[Senate Hearing 111-]
[From the U.S. Government Publishing Office]



 
  FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR FISCAL 
                               YEAR 2010

                              ----------                              


                         TUESDAY, JUNE 9, 2009

                                       U.S. Senate,
           Subcommittee of the Committee on Appropriations,
                                                    Washington, DC.
    The subcommittee met at 10:30 a.m., in room SD-138, Dirksen 
Senate Office Building, Hon. Richard J. Durbin (chairman) 
presiding.
    Present: Senators Durbin, Lautenberg, Nelson, Tester, 
Collins, and Bond.

                       DEPARTMENT OF THE TREASURY

                        Office of the Secretary

STATEMENT OF HON. TIMOTHY F. GEITHNER, SECRETARY

             OPENING STATEMENT OF SENATOR RICHARD J. DURBIN

    Senator Durbin. Good morning. My apologies. I was on the 
floor, defending the administration, that's all I can say. To 
my colleagues, I apologize.
    Please convene this hearing to examine the fiscal year 2010 
funding request of the Department of the Treasury, including 
the Internal Revenue Service (IRS). Mr. Secretary, thank you 
for joining Senator Collins and my other colleagues this 
morning. We know that IRS Commissioner, Doug Shulman, is also 
here and prepared to testify.
    And I am going to waive the remainder of my opening 
statement, in the interest of time, and to allow my colleagues 
to say few words so that we can catch up with the schedule.
    Senator Collins.

                   STATEMENT OF SENATOR SUSAN COLLINS

    Senator Collins. Thank you, Mr. Chairman. Secretary 
Geithner, Commissioner Shulman, I am very pleased to welcome 
you to this hearing and I thank you for your service to our 
Nation.
    Mr. Secretary, you have so many challenging 
responsibilities that it's difficult to know where to begin. 
You're responsible for reinvigorating bank lending to consumers 
and small businesses, stabilizing the housing markets, 
overseeing the automobile industry and encouraging sustainable 
economic growth. Most important, you must try to protect 
American taxpayers and their investments and promote the long-
term financial security of the United States at a time of 
unprecedented debt.
    The current financial crisis is rooted in a tangled web of 
high-risk financial instruments backed by high-risk loans, 
issued by high-risk individuals. To emerge from this crisis and 
to overcome its effects, we must restore trust in our Nation's 
financial institutions and financial markets. And, in my view, 
that will require significant reforms in our system of 
financial regulation, an issue that I want to discuss with you 
today.
    Several developments are shaking American's trust in the 
economy. First among these is the dangerous increase in our 
Nation's long-term debt. While I supported the short-term 
fiscal stimulus as necessary to get our economy back on track, 
I am troubled that the President's budget proposes to double 
the debt in 5 years and triple it in 10. I am concerned that 
the long-term debt proposed by this administration poses a 
threat to the sustainability of our economy. Where will the 
money come from to pay these debts? China, where you have 
recently visited? Saudi Arabia? Sovereign wealth funds? Will 
this public debt crowd out private investment and slow the 
recovery? Who ultimately will pay for this--our children and 
our grandchildren? We need to assess what we're doing to our 
country's long-term financial health.
    Finally, Mr. Secretary, I remain very concerned, as I 
indicated to you in our conversation yesterday, about the 
management accountability and transparency of the troubled 
asset relief program (TARP) fund. Originally, TARP was 
envisioned as a fund to prevent our largest banks and financial 
institutions from failing and to increase liquidity in our 
credit markets. Today, however, TARP encompasses 12 different 
programs, not just for banks but also for insurance companies 
and automobile manufacturers, and involves Government funds 
combined with private funds adding up to almost $3 trillion.
    It is disturbing to me that we really cannot assess what 
impact TARP funds has had on recipients, and whether TARP has 
truly increased lending. And the Treasury Department has yet to 
articulate how it will measure whether this injection of 
capital has been an effective use of taxpayer dollars. I am 
concerned that we're being asked simply to trust that this 
large infusion of capital into the economy will lift us out of 
a severe financial crisis, whose complex origins are still 
being untangled.
    Secretary Geithner and Commissioner Shulman, you both face 
great challenges in managing the Federal Government's finances 
and attempting to reinvigorate our economy. These truly are 
extraordinary times. I pledge to work very closely with you, as 
well as with our chairman, to make sure that you have the 
staff, the authority, and the resources that you need to serve 
the American people.
    Thank you, Mr. Chairman.
    Senator Durbin. Thank you, Senator Collins. I am going to 
invite my colleagues to make brief opening statements.
    And Senator Lautenberg, I recognize you.

                STATEMENT OF SENATOR FRANK R. LAUTENBERG

    Senator Lautenberg. Thanks very much Mr. Chairman. 
Greetings Mr. Geithner, Secretary Geithner. You've taken on a 
formidable task and, so far, I think that the score in the ball 
game is going your way, but we are quite a distance from the 
ninth inning.
    As we meet today, the economy is slowly beginning to show 
signs of a possible recovery and the challenges still remain. 
This recovery will require strong reforms to place our 
financial system on a firm footing. We've got to give the 
regulators the tools that they need to predict and prevent 
financial crisis.
    And we've got to change corporate culture. That says, the 
people, the leadership at the top, can often take its 
compensation without regard for what happens with the employees 
or the future investing for the well-being of the company and 
taxpayers.
    I am still on the board of the Columbia Business School and 
some time ago I gave them the chair, I was out of the Senate 
for a couple years, I took a hiatus, and what I proposed was 
that salaries at the top be related to salaries at the bottom. 
And instead of letting the ratio slip as it has, from 40 times 
typically in the eighties, to 400 times recently at times, and 
also--and I don't know, Mr. Secretary, what kind of latitude 
you have or what kind of authority you have to suggest conduct 
in the CEOs office. But one of the things I think we have to 
look at while we change this corporate culture is to make it 
clear that, when an executive retires, that the reward ought to 
be, my view, in the performance of the company after the leader 
leaves. And the bonuses should be expanded as time goes by, and 
not simply related to the stock price. Because stock price may 
be at the expense of investing in the future of the business.
    Anyway, we're glad to see you here and urge you to carry on 
and work hard. Thank you.
    Senator Durbin. Senator Nelson.

                    STATEMENT OF SENATOR BEN NELSON

    Senator Nelson. Thank you, Mr. Chairman. Secretary, we are 
glad you're here. We appreciate the efforts that you are 
providing and that the progress that we hope will come will, in 
fact, come.
    When I go home, I have people come to me complaining about 
the bailouts, complaining about TARP, complaining about putting 
the auto industry into bankruptcy and they're all concerned 
about that. They're concerned also about the growing deficit 
and the increasing budget. The one thing that they are now 
becoming alarmed about is the Government ownership of stock. 
And when we come to the questions, I've got some questions 
about that. Because they come to me and say, look, aren't we 
drifting into socialism at a rapid rate. And I assure them that 
our goal is not to hold the stockholdings or warrants or any 
other financial instruments that we shouldn't be holding. That 
our goal is to get these companies so that they are functioning 
on their own, so that they are either publicly traded or that 
they are privately owned, but not Government owned. So, I'll be 
asking you for reassurance on that side.
    Because I hope and I believe that our goal is just as I've 
stated it, to help these companies get on their feet and, when 
on their feet, to become private once again, not to have that 
kind of public ownership that we currently have. So I'll be 
anxious to get your take on that.
    Thank you, Mr. Chairman.
    Senator Durbin. Senator Tester.

                    STATEMENT OF SENATOR JON TESTER

    Senator Tester. Thank you, Mr. Chairman. Commissioner 
Shulman, Secretary Geithner. It's good to have Secretary 
Geithner and Commissioner Shulman here today. I've gotten to 
visit with Secretary Geithner on several occasions and I look 
forward to the one today.
    We have just, we have just experienced, over the last 
little over 1 year, the biggest economic downturn since the 
1930's. We have seen irresponsibility on Wall Street, we have 
seen irresponsibility in Government, with a lack of regulation. 
In some cases, no regulation. We have stepped forth with the 
TARP program, we have stepped forth with the recovery bill. You 
are in the eye of the storm.
    I look forward to visiting with you about all those things 
that impact the economy and where we're going from here. And I 
appreciate your coming in front of the subcommittee.
    Thank you.
    Senator Durbin. Senator Bond.

                STATEMENT OF SENATOR CHRISTOPHER S. BOND

    Senator Bond. Thank you very much, Mr. Chairman, Ranking 
Member Collins. Welcome, Secretary Geithner.
    Everybody knows, over the past year, we've had a major 
economic storm raging with great damage to everybody. The 
Federal Government has responded to the economic crisis with 
aggressive and unprecedented, but unfortunately, I believe, ad 
hoc actions through taxpayer-funded bailouts of too-big-to-fail 
private corporations, a $1 trillion stimulus, foreclosure 
rescue programs, just to name a few.
    We've seen some positive signs of green shoots, but there 
are some wondering whether they will wither away due to 
continuing problems in the housing sector, consumer debt 
remaining high, significant de-leveraging occurring in the 
financial sector, and lingering questions about the solvency of 
banks. Are we seeing a ``dead cat bounce'' in the markets?
    Economic and financial experts are telling us that economic 
recovery cannot occur or be sustained until we address the root 
cause, the credit crisis. That's what TARP was supposed to do, 
but it got off on the wrong foot last fall, in my view, and 
it's still there. And President Obama told us in January we 
can't have a recovery until we get the toxic assets out.
    These are questions that I want to follow-up with. The size 
of the stimulus also is now causing questions from the Federal 
Reserve. If we get in a position of monetizing our debt, we 
will face an unprecedented disaster and go the way perhaps of 
Argentina. And tripling the debt in 10 years seems to me to be 
a very risky approach.
    We've seen the United Kingdom, which was recently warned 
about its credit rating. Perhaps that is the canary in the coal 
mine for our Nation's own future.
    Thank you, Mr. Chairman.
    Senator Durbin. Thank you very much, Senator Bond.
    [The statement follows:]

           Prepared Statement of Senator Christopher S. Bond

    Thank you Chairman Durbin and Ranking Member Collins for holding 
today's hearing on the Department of the Treasury and the Internal 
Revenue Service (IRS). I welcome both Treasury Secretary Timothy 
Geithner and IRS Commissioner Douglas Shulman and thank them for 
appearing before our subcommittee.
    Over the past year, a major economic storm has raged across America 
causing hardships and damage to families, communities, and businesses. 
Families have lost their jobs and homes. Retirement savings have 
plummeted turning 401(k)s into ``201(k)s.'' Students have seen their 
college savings evaporate. And, our financial and auto industries have 
been shaken to their core.
    The Federal Government has responded to the economic crisis with 
aggressive and unprecedented, albeit ad hoc, actions through taxpayer-
funded bailouts of ``too big to fail'' private corporations, a trillion 
dollar stimulus, and foreclosure rescue programs, just to name a few.
    In recent weeks, some have identified positive signs of economic 
recovery or ``green shoots.'' But other experts believe that these 
green shoots may just wither away due to continuing problems in the 
housing sector, consumer debt remaining high, significant deleveraging 
occurring in the financial sector, and lingering questions about the 
solvency of some of our big banks. As they say in the financial 
industry, we may be experiencing a ``dead cat bounce.''
    Economic and financial experts believe that true economic recovery 
cannot occur or be sustained until the root cause of the crisis is 
addressed--the credit crisis. The financial system cannot be fully 
repaired unless the toxic assets are cleansed from the balance sheets 
of financial institutions. I strongly agree.
    Unfortunately, the administration has failed to develop or execute 
a credible plan to cleanse the toxic assets that continue to choke our 
financial institutions. The center-piece of the administration's 
financial rescue plan to remove the toxic assets--the Public-Private 
Investment Program or ``PPIP''--remains sidelined, and based on the 
recent comments by leaders such as Secretary Geithner's successor at 
the Federal Reserve Bank of New York, the growing sentiment is that it 
will never be launched.
    Due to fundamental flaws with the design of PPIP that placed most 
of the risk at the taxpayers' feet, it is frankly no surprise that this 
program has stalled and is not likely ever to be implemented.
    It cannot be emphasized enough that a well-functioning credit 
market must be restored for economic recovery. Too much money has been 
thrown at our financial institutions without removing the toxic assets, 
and further delay only makes the problem worse as we have seen with 
Japan in the 1990s. The good news is that we can face this 800-pound 
gorilla by using a true-and-tried approach that helped our Nation 
recover from the Savings and Loan Crisis.
    Unfortunately, the administration has resisted the creation of a 
Resolution Trust Corporation approach but continues an ad hoc, 
incremental approach to our ``too big to fail'' financial institutions 
without any semblance of an exit strategy.
    But when it comes to our domestic auto industry, the administration 
has not shied away from taking a different approach. It fired the head 
of General Motors and orchestrated the bankruptcy of both GM and 
Chrysler.
    The creation of jobs will be an essential ingredient to economic 
recovery and President Obama has staked his performance on this 
measure. The administration's main effort to create jobs was a trillion 
dollar ``stimulus'' bill with the promise of saving or creating at 
least 3 million jobs, which would prevent the unemployment rate from 
rising above 7.8 percent. Clearly, this estimate was overly rosy as the 
most recent jobs report showed that unemployment had reached 9.4 
percent.
    To be fair, the sliding economy necessitated a significant fiscal 
stimulus. But instead of stimulating the creation of jobs, so far, it 
only seems to be stimulating the growth of Government programs and 
ballooning our debt.
    While the lack of stimulus is extremely troubling, what is truly 
alarming is the administration's future budget plan, which promises 
more spending that will double the debt in 5 years and triple the debt 
in 10 years. This means that our children are going to inherit an 
obligation where interest payments on the debt--around $800 billion 
annually--are likely to be the largest single item of the Federal 
Government. These figures are certainly not funny to future 
generations, but it is difficult not to laugh when administration 
officials publicly claim that lending money to the U.S. Government is 
still safe.
    Frankly, our country's fiscal health and viability are serious 
matters that must be addressed sooner than later. There are recent 
signs of investor concern about our Nation's fiscal health. Interest 
rates on 10-year Treasury notes have recently shot up. This means that 
the Government's cost to borrow money will increase by tens of billions 
of dollars. One of the most stable and industrialized nations in the 
world, the United Kingdom, was recently warned about its credit rating. 
What is happening in the United Kingdom should be viewed as a ``canary 
in the coal mine'' for our own Nation's future fiscal situation. Even 
Federal Reserve Chairman Ben Bernanke recently called for our Nation to 
begin planning now for the restoration of fiscal balance.
    The good news is that we still have the opportunity to change 
course, but we can only do so if there is the will to confront the most 
treacherous political landmines, such as entitlement spending. Much has 
been said publicly about the importance of our fiscal health and the 
commitment to tackle spending matters. However, action speaks louder 
than words, and until I see action, many Americans, including myself, 
will continue to sound the alarm.
    Thank you.

    Senator Durbin. Mr. Secretary, the floor is yours.

             SUMMARY STATEMENT OF HON. TIMOTHY F. GEITHNER

    Secretary Geithner. Chairman Durbin, Ranking Member 
Collins, and members of the subcommittee, it's a pleasure to be 
before you today, my first time appearing before you about the 
Treasury's budget. I look forward to building a close working 
relationship and I look forward to having a chance to answer 
the many important questions you raised in your opening 
statements.
    While we see some initial signs of economic improvement, I 
think you could say that the force of the storm is weakening a 
bit. And although the financial system is beginning to heal, 
our country faces very substantial economic and financial 
challenges.
    Now the President and the administration are working to 
meet these challenges. We are working hard to get Americans 
back to work, to get our economy back to a growth path again, 
by committing to restoring fiscal discipline to ensure and 
sustain recovery and by making the long-neglected investments 
in healthcare reform and energy and education necessary to 
improve the productive capacity of our economy and to ensure 
that, over the longer term, we enhance the competitiveness of 
the U.S. economy.
    To achieve these goals, we are working to repair and reform 
our financial system so that it works for, not against, 
recovery. We are working to restore growth and meet our fiscal 
goals by redesigning our Tax Code, bolstering enforcement. We 
are working to advance our interests globally, working with 
other countries to promote economic recovery and financial 
repair and to ensure more open markets for U.S. businesses.
    And to protect our Nation's national security interests, we 
are deploying all of the tools at our disposal to exclude 
terrorists, proliferators, and other illicit actors from the 
international financial stage and thereby secure our financial 
system and prevent threats to our security.
    Now, the fiscal year 2010 budget you have before you will 
allow Treasury to pursue these core missions. The $13.4 billion 
request includes a $676 million, or 5.3 percent increase over 
the enacted 2009 levels.
    Just a few brief highlights about the budget request. Of 
the increase we are seeking, $14 million would go to bolstering 
the staffs of our domestic finance and tax policy offices. Now, 
these offices, domestics finance and tax policy, are at the 
center of the administration's efforts to support strong 
design, rigorous analysis, improve the financial system, reform 
the financial system, and implement reforms to our tax policies 
and Tax Code.
    We include in the budget a $137 million request to more 
than double our community development financial institutions, 
our community development financial institutions (CDFI) fund, 
to ensure that the benefits of our financial efforts reach 
beyond major banks and businesses to help economically 
distressed communities. These communities were underserved by 
our financial system even before the current crisis and they 
have been deeply hurt by the job losses and business failures 
that the crisis has exacerbated.
    We propose a total of $332 million for new IRS enforcement 
efforts, including $128 million to add nearly 800 new IRS 
employees to combat offshore tax evasion and improve compliance 
with the U.S. international tax laws by businesses and high-
income individuals. Another $130 million would go to bolster 
the security of the IRS's information technology, improve the 
efficiency of its business systems, and upgrade its fraud 
detection capabilities.
    Now, although not directly under the jurisdiction of the 
subcommittee, I just wanted to note also that our budget 
includes funds to meet our international obligations and to 
help us craft a global response to the crisis in this more 
integrative global system we live in today.
    Now, as we seek these additional funds to respond to our 
Nation's immediate challenges, we've cut back on some programs 
that are either ineffective or we believe can be safely 
deleted. Just one example, even as we are trying to increase 
capital investment for the IRS, our budget would reduce the 
Department-wide Treasury's Department-wide capital investment 
account by 65 percent, for a modest savings of $17 million.
    Now, just before I end, I want to say a few words about the 
Treasury staff. I have the honor of leading a team of 
exceptionally smart and dedicated individuals who are working 
very hard to make our Government more effective. They're 
performing a great service to our country under challenging 
circumstances. I am very grateful to them and I think if you 
look at the scale of what we've set in motion, just in the last 
6 months, they have done extraordinary things in a very short 
period of time.

                           PREPARED STATEMENT

    Thank you, Mr. Chairman, I'd be happy to answer any 
questions.
    [The statement follows:]

               Prepared Statement of Timothy F. Geithner

    Chairman Durbin, Ranking Member Collins, members of the 
Subcommittee, I appreciate the opportunity to testify before you for 
the first time as Treasury Secretary on the President's fiscal year 
2010 budget request for the Department of the Treasury.
    While we see some initial signs of economic improvement and the 
financial system is beginning to heal, our country faces very 
substantial economic and financial challenges.
    President Obama and his administration are working to meet these 
challenges by getting Americans back to work and getting our economy to 
grow again; by restoring fiscal discipline to ensure a sustained 
recovery, and by making the long-neglected investments in health care, 
energy and education needed to enhance America's global competitiveness 
and produce more balanced, sustainable growth over the long-term.

                       TREASURY'S KEY PRIORITIES

    To achieve these goals, we are repairing and reforming our 
financial system so that it works for, not against, a recovery that 
serves all Americans.
    To restore growth and meet our fiscal goals, we are redesigning and 
bolstering enforcement of our tax code so that it is both fairer and 
more efficient.
    To advance our interests globally, we are working with other 
nations to promote economic recovery and financial repair, and to 
ensure more open markets for U.S. business.
    And to protect the country, we are deploying all of the tools at 
our disposal to exclude terrorists, proliferators, and other illicit 
actors from the international financial stage, and thereby secure our 
financial system and combat threats to our security.
    The fiscal year 2010 budget that you have before you will allow 
Treasury to pursue these core missions assigned to the Department by 
the President and the Congress. The $13.4 billion request includes a 
$676 million, or 5.3 percent, increase over enacted 2009 levels.
    Of this increase, $14 million would go to bolstering the staffs of 
our Domestic Finance and Tax Policy offices, which are at the epicenter 
of administration efforts to support rigorous analysis and 
implementation of revenue policy and to redesign and improve our tax 
policies and tax code.
    Some $137 million would be devoted to more than doubling our 
Community Development Financial Institutions (CDFI) Fund to ensure that 
the benefits of our financial repairs reach beyond our major banks and 
businesses to help economically distressed communities. These 
communities were underserved by our financial system even before the 
current crisis, and have been deeply hurt by the job losses and 
business failures that the crisis has spawned.
    A total of $332 million would be devoted to new Internal Revenue 
Service (IRS) enforcement efforts, including $128.1 million to add 
nearly 800 new IRS employees to combat offshore tax evasion and improve 
compliance with U.S. international tax laws by businesses and high-
income individuals. Another $130 million would go to bolster the 
security of the IRS information technology, improve the efficiency of 
its business systems and upgrade its fraud detection capabilities.
    Although not directly under the jurisdiction of this Subcommittee, 
our budget also includes funds to meet our international obligations to 
help us in mounting a global response to the crisis and in creating 
mutually reinforcing growth around the world.
    As we seek these additional funds to respond to our Nation's 
troubles, we have cut back on some programs that are either ineffective 
or that we believe can be safely delayed.
    For example, while the Earned Income Tax Credit (EITC) continues to 
be one of the most effective anti-poverty programs that the Federal 
Government administers, the Advanced EITC, a related program which 
provides benefits in advance of filing a tax return, has been prone to 
exceptionally high levels of error and low use by those eligible for 
it. Accordingly, our budget proposes to end this latter program for 
savings next fiscal year of $125 million.
    Similarly, even as we seek to increase capital investment for the 
IRS, our budget would reduce the Department-wide capital investment 
account by 65 percent for a savings of $17 million.
    The Treasury budget would reduce the number of international 
economic attaches from 20 to 16, saving $2 million next fiscal year. It 
would absorb a portion of our non-pay inflation through more efficient 
use of contracting and other cutbacks, saving $18 million. It would 
take advantage of the growth of efficient electronic filing of tax 
returns to reduce the IRS processing budget by $8 million next fiscal 
year.
    Given we have had control over the budget for fewer than 5 months, 
the reductions that I have just described represent a first attempt to 
do more with less. As we begin work on the Budget for fiscal year 2011, 
Treasury has prepared itself for a more rigorous assessment of its 
spending.
    I have already issued guidance to Treasury senior staff that says, 
in part: ``To afford any new investments, we will have to take new 
approaches to solving old problems. I expect each bureau and policy 
office to identify opportunities for innovation that will transform how 
Treasury fulfills its missions in order to both improve performance and 
reduce cost.''
    In addition, the President has announced his intention to nominate 
Dan Tangherlini to be our Assistant Secretary for Management and 
Budget. Consistent with the President's mandate, I will look to Mr. 
Tangherlini to scour the Treasury's budget for efficiencies and cost 
savings. He comes to the job with an impressive track record of working 
on budget, management and performance issues with District of Columbia 
Mayor Adrian Fenty, and I am convinced that he will bring the same 
results-oriented approach to the Federal Government.

              REPAIRING AND REFORMING THE FINANCIAL SYSTEM

    The President has assigned the Treasury to repair key sectors of 
our economy so that they help revive growth and produce broadly shared 
prosperity.
    The Treasury has been working to repair and reform every major 
element of our financial system, and to fill gaps in the system so that 
it benefits all Americans.
    Last month, Federal banking supervisors announced results of the 
stress tests that we asked them to conduct on our 19 largest financial 
institutions. The aim of these assessments was to ensure that these 
institutions have sufficient capital buffers to absorb the losses that 
they could suffer under worse-than-expected economic conditions and 
continue to make the loans necessary to sustain recovery.
    The clarity and transparency provided by the tests has helped 
improve market confidence in the banks, making it possible for them to 
collectively raise nearly $90 billion through private equity offerings, 
bond issuances without Government guarantees and sales of business 
units.
    On housing, Treasury is working with HUD to bolster our housing 
markets by helping to drive down mortgage interest rates and by 
assisting responsible homeowners to refinance into more affordable 
mortgages or modify their at-risk loans to avoid preventable 
foreclosures.
    In terms of the non-bank financial sector, Treasury is working to 
revive critically important securitization markets for both new and old 
asset-backed securities.
    We have begun to boost new consumer and business lending by re-
starting the markets for asset-backed securities that financed almost 
half of all lending in this country before the crisis. There were more 
securities of this type issued the 4 months after we launched our 
effort than in the preceding 9.
    Additionally, Treasury is about to join with private investors in 
seeking to restart the markets for legacy mortgage loans and securities 
that are now stuck on bank balance sheets, keeping these institutions 
from making new loans to families and businesses.
    As we have made repairs to the financial system, we have understood 
that repair alone is not enough. We must also reform the system so that 
it is less prone to crises of the dimensions that we now face.
    In the next few weeks, we will outline a comprehensive plan of 
reform that will include systemic risk regulations to ensure that no 
large and interconnected firm or market can take on so much risk that 
its failure could destabilize the entire financial system. The plan 
calls for bolstering consumer and investor protections. And it will 
streamline our out-of-date regulatory structure so that our regulatory 
system matches the size, shape and speed of our modern financial 
system. Together, these changes will help prevent another crisis of the 
magnitude that we have just lived through, and give the Government new 
tools to better cope with similar problems should they occur in the 
future.
    In addition to the financial system, Treasury is helping to ensure 
that the Nation has a viable auto industry in the future. We are 
working with General Motors and Chrysler to make sure these companies 
make the changes necessary to again prosper. As President Obama has 
said ``we cannot . . . must not . . . and will not let our auto 
industry simply vanish.''
    The resources for administering key elements of both our financial 
and auto repair efforts were authorized by the Emergency Economic 
Stabilization Act.
    These activities are being handled by our Office of Financial 
Stability (OFS), which is focused on ensuring that TARP funds serve the 
public purpose of economic and financial stabilization; that they are 
fulfilling this purpose in ways that protect taxpayers; and that we can 
provide a clear account to the Congress and the American people about 
the effectiveness of the funds' use.
    In order to administer TARP and ensure compliance by TARP 
recipients, OFS has had to quickly assemble a substantial staff. OFS 
staffing levels, which were at 88 when I arrived in office, had risen 
to approximately 165 by the end of last month and are expected to rise 
to 225 by next fiscal year. The office's budget for next fiscal year 
will total $262 million, a 6 percent decline from the current fiscal 
year's $279 million. The change is largely due to a decline in 
estimated spending on contracts as part of the program's initial start-
up.
    While TARP is proving effective at improving the immediate 
stability of the financial system, the scope of the issues that this 
administration and this Department face extend beyond TARP to include 
striking the delicate balance between intervention and allowing market 
participants latitude to operate; devising a new financial regulatory 
structure for the future; and working through the tough problems of 
what form our Government-sponsored enterprises, Fannie Mae and Freddie 
Mac, should take as we emerge from this difficult period.
    All of these issues fall to Treasury's Office of Domestic Finance, 
which, together with OFS, is having to operate on new policy terrain, 
tackling problems that the country has not faced in generations and for 
which we have few guideposts in our immediate past.
    That is why the workload of the Office Domestic Finance has already 
expanded greatly, and is all but certain to expand still further. And 
it is why we are seeking to modestly increase its size and bolster its 
expertise in several critical areas.
    Our budget requests an additional $8.7 million for the office to 
add 26 full-time equivalent (FTE) positions to the staff. This 
represents a 26 percent increase from the office's current fiscal year 
staffing of 101.
    The additional funds will be used to create two new Deputy 
Assistant Secretary positions, one for housing finance, small business 
and consumer issues, and a second for capital markets. These two new 
officials will lead teams that will perform the economic and 
institutional research necessary to ensure that we understand all of 
the policy options in each of these areas and choose the most effective 
ones for solving our problems.
    As we seek additional funds for Treasury, we must also seek them 
for the front-line institutions that will sustain our economic recovery 
and ensure that its benefits are broadly shared.
    Our budget would more than double the resources of the Community 
Development Financial Institutions (CDFI) Fund to $243.6 million. The 
fund's mandate is to help low-income, economically distressed 
communities that were poorly served by our financial system even in 
economic good times, and--although they had nothing to do with causing 
current conditions--have been significantly hurt by the economic and 
financial fallout of the crisis that we now face.
    The $136.6 million, or 128 percent increase in funding, would allow 
this program to support financial institutions in making job-creating 
investments and in providing access to capital in communities that are 
often considered too risky for mainstream financial institutions to 
serve. By targeting lenders and borrowers in these communities, the 
Fund would help some of our most vulnerable populations weather the 
crisis and benefit once recovery is underway.
    The aim of the fund is to make sure that we provide distressed 
communities with more than simply Government grants and aid. We must 
also build the capacity of their local financial institutions to ensure 
that capital is flowing to homebuyers and businesses so that they can 
finance their own economic futures. Since its inception in 1994, the 
fund has directed nearly $1 billion to distressed communities, and 
allocated $19.5 billion in tax credits through its New Markets Tax 
Credit program.
    Financial institutions funded through the CDFI program make loans 
to small businesses and micro-enterprises and take equity positions in 
them. They provide mortgages to low-income homebuyers, and finance 
developers of low-income housing and community facilities, such as 
charter schools, health clinics and child care centers.
    One example can be seen right here in the Anacostia neighborhood of 
Washington, DC. City First Bank--a local CDFI--and Charter Schools 
Development Corporation partnered to provide a $13.3 million New 
Markets Tax Credit for the Thurgood Marshall Academy, the city's first 
charter school focused on law, serving 360 students in grades 9 through 
12 and achieving a 100 percent college acceptance rate for its first 
three graduating classes.
    Historically, the CDFI program has been heavily oversubscribed and 
has had to turn away qualified applicants. For example, in the current 
fiscal year, the program for CDFI financial and technical assistance 
awards is budgeted at $55 million, but it expects to receive 
applications for more than $500 million in funding.

         REDESIGNING THE TAX SYSTEM FOR FAIRNESS AND EFFICIENCY

    The President has asked Treasury to redesign and bolster 
enforcement of our tax code so that it supports growth, sets the stage 
for our return to a sustainable fiscal path, and accomplishes these 
goals in a manner that is fair, efficient and supportive of our 
society's broadest goals.
    To make good on the President's assignment, our budget requests a 
modest increase in funding for Treasury's Office of Tax Policy and more 
substantial increases to expand IRS enforcement activities and to 
improve its information technology.
    Treasury has moved quickly in implementing the more than 30 tax 
provisions of the President's economic recovery plan. Treasury also has 
played an integral role in designing the tax provisions of the 
President's fiscal year 2010 budget, and it will play a similar role in 
implementing these.
    The President has made clear that he will not seek any major 
revenue increases until 2011 when the recovery should be firmly in 
place. He has, however, been equally clear that once recovery is 
underway, we must get our fiscal house in order or risk having 
Government borrowing crowd out productive private investment. Treasury 
and the White House will work with Congress to make the tax changes 
that are necessary to reduce deficits and to do so in a manner that is 
fair to all Americans.
    As part of our efforts to make sure that the tax system is working 
for recovery and is operating fairly, we have designed new policies to 
curb the use of off-shore tax havens, close the international tax gap, 
remove tax incentives for companies to shift jobs overseas, and replace 
these incentives with ones that encourage creation of jobs at home.
    Our tax work on the recovery plan, the fiscal year 2010 budget, and 
these international tax issues are just the beginning of an ambitious 
agenda for this administration.
    On healthcare, the President has made clear that the road to fiscal 
discipline and to solvency for Medicare and Social Security runs 
through overall healthcare reform. Although much of the cost of the 
President's reform plan will be covered by savings from the system, we 
will need to design programs to cover some of the costs in ways that 
are fair to all Americans and do not harm the economy. Treasury is 
deeply involved in this effort and in the related work to expand 
coverage and improve our healthcare system in other important ways.
    On retirement and economic security, Treasury and, in particular, 
the Office of Tax Policy, is taking the lead in developing and actively 
working with Congress to flesh out the initiatives proposed in the 
President's budget to help enhance retirement security and savings for 
the half of working Americans who have no retirement provisions beyond 
Social Security. These proposals would make it easier for people to 
save for their own retirement, either through their workplaces or on 
their own, and would move us toward universal retirement savings 
coverage.
    On climate change, Treasury is already working closely with 
Congress to design the auction mechanisms that will be needed to 
implement the administration's greenhouse gas cap-and-trade program.
    Our Office of Tax Policy has been deeply involved in all of these 
issues from the outset of the administration. Like our Office of 
Domestic Finance, its workload already has substantially increased and 
is certain to grow as the health reform, retirement security and 
climate change debates get underway in earnest.
    At the moment, the Office of Tax Policy's career staff includes 30 
lawyers and 44 economists as well as support staff for an overall 
staffing level of 93. This is lower than its usual complement of over 
100 professionals.
    Our fiscal year 2010 budget would increase the office budget by 
$4.9 million to add 15 full-time equivalent (FTE) positions in order to 
increase overall staffing to 108, and would therefore represent a 
return to historical norms. The additional staff is needed to perform 
analysis and revenue estimates for new policy proposals, conduct 
research for, among other things, congressionally mandated studies, and 
develop regulations and guidance for new legislation.
    The vast majority of the new funds that we request in this budget 
are for improving the enforcement efforts and the information 
technology of the IRS.
    As I have said, $332 million would go to new IRS enforcement 
efforts, including $128.1 million to improve international tax 
compliance. The balance of these funds would be used to support three 
critical programs: 755 employees to increase examinations of tax 
returns for businesses and high-income individuals; 300 employees to 
expand the IRS document matching program, which compares tax returns to 
other forms such as W-2s and 1099s; and an additional 491 employees to 
improve collection operations and build two new IRS automated 
collection center sites.
    Turning to IT, our Budget requests a $90 million increase in 
funding to protect taxpayers' personal records from the increasing 
number and sophistication of Internet-based attacks. With these funds, 
the agency will deploy state-of-the-art, automated tools to improve 
record access management, risk assessment and system auditing. This 
effort would address concerns noted in the past by both the Government 
Accountability Office and the Treasury Inspector General for Tax 
Administration.
    Our budget also requests an additional $18 million for systems to 
help the IRS return review program detect noncompliance and fraudulent 
refunds, and a $22 million increase to continue modernizing the 
agency's core taxpayer account database and modernized the e-File web-
based platform.

              REENGAGING WITH THE WORLD ON ECONOMIC ISSUES

    The President assigned Treasury to ensure that this country 
reengages with the world, not just on issues of war and peace, but also 
on the current crisis, and on issues crucial to our common economic 
futures.
    This is a global crisis. Recovery here depends on recovery abroad. 
We are working closely with other major economies to put in place the 
fiscal stimulus and make the financial repairs necessary to ensure U.S. 
and global recovery.
    The United States is seeking to mobilize the financial resources of 
the better-off nations to help the emerging and developing economies 
that have been especially hard-hit by this crisis. We are doing this 
for more than simply humanitarian reasons; as recently as last fall, 
these economies accounted for fully 42 percent of all U.S. exports.
    Last month, the President and leaders of the other G-20 nations 
agreed on the need to make more than $1 trillion in financial resources 
available to support global growth and trade.
    Those funds include our commitment of up to $100 billion for an 
expanded New Arrangements to Borrow, a permanent back-up mechanism that 
provides the International Monetary Fund with supplemental resources to 
help emerging markets and developing nations weather the crisis.
    As part of our effort to rekindle global growth for the sake of our 
own recovery, we are seeking to meet our past and present financial 
commitments to the multilateral development banks that help emerging 
and developing countries.
    Although the funds to do this are not directly within the purview 
of your Subcommittee, I mention them to illustrate how Treasury's 
entire budget is tailored to let us fulfill the missions that the 
President has set out for us. Our budget request includes $2.5 billion 
for international programs, most of which would serve to meet our past 
and present commitments to the multilateral development banks.
    Our financial reform effort in the United States must be matched by 
similarly strong efforts elsewhere in order to succeed.

                               CONCLUSION

    Before I end, let me say a word about the Department's staff. I 
have the honor of leading a team of smart and dedicated individuals who 
are working to make our Government more effective and our society 
fairer, who are following a long tradition of debating policies 
fearlessly on their merits, doing what is right and not what is 
expedient, and drawing on the best ideas and expertise that are 
available. They are performing an incalculable service to our country 
in these challenging times, and I am immensely grateful to them.
    The Department of the Treasury is responsible for promoting the 
Nation's economic prosperity and protecting its financial security. We 
advance our interests around the world through the strength not only of 
our economy but of our ideas.
    This President and Treasury have already begun the hard work of 
recovery and reform. Our fiscal year 2010 budget will allow us to 
pursue these critical goals, and deliver the balanced and sustainable 
growth that the American people seek and deserve.

                          MORTGAGE FORECLOSURE

    Senator Durbin. Mr. Secretary, many of the questions we'll 
ask will be policy questions, somewhat global in scope. I will 
try to bring those home to the actual budget aspects of this 
hearing as best I can.
    Let me start with a topic that you won't be surprised that 
I'm interested in, mortgage foreclosure. I have brought before 
the Senate, twice now unsuccessfully, an attempt to change the 
bankruptcy code so that we can create more incentives for 
renegotiating mortgages to avoid foreclosure. I failed in both 
efforts and, in the last effort, was opposed by virtually all 
of the banking institutions of the United States, save one, 
Citigroup, that supported our efforts.
    The Mortgage Bankers Association reported last week that 
about 12.07 percent of mortgage loans were delinquent or in 
foreclosure in the first quarter, the highest level ever 
recorded since the survey was launched in 1972. Also, for the 
first time, most mortgages in foreclosure were prime loans, 
49.8 percent, compared to 43.2 percent subprime, which we 
initially identified as our major concern. Foreclosures bounced 
up 32 percent to 342,000 during the year over year period 
ending in April, according to Realty Track.
    The Obama administration's ``Making Home Affordable'' 
program has resulted in only 55,000 mortgage modifications in 
the last 2 months. According to The Washington Post, experts 
say foreclosure prevention programs will not be successful 
unless they address homeowners who owe more than their 
properties are worth.
    I sense that this was the catalyst that led us into this 
recession. It is my feeling that the previous administration 
and, so far, this administration has failed to come up with an 
approach which is dramatically, could dramatically turn around 
this increasing number of mortgage foreclosures. A year ago, 
the estimate was 2 million, this year it's 8 million. 
Ultimately, one out of every six home mortgages faces 
foreclosure based on current predictions.
    Do you agree that we need to strengthen incentives to 
modify more mortgages to turn this economy around? And wouldn't 
it help, wouldn't that help spur participation in the 
Treasury's own mortgage modification program? And can you 
suggest a better method to give homeowners more leverage than 
to change the bankruptcy code?
    Secretary Geithner. Senator, you're right that housing is 
at the center of this crisis and, of course, millions of 
Americans are losing their homes, including many who were very 
responsible and are suffering simply because of the actions of 
those borrowers who lived way beyond their means and those 
banks that made a bunch of loans they should not have made.
    And I agree with you that I think this Government should 
have moved earlier to address this crisis. We were late, as a 
country, and behind the curve. I do believe though that the 
President's program is a, does provide a very powerful set of 
incentives to induce a substantial increase in successful 
modifications. We are at the very early stage of implementing 
that program.
    It's true we've been in office now almost 6 months, but--
and this program was laid out, in terms of its detail, only a 
few months ago, but there is a substantial increase in efforts 
to put out notifications to potentially eligible borrowers and 
I expect to see a very substantial acceleration of the pace of 
modifications.
    Now, this program does create significant incentives for 
servicers to participate. It also does reach homeowners that 
are significantly underwater. It won't reach all homeowners. 
There are some homeowners that simply borrowed--got themselves 
to the point where they've got a completely unsustainable 
mortgage and are unlikely to retain their house. But the 
program is designed to reach homeowners that are living today 
with significant amounts of negative LTV's, or high LTV's, 
negative equity.
    Now, the program has been successful in helping bring down 
interest rates, working alongside the Fed. It has been 
successful in substantially increasing refinancing so that more 
Americans can take advantage of those lower rates and, as I 
said, we are just beginning to see the effects of these very 
substantial incentives we put in place to encourage 
modifications.
    Realistically, I don't think we are going to know, until 
probably early fall, whether we've got the incentives right and 
whether they will prove powerful enough. But our judgment is 
that this is the best package of incentives which offers the 
best return for the taxpayer's resources we are going to use to 
help address the housing crisis.
    Senator Durbin. I would just say that I have asked this 
question of your predecessor; in perhaps a little different 
form, and still remain skeptical that the voluntary approach to 
mortgage renegotiation is going to save us from this crisis 
that we are facing.
    I think, until we get an honest approach that really 
results in substantial renegotiation of mortgages, that the 
real estate industry and the housing industry are going to 
continue to be weak. I don't know how we can build a strong 
American economy if our homes are losing value and we see our 
neighbors facing foreclosure as we find across this country.
    Secretary Geithner. Senator, I understand your concern and 
I commend you for your leadership and focus on this issue from 
an early perspective. But this program is a dramatically 
different program from what was tried in the previous 
administration. The financial incentives that we put in place 
here are very substantial. And it came alongside a substantial 
change in policies by Fannie and Freddie to help allow for 
refinancing, even for homeowners who were slightly underwater.
    So, I think that we all want to see results. And you should 
judge us by our results. And it will take a little longer 
though to judge whether this is as powerful as we expect it to 
be. Now, I think if you just step back and look what's happened 
in the housing market over the last 6 months or so, partly 
because the effectiveness of the recovery program and 
confidence and partly because of the impact of the Fed's 
programs and the Treasury's programs, the pace of decline in 
house prices has started to slow. And that is early signs of us 
being able to look to the other side of this.
    But realistically, I think you are going to still see a 
very challenging period ahead for many homeowners, many more 
Americans are still at risk of losing their homes and that's 
why we want these programs to work.
    Senator Durbin. Senator, I might say that each member will 
have 5 minutes and probably more than one go-round.
    Senator Collins.

                     TROUBLED ASSET RELIEF PROGRAM

    Senator Collins. Thank you, Mr. Chairman.
    Mr. Secretary, I want to follow-up on the discussion we had 
about the use of TARP funds. It troubles me that banks have 
received billions of dollars without having to demonstrate that 
they've increased lending as a result and without having to be 
fully accountable and transparent in the expenditure of the 
funds they have received.
    I mentioned to you that I've seen, in my State, a large 
recipient of TARP funding constrain credit, to actually cut off 
lines of credit, to cease lending to a nonprofit hospital in my 
State, and a major retailer.
    So I don't see, on the grassroots level, the benefits of 
putting billions of dollars into financial institutions, the 
intent of which was to prevent this constrained credit. In 
addition, the Special Inspector General for TARP, in his report 
in April, criticized the Treasury for not adopting 
recommendations to require that all TARP recipients account for 
the use of the funds.
    So, I'd like to ask you to comment on why the Treasury 
hasn't made, as conditions for receipt of TARP funds, 
requirement for increased lending and full transparency?
    Secretary Geithner. Senator, excellent question. Could I 
just start by saying that we, you know--this is a crisis 
produced, in significant part, by two things.
    One is, families across the country substantially increased 
the amount they borrowed. So household debt rose dramatically 
as a share of our overall economy. And we had pockets of excess 
leverage, too much lending buildup, across the financial 
system. Now we are going through a very deep recession. In any 
recession, the demand for credit falls because economic 
activity falls. In a recession that follows a long credit boom 
like this, you would normally have expected the credit to fall 
quite sharply. That's an important context because it's hard to 
know how best to measure the full impact of these programs. 
Because again, it would have been, under any circumstance, we 
would have had a period where borrowing would fall, as 
homeowners, as families decided to go back to living within 
their means, decide to save more, reduce their debt 
outstanding. And lending would fall as the weaker parts of the 
financial system decline to a more sustainable level.
    Now, it is very important to us that we have better ways of 
measuring the impact of these programs. So when we came into 
office, we put in place a much more comprehensive reporting so 
that all banks that received TARP assistance have to report 
monthly on what is actually happening to lending behavior. We 
started with the major banks and we extended that out to all 
TARP recipients and you will be able to see monthly now, on the 
Treasury website, what banks are actually doing in terms of 
lending. And that is the ultimate measure of the impact of 
these capital assistance programs.
    We are very committed to improving the overall quality, 
transparency, and accountability across these programs and each 
of the programs we have designed provides for an exceptionally 
careful level of oversight, and a level transparency so people 
can measure the actual impact and effects.
    Now, if there are other things that we can do to strengthen 
that, we will do it. Because nothing is more important to the 
credibilities programs than a better sense among the American 
people that they have the chance to judge and measure impact.
    Now, just to finish quickly, where do you begin. My own 
judgment is that the programs that the Congress authorized last 
fall, and the actions that my predecessor took initially to put 
capital into the U.S. banking system, were absolutely essential 
to prevent a catastrophic financial collapse. If you look back 
to that period of time, lending absolutely stopped. And because 
lending stopped, and because confidence was so badly damaged, 
basic business stopped. And it happened around the world. And 
when that capital was put into those banks initially, that was 
the first step in beginning to lay a foundation for recovery 
and repair.
    We cannot know with certainty what would have happened in 
the absence of that action, but my judgment is that, without 
those actions, you would have faced the prospect of a 
catastrophic failure in the U.S. financial system and much, 
much, more damage to economic activity than we already saw.
    Now today, we're seeing, over the last several weeks, we 
are seeing some very impressive and encouraging signs of 
improvement in the overall credit conditions. So if you look at 
concern about risk and exposure to banks, and if you look at 
the ability of banks to go raise equity to replace the 
Government's investment, if you look at what's happening to the 
borrowing in businesses across the country. If you look at 
what's happening to mortgage rates, the interest rates, there 
have been substantial improvements in those basic measures of 
these programs. So, my sense it is early days, as I said, and 
this is just the beginning, but I think where the Government 
has acted, you can see very tangible benefits in improvement.
    Now, we have a ways to go. This crisis took a long time, 
the conditions of this crisis took a long time to build up and 
it will take a long time to work through, but I think these 
programs are having, are achieving traction and they're the 
right mix of programs. And we will do everything we need to do 
to make sure that we are adopting sensible recommendations by 
not just the SIGTARP, but by the congressional oversight panel 
and the Government Accountability Office (GAO) who are looking 
very, very carefully at all these programs.
    Senator Collins. Thank you.
    Senator Durbin. Senator Lautenberg.

                         EXECUTIVE COMPENSATION

    Senator Lautenberg. Thank you, Chairman.
    Mr. Geithner, the financial crisis that we're seeing was, 
in my view, due in significant part to the poor management of 
these companies and particularly I am pained by the outcome of 
the management years in the automobile industry who refused to 
see what the public appetite was, when we refused to be 
competitive, and thus jobs have been lost and an industry 
practically destroyed that we loved and admired for so many 
years.
    When we look at the risks taken by corporate executives, 
decisions made, many of these executive pay packages insulate 
CEOs from the risk and, again, I may, I don't want to take you 
out of your bailiwick, but to avoid this excessive 
mismanagement, should executive compensation be tied to the 
long term health of the company? Where do we have a right to 
interject our views?
    Secretary Geithner. Senator, this is a very important 
issue. And I agree with you that I think, although many things 
caused this crisis, what happened to compensation and the 
incentives that created risk-taking did contribute in some 
institutions to the kind of vulnerability we saw in this 
financial crisis. And my view is that we need to help encourage 
substantial reforms in compensation structures, particularly in 
the financial industry because of the dependence of the economy 
on a well-functioning, more stable, better set of judgments by 
financial institutions.
    I think boards of directors did not do a good job. I think 
shareholders did not do a good job in terms of disciplining 
compensation practices. And I think a centerpiece of sensible 
reforms would be to tie compensation to better measures of 
long-term investment and return and to adjust them to reflect 
the risk, to reflect risk. That's part of the reforms and we 
are, as part of our broader regulatory reform proposals, our 
proposals to reform the whole framework of renewed regulation 
in the United States, will include some suggestions for trying 
to encourage reform in compensation practices.
    Senator Lautenberg. Where does the start begin? Is it in 
Treasury or is it IRS or the Securities and Exchange Commission 
(SEC)? How do we get things introduced into the governance of 
these things?
    Secretary Geithner. Well, as you'll hear from us in the 
next few days, the SEC has some important responsibilities and 
obligations in this area and some tools and authorities they 
may seek in this area. The bank supervisors, under the 
leadership of Chairman Bernanke and others, have already 
initiated a process to define standards and principles that 
supervisors would use to help bring about reforms in 
compensation practices in the financial industry.
    Those are two ways we can have influence over the shape of 
practice in these areas. There are other ways, too, but my own 
sense is that the core will be those two authorities.
    Senator Lautenberg. Senator Nelson mentioned something 
about the Government owning shares in these companies and its, 
I think it has to happen. Who, for instance, would vote the 
shares? Would the Government be, the American Government, be 
likely to appoint the board of directors and have them make a 
decision?
    Secretary Geithner. Senator, this is an enormously 
important set of questions. As we said before, the President 
and I have said, we are an extremely reluctant investor, an 
investor. We do not want to be in the business of managing 
these companies on a day-to-day basis. We would like to make 
sure that we have the ability to get out as quickly as we can 
and have these companies emerge on their own as viable entities 
without our assistance on an ongoing basis and the capacity to 
go raise capital in the markets to repay the Government's 
investments.
    To underscore that, we are--we've designed a set of 
policies and mechanisms that will ensure that people understand 
we only intend to use our voting rights for a very limited 
number of core judgments about financial structures of the 
firm, to make sure that there's a strong board and management 
in place at the time that we take our equity investments so 
that the taxpayers' interests are protected. So we have 
confidence in their ability to oversee a sufficiently robust 
restructuring plan.
    We do not want to leave the impression or the reality in 
place that the Government of the United States will, will be 
able to and will have the capacity to exercise judgments over 
the day-to-day operations of these businesses. We think that 
would be damaging to franchise value, damaging to the interests 
of the taxpayers in trying to make sure that we can get out as 
quickly as possible. And our hope is that we design a set of 
institutional protections to avoid that risk.
    Senator Lautenberg. Thank you, Mr. Chairman.
    Senator Durbin. Thank you. Senator Bond.
    Senator Bond. Thank you very much, Mr. Chairman.

                      FAILED BANKING INSTITUTIONS

    Mr. Secretary, a lot of us in the heartland are wondering 
why you are treating failed banking institutions differently 
from General Motors and Chrysler? The administration has 
orchestrated forcing car companies into bankruptcy, but they 
seem to be reluctant to force failed large financial 
institutions, like Citi, into restructuring. Now, we've seen in 
the past that large organizations, not as large as Citi, but 
IndyMac has gone through a Federal Deposit Insurance 
Corporation (FDIC) cleansing program and this one is outside of 
politics. And when you do it through the FDIC, you don't get 
the political questions that are asked, you don't get the 
political involvement in it. And, as The Wall Street Journal 
asked today, if Citi is not forced into an FDIC-like 
restructuring, you know, how can you ensure taxpayers that 
failed banks will not continue to return for billions and 
billions of bailouts, which I think all of us have heard great 
concerns from our constituents about.
    Secretary Geithner. Senator, I share those concerns and I 
think it's important to acknowledge that the actions that the 
Government has had to take, over the last 12 months in 
particular, to help protect the economy from this financial 
crisis have created, well, they have been exceptional and 
extraordinary, and they have created the risk that, unless we 
reform the system, we are going to face a greater risk of 
financial crises in the future, because we will have created a 
moral hazard that might make the system more vulnerable in the 
future.
    I am deeply worried about that, I share that concern. And 
that is why it is so important that we put in place stronger 
protections against constraints on risk taking in the future. A 
centerpiece of what the President will recommend, in terms of 
financial reform, will be a set of much more conservative set 
of constraints on risk taking across the financial system, more 
evenly enforced with a more effective oversight. And, as part 
of that, we need to have a better capacity to deal with 
potential failure of large institutions.
    Now the system that you referred to, the system that the 
Congress helped to put into place, built around the FDIC, 
strengthening in the wake of the savings and loan (S&L) crisis, 
is a very effective process, but it was designed to deal with 
relatively small banks and thrifts and was it not designed for 
a crisis of this severity. That is why we do not have--and that 
system was not designed to deal with a more complex set of 
failures, for example like AIG.
    That's why a centerpiece of what the President will 
recommend would be a stronger capacity to resolve, address, 
better manage the risks to the system posed by those types of 
institutions.
    Now, I just want to underscore just a couple things about 
context. Now, when I came into office, the Government of the 
United States had already invested roughly $200 billion in our 
Nation's banks. As I said to Senator Collins, I think that was 
a necessary thing to do. We would never want to do that, but it 
was the correct thing to do.

                              TOXIC ASSETS

    Senator Bond. Mr. Secretary, I'm running out of time but I 
think everybody would agree, the Federal Reserve came up and 
flooded the system with money, we put--the TARP money in. But 
now we're past that. And unless we take some steps to deal with 
too-big-to-fail, we're going to have a moral hazard. And I'm 
also worried about the PPIPs, a lot of people saying that the 
banks aren't participating because it looks like it's going to 
be political. And if they get in--who would want to get in 
partnership with the Federal Government when they see what some 
of our fellow Members of Congress are doing?
    Are you going to be able to get any of these toxic assets 
out with PPIP? Where are the participants?
    Secretary Geithner. Senator, again, I want to underscore 
that you are right. This issue of too-big-to-fail moral hazard 
is a really important thing. And that's why the President wants 
to move so quickly on legislation.
    Now on the issue of these legacy assets, that are still on 
the books of the Nation's banks. You're right that there is 
some concern in the market still about participation and 
whether that brings some risk of political conditions imposed 
in the future. And that could limit participation in the 
beginning and that would be an unfortunate thing. I think we 
all have a responsibility to act to reduce that sense of risk 
and uncertainty about the rules of the game.
    It's also true that banks have found it more easy to raise 
equity than they thought. And that, combined with a slight 
improvement in confidence in the system, may also reduce 
participation. In my judgment though, these funds still are an 
important part of the necessary framework of tools to help get 
our country through this crisis. And I believe it is important 
that we go ahead and put them in place, even if we see 
participation somewhat more limited than people would have 
expected because of both the political concerns and because the 
basic improvement----
    Senator Bond. I would hope that we would use the FDIC model 
I and others and Senator Dodd have proposed, beefing up the 
FDIC, we need to use them. And I'll have further questions for 
the record.
    And Mr. Chairman, I would ask that my full statement and 
all of my good advice in it be included in the record, in the 
hopes that somebody might read it someday.
    Senator Durbin. Well, we'll look forward to reading that 
and it will gladly be inserted. Thank you, Senator Bond.
    Senator Nelson.

                          AUTOMOBILE INDUSTRY

    Senator Nelson. Thank you, Mr. Chairman. Secretary 
Geithner, you mentioned that we are reluctantly in a position 
of holding the shares of General Motors and perhaps in a 
position of controlling other institutions, but we are doing so 
reluctantly.
    I am so reluctant to be one of those holders of that stock 
that I am introducing a resolution, as a sense of the Senate 
resolution, that we begin the process to divest ourselves of 
that stock ownership over a reasonable period of time, making 
clear that we are only a temporary shareholder and that we 
should take obviously all steps to protect the American 
taxpayer dollars and begin to divest the ownership as 
expeditiously as possible and call for a GAO study to help 
determine the period of time that it may take to return General 
Motors and Chrysler to solvency and complete the divestiture.
    I think that says what I would like to say. In addition, 
I've heard it said that, for those who worry that somehow we 
are drifting into socialism, that socialism is where the 
Government wants to take over profitable ventures, as opposed 
to being where we are right now.
    Apart from the levity, I think it is probably accurate. And 
so I hope that the administration will be supportive of every 
effort to make public statements that this is a temporary 
situation, not one that is optimum or optimal in terms of what 
we would prefer to do, but where we are at the moment but to 
make certain also that we are not going to stay there one day 
longer than we should in that position of ownership.
    And I'm encouraged where you say that we won't exercise 
day-to-day judgment over many of the decisions and 
opportunities that the industry will have.
    I've got some other questions about that and that relates 
to the dealerships. I know they're very concerned about 
summarily being dismissed after decades of relationships with 
the auto industry. Is there any effort to try to establish some 
sort of a recognition of the rights, and not just contractual 
rights, but the rights of dealerships in this dismissal where 
any compensation is being directed toward those dealerships to 
soften the blows?
    It's not taking their position that is so important, it is 
recognizing that, in small communities all across America, 
particularly Nebraska, where dealerships are going to be lost, 
people are going to lose their jobs as well. In small 
communities where job replacement can be even more difficult 
than in the urban centers. I wish you might comment on that.
    Secretary Geithner. Senator, can I just begin where you 
began to say, and I think you said it right, in terms of the 
Government stake in these entities, where we take a stake, 
temporary, clear path to exit, not a day longer than is 
necessary, no ongoing role in day-to-day management.
    And, in that context, this broader question about the 
impact of communities of the substantial reduction in 
dealerships that the automobile companies have decided was 
necessary to get back on the path of viability. I just want to 
underscore that these were their judgments, based on a careful 
analysis of what was necessary, again, to get them down to a 
cost basis that was more attainable over time.
    But I understand the concern about the impact and would be 
happy to explore with you and talk to my colleagues about--to 
make sure you have responses to your thoughtful questions about 
with the companies themselves might be able to do to help to 
soften the blow.
    Senator Nelson. I appreciate that. Thank you.
    Secretary Geithner. But it has to be their judgment----

                      FINANCIAL REGULATORY REFORM

    Senator Nelson. Of course, of course.
    In terms of financial regulation, can you give us a preview 
of what you have planned for financial regulation? For example, 
are there any plans to change the State-based regulation of 
insurance? Will you propose an Office of Insurance Information 
or a similar position or will you seek authority to regulate 
insurance at the Federal level?
    Secretary Geithner. Senator, I don't want to get ahead of 
the President of the United States on this. He is going to 
layout a comprehensive set a proposals next week. In that 
context, we will lay out our judgment about what we think is 
the most practical way to help begin the process of ensuring 
more effective supervision of at least parts of our insurance 
industry. But I don't want to get out in front of him. But 
we'll be taking a careful look at what is the most practical 
way to help to begin that, begin progress against the 
objective.
    Senator Nelson. Well, as you take a look at the case of 
AIG, although it's an insurance holding operation, keep in mind 
that the insurance subsidiaries were profitable. That they 
didn't have bad assets. That this is not, this is not something 
that has rippled through the insurance industry. But focus on 
what happened with the Glass-Steagall modifications that 
permitted AIG to do what it did.
    And so let's don't cure problems that don't exist as we try 
to take a ``comprehensive approach''. Let's just make sure that 
it is not so comprehensive that the sweep in regulatory schemes 
and mechanisms that are currently working.
    Secretary Geithner. Senator, I completely agree and we are 
bringing a broader pragmatic spirit to this exercise and try to 
focus on things that were central to the crisis, not things 
that were not. On things that are necessary to do, not just 
those, not those that would be desirable to achieve over time.
    Now, we may not all agree on the judgments we're making, 
but that's the pragmatic framework we're trying to make.
    Senator Nelson. Apparently, you are making a commitment not 
to have collateral damage, right?
    Secretary Geithner. Well, that is something of an 
obligation that we all share and we would be very careful to 
try to avoid that, but Senator we did have really systematic 
failures across the regulatory framework of the United States 
and we are going to have to change a lot of things to address 
those failures.
    Senator Nelson. Thank you. Thank you, Mr. Chairman.
    Senator Durbin. Thank you, Senator Nelson. Senator Tester.

              TROUBLED ASSET RELIEF PROGRAM: RESERVE FUND

    Senator Tester. Thank you, Mr. Chairman.
    So many questions, so little time. Secretary Geithner, in 
your budget there's a financial stabilization reserve of $250 
million. In front of the Banking Committee last week, Herb 
Allison was there. He is going to oversee the TARP, hopefully. 
He talked about, he called it head room, I interpret it as 
being reserve, of $100 billion. Can you tell me why we need 
$250 million in the budget?
    Secretary Geithner. Senator, could I just begin by saying 
that I announced this morning that banks have, we've indicated 
to banks, the Fed indicated to banks that they have the right 
to repurchase $68 billion, return $68 billion of those initial 
investments and those will be coming back into the general 
fund. Now the way the EES legislation is designed, that does 
create additional flexibility to allow us to use those funds, 
if we believe there's a strong, compelling case. And since 
were--things are getting better in the financial system, I 
think, to be realistic, there's a lot of risk ahead for us and 
we need to be careful, to remind people that that flexibility 
authority is important.
    Now, in the reserve fund. The President put in the budget 
this additional reserve fund, in an abundance of caution, 
against the possibility that we could face a deepening crisis. 
Now, we do not expect, at this time, to come back to Congress 
to ask for authority to use those resources.
    I began by pointing out the $68 billion repayment thing, 
because it does provide some modest encouragement, I think, 
that we are going to be able to get through this without having 
to put you in the position of coming back for substantial 
additional funds.
    Senator Tester. We appreciate that. I guess the question is 
out of $700 billion, $250 million, even though it's a ton of 
money, is like spitting in the ocean.
    Secretary Geithner. Well, you're right. We are a $14 
trillion economy. This is a very severe financial crisis, the 
worst in generations, and financial crises are expensive to 
solve, particularly if you wait to solve them.
    Senator Tester. All right. I interpret by your answer to 
the last question that you anticipate the money that is going 
to be paid back will go into the general fund and not 
reinvested in the troubled banks.
    Secretary Geithner. By law, it goes to the general fund but 
it also goes, as the law is written, and I think this was wise, 
it does give us flexibility to use that, again, if we think 
there's a compelling case.

               EXTENSION OF TROUBLED ASSET RELIEF PROGRAM

    Senator Tester. Okay. In the end--well, you have an 
opportunity to extended it to the fall of 2010, the TARP 
program.
    Secretary Geithner. We do.
    Senator Tester. Do you anticipate that that trigger will be 
asked for?
    Secretary Geithner. I don't know at this stage. There's a 
range of exceptional programs we put in place, as Senator 
Collins just said, and some of them expire at the end of 
October and some of them have a longer fuse on them. Some of 
them can be extended. We will have to make that judgment as we 
get a little more----
    Senator Tester. If you ask for an extension, I assume it 
applies to all the money and not just a portion? Is that 
correct?
    Secretary Geithner. That's right. The way the law is 
structured, the authority is about the $700 billion and it 
applies to the full $700 billion.

           TRANSPARENCY OF THE TROUBLED ASSET RELIEF PROGRAM

    Senator Tester. Okay. You talked about, and it has been 
referenced before, about reluctant investor, not involved in 
day-to-day decisions. It has been pointed out to me that some 
of the TARP funds are being used by banks for speculation in 
the oil market and the commodities market. Is there enough 
transparency now that they are using the TARP funds for you to 
know that?
    Secretary Geithner. Well, I think that's really a question 
that I would have to refer to the supervisors. The supervisors 
of those banks that receive assistance have the full capacity 
to judge what kind of risk they're taking generally and whether 
those risks are appropriate, given the conditions of the----
    Senator Tester. I know you don't want to be day-to-day, and 
I don't want you to be in on the day-to-day decisions. The 
question is, do you think that's an appropriate use of TARP 
monies?
    Secretary Geithner. Look, I want to make a big distinction 
between banks and others. Banks, because the risks they pose to 
the economy and because of the protections they enjoy, they are 
subject to a very intensive level of supervision and regulation 
by the Nation's banking authorities. That was not strong enough 
in some cases and needs to be stronger, but that is a perfectly 
legitimate public policy interest because of the interest of 
the system. So, I would distinguish that from the role of the 
Government as temporary shareholder.
    Senator Tester. Okay. In the previous question, you said 
that, as far as closing down dealerships, that was their 
decision. Who is they?
    Secretary Geithner. The companies themselves. And their 
boards.
    Senator Tester. Okay. In the plan for General Motors, the 
investment of billions of dollars into that, were there any 
assurances that they wouldn't move manufacturing overseas?
    Secretary Geithner. In the context of General Motors, the 
company has publicly committed to lay down a path for 
production in the United States as a share of total production. 
And in those plans, they've indicated that they expect 
production to be maintained at current levels, and perhaps 
expand slightly as they build this new plan for small cars.
    So their plans now are, and these were part of the 
framework established for a bunch of reasons, they expect 
production in the United States to not just level off, but to 
expand slightly.
    Senator Tester. Okay. Thank you.

           REPAYMENTS UNDER THE TROUBLED ASSET RELIEF PROGRAM

    Senator Durbin. Thanks, Senator Tester. Going back to the 
repayment of TARP, which is $68 billion which was announced 
this morning. What is the expected return on investment for 
taxpayers?
    Secretary Geithner. The way the terms were initially 
established, these preferred investments came with a 5 percent 
coupon. I don't have my press statement with me, but the 
Treasury has already earned several billion dollars in terms of 
those dividend payments on the preferred.
    Now, the full terms for the Government include the value of 
the warrants that Treasury took as part of these investments. 
We are in the process of going through a judgment about what 
fair market value for those warrants is likely to be and in the 
release we put out this morning, I'm not sure we made an 
estimate, but some of the estimates now are in the several 
billion dollar range for those initial banks that are repaying.
    Government--so people will bring all sorts of financial 
prisms to judge the return, of course you have to look at the 
returns to the country, not just in terms of the direct 
financial returns to country which are significant. They really 
are significant. But you have to look at the broader benefit in 
avoiding a financial collapse because there is dramatically 
more credit available today than there would have been if these 
banks were forced to shrink dramatically.
    Senator Durbin. That's the second question. Assuming that 
you wouldn't allow repayment, if there's any question of 
soundness in the institution, what kind of assurance do we have 
that these banks that return this money are going to be issuing 
credit, which was one of the original goals?
    Secretary Geithner. Right. Well, the judgment on the law 
was made by the Federal banking industry's responsible, so they 
did a very careful process of judging whether they really could 
prudently repay this money. And the figure I announced this 
morning reflects the judgment of the Federal banking agencies. 
That means these banks are in the position now where they can 
make normal business judgments about lending. And I think, by 
many measures, lending is very--expanding credit is a very 
economic thing to do today.
    But as I said, we are in recession that followed a huge 
boom in credit. So it's going to be, for many parts, many 
families, many businesses, borrowing will decline as we go 
through this. And that is a healthy, necessary thing. It makes 
it very hard to judge, because you don't know what would have 
happened in the absence of investments, what lending would have 
been produced.
    But I think you have a different financial system today 
that is substantially stronger than it was 2, 3, 6, 9 months 
ago and is in a much better position to provide the credit 
necessary to help us get through this recession and to get back 
on a growth path again.

                      CREDIT CARD INTERCHANGE FEES

    Senator Durbin. Mr. Secretary, we recently enacted or 
passed in the Senate an historic credit card reform bill, which 
I commend my colleague, Senator Dodd, although the Banking 
Committee worked so hard on it. It's been 25 years or more 
since we've done anything in that field.
    There was the third rail in this discussion which we 
couldn't bring up and couldn't discuss for fear it would 
explode the whole process, interchange fees. Interchange fees 
are the fees that are charged by credit card companies and 
imposed on retailers, and there's very little room, when it 
comes to the retailers, to negotiate these fees. Approximately 
2 percent of our purchases using credit cards are paid back to 
the credit card company in interchange fees and the retail 
establishments across America are very concerned about this 
because they have little or no voice in that.
    I'd like to ask you two questions about interchange fees. 
First is a more general question about what the Treasury is 
doing, if anything, to look into the interchange fee system.
    But then, in particular, since it turns out that the 
Federal Government is now accepting credit cards, it turns out 
that there are 200 Federal entities that accept credit cards, 
Amtrak, the Postal Service, the Treasury's financial management 
services, it turns out that our Government paid these credit 
card companies over $200 million in interchange fees to Visa 
and MasterCard, in fiscal year 2007.
    I have repeatedly asked the credit card industry and the 
banks to demonstrate that the rates that they've established 
are legitimate to process the card transactions and 
unfortunately they have not been able to provide any data or 
information to suggest that the amount charged, even to the 
Federal Government, represents a reasonable fee. In fact, the 
GAO report on this recently said that the FMS tried to 
negotiate lower interchange fees with Visa and MasterCard and 
negotiations were not successful.
    So, in addition to the general question of interchange fees 
on retail establishments across America, what is the status of 
your effort to make sure that Uncle Sam isn't paying too much 
to these credit card companies for the use of the credit cards?
    Secretary Geithner. Senator, this is a very complicated 
question and, to be honest with you, I have not thought about 
this very much yet. But I would be happy to spend some time 
with you and your staff, understanding your concerns about this 
and taking a careful look at both questions you raised.
    If I'm not mistaken, I think you asked the GAO to do a 
study of one of these dimensions and of course we would look 
carefully at the conclusion of this study. But I am happy to 
commit to spend some time on this and see if we can--see if 
there are some sensible things that we can do to protect the 
Government's interests, not just to address the broader reform 
question you raised.

             STAFFING OF THE TROUBLED ASSET RELIEF PROGRAM

    Senator Durbin. If Senator Collins would just bear with me 
for one more question. I think, with the establishment of TARP 
under the previous administration and the continuance under 
this administration, there has been a shift of personnel within 
the Department of the Treasury to deal with the obvious 
demands, administrative demands.
    Can you give me a general impression of whether or not this 
has created dislocations in other parts of the Treasury 
Department which need to be addressed and whether the repayment 
or the payback on these TARP funds is some indication that we 
be getting out of this business and can get back to business as 
normal?
    Secretary Geithner. The way that the EESA legislation was 
written it provided funding for the administrative resources 
required to design and run these programs and we have 
substantially increased resources, using that authority, to 
staff that part of Treasury, the Office of Financial Stability.
    But we are also going to have to increase, as we proposed 
in the budget, the rest of the domestic finance staff. Because 
they have got this greatly expanded, much more complicated set 
of challenges in a range of policies, including the one you 
just raised. And we did announce several weeks ago the 
appointment of a new Deputy Assistant Secretary for Consumer 
Policy Issues in the financial sector.
    I do not believe that we've had to devote resources from 
other parts of the Government to these financial crisis 
imperatives on a scale that would jeopardize our capacity to 
carry out those broader responsibilities. And we will be very 
careful to avoid that risk. But there are parts of the 
Treasury, as I suggested, where we think that we are going to 
need to have some modest increases in baseline, like tax 
policy, which is outside of domestic finance. And I think, with 
that support, I think we will be in a stronger position to meet 
these broader objectives.
    But my basic answer to your question is, no, I'm not 
concerned now that we've had a substantial diversion of 
resources, as important as the financial crisis is, at the 
expense of other core priorities of the Government.
    Senator Durbin. Senator Collins.

                   AUTOMOBILE DEALERSHIP TERMINATIONS

    Senator Collins. Thank you, Mr. Chairman.
    Mr. Secretary, I want to follow up on the questions that 
Senator Nelson asked you with regard to the decision of General 
Motors and Chrysler to terminate dealerships.
    This decision has been perplexing to many of the automobile 
dealers in my State. Everyone understands that General Motors 
and Chrysler have to restructure and shed costs in order to 
survive, but the dealerships in Maine tell me that they pay for 
the cars, that they pay for the shipping, that they own their 
own showrooms, and they pay for their sales people. So, they've 
raise the question of how does this save money for the 
automobile manufacturers to have fewer people promoting their 
products? Could you shed some light on this for us?
    Secretary Geithner. Senator, that is an excellent question 
and I have spent some time, I've never run an automobile 
company, but I've spent some time trying to----
    Senator Collins. Until now.
    Secretary Geithner. I don't expect to be running one now 
either. But I've spent some time looking at this and I guess I 
would say, I'm not sure this is going to be convincing or 
persuasive to you, but if you look at the broad consensus, 
people who looked at what was going to be necessary to put 
these companies back on a better financial foundation, I think 
there is a very broad consensus that, to do that, they need to 
get the distribution costs down and the distribution system 
more efficient. And that's why the companies themselves, at the 
center of their plans, have proposed very substantial reduction 
in the number of dealers.
    Now, I know that it's--I'm not sure that's persuasive, but 
my sense, again, in reading a bunch of and listening to people 
who study these companies look at them and say, a very broad 
sense, that this is a part of, an important part, to get them 
down to a cost basis to allow them to be viable. Now that comes 
with enormous damage in those communities, and it is a 
wrenching adjustment, but the reality is that these 
restructuring programs will leave the country with many, many 
more dealers then what would have existed in the absence of 
these programs.
    The balance, it may not be perfect, but I think that my 
sense in looking at it is that this is a necessary part of 
their efforts to get back to a path where they don't need the 
Government.
    Senator Collins. Was the decision to reduce dealerships 
made by the manufacturers or was it imposed upon them by the 
auto industry task force?
    Secretary Geithner. It was not imposed by the auto industry 
task force. It was a judgment made by those boards of directors 
and their management, again, about what was a critical part of 
a restructuring plan.
    Senator Collins. Thank you.

                      FINANCIAL REGULATORY REFORM

    I'd like now to return to the issue of financial regulatory 
reform. I introduced a bill in March to create a council of 
regulators to act as a systemic risk monitor. I know that the 
other model for that is to have the Federal Reserve assume that 
responsibility. I think there's widespread consensus that we do 
need to have a systemic risk monitor so that someone, or some 
entity, is looking across the financial system and identifying 
high-risk practices, policies, or products and regulatory black 
holes, so that we don't have the problem of no one regulating 
faulty credit or swaps or the next product that comes along.
    The reason that I support the council is I believe there's 
value in bringing many perspectives to the table and many areas 
of expertise. The Fed frankly has its hands full. There are 
also issues about congressional oversight. We want the Federal 
Reserve to be independent in order to set monetary policy. If 
it's also going to be the systemic risk monitor, there's going 
to have to be more congressional oversight of its operations.
    So tell me, I know you don't want to precede the President 
in announcing his plan, but discuss with me the pros and cons 
of the two approaches.
    Secretary Geithner. Well, I should begin by saying, 
although I am not going to get ahead of the President, that we 
share many of the objectives you laid out.
    I think a necessary part of the solution for the U.S. 
financial system will be a more effective body to bring 
together the responsible supervisory agencies, alongside the 
Fed, to make sure we are looking across the system as a whole, 
that we are keeping abreast of changes in the structure of the 
system so that we can better limit the risk in the system. And 
I think a council has a lot of merits in that context.
    And I don't believe it is necessarily desirable for us to 
concentrate all authority for dealing with the future risk of 
the system in one part of our complicated governmental 
structure.
    So, although we are going to propose some important 
streamlining consolidation simplification of the oversight 
regime, we are not going to propose to concentrate all the 
authority for systemic issues in only one place. It's too 
complicated really to do that.
    I think the really important thing is, again, is that we 
have more effective oversight over the core institutions that 
are critical to the system, that we bring critical markets like 
derivatives under an effective framework of oversight and 
protections there, that we have much better enforcement with 
tougher rules for enforcement for consumer investor protection. 
That we have better tools for managing future crises. And we 
are going to have to have tougher constraints on risk-taking 
involving better constraints on leverage and capital, so that 
you have thicker shock absorbers, thicker cushions against 
future crises. We are more able to let firms fail. The system 
is more robust to potential failure.
    So, those are broader objectives in our approach. But 
you'll find many of the concerns and objectives you laid out 
present in our recommendations.
    Senator Collins. Thank you.
    Senator Durbin. Senator Tester.

                 TERMINATION OF AUTOMOBILE DEALERSHIPS

    Senator Tester. Thank you, Mr. Chairman. I don't want to 
beat this horse, but I will just say this. And I like ya. 
There's an overwhelming attitude in this country that bigger is 
better. And I think what we're allowing General Motors and 
Chrysler to do, by closing down these small dealerships, is 
putting all the forces into a few big dealerships because, 
number one, it is easier to deal with a few people than it is a 
lot. And number two, it will reduce competition. And I've got 
to tell ya, if the dealership is making money, I don't see any 
criteria for shutting them down. And that's my only editorial 
comment I will tell you.
    And the only other thing to keep in mind is, in rural 
America, it's a heck of a lot different than it is in urban 
America. You shut down some of these smaller dealerships in 
some of these small towns that are making money, that General 
Motors is making money off of, its going to have an incredible 
impact on the economy. That's all. And I know you aren't making 
that decision, but if you could pass that along to the powers 
that be, I would appreciate it.
    Secretary Geithner. Message heard and received.
    Senator Tester. Okay. Thank you.

                            FEDERAL DEFICITS

    Chairman Bernanke talked restoring fiscal balance. Could 
you just comment on that and where you see us going over the 
next few years, assuming the economy gets turned around?
    Secretary Geithner. It is critically important for this 
country, it's central to the prospects of recovery, that we put 
in place a framework that gives confidence to Americans and 
investors around the world, that we are going to have the 
ability, the will and ability, to bring our fiscal deficits 
down to a sustainable position over the medium term. And that's 
why the President, in his initial budget, laid a path for 
dramatic reductions in the deficit to bring them down over a 5-
year period to a level at which our overall debt is not growing 
and can start to come down.
    Senator Tester. I just heard the Government will triple in 
10 years not more than one-half an hour ago.
    Secretary Geithner. Well, you know, we came into--I last 
served in the administration during the period where we had an 
extraordinary accomplished record of fiscal discipline, 
produced surpluses, helped bring down interest rates, helped 
lay the foundation for not just a strong dollar but an 
incredibly long period of private investment growth, 
productivity growth. So, I am a deep believer in and have deep 
conviction in the central importance of fiscal responsibility 
for this country.
    Now, we started this year in the worst financial crisis in 
decades and, because of that crisis and the damage done by the 
financial system, we had to do, with the Congress, 
extraordinary things. And those, by necessity, produced a 
short-term temporary increase in our deficits. There was no 
path through this crisis that did not involve some temporary 
short-term increase in borrowing. But at the time that we 
proposed and, again, the President proposed and he acknowledged 
that we were going to have to bring this deficit down over time 
and that's what we're going to do with the Congress, it is 
going to be difficult to do, and it is going to be important to 
do, because, again, we are going to find that recovery will be 
weaker, private investment will be weaker, interest rates will 
be higher unless we are able to convince people that we're 
going to have the will and ability to do that.

                      FINANCIAL REGULATORY REFORM

    Senator Tester. Okay. Too-big-to-fail. It can't be an 
option in any industry and I think we may be there in energy 
and we may be there in food systems. We are absolutely there in 
the banking industry. How do we fix it? Do we fix it with 
regulation? How do we fix it?
    Secretary Geithner. I think there are, I would just mention 
a few things and they will be the core of what the President 
lays out soon.
    First, you have to have better design, tougher constraints 
on leverage, on risk taking in the core parts of the system. 
You have to have better oversight of the central markets like 
derivatives, because those are the markets that sort of effect 
whether failure is going to risk wrecking the system or whether 
failure can be absorbed and accommodated. So you need thicker 
shock absorbers in those central market, too.
    You need resolution authority, as I said in response to 
Senator Bond's comments, that allows us to deal with the 
perspective failure of a large complex institution like AIG. 
Those are some of the things you need.
    And I would just make one observation, Senator, just to 
show how hard and complex this is. It's not just the size. And 
in some ways size is not the most important factor. It is the 
role the firm plays in the system, how connected it is, what 
impact its failure has. And you've had, in this crisis, what 
are not the largest institution in the world, present the risk 
of catastrophic damage because of how interconnected they are.
    So, better capital applied across the system to limit scale 
of leverage, much better oversight and shock absorbers in the 
central infrastructure to limit the risk of damage caused by 
failure and better resolution tools.
    Senator Tester. Okay. I want to step back, step back for 
just a second. Neel Kashkari said that that the big guys had an 
advantage over the community banks in particular, because of 
their access to credit due mainly to TARP, I would imagine. Do 
you think that they have an unfair advantage and----
    Secretary Geithner. I don't, I don't--you know, we have 
9,000 banks in this country. I expect that, 10 years from now, 
we will still have a financial system, and it is very important 
that we have a financial system, that has thousands and 
thousands of small community banks operating across the 
country. I think that makes our system more resilient and 
stronger and I think this crisis would have been worse without 
that. And one of the importance of the reforms that we are 
going to layout is to make sure that large institutions have 
constraints on leverage that are appropriate, given their scale 
and risk. And that will help offset some of the potential 
concerns you raised about a level playing field for community 
banks.
    Senator Tester. Thank you very much.

              FINANCIAL PRODUCT SAFETY COMMISSION PROPOSAL

    Senator Durbin. Mr. Secretary, I was glad the President 
announced the support for the concept of a Financial Product 
Safety Commission. I first introduced that bill in March and I 
think that to have an agency charged with protecting consumers 
from predatory tricks and traps is a good idea and could have 
spared us some of the problems we are currently going through 
with prepayment penalties on mortgages, for example.
    But, in a way that is the easy part of my question. The 
tougher part gets to the heart of the issue and the heart of 
the issue would be an interest rate charge. Is there too much, 
is there an interest rate that is too high in America? Do we 
have an obligation as a country to say that certain levels of 
interest rates are unconscionable, intolerable, illegal, 
unacceptable?
    I put in a bill to put the usury rates at 36 percent 
because I thought that was so high that we would be just fine. 
As I said, if you wanted to start a snake farm, you should put 
in a usury bill and watch what crawls under your door. The 
folks that came from title loans and payday loans could sit and 
say to me, with a straight face, Senator, you're going to put 
us out of business. Thirty-six percent will put you out of 
business? Yes. I asked them how much do you charge for loans? 
Oh, somewhere between 58 percent and 800 percent. People used 
to go to prison, they called it juice in the old days, when 
people were engaged in that sort of thing, you know, in the 
back alleys. Now it is acceptable, legal in this country.
    Is there, should there be a consideration about limiting 
interest rates charged for certain products in America?
    Secretary Geithner. Senator, I believe that we have to have 
a much stronger set of protections for consumers, particularly 
in the area of financial products that involve debt and credit. 
Those were where the failures were the most stark and I think 
it is going to require more than institutional and I agree with 
you, just establishing a commission doesn't, it just doesn't--
it may be necessary but it is not sufficient.
    So, I think you need to have stronger protections. I think 
the credit card reform bill is a good step, but it is a not a 
sufficient step. And we're going to propose what we believe and 
the President believes is a necessary set of much stronger 
protections.
    Now, I understand your, the reason why you're supportive of 
a cap on interest rates. You have been exposed to a lot of the 
concerns on the other side of that, in terms of that would have 
unintended effects, in terms of denying people the rights to 
some forms of credit. I think you're right, it's sort of hard 
to make the case as to why some of those products are necessary 
or desirable, but I do not believe that those caps are a 
necessary part of a strong, credible consumer protection 
regime. And what I suggest is, I hope that when we lay out our 
proposals, we will have a chance to look at those and talk to 
you about whether those go far enough to meet your concerns.

                               USURY CAP

    Senator Durbin. Can I ask you to also consider the 
following? If we can't sell the notion of a usury cap, 
shouldn't we prevail upon institutions? I mean, credit unions 
have been coming to me for over two decades saying we're 
different, we're not greedy like banks, we're just trying to 
serve our little group of people that save there and we loan to 
them.
    Shouldn't we be talking about making credit available to 
the poor people who are lured into these payday loans and title 
loans? Have credit available in lower amounts at reasonable 
interest rates so that these people are not exploited? I just 
don't think we can continue to look the other way. I have 
challenged the credit unions to do it, they haven't responded.
    But perhaps the banks bear some responsibility here. If we 
are going to have credit available for people who are truly 
struggling in this economy, why do we throw them to the wolves 
with these payday loans and title loans?
    Secretary Geithner. I agree. I think people who have spent 
their lives, like you, thinking about these issues believe that 
an important part of the solution is to make sure that all our 
citizens feel that they have the capacity to be part of the 
broader financial system that has these protections. And one 
step toward the objective you laid out is to make sure that 
they have bank accounts, have a relationship that allows them 
access credit which is going to be on forms where they are less 
vulnerable--I think that's an important thing.
    The President's nominee for Assistant Secretary for 
Financial Institutions at the Treasury, his name is Michael 
Barr, has spent his life's work on these kinds of questions and 
he is one of the more thoughtful people in the country thinking 
about to bring about reform in those areas.
    Senator Durbin. Thank you. Senator Collins.

                           REGULATORY REFORM

    Senator Collins. Thank you, Mr. Chairman.
    Mr. Secretary, another issue that keeps coming up is 
regulatory shopping. In other words, financial institutions 
will figure out which regulator gives them the most advantages. 
I saw this on the State level 20 years ago where we would have 
a financial institution come in and threaten to switch to a 
Federal charter because our audits were too tough or our 
consumer protections were too strong.
    I don't think that it's a coincidence that AIG bought a 
small federally chartered thrift, or established a small 
federally chartered thrift, in order to get under the 
regulation of the Office of Thrift Supervision, OTS, which is 
generally viewed as being a weaker regulator than the 
Comptroller of the Currency.
    Are you looking, as part of your reforms, on combining the 
OTS with the OCC? That's what my bill does. And needless to 
say, I think it's a brilliant idea and needs to be done.
    Secretary Geithner. Senator, you're absolutely right that 
one of those things that helped produce this crisis was that, 
in our country, we allowed people to choose their regulator, to 
put risk in areas where they thought it was going to be least 
well-regulated, and that level of unevenness in the basic 
standards and protections in our system proved tragically 
damaging to the stability of our system. And fixing that will 
be critically important.
    And, as part of that, we are looking at the areas in our 
system where we are most vulnerable to that kind of shopping 
for regulators and regulatory arbitrage. You pointed out one 
example, and I think it is one the more compelling examples, of 
that failure and weakness in our system. But just to say that 
we're looking beyond that. Of course, we're looking at that, 
but we know that this is something that we need to do globally, 
too. Because we need to make sure that we're not vulnerable in 
the future to risks if we get the standards better here, risks 
just moving offshore to other areas where there is still risk 
to our system. So, we want to have a level playing field, more 
conservatively set, more evenly enforced across the U.S. 
financial system. And we want to try to bring the world to 
those higher standards as well.
    Senator Collins. You know, you also made an excellent point 
when you talked about the excessive leverage in the system. I 
think when Bear Stearns failed, its leverage ratio was an 
astonishing 30:1. That's something that never would have been 
allowed to happen under our regulatory process for a small 
community bank or a credit union.
    So, I hope, as you look at this issue, that we're going to 
be establishing safety and soundness requirements regardless of 
the type of institution. It seems to me that Bear Stearns, the 
larger investment banks, all of which have either disappeared, 
have been acquired, or no longer exist, should have been 
required to meet the same kinds of capital requirements and 
leverage ratios that we would impose upon a community bank or a 
credit union.
    Secretary Geithner. Senator, I have a lot of sympathy for 
that view and I think that, again, a centerpiece of what we 
need to do for this country is to make sure there are more 
conservative, better designed constraints on leverage applied 
more evenly across those institutions that play a critical role 
in how our markets function, both in normal times and in 
distress.
    Now, it is true that, in the United States, we were 
fortunate to have, across the banking system, a very simple, 
easily enforceable, crude constraint on leverage. And for that 
reason, in many ways our financial troubles today are much less 
acute than they are for countries around the world where that 
kind of constraint did not exist.
    So just an example, banking assets in our country today 
about one times gross domestic product (GDP). They are between 
two and eight times GDP across Europe. In part because they did 
not have in place that kind of simple, crude constraint on 
leverage. So, you are right. That is an important part of the 
reform. We want to have, as I say, thicker shock absorbers in 
the system, thicker cushions of capital against risk, that are 
more simple, more evenly enforced, and are less pro-cyclical, 
you know, that they dampen future crises rather than amplify 
them. And that would be a part of what we propose.
    Now, I want to just say that these are things that--these 
are very complicated things. Of course, we want to get them 
right. And we are going to go through a very careful process to 
bring experts together and thinking about what the right mix of 
those constraints are so that we have them in place before we 
start to see the seeds of next boom.
    Senator Collins. If you haven't already looked at them, I 
would encourage you to look at the Canadian and the Australian 
twin peaks system, which I think also have benefits to them.
    Canada has not had the kind of financial crisis that we've 
had, and it is very interesting to look at the differences in 
their regulatory structure, their mortgage lending, and their 
tax deductions. It's fascinating to look at those differences 
and then look at the results.
    My time has expired, so I am going to submit for the 
record, with the chairman's permission, some questions on our 
debt level because I wasn't able to get to that important issue 
today.
    Thank you.
    Senator Durbin. Of course, Senator Collins, your questions 
will be submitted for the Secretary, along with others, for him 
to consider.
    The last question will come from an organic farmer from 
Montana, Senator Tester.

                   STRESS TESTS AND ECONOMIC RECOVERY

    Senator Tester. Thanks, Mr. Chairman. The Congressional 
Oversight Board issued a report this morning stating that 
additional stress tests may be necessary due to uncertain 
economic conditions. What are your thoughts on that?
    Secretary Geithner. Yeah. I haven't had a chance to look at 
the report, but of course I'll look at it and read it. But I 
did see some of the initial coverage of the report.
    I think I should say that--just two things. The process was 
designed by the Federal Reserve, it was a very conservative 
test. And I want to cite one example. People are focused, like 
the Congressional Oversight Board did, on the unemployment 
assumptions in the initial scenarios. Those were not the 
binding constraint. The loss estimates that the Fed used for 
its estimate were more conservative than the worst 2 year 
period in the Great Depression, when unemployment was in the 
high 20s, 30s for a period of time. Those were the ones, those 
were the parts of that test where the--those were the ones that 
were most important.
    I think it was a reasonably conservative and, in some ways, 
the best test of that was that, in the wake of that conclusion 
of those results, we've seen a very, very substantial amount of 
equity come back into the financial system because it provided 
a level of clarity and disclosure about balance sheets that did 
not exist before. And I think that's a good test.
    Now, markets don't get everything right and, you know, 
we're still going through a deep recession and we are at the 
early stage of repair and recovery. Life is uncertain and there 
are risks ahead. But I think it was a very carefully designed 
conserve test and it has helped play an important role in 
improving confidence in the system.

               REFORMING GOVERNMENT SPONSORED ENTERPRISES

    Senator Tester. Okay. The administration, you've referenced 
it several times, is going to be sending out a plan for 
Congress on modernization and regulation for financial markets. 
Will there be a recommendation for Freddie Mac and Fannie Mae?
    Secretary Geithner. The future of the GSEs, including 
Fannie and Freddie, will be an important, is an important 
challenge for us, but we are not going to--I'm violating my 
rule of getting ahead of the President, we're not going to 
recommend, in our initial proposals for reform, precisely what 
we think the future of those issues should be.
    We are going to begin the process of consulting with 
Congress and a broad section of housing experts on what we 
think the range of options are. But we are going to defer 
recommendations on those things for a bit longer.
    Senator Tester. Okay. Can you give me any kind of timeframe 
that you're looking at?
    Secretary Geithner. I can't yet, but we probably will next 
week when we lay it out. But it's just a little early, just 
given the scale of the stuff that we are going to get to take 
on. We want to do this carefully.
    Senator Tester. No problem. Thank you.
    Senator Durbin. Mr. Secretary, thank you for your time here 
today. We are going to allow you to leave, of course, and go 
about your business of saving the American economy, or lunch. 
Whatever is on your schedule.

                     ADDITIONAL COMMITTEE QUESTIONS

    But we thank you very much for being here. We'll send you 
some questions that you might consider and, while we're 
changing witnesses here. Mr. Shulman is going to come up here, 
the IRS always has the last word. We will let him take the 
table.
    Secretary Geithner. Thank you. He is doing a great job and 
I hope you will give him the support he needs.
    [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

                          DEPARTMENTAL OFFICES

    Question. Secretary Geithner's testimony stated that the Treasury 
Department will be reducing costs by cutting the number of the 
Department's economic attaches from 20 to 16.
    During this global economic crisis, why has the Department 
requested to eliminate staff tasked with communicating with our 
international economic partners?
    Answer. The Department is working daily to address the current 
economic problems and ensure the quickest path to recovery. The fiscal 
year 2010 budget for the Departmental Offices will improve the 
analytical capabilities at the Department to address these challenges 
while also maintaining fiscal responsibility. We looked to offset some 
of the proposed increases in the Office of Domestic Finance and the 
Office of Tax Policy by identifying savings in the attache program. The 
reallocation of resources will not negatively impact our long-term 
missions.
    Treasury places great value on its international attache presence, 
which helps advance Treasury priorities across a broad range of issues. 
Indeed, the attache program has grown from 8 attaches in April 2007 to 
the 15 attaches currently in the field. Nonetheless, the five attache 
posts in question are currently vacant. By extending the vacancies in 
the four posts in question, Treasury can help free up funding for 
programs focused on the domestic economic situation. We will continue 
to actively communicate with our international partners through our 
existing 15 attaches posted around the world, and we remain committed 
to working with our existing staff and other Executive Branch agencies 
to promote and support economic prosperity at home and abroad.
    Question. The fiscal year 2009 omnibus provided $6.2 million for a 
new Operations Center to provide the Department with a 24/7 capability 
to monitor the global market.
    What is the current status and timetable for full functionality of 
the Center?
    Do you agree with the previous Administration that this 24/7 
capability will enhance Treasury's responsiveness to global partners 
and to financial crises?
    Answer. The Department does support the development of an 
Operations Center. Construction of the Operations Center is set to 
start at the end of September with phase 1 (24/7 call center ops).
    Phase 2, which is ongoing, is to reassess the requirements for the 
Treasury Markets Room in light of the evolving mission of Treasury 
related to financial stability and economic recovery requirements. In 
this context, we are also refining the interaction between the Markets 
Room staff, the executive communications support team, and the 
emergency planning team. Since the original concept of the Treasury 
Operations Center was developed in 2007, prior to the 2008 financial 
crisis and the onset of the recession, Treasury leadership has been 
working to leverage investments in the Operations Center to full 
effect. To do so, we are refining the capabilities needed in the areas 
of financial markets and economic policy analysis as a result of 
financial stability and economic recovery initiatives. Results of this 
assessment will be completed this fall and will inform decisions 
related to staffing and organizational alignment of the Markets Room.
    Phase 3 will reassess the coordination and interaction between the 
Treasury Operations Center and the Intelligence Operations Center. 
Phase 3 should not require additional resources.

                COMMITTEE ON FOREIGN INVESTMENT (CFIUS)

    Question. The Department has seen a significant increase in its 
CFIUS caseload over the last several years. The fiscal year 2009 
omnibus provided additional funds for CIFIUS to address the growing 
backlog of cases.
    To what extent have the additional funds allowed CFIUS to make 
progress in clearing out the backlog of cases?
    Has the caseload dropped off significantly due to the economic 
crisis?
    Answer. Treasury has utilized additional funding to increase 
critically needed staffing for CFIUS to handle the significant increase 
in caseload over the last several years. The number of covered 
transactions reviewed by CFIUS nearly tripled between 2005, when 64 
notices were filed, and 2008, when 155 notices were received. Because 
of the statutory timelines for CFIUS reviews (30 days) and 
investigations (45 days), cases cannot accumulate in a backlog but must 
be reviewed within those required periods regardless of the transaction 
volume at any particular time. This is why adequate staffing to fully 
review each case for potential national security concerns is essential. 
Although there was a decline in the number of cases during the economic 
crisis of recent months, the number of anticipated cases in the 
pipeline has begun to rise. We expect that case volumes will return to 
levels of recent years when merger and acquisition activity picks up 
with economic growth.

                OFFICE OF FOREIGN ASSETS CONTROL (OFAC)

    Question. Building on the lifting of certain travel and trade 
restrictions included in the fiscal year 2009 omnibus, President Obama 
has committed to further opening trade and communication with Cuba.
    What is the economic potential in agricultural trade between the 
United States and Cuba if all agriculture trade restrictions are 
lifted?
    How does that compare to the level of agricultural trade today?
    Answer. The Census Department reports that goods trade between the 
United States and Cuba since 2000 has been as follows:

                       U.S. GOODS TRADE WITH CUBA
                       [Millions of 2008 dollars]
------------------------------------------------------------------------
                                                  Exports      Imports
------------------------------------------------------------------------
2000..........................................          8.8          0.4
2001..........................................          8.8  ...........
2002..........................................        174.6          0.2
2003..........................................        303.2          0.4
2004..........................................        460.6  ...........
2005..........................................        406.8  ...........
2006..........................................        363.6          0.1
2007..........................................        464.3          0.3
2008..........................................        711.5  ...........
1Q09..........................................        182.5  ...........
------------------------------------------------------------------------
Source: http://www.census.gov/foreign-trade/balance/c2390.html#2000.

    The Trade Sanctions Reform and Export Enhancement Act of 2000 or 
TSRA allows sales of agricultural commodities to Cuba, while 
prohibiting U.S. government assistance, foreign assistance, export 
assistance, credits, or credit guarantees for purposes of financing 
such exports. TSRA also denies exporters access to U.S. private 
commercial financing or credit; all transactions must be conducted with 
cash in advance or with financing from third countries.
    We do not have an estimate of the potential increase in 
agricultural trade with Cuba if remaining trade restrictions are 
lifted. A July 2007 report by the International Trade Commission 
estimated that the U.S. share of Cuban agricultural, fish and forest 
imports would increase if financing restrictions were lifted.
    Question. In April of 2009, President Obama announced his intent to 
allow U.S. telecommunications network providers to provide phone and 
internet services in Cuba. However, the Cuban government would have to 
allow the presence of U.S. providers in Cuba for U.S. companies to 
enter the Cuban market, and it is unclear if or when that approval will 
occur.
    How do you plan to pursue persuading the Cuban government to accept 
the operation of U.S. telecommunications companies in Cuba?
    Answer. While Treasury is responsible for implementing and 
enforcing the Cuba Sanctions program, this question is more 
appropriately addressed to the Departments of State and Commerce. This 
would likely be part of a larger dialogue between the United States and 
Cuban governments over diplomatic and trade issues.

        COMMUNITY DEVELOPMENT FINANCIAL INSTITUTIONS (CDFI) FUND

    Question. Like a lot of individuals and businesses, CDFIs are 
having trouble finding financing in this economy. The budget proposes 
to continue a provision in the Recovery Act that temporarily waives the 
matching fund requirement for CDFIs.
    How much of the requested budget increase will fill in the gaps 
left open by the decrease in private financing, and how much will 
actually go toward expanding the reach of CDFI funds?
    Answer. Treasury estimates that private sector capital 
contributions to CDFIs will decline by at least $125 million in fiscal 
year 2010. The requested increase of $136.6 million, or a 127 percent 
increase in fiscal year 2010 for the CDFI Fund, which includes $80 
million for the new Capital Magnet Fund and $113.6 million for the CDFI 
Program, will provide considerable support to CDFI industry. The 
request also includes additional funding to support a more robust 
research and evaluation program and the implementation of operational 
improvements.
    Treasury believes that 100 percent of its CDFI Program award 
dollars allow CDFIs to expand their reach by: (i) introducing new 
financial product offerings; (ii) expanding their geographic service 
areas; and/or (iii) increasing the number of customers served.
    Question. When does the Department project that CDFIs will be able 
to once again secure sufficient private funding so that Congress can 
reinstitute the matching funds requirement?
    Answer. With the onset of the financial crisis in 2008, and 
resulting mergers among major banks, CDFIs have experienced severe 
reductions in capital contributions and investments by the major 
depository institutions in the CDFIs over the last 2 years, as well as 
significant reductions in philanthropic contributions. Declining 
capital contributions from depository institutions, corporations, and 
philanthropic institutions (amounting to a decrease of at least $125 
million in private sector investments in 2010) necessitate a matching 
funds waiver for fiscal year 2010. Treasury is hopeful that conditions 
in the market will change significantly such that the matching fund 
requirements can be reinstated in full in fiscal year 2011. The 2010 
budget requested a waiver only through 2010.
    Question. Even without the matching funds requirement, CDFI grants 
generally only make up part of the financing package for projects such 
as housing units and community centers.
    Considering the economic downturn, is there enough demand from 
high-quality CDFIs to spend the additional funds requested in fiscal 
year 2010?
    Answer. CDFIs have seen a huge increase in loan applications since 
the current economic crisis began from both existing customers and 
customers who had been working with regulated financial institutions. 
Also, many CDFIs are developing neighborhood stabilization programs 
which entail housing and neighborhood rehabilitation, including 
community services. Finally, there is continuing demand for small 
business financing in neighborhoods that are heavily impacted by 
foreclosures and high vacancy rates.
    Given this tremendous need for capital, Treasury believes that the 
$90 million in Recovery Act funding and $113.6 million requested in 
fiscal year 2010 will provide significant support to qualified CDFI 
Program applicants. Including the additional Recovery Act resources, 
the CDFI Fund will make approximately 90 awards totaling $145 million 
through the CDFI Program.

                          CAPITAL MAGNET FUND

    Question. The fiscal year 2010 budget requests an $80 million 
appropriation to jump start the Capital Magnet Fund. The Capital Magnet 
Fund will be much like the CDFI program but will focus exclusively on 
the development of affordable housing. When the Capital Magnet Fund was 
created, Fannie Mae and Freddie Mac were required to provide revenues 
to the fund. However, the program has not been started because Fannie 
Mae and Freddie Mac are not currently in a financial position to allow 
them to make any contributions.
    Considering the start-up time needed to administer a new program, 
how soon will Capital Magnet Fund grants be disbursed?
    Answer. In March 2009, the CDFI Fund solicited public comments 
regarding the design and implementation of the Capital Magnet Fund 
(CMF). Over the next several months, the CDFI Fund will develop 
proposed regulations, the Notice of Funding Availability (NOFA) for a 
fiscal year 2010 funding round, a funding application, standard 
operating procedures for application review and awardee compliance/
performance monitoring, and related automated systems. The CDFI Fund's 
goals are to publish the NOFA and solicit applications in the spring of 
2010 and to make CMF award announcements in the summer of 2010.
    Question. Please describe the major differences between the CDFI 
Fund and the Capital Magnet Fund.
    Answer. The CMF is similar to the CDFI Program, and consistent with 
the CDFI Fund's core mission, in that it provides capital to 
organizations to support their financing activities, rather than 
providing subsidies for specific projects or units, as is the case with 
most other Federal housing programs (e.g., Hope VI; Low-Income Housing 
Tax Credit; Section Eight). However, there are several differences 
between the CMF and the CDFI Program:
  --The CMF targets a broader pool of applicants than the CDFI Program. 
        CMF funding is available to CDFIs and to other nonprofits, 
        whereas CDFI Program financial assistance is only available to 
        CDFIs.
  --The size of CMF awards is expected to be much larger than CDFI 
        Program awards. CDFI Program award requests have been capped at 
        $2 million per application, and award amounts have actually 
        been lower (averaging $1 million per applicant in the fiscal 
        year 2008 funding round). By contrast, with an $80 million 
        appropriation, the CDFI Fund anticipates that it can make CMF 
        awards in much larger amounts.
  --CMF awards may only be used to attract private capital to finance 
        the development, rehabilitation, preservation, and purchase of 
        housing that is affordable to low-, very low, and extremely 
        low-income households, and related economic development 
        activities. Thus, the CMF fulfills a distinct need for flexible 
        and innovative affordable housing financing such as: pre-
        development grants and loans; loan guarantees; loan loss 
        reserves; project equity; subordinated gap financing and bridge 
        loans. CDFI Program awards may be used for a broader range of 
        activities including, among others: business and 
        microenterprise lending; consumer lending; the provision of 
        financial services; and CDFI capacity building.
    Question. The Treasury Department is currently overseeing the 
management of Fannie Mae and Freddie Mac.
    When does Treasury project that Fannie Mae and Freddie Mac will 
become healthy enough to begin the mandatory payments into the Capital 
Magnet Fund?
    Answer. The Federal Housing Finance Agency (FHFA) placed Fannie Mae 
and Freddie Mac into conservatorship on September 7, 2008, and as 
conservator is responsible for overseeing the management of Fannie Mae 
and Freddie Mac. Consistent with its responsibilities as conservator, 
FHFA suspended the required Housing and Economic Recovery Act of 2008 
contributions (which include the Capital Magnet Fund) by Fannie Mae and 
Freddie Mac in view of their losses and draws on the Treasury 
Department's Senior Preferred Stock Purchase facility. The ability of 
Fannie Mae and Freddie Mac to begin making these contributions will 
depend on an improvement in their overall financial condition, which is 
closely tied to overall conditions in the housing market.

             FINANCIAL CRIMES ENFORCEMENT NETWORK (FINCEN)

    Question. The fiscal year 2009 omnibus provided an $865,000 
increase for FinCEN to strengthen its global efforts to combat 
terrorist financing and money laundering, including for addressing a 
large case backlog. FinCEN's work in this area is expanding as the 
global financial intelligence community grows. For example, in May of 
2009, the Egmont group, the international organization of Financial 
Intelligence Units, added nine new members, including Saudi Arabia and 
Sri Lanka.
    Why does the budget request decline to include additional funding 
to continue to enhance the capacity of FinCEN to communicate and 
coordinate with other Financial Intelligence Units around the globe?
    Answer. FinCEN continues to work with FIUs around the world to 
expand and enhance global financial intelligence sharing initiatives 
aimed at combating transnational crime threats facing U.S. financial 
markets. FinCEN's information exchanges and case support workload to 
support the growing number of FIUs continues to grow.
    This is very important work and continues to be a priority for the 
Department, however, we are operating in a tight fiscal environment 
with many competing priorities. The President's budget maintains the 
level of staff and other resources supporting FinCEN's work with 
international partners; it also invests in FinCEN's IT Modernization 
effort, which will improve data integrity and better equip FinCEN 
analysts to provide accurate, complete and timely responses to 
requests.
    Question. The President's fiscal year 2010 budget requests $10 
million to fund an upgrade to the information technology (IT) system 
used for financial reporting under the Bank Secrecy Act. In July 2006, 
FinCEN halted work on BSA Direct, the previous attempt to upgrade its 
IT systems. Treasury spent 2 years of planning and invested $14.4 
million in that failed system.
    What lessons were learned from the previous attempt to replace 
FinCEN's IT systems?
    Answer. An independent review of the BSA Direct program identified 
several key factors that played a part in its failure. The most 
critical of these were: unclear project scope and requirements; 
inadequate program governance; and a lack of demonstrated project 
management experience (both Government and Contractor).
    FinCEN has been diligent in resolving all of these factors, as well 
as taking additional steps necessary to develop a solid foundational 
approach to assure the success of the new BSA IT Modernization 
initiative. Over the last 3 years, FinCEN has developed a comprehensive 
IT Modernization Vision and Strategy that identifies the scope of what 
is required to meet customer needs; an Enterprise Transition Strategy 
that outlines the high level plan for how we plan to accomplish the 
initiative; and employed a System Development Lifecycle, based on a 
model that has been successful within the IRS, to execute and monitor 
the program. FinCEN has committed to transparency and active engagement 
of internal/external stakeholders, working through the Bank Secrecy Act 
Advisory Group (BSAAG) and establishing an active partnership with the 
IRS at both an operational and strategic level. Further, we are 
currently working to establish a project plan that will allow the IT 
Modernization effort to be accomplished in the most cost-effective 
manner.
    Finally, and to address the most critical lesson learned, Treasury 
has emphatically addressed the issue of program governance. FinCEN has 
collaborated with the Department and IRS to establish proper governance 
and oversight for the BSA IT Modernization initiative. In 2008, the 
Modernization Executive Group (MEG) was created and currently serves as 
the highest level, integrated governing body in support of BSA 
information management and is tri-chaired by the Treasury Chief 
Information Officer, the IRS Deputy Commissioner, and the FinCEN 
Director. The MEG established an Executive Steering Committee, 
comprised of senior Departmental, IRS and FinCEN business and technical 
representatives, to provide oversight and guidance to the Modernization 
program. FinCEN also has a new bureau-wide Project Management Office 
and an IT-specific Modernization Management Office to ensure the day-
to-day project controls are in place for successful execution of its IT 
Strategy. Finally, this initiative was discussed and endorsed as a 
Departmental priority by the Treasury Department's Executive Investment 
Review Board, consisting of representatives of all Treasury components 
for the purpose of providing executive direction and review of 
significant Treasury IT projects.
    Question. What improvements has FinCEN made to the planning and 
implementation process that will avoid problems that plagued the 
previous failed upgrade?
    Answer. FinCEN has established the organization's first enterprise 
business transformation and IT modernization strategy (the BSA IT 
Modernization Vision & Strategy), which serves as the roadmap for 
aligning FinCEN's IT portfolio with business objectives and processes. 
The bureau has also leveraged the IRS Enterprise Life Cycle to develop 
a System Development Life Cycle (SDLC) to ensure a robust, repeatable 
process is in place to manage the projects and overall program efforts 
required to modernize its IT environment. As part of the SDLC, the 
Executive Steering Committee must approve the results of each phase of 
the life cycle before FinCEN can move to the next phase.
    Since fiscal year 2007, FinCEN has hired six seasoned managers from 
industry, Department of Defense, and other Federal Agencies to oversee 
the Technology Solutions and Services Division (TSSD), establishing an 
entirely new senior management team supporting IT. The Chief 
Information Officer and new TSSD management team have extensive 
experience in managing large information technology programs and IT 
Modernization efforts, as well as years of hands-on experience in 
acquisition. Over the past 2 years, TSSD has elevated all critical 
Contracting Officers Technical Representatives (COTRs) responsibilities 
to the new senior staff, while also ensuring each COTR holds the 
requisite Federal Acquisition Certification for COTRs (FAC-COTR). The 
manager responsible for overall program control is a certified Project 
Management Professional from the Project Management Institute and is 
currently undergoing the necessary steps to obtain the Federal 
Acquisition Certification for PM's (FAC-PM) for FinCEN's major IT 
investment (BSA IT Modernization).
    In addition to ensuring the appropriate planning and execution 
processes are in place, establishing appropriate governance and 
oversight, and incorporating an entirely new management team, we are 
continuously involving both our internal and external stakeholders to 
ensure successful project implementation.
    Question. How does FinCEN plan to involve the wide variety of 
stakeholders in the planning for this IT overhaul--including banks, 
federal law enforcement, state and local law enforcement, and other 
federal intelligence agencies?
    Answer. FinCEN has engaged its internal stakeholders by 
establishing a Cross-FinCEN Integrated Product Team (IPT) made up of 
representatives from each FinCEN Office (Regulatory/Policy, Analytics/
Liaison, International, Office of Counsel, and Management Programs). 
The Data Management Program and Data Management Council (DMC), which is 
comprised of Federal law enforcement and regulatory members, were 
established to engage FinCEN's government stakeholders. These two 
entities have participated in the identification and validation of BSA 
capabilities and requirements. In addition, FinCEN plans to engage the 
IPT and DMC continuously through the modernization initiatives in such 
System Development Life Cycle activities as user acceptance testing, 
training, and communications. When appropriate, FinCEN will also 
leverage the BSA Advisory Group, comprised of Federal representatives 
as well as financial institutions, for feedback pertaining to the 
impacts of the Modernization on their respective user communities. 
Finally, these processes will ensure this investment is leveraged in 
the most efficient manner possible by incorporating the common needs of 
the over 300 agencies at the Federal, State, and local levels that 
depend upon the system.

                       TREASURY INSPECTOR GENERAL

    Question. The recent increase in bank failures has forced the 
Treasury Inspector General to defer much of its routine but important 
audit and investigative work in order to meet its statutory 
responsibility to review certain bank failures. For fiscal year 2009, 
Congress provided $26.1 million for the Treasury Inspector General, a 
$7.6 million increase compared to the fiscal year 2008 level, so that 
staff could return focus on critical audit and investigative work. 
However, the budget proposes an increase of just $575,000 over the 
fiscal year 2009 enacted level.
    Considering that analysts anticipate that a significant number of 
bank failures will occur in fiscal year 2010 and over the next several 
years, without a larger funding increase, how would the Treasury 
Inspector General's office be able to fully maintain its oversight work 
while conducting these critical bank reviews?
    Answer. Based on the best information we have to date, we believe 
that the fiscal year 2010 budget request is sufficient for the OIG to 
meet its responsibilities, including material reviews. The fiscal year 
2010 request allows the OIG to retain the larger workforce that was 
approved for fiscal year 2009, an increase of 39 FTEs, or nearly 34 
percent, over the fiscal year 2008 level. We will continue to monitor 
OIG workload and seek additional resources if necessary.

             ALCOHOL AND TOBACCO TAX AND TRADE BUREAU (TTB)

    Question. The fiscal year 2010 budget proposes to charge producers, 
wholesalers, and retailers of beer, wine, and distilled spirits annual 
regulatory fees. These fees would offset the operating costs of TTB.
    What impact would these new fees have on the industry?
    Answer. Revenue from the proposed ongoing permanent ``licensing and 
registration fee'' starting in fiscal year 2010 would support the 
bureau's mission. Members of the alcohol industry (including retailers, 
wholesalers, breweries, wineries, distilleries, and industrial alcohol 
businesses) would pay fees ranging from $300 to $1,000, depending on 
the type and size of the business entity. Revenue in the first year, 
from annual estimated offsetting receipt collections would start out 
low, but grow in subsequent years to eventually offset the annual 
operating costs of TTB (currently around $100 million).
    Annual fees are shown in the table below. A licensing and 
registration fee of $300 from over 350,000 retailers will generate an 
estimated 90 percent of the yearly revenue collected, while the 
remaining 10 percent would be collected from wholesalers and alcohol 
producers. TTB currently collects over $7 billion in federal excise 
taxes from alcohol producers.
    The licensing/registration fee would shift the burden of paying for 
regulation of the alcohol industry from the general public to 
consumers, producers, wholesalers, and retailers of alcohol beverages.
Annual Fee Requirement
    The annual fees to be charged under this program are as follows:

------------------------------------------------------------------------
                                                                 Amount
------------------------------------------------------------------------
Retailer Dealers in Liquors and Beer.........................       $300
Wholesaler Dealers in Liquors and Beer.......................        500
Alcohol Producers............................................      1,000
    Distilled Spirits Plant \1\
    Bonded Wine Cellar \1\
    Bonded Wine Warehouse \1\
    Tax paid Wine Bottling House \1\
Every Brewer \1\.............................................      1,000
Denatured Spirits, Recovery and Tax Free Users (Industrial           300
 Alcohol)....................................................
Non-beverage Domestic Drawback Claimants.....................        500
------------------------------------------------------------------------
\1\ Reduced fees by substituting ``$500'' for ``$1,000'' if gross
  receipts are less than $500.
$500,000 for the most recent taxable year before the 1st day of the
  taxable period.
Certain exemptions and exceptions of the annual fee may apply to the
  certain business as outlined under the legislative proposal.

                  TROUBLED ASSET RELIEF PROGRAM (TARP)

    Question. TARP places strict limitations on compensation for 
executives of companies receiving financial assistance from the federal 
government, and the Recovery Act strengthened those restrictions after 
weaknesses in the original TARP restrictions emerged. GAO reports that 
Treasury has been working to increase oversight and compliance with 
executive compensation restrictions, including the new provisions 
included in the Recovery Act.
    Please provide an update on the steps Treasury is taking to 
institute a clear, robust process to monitor compliance with the 
executive compensation restrictions.
    Answer. On June 15, 2009, Treasury published an Interim Final Rule 
(``IFR'') entitled ``TARP Standards for Compensation and Corporate 
Governance'' that implements the executive compensation provisions of 
the Recovery Act. The IFR sets forth detailed restrictions on executive 
compensation applicable to TARP recipients, as well as periodic 
reporting and certification requirements and other procedures for 
monitoring compliance. The IFR also provides for the appointment of a 
Special Master, who has the responsibility to (i) review and approve 
the compensation of each of the 25 most highly compensated employees of 
each TARP recipient that has received exceptional assistance, (ii) 
review and approve the compensation plans applicable to the next 75 
most highly compensated employees of each such TARP recipient, (iii) 
review prior compensation paid to Senior Executive Officers by TARP 
recipients and negotiate the return of any payments that are found to 
have been contrary to the public interest, and (iv) issue interpretive 
guidance under the rule. All TARP recipients will be required to submit 
detailed compensation information in order to facilitate the review 
process.
    Question. In light of criticism that Treasury was not requiring 
institutions receiving TARP funds to provide detailed reports on their 
use of taxpayer dollars, Treasury has required that all participants in 
the Capital Purchase Program complete a monthly survey of lending 
activities. Treasury has declined to seek any further details on any 
TARP recipients' use of funds, with the exception of Citigroup and Bank 
of America, citing that such data would not be useful and would be 
difficult to gather.
    However, the Special Inspector General for TARP sought more 
detailed data from over 350 TARP recipients and found that banks were, 
in fact, able to provide a reasonable level of detail on their use of 
funds. The IG reported: ``. . . one thing is clear: Treasury's 
arguments that such an accounting was impractical, impossible, or a 
waste of time because of the inherent fungibility of money were 
unfounded.''
    Why has Treasury declined to require more detailed reporting from 
TARP beneficiaries?
    Answer. It is important to distinguish between Treasury's capital-
enhancement programs and its other programs. The Capital Purchase 
Program, Capital Assistance Program and institution-specific programs 
for AIG, Citigroup and Bank of America are designed to provide capital 
to cushion against losses and allow financial institutions to continue 
operating in the ordinary course of business, including lending to 
consumers and businesses. In order to serve its purpose, capital must 
be available for any legitimate business purpose. Although Treasury 
requires applicants for the Capital Assistance Program to specify how 
they intend to use the funds, accounting for actual use of particular 
dollars invested as capital is not a meaningful exercise and therefore 
not required. Because banks' double-entry bookkeeping systems do not 
trace the paths from creating liabilities (receiving capital) to 
investing in assets (making loans), we cannot precisely attribute the 
contribution of TARP capital to particular uses. The banks can, 
however, report trends in loans and other uses of funds, and we do 
require that they report such to Treasury.
    On the other hand, Treasury's home ownership preservation program, 
small business lending initiative, auto industry programs, and the 
terms of Treasury's participation in the Term Asset Backed Securities 
Loan program impose specific limitations on the use of TARP funds, and 
require controls and periodic reports to insure that those limitations 
are respected.
    Question. When Congress approved TARP, the expectation was that 
TARP funds would be used to purchase toxic assets--mainly, assets 
related to subprime and other troubled mortgages. Since then, TARP has 
evolved into 12 separate programs aimed at addressing different stress 
points in the market and at rebuilding a basic lending capability for 
domestic markets. The complexity of this program has created a 
communications challenge. GAO reported in March 2009 that TARP is still 
very poorly understood by Congress and the public. GAO reports that 
Treasury has not yet developed an effective strategy for communicating 
with Congress, the public, and other stakeholders.
    How can Treasury's actions support increasing confidence in the 
financial markets if the public does not have a basic understanding of 
the goals of TARP?
    How can the Department better articulate and justify its strategy 
so that Americans and the markets can regain confidence in the economy?
    What can Treasury do to educate concerned members of the public?
    Answer. Treasury publishes a wealth of information about TARP 
investments and the activities of the Office of Financial Stability. In 
addition to transaction reports detailing every transaction, monthly 
financial reports, and tranche reports that review how each $50 billion 
of TARP funds have been spent, Treasury posts on its 
FinancialStability.gov website all program descriptions, guidelines, 
frequently asked questions and answers, contracts, press releases, and 
a variety of other information about TARP. Treasury also maintains a 
separate MakingHomeAffordable.gov website that sets forth extensive 
information about Treasury's homeownership preservation programs.
    Nevertheless, Treasury recognizes that public perceptions of TARP 
could benefit from improved communications. To that end, Treasury is in 
the process of developing and implementing an overall communications 
strategy that will include regular proactive briefings for Congress and 
the press, clearer explanations of TARP programs and OFS activities, 
discussions of progress being made in achieving program objectives, and 
expanded efforts to communicate with and educate the public about the 
goals and achievements of TARP.
    Question. Firms that repay preferred stock purchased under the TARP 
program will also have the option to repurchase warrants that Treasury 
holds at Fair Market Value.
    How is Treasury ensuring that the valuation of the warrants is 
accurate so that taxpayers get a return at fair market value?
    Answer. Treasury will ensure that taxpayers' interest are protected 
by conducting a process to determine whether to accept the bank's 
initial determination of the fair market value of the warrants. 
Treasury has developed a robust set of procedures for evaluating 
repurchase offers, based on three categories of input: market prices, 
financial modeling, and outside consultants/financial agents.
    Question. Contracts for implementing TARP include the primary, 
large contract for the asset manager, Bank of New York Mellon, as well 
as smaller contracts for tasks such as legal and accounting services. 
These contracts have for the most part been priced on a ``time and 
materials'' basis. GAO has warned that such contracts are considered 
``High Risk'' to the taxpayer dollar. This is because, unlike fixed-
price contracts, the structure of the time-and-materials contracts 
provides no incentive for the contractor to control for cost or labor 
efficiency. In a recent TARP review, GAO reported that in response to 
GAO's warning, Treasury has converted two time-and-materials contracts 
into fixed-price arrangements and is closely assessing new contracts to 
identify those that may effectively utilize a fixed-price contract.
    What do TARP officials consider when determining the appropriate 
compensation structure for new contracts?
    Is Treasury conducting a thorough, comprehensive review of all of 
its existing contracts so that more can be converted to fixed-price, 
lower-risk arrangements?
    Answer. Treasury considers the degree to which the contract 
requirements can be clearly defined to permit negotiation of a 
reasonable price. In the legal services contracts, the requirement to 
create novel, unprecedented financial structures for government 
investment in private corporations inhibits Treasury's ability to 
accurately predict the level of effort that will be required. Over 
time, as certain transactions are repeated, our ability to reasonably 
predict the level of effort increases. Treasury gathers data on the 
number of hours required to complete transactions and uses the data to 
negotiate fixed prices on a per transaction basis.
    Opportunities have been limited thus far to convert significant 
number of contracts to fixed-price due to the difficulty in estimating 
with a reasonable degree of accuracy the extent or duration of the 
required services. Due to this high degree of uncertainty, fixed-price 
arrangements may not be appropriate for many TARP contracts. Treasury 
selects appropriate contract types based on the risk to successful 
performance and the capacity to negotiate a fair and reasonable price 
for the required services. Given the still-evolving nature of TARP, and 
the challenge of reasonably forecasting the level of effort required to 
design new financial structures and execute transactions, premature 
conversion to fixed price contracts would place Treasury at risk of 
agreeing to too high a price for services rendered. Treasury is 
gathering cost data from all of its time and materials and labor hour 
contracts to identify areas where the level of effort can be reasonably 
predicted, and the costs associated with those efforts, to support the 
future negotiation of fixed pricing for follow-on work where 
appropriate.
                                 ______
                                 
               Questions Submitted by Senator Ben Nelson

    Question. While much of the focus up until recent weeks has been 
placed on the auto manufacturers, the dealerships also have much at 
stake. Considering that the Treasury has provided auto manufacturers 
with a significant amount of funding and has taken on significant 
ownership in these companies, how much of the assistance already 
provided is the Treasury prepared to allow to dealerships that have 
lost their franchise designations and have been left with few options?
    Answer. Both General Motors (GM) and Chrysler and have committed to 
operating with transparency with regard to the dealership closings. The 
plans to consolidate dealer networks were developed by each company 
over a long period of time and were a part of their overall plans to 
restructure in order to achieve financial viability. Without the funds 
provided by the Treasury Department, GM and Chrysler's entire dealer 
network might have been eviscerated. Chrysler has worked to have the 
majority of its inventory off of the rejected dealership lots. GM has 
set up an appeals process for its rejected dealers and is providing 
them with 18 months of support to allow them to dispose of their 
inventory, which GM believes should be a sufficient amount of time 
given current inventory levels.
    Question. No one disputes the importance of the domestic auto 
industry to our country and economy. Everyone understands we aren't 
only talking about the auto manufacturers. For instance in my state we 
are also talking about the dealerships, parts supplier, and a host of 
other industries that are either touched directly or indirectly by the 
auto industry.
    However, I have great concerns about the United States government 
having an open-ended ownership stake in private companies because of 
the assistance that the federal government has provided.
    What oversight is the Treasury Department prepared to take or 
conditions established so that domestic automakers are being good 
stewards of taxpayer money and can ensure the taxpayers of a return of 
their investment?
    Answer. The government expects to protect the taxpayers' investment 
by managing its ownership stake in a hands-off commercial manner. Both 
companies now have new Boards of Directors comprised of distinguished 
business professionals who will help guide these companies through 
their ongoing restructurings. The Treasury Department will continue to 
monitor the taxpayer's investment under the TARP program and will seek 
to dispose of the ownership interest as soon as is practicable.
    Question. While the federal government is a reluctant stakeholder 
in domestic companies, what should the American taxpayer expect when it 
comes to the divestment of funds they've provided to these auto 
companies? Are there benchmarks of solvency that are established or are 
planning on being established that will allow the taxpayers to be 
repaid of their investment in the auto companies? Will repayment of 
federal funds be on a continual basis?
    Answer. The return will depend on the overall market, the economy, 
and the recovery of the auto sector. The decision to provide funds to 
the companies by the current Administration was based upon a 
determination that the companies have viable business plans. As a 
result, we will monitor GM and Chrysler's performance and seek the 
return of taxpayer funds as soon as is practicable.
    Question. How can technology best be utilized to maximize 
transparency with regard to TARP transactions and the use of TARP funds 
by recipients? How can we ensure that this information is available as 
quickly, comprehensively and understandably as possible, for the 
benefit of both taxpayers and market participants?
    Answer. Improving the ways in which the Office of Financial 
Stability (OFS) communicates its activities and shares relevant data 
with the public, market participants, and our oversight bodies is one 
of my highest priorities. Treasury has already improved its ability to 
share information through the development of our website, 
FinancialStability.gov, and I fully expect that the Internet will 
continue to play a central role in our efforts to operate in as 
transparent a fashion as possible.
    We are working to add to the website's functionality, increase the 
resources available through the site, and develop additional features. 
I believe we need to expand the ability of people to interact with OFS, 
such as through a question and answer feature, and offer presentations 
of information tailored to the widest possible audience, including 
those people who do not regularly read the business page or follow the 
financial markets.
                                 ______
                                 
              Questions Submitted by Senator Susan Collins

    Question. An analysis of the Obama administration budget proposal 
by the Congressional Budget Office projects that the public debt ratio 
will double in 10 years, to 82 percent of GDP. This would be the 
highest debt level since World War II.
    The CBO analysis also shows that the Obama budget will produce a 
deficit level averaging 5.3 percent of GDP across the 10-year budget 
window. Worse, the deficit level will be rising--not shrinking--toward 
the end of the 10-year period, reaching 5.7 percent in 2019.
    Last month, you told Bloomberg Television that: ``It's very 
important that this Congress and this president put in place policies 
that will bring those deficits down to a sustainable level over the 
medium term,'' and you added that the proper deficit target is 3 
percent of GDP or smaller.
    What policies do you believe should be put in place to reduce the 
deficit to 3 percent or less of GDP over the long term?
    Answer. When we developed the fiscal year 2010 budget, we projected 
that the budget deficit would shrink to just above 3 percent of GDP on 
average during 2012-2019. The Administration's Mid-Session Review 
projections show a higher deficit outlook, with deficits averaging just 
above 4 percent of GDP over that period. This increase is primarily 
driven by changes in our economic assumptions, based on new data on the 
severity of the recession that weren't available when we developed the 
fiscal year 2010 budget.
    Our first priority is to make sure that we do not choke off 
recovery in the near term by taking actions to reduce the deficit in 
the near term. As the recovery proceeds and the temporary surge in 
spending retreats, the deficit will fall. The process of developing the 
2011 budget will include proposals for further deficit reduction to the 
extent that they are needed to put the nation back on a fiscally 
sustainable path.
    Question. Thinking about our long-term debt situation for the 
moment, do you believe that it will be necessary to raise taxes to 
achieve a 3 percent deficit-to-GDP level?
    Answer. We agree that it is important to keep the deficit at a 
sustainable level relative to GDP in the long term. The proposed fiscal 
year 2010 budget moved the budget deficit to about 3 percent of GDP, 
with a combination of some programs that raise revenue and put fiscal 
restraint on discretionary spending. The updated economic assumptions 
in the Mid-Session Review, which reflect a more severe recession than 
evident when the 2010 budget was developed, have raised projected 
deficits relative to GDP over the 10-year budget window. We would 
consider a wide range of approaches consistent with the President's 
commitment if we see the need to further lower the deficit after the 
economy recovers.
    Question. In his testimony before the House Budget Committee last 
week, Federal Reserve Chairman Bernanke made the point that the debt 
cannot be sustained unless ``debt and interest payments . . . are 
stable or declining,'' with ``tax rates [that] are not so high as to 
impede economic growth.'' Do you agree with the Chairman that higher 
taxes can impede economic growth?
    Answer. Most economists agree that high tax rates can hurt economic 
growth and that taxes should be as low as possible while still funding 
the needs of the United States. But large and rising deficits that 
become a permanent part of the economic landscape also pose a threat to 
economic growth. They destroy confidence in the economy and reduce 
business capital spending, which will lower productivity and the 
standard of living.
    In the longer term, all policymakers will need to balance the goal 
of creating a sustainable fiscal path with the goal of keeping taxes 
low. It does the economy no good overall to have a large deficit that 
saps business and consumer confidence and crowds out business spending 
just to keep taxes low. And likewise, it does the economy no good if 
needed government programs are unfunded--with attendant consequences 
for productivity and quality of life--just to keep taxes low.
    We look forward to working with the Congress to find a sustainable 
balance of policies in keeping with the President's commitments.
    Question. The Treasury Department has an abysmal record for 
implementation of major capital IT investments. Some of these failures 
include FinCEN's Bank Secrecy Act (BSA) Direct System, IRS's web-based 
Electronic Fraud Detection System, and the abandoned Treasury 
Communication Environment.
    As of last week, the Director of FinCEN was unable to explain to 
Appropriations Committee staff the anticipated total cost for the new 
BSA IT system. The FinCEn Director could also not explain how the 
fiscal year 2010 requested budget increase of $11 million would be 
used. Given that this is a complex, multi-year effort, we would like to 
have more details about the fiscal year 2010 request and the long-term 
project costs. Secretary Geithner, can you tell us how the $11 million 
would be spent and what the long-term costs of this project will be?
    Answer. The fiscal year 2010 President's budget request is part of 
a larger, multi-year initiative, that provides the ability to begin the 
integrated BSA IT Modernization Effort, including the full scope of BSA 
IT modernization capabilities. The fiscal year 2010 request of $10 
million will be combined with base resources of $2.5 million to begin 
the project.
    Specifically, the resources included in the fiscal year 2010 
President's budget will be used to complete the planning, requirements, 
architecture and design (Lifecycle Milestone 3) activities for the 
following projects:
  --Infrastructure
    --IT Modernization Development and Test Environment
    --Storage Area Network (SAN)
  --Registered User Portal
    --User portals
    --Access Control
    --Identity Management
  --E-Filing
    --E-Filing
    --E-Forms/Paper Filer Analysis
    --Shared Filing Services/Work in Progress Database
  --System of Record (SOR)
    --SOR
    --Bulk Data Dissemination
    --Basic Query
    --Alerts
  --Query Audit Log
  --Advanced Analysis
    --Proactive Analysis
    --Analytic/Visualization Tool
    In terms of long-term costs, initial estimates are for a 4-year 
project plan estimated at $120 million; however, in order to create the 
most cost-effective solution for the taxpayer's dollar, estimates will 
be refined and adjusted based on the results of the fiscal year 2009 
requirements and alternatives analysis.
    Question. The stimulus provided the CDFI Fund with $100 million for 
additional grants under its core and Native American programs and to 
cover associated administrative expenses. The stimulus also gave the 
Fund an additional $3 billion in new markets tax credits. These new 
resources coupled with the Administration's fiscal year 2010 request of 
$243.6 million represent a huge expansion of the Fund's programs from 
the fiscal year 2009 appropriation of $107 million.
    The last two financial audits issued by the Treasury Office of 
Inspector General cited a ``significant deficiency'' in the CDFI's 
monitoring of grant recipients to determine if those recipients had 
complied with their grant agreements. The auditors reported that CDFI 
managers continued to have difficulty communicating with each other. 
The auditors called this situation a ``significant deficiency.'' I 
understand that the Treasury moved the chief financial officer's 
function out of the CDFI to the Department even though CDFI is required 
to have a CFO. Taken together, it appears that this office has some 
serious management and operational problems.
    Mr. Secretary, in light of the large increase for the CDFI in the 
budget request, could you please comment on these issues? Specifically 
I'd like to know what actions the Department has taken to ensure that 
CDFI is making grants and awarding tax credits in a speedy but 
responsible manner, and how CDFI will monitor those grants to determine 
the money is used for their intended purposes.
    Answer. Although Treasury's Office of the Inspector General (OIG) 
did identify concerns with respect to compliance monitoring and 
management communication, no material weaknesses were identified in 
either the fiscal year 2007 or fiscal year 2008 audits, and the CDFI 
Fund received a clean opinion on its fiscal year 2008 balance sheet. 
Since fiscal year 2007, the Department, in conjunction with the CDFI 
Fund, has taken action to improve the efficiency and operations of the 
CDFI Fund, bolstering: (1) the awardee selection process, (2) 
compliance monitoring, (3) management communication; and (4) other 
areas to better meet the CDFI Fund's mission and provide better service 
to stakeholders and constituents. In addition to improving operational 
efficiency, these steps were taken to ensure that the CDFI Fund is in 
alignment with Treasury directives, orders, policies, procedures, and 
guidelines. Treasury is confident that the CDFI Fund has the necessary 
systems and processes in place to ensure the full integrity of its 
award programs.
Awardee Selection
    The CDFI Fund has an extremely rigorous application selection 
process that ensures awards are made in an expeditious and responsible 
manner. Further, the Fund has developed compliance monitoring protocols 
and systems to ensure that award funds are used for their intended 
purposes.
    In fiscal year 2008, the CDFI Fund began working with an outside 
consultant to evaluate and streamline the CDFI Program award review and 
selection process. The resultant new Standard Operating Procedures 
streamline the application process and strengthen internal controls and 
accountability. Among other benefits, through these new procedures, the 
CDFI Fund reduced fiscal year 2009 grant selection decisions by about 
60 days and reduced the time from award selection to disbursements by 
120 days. In fact, the CDFI Fund anticipates disbursing substantially 
all of the $98 million in Recovery Act award dollars within 60 days of 
award announcement.
    With respect to its two largest programs, the CDFI Program and the 
New Markets Tax Credit (NMTC) Program, applicants are required to 
submit uniform application materials. Each funding application is rated 
and scored independently by three readers, followed by a Quality 
Assurance reviewer. Applications meeting previously established minimum 
aggregate scoring thresholds are considered eligible for an award. 
These eligible applicants are then reviewed again and an award 
determination is made.
    There are several internal control safeguards that mitigate against 
any one person being able to exercise undue influence over the 
selection of awardees, including:
  --Conflict of interest policies preclude a reader from reviewing an 
        application of an applicant for which the reader has a 
        previous, current, or potential relationship, financial or 
        otherwise.
  --Readers score applications independently and in remote locations. 
        They do not discuss their reviews with other team members. 
        Reviewers cannot communicate directly with one another 
        regarding their applications without first making contact with 
        the Quality Assurance reviewer.
  --Review Forms provide instructions to readers with respect to how 
        each element is to be scored, thus helping to limit reader 
        variance.
  --The relative weight ascribed to each scoring element is computer-
        generated and unalterable by the reader, thereby limiting the 
        degree to which a reader can change the outcome of an overall 
        application score.
  --Each Review Form is reviewed by a Quality Assurance reviewer to 
        ensure that (i) the reader followed the scoring guidelines and 
        (ii) the scores are appropriate, given the reader's ratings and 
        narrative.
  --If a reader review results in a scoring anomaly, the application is 
        re-scored by a fourth reviewer and the anomalous score will 
        likely be disregarded.
  --If the Selecting Official varies significantly from the 
        recommendation of the review manager, a third person (the 
        Reviewing Official) is engaged to make a final determination.
Compliance Monitoring
    The significant deficiencies noted by the Treasury Inspector 
General for the compliance area focused on a lack of consistency in 
following established written policies and procedures to determine 
awardee compliance. The auditor's recommendation to address these 
significant deficiencies was to increase staff resources dedicated to 
compliance and monitoring. The CDFI Fund implemented these 
recommendations, hiring a compliance manager and additional staff, as 
well as providing additional training to the compliance staff. It also 
updated compliance monitoring policies and procedures related to 
awardee financial statements.
    With respect to awardee compliance and performance monitoring, the 
CDFI Fund has developed automated on-line data collection tools, known 
as the Community Investment Impact System (CIIS) and the CDFI 
Compliance Monitoring System (CCMS), through which CDFI Program and 
NMTC Program awardees report institution- and transaction-level 
information and reports to the CDFI Fund annually, along with their 
audited financial statements. The CDFI Fund uses these reports to 
verify compliance with award agreements, and they are a valuable source 
of data for program evaluation and dissemination of information about 
the CDFI industry.
    In addition to reviewing the annual financial statements and 
reports from all of its awardees, the CDFI Fund engages in ``desk 
audits'' and site visits each year to a small percentage of awardees. 
Desk audits are ordered when a potential issue of non-compliance is 
discovered through standard review of annual reports, and generally 
require the awardee to provide additional clarifying information and/or 
supporting documentation. Site visits may be conducted in response to a 
particular incidence of non-compliance, and are scheduled for a random 
sample of awardees.
Management Communication
    The Department takes very seriously the Inspector General's 
findings with respect to the need to improve management communication 
within the Fund, and has instituted a number of initiatives to address 
this concern. In addition to weekly meetings with the management team, 
the CDFI Director has established quarterly all-hands meetings and 
monthly brown-bag lunches with the staff to ensure employees have an 
opportunity to raise concerns, receive recognition for exemplary work 
and discuss cross-cutting issues impacting all of the Fund's programs.
    Recently, the Fund established the position of Chief Operating 
Officer to bring together core management and administration functions.
    In addition, the Fund has encouraged program managers to conduct 
offsite planning retreats with their staff. Three out of seven managers 
have already held these sessions; the remaining four will be convened 
within the next 60 days.
Steps and Actions Taken to Improve CDFI Fund Operations
    Numerous other steps and actions taken to improve CDFI Fund 
operations include:
  --Comprehensive, third-party assessment of the CDFI Fund's financial 
        management functions and capabilities, which resulted in the 
        appointment of Treasury's Assistant Secretary for Management/
        Chief Financial Officer as the CDFI Fund's Chief Financial 
        Officer. Through this action, the CDFI Fund benefits from 
        standardized financial management and internal control 
        processes, enhanced cost effectiveness, and improved risk 
        management.
  --Creation of new programmatic Standard Operating Procedures by Booz 
        Allen Hamilton, which were implemented in late fiscal year 2008 
        and continue to be refined.
  --Comprehensive skills assessment (conducted by Booz Allen Hamilton) 
        of CDFI Fund program staff, to identify the resources necessary 
        to carry out the new Standard Operating Procedures.
  --Assessment of the CDFI Fund's human resource functions and the 
        transfer of services to the Office of Human Resources, which 
        allows CDFI Fund employees and managers to have consistent with 
        the rest of the Department's employees, in addition to the 
        establishment and implementation of human capital policies and 
        procedures approved by the Office of Human Resources.
  --Procurement of a minority-owned vendor to provide support in 
        updating position descriptions of all employees, training in 
        writing employee specific performance plans using Treasury's 
        new performance management system, and tailoring Individual 
        Development Plans for all CDFI Fund employees to reflect the 
        new Standard Operating Procedures and defined roles and 
        responsibilities.
  --Implementation of ``best practice'' recruitment tools so as to 
        recruit a diverse talent pool, including the use of multiple 
        recruiting mechanisms and hiring authorities.
  --Development and implementation of a new strategic plan for fiscal 
        year 2009 with line staff involvement.
  --Establishment of a performance-based awards program to encourage 
        continued improvements of the CDFI Fund's programs and 
        operations through motivation and reward of employees.
  --Creation of a strong collaborative working relationship with union 
        representatives to identify bargaining unit employee needs and 
        concerns.
    Question. Mr. Secretary, during your recent trip to China, I was 
troubled by the response you were given by some in China when you 
attempted to assure the Chinese that their investments in U.S. 
Treasuries are ``very safe.'' As the Washington Post put it in an 
editorial on Friday, the fact that the Chinese question the 
trustworthiness of bonds backed by the full faith and credit of the 
United States should serve as a ``wake up call'' for all Americans.
    China is currently the largest purchaser of U.S. Treasurys and many 
high level Chinese officials are worried about the safety of their 
assets and have begun to push for alternatives to the dollar as a 
reserve currency. Such a move would be disastrous for the United States 
and world economy. How do you intend to avoid such a move by the U.S. 
Government's largest creditor?
    Answer. We are confident that the dollar will remain the major 
currency of use in international transactions and thus a major reserve 
currency. The attractiveness of the dollar to foreign investors is the 
unparalleled breadth, depth, and liquidity of U.S. financial markets 
and the confidence that foreign investors have in the long-term 
prospects of the American economy and American economic policy.
    As Secretary of the Treasury, I am committed to ensuring that the 
U.S. economy and U.S. financial markets are vibrant, robust, and open 
to foreign investors. In addition to ensuring a growing economy, the 
President is committed to reducing the medium- and long-term federal 
budget deficit and securing fiscal sustainability.
    Question. Treasury has pumped at least $70 billion into the failing 
multinational corporation, AIG. This insurance company nearly failed 
not because of its insurance business but because it had engaged in 
hundreds of Credit Default Swaps transaction which it could not cover 
when counterparties all came calling for payment at the same time. AIG 
used much of the TARP funds to pay these counterparties, not only 
Goldman Sachs, but many foreign banks, including Deutsche Bank and 
Societe Generale. The Special Inspector General has raised questions 
about whether Treasury could have used its contribution to AIG as 
leverage to monitor these payments and force these counterparties to 
accept a ``haircut'' on their payments. After all, without Treasury's 
injection of funds, AIG would have failed and they likely would have 
received nothing at all. Do you believe Treasury missed an opportunity 
to save taxpayer dollars?
    Answer. When evaluating the costs to the taxpayer of Treasury's 
support of AIG, the benefits also should be taken into account.
    The disorderly failure of AIG would have caused direct damage to 
the system as a whole and would likely have lowered overall risk 
appetite throughout the system due to the heightened uncertainty that 
such an event would have generated. As with all of our TARP programs, 
we have two goals--preserving the stability of the financial system as 
a whole and making sure that the taxpayers are protected and 
appropriately rewarded for the risk they are taking. The mitigation of 
systemic risk generates significant, but difficult to quantify, 
benefits for taxpayers.
    Moreover, Treasury makes every effort to protect the taxpayer. 
Treasury works with AIG to maximize the chances that AIG can repay the 
government for its very significant financial support. In this way, the 
success of AIG as a business and the success of AIG's restructuring are 
very much in the taxpayer's medium- to long-term interest.
    Treasury understands that, as a steward of taxpayer dollars, we 
must work hard to ensure that the financial support offered to AIG is 
not wasted or abused.
    Treasury's ability to impose ``haircuts'' on AIG's derivatives 
counterparties is extremely limited due to the nature of derivatives 
contracts. Most derivatives trades are governed by standardized 
contracts (ISDAs) and many have so-called credit support annexes or 
CSAs, which govern the posting of collateral. The purpose of a CSA is 
to mitigate counterparty credit risk, thereby enabling the parties to 
focus on pricing and trading the underlying risk factors instead of 
worrying about whether their counterparty will be able to pay, should 
the trade swing in their favor. This feature facilitates liquidity, 
price discovery, risk transfer, and the functioning of markets 
generally.
    Under a CSA, the failure to meet a collateral posting obligation in 
full generally constitutes an event of default and results effectively 
in the immediate termination of the underlying trades. Most of the 
governing contracts also contain a provision that a default on any 
other such contract (e.g., with another counterparty) constitutes a 
default on that particular one, which gives rise to so-called ``cross-
default risk.'' Put simply, if AIG were to unilaterally ``haircut'' one 
of its counterparties by posting less than the contractually obligated 
amount, that would constitute an event of default, trigger cross 
defaults, and result in mass trade terminations. In the fall of 2008, 
AIG had almost 50,000 derivative trades in a wide variety of asset 
classes with over 1,000 counterparties. Defaulting then would have 
destabilized an already fragile market.
    This is why the Administration has proposed a special resolution 
regime to give the government the tools necessary for an orderly 
resolution of complex non-bank firms, in which creditors and 
counterparties may share in the losses.
                                 ______
                                 
           Questions Submitted by Senator Christopher S. Bond

                              TOXIC ASSETS

    Question. The Administration seems to be still treating the 
symptoms but not the cause of the financial credit crisis. Throwing 
billions of taxpayer dollars at the banks without cleansing the toxic 
assets is simply throwing money down a rat hole. And it appears that 
your plan to address the toxic assets--the so-called PPIP program--may 
never get off the ground given FDIC Chairman Sheila Bair's recent 
announcement to postpone the program. Many people, including myself, 
are highly skeptical of the PPIP program, in the first place, since it 
is voluntary for the banks to participate. Without forcing the banks to 
clean up their balance sheets and expected losses mounting in the 
commercial and residential real estate markets and credit card markets, 
we are simply postponing their day of reckoning.
    In your testimony, you seem to indicate that Treasury intends to 
still move forward with PPIP.
    How do you intend to go forward with the PPIP program given the 
government's inability to attract bank participation since it is 
voluntary? Is there a Plan B?
    Answer. Treasury is committed to the Legacy Securities PPIP, and we 
have been finalizing the details over the past several months. The 
Legacy Securities PPIP will address the market for commercial mortgage-
backed securities (MBS) and non-agency residential MBS. Treasury 
announced in early July that it had selected nine pre-qualified fund 
managers that will receive up to $30 billion in investments from 
Treasury. As of October 5, 2009, Treasury announced three additional 
closings of Public-Private Investment Funds (PPIFs) established under 
the Legacy Securities Public-Private Investment Program (PPIP), 
bringing the total number of initial closings completed to five. As of 
October 5, total Treasury commitments to these five PPIFs amounts to 
$16.67 billion, of which $9.20 billion has been closed on. Including 
private capital, total PPIP closings to date amount to $12.27 billion. 
Fund managers have established relationships with small, minority- and 
women-owned businesses. Following an initial closing, each PPIF will 
have the opportunity for two more closings over the following 6 months 
to receive matching Treasury equity and debt financing, with a total 
Treasury equity and debt investment in all PPIFs equal to $30 billion 
($40 billion including private investor capital).
    Financial market conditions have improved since the early part of 
this year, and many financial institutions have raised substantial 
amounts of capital as a buffer against weaker than expected economic 
conditions. However, these legacy assets are still highly illiquid 
despite significant increases in the prices of many of these 
securities. The difficulty of obtaining private financing on reasonable 
terms to purchase these assets has limited the ability of investors to 
reduce liquidity discounts in legacy assets. The lack of clarity about 
the value of these legacy assets has also made it difficult for some 
financial institutions to raise new private capital and has continued 
to clog balance sheets.
    One of the PPIP's primary objectives is to facilitate price 
discovery and reduce excessive liquidity discounts that have been 
embedded in legacy asset prices. As capital is freed up, U.S. financial 
institutions should engage in new credit formation. Furthermore, 
enhanced clarity regarding the value of legacy assets should increase 
investor confidence and enhance the ability of financial institutions 
to raise new capital from private investors. Finally, an inherent link 
exists between the new issue securitization market and the secondary 
market performance of legacy assets. As spreads compress in the legacy 
asset market, new securitization issuance should come to market at 
reasonable borrowing costs. The new issue securitization market is an 
absolutely critical component of lending in the economy.

                           REGULATORY REFORM

    Question. Clearly, our financial regulatory system must be 
addressed since it played a role in the current credit crisis. One of 
the core issues is how to address ``too big to fail'' companies. Some 
argue that ``too big to fail'' is now ``too big to exist.''
    Is anti-trust reform being considered as part of the 
Administration's regulatory reform proposal? How are you proposing to 
align the incentives properly to prevent future irresponsible behavior 
by financial institutions and future taxpayer-funded bailouts?
    Answer. While effective enforcement of anti-trust laws is an 
important part of protecting consumers and competition in the financial 
sector, we have not proposed anti-trust reform as part of our 
regulatory reform proposals. We do not believe that the risks we 
propose to address are directly related to competition issues that can 
be addressed through an anti-trust framework.
    In the past 2 years, we learned that the system was not resilient 
enough to bear the failure of a large, interconnected firm or contain 
the damage from such a failure on the broader economy. The problem was 
that such firms had not been required to maintain sufficient capital 
and liquidity cushions and were not supervised on a consolidated basis. 
In other words, they were not required to internalize the risks they 
presented to the financial system. Our plan fixes that.
    Under our plan, firms that could present risks to the stability of 
the financial system if they failed will be subject to much higher 
standards so that the risk of failure will be lower. Moreover, our 
special resolution regime for nonbank financial firms gives the 
government an effective tool for an orderly resolution, in which 
creditors and counterparties may share in the losses rather than a 
bailout. In addition, we will reduce incentives for risk taking by 
reforming and raising capital standards for financial firms and working 
to address misalignment of incentives in specific markets, like the 
securitization markets, through such steps as requiring originators or 
sponsors to maintain an economic interest in the performance of a 
securitization.
    Finally, we have proposed steps to align the compensation of 
executives with the long-term interests of shareholders so that they do 
not have incentives for excessive risk-taking--both through regulation 
and supervision of financial firms and through corporate governance 
reform, such as ``say on pay'' legislation and legislation requiring 
independent compensation committees on corporate boards of directors.

                      SOCIAL AND ECONOMIC MISSIONS

    Question. There is growing concern about asking weakened financial 
institutions to carry out the government's economic and social 
policies. While I understand the pressure to have bailed-out banks more 
engaged in efforts such as foreclosure mitigation, the danger is more 
financial losses that will be covered with more taxpayer funds. 
Further, this leads to more government involvement in dictating private 
business practices.
    What is the Administration's exit strategy when it comes to those 
financial institutions--such as Fannie and Freddie, Citi--who are being 
required by the government to carry out various social policy programs? 
How will you avoid the negative consequences of forcing these entities 
to fulfill the inherent conflicting goals of serving shareholders and 
meeting the needs of the public good?
    Answer. Given the important role that Fannie Mae and Freddie Mac 
play in the mortgage market, their participation in efforts to reduce 
preventable foreclosures is vital to speeding the housing recovery. The 
future of Fannie Mae and Freddie Mac will require careful consideration 
of the appropriate role of the Federal government in the mortgage 
market. The Administration has committed to undertaking a wide-ranging 
initiative to develop recommendations by early next year on the future 
of Fannie Mae and Freddie Mac. There are a number of options for the 
reform of the GSEs, including: (i) returning them to their previous 
status as GSEs with the paired interests of maximizing returns for 
private shareholders and pursuing public policy home ownership goals; 
(ii) gradually winding-down their operations and liquidating of their 
assets; (iii) incorporating the GSEs' functions into a federal agency; 
(iv) introducing a public utility model, in which the government 
regulates the GSEs' profit margin, sets guarantee fees, and provides 
explicit backing for GSE commitments; (v) instituting a conversion to 
providing insurance for covered bonds; or (vi) dissolving Fannie Mae 
and Freddie Mac into many smaller companies.
    The 2008 Housing and Economic Recovery Act (HERA) reformed and 
strengthened the regulation of Fannie Mae and Freddie Mac by 
establishing a Federal Housing Finance Agency (FHFA) as a new 
independent regulator. In addition to the establishment of FHFA, HERA 
also provided FHFA with enhanced authority to develop regulations 
regarding the safety, soundness, and the mission activities of Fannie 
Mae and Freddie Mac.

                              STRESS TESTS

    Question. Many experts question the reliability of the stress tests 
that were conducted on the large banks. Some believe that the results 
are too optimistic because the tests were too lenient and banks 
bargained with the government to reduce their capital needs. Further, 
to meet the capital levels required by the stress test results, it was 
reported that banks are relying on preferred-stock conversions for 22 
percent of their fundraising. One financial expert stated that 
``Conversions from preferred to common don't do anything; you can just 
ignore them.''
    Do you stand by these tests? If so, can you assure the American 
taxpayer that they will not be asked to fund additional rounds of 
bailouts for these large banks? Will you conduct more stress tests? If 
so, under what circumstances would you conduct more stress tests?
    Answer. The Supervisory Capital Assessment Process (SCAP) or 
``stress test'' was a carefully designed, stringent test. The test was 
designed to account for the highly uncertain financial and economic 
conditions by identifying the extent to which our largest banks are 
currently vulnerable to a weaker than expected economy in the future.
    Supervisors applied a historically high set of loss estimates on 
securities and loans, as well as a conservative view towards potential 
earnings that could act as a buffer against those losses. For instance, 
the 2-year, loan-loss rate assumed under the ``more adverse'' scenario 
exceeds the observed 2-year loss rates for U.S. commercial banks from 
1920 to present.
    Since the stress test results were announced more than $80 billion 
of total private capital has been raised by the 19 participating 
institutions. This additional private capital reduces the likelihood 
that the U.S. government will need to inject additional public capital 
into the banking system. Treasury must balance the desire to exit its 
investments in private sector entities as quickly as is practicable 
with the need to ensure that such a withdrawal does not put the 
progress that the Obama Administration has made in restoring financial 
stability at risk. To that end, Treasury will continue to provide 
support where it is necessary to sustain confidence in the financial 
system and to support critical channels of credit to households and 
businesses. The SCAP focused not only on the amount of capital but also 
on the composition of capital held by the largest banks. That is, SCAP 
focused on the proportion of capital that is common equity. The SCAP's 
emphasis on common equity reflects the fact that common equity is the 
first element of the capital structure to absorb losses, offering 
protection to more senior parts of the capital structure and lowering 
the risk of insolvency. All else equal, more common equity gives a bank 
greater permanent loss absorption capacity and a greater ability to 
conserve resources. Therefore, while we were particularly pleased with 
the record amounts of new common equity that was raised following the 
SCAP, we also believe that exchanges of preferred stock for common 
stock have enhanced the ability of some of our largest institutions to 
withstand a weaker than expected economic scenario.
    Currently there are no plans to conduct another stress test of the 
largest banks.

                             PROTECTIONISM

    Question. Despite history's lessons on how protectionism 
contributed to the Great Depression, there continues to be active 
efforts from some in Congress to push trade protectionism, which will 
clearly endanger our economic recovery. There are reports that the 
``Buy American'' provision in the stimulus has slowed down some 
projects and has contributed to some job losses. Now, there is an 
effort on the House side that is pushing protectionism further on 
climate change legislation by tying federal aid to companies that only 
develop and produce plug-in cars in the United States.
    What is the Administration's official policy on protectionism and 
free trade? What is the Administration doing to prevent the growth of 
protectionism? Will it work to stop these types of protectionist 
measures?
    Answer. President Obama has clearly stated that trade is a key 
engine for U.S. economic growth and job creation. The President has 
also emphasized the importance of avoiding protectionism in responding 
to the financial and economic crisis.
    As part of the commitment made by G-20 Leaders to avoid 
protectionist trade measures, the World Trade Organization (WTO) was 
tasked to monitor and report on trade and trade policy-related 
reactions to the financial and economic crisis, a process in which the 
United States actively participates. While continued vigilance is 
important, thus far the process appears to be working--in large part 
due to the presence of WTO rules and the effect of very visible 
individual and collective monitoring. Moreover, where protectionist 
measures are identified, the United States will engage our trading 
partners in both bilateral and multilateral settings. Enforcement of 
WTO rules is a top priority.
    With respect to the American Recovery and Reinvestment Act of 2009, 
we appreciate that Congress responded to the President's call to avoid 
protectionism in responding to the financial crisis and included a 
provision in the Recovery Act that ensures that the ``buy American'' 
requirement is applied in accordance with U.S. international agreements 
on government procurement. Public comments have been solicited on an 
interim Federal procurement rule and interim OMB guidance implementing 
the ``buy American'' requirement in the Recovery Act. After a thorough 
review of the public comments, a final rule and final OMB guidance will 
be prepared with the aim of ensuring that the law is implemented 
effectively and consistently with the objective of promoting economic 
recovery and job creation.
    As the Congress prepares legislation, the Administration will 
continue to review proposed bills with a view to ensuring that they 
avoid protectionism and that they are fully consistent with our 
international trade obligations.

                        REPAYMENT OF TARP FUNDS

    Question. The Administration has begun some banks to repay funds 
from the Troubled Asset Relief Program (TARP).
    For these cases--especially those who are still considered ``too 
big to fail''--how can you assure the taxpayer that they will not 
return to the government trough for more bailout funds? Can you 
definitely say that they will not be back for more taxpayer-funded 
bailouts?
    Answer. The government's Supervisory Capital Assessment Program 
(SCAP), the so-called ``stress test'', estimated the capital needs for 
major banks under an adverse economic scenario. In particular, the SCAP 
estimated losses that those banks are likely to incur through 2010 and 
the appropriate level of loan loss reserves at the end of that period. 
The estimated losses and the required level of reserves took into 
account the potential for significant additional declines in housing 
prices and further increases in mortgage defaults resulting from, among 
other things, interest rate resets. We believe that the SCAP captured 
the likely capital needs of the major banks under an economic scenario 
that is more adverse than what we, and private forecasters, expect. 
Since the stress test results were announced, many major banks have 
raised a substantial amount of new private capital. This additional 
private capital reduces the likelihood that the U.S. government will 
need to inject additional public capital into the banking system. 
Treasury must balance the desire to exit its investments in private 
sector entities as quickly as is practicable with the need to ensure 
that such a withdrawal does not put the progress that the Obama 
Administration has made in restoring financial stability at risk. To 
that end, Treasury will continue to provide support where it is 
necessary to sustain confidence in the financial system and to support 
critical channels of credit to households and businesses.

                              AUTO RESCUE

    Question. The Administration has orchestrated and forced the car 
companies into bankruptcy but seems to be reluctant to force failed 
large financial institutions like Citi into restructuring.
    Why are you treating failed financial institutions differently from 
GM and Chrysler? If Citi is not forced into a FDIC-like restructuring, 
how can you assure the taxpayer that they will not return for 
additional bailouts?
    Answer. In acting to help financial institutions such as Citigroup 
and the automotive industry, the overarching goals of the 
Administration have been the same: promote the liquidity and stability 
of the financial system and protect the taxpayer. The actions taken 
have depended on the particular circumstances facing the different 
institutions.
    The Administration took action to help the automotive industry in 
order to prevent a significant disruption to the industry, as 
conditions in the industry posed a risk of creating significant 
disruptions to financial market stability and negative effects on the 
real economy of the United States. One of the conditions on which the 
Administration initially provided loans to these companies was that 
they develop viability plans. As a result of development and 
consideration of these plans, it became clear that the best way to 
achieve viability was for GM and Chrysler to substantially restructure 
their businesses. Due to a variety of factors, Chapter 11 bankruptcy 
proved to be the most effective means of accomplishing this important 
goal.
    Last fall, the Administration and Congress believed quick, forceful 
action was necessary to stabilize the financial system and certain 
financial firms. With Congressional authorization, these actions were 
taken to meet the specific needs of the time and to address the 
distinct difficulties faced by financial firms as a result of the 
crisis. The Treasury initially provided support to Citigroup on the 
same terms as over 650 institutions received funding pursuant to the 
Capital Purchase Program. The Treasury subsequently determined that 
additional assistance was needed to Citigroup pursuant to the Targeted 
Investment Program. This program is used when an institution is 
sufficiently important to the nation's financial and economic system 
that a loss of confidence in the firm's financial position could 
potentially cause major disruptions to credit markets or payments and 
settlement systems, destabilize asset prices, significantly increase 
uncertainty, or lead to similar losses of confidence or financial 
market stability that could materially weaken overall economic 
performance. This assistance is provided on terms that are more 
restrictive than those under the CPP program. These include more 
stringent restrictions related to executive compensation, dividend 
payments, share repurchases, corporate expenses, internal controls and 
other matters.
    Citigroup was also one of the banks examined as part of the 
government's Supervisory Capital Assessment Program (SCAP), the so-
called ``stress test'', which estimated the capital needs for major 
banks under an adverse economic scenario. In particular, the SCAP 
estimated losses that those banks are likely to incur through 2010 and 
the appropriate level of loan loss reserves at the end of that period. 
The estimated losses and the required level of reserves took into 
account the potential for significant additional declines in housing 
prices and further increases in mortgage defaults resulting from, among 
other things, interest rate resets. We believe that the SCAP captured 
the likely capital needs of the major banks, including Citigroup, under 
an economic scenario that is more adverse than what we, and private 
forecasters, expect. Since the stress test results were announced, many 
major banks have raised a substantial amount of new private capital. 
This additional private capital reduces the likelihood that the U.S. 
government will need to inject additional public capital into the 
banking system. Treasury must balance the desire to exit its 
investments in private sector entities as quickly as is practicable 
with the need to ensure that such a withdrawal does not put the 
progress that the Obama Administration has made in restoring financial 
stability at risk. To that end, Treasury will continue to provide 
support where it is necessary to sustain confidence in the financial 
system and to support critical channels of credit to households and 
businesses.

                        Internal Revenue Service

STATEMENT OF DOUGLAS H. SHULMAN, COMMISSIONER
    Senator Durbin. I am pleased to welcome Douglas Shulman, 
now well-immersed in his second year of a 5 year term as the 
47th Commissioner of the Internal Revenue Service. Thank you 
for your service and your pledge to lead the IRS from good to 
great.
    Each year, IRS employees make hundreds of millions of 
contacts with American taxpayers and businesses and represent 
the face of our Government to more U.S. citizens than any other 
agency. With approximately 93,000 employees, the IRS is 
effectively the accounts receivable department of the United 
States.
    In fiscal year 2008, the IRS collected $2.7 trillion, 96 
percent of total Federal receipts. Simply stated, the more 
revenue the IRS collects, the more revenue Congress has 
available to deal with some of the challenges facing our Nation 
and the more revenue we have available to ease the tax burden 
on those citizens we believe to be deserving of that. 
Conversely, the less revenue, the less revenue Congress has for 
tax cuts or for worthy expenditures.
    The President's proposed budget of $12.126 billion for the 
IRS is an overall increase of 5.2 percent above the fiscal year 
2009 enacted level, which supports 95,081 full-time equivalents 
(FTEs) and an additional 2,376 above the current fiscal year 
2009 base.
    Mr. Commissioner, thank you for your patience. Thank you 
for joining us. Senator Collins and others may have some 
questions along with mine after you've given your presentation. 
The floor is yours.

               OPENING STATEMENT OF COMMISSIONER SHULMAN

    Commissioner Shulman. Thank you Chairman Durbin and Ranking 
Member Collins. I appreciate the opportunity to testify about 
the IRS's fiscal year 2010 budget.
    Over the past year, I think the agency has shown that it 
can improve performance and be agile and respond to changing 
situations. I often say that we need to excel at both service 
and enforcement. It's not an either/or proposition. And I 
believe this budget will allow us to make continuous 
improvements in both our service and our enforcement, as well 
as in technology and the workforce.
    As the Secretary mentioned, the President's budget requests 
$332 million in additional enforcement initiatives. This set 
includes a robust set of international enforcement initiatives 
that the President, the Secretary, and I unveiled on May 4.
    Increased resources for IRS compliance initiatives have 
direct measurable results through a return on investment, and 
this $332 million will yield about $2 billion a year once it 
becomes fully operational in 2012.
    In addition, we've asked for money so we can continue to 
improve our service, including face-to-face, telephone, web-
based, and self-service service models. I believe it is 
incredibly important and fundamental to keeping honest 
taxpayers in the system that we have world-class service. And 
it's a key part of bringing in the $2.5 trillion it takes to 
run the Government every year.
    And as you mentioned, Mr. Chairman, we are the face of the 
American Government to more people than any other agency. In 
this regard, I also want to point out to the subcommittee that 
I plan to deliver recommendations to the President and the 
Treasury Secretary by the end of this year on how we, the IRS, 
can better leverage the tax return preparer community to 
increase compliance and ensure high ethical standards of 
conduct for paid preparers.
    Over 80 percent of the American people use either tax 
software or a paid preparer to prepare their return each year. 
This has been a transformational shift in the way taxes are 
prepared. And because paying taxes is one of the largest 
financial transactions that individual Americans have each 
year, we need to make sure that the professionals who serve 
them are ethical and that they ensure the right amount of taxes 
are paid.
    I'm also pleased to report that we've moved, for the second 
year in a row, to enact stimulus legislation. This year we 
implemented major provisions of the American Recovery and 
Reinvestment Act, getting money into the hands of individuals, 
as well as small businesses.
    Let me turn briefly to our ongoing effort to modernize our 
core taxpayer account database. We have consistently delivered 
on commitments over the last several years. This year I have 
adopted a much more focused strategy, which will allow the IRS 
to complete the taxpayer database conversion on an accelerated 
timeframe. We're doing this by gradually shifting course from 
simultaneously developing the database and the associated 
applications, to a more streamlined focus on completing the 
modernized database. This is going to be key to our future 
success, to future on-line services, and to new compliance and 
enforcement systems.
    This budget also reflects our long-term commitment to 
efficiency savings and productivity. With e-filing going up, 
I'll just note we've consolidated processing centers into 5 
sites instead of 10, and we project 5 year savings to be over 
$100 million.
    And finally, let me just point out three important 
legislative changes in the President's budget. There are many 
on which we worked and I support them all. Three very important 
ones are: one, the robust set of international legislative 
proposals which will be essential to us curbing offshore tax 
abuse; two, the proposal to require tax preparers that have a 
certain volume of tax filings to file electronically; and 
three, the proposal that we eliminate the 20 percent 
downpayment for a taxpayer who comes in trying to enter a offer 
in compromise with us. Those are often taxpayers in financial 
distress and right now they have to put 20 percent down. 
There's been some decrease in the program and we want to get 
the program back up and so we are recommending getting rid of 
that 20 percent payment.

                           PREPARED STATEMENT

    Mr. Chairman and Ranking Member Collins, thank you again 
for the opportunity to testify. I am happy to answer any 
questions.
    [The statement follows:]

                Prepared Statement of Douglas H. Shulman

                              INTRODUCTION

    Chairman Durbin, Ranking Member Collins, and Members of the 
Subcommittee, thank you for the opportunity to appear today to discuss 
the President's fiscal year 2010 budget request for the Internal 
Revenue Service. The President's budget represents a strategic and wise 
investment in the Nation's tax system and will help the IRS stay on a 
path of continuous improvement in such critical areas as service, 
enforcement, technology, and human capital.
    Through its service delivery, the IRS is often the face of 
government to the American people. The IRS is the only agency that 
interacts with every business, every taxpaying individual, and every 
non-profit organization each year. We have that rare opportunity to 
influence how people think about their government.
    In terms of service, I believe that taxpayers want to come to the 
IRS, get their questions answered and issues resolved quickly, and be 
on their way. It sounds simple, but in a time of increasing complexity 
of the tax law, and challenging economic circumstances, achieving this 
goal will require discipline, focus, and resources. Our service 
operations must be designed with the taxpayer experience as the 
ultimate measure of our success.
    We also need a vigorous and effective enforcement program. In 
today's tough economic environment, it is more important than ever that 
every citizen feels confident that individuals and corporations are 
paying the taxes they owe.
    The American people who play by the rules every day expect the IRS 
to pursue those taxpayers who do not pay their taxes, and we are 
vigorously enforcing the tax law. We are focusing on current 
enforcement initiatives, such as in the international arena, while 
seeking to evolve and innovate. We can also hone our enforcement 
techniques by adding new tools, such as more information reporting, 
soft notices, and self-correction.
    Of course, all of our efforts depend upon the people of the IRS. We 
must ensure that we have talented and capable leaders and employees for 
the foreseeable future at the IRS, and that they have the tools and 
resources they need to succeed.
    We also need to continue moving our technology to the next level. 
The tax system, America's taxpayers, and the approximately $2.5 
trillion of revenue depend on it.
    Finally, as I announced last week, I plan to make recommendations 
by the end of the year to Secretary Geithner and the President on how 
to better leverage the tax preparer community to increase taxpayer 
compliance and ensure uniform and high ethical standards of conduct for 
preparers. Today, over 80 percent of taxpayers use either a tax return 
preparer or third-party software to complete their returns. This is 
nothing less than a transformational shift in tax administration. The 
first part of the review I plan to undertake will involve fact finding 
and receiving input from a large and diverse constituent community. 
Paying taxes is one of the largest financial transactions individual 
Americans have each year, and we need to make sure that professionals 
who serve them are ethical and ensure the right amount of tax is paid.

                 A FIRM FOUNDATION UPON WHICH TO BUILD

    The IRS has a firm foundation upon which to build. Let me briefly 
highlight some key trends that demonstrate both across-the-board 
performance improvements and the IRS' ability to be agile and respond 
quickly to changing situations.
Service
    As of May 9th, for the 2009 filing season, the IRS has received 
133.2 million total individual returns and has issued 102.3 million 
refunds, for a total of $278.5 billion. A record 91.6 million tax 
returns were electronically filed this year--a major milestone for the 
IRS and testament to our commitment to a robust electronic tax 
administration program. So far this filing season, the e-filing rate is 
almost 70 percent for individuals, as compared to 61 percent for the 
same time period last year.
    This year, there was also a surge in e-file from home computers. 
More than 31 million people prepared their own e-file return, 
representing more than a 19 percent increase from the previous year. 
And there were almost 200 million visits to IRS.gov, comparable to last 
year.
    Taxpayers could also find on the IRS Web site the latest 
information about the American Recovery and Reinvestment Act (ARRA), 
including details on extending health insurance for people who lost 
their jobs and tax breaks for first-time homebuyers. In addition, the 
IRS has developed ``What If'' scenarios and the possible tax 
implications for people who may be facing financially difficult times.
American Recovery and Reinvestment Act
    The IRS is proud of the role it has played, and will continue to 
play in helping to implement, provide guidance, and publicize many of 
the provisions of the ARRA that will assist both individuals and 
businesses in economic distress and is getting the Nation back on the 
road to economic recovery.
    For example, a mere 4 days after President Barack Obama signed ARRA 
into law, the Treasury Department and the IRS swung into action in 
record time, developing new withholding tables to ensure money would 
get into American's pockets through the Make Work Pay Credit.
    In March, the IRS announced that businesses with deductions 
exceeding their income in 2008 can use a new net operating loss tax 
provision to get an expedited refund of taxes paid in prior years. This 
provision could throw a lifeline to struggling businesses, providing 
them with a quick infusion of cash. We are also making it as easy as 
possible for businesses large and small to take advantage of these 
benefits.
    We have shifted resources to deal with the expected growth of 
bankruptcies and business workouts. Moreover, we worked with the 
Treasury Department on a number of regulations that clarified rules to 
unclog the credit markets.
    On the individual front, we have taken a broad approach. Through a 
series of massive, nation-wide outreach efforts, such as ``Super 
Saturday,'' we wanted to make sure that even more taxpayers are aware 
of every credit, deduction, and exclusion for which they qualify, 
including several new benefits this year.
    Our message to taxpayers was that we are going the extra mile to 
help those in economic distress. We want to get them their refunds as 
quickly as possible. And if they think they can't pay, we ask them to 
come in and talk about it. There are steps we can take to help.
    The bottom line is that we need to be flexible yet principled and 
to empower our employees to use their judgment when dealing with these 
taxpayers in areas such as missed payments and postponing collection 
actions.
    This year there are also a variety of new benefits and tax credits 
the IRS is administering that can also help energize the economy and 
generate much needed jobs. We are working with the media and other 
stakeholder groups to get out the message about their availability.
Enforcement
    In fiscal year 2008, both the levels of individual returns examined 
and coverage rates rose substantially. We conducted nearly 1.4 million 
examinations of individual tax returns in fiscal year 2008, an 8 
percent increase over fiscal year 2006. This reflects a steady and 
sustained growth over the past 3 years. Similarly, the audit coverage 
rate has risen from 0.58 percent in fiscal year 2001 to 1.01 percent in 
fiscal year 2008.
    While the growth in examinations of individual returns is visible 
in all income categories, it is most apparent in examinations of 
individuals with incomes over $200,000. Audits of these individuals 
increased from 105,549 in fiscal year 2007 to 130,751 during fiscal 
year 2008, an increase of 24 percent. Their coverage rate has risen 
from 2.68 percent in fiscal year 2007 to 2.94 percent in fiscal year 
2008.
    In the business arena, audit coverage rates for small corporation 
returns (assets under $10 million) increased slightly over fiscal year 
2007 by .03 percent. Of note, coverage rates for three classes of large 
corporations with assets between $50 million and $250 million and 
higher all increased. Coverage rates for partnership returns stayed 
even as compared to fiscal year 2007, while Subchapter S returns 
reflected a small .05 percent drop due largely to the increase in 
number of S-corporations. The coverage rate for tax-exempt 
organizations increased slightly.
    IRS Criminal Investigation has also been vigorously attacking 
egregious tax avoidance, money laundering, and other financial crimes 
that have a corrosive effect on our tax system. For example, overall 
number of individuals charged in an information or indictment rose from 
2,323 in fiscal year 2007 to 2,547 in fiscal year 2008.
    Over the same period of time, prosecution recommendations for 
employment tax evasion more than doubled. The incarceration rate in 
these investigations was 81 percent and the average sentence was 29 
months.
    In fiscal year 2008, IRS-developed cases related to foreign and 
offshore issues also resulted in 61 criminal convictions, and the 
average term for those going to jail was 32 months. For the first 4 
months of fiscal year 2009, there were 20 convictions, and the average 
sentence was 84 months.
IRS Workforce
    In late fiscal year 2008, the IRS established the Workforce of 
Tomorrow task force to address recruitment and retention issues so that 
the IRS has the necessary leadership and workforce in place to address 
future challenges.
    The IRS considers employee engagement fundamental to the overall 
success of the organization and believes that employee engagement is an 
ongoing process. The IRS conducts an annual survey to assess the level 
of engagement of employees. Overall satisfaction showed steady 
improvement from a score of 3.48 in 2002 to a score of 3.79 in 2008, on 
a scale of 1 to 5, with 5 being the most satisfied.
    IRS job satisfaction is higher than most other Federal agencies, 
according to the Office of Personnel Management's Federal Human Capital 
Survey.

    THE ADMINISTRATION'S FISCAL YEAR 2010 BUDGET REQUEST FUNDS KEY 
                               PRIORITIES

    Total resources to support IRS activities for fiscal year 2010 are 
$12,440,801,000. This amount includes $12,126,000,000 from direct 
appropriations, an estimated $147,101,000 from reimbursable programs, 
and an estimated $167,700,000 from user fees. The direct appropriation 
is a $603,402,000 increase, or a 5.2 percent increase over the fiscal 
year 2009 enacted level of $11,522,598,000. This amount excludes 
funding to implement the ARRA.
    The IRS continues to achieve efficiency savings in its operations. 
Because of the increase in e-filing, the IRS has effectively revised 
base operations and continues to implement savings resulting from the 
consolidation of an additional two of the paper processing sites. This 
consolidation has already resulted in significant savings and will 
continue to do so.
    The IRS Strategic Plan 2009-2013 guides program and budget 
decisions and supports the Department of the Treasury Strategic Plan. 
The IRS Strategic Plan builds on past successes while being innovative 
and adapting to new situations, such as the increasing complexity of 
tax laws, changing business models, expanding use of electronic data 
and related security risks, accelerating growth in international tax 
activities, and growing human capital challenges. I am a firm believer 
that organizations must always be evolving, changing, and improving and 
the strategic plan reflects that philosophy.
    The IRS Strategic Plan has two overarching goals: (1) improve 
service to make voluntary compliance easier; and (2) enforce the law to 
ensure everyone meets their obligation to pay taxes. The IRS must excel 
at both service and enforcement to meet its mission; it is not an 
either-or proposition.
    To improve service and make voluntary compliance easier, the fiscal 
year 2010 President's budget request for IRS provides the necessary 
funding to implement the following key strategic priorities.
Enforcement Program
    The fiscal year 2010 President's budget request includes program 
increases of $332.2 million for investments in strong compliance 
programs, including a robust portfolio of international enforcement 
initiatives that the President and Treasury Secretary Geithner and I 
unveiled on May 4, 2009.
    The international initiatives include reforming business tax 
deferral rules so that--with the exception of research and 
experimentation expenses that have significant spillover benefits to 
the United States--companies cannot receive deductions on their U.S. 
tax returns supporting their offshore investments until they pay U.S. 
taxes on their offshore profits. The Administration also seeks to 
prevent abuse of the foreign tax credit.
    In addition, getting tough on overseas tax havens is an integral 
part of the Administration's plan. It would reform the so-called 
``check-the-box'' rules to require certain foreign subsidiaries to be 
considered as separate corporations for U.S. tax purposes. It would 
also crack down on the abuse of tax havens by wealthy Americans. For 
example, the Administration proposes withholding taxes from U.S. 
customer accounts at foreign institutions doing business with the 
United States but which don't share information with the IRS through 
the ``Qualified Intermediary'' program. To further combat abuse, the 
Administration proposes extending the statute of limitations for 
international tax enforcement to 6 years.
    The Administration's full budget describes additional international 
tax reform proposals. Other legislative proposals to improve compliance 
and strengthen tax administration can be found later in this testimony. 
A key focus of our strategy is to shift enforcement resources so we can 
expand programs targeted at non-compliance among large corporations, 
U.S. business with international operations, high net-worth 
individuals, flow-through entities and partnerships.
    Increased resources for the IRS compliance programs yield direct 
measurable results through high return-on-investment activities. The 
new enforcement personnel funded in the fiscal year 2010 President's 
budget are expected to generate $2.0 billion in additional annual 
enforcement revenue once the new hires reach full potential in fiscal 
year 2012. This estimate does not account for the deterrent effect of 
IRS enforcement programs, which are conservatively estimated to be at 
least three times larger than the direct revenue impact.
    The tax law is complex, and even sophisticated taxpayers make 
honest mistakes on their tax returns. Accordingly, helping taxpayers 
understand their obligations under the tax law is critical to improving 
compliance. To this end, the IRS remains committed to a balanced 
program of assisting taxpayers in both understanding the tax law and 
paying the proper amount of tax.
Taxpayer Service Program
    The fiscal year 2010 President's budget request continues 
improvements to both the quality and efficiency of taxpayer service, 
using a variety of person-to-person, telephone, and web-based and self-
serve methods to help taxpayers understand their tax obligations and 
pay what they owe. The IRS taxpayer service program is funded in the 
Taxpayer Services and Operations Support appropriations. It should be 
noted that service investments and strategy are guided by the Taxpayer 
Assistance Blueprint--a 5-year plan that outlines the steps the IRS 
should take to improve taxpayer service and the IRS strategic plan.
    Providing quality taxpayer service is fundamental to keeping honest 
taxpayers in the tax system and compliant. It also helps them avoid 
making unintentional errors before returns are filed, which, in turn, 
reduces the need for follow-up correspondence from the IRS.
    The IRS provides year-round assistance to millions of taxpayers, 
including outreach and education programs, issuance of tax forms and 
publications, rulings and regulations, toll-free call centers, the 
IRS.gov web site, Taxpayer Assistance Centers (TACs), Volunteer Income 
Tax Assistance (VITA) sites, and Tax Counseling for the Elderly (TCE) 
sites.
    For example, in the Small Business arena alone, in fiscal year 
2008, the IRS participated in over 2,600 meetings, symposiums, and 
seminars attended by over 162,000 small business owners and tax 
professionals. The IRS also holds national and local Small Business 
Forums which provide an open avenue of communication between IRS and 
trade and industry groups. We held 135 Small Business Forums and 
facilitated 410 Small Business Tax Workshops in fiscal year 2008.
American Recovery and Reinvestment Act
    As noted in the introduction, the IRS is now implementing a number 
of ARRA tax provisions, including individual tax credits, such as the 
Make Work Pay credit; energy credits for certain appliances, education 
credits, and child credits; tax incentives for business; bond 
incentives; and a tax credit to provide discounted health benefits to 
certain workers who have lost their jobs. The IRS will be able to 
continue to implement and administer these critical tax programs within 
the levels contained in this budget request.

                    EXPLANATION OF BUDGET ACTIVITIES

Enforcement
    The fiscal year 2010 President's budget request is $5,504,000,000 
in direct appropriations and an estimated $60,797,000 from reimbursable 
programs, plus an estimated $7,800,000 from user fees\1\, for a total 
operating level of $5,572,597,000. The direct appropriations level is 
an increase of 7.6 percent from the fiscal year 2009 enacted level and 
includes $600,000,000 to support tax enforcement activities funded by 
an allocation adjustment. This appropriation funds the following budget 
activities.
---------------------------------------------------------------------------
    \1\ Note that user fees are available to supplement appropriations 
contingent on demand for user fee services and receipt of fees. These 
amounts are subject to change.
---------------------------------------------------------------------------
    Investigations ($637,694,000 from direct appropriations and an 
estimated $51,553,000 from reimbursable programs).--This budget 
activity funds the criminal investigations programs that explore 
potential criminal violations of the internal revenue tax laws, enforce 
criminal statutes relating to these violations, and recommend 
prosecution as warranted. These programs identify and document the 
movement of both legal and illegal sources of income to identify and 
document cases of suspected intent to defraud. It also includes 
investigation and prosecution of tax and money laundering violations 
associated with narcotics organizations.
    Exam and Collections ($4,706,350,000 from direct appropriations, an 
estimated $8,783,000 from reimbursable programs, and an estimated 
$7,800,000 from user fees).--This budget activity funds programs that 
enforce the tax laws and compliance through examination and collection 
programs that ensure proper payment and tax reporting. The budget 
activity also supports appeals and litigation activities associated 
with exam and collection.
    Regulatory ($159,956,000 from direct appropriations and an 
estimated $461,000 from reimbursable programs).--This budget activity 
funds the development and printing of published IRS guidance materials; 
interpretation of tax laws; advice on general legal servicing, ruling 
and agreements; enforcement of regulatory rules, laws, and approved 
business practices; and supporting taxpayers in the areas of pre-filing 
agreements, determination letters, and advance pricing agreements.
    The Office of Professional Responsibility is funded within this 
budget activity and is responsible for identifying, communicating, and 
enforcing the Treasury Circular 230 standards of competence, integrity, 
and conduct of professionals representing taxpayers before the IRS.

Taxpayer Services
    The fiscal year 2010 President's budget request is $2,269,830,000 
in direct appropriations, an estimated $39,000,000 from reimbursable 
programs, and an estimated $127,000,000 from user fees, for a total 
operating level of $2,435,830,000. The direct appropriations level is a 
reduction of 1.0 percent from the fiscal year 2009 enacted level, 
though it does not represent a program reduction due to non-recurrent 
activities and savings. This appropriation funds the following budget 
activities.
    Pre-Filing Taxpayer Assistance and Education ($676,063,000 from 
direct appropriations, an estimated $819,000 from reimbursable 
programs, and an estimated $18,700,000 from user fees).--This budget 
activity funds services to assist with tax return preparation, 
including tax law interpretation, publication production, and advocate 
services. In addition, funding for these programs continues to 
emphasize taxpayer education, outreach, increased volunteer support 
time and locations, and enhancing pre-filing taxpayer support through 
electronic media.
    Filing and Account Services ($1,593,767,000 from direct 
appropriations, an estimated $38,181,000 from reimbursable programs, 
and an estimated $108,300,000 from user fees).--This budget activity 
funds programs that provide filing and account services to taxpayers, 
process paper and electronically submitted tax returns, issue refunds, 
and maintain taxpayer accounts. The IRS continues to make progress in 
decreasing paper returns and increasing the use of electronic filing 
and payment methods. As previously noted, a record 90 million tax 
returns were filed electronically this year.

Operations Support
    The fiscal year 2010 President's budget request is $4,082,984,000 
in direct appropriations, an estimated $47,304,000 from reimbursable 
programs, and an estimated $32,900,000 from user fees, for a total 
operating level of $4,163,188,000. The direct appropriation level is an 
increase of 5.6 percent from the fiscal year 2009 enacted level and 
includes $290,000,000 of support funding for enhanced enforcement 
activities. This appropriation funds the following budget activities.
    Infrastructure ($900,852,000 from direct appropriations, an 
estimated $155,000 from reimbursable programs, and an estimated 
$16,100,000 from user fees).--This budget activity funds administrative 
services related to space and housing, rent and space alterations, 
building services, maintenance, guard services, and non-Automated Data 
Processing (ADP) equipment.
    Shared Services and Support ($1,296,629,000 from direct 
appropriations and an estimated $32,228,000 from reimbursable 
programs).--This budget activity funds policy management, IRS-wide 
support for research, strategic planning, communications and liaison, 
finance, human resources, and equal employment opportunity and 
diversity services and programs. It also funds printing and postage, 
business systems planning, security, corporate training, legal 
services, procurement, and specific employee benefits programs.
    Information Services ($1,885,503,000 from direct appropriations, an 
estimated $14,921,000 from reimbursable programs, and an estimated 
$16,800,000 from user fees).--This budget activity funds staffing, 
equipment, and related costs to manage, maintain, and operate the 
information systems critical to the support of tax administration 
programs. The IRS business programs rely on these systems to process 
tax and information returns, account for tax revenues collected, send 
notices for taxes owed, issue refunds, assist in the selection of tax 
returns for audit, and provide telecommunications services for all 
business activities including the public's toll-free telephone access 
to tax information.

Business Systems Modernization (BSM)
    The fiscal year 2010 President's budget request is $253,674,000 in 
direct appropriations. This amount is an increase of 10.3 percent from 
the fiscal year 2009 enacted level. This appropriation funds the 
planning and capital asset acquisition of information technology (IT) 
to continued modernization of the core taxpayer account database.
    This effort is a critical underpinning of the next generation of 
IRS service and enforcement initiatives. The integration strategy 
includes a particular focus on enhanced information technology security 
practices and robust accounting and financial management controls. This 
activity also funds the ongoing development of the Modernized e-File 
platform for filing tax returns electronically. The account also funds 
BSM labor (salaries and expense dollars) and related contract costs.
Health Insurance Tax Credit Administration (HITCA)
    The fiscal year 2010 President's budget request is $15,512,000 in 
direct appropriations. This amount is an increase of 0.7 percent from 
the fiscal year 2009 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 (Public Law 107-210).

                  FISCAL YEAR 2010 BUDGET ADJUSTMENTS

    The IRS funding increase for fiscal year 2010 is $603,402,000, 
which includes $256,329,000 for maintaining current levels; a net 
decrease of $115,794,000 from efficiencies, savings and reinvestments; 
and a program increase of $462,867,000 to strengthen enforcement, 
address IT security needs and deploy information technology systems. 
These investments also fund increased front-line enforcement efforts. 
By fiscal year 2012, these investments are projected to increase annual 
enforcement revenue by $2.0 billion.
    The budget request supports these activities by proposing:
  --$332,160,000 to target the tax gap by addressing underreporting of 
        tax associated with complex international activities; expanding 
        enforcement efforts on noncompliance among business and high-
        income taxpayers; and minimizing revenue loss by increasing 
        document matching efforts;
  --$108,100,000 to address critical IT operational and security 
        infrastructure needs; and
  --$22,607,000 to accelerate efforts to modernize the core taxpayer 
        account database.
Fiscal Year 2009 Enacted Level
    The fiscal year 2009 enacted level for the IRS is $11,522,598,000, 
supporting an estimated 94,209 FTE.
            Maintaining Current Levels
    Adjustments Necessary To Maintain Current Levels +$260,061,000/0 
FTE.--Funds are requested for: fiscal year 2010 cost of the January 
2009 pay increase of $80,054,000, the proposed January 2010 pay raise 
of $148,894,000, and non-labor related items such as contracts, travel, 
supplies, equipment, and GSA rent adjustments of $31,113,000.
    Government-wide Reduction for Productivity Improvements 
-$13,732,000/0 FTE.--The IRS continues to focus on improving the 
efficiency of its operations through a disciplined process of 
productivity improvement. Additional efficiency savings are outlined in 
the next section.
    GAO Audit Reimbursement Pursuant to Public Law 110-323 
+$10,000,000/0 FTE.--This estimated adjustment will provide funds to 
reimburse the Government Accountability Office (GAO) for the audit of 
the IRS annual financial statements. The IRS must pay this cost 
pursuant to Public Law 110-323. In prior years, GAO conducted the 
financial statement audit for which it did not receive reimbursement.
            Efficiency Savings
    Increase e-File Savings -$8,360,000/-182 FTE.--This decrease is a 
result of savings from increased electronic filing (e-File), which is 
projected to lead to 4.6 million fewer returns filed on paper (2.9 
million individual and 1.7 million business) in fiscal year 2010. This 
is projected to result in a savings of 182 FTE in submission 
processing.
    Non-Recur Savings -$27,074,000/0 FTE.--This decrease is the net 
reduction of one-time costs associated with the IRS fiscal year 2009 
enforcement initiatives.
    Non-Recur Stimulus Savings -$67,900,000/-1,322 FTE.--One-time 
resources were provided in fiscal year 2009 to meet the requirements of 
the Economic Stimulus Act of 2008 (Public Law 110-185).
    Non-Recur Fiscal Year 2009 Reduction Adjustment/Correspondence 
Inventory -$13,439,000/0 FTE.--One-time resources were provided in 
fiscal year 2009 to handle the increased adjustment/correspondence 
workload that resulted from diverting staff from paper correspondence 
to telephone service to meet the requirements of the Economic Stimulus 
Act of 2008 (Public Law 110-185).
    Non-Recur Pension Plan Form Processing -$1,352,000/0 FTE.--This 
decrease results from the funding of the one-time cost in fiscal year 
2009 to test the IRS ERISA (Employee Retirement Income Security Act of 
1974) Residual Solution (IERS) system. This system will process the 
electronic Form 5500, Annual Return/Report of Employee Benefit Plan 
from the new Department of Labor ERISA Filing Acceptance system and the 
paper Form 5500EZ, Annual Return of One-Participant (Owners and Their 
Spouses) Retirement.
            Reinvestment
    Submission Processing Consolidation (Andover) +$2,331,000/0 FTE.--
Increased use of electronic filing options has led to consolidation of 
the individual return processing sites. Increased e-File savings will 
be reinvested to fund one-time severance pay costs for the ramp-down of 
the Andover submissions processing site. As the Andover consolidation 
approaches, the IRS will continue to assist employees in finding 
employment either in or outside the IRS.
            Program Increases
    Reduce the Tax Gap Attributable to International Activities 
+$128,064,000/+784 FTE.--The IRS plans a multi-year investment, 
beginning in fiscal year 2010, to deal more effectively with increasing 
international tax activities of individual and business taxpayers.
    This multi-year investment will improve the identification and 
coverage of international issues and increase issue specialization to 
address increasingly complex international transactions by both 
business and individual taxpayers. It will bring an unprecedented 
increase in international resources with the specialized skills to 
identify and examine international non-compliance.
    The resources will improve the use of data we receive from non-U.S. 
entities and foreign governments, provide the needed legal resources, 
and address aggressive profit allocation activities of multinational 
entities doing business in the United States.
    This effort will also focus on increasing reporting compliance of 
domestic taxpayers with offshore activity. The additional resources 
will allow the IRS to implement a stronger presence in offshore 
activities that will be able to uncover the use of offshore credit 
cards, disguised corporate ownership, brokering activities, and non-
U.S. financial institutions providing banking services to U.S. and non-
U.S. persons. This initiative will also fund the anticipated growth of 
collection activities resulting from increases in small and large 
business examination assessments, foreign investment transactions, and 
withholding compliance for nonresident aliens.
    Finally, this initiative will allow the IRS to increase its 
overseas presence by adding attaches in key countries to continue our 
efforts to aggressively combat abusive foreign tax schemes and other 
tax evasion schemes. These resources are also a key component in 
supporting the Department of Treasury's objective of ``Pre-empted and 
neutralized threats to the international financial system and enhanced 
U.S. national security.''
    This multi-pronged approach will aggressively target the many areas 
of offshore tax abuse with the goal of identifying more of these abuses 
and curbing this activity.
    Improve Reporting Compliance of Small Business and High Income 
Taxpayers +$94,215,000/+755 FTE.--This initiative will improve 
reporting compliance by increasing examinations of business and high-
income returns and exams involving flow-through entities by 47,400; 
audits targeting employment, excise, and estate and gift taxes by 
6,350; and investigations of business non-filers by 183,000. This 
request will generate $567.2 million in additional enforcement revenue 
once new hires reach full potential in fiscal year 2012.
    Expand Document Matching for Business Taxpayers +$26,237,000/+300 
FTE.--This initiative will increase the coverage of the document 
matching program to reduce the number of business taxpayers who 
misreport their income. This request will generate $386.5 million in 
additional revenue once new hires reach full potential in fiscal year 
2012.
    Address Nonfiling/Underpayment and Collection Coverage 
+$83,644,000/+491 FTE.--With expanded enforcement efforts in recent 
years, the IRS must invest in improving its collection operations to 
ensure appropriate overall balance and coverage. This initiative will 
generate $359.4 million in additional revenue once new hires reach full 
potential in fiscal year 2012. In addition, this initiative will fund 
the rent, furniture, telecommunication, and IT costs to build two new 
Automated Collection System (ACS) sites.
    Address IT Security and Material Weakness +$90,000,000/+36 FTE.--
Improving IT security is necessary to ensure the integrity of the tax 
system and maintain taxpayer confidence. This initiative will allow the 
IRS to enhance enterprise security risk management; harden software 
applications and network infrastructure security; improve security 
compliance monitoring and reporting; and provide an enterprise solution 
to deploy end-to-end audit log collection.
    Implement Return Review Program (RRP) +$18,100,000/+10 FTE.--In 
fiscal year 2008, the Electronic Fraud Detection (EFDS) System stopped 
$1.4 billion in erroneous refunds. This initiative will complete 
modernization of the IRS fraudulent refund detection systems. It will 
deliver an integrated and unified RRP system that will enhance IRS 
capabilities to detect, resolve, and prevent criminal and civil tax 
refund and abuse.
    Business System Modernization (BSM) +$22,607,000/0 FTE.--This 
initiative will provide funding for the continued modernization of the 
core taxpayer account database. This effort is a critical underpinning 
of the next generation of IRS service and enforcement initiatives. The 
integration strategy includes a particular focus on enhanced 
information technology security practices and robust accounting and 
financial management controls.
Legislative Proposals
    The fiscal year 2010 President's budget includes a number of 
legislative proposals intended to improve tax compliance with minimum 
taxpayer burden. These proposals will specifically target the tax gap 
and generate nearly $10 billion over the next 10 years. The Obama 
Administration proposes to expand information reporting, improve 
compliance by businesses, strengthen tax administration, and expand 
penalties.
    Modify Electronic Filing Requirements.--Electronic filing benefits 
taxpayers and promotes effective tax administration because it 
decreases processing errors, expedites processing and payment of 
refunds, and allows the IRS to efficiently maintain up-to-date records. 
This proposal would require electronic filing by tax return preparers 
(initially defined by a set threshold amount).
    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 a certified taxpayer identification number (TIN) from 
        contractors;
  --Require increased information reporting on certain government 
        payments; and
  --Increase information return penalties.
    Improve Compliance by Businesses.--Improving compliance by 
businesses of all sizes is as 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;
  --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;
  --Improve the investigative disclosure statute;
  --Repeal the requirement of a partial payment with an application for 
        an offer-in-compromise; and
  --Allow assessment of criminal restitution as tax.
    Expand Penalties.--Penalties play an important role in discouraging 
intentional non-compliance. Specific proposals to expand penalties 
would:
  --Impose a penalty on failure to comply with electronic filing 
        requirements; and
  --Clarify that the bad check penalty applies to electronic checks and 
        other forms of payment.
      improve tax administration and other miscellaneous proposals
    The Administration has put forward additional proposals relating to 
IRS administrative reforms. These proposals would:
  --Require information reporting on expense payments relating to 
        rental property;
  --Improve the foreign trust reporting penalty;
  --Apply the Federal Payment Levy Program to contractors before 
        providing Collection Due Process; and
  --Clarify that vendor levy on ``goods and services'' would not 
        exclude ``property.''

                               CONCLUSION

    Mr. Chairman, thank you again for this opportunity to testify on 
the President's fiscal year 2010 budget for the Internal Revenue 
Service. We urge its passage. It provides the IRS with the much needed 
resources to provide taxpayers with high quality customer service, and 
bolster IRS enforcement in critical areas, such as unlawful offshore 
tax evasion. It also makes wise investments for the next generation of 
technology and the IRS workforce.
    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 $10 billion over the next 10 
years if enacted.
    I look forward to working with you and the Subcommittee on this 
important budget request and I will be happy to respond to any 
questions.

                        REGULATION OF PREPARERS

    Senator Durbin. Thank you, Mr. Shulman. Three States that I 
know of here, the staff has found, Oregon, California, and 
Alabama, already regulate tax preparers. Can you find, in their 
State regulation, evidence that the tax preparers in those 
States are doing a better job?
    Commissioner Shulman. Some of this regulation is pretty 
recent and it is a relatively small subset. The Government 
Accountability Office (GAO) has actually done some studies of 
State regulation and what is effective. It kind of is across 
the board, everything from registration, to registration and 
licensing, to actual continuing education.
    What I announced last week is that I'm going to have a 
wide-open discussion about this. We're going to invite the 
industry in; we're going to invite taxpayers in; we're going to 
invite consumer advocates in. I would love to work with the 
subcommittee on this and look and say, ``what's the most 
effective way for us to work with that community to make sure 
there's good compliance?'' And that could include service and 
education. It clearly will include ramped up enforcement of the 
bad preparers, and then regulation is on the table. And we will 
closely look at those States----

                          MISTAKES ON RETURNS

    Senator Durbin. Are there some parts of the 1040 or 
schedules and such where you most often find mistakes being 
made?
    Commissioner Shulman. The most common mistakes occur where 
there's complexity. Refundable credits are one place there's 
quite a bit of mistakes, including the earned income tax 
credit. Another common mistake is math error, like not putting 
your Social Security number right. One of the reasons we 
encourage electronic filing is it often catches math errors. 
You can't submit it until the form is complete.
    Senator Durbin. Years ago, my bookkeeper in Springfield, 
Illinois passed away and I said, listen, I'm a lawyer. I took a 
tax course, I'll do my own tax return. I think every Member of 
Congress should be required to do their own tax return. I think 
we'd have tax simplification in a hurry in this country.
    And, as you might guess, the IRS sent back my tax return 
and said, you did a math error here, Mr. Durbin, which was a 
humbling experience and disqualifies me from service in the 
President's Cabinet. But, having said that, it was an eye 
opener.

                       REFUND ANTICIPATION LOANS

    May I ask you about refund anticipation loans (RAL). I 
don't know if you are familiar with these. I have co-sponsored 
legislation to require companies operating as refund loan 
facilitators that offer loans to register with the Federal 
Government. The National Consumer Law Center found that the 
effective annualized rate, interest rate, for a refund 
anticipation loan can range from 50 percent to 500 percent.
    Is the IRS doing anything at this point to address concerns 
about refund anticipation loans?
    Commissioner Shulman. A couple of things. One of the most 
important things we do is continue to get our technology in 
order, so that we can get refunds out quickly to people, so 
they can get money in their pockets without having to take a 
RAL. Now, if you electronically file and choose a direct 
deposit, you may get your refund back in under 10 days. 
Anecdotally, it may come back in even fewer days.
    If we can finish our modernized taxpayer database, every 
taxpayer will have the opportunity to get a refund back 
quicker. So, one key to addressing RALs is to get rid of the 
need. I personally think that it's incredibly unfortunate that 
people's financials are in a state, many times often not their 
own doing, that they need to take a high-interest loan and that 
they can't wait the 10 days to get this refund. As we look at 
the whole preparer issue, refund anticipation loans are clearly 
an associated service that some preparers provide, and we will 
take a look at this.
    The focus is on preparer conduct, but clearly all the 
related industries will be part of the preparer review.

                  PERFORMANCE ON TOLL-FREE PHONE LINES

    Senator Durbin. What about answering the phone at the IRS? 
You reduced your performance goal from providing telephone 
assistance from 82 percent last year to 77 percent this year. I 
wonder why you did that. And what steps are you taking to 
improve the IRS's telephone performance for next year?
    Commissioner Shulman. Phones have been stressed after 
sending checks out to all the American people last year, this 
year doing the Recovery Act, and the truing up the checks. Just 
to give you a sense, in 2007, we had 48 million calls between 
January and May. In 2008, we actually had 64 million and in 
2009 we had 74 million.
    And so one thing we have done as a result is redone our 
call routing to make it quicker for people to get in the right 
queue and answer important questions quickly for people, 
filing-dependent questions.
    Second is, we're trying to push more taxpayers to the Web. 
So, for instance, one of the reasons for the decline this year 
is about 5 million people called and said, ``what is my 
adjusted gross income?'' Next year, we will have a Web service 
to get your adjusted gross income.
    And then third, we've actually added an estimated wait 
time. So, if you call and it says it is going to be 15 minutes 
before we get to you, you can hang up and call back when it's 
not as busy.
    So, we're doing a lot of refinements. I think the reality 
is lots of Government services are competing for money. We are 
trying to figure out the right number for level of service. I 
think the 77 percent doesn't mean 23 percent are unhappy. Only 
7 percent got a busy signal or disconnected; it's a much 
smaller number. And so we're trying to get better at the Web 
and figure out the right level of service.

                      PHISHING AND DATA PROTECTION

    Senator Durbin. Two weeks ago, I got the best e-mail that I 
could possibly imagine. It was from the IRS! And they told me 
that I had a refund coming. I was elated, $600. It's terrific. 
I'll think of something to do with that.
    Of course you know as I know, right off the bat, there's 
something wrong with this. Can you tell me what it is?
    Commissioner Shulman. We don't send e-mails to people 
soliciting things.
    Senator Durbin. And so there are lots of scams like that 
out there. This person wanted me to send back some information 
so they could send me a refund check, nominally in the name of 
the IRS.
    Do you go after these folks? Do you try to initiate 
prosecution?
    Commissioner Shulman. We're very troubled. We would like to 
get the message out that you are not going to get an 
unsolicited phone call or an e-mail from the IRS telling you 
that you have some special deal with the IRS. So people should 
just delete that. We shut down about 2,000 sites this year. It 
is called phishing, sending out e-mail pretending like they are 
the IRS. We work with law enforcement authorities when we see 
these. We have hot lines. We have lots of people reporting to 
us. Two thousand Internet sites have been shut down just this 
filing season. We are very aggressive about it.
    Some of these are originating from overseas and it's hard 
for----
    Senator Durbin. My friends from Nigeria have an ongoing 
correspondence with me.
    Thank you. Senator Collins.
    Senator Collins. Thank you, Mr. Chairman. I just want to 
associate myself with the chairman's last question to express 
concern about the need for more enforcement and education to 
deal with these scams. They are pervasive. I've talked with the 
Federal Trade Commission (FTC), but the IRS can certainly play 
an important role as well in alerting consumers.
    Consumers are particularly confused because, 2 years ago, 
they received rebate checks from the Federal Government. So 
when they get an e-mail message supposedly from the IRS saying 
that ``your stimulus check is now available,'' they equate it 
to the rebate checks.
    So I just want to second Senator Durbin's concern in that 
area. I think we need to do more both to educate consumers and 
go after the people who are perpetrating these scams, which is 
difficult to do in an Internet world.

                                TAX GAP

    Let me switch to some other issues. The IRS Oversight 
Board, in its statement to this subcommittee, identified two 
serious weaknesses of our tax administration system. The first 
is the $290 billion tax gap, and the second is what the Board 
referred to as the archaic nature of IRS information systems. 
And I am well aware of that second issue because year after 
year after year, the GAO puts the IRS informations systems on 
its high risk list.
    I'd like to start with the tax gap issue and ask you what 
you think should be done to address the tax gap, in addition to 
better enforcement.
    Commissioner Shulman. I would say that tax gap numbers are 
imperfect and a lot of them are extrapolated numbers from 1980 
data. The only way to really get good tax gap numbers is to do 
random audits. We like to do our audits in a more focused, 
risk-based way, so random audits would be a burden on people.
    With that said, we take the tax gap very seriously. I think 
there are three important things that can be done with tax gap. 
One is simplification. As long as the Tax Code is this complex, 
people are going to make mistakes and people are going to have 
opportunities to use the complexity of the system for evasion.
    Second is information reporting. All our statistics show 
that if we get a W-2 from an employer and tax is withheld at 
the source, we have 99 percent compliance. When people operate 
a cash business, and there's no information reported to us and 
it is all voluntary, the compliance rate is much lower. The 
Congress passed a couple of very important information 
reporting provisions last year, such as credit card reporting 
for small businesses, as well as basis reporting. They will be 
helpful.
    The President's budget this year has very important 
information reporting proposals, especially in the 
international context. So we would get more information about 
across-border wire transfers, and that is going to be 
important.
    And so, the first step is simplification and the second 
step is information reporting. We also are taking a look at 
this whole issue of how to leverage preparers to be part of the 
system. If you think about the image of someone sitting down 
with the 1040 form and a pencil, the chairman notwithstanding, 
not that many people do that anymore. People are using a third 
party, someone as an intermediate. And those people need to be 
part of the solution to getting people to pay the right amount 
of taxes. Because when they don't, it is actually a huge 
disservice to the American people. You know, if you end up 
paying penalties and interest and having trouble with the IRS, 
your preparer hasn't done you any favors. So, I think that the 
whole issue of leveraging preparers is going to be part of our 
tax gap strategy.

                        REGULATION OF PREPARERS

    Senator Collins. Let me follow-up on the issue of so-called 
bad preparers. Do you make referrals to State licensing boards 
when you identify a ``bad preparer'' who is a CPA? Because 
they're the ones who have the ability to impose sanctions.
    Commissioner Shulman. Under Circular 230, we have the 
ability to impose sanctions on anyone who represents a person 
before the IRS. We can also give preparer penalties and then we 
coordinate with States. And so we do all of the above. It is 
such a transformational shift, with so many people using a 
third party, standing between them and the IRS, that we need to 
have this overall strategy. It includes the punitive aspect of 
enforcement, but also includes making sure that we are getting 
the right education, the right services, to preparers so that 
they can serve the American people well.

                 INTERNATIONAL ACTIVITY AND THE TAX GAP

    Senator Collins. Does the IRS have an estimate of the tax 
gap attributable to international activities? The reason I ask 
this is you mentioned in your opening statement offshore tax 
abuses, and it seems that that is the focus of your fiscal year 
2010 enforcement initiative.
    Commissioner Shulman. The short answer is no. We don't have 
a good international tax gap estimate. The reason for that is, 
to get good estimates that we are willing to put out, we 
actually need to do random audits. To do them internationally, 
we have to coordinate with other law enforcement agencies. By 
its nature, the reason that people evade paying taxes by going 
overseas is its hard for the U.S. Government to get to them.
    There are some wildly high estimates that are based on 
total deposits and how many are overseas, and assuming that no 
one is paying taxes on them. There are some numbers that get 
bandied about as part of the debate.
    For me, when I think about tax gap and I think about 
enforcement, I think not only about the dollars that we're 
going to bring in directly, but also about the deterrent effect 
and how we project fairness to all American people.
    And so the international issues that are very important to 
me are to go get the money that is being hidden offshore. And I 
also think ordinary Americans need to know that, if they are 
wealthy and have a lot of assets and are playing the 
international capital markets, they are not going to get a free 
pass while firemen and teachers are paying their fair share of 
taxes. And so it's a long way of saying it's part of collecting 
the $2.5 trillion you need to run the Government. This is a 
matter of fundamental fairness and the deterrent effect, and 
people need to know that the U.S. Government is on the job.

                     BUSINESS SYSTEMS MODERNIZATION

    Senator Durbin. I would like to ask one follow-up question 
here. It is on CADE, customer account data engine. I am kind of 
noticing, I worked with Senator Collins on this issue after 9/
11 on technology in the Federal Government. And I have to tell 
you, after following it for years, it has been a source of 
frustration of how many bad starts we've had different with 
different agencies, trying to bring modern technology. Maybe 
the private sector has the same problem, but it seems to be 
endemic at the Federal Government.
    Your CADE system, a core component of BSM, Business Systems 
Modernization, was intended to replace the original master 
file. It has now cost over $400 million since work began almost 
5 years ago. But it has only delivered only about 15 percent of 
the full capability intended. The fiscal year 2010 budget 
request proposes a 10 percent increase for BSM, or about $24 
million of the $229.9 million enacted last year.
    Has the IRS taken actions to address GAO's recommendations 
to fully revisit the division's strategy for Business System 
Modernization, including developing long-term plans for 
completing the program?
    Commissioner Shulman. I'm aware of the GAO report that came 
out yesterday and have a couple of thoughts.
    The first thing I did when I came in is I talked to lots of 
stakeholders. I talked to GAO and our auditor and I said, you 
know, tell me about CADE. To put it into perspective, CADE is a 
$50 million or so project each year within a $1.5 billion 
technology portfolio. And so while it's important because it is 
our core database, it is not everything we do on technology.

                      CUSTOMER ACCOUNT DATA ENGINE

    What I was told by overseers is we've made great progress, 
we've proven that we can do systems development, but they don't 
see a path to finishing CADE. And the internal projections for 
finishing were 2015, 2017, 2020. I believe the key to 
technology projects, the way get them done, is you have 
leaders--not just technology leaders, but the people who run 
agencies-- focus on them and drive toward those results.
    And so what we've done is refocus the effort and split 
apart all the application work from the database work. If we 
get the database done, we will get refunds out quicker, we will 
address material weaknesses, and we will be able to use data 
for enforcement purposes. So the real business value of CADE 
comes out of the database; we are focused on getting that done 
now. And we are slowing down the application development and 
just focusing on conversion of the database.
    The other thing that I think is important from that report 
that came out is that the vast majority of that $400 million is 
being put to good use. The key is getting a data model with 
consistent definitions used in all of our systems. That was 
under that umbrella. We put out faster refunds to millions of 
taxpayers using the money that's been spent. Especially in 
these difficult economic times, that has been really important. 
And we are using a huge amount of the software and hardware.
    So, this is a gradual shifting of focus. It is what you do 
with any big technology project, you learn as you go along. I 
certainly would hope it is not put in a category of failure; I 
don't believe it has failed at all. I think it's a step in what 
we can get done during my 5-year tenure. And that is what we 
are trying to get done.
    Senator Durbin. Thank you. Senator Collins.

                    INFORMATION TECHNOLOGY SECURITY

    Senator Collins. Thank you, Mr. Chairman. Just one final 
question and the rest I will submit for the record.
    I appreciate the chairman bringing about the CADE strategy 
because that has been of concern to me. The other issue that 
concerns me has to do with IT security weaknesses. How much 
improvement in data protection do you believe the IRS will be 
able to make with the $90 million that you are requesting for 
IT security? Give us your assessment of the vulnerabilities and 
whether that is, in fact, a sufficient amount to address the 
problem.
    Commissioner Shulman. Senator, when I came in, all everyone 
talked about was modernization. And I actually believe that if 
you have a big technology portfolio, you need to worry about 
the current systems, updating those, so that your workers have 
tools along the way, making sure that there's the right balance 
between security and infrastructure. You need to worry about 
data security, especially when you hold the taxpayer records of 
the United States. And you need to worry about your new 
systems.
    So, one of the things this budget reflects is rebalancing 
the portfolio so we are not myopically focused on 
modernization; we care a lot about security and data. There's 
$90 million in the budget request to upgrade our security 
posture and infrastructure. It is incredibly important. I 
think, knock on wood, we haven't had any major data breaches. 
There is always going to be a spectrum of weaknesses that 
overseers are going to point out, and you have to do risk-
reward evaluations. You're never going to get every single 
piece of potential weakness but you have to figure out what is 
important.
    I pay a lot of attention to GAO procedure reports. All 
development is now new development. We're seeing a lot of laws 
which are incredibly important for internal threats. We are 
consolidating our access points into our networks so that we 
have perimeter security.
    A lot of data security is cultural. You want people who 
have access to data to wake up every day and feel it's their 
responsibility to lock down the data. So, we had something 
called Operation Red last year where we stood down every 
employee of the IRS for 2 hours to talk about what data is 
under their sphere and what can they do to better protect it, 
everything from file cabinets to safes to technology.
    I would say we are in a better security posture now than 
when I started. The people who are interested in breaching the 
security are always going to be innovating, and so we are going 
to need to stay ahead of the curve. But I think the money 
requested in this budget will allow us to keep improving in 
that vein.
    Senator Collins. Thank you. Thank you, Mr. Chairman.
    Senator Durbin. I'd like to say that the IRS Oversight 
Board has submitted for inclusion in the record and preliminary 
recommendations on the fiscal year 2010 IRS budget proposal. 
The GAO office, at my request, is evaluating the budget 
proposal and will submit its analysis and recommendations.
    Colleen Kelly, president of the National Treasury and 
Employer's Union on behalf of employers has submitted a written 
statement. Without objection, these will all be made part of 
record.
    [The statements follow:]

             Prepared Statement of the IRS Oversight Board

    The Internal Revenue Service (IRS) Oversight Board thanks Chairman 
Durbin, Ranking Member Collins, and members of the Subcommittee for the 
opportunity to present the Oversight Board's views on the 
administration's fiscal year 2010 IRS budget request.
    This statement presents the Board's recommendations for the IRS' 
fiscal year 2010 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.
    The Board has a responsibility to ensure that the IRS' budget and 
the related performance expectations contained in the performance 
budget support the recently published IRS Strategic Plan 2009-2013. In 
addition to this statement, the Board develops a formal report in which 
it explains in detail why it has recommended this budget for the IRS. 
Because of the late budget cycle caused by the change in 
administrations, this report is still under development. The Board 
requests that this report be entered into the meeting record when it is 
sent to the Subcommittee later this month.

              FISCAL YEAR 2010 IRS BUDGET RECOMMENDATIONS

    The IRS Oversight Board recommends an fiscal year 2010 IRS budget 
of $12.489 billion, an increase of $966 million over the enacted fiscal 
year 2009 amount of $11.523 billion. This recommendation is $363 
million above the President's request of $12.126 billion.
    Tables 1 and 2 at the end of this statement show more information 
on the Board's budget recommendations. Table 1 shows the program 
initiatives or increases the Board is recommending, and Table 2 shows 
the Board's recommended budget by account.
    As the Board stated in its 2008 Annual Report to Congress, our tax 
administration system has two serious weaknesses, the $290 billion tax 
gap and the archaic nature of IRS information systems. As a result, the 
Board recommends that strengthening the system be a national priority.
    Addressing those weaknesses is critical and urgent. The Board is 
fully supportive of the administration's boost in enforcement funding. 
However, the Board recommends greater funding in the areas of Business 
Systems Modernization (BSM) and Operations Support than the President's 
budget requests. While the Oversight Board and the administration's 
budgets agree in many ways, the Board feels that these key additional 
investments are needed sooner--not later--to strengthen our tax 
administration system.
    The effort required to correct the two weaknesses identified above 
is not to be taken lightly. Although the tax gap can never 
realistically be eliminated, it is equally as foolish to suggest that 
nothing can be done to reduce it. As the Board has opined on numerous 
occasions, there is not a single solution to reducing the tax gap. 
Rather, a comprehensive, multi-faceted, multi-year, approach is needed 
that provides for excellent taxpayer service combined with vigorous 
enforcement, along with a long-term investment in IRS information 
technology and infrastructure. It is generally recognized that the IRS 
``cannot audit its way out of the tax gap.'' Balance between immediate 
expansion of personnel combined with long term investments in 
information technology and infrastructure is needed.
    The second weakness, modernizing the IRS' archaic information 
technology systems, is equally daunting--yet it must be done. As noted 
in the Board's 2008 Annual Report to Congress, the IRS' systems 
modernization program has been on the Government Accountability 
Office's (GAO's) high risk list since 1995. The GAO placed this program 
on its high risk list because it believed that the IRS relied on 
obsolete automated systems for key operational and financial management 
functions. The Board believes that it is unacceptable for this program 
to remain on the high risk list for so long is unacceptable.
    The Board believes strongly that the IRS' BSM program must be in a 
position to move forward in fiscal year 2010 and fiscal year 2011 so 
that program milestones scheduled for 2011 can be achieved. Because the 
President's budget provides little additional funding for the Customer 
Account Data Engine in fiscal year 2010, it puts the fiscal year 2011 
milestones at great risk. In addition, the Board believes additional 
funding is needed to refresh and update the IRS' aging infrastructure. 
In total, of the $363 million difference in the two budgets, about $332 
million is for investments in critical information technology and 
infrastructure.
    The Board would also increase funding for several key initiatives 
to improve taxpayer service. These initiatives are all designed to help 
the IRS plan and implement better taxpayer service in the future.
Board Fully Supports Increased Enforcement Funding
    The Board's recommendation for the enforcement account, which at 
$5.5 billion is close to half of the IRS total budget, is identical to 
the President's budgets. Both the President's and Oversight Board's 
budgets add $332 million for additional enforcement. This increase 
constitutes a 7.6 percent boost in enforcement funding, and includes 
additional funding to strengthen criminal investigations programs, 
increase examinations and collections, and support a variety of 
regulatory matters.
    This increase in enforcement resources pays for itself; in some 
cases many times over--a consideration that should not be ignored in 
the budget process. In addition, it helps to reduce the tax gap, which 
deprives the nation, and hence its citizens, of $290 billion it is 
legally owed. The tax gap is an affront to honest taxpayers and efforts 
must be made to reduce it.
    The President's request for enforcement funding includes a multi-
year investment of $128 million, starting in fiscal year 2010, to deal 
more effectively with increasing international tax activities of 
individual and business taxpayers. The Board is pleased with this, as 
the effects of globalization on tax administration are significant and 
must be addressed.
    The Board also strongly supports additional funding to improve 
compliance among ``high-risk'' taxpayer segments. Estimates shows that 
much of the tax gap is due to underreporting of income by businesses, 
mostly run by individuals. It is imperative that the IRS not only 
ensure that all individuals understand their tax obligations, but that 
they report their income and pay their taxes.

Taxpayer Service Increase Recommended
    For the taxpayer service account, the Oversight Board's and 
President's budgets are within 0.2 percent of one another. The 
President's budget request for taxpayer service benefits from 
congressional action taken during consideration of the fiscal year 2009 
budget. By adding additional funding to the IRS taxpayer service budget 
in fiscal year 2009, Congress raised the base amount for taxpayer 
service in fiscal year 2010, giving the IRS additional resources to 
serve taxpayers in an increasingly more complex economic environment.
    The need for taxpayer service is especially acute during periods of 
economic hardship, as taxpayers may find themselves facing challenging 
financial situations. In addition, taxpayers need additional help to 
understand new tax provisions and programs designed to help them during 
difficult times. Every change in the tax code causes the tax 
administration system to become more complex, with more taxpayers in 
need of help to understand and meet their obligations. It is especially 
important during this recession that the IRS be able to follow through 
on its strategic goal to ``make voluntary compliance easier.''
    Despite a higher funding base for taxpayer service, there are 
several areas where the Board recommends additional funding. In 2005, 
Congress asked the IRS, National Taxpayer Advocate, and the IRS 
Oversight Board to develop a 5-year plan to improve taxpayer service. 
The result was the Taxpayer Assistance Blueprint (TAB), which was 
completed in April 2007. In the Board's opinion, the IRS needs 
additional resources to more fully carry out the TAB by expanding its 
on-line capabilities. Additional funding is also needed to optimize the 
use of Taxpayer Assistance Centers, also known as walk-in sites, which 
traditionally serve lower income taxpayers who depend more on walk-in 
services. Overall, the Board recommends an additional $31.6 million be 
appropriated for taxpayer service, all of which will be focused on 
improving taxpayer service in the future.

Strategic Funding Needed for Business Systems Modernization
    The IRS' archaic computer systems are a serious challenge facing 
the IRS. The Board is dismayed by the long-term under-funding of the 
BSM program, forcing the IRS to stretch out its efforts at a painfully 
slow pace, to the detriment of taxpayers.
    The Board is pleased that the IRS has revised its BSM approach to 
put more focus on completing the program, and considers it a critical 
foundation of service and enforcement in the future.
    However, the Board questions whether the President's budget will 
allow for substantive progress in the coming years. The Board has 
opined in past years that the BSM account is fundamentally under-
funded, and despite the additional $7.3 million added by Congress in 
fiscal year 2009 and the President's fiscal year 2010 requested 
increase of $22.6 million, the fiscal year 2010 request for BSM 
continues to be far too low. Progress will come slowly should that 
trend continue. The Customer Account Data Engine project, in 
particular, has funding needs that go far beyond what was requested in 
fiscal year 2010, and those needs will only grow in fiscal year 2011.
    The Board's recommended BSM budget of $400 million is 58 percent 
higher than the President's BSM budget of $253.7 million. At $253.7 
million, the President's BSM budget consumes 2.1 percent of the IRS 
total budget of $12.126 billion. This compares to the Board's 
recommendation of a $400 million BSM budget, which consumes 3.2 percent 
of its total $12.489 billion budget. Although the difference is quite 
small when viewed as a portion of the total budget, the vision 
presented by these two BSM budgets is quite different. The Board 
believes that funding decisions for the IRS must look beyond 
consideration of short term benefits and immediate return on 
investment. Serious consideration must also be given to the long term 
benefits to taxpayers and the tax administration system that will 
result from a modernized information technology system. These 
investments will result in fundamental changes to tax administration 
that will benefit both taxpayers and tax administrators alike.
    The Board recommends that a total of $400 million be appropriated 
for the BSM program so that the pace of progress is increased, allowing 
the IRS to achieve key milestones in fiscal year 2011, such as the 
deployment of a daily Individual Master File capability and a Customer 
Account Data Engine relational database.

More Funding for Operations Support
    Another important aspect of the IRS' performance is the state of 
its legacy infrastructure: the technology and tools used by IRS 
employees to do their work. IRS laptops, software, the 
telecommunications systems, and the buildings themselves are aging and 
must be updated and maintained. In addition, the IRS must protect its 
hardware and data infrastructure from threat, whether it comes from bad 
weather or cyber-attack.
    The administration's fiscal year 2010 budget calls for $108.1 
million in program increases to address information technology security 
and material weaknesses and to strengthen the Electronic Fraud 
Detection System. The Board supports this funding, as both can help 
ensure the integrity of the tax system and maintain taxpayer confidence 
that its returns remain private and safe from security risks.
    However, more needs to be done. The Board recommends a total of 
$292 million in infrastructure program initiatives, compared to the 
$108 million requested by the President's IRS budget. The Board 
recommends an additional $164 million in technology initiatives and a 
$20 million initiative related to workforce development. This funding 
is needed to refresh and maintain the IRS' infrastructure, strengthen 
its ability to protect the personal information of taxpayers, increase 
the productivity of its workforce by leveraging information technology, 
and upgrade its financial services accounting system that uses a 
software application product that is so old the vendor will no longer 
support the program in 2013.
    In addition, workforce development cannot be ignored, especially 
during a period when the IRS is losing experienced employees to 
retirement and is hiring a significant number of new employees. 
Frontline supervision plays a key role in employee satisfaction, 
quality, and productivity, and the IRS lacks funding to properly train 
frontline managers in a timely fashion. Approximately $15 million of 
the workforce initiative is for frontline management training, with the 
remaining $5 million for succession planning and executive development.
Long-Term Investment Key to IRS Strength
    Although the magnitude of the Board's budget recommendations for 
the IRS are not vastly different from the President's budget request in 
amount, they do focus more on the IRS' strategic goals and call for 
investments that are needed today for a stronger tax administration 
system in the future. The Oversight Board believes that its approach 
represents a meaningful long-term investment to benefit our Nation in 
the decades to come.

TABLE 1.--IRS OVERSIGHT BOARD RECOMMENDED FISCAL YEAR 2010 IRS BUDGET BY
                           PROGRAM INITIATIVE
                        [In thousands of dollars]
------------------------------------------------------------------------

------------------------------------------------------------------------
Fiscal Year 2009 Enacted...............................      11,522,598
Changes to Base:
    Maintaining Current Levels.........................         256,329
    Efficiencies/Savings...............................        (118,125)
    Reinvestment.......................................           2,331
                                                        ----------------
      Subtotal Changes to Base.........................         140,535
                                                        ================
      Total Fiscal Year 2010 Base--Current Services....      11,663,133
                                                        ================
                   Program Increases

Taxpayer Service Initiatives:
    TAB Technology Enhancements........................           6,000
    Optimize TAC Footprint.............................          17,880
    Research and Analysis to Improve Taxpayer Service..           7,750
                                                        ----------------
      Subtotal, Taxpayer Service Initiatives...........          31,630
                                                        ================
                   Program Increases

Enforcement Initiatives:
    Reduce the Tax Gap Attributable to International            128,064
     Activities........................................
    Improve Reporting Compliance of SB/SE Taxpayers....          94,215
    Expand Document Matching for Business Taxpayers....          26,237
    Address Nonfiling/Underpayment and Collection                83,644
     Coverage..........................................
                                                        ----------------
      Subtotal, Enforcement Initiatives................         332,160
                                                        ================
Infrastructure Initiatives:
    Address IT Security and Material Weakness..........          90,000
    Implement Return Review Program....................          18,100
    Refresh/Sustain Infrastructure.....................          75,000
    Training and Certifying Project Managers...........           5,000
    Enhance Privacy, Information Protection and Data              9,154
     Security..........................................
    Technology Investments to Enhance Operations.......          35,000
    Upgrade Integrated Financial System (IFS)..........          40,700
    Leadership Training and Development................          20,000
                                                        ----------------
      Subtotal, Infrastructure Initiatives.............         292,954
                                                        ================
BSM Initiative:
    Fund BSM to Accelerate Taxpayer Benefits...........         168,933
                                                        ----------------
      Subtotal, BSM....................................         168,933
                                                        ================
      Subtotal Fiscal Year 2010 Program Initiatives....         825,677
                                                        ================
      Total Fiscal Year 2010 Request...................      12,488,810
                                                        ================
Fiscal Year 2010 President's Request for IRS...........      12,126,000
Increase Over President's Request......................         362,810
------------------------------------------------------------------------


                                 TABLE 2.--SUMMARY OF OVERSIGHT BOARD RECOMMENDED IRS FISCAL YEAR 2010 BUDGET BY ACCOUNT
                                                                 [Dollars in thousands]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                           Taxpayer
                                                           Service        Enforcement     Ops Support          BSM            HITCA           Total
--------------------------------------------------------------------------------------------------------------------------------------------------------
Fiscal Year 2009 Enacted Budget......................      $2,293,000       $5,117,267      $3,867,011         $229,914         $15,406     $11,522,598
Changes to Base:
    Maintaining Current Levels Adjustment............         $60,195         $133,815         $61,060           $1,153            $106        $256,329
    Efficiencies/Savings.............................        ($90,918)  ..............        ($27,207)  ..............  ..............       ($118,125)
    Reinvestment.....................................          $2,025   ..............            $306   ..............  ..............          $2,331
                                                      --------------------------------------------------------------------------------------------------
      Subtotal Changes to Base.......................        ($28,698)        $133,815         $34,159           $1,153            $106        $140,535
                                                      ==================================================================================================
      Total Fiscal Year 2010 Base--Current Services..      $2,264,302       $5,251,082      $3,901,170         $231,067         $15,512     $11,663,133
                                                      ==================================================================================================
                  Program Increases

Taxpayer Service Initiatives:
    TAB Technology Enhancements......................            $592   ..............          $5,408   ..............  ..............          $6,000
    Optimize TAC Footprint...........................          $4,238   ..............         $13,642   ..............  ..............         $17,880
    Research and Analysis to Improve Service.........  ...............  ..............          $7,750   ..............  ..............          $7,750
                                                      --------------------------------------------------------------------------------------------------
      Subtotal, Taxpayer Service Initiatives.........          $4,830   ..............         $26,800   ..............  ..............         $31,630
                                                      ==================================================================================================
Enforcement Initiatives:                               ...............  ..............  ...............  ..............  ..............  ...............
    Reduce the Tax Gap Attributable to International           $3,124         $104,113         $20,827   ..............  ..............        $128,064
     Activities......................................
    Improve Reporting Compliance of SB/SE Taxpayers..            $267          $75,114         $18,834   ..............  ..............         $94,215
    Expand Document Matching for Business Taxpayers..          $1,425          $17,955          $6,857   ..............  ..............         $26,237
    Address Nonfiling/Underpayment and Collection                $712          $55,736         $27,196   ..............  ..............         $83,644
     Coverage........................................
                                                      --------------------------------------------------------------------------------------------------
      Subtotal, Enforcement Initiatives..............          $5,528         $252,918         $73,714   ..............  ..............        $332,160
                                                      ==================================================================================================
Infrastructure Initiatives:
    Address IT Security and Material Weakness........  ...............  ..............         $90,000   ..............  ..............         $90,000
    Implement Return Review Program (RRP)............  ...............  ..............         $18,100   ..............  ..............         $18,100
    Refresh/Sustain Infrastructure...................  ...............  ..............         $75,000   ..............  ..............         $75,000
    Training and Certifying Project Managers.........  ...............  ..............          $5,000   ..............  ..............          $5,000
    Enhance Privacy, Information Protection and Data   ...............  ..............          $9,154   ..............  ..............          $9,154
     Security........................................
    Technology Investments to Enhance Operations.....  ...............  ..............         $35,000   ..............  ..............         $35,000
    Upgrade Integrated Financial System (IFS)........  ...............  ..............         $40,700   ..............  ..............         $40,700
    Leadership Training and Development..............  ...............  ..............         $20,000   ..............  ..............         $20,000
                                                      --------------------------------------------------------------------------------------------------
      Subtotal, Infrastructure Initiatives...........  ...............  ..............        $292,954   ..............  ..............        $292,954
                                                      ==================================================================================================
Business Systems Modernization Initiative:             ...............  ..............  ...............  ..............  ..............  ...............
    Fund BSM to Accelerate Taxpayer Benefits.........  ...............  ..............  ...............        $119,133  ..............        $119,133
                                                      --------------------------------------------------------------------------------------------------
      Subtotal, Business Systems Modernization.......  ...............  ..............  ...............        $168,933  ..............        $168,933
                                                      ==================
      Subtotal Fiscal Year 2010 Program Changes......         $10,358         $252,918        $393,468         $168,933  ..............        $825,677
                                                      ==================================================================================================
      Total Fiscal Year 2010 Board Recommendation....      $2,274,660       $5,504,000      $4,294,638         $400,000         $15,512     $12,488,810
                                                      ==================================================================================================
Fiscal Year 2009 Enacted.............................      $2,293,000       $5,117,267      $3,867,011         $229,914         $15,406     $11,522,598
Fiscal Year 2010 President's Request for IRS.........      $2,269,830       $5,504,000      $4,082,984         $253,674         $15,512     $12,126,000
Increase Over President's Request....................          $4,830   ..............        $211,654         $146,326  ..............        $362,810
Percent Increase Over President's Request (Percent)..             0.2   ..............             5.2             57.7  ..............             3.0
--------------------------------------------------------------------------------------------------------------------------------------------------------

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

    Chairman Durbin, Ranking Member Collins, and distinguished members 
of the Subcommittee, I would like to thank you for allowing me to 
provide comments on the administration's fiscal year 2010 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 2010 BUDGET REQUEST

    Mr. Chairman, NTEU strongly supports the administration's fiscal 
year 2010 budget request of $12.1 billion for the IRS, a roughly $600 
million increase over fiscal year 2009 levels. We believe that the 
President's request will allow the IRS to continue providing taxpayers 
with top quality service and will assist efforts to enhance taxpayer 
compliance and close the tax gap.
    We are particularly pleased the administration's budget request 
would provide $5.5 billion for IRS tax enforcement, including 
additional resources made available through a program integrity 
allocation adjustment. According to the administration, IRS enforcement 
efforts recoup $5 for every $1 dollar invested and the program 
integrity savings from increased investment for IRS enforcement efforts 
will be more than $13 billion between 2010-2014.
    We are also pleased to see the recently passed budget resolution 
fully funds the President's budget request for the IRS and includes the 
President's request for additional resources for IRS tax-law 
enforcement.
    I would also note that in previous years, NTEU has supported the 
budget recommendations proposed by the IRS Oversight Board which have 
generally called for additional resources above that requested by the 
administration. For fiscal year 2010, the Oversight Board has 
recommended $12.961 billion in funding for the IRS. While we have not 
seen the specific details of the Board's updated proposal, we would be 
inclined to support providing additional funding for the IRS above the 
administration's request and look forward to reviewing the Board's 
final recommendation.

                            MAJOR CHALLENGES

    Mr. Chairman, NTEU believes the President's request will allow the 
IRS to meet its customer service and enforcement challenges while also 
addressing some of the most immediate challenges it will face in the 
coming years, including the growing human capital crisis, increasing 
complexity of tax administration, and a burgeoning tax gap.

                          HUMAN CAPITAL CRISIS

    NTEU believes that IRS employees are the most valuable asset in 
effective tax administration. We are glad to see that the IRS Strategic 
Plan for 2009-2013 recognizes this fact and stresses the importance of 
investing in the workforce in order to achieve its service and 
enforcement goals. But as the IRS notes, they face several major 
challenges such as large numbers of retirements and competition with 
both the public and private sectors for critical talent. According to 
the IRS, more than half of IRS employees and managers are age 50 or 
older. The expected large scale retirements of thousands of Service 
personnel over the next several years will only further deplete the 
decimated IRS workforce that is down by more than 23,000 since 1995. 
According to a report by the IRS Oversight Board, an independent body 
charged with providing IRS with long-term guidance and direction, 
roughly 4,000 IRS employees a year for the next four years are expected 
to retire, taking with them years of experience and valuable skills. 
The dramatic decline in staffing levels coupled with the pending 
retirement wave has caused the Oversight Board to identify human 
capital issues as one the most important strategic challenges facing 
the IRS.
    In the face of an aging workforce and looming wave of retirements, 
Commissioner Shulman created the Workforce of Tomorrow task force to 
ensure that in five years the IRS has the leadership and workforce 
ready for the next 15 years and to help make the IRS the best place to 
work in government.
    NTEU was happy to see that the President's budget request 
acknowledges the human capital crisis at the Service and provides for 
major increases in Service staffing, particularly in the area of 
enforcement. According to the administration, the new enforcement 
personnel funded in the President's budget will generate $2.0 billion 
in additional annual enforcement revenue once the new hires reach full 
potential in fiscal year 2012.

              INCREASING COMPLEXITY OF TAX ADMINISTRATION

    Under the President's budget request, the IRS will also be better 
equipped to handle the challenges associated with the increasingly 
complexity of tax administration. For example, one of the biggest 
challenges the IRS confronts each year is identifying new tax law and 
administrative changes as well as expiring tax provisions. According to 
the IRS, in 2007 alone, 41 tax provisions expired affecting a wide 
range of taxpayers.
    During the 2009 Filing Season, the IRS was presented with 
additional challenges due to the enactment of two significant new tax 
laws, the ``Housing and Economic Recovery Act of 2008,'' which includes 
a refundable homebuyer credit as well as an additional standard 
deduction for real property taxes, as well as the ``Emergency Economic 
Stabilization Act of 2008,'' which included 116 different tax 
provisions.
    In the future, the IRS will also be confronted with the challenges 
presented by the increasing globalization of individual taxpayers and 
businesses. As more and more U.S. taxpayers and businesses expand into 
global markets, it will be important that the IRS has the technical 
expertise to identify and understand the proliferation of complex 
international activities and the emerging global nature of tax 
administration.

                                TAX GAP

    Recent and projected large Federal budget deficits have generated 
congressional and executive branch interest in raising revenue by 
reducing the tax gap, that is, the difference between what taxpayers 
should have paid and what they actually paid on a timely basis. For tax 
year 2001, the IRS estimated a gross tax gap of $345 billion, equal to 
a noncompliance rate of 16.3 percent.
    NTEU believes that efforts to close the tax gap must focus on 
improving compliance activities and enhancing taxpayer service. By 
improving document matching, examination, and collection activities, 
the IRS will be better able to prevent, detect, and remedy 
noncompliance. And providing taxpayers with assistance and clear and 
accurate information before they file their tax returns will help 
reduce unnecessary contacts afterwards, allowing IRS to focus 
enforcement resources on taxpayers who are intentionally evading their 
tax obligations.
    In addition to generating additional revenue for the Federal 
Government, reducing the tax gap will help strengthen public trust in 
the fairness of the tax system which will positively impact voluntary 
compliance with tax laws.
    That is why NTEU supports the President's request for an additional 
$332 million to help close the tax gap by strengthening compliance and 
allowing the IRS to better address the main components of the tax gap 
including, underreporting, non-filing and underpayment.

                              ENFORCEMENT

    Mr. Chairman, as you know enforcement of the tax laws is an 
integral component of IRS' effort to enhance voluntary compliance and 
close the tax gap. IRS enforcement activities, such as examination and 
collection, target elements of the tax gap and are a high priority for 
the Service. In fiscal year 2008, the IRS initiated additional 
information reporting requirements for large partnerships and foreign 
corporations, soft notices and self-correction to improve compliance.
    These efforts helped the IRS bring in $56.4 billion in enforcement 
revenue in 2008, a 65 percent increase over fiscal year 2002. The $56.4 
billion in collections in 2008 represents a 5 to 1 return on investment 
for all IRS activities. In addition, the IRS showed consistent 
improvement in its enforcement results meeting or exceeding 78 percent 
(14 of 18) of its program targets.
    Most impressively, the IRS continues to bring in record amounts of 
enforcement revenue despite severe cuts to enforcement staffing over 
the past 13 years. In particular, the number of revenue officers and 
revenue agents--two groups critical to closing the tax gap and thereby 
reducing the Federal budget deficit--have shrunk by 33 and 20 percent 
respectively. Revenue officers went from 8,139 to 5,481 and revenue 
agents fell from 16,078 to 12,951. As noted previously, these drastic 
cuts have come at a time when the IRS workload has increased 
dramatically due to the increasing complexity of tax administration.
    NTEU believes it is essential that the IRS continue to direct 
resources toward enforcement activities that have the greatest overall 
impact on compliance and can best aid the Service's efforts to close 
the tax gap. One such activity is the IRS Automated Underreporter (AUR) 
program which has evolved as an important Service compliance initiative 
using third-party information returns to identify income and deductions 
that were not reported on tax returns. NTEU believes the program is an 
effective way to detect taxpayer underreporting which accounts for 
roughly 82 percent of the gross tax gap.
    In fiscal year 2008, increased AUR contact closures increased by 
almost 4 percent from the previous year and dollars collected through 
AUR and information return processing increased by 22 percent.
    The administration's budget request acknowledges the import role 
the AUR program can have in closing the tax gap by reducing the number 
of taxpayers who underreport their income and proposes an increase of 
$26.2 million and 300 FTE to increase coverage of the AUR document 
matching program. According to the administration, this request will 
generate $386.5 million in additional revenue once new hires reach full 
potential in fiscal year 2012 resulting in a return on investment (ROI) 
of 17 to 1.

                            TAXPAYER SERVICE

    Mr. Chairman, NTEU strongly believes that providing quality 
customer service to the taxpayer is an important part of IRS efforts to 
help the taxpaying public understand their tax obligations while making 
it easier to participate in the tax system. Through many sources, the 
IRS provides year-round assistance to millions of taxpayers, including 
outreach and education programs, issuance of tax forms and 
publications, rulings and regulations, toll-free call centers, the 
IRS.gov web site, Taxpayer Assistance Centers (TACs), Volunteer Income 
Tax Assistance (VITA) sites, and Tax Counseling for the Elderly (TCE) 
sites. These efforts have helped the IRS raise their standard of 
service to America's taxpayers and assisted in efforts to improve 
voluntary compliance. The IRS has continued to make great strides in 
recent years in the quality of the service it provides despite 
relatively flat budgets, that when adjusted for inflation, have 
provided the IRS with fewer resources over the past several years 
compared to fiscal year 2002.
    But despite receiving fewer resources and continued reductions in 
the number of customer service representatives at the Service, the IRS 
was able to deliver a successful 2008 filing season. As you know, the 
2008 filing season was particularly challenging due to late enactment 
of the AMT legislation and implementation of the Economic Stimulus 
Payment program. Despite these challenges, the IRS carried out another 
successful filing season during which IRS employees processed more than 
155 million individual returns including returns filed solely to claim 
an economic stimulus payment, an increase of 11 percent over last year 
and issued 107.6 million refunds, totaling $369 billion; answered over 
40.4 million calls, an increase of 21 percent due to a large increase 
in taxpayer inquiries about the economic stimulus checks; completed 52 
million automated calls, an increase of over 123 percent; maintained 
account and tax law accuracy rates of over 90 percent and expanded 
return preparation at IRS Taxpayer Assistance Centers (TACs) preparing 
over 575,000 returns, a 42 percent increase over last year.
    Mr. Chairman, while IRS employees were able to continue providing 
quality service to taxpayers in fiscal year 2008, we do have concerns 
about the potential negative effect on IRS' ability to continue doing 
so should the ``efficiency savings'' assumed in the administration's 
budget request not materialize. For fiscal year 2010, the budget 
request identifies ``efficiency savings'' of more than $118 million at 
the cost of 1,504 FTE's. If, as sometimes been the case in previous 
years, IRS fails to realize all expected savings then the funds 
available for critical Service personnel, such as those working at the 
401 TACs located nationwide, would be further reduced.
    As stated previously, NTEU strongly believes providing quality 
service to taxpayers is critical to ensuring taxpayers understand their 
tax obligations while making it easier for them to participate in the 
tax system. And in the current economic climate, we believe it is more 
important than ever that taxpayers be able to deal with the IRS 
directly to work through any financial difficulties they may encounter. 
IRS employees have a wide range of tools and information at their 
disposal, which allow them to work with taxpayers to address their 
financial hardships and to become compliant.
    Above all else, the IRS employee's interest is in assisting 
struggling taxpayers to meet their tax obligations in a way that will 
not exacerbate their financial distress. When an IRS employee works 
with a taxpayer, the employee has access to all of the taxpayer's 
information and can answer questions and offer advice. For example, 
they can see whether a taxpayer has not filed a return and explain that 
the sooner the taxpayer makes arrangements to address filing and 
balance due issues the less penalty and interest they will owe. They 
can look at the taxpayer's records and answer questions about why they 
owe a balance and what they can do about it. They can also tell the 
taxpayer that they are not having enough taxes withheld by their 
employer and need to address that or that if an ex-spouse is claiming a 
child as a dependent they will not also be able to receive an 
exemption. If a simple mistake, like a math error, has occurred, they 
can fix it. They can provide an extension of the time period for 
payment. They can make a determination that the taxpayer meets the 
currently not collectible requirements or whether the taxpayer may be 
eligible for an Offer in Compromise, in which part of the balance due 
is foregone.
    NTEU believes providing quality services to taxpayers is an 
important part of any overall strategy to improve compliance and that 
the President's request for taxpayer services will enable the IRS to 
deliver another successful filing season, improve the responsiveness 
and accuracy of taxpayer service, and support Service efforts to 
enhance taxpayer compliance.

                              SECTION 1203

    Mr. Chairman, while meaningful funding for the IRS is important to 
operations, NTEU also believes that in order to maximize efficiencies 
at the IRS, Congress must act to modify Section 1203 of the IRS 
Restructuring and Reform Act of 1988 (RRA 98). Commonly known as the 
``Ten Deadly Sins,'' Section 1203 outlines ten infractions for which 
IRS employees must be fired, including the untimely filing of Federal 
income taxes even when a refund is due. No other Federal or 
congressional employee is subject to similar mandatory termination.
    Without question, Section 1203 has had a negative impact on the 
morale of the IRS workforce and is impeding the ability of the IRS to 
perform its mission. According to numerous GAO reports, IRS employees 
greatly fear the threat of being fired under Section 1203. This in turn 
has had a chilling effect on the ability of IRS employees to do their 
jobs. In particular, employees specifically attribute the decrease in 
recommending a seizure of taxpayer's assets to Section 1203. Clearly, 
Section 1203 impedes IRS' enforcement mission and is unfair to the IRS 
employees who must work under the constant threat of losing their jobs.
    NTEU believes mandatory termination for Section 1203 violations is 
unduly harsh and should not be the only disciplinary action available. 
We advocate amending RRA 98 to allow for appropriate penalties other 
than mandatory termination for Section 1203 violations and to allow for 
independent review of determinations.
    To be clear, NTEU does not condone any violation of law or rules of 
conduct by its members at the IRS or in any other government agency. 
Violations of some rules clearly warrant termination of employment. 
However, one group of Federal employees should not be singled out and 
required to be fired for offenses that do not subject other executive, 
judicial, or legislative branch employees to the same penalty.
    Mr. Chairman, the large majority of IRS employees work hard, follow 
the rules and pay their taxes on time. It is patently unfair to hold 
those who are charged with enforcing the tax laws to a higher standard 
than those who write them. NTEU asks for your support for changes to 
section 1203 of the IRS Reform and Restructuring Act, so that tax 
fairness applies to all Americans, even those who work at the IRS.

                               CONCLUSION

    Mr. Chairman, thank you for the opportunity to provide NTEU's 
thoughts on the administration's fiscal year 2010 budget request for 
the IRS. We believe that by investing in the IRS workforce and 
demonstrably effective enforcement and taxpayer service programs, the 
administration's request will ensure the IRS continues to meet its 
mission of providing America's taxpayers top quality service by helping 
them understand and meet their tax responsibilities and by applying the 
tax law with integrity and fairness to all.

                     ADDITIONAL COMMITTEE QUESTIONS

    Senator Durbin. The record will remain open, Mr. 
Commissioner, until Wednesday, June 17, for subcommittee 
members to submit statements and questions to be submitted to 
you for consideration.
    [The following questions were not asked at the hearing, but 
were submitted to the Service for response subsequent to the 
hearing:]

            Questions Submitted by Senator Richard J. Durbin

            MEASURING RETURN ON INVESTMENT: NEW INITIATIVES

    Question. In your fiscal year 2010 budget request, the IRS seeks 
$332 million for new enforcement initiatives projected to yield direct 
measurable results through high return-on-investment. The proposed 
investments in enforcement personnel in fiscal year 2010 are expected 
to yield $2 billion in additional annual enforcement revenue once new 
hires reach their fully trained potential in fiscal year 2012.
    GAO's review and written assessment of the proposed budget 
observes, with concern, that the IRS has no plans to compare the actual 
performance to the projections.
    Would it not be prudent and beneficial to determine the extent to 
which your revenue forecasts were accurate and the yield was realized?
    Answer. The IRS maintains a historical record of enforcement 
revenue produced by its enforcement programs at an aggregate level, and 
the IRS uses this historical revenue information to estimate future 
revenue produced from proposed enforcement initiatives in budget 
requests and to compare its estimated revenue projections with actual 
revenue. Actual annual enforcement revenue is analyzed to determine 
factors causing variance from expected results. For example, analysis 
of fiscal year 2007 enforcement revenue indicated that the increase 
from $48.7 billion in fiscal year 2006 to $59.2 billion was primarily 
the result of two large settlements.
    While the IRS does compare the actual performance to the 
projections at the aggregate revenue level, specific examination and 
collection activities are fungible, and therefore, it is difficult to 
isolate the revenue attributable to a specific initiative. The IRS uses 
its existing suite of performance measures as a tool for managing its 
activities. IRS performance measure results, including examination and 
collection coverage, are a better gauge of the efficiency and 
effectiveness of existing programs.
    Question. Assuming that Congress is able to provide these funds as 
requested and the IRS proceeds with the initiatives planned, how will 
we know whether this was a wise investment?
    Answer. At full performance levels in fiscal year 2012, the 
additional enforcement personnel will produce additional revenue and 
increases in performance measures in examination and collection as 
presented in the fiscal year 2010 budget request. For example, the 
number of audits in targeted categories is projected to increase, and 
the number of collection accounts resolved is expected to increase, 
both resulting in increased revenue. The IRS expects these initiatives 
to yield a return-on-investment (ROI) of 7.8 to 1 once they reach full 
potential.
    Question. Do you agree that knowing what actually happens as a 
result of these targeted investments would be a helpful indicator of 
success and useful in making future spending decisions and resource 
allocation plans?
    Answer. The IRS will continue to collect actual cost and revenue 
data associated with high-level enforcement programs, and will continue 
to analyze actual enforcement revenue results to refine future 
projections for budget initiatives, as needed.
    The IRS uses actual enforcement revenue from prior years to 
calculate its Return on Investment figures (ROIs) for proposed 
enforcement initiatives. The ROIs are based on rolling, 10-year 
averages of enforcement revenue produced by specific enforcement 
functions with greater weight placed on the most recent year revenue. 
The IRS bases revenue estimates on historical yield per FTE, which it 
evaluates and updates annually.
    Question. Will IRS collect data to determine the actual costs, 
revenues, and ROI to determine whether the investment produced the 
anticipated results? If ``NO''--what is the IRS's rationale for not 
keeping track of the actual return on investment of these new 
initiatives?
    Answer. As stated above, the IRS does collect actual cost and 
revenue data associated with high-level enforcement programs and uses 
the cost and revenue data to develop its proposed budget initiatives. 
Tracking the revenue produced by each initiative hire is not possible. 
For example, each new international examiner will work on a mix of 
cases which could include audits that are not associated with the 
initiative because of shifting work priorities or the emergence of new 
international issues. Additionally, the new international examiner will 
work on cases as part of an audit team. Apportioning actual revenue 
resulting from a team audit to various audit team members, who may or 
may not be an initiative hire, is not feasible. Initiative hires work 
on a variety of tasks and on group audits, and as a result, tracking 
the revenue derived from a specific initiative hire is not possible, 
but the revenue is tracked and analyzed for high-level enforcement 
programs.

              DETERRENT EFFECT OF ENFORCEMENT INITIATIVES

    Question. In addition to the direct revenue impact of such an 
investment, isn't there a deterrent effect?
    Answer. Yes. Several empirical studies have indicated that the 
``deterrent'' effect from enhanced enforcement efforts could be larger 
(perhaps much larger) than the direct revenue effect.
    Question. How does IRS measure deterrent effect? What is the 
estimate?
    Answer. By the ``deterrent'' effect of an IRS activity, we mean the 
change in voluntary compliance--both subsequent compliance by a person 
directly contacted as a part of that activity and changed compliance 
behavior by the population in general--that is prompted by an expansion 
or intensification of that IRS activity. More generally, the IRS refers 
to this phenomenon as the ``indirect'' effect since deterrence may not 
always be the mechanism at work. For example, the general population 
may demonstrate improved voluntary compliance in response to expanded 
prosecutions of tax criminals, but not because they fear being caught 
committing tax crimes; rather, the expanded prosecutions may reassure 
the average taxpayer that criminals are receiving justice, which makes 
the average taxpayer more likely to pay his or her taxes in full. 
Likewise, IRS's services to taxpayers may have a positive effect on the 
voluntary compliance of those who do not receive those services, but 
who hear positive reports from those who do.
    We can observe the compliance behavior of each taxpayer, but that 
behavior is driven by a complex set of factors (including things 
outside of IRS control, such as economic, demographic, and socio-
political factors) that vary widely across the population. We cannot 
observe how many dollars are paid as a result of each of those factors 
separately; we can only attempt to estimate that. Several academic 
studies have attempted to estimate the indirect effect of audits, and a 
few have also estimated the effect of criminal investigations and other 
IRS activities, but since all of these statistical studies have 
limitations and weaknesses, there has not yet formed a consensus as to 
the true indirect effect of these or other IRS activities. The 
estimates that exist for the indirect effects range from approximately 
zero to over 10 times the magnitude of the direct effect.
    Question. Are there particular remedial actions or collection 
interventions that IRS uses that you have found to be more conducive or 
effective than others when it comes to deterrent effect?
    Answer. There is some limited statistical evidence that audits of 
individuals are quite cost-effective in generating an indirect effect 
(partly because they are less costly to complete than activities such 
as criminal investigations or complicated corporate audits). The IRS is 
continuing to research the indirect effects of both enforcement and 
service activities in an effort to allocate resources optimally.

                   ELECTRONIC FILING--STAFFING SHIFTS

    Question. The IRS budget for fiscal year 2010 reflects that due to 
increased e-filing options there will be an expected decline of 4.6 
million in the number of paper returns filed, resulting in a savings in 
submission processing of 187 FTE. The IRS is also consolidating its 
individual return processing centers to achieve efficiency as the paper 
return volume drops. The IRS is slated to ramp-down its processing 
center in Andover, Massachusetts and plans to reinvest $2.3 million to 
fund a one-time severance payment for employees.
    How is the IRS transforming its workforce to adapt to 21st century?
    As the volume of e-filing grows, what is the IRS doing to 
facilitate retraining of processing staff to perform different 
activities and functions?
    Answer. One of the IRS' top priorities is to support the Submission 
Processing employees whose jobs are affected by site consolidation. 
Though some of the information included below is specific to the 
Andover, MA site that is scheduled to close in September 2009, the 
actions taken are representative of the efforts that have been made 
with each consolidation and demonstrate the IRS' strong commitment to 
provide all employees with a wide range of options.
Mitigation Strategies to Minimize Employee Impact
    A number of mitigating strategies are used to assist employees in 
minimizing the impact of consolidation. These strategies are generally 
broken down into two distinct groups:
    Formal strategies--outlined in Article 19 (Reduction in Force and 
Mitigation Strategies) of the 2006 National Agreement between IRS and 
NTEU, these strategies are available to employees 1 year prior to the 
projected Reduction in Force date.
    Other strategies--undertaken outside of Article 19 to focus on 
preparing employees for the consolidation. Many of these strategies 
begin prior to the onset of the required Article 19 strategies.
    Formal strategies include:
  --Reassignment Preference Notice (RPN)--entitles directly affected 
        employees to priority selection for vacant positions for which 
        they apply and qualify, either at their same or lower grade 
        Servicewide, i.e. both within and outside the employee's 
        commuting area.
  --Voluntary Early Retirement Authority/Voluntary Separation Incentive 
        Payment (VERA/VSIP)--provides an opportunity for eligible 
        employees to separate from the Service early and receive a 
        buyout.
  --Severance Pay--received by those employees who are separated via a 
        RIF and are not eligible to retire.
  --Job Swaps--per Article 19, directly affected employees may swap 
        jobs into other occupied positions, either inside or outside 
        the commuting area.
  --Outplacement Services--employees are granted administrative time to 
        participate in outplacement and career services.
  --Relocation to ``Follow Your Work''--allows directly affected 
        employees who occupy positions to be abolished to voluntarily 
        relocate and be realigned to a vacant position in a continuing 
        site to perform the work that the employee is currently 
        performing.
  --Career Transition Assistance Program (CTAP)--grants the affected 
        employee selection priority for any internal vacancy for which 
        s/he applies and is determined to be well-qualified.
  --Inter-Agency Career Transition Assistance Program (ICTAP)--grants 
        affected employees selection priority for any external Federal 
        Government vacancy for which s/he applies and is determined to 
        be well-qualified.
  --Grade and Pay Retention--provided to affected employees who are 
        selected for a position not more than three grades below their 
        current grade.
    Other Strategies include:
  --Identifying work that can be consolidated or redirected into 
        continuing sites. The following summarizes the positions 
        created through these efforts:

------------------------------------------------------------------------
                                                              Positions
------------------------------------------------------------------------
Brookhaven:
    Centralized Offer in Compromise........................          325
    Campus Support Department..............................          140
Memphis:
    Centralized Offer in Compromise........................          350
    Case Processing........................................          325
    Campus Support Department..............................           90
Philadelphia:
    Centralized Insolvency.................................          280
    Case Processing........................................          230
    Campus Support Department..............................          180
Andover:
    Automated Underreporter................................      \1\ 200
    Campus Support Department..............................           89
------------------------------------------------------------------------
\1\ Wth plans to grow to about 300-400 total.

  --Communications--numerous vehicles are used to keep employees 
        updated on the consolidation plan and to assist employees in 
        minimizing the impact of consolidation, including:
    --Newsletters--the Andover campus developed and distributed a 
            publication titled ``Changing Times'' to employees on a 
            regular basis beginning in February 2008. The issues have 
            addressed various consolidation issues and include employee 
            Q&A's.
    --Webpage--info included on Andover SP webpage includes 
            newsletters, FAQ's, and information on Article 19.
    --Employee Meetings--management holds routine meetings with 
            employees to provide consolidation updates and ensure 
            employees are aware of the effect consolidation will have 
            on their current and future positions.
    --Flyers and handouts--will cover topics such as buyouts, early 
            outs, and job swaps.
    --Info to employees in non-work status--pertinent information is 
            mailed to seasonal employees in non-work status.
  --Training--provided on various topics to assist employees in 
        continuing with or finding new employment, including:
    --How to apply for positions on USAJobs, the official job site of 
            the federal government.
    --How to a prepare a resume.
    --How to interview for a job.
    --How to apply for a job swap (will be conducted in Andover at a 
            later date).
  --Term Hiring--In an effort to minimize the employee affect from 
        consolidation, sites scheduled to consolidate began hiring Term 
        employees at least 2 years prior to consolidation. The Andover 
        site initiated this practice in 2003, 6 years prior to 
        consolidation. This hiring practice has helped to mitigate the 
        effect of consolidation on our career and career conditional 
        employees by limiting the number of potential applicants for 
        continuing positions on the campus. Andover is the first 
        consolidating site where the number of Term employees exceeds 
        the number of career conditional employees.
  --Job Fairs--job fairs include employers from the private sector and 
        IRS Business Units that will remain at the campus after 
        consolidation.
  --Tuition Assistance--program offered to all IRS employees to assist 
        them in gaining the skills needed for continued employment.
  --Mock Interview Cadre--established to assist Andover employees with 
        upcoming interviews.
  --Link Line--a phone number established for Andover employees in non-
        work status to receive information on W&I job openings in 
        Andover Posts of Duty.
  --Career Link--Andover IRS is partnering with local Department of 
        Labor to establish an office within Andover IRS office to 
        provide career guidance, employment workshops, and reemployment 
        assistance.
  --Computer Kiosks--set up in Andover Posts of Duty for employees 
        without access to a computer to look for job vacancies or 
        update their Merit Promotion Questionnaire's (MPQs).
  --Employee Meetings--One-on-One meetings have been held with every 
        employee in Andover SP to determine future plans (i.e. 
        continued employment, retirement, etc.) and provide information 
        related to MPQ assistance, Mock Interviews, etc.
  --Job Vacancies--Weekly Career Opportunity Listing (COL) and USAJobs 
        vacancy announcements distributed to SP Operations for 
        dissemination to all employees, in order to keep them informed 
        of potential jobs, both internally and throughout the 
        government.
  --Employee Assistance Program (EAP) representatives are in attendance 
        at each RIF briefing and have committed to provide extended 
        services to SP employees during this transition.
                                 ______
                                 
           Question Submitted by Senator Frank R. Lautenberg

    Question. Federal receipts at the U.S. Treasury have declined 
nearly 19 percent for the first 7 months of fiscal year 2009 as 
compared to the same period in fiscal year 2008. A significant portion 
of this revenue loss is due to a decrease in tax receipts as a result 
of the current economic recession. To what extent do you expect tax 
revenues to increase as a result of federal efforts to create jobs and 
spur economic recovery?

                               FEDERAL RECEIPTS, FISCAL YEAR TO DATE (APRIL 2009)
----------------------------------------------------------------------------------------------------------------
                                                                                    Comparable
                                                                   Year to date,     period in
                                                                    fiscal year     fiscal year   Percent change
                                                                       2009            2008
----------------------------------------------------------------------------------------------------------------
Total...........................................................      $1,256,066      $1,549,720           -18.9
Individual Income Tax...........................................        $566,369        $747,558           -24.2
Corporation Income Taxes........................................         $70,781        $171,142           -58.6
----------------------------------------------------------------------------------------------------------------

    Answer. The IRS does not predict the effect legislation will have 
on tax revenues. The Joint Committee on Taxation and the Department of 
the Treasury under certain circumstances will provide estimates of the 
revenue effects of proposed but un-enacted tax legislation.
                                 ______
                                 
                Question Submitted by Senator Ben Nelson

    Question. In a Ways and Means Subcommittee hearing on June 4, 2009, 
you said you would like to work with Congress to provide the Internal 
Revenue Service with more discretion regarding imposition of the 6707A 
penalty for failure to include reportable transaction information with 
a taxpayer's return. Can you elaborate on what kind of discretion would 
be appropriate, especially in cases where taxpayers acting in good 
faith unknowingly failed to file--or, worse, were mislead into 
believing they did not need to file information about such 
transactions?
    Answer. As we have stated before, the IRS is concerned there are 
taxpayers who have been caught in a penalty regime that was not 
intended by the legislation. Many taxpayers are subject to this penalty 
and the amount due significantly exceeds the tax benefit resulting from 
the transaction. Furthermore, the statutory language does not allow for 
any adjustment to the penalty based on the tax benefit to the taxpayer. 
We may be open to changes that allow sufficient flexibility for a 6707A 
penalty to be proportional to the tax benefit associated with the 
reportable transaction giving rise to the penalty. This change could 
improve the fairness of the penalty, provide some measure of relief for 
virtually all taxpayers, and simplify tax administration.
                                 ______
                                 
              Questions Submitted by Senator Susan Collins

    Question. The IRS is in the midst of a significant hiring 
initiative for enforcement staff as a result of its fiscal year 2009 
budget. What enforcement areas will the new staff be focused on and 
what do you anticipate the resulting increased revenues to be?
    Answer. The enforcement staff hired in fiscal year 2010 will be 
focused on the activities listed below and will generate over $2 
billion in additional revenue once they reach full potential in fiscal 
year 2012.

                                                      RETURN ON INVESTMENT ENFORCEMENT INITIATIVES
                                                                  [Dollars in millions]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                    First year (fiscal year 2010)         Full performance (fiscal year
                                                                            --------------------------------------------              2012)
                  Fiscal year 2010 enforcement investment                                                               --------------------------------
                                                                              FTE \1\      Cost     Revenue      ROI        Cost     Revenue      ROI
--------------------------------------------------------------------------------------------------------------------------------------------------------
Direct Revenue Producing Initiatives.......................................      2,330     $332.1     $611.1        1.8     $262.8   $2,049.7        7.8
    Reduce the Tax Gap Attributable to International Activities. This              784      128.1       93.8        0.7      103.4      736.6        7.1
     initiative funds a multi-year investment to deal more effectively with
     increasing international tax activities of individual and business
     taxpayers. This effort addresses the underreporting of tax associated
     with international transactions as well as domestic taxpayers involved
     in offshore activities. It expands the IRS presence in the tax-exempt
     and governmental sectors and confronts international tax evasion
     schemes...............................................................
    Improve Reporting Compliance of SB/SE Taxpayers. This initiative               755       94.2      159.6        1.7       72.6      567.2        7.8
     improves reporting compliance among Small Business/Self Employed (SB/
     SE) taxpayers by increasing examinations of business and high-income
     returns, exams involving flow-through entities, audits targeting
     employment, excise, and estate and gift taxes, and investigations of
     business non-filers...................................................
    Expand Document Matching for Business Taxpayers. This initiative               300       26.2      191.8        7.3       22.8      386.5       17.0
     increases coverage of the document matching program to reduce the
     number of taxpayers who misreport their income. Matching third party
     information such as W-2s and 1099s against tax returns is critical to
     ensure compliance.....................................................
    Address Nonfiling/Underpayment and Collection Coverage. This initiative        491       83.6      165.9        2.0       64.0      359.4        5.6
     improves voluntary compliance and decreases nonfiling by broadening
     collection coverage with a focus on repeat non-filers and non-filers
     with high income. Additional collection staff will increase the number
     of collection actions against unpaid assessments and allow the IRS to
     close more collection cases...........................................
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Total includes revenue and non-revenue generating FTE.

    Question. Commissioner Shulman, how can we address the tax gap?
    Answer. The Internal Revenue Service and Treasury issued an update 
of the 2007 Tax Gap Strategy report in early July. That report 
addressed this question in detail.
    Question. Does IRS have an estimate of the tax gap attributable to 
international activities?
    Answer. No. The data on which we base our tax gap estimates do not 
generally allow us to separate international and domestic issues. 
Moreover, some forms of noncompliance do not lend themselves to a clear 
characterization based on geography.
    Question. If there is not an estimate of the effect of 
international activities on the tax gap, why is that the focus of the 
fiscal year 10 enforcement initiative?
    Answer. Globalization has led to an increase in international tax 
activity, which has historically been an area of significant concern to 
the IRS. For example, foreign tax credits claimed by U.S. corporations 
increased by 71 percent between Tax Years 2000 and 2007, while foreign 
tax credits claimed by U.S. individuals increased by 133 percent during 
that time period. Likewise, between 2001 and 2006, foreign-source gross 
income of individuals grew 86.6 percent in real percentage terms, 
whereas worldwide income reported on all individual U.S. tax returns 
grew only 14.8 percent during that period.
    Question. Please describe any plans the Service may have to develop 
an international tax gap estimate.
    Answer. We are conducting a pilot study, beginning with Tax Year 
2006, to extend our National Research Program (NRP) reporting 
compliance studies of individual returns to include a small sample of 
returns with international addresses. We hope to determine from this 
pilot how best to compile representative compliance data for this 
population. If successful, this approach may allow us to estimate this 
portion of the international tax gap. Future studies of corporation 
income tax reporting compliance will need to address this concern, as 
well.
    Question. IRS reduced its performance goal for providing telephone 
assistance from 82 percent last year to 77 percent this year. 
Commissioner Shulman, why was the goal reduced and what does it mean 
for taxpayers? In your opinion, does this lower level allow for 
sufficient access for taxpayers to speak directly with an IRS assistor?
    Answer. The IRS is dedicated to providing the best possible service 
regardless of the channel the customer chooses. Although the goal and 
actual CSR LOS was lower this year than in prior years, the IRS funded 
the Toll-free program in 2009 at higher levels than in prior years by 
allocating more staffing (full time equivalents (FTEs)) during filing 
season than in 2007 and 2008. The actual toll-free FTEs for 2007, 2008, 
and 2009 filing seasons were 3,067, 3,100 and 3,344, respectively. 
However, increased customer demand, the introduction of new programs 
such as the Identity Protection Specialized Unit, and increased 
complexity of the calls handled by assistors resulted in lower service 
levels, despite increased resources. From January 1st through April 18, 
2009, the IRS serviced over 39 million taxpayers through both assistor 
and automated telephone service during the 2009 filing season. This 
level compares to just over 35 million taxpayers serviced during the 
same time period during the 2008 filing season and 32 million serviced 
in 2007. On most days, taxpayers were able to get to an assistor if 
they chose to wait. We provided an estimated wait time to the vast 
majority of callers, so they could make an informed decision about 
whether to wait or call back at a later time.
    Question. This year, IRS's average actual telephone performance has 
been well below its goal. Next year, IRS can expect another year with 
high call demand given the Recovery Act tax law changes. What specific 
steps are you taking now to improve IRS's telephone performance for 
next year should call volume could remain high?
    Answer. We are taking numerous steps to prepare for the coming 
year. During the 2009 filing season, there were 4.8 million calls from 
taxpayers asking for their prior year Adjusted Gross Income (AGI) or 
Personal Identification Number (PIN), which is required by online 
filers to submit their returns electronically. For 2010, we are 
developing both a web and automated telephone application to provide 
this information to taxpayers without requiring interaction with an 
assistor. This enhancement will free up assistors to handle more 
complex taxpayer questions. We will be implementing improvements in our 
Toll-free menus, which will get customers to the right resource faster. 
We will be expanding the use of estimated wait time announcements to 
more applications and customers. Lastly, we are planning to increase 
the number of staff on-rolls at times of peak customer demand during 
the filing season, through seasonal hiring.
    Question. IRS has spent $2.6 billion on its business systems 
modernization effort since 1999. Its Customer Account Data Engine 
(CADE), a part of BSM intended to replace the Individual Master File, 
has cost over $400 million since work on it began almost 5 years ago, 
but CADE has only delivered about 15 percent of the full capability 
intended. Please explain this small return on investment?
    Answer. The IRS has received approximately $309.3 million in 
funding for CADE over the past 5 years. With that funding, the IRS has 
delivered a complete tax return processing system for approximately 40 
million taxpayers who are enjoying the benefits of substantially faster 
refunds. In addition, the CADE project has proved the IRS is capable of 
delivering a modern database with significant functionality, including 
improved financial accounting capabilities, which have allowed the IRS 
to make progress against addressing its material weakness in this area.
    CADE also already includes capabilities to process Forms 1040, 
Schedules A, B, C, D, E, F, R, SE and Form 1040A, Schedules 1 and 3 for 
single and married filers and filers with certain dependents; extension 
Forms 4868; decedent and surviving spouse returns; certain math error 
notices; online address changes; returns with disaster area 
designations; receipt processing; and last name changes. In addition, 
CADE has supported legislative tax refund programs, such as Telephone 
Excise Tax Refunds and the recent Economic Stimulus payments.
    The IRS created the statistic referenced in your question for 
different purposes during a very specific engineering analysis, and we 
never intended to reflect a holistic assessment of the status of the 
effort. It understates nearly half the percentage of taxpayers that are 
in the new system, and it also does not reflect that a substantial 
portion of the overall effort is expended in setting up infrastructure 
to process the very first tax return.
    Finally, any discussion of return on investment should recognize 
the public's return on IRS IT investments. Because of the IRS's 
progress on CADE, approximately $58 billion in refunds went out on 
average 5 days faster that they would under legacy systems. This 
improvement has real economic value to taxpayers, particularly those in 
difficult economic situations.
    Question. Of the vast extent of IT security weaknesses that exist 
in IRS current and modernized systems, how much improvement in data 
protection can the IRS make with the requested $90 million for IT 
Security and what data and systems are still vulnerable?
    Answer. The way IRS business is transacted, the way the Service 
operates, and the way core tax administration is conducted have 
changed. These activities now rely on an interdependent network of 
information technology infrastructures. At the same time, threats from 
cyberspace have risen dramatically and are growing increasingly more 
complex, harder to detect and prevent. In order for the Service to keep 
abreast of the latest security threats from cyberspace and elsewhere, 
more strategic and tactical investments will have to be made to protect 
against the debilitating disruption of the operation of the IRS' 
information systems or breaches of the sensitive personally 
identifiable information entrusted to us by the American taxpaying 
public.
    This initiative requests an increase of $90.0 million and 36 FTE to 
improve IT security and address specific components of the Computer 
Security Material Weakness. At the more strategic level, this budget 
initiative will:
  --Better ensure the integrity of the tax system and maintain taxpayer 
        confidence;
  --Allow the IRS to improve the privacy and security of taxpayer 
        information;
  --Segregate securely the development, testing, and production 
        environments for IT systems, and;
  --Implement the Federal Information Security Management Act (FISMA) 
        security compliance controls on all enterprise-wide Windows and 
        UNIX computing assets.
    At the more tactical levels, specific activities that will be 
included in this initiative are:
  --Implementation of Network Access Control to better manage what 
        devices are permitted to connect to the internal network. This 
        change will specifically strengthen controls over many of the 
        700+ remote places of duty.
  --Bolsters the disaster recovery capabilities for the enterprise.
  --Improve the replication of our production environment in our test 
        and development environments. This improvement will enable more 
        complete testing of security controls and their impact before 
        moving new applications into production.
  --Improving the real-time ability for the IRS to monitor and report 
        on the security posture of all devices on the IRS network. This 
        enhancement will allow the IRS to better understand how new and 
        developing threats could potentially affect core business 
        systems.
  --Implementing data leakage protection tools to monitor and control 
        the movement of sensitive information in and out of the IRS 
        network.
  --Providing an enterprise solution to deploy end-to-end audit log 
        collection, storage, and reporting to directly address a major 
        component of the Computer Security Material Weakness.
                                 ______
                                 
           Questions Submitted by Senator Christopher S. Bond

                              ENFORCEMENT

    Question. In the 1998 IRS Restructuring Act, Congress directed the 
IRS to refocus its mission not only to enforcement of the tax laws, but 
also serve the public and meet the needs of taxpayers. With the 
emphasis that you and the Administration has placed on enforcement, it 
appears that the pendulum is swinging further back to the ``bad old 
days'' of heavy handed IRS enforcement that led to the restructuring 
legislation in the first place.
    Are the enforcement initiatives that the IRS has announced this 
year coming at the cost of taxpayer service? What steps are you taking 
to ensure that taxpayer service remains an equal part of the IRS' 
mission?
    Answer. The IRS remains committed to a balanced program of 
assisting taxpayers in both understanding the tax law and paying the 
proper amount of tax.
    The fiscal year 2010 President budget request of $2.27 billion for 
taxpayer service will allow the IRS to continue improvements for both 
the quality and efficiency of taxpayer service, using a variety steps 
including, person-to-person, telephone, and web-based and self-serve 
methods to help taxpayers understand their tax obligations and pay what 
they owe.
    The IRS provides year-round assistance to millions of taxpayers 
including: Outreach and education programs; issuance of tax form and 
publications; rulings and regulations; toll-free call centers; IRS.gov 
web site; Taxpayer Assistance Centers (TACs); Volunteer Income tax 
Assistance (VITA) sites; and Tax Counseling for the Elderly (TCE).
    The IRS will continue to implement and administer these critical 
programs within the levels contained in the budget request.

                     BUSINESS SYSTEMS MODERNIZATION

    Question. For many years, the IRS has struggled to update its 
computer systems to improve processing, enhance collections, and 
strengthen customer service. To address IRS' computer system problems, 
the Business Systems Modernization (BSM) was created. The center-piece 
of BSM is the Customer Account Data Engine (CADE) project.
    What is the status of BSM?
    Answer. The BSM program is a critically important component of the 
IRS's overall technology portfolio. In recent years, the IRS has 
consistently delivered on its commitments and is providing systems that 
deliver concrete benefits to taxpayers. Some of these benefits include:
  --CADE.--Issuing refunds for nearly 40 million taxpayers on average 5 
        days faster than existing legacy systems;
  --Modernized e-File.--Dramatically reduced processing error rates, 
        which eliminates rework for taxpayers and the IRS;
  --E-Services.--Delivering value-added, web-based services for 
        taxpayers and the tax practitioners who serve them;
  --Account Management Services.--Providing IRS customer service 
        representatives (CSRs) with faster and improved access to 
        taxpayer account data with real-time data entry, validation and 
        update of taxpayer addresses; and
  --Filing and Payment Compliance.--Placed more than 203,800 taxpayers 
        with Private Collection Agencies since September 2006, 
        facilitating the collection of more than $90 million on cases 
        formerly unassigned for active collection.
    The Modernized e-File project is on track to begin delivery of Form 
1040 and certain schedules in 2010, which will extend the benefits of 
this program to individual taxpayers.
    The CADE project has delivered a modern database with significantly 
more functionality than the Individual Master File, including improved 
financial accounting capabilities, which have allowed the IRS to make 
progress against addressing its material weakness in this area. In 
2008, the IRS refined the program focus to target an accelerated 
integration of the legacy and modernized databases to get all 140 
million taxpayers into a common relational database, and into a faster 
processing cycle. That database will serve as a strategic foundation 
for the IRS's next generation taxpayer service and compliance programs.
    Finally, as the IRS proceeds with its modernization efforts, we are 
mindful of maintaining a holistic, overall portfolio approach to our 
technology programs. In particular, we are focused on balancing our 
work on modernization with appropriate investments in core IT 
operations, and in particular, IT security.
    Question. When will the CADE system be able to handle all 
individual and business tax returns?
    Answer. The Commissioner has set a goal of completing the 
development of the taxpayer account database for all individuals, and 
moving to a faster processing cycle within 5 years. The team has 
developed and delivered a long-range plan, and is in the process of 
developing the BSM expenditure plan for fiscal year 2010, each of which 
provide further details on the interim deliverables for 2010 and 2011.
    In the interests of prioritization and focus, the IRS plans to 
deliver on the individual account database before upgrading the 
business tax account database.

                        PRIVATE DEBT COLLECTION

    Question. With the start of the new Administration, the IRS 
abandoned its private debt collection program.
    What is your justification from a purely business case perspective 
for abandoning this program for collecting small-dollar, non-complex 
collection cases? Are we to assume that these tax debts will now just 
go uncollected, since IRS officials have previously testified that the 
agency does not have the staff to work these cases? Or, do you plan to 
pull staff off of more complex, higher-dollar cases to work the ones 
that were handled by the private debt collection program?
    Answer. In early 2009, the IRS completed a cost effectiveness study 
of the Private Debt Collection (PDC) program, supported by an 
independent review, which showed that it is reasonable to conclude that 
when working similar inventory, collection efforts are more cost-
effective using IRS employees rather than outside contractors. In 
addition, from 2002 to 2008, the percentage of potentially collectible 
inventory in active IRS collection status increased from 62.2 percent 
to 71.4 percent, and the dollar amount of potentially collectible 
inventory shelved due to lack of IRS resources declined from $7.6 
billion to $3.6 billion. These elements contributed to the March 2009 
decision not to renew contracts with the private collection agencies 
(PCAs).
    The IRS plans to work the types of cases that were assigned to PCAs 
as part of its overall collection strategy, which includes notice, 
telephone, and in-person contact. A part of this strategy is supported 
by a fiscal year 2010 IRS budget initiative which requests funding for 
two new Automated Collection System sites.

                                TAX GAP

    Question. The Administration's budget includes a number of 
proposals aimed at closing the so-called ``tax gap,'' many of which 
originated in the last couple of budgets submitted by the previous 
Administration. Yet, the last estimate that the IRS undertook to 
quantify the tax gap was in 2001.
    When is the IRS going to update its tax gap estimates so we can 
measure accurately the success of these initiatives?
    Answer. We do not have plans to update estimates of all components 
of the tax gap simultaneously for a common year since new data will not 
be available for all components at the same time. Furthermore, any 
post-initiative tax gap estimates will require compliance data to be 
compiled and analyzed for a tax year in which the initiatives are fully 
implemented. Since the tax gap estimates are, of necessity, very 
approximate, it would probably be more effective to estimate the effect 
of the initiatives by analyzing trends of observable tax data, such as 
tax revenue or enforcement revenue, accounting for other factors that 
have caused the trends to vary over time.
    Question. Does the IRS plan to estimate the extent to which the 
current tax gap is associated with taxpayers' intentional efforts to 
evade the tax law as opposed to honest mistakes due to the incredible 
complexity of our tax code today?
    Answer. The IRS seeks to be able to distinguish intentional 
noncompliance from unintentional mistakes. Several of our reporting 
compliance studies have tried to address this question. However, we 
have found that it is virtually impossible for auditors to know for 
sure what motivated an error. It is relatively easy for a taxpayer to 
claim that an error was an unintentional mistake (e.g., ``I lost my 
receipts,'' or ``I forgot about that income.''), whether that is true 
or merely an attempt to avoid penalties and more detailed scrutiny. 
Moreover, even if IRS employees could distinguish between intentional 
and unintentional errors, the unintentional errors among all returns 
would likely include both overstatements and understatements of tax in 
roughly equal amounts. Since the tax gap is defined as the aggregate 
amount of understatements net of overstatements, those unintentional 
overstatements and understatements are likely to cancel each other when 
added to the tax gap. If so, the tax gap likely includes very little 
net unintentional noncompliance. Having said that, though, the IRS 
seeks to minimize unintentional noncompliance since it represents 
unnecessary burden on both taxpayers and the IRS. It is also important 
to point out that, in addition to spawning unintentional errors, the 
complexity of the tax code undoubtedly creates opportunities for 
willful noncompliance.
    Question. Does the IRS plan to produce an estimate of how much of 
the tax gap is associated with international transactions, since the 
Administration has placed so much emphasis on this compliance area?
    Answer. We are conducting a pilot study, beginning with Tax Year 
2006, to extend our NRP reporting compliance studies of individual 
returns to include a small sample of returns with international 
addresses. We hope to determine from this pilot how best to compile 
representative compliance data for this population. If successful, this 
approach may allow us to estimate this portion of the international tax 
gap. Future studies of corporation income tax reporting compliance will 
need to address this concern, as well.

                   IMPLEMENTATION OF TAX GAP STRATEGY

    Question. In 2006, the Treasury Department and the IRS prepared a 
strategy for addressing the tax gap, and in 2007, the IRS released a 
progress report on the implementation of that strategy.
    Please provide me an update on the implementation of the tax gap 
strategy, including new initiatives that the IRS plans to implement 
over the next 5 years to close the tax gap.
    Answer. The Internal Revenue Service and Treasury issued an update 
of the 2007 Tax Gap Strategy report in early July. That report 
addressed this question in detail.

                          SUBCOMMITTEE RECESS

    Senator Durbin. We thank you for your appearance today and 
thank Senator Collins.
    This subcommittee stands recessed.
    [Whereupon, at 12:33 p.m., Tuesday, June 9, the 
subcommittee was recessed, to reconvene subject to the call of 
the Chair.]
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