[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



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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.
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    \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.
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    \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.
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    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.
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    \3\ The Individual Master File is the IRS database that stores 
individual taxpayer account information.
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    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).
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  --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.
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    \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).
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    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\
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    \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).
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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).
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    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\
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    \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.
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    \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.
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    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).
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    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.
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                    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\
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    \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.
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    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.
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    \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.
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    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).
---------------------------------------------------------------------------
  --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\
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    \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.
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    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\
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    \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.
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    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.
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    \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).
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            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.
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    \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).
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            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.
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    \35\ Information obtained from IRS Wage & Investment Division 
(Field Assistance function) (September 2007).
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            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.
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    \36\ IRS Small Business/Self-Employed Division, Response to TAS 
Information Request (Oct. 30, 2007).
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    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\
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    \37\ IRC  6033(i); IRC  6033(a)(3)(B); Announcement 82-88, 1982-
25 I.R.B. 23.
    \38\ IRC  6033(j).
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    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.
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    \39\ IRS, TE/GE Fiscal Year 2005 Strategic Assessment 3 (Feb. 2, 
2005).
    \40\ Id.
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            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.
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    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\
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    \43\ National Taxpayer Advocate 2007 Annual Report to Congress 257.
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            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.
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    \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).
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    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\
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    \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).
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    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\
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    \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.
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    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\
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    \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.
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            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:
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    \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).
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  --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\
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    \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).
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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\
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    \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.
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    \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\
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    \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).
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    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.
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    \70\ IRS Response to TAS Request for Information (April 10, 2008).
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            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.
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    \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.
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    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.
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    \72\ IRS, Filing Payment Compliance Advisory Council (April. 14, 
2008) at 3.
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            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\
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    \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).
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            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.
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    \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.
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            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.
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    \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).
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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.
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    \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).
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    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\
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    \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).
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    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.
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    \87\ IRS Tax Year 2006 Taxpayer Usage Study (through Oct. 26, 
2007).
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    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.
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    \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.
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    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.
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    \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).
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    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.
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    \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.
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    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.
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    \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.
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    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:
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    \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.
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  --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\
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    \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).
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    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.
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    \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.
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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.
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    \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.
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    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\
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    \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.
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    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\
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    \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.
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    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.
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    \104\ Fiscal Year 2008 data reflects case closures from October 1, 
2007 through March 31, 2008 (six months).
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    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\
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    \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: 
[email protected].

                               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: 
[email protected].

                               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: 
[email protected].

                               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: 
[email protected].

                               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: 
[email protected].

                               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: 
[email protected].

                               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: 
[email protected].

                               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: 
[email protected].

                               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: 
[email protected].

                               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: 
[email protected].

                               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: [email protected].

                               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: 
[email protected].

                               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: [email protected].

                               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: 
[email protected].

                               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: 
[email protected].

                               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: [email protected].

                               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: 
[email protected].
       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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H. Yu, F. Dong, C.E. Hart, and J.C. Beghin. ``Emerging Biofuels: 
Outlook of Effects on U.S. Grain, Oilseeds, and Livestock Markets.'' 
Staff Report 07-SR 101, Center for Agricultural and Rural Development, 
Iowa State University, 2007.
    Vedenov, D.V., J.A. Duffield, and M.E. Wetzstein. ``Entry of 
Alternative Fuels in a Volatile U.S. Gasoline Market.'' Journal of 
Agricultural and Resource Economics, 2006: 1-13.
    Wang, M., M. Wu, and H. Huo. 2007. ``Life-Cycle Energy and 
Greenhouse Gas Emission Impacts of Different Corn Ethanol Plant 
Types.'' Environmental Research Letters 2 (April-June) Article 024001, 
available at http://www.iop.org/EJ/abstract/1748-9326/2/2/024001/ 
(accessed January 2008).
    Wooldridge, J. Econometric Analysis of Cross Section and Panel 
Data. Cambridge, MA: MIT Press, 2002.

               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.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
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\
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    \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.
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    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.
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    \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.
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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.
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    \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.
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    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.
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    \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.
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    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\
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    \15\ Preserve Access to Affordable Generics Act, S. 316, 110th 
Cong. (2007) (as reported by S. Comm. on the Judiciary).
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    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.
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    \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).
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    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\
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    \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.
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    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\
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    \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.
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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\
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    \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.
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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.
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    \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.
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    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.
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    \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.
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    \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.
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    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.
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    \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.
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    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.
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    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\
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    \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).
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    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\
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    \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.
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    \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).
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    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.
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    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.
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    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.
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                      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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