT security services, disaster recovery, and operational
    services, such as customer support (Help Desk), network management,
    change and configuration management, e-mail, and system administration
    services.
        The requested resources will continue the significant progress made
    by CSP OIT to increase the timeliness and accuracy of data used by
    agency staff and our partners to make day-to-day law enforcement
    decisions affecting public safety in the District. These resources will
    be used to continue SMART and SOR enhancements, transition to a next-
    generation Service Oriented Architecture platform, continue building
    the EDW and performance management platform, and continue improving our
    capacity to integrate data with our partner agencies.
        The resources will be allocated as follows:
        Infrastructure Enhancements
        --$300,000 in contract funding to support EDW software, development
                and maintenance;
        --Five (5) New Positions: Two Systems Engineers (GS-13); One
                infrastructure Architect/Project Manager (GS-14); One
                Customer Support Specialist (GS-8); One EDW Database
                Administrator (GS-13).
        SMART Enhancements
        --$1,000,000 in contract funding to support SMART, SOR and Data
                Sharing development and maintenance;
        --Five (5) New Positions: One Systems Integration Architect (GS-
                14); One Systems Integration Analyst (GS-13); One
                Configuration Manager (GS-13); One Business Intelligence
                Analyst (GS-13); and One Technical Writer (GS-13).
        CSP OIT currently lacks sufficient staff to sustain operations and
    to plan and implement migration to an ``agile'' service-based
    infrastructure. Current CSP funding does not provide sufficient ongoing
    resources to maintain the current IT infrastructure and continue the
    SMART development process. To date, CSP has been able to support the
    significant SMART and IT infrastructure accomplishments through delayed
    operational costs at two new field units. One of those field units
    (Rhode Island Avenue) became operational in fiscal year 2006, and the
    other is planned for implementation in fiscal year 2009. Without the
    requested fiscal year 2009 resources, planned SMART, partnership/data
    sharing and infrastructure improvements will be significantly reduced,
    affecting the effectiveness and efficiency of CSP and our law
    enforcement partners.
        Lack of additional resources will effectively derail investments
    made in our information technology (IT) infrastructure over the past 2
    years, most of which were implemented to comply with Federal IT
    mandates for security, disaster recovery and performance management. It
    is vital that CSOSA have the IT capability to effectively perform its
    law enforcement and public safety functions for the Nation's capital.
    Compared to its Federal counterparts, CSOSA is still very new and very
    small. We are still in need of funding for critical IT infrastructure
    and developmental initiatives to implement the full scope of the local
    public safety functions that CSOSA was created to assume.
    PSA Misdemeanor and Traffic Court Supervision Initiative
        In our other new budget initiative, PSA requests $3,340,000 and 23
    positions for defendant supervision, substance abuse and mental health
    assessments, and drug testing services for D.C. Misdemeanor and Traffic
    Court (drunk driving) cases.
        In 2006, the Office of the Attorney General's (OAG) Criminal
    Section papered over 12,400 D.C. misdemeanor and traffic cases. Based
    on estimates from the OAG's Public Safety Division and the D.C.
    Superior Court, over 3,600 of these cases (29 percent) involved
    defendants in need of mental health and/or substance abuse treatment
    services. To better address the problems and community safety issues
    within this population, beginning in fiscal year 2009, the D.C.
    Superior Court and OAG will lead a court-centered, problem-solving
    initiative geared to the unique problems and service requirements of
    mentally ill and substance abusing arrestees. This initiative will
    identify mental health and substance abuse issues in this population
    and link defendants to community-based services; ensure the least
    restrictive diversion and community supervision options needed to
    address public safety and treatment concerns; ensure comprehensive and
    individualized treatment and supervision placements; provide a
    comprehensive team-oriented approach to addressing health and social
    issues geared to a defendant's criminal behavior; and provide
    supervision of participants, including court notice for infractions of
    supervision conditions.
        The initiative already has the support of many local criminal
    justice and community partners. Defendants will be referred to the
    District of Columbia's Addiction Prevention and Recovery Administration
    (APRA) and the Department of Mental Health (DMH) for needed treatment
    services. DMH also will establish a crisis care center within the D.C.
    Superior Court to temporarily assist defendants with severe mental
    health issues. The city's Department of Employment Services (DOES) will
    offer job referral and training geared to the special needs of this
    population.
        The missing elements of the program design are strong defendant
    supervision and drug testing, as well as assessments for and linkages
    to needed treatment and social services in the community. Therefore,
    the D.C. Superior Court and the OAG have requested that PSA provide
    supervision, substance abuse and mental health assessments, linkage to
    treatment, and drug testing services. Supervision would include
    conditions such as weekly drug testing, in-person contact as needed
    with a case manager, and referrals to treatment and social service
    agencies. Besides helping the OAG, the Court, and other collaborative
    partners meet an important strategic goal, this assistance would help
    PSA meet its statutory obligation under D.C. Code Sec. 23-1303(h) to
    provide supervision to all defendants released with conditions and to
    address within this population what potentially may be unacceptable
    safety risk to the Washington metropolitan community.
        To ensure proper management of treatment and other conditions, as
    well as prompt administrative and judicial responses to infractions,
    PSA recommends a maximum case manager-to-defendant ratio of 1:75.
        The proposed request would fund the following supervision, drug
    testing, and treatment assessment personnel costs: 12 Pretrial Service
    Officers; 1 supervisory Pretrial Service Officer; 3 Community Treatment
    Specialists; 2 Chemists; 1 Laboratory Technician; 3 Drug Testing
    Technicians; 1 Program Assistant; and $120,000 for drug testing
    supplies (chemical reagents).
        PSA data supports enhanced supervision for defendants charged with
    serious traffic offenses as well as misdemeanants with serious mental
    health and substance abuse needs. Drug-involved defendants are three
    times as likely to be rearrested and more than twice as likely to fail
    to appear as non-users. Introducing pretrial supervision to the high
    risk defendants in D.C. Misdemeanor and Traffic Court who have mental
    health and substance abuse challenges will assist the Court in
    enhancing public safety and assuring that these defendants keep their
    court dates.
        This initiative will also enhance PSA's collaborations with the
    D.C. Superior Court, OAG, and other criminal justice and community
    partners. The proposed initiative is a combined effort to screen,
    assess, and supervise potentially high-risk defendants who now receive
    little or no supervision and support. No other partner in this
    initiative can provide the assessment, supervision, and drug testing of
    this population; these services are needed to ensure court appearance
    and protect the public.
    Adjustments to Base
        CSOSA also requests $6,224,000 in adjustments to base to fund
    employee cost of living pay raises and general price increases. Of this
    amount, $4,620,000 is for CSP, and $1,604,000 is for PSA.

                                   CONCLUSION

        CSOSA's budget initiatives reflect the developmental challenges the
    agency continues to face. While CSP has implemented a wide range of
    program enhancements, such progress necessitates ongoing maintenance
    and expansion of IT infrastructure to ensure that our ability to manage
    cases efficiently, analyze data, and measure performance keeps pace
    with our operations. PSA continues to face the need to collaborate with
    and support its partners--most particularly, Superior Court--by
    participating in initiatives that will enhance defendant compliance and
    protect the public.
        Unless CSOSA responds to these challenges, we are at risk of losing
    the ground we have gained. These initiatives will enable us to continue
    building and supporting a model supervision system that achieves the
    benefits CSOSA was established to bring to the District of Columbia:
    increased public safety, reduced recidivism, and enhanced systemwide
    collaboration.
        We appreciate the support we have received to date, and we look
    forward to working with the Committee on this request.

           LIST OF WITNESSES, COMMUNICATIONS, AND PREPARED STATEMENTS

                                  ----------
                                                                       Page
    Allard, Senator Wayne, U.S. Senator From Colorado:
        Prepared Statements of.....................................132, 276
        Questions Submitted by.......................................   202
        Statement of.................................................   131

    Brownback, Senator Sam, U.S. Senator From Kansas:
        Prepared Statements of...................................5, 42, 133
        Questions Submitted by........................32, 92, 251, 249, 403
        Statements of....................................132, 209, 255, 372

    Chatfield, Honorable William A., Director, Selective Service
      System, Prepared Statement of the..............................   413
    Cherecwich, Paul, Jr., Chairman, Internal Revenue Service
      Oversight Board................................................   162
        Prepared Statement of........................................   164
    Cox, Hon. Christopher, Chairman, Securities and Exchange
      Commission.....................................................   349
        Prepared Statement of........................................   352

    Duff, James C., Director, Administrative Office of the U.S.
      Courts, the Judiciary..........................................    66
        Prepared Statement of........................................    68
    Durbin, Senator Richard J., U.S. Senator From Illinois:
        Opening Statements of......................1, 41, 97, 207, 253, 371
        Prepared Statement of........................................   253
        Questions Submitted by.............................23, 82, 228, 395
        Statement of.................................................   130

    George, J. Russell, Treasury Inspector General for Tax
      Administration, Department of the Treasury.....................   148
        Prepared Statement of........................................   150
    Gibbons, Hon. Julia S., Judge, U.S. Court of Appeals, Sixth
      Circuit; Chair, Budget Committee of the Judicial Conference,
      the Judiciary..................................................    41
        Opening Statement............................................    43
        Prepared Statement of........................................    45

    Kelley, Colleen M., National President, National Treasury
      Employees Union, Prepared Statement of.........................   109
    Kovacic, Hon. William E., Chairman, Federal Trade Commission.....   371
        Prepared Statement of........................................   376
        Summary Statement of.........................................   374

    Landrieu, Senator Mary L., U.S. Senator From Louisiana, Questions
      Submitted by...................................................   201
    Leibowitz, Hon. Jon, Commissioner, Federal Trade Commission......   371
        Summary Statement of.........................................   383
    Lukken, Hon. Walter L., Acting Chairman, Commodity Futures
      Trading Commission.............................................   253
        Prepared Statement of........................................   259
        Summary Statement of.........................................   256

    McFarland, Honorable Patrick E., Inspector General, Office of
      Personnel Management, Prepared Statement of the................   411
    Michel, Paul R., Chief Judge, United States Court of Appeals for
      the Federal Circuit, the Judiciary, Prepared Statement of......    57
    Moore, Thomas H., Commissioner, Consumer Product Safety
      Commission.....................................................   207
        Prepared Statement of........................................   217
        Questions Submitted to.......................................   251

    Nord, Nancy A., Acting Chairman, Consumer Product Safety
      Commission.....................................................   207
        Prepared Statement of........................................   212
        Questions Submitted to.......................................   228

    OMB Watch, Prepared Statement of.................................   116
    Olson, Nina E., National Taxpayer Advocate, Internal Revenue
      Service........................................................   178
        Prepared Statement of........................................   179
    Paulson, Hon. Henry M., Jr., Secretary of the Treasury,
      Department of the Treasury.....................................     1
        Prepared Statement of........................................     4

    Quander, Paul A., Jr., Director, Court Services and Offender
      Supervision Agency for the District of Columbia, Prepared
      Statement of...................................................   415

    Restani, Jane A., Chief Judge, United States Court of
      International Trade, the Judiciary, Prepared Statement of......    59
    Rothstein, Hon. Barbara J., Director, Federal Judicial Center,
      the Judiciary, Prepared Statement of...........................    61

    Shelby, Senator Richard C., U.S. Senator From Alabama:
        Prepared Statement of........................................   255
        Questions Submitted by.......................................   368
    Shulman, Douglas, Commissioner, Internal Revenue Service,
      Department of the Treasury.....................................    97
        Statement of.................................................   134
        Prepared Statement of........................................   136
    Spires, Richard, Deputy Commissioner, Internal Revenue Service,
      Department of the Treasury.....................................    97
    Springer, Honorable Linda M., Director, Office of Personnel
      Management, Prepared Statement of the..........................   409
    Stiff, Linda, Deputy Commissioner, Internal Revenue Service,
      Department of the Treasury.....................................    97

    United States Sentencing Commission, the Judiciary, Prepared
      Statement of the...............................................    62

    White, James R., Director, Strategic Issues, Government
      Accountability Office, Prepared Statement of...................    98

                                 SUBJECT INDEX

                                  ----------
                                                                       Page

                      COMMODITY FUTURES TRADING COMMISSION

    Abstract.........................................................   295
    Adequate Staffing to Meet Volume Increases.......................   267
    Analysis of Potential Causes of Consumer Food Price Inflation....   312
    As Biofuels Catch on, Next Task is to Deal With Environmental,
      Economic Impact................................................   285
    Background and Current Market Events.............................   259
    CFTC-SEC Coordination............................................   280
    Commodities: Who's Behind the Boom?..............................   271
    Ethanol Impact on Gas Prices.....................................   281
    Evolution of the Markets.........................................   260
    Fiscal Year:
        2008 Budget..................................................   262
        2009 Budget..................................................   265
    Impact of Biofuels Mandate on Price Increases....................   279
    Index Funds in Oil Markets.......................................   275
    Limitations on Open Positions....................................   274
    Long Contracts Held by Index Funds...............................   281
    Margin Requirements..............................................   269
    Monitoring Market Fundamentals...................................   270
    Program Assessment Rating........................................   277
    Speculation Impact on Energy Futures.............................   268
    The Impact of Ethanol Production on U.S. and Regional Gasoline
      Prices and on the Profitability of the U.S. Oil Refinery
      Industry.......................................................   295
    The Relative Impact of Corn and Energy Prices in the Grocery
      Aisle..........................................................   287

                       CONSUMER PRODUCT SAFETY COMMISSION

    Additional Committee Questions...................................   227
    All-Terrain Vehicles.............................................   232
    Are we Better Off Now?...........................................   226
    Building a New Import Surveillance Division......................   213
    CPSC:
        Reauthorization..............................................   224
        Safety Work Can Continue in Fiscal Year 2009.................   219
    Certification Authority..........................................   226
    Consumer Complaint Database......................................   225
    Data Analysis--New Early Warning System Pilot Program............   231
    Establishing a New Early Warning System..........................   214
    Fiscal Year 2009:
        Budget Request...............................................   212
        President's Budget...........................................   208
    Illinois--Lead in Keychains......................................   248
    Impact of Fiscal Year 2008 Funding...............................   217
    Improving CPSC's IT Infrastructure...............................   213
    Meeting the Challenge of Imported Products.......................   212
    Misinformed Approaches to Consumer Protection....................   208
    Modernizing CPSC's Testing Laboratory............................   213
    Most Important Elements of CPSC Reauthorization Bill.............   225
    New Import Safety Initiative...................................221, 228
    New Improvements in IT...........................................   229
    New Pool and Spa Safety Act......................................   233
    Ongoing CPSC Activities..........................................   214
    Senate CPSC Reauthorization Bill and Cost Estimates..............   225
    Staffing Levels..................................................   220
    Status of CPSC Laboratory........................................   229
    Then and Now.....................................................   207
    Update on U.S.-China Agreement...................................   228
    What Else Will CPSC Study This Year?.............................   230
    Why Does It Take So Long for CPSC to Publish a Final Rule?.......   247
    Why are CPSC Goals for Customer Satisfaction Decreasing?.........   232
    Will There be a CPSC Presence in China?..........................   222
    Yo-Yo Water Ball.................................................   233

      COURT SERVICES AND OFFENDER SUPERVISION AGENCY FOR THE DISTRICT OF
                                    COLUMBIA

    Background.......................................................   415
    2009 Budget Initiatives..........................................   416

                           DEPARTMENT OF THE TREASURY

    Additional Committee Questions...................................    22
    Alternative Metals for Coins.....................................    20
    Bankruptcy.......................................................11, 15
    Budgetary Implications of Cuba Sanctions.........................    26
    Capital Markets..................................................    11
    Committee on Foreign Investment in the United States (CFIUS)--
      Caseload Management............................................    29
    Conflict Minerals................................................    12
    Congo/Coltan.....................................................    38
    Cost of Pennies and Nickels......................................    14
    Costs of Coins...................................................    13
    Counseling Funding...............................................17, 20
    Cross-Border Wire Transfers......................................    26
    Economic Stimulus Rebates........................................    25
    Fiscal Discipline................................................     4
    Hope Now Alliance................................................     6
    Integration of Treasury Into U.S. Intelligence Community.........    30
    International:
        Programs.....................................................     5
        Sanctions:
            Cuba.....................................................    24
            Sudan....................................................    24
    Loan:
        Modifications................................................    22
        Work Outs.................................................... 9, 18
    Management of Treasury's IT Systems..............................    28
    Metal Content of Coins...........................................    14
    New 24/7 Operations Center.......................................    25
    Reduction in Requested CDFI Funding..............................    24
    Repatriation of Funds............................................    19
    Speculators......................................................     9
    Strengthening National Security..................................     4
    Subprime Borrowers...............................................     7
    Tax Credits......................................................    12
    Trade............................................................    23
    U.S. Economic Steward............................................     4

                            Internal Revenue Service

    A Commitment to Service, Enforcement and Modernization...........   138
    A Primary Cause: Lack of Resources at the IRS....................   119
    Acknowledgements.................................................   117
    Additional Committee Questions...................................   201
    Addressing the Tax Gap...........................................   158
    Agency Comments..................................................   109
    Bridging the Tax Gap--The Case for Increasing the IRS Budget.....   117
    Business Systems Modernization...................................   198
        Program Initiative...........................................   170
    Colorado Department of Revenue Settlement Offer..................   205
    Conservation Easements...........................................   144
    Contracting Out..................................................   115
    Contractors......................................................   141
    Economic Stimulus Act of 2008....................................   160
    Enhance Enforcement of Tax Laws..................................   157
    Expand Internal Tax Collection...................................   126
    Fiscal Year 2009 IRS Budget Recommendations......................   165
    Forms and Complexity.............................................   143
    Further Progress Made in Implementing BSM, but Challenges and
      Risks Remain...................................................   105
    Highlights.......................................................    98
    Impact of the Tax Gap............................................   118
    Improve Taxpayer Service.........................................   155
    Increase Services for EITC Taxpayers.............................   127
    Increases Resources for Audits...................................   121
    Information Technology/Infrastructure Program Initiatives........   172
    Internal Revenue Service:
        Assessment of the Fiscal Year 2009 Budget Request............    98
        Estimates the Cost of Implementing the Economic Stimulus
          Legislation may be up to a Total of $767 Million and
          Expects Declines in Some Taxpayer Services.................   107
        Fiscal Year 2009 Budget Request..............................   109
        Has Enhanced Its Justifications for Initiatives and Could
          Benefit From Using ROI Analyses More Broadly, Even With
          Their Limitations..........................................   103
    Investing in IRS is a Good Business Decision Supported by the
      Public.........................................................   173
    Legislative Proposals............................................   159
    Misclassification of Workers.....................................   146
    NTEU Staffing Proposal...........................................   111
    OPM Prescription Drug Subsidy....................................   115
    Overview of the IRS's Fiscal Year 2009 Budget Request............   151
    Pay Raise........................................................   114
    Private:
        Debt Collection............................................142, 196
        Tax Collection...............................................   112
    Security of the Internal Revenue Service.........................   155
    Stimulus Payments..............................................143, 147
    Tax:
        Enforcement Has to be a Priority.............................   129
        Simplification...............................................   199
    The $300 Billion Problem: The Tax Gap............................   117
    The Administration's Fiscal Year 2009 Budget Funds Taxpayer
      Service and Enforcement........................................   138
    The Fiscal Year 2009 Budget Request Proposes to Maintain Taxpayer
      Service at Recent Levels and Increase Enforcement..............   101
    Treasury Inspector General for Tax Administration Fiscal Year
      2009 Budget Request............................................   161
    2008 Filing Season.............................................136, 159

                            FEDERAL TRADE COMMISSION

    Additional Committee Questions...................................   395
    Competition Mission..............................................   380
    Consumer Protection Mission......................................   376
    Credit Card Practices............................................   393
    Debt Relief......................................................   406
    Do Not Call......................................................   390
    Ethanol..........................................................   403
    Food Marketing to Children.......................................   388
    Fraud Complaints.................................................   395
    Gas Prices.......................................................   400
    Gasoline Prices..................................................   403
    Green Marketing..................................................   394
    Identity Theft...................................................   393
    Marketing Adult-rated Entertainment to Children..................   391
    Merger Activity..................................................   395
    Mortgage Marketing...............................................   405
    Needed Resources for Fiscal Year 2009............................   382
    Price Gouging....................................................   402
    Real Estate Markets..............................................   407
    Resources for Price Monitoring...................................   401
    Speculation in the Oil Market....................................   389
    Strategic Petroleum Reserve......................................   403
    Subprime Lending.................................................   396
    Telecommunications...............................................   404
    Trends in the Oil Market.........................................   385
    U.S. SAFE WEB Act................................................   399

                         OFFICE OF PERSONNEL MANAGEMENT

    Federal Employees Health Benefits Program (FEHB).................   409
    Human Resources:
        Line of Business.............................................   410
        Management...................................................   410
    Implementing Human Capital Standards for Success.................   410
    Mandatory Payment Accounts.......................................   411
    Retirement Claims Processing and Benefits Programs...............   409
    Revolving Fund...................................................   410
    Security-related Activities......................................   410

                       SECURITIES AND EXCHANGE COMMISSION

    Additional Committee Questions...................................   368
    Broker-Dealer Rulemaking.........................................   366
    CRA Program......................................................   368
    CSE Program......................................................   369
    Divestment Disclosures...........................................   368
    Enforcement......................................................   369
    Financial Services Regulatory Structure..........................   366
    Fiscal Year 2008 to Date.........................................   353
    Imposition of User Fees..........................................   358
    Oversight of:
        Credit Rating Agencies.......................................   365
        Investment Banks.............................................   357
    Review of Fiscal Year 2007.......................................   352
    Securities Litigation Reform.....................................   367
    Staffing Levels..................................................   356
    Subprime Mortgage Crisis.........................................   358
    Summary Statement................................................   349
    Triple-A Failure.................................................   359

                            SELECTIVE SERVICE SYSTEM

    Areas of Emphasis................................................   413
    National in Scope, Local in Service..............................   415
    What We Do Today.................................................   413

                                 THE JUDICIARY

    Additional Committee Questions...................................    82
    Administrative Office:
        Challenges...................................................    69
        Fiscal Year 2009 Budget Request..............................    73
        Internal Review..............................................    69
    Budgetary Impact of Judges Assuming Senior Status................    86
    Contributions of the:
        Administrative Office........................................    55
        Federal Judicial Center......................................    55
    Cost Containment Efforts.........................................    49
    Court Security...................................................45, 76
        Department of Justice Inspector General Report...............    83
        Pilot Project................................................    44
        U.S. Marshals Service........................................    82
    Courthouse Construction..........................................72, 76
        San Diego and Los Angeles....................................    85
    Courts of Appeals for the Federal Circuit........................    78
    Current Issues at the Administrative Office......................    67
    Federal Protective Service and Pilot Project.....................    74
    Fiscal Year:
        2008 Funding.................................................43, 45
        2009 Budget Request......................................43, 53, 68
    Impact of Increased:
        Border Enforcement...........................................47, 88
        Increased Immigration Enforcement............................    44
    Implementation of the Court Security Improvement Act.............    85
    Increase in Non-Capital Panel Attorney Rate......................    54
    Innovation in the Federal Courts.................................    50
    Judicial Authority for Offender Re-entry Programs................    88
    Judiciary Workload...............................................    92
    Justification for the Commission's Appropriations Request........    63
    Partnership With the General Services Administration.............    71
    Pay for Bankruptcy Case Trustees.................................    81
    Planning for the Future..........................................    70
    Projects Under the ``Care of the Building and Grounds of the
      Supreme
      Court''........................................................    89
    Rent Savings.....................................................    89
    Resources Requested..............................................    62
    Retroactivity of Crack Cocaine Sentencing Amendment..........46, 79, 90
    Review of the Administrative Office..............................    67
    Role of the Administrative Office................................66, 68
    Senior Judges....................................................    77
        At the Court of Appeals for the Federal Circuit..............    87
    Supreme Court Modernization Project..............................    79
    The Center Has Managed Its Appropriation Responsibly.............    62
    The Center's:
        Contribution to the Courts...................................    61
        Fiscal Year 2009 Request.....................................    62
    The Judiciary's Workload.........................................    51
    Workload in the Federal Courts...................................    81

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