[Senate Hearing 112-498]
[From the U.S. Government Publishing Office]



                                                         S. Hrg. 112-498
 
          CONCURRENT RESOLUTION ON THE BUDGET FISCAL YEAR 2012

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

                                HEARINGS

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                      ONE HUNDRED TWELTH CONGRESS

                             FIRST SESSION

                               ----------                              


January 7, 2011-THE U.S. ECONOMIC OUTLOOK: CHALLENGES FOR MONETARY AND 
                             FISCAL POLICY

  January 27, 2011-THE BUDGET AND ECONOMIC OUTLOOK: FISCAL YEARS 2011-
                                  2021

               February 1, 2011-THE U.S. ECONOMIC OUTLOOK

February 2, 2011-TAX REFORM: A NECESSARY COMPONENT FOR RESTORING FISCAL 
                             RESPONSIBILITY

       February 3, 2011-CHALLENGES FOR THE U.S. ECONOMIC RECOVERY

   February 15, 2011-THE PRESIDENT'S FISCAL YEAR 2012 BUDGET PROPOSAL

 February 17, 2011-THE PRESIDENT'S FISCAL YEAR 2012 BUDGET AND REVENUE 
                               PROPOSALS

   March 1, 2011 09THE PRESIDENT'S FISCAL YEAR 2012 EDUCATION BUDGET

March 2, 2011 09THE PRESIDENT'S FISCAL YEAR 2012 BUDGET REQUEST FOR THE 
                          DEPARTMENT OF ENERGY

 March 3, 2011-THE PRESIDENT'S FISCAL YEAR 2012 BUDGET REQUEST FOR THE 
                    U.S. DEPARMENT OF TRANSPORTATION

     March 8, 2011-THE REPORT OF THE NATIONAL COMMISSION ON FISCAL 
                        RESPONSIBILTY AND REFORM

 March 9, 2011-DISTRIBUTION AND EFFICIENCY OF SPENDING IN THE TAX CODE

      March 10, 2011-THE PRESIDENT'S FISCAL YEAR 2012 DEFENSE AND 
                      INTERNATIONAL AFFAIRS BUDGET










                                                        S. Hrg. 112-498

          CONCURRENT RESOLUTION ON THE BUDGET FISCAL YEAR 2012

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

                                HEARINGS

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                      ONE HUNDRED TWELTH CONGRESS

                             FIRST SESSION

                               __________

January 7, 2011-THE U.S. ECONOMIC OUTLOOK: CHALLENGES FOR MONETARY AND 
                             FISCAL POLICY
  January 27, 2011-THE BUDGET AND ECONOMIC OUTLOOK: FISCAL YEARS 2011-
                                  2021
               February 1, 2011-THE U.S. ECONOMIC OUTLOOK
February 2, 2011-TAX REFORM: A NECESSARY COMPONENT FOR RESTORING FISCAL 
                             RESPONSIBILITY
       February 3, 2011-CHALLENGES FOR THE U.S. ECONOMIC RECOVERY
   February 15, 2011-THE PRESIDENT'S FISCAL YEAR 2012 BUDGET PROPOSAL
 February 17, 2011-THE PRESIDENT'S FISCAL YEAR 2012 BUDGET AND REVENUE 
                               PROPOSALS
    March 1, 2011-THE PRESIDENT'S FISCAL YEAR 2012 EDUCATION BUDGET
 March 2, 2011-THE PRESIDENT'S FISCAL YEAR 2012 BUDGET REQUEST FOR THE 
                          DEPARTMENT OF ENERGY
 March 3, 2011-THE PRESIDENT'S FISCAL YEAR 2012 BUDGET REQUEST FOR THE 
                    U.S. DEPARMENT OF TRANSPORTATION
     March 8, 2011-THE REPORT OF THE NATIONAL COMMISSION ON FISCAL 
                        RESPONSIBILTY AND REFORM
 March 9, 2011-DISTRIBUTION AND EFFICIENCY OF SPENDING IN THE TAX CODE
      March 10, 2011-THE PRESIDENT'S FISCAL YEAR 2012 DEFENSE AND 
                      INTERNATIONAL AFFAIRS BUDGET




                                _____

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           Printed for the use of the Committee on the Budget












                        COMMITTEE ON THE BUDGET

                  KENT CONRAD, NORTH DAKOTA, CHAIRMAN

PATTY MURRAY, WASHINGTON             JEFF SESSIONS, ALABAMA
RON WYDEN, OREGON                    CHARLES E. GRASSLEY, IOWA
BILL NELSON, FLORIDA                 MICHAEL ENZI, WYOMING
DEBBIE STABENOW, MICHIGAN            MIKE CRAPO, IDAHO
BENJAMIN CARDIN, MARYLAND            JOHN CORNYN, TEXAS
BERNARD SANDERS, VERMONT             LINDSEY O. GRAHAM, SOUTH CAROLINA
SHELDON WHITEHOUSE, RHODE ISLAND     JOHN THUNE, SOUTH DAKOTA
MARK R. WARNER, VIRGINIA             ROB PORTMAN, OHIO
JEFF MERKLEY, OREGON                 PAT TOOMEY, PENNSYLVANIA
MARK BEGICH, ALASKA                  RON JOHNSON, WISCONSIN
CHISTOPHER A. COONS, DELAWARE        KELLY AYOTTE, NEW HAMPSHIRE


                Mary Ann Naylor, Majority Staff Director

                Marcus Peacock, Minority Staff Director

                                  (ii)
















                            C O N T E N T S

                               __________

                                HEARINGS

                                                                   Page
January 7, 2011-The U.S. Economic Outlook: Challenges for 
  Monetary and Fiscal Policy.....................................     1
January 27, 2011-The Budget and Economic Outlook: Fiscal Years 
  2011-2021......................................................    83
February 1, 2011-The U.S. Economic Outlook.......................   157
February 2, 2011-Tax Reform: A Necessary Component for Restoring 
  Fiscal Responsibility..........................................   265
February 3, 2011-Challenges for the U.S. Economic Recovery.......   363
February 15, 2011-The President's Fiscal Year 2012 Budget 
  Proposal.......................................................   461
February 17, 2011-The President's Fiscal Year 2012 Budget and 
  Revenue Proposals..............................................   639
March 1, 2011-The President's Fiscal Year 2012 Education Budget..   719
March 2, 2011-The President's Fiscal Year 2012 Budget Request for 
  the Department of Energy.......................................   831
March 3, 2011-The President's Fiscal Year 2012 Budget Request for 
  the U.S. Department of Transportation..........................   949
March 8, 2011-The Report of the National Commission on Fiscal 
  Responsibility and Reform......................................  1005
March 9, 2011-Distribution and Efficiency of Spending in the Tax 
  Code...........................................................  1075
March 10, 2011-The President's Fiscal Year 2012 Defense and 
  International Affairs Budget...................................  1173

                    STATEMENTS BY COMMITTEE MEMBERS

Chairman1, 83, 157, 265, 363, 461, 639, 719, 831, 949, 1005, 1075, 1173
R11, 117, 169, 274, 398, 468, 648, 696, 728, 838, 895, 958, 993, 1013, 
                                                             1084, 1183
Senator Crapo....................................................    91
Senator Thune..................................................353, 995
Senator Wyden....................................................   998

                               WITNESSES

Roseanne Altshuler, PhD., Professor, Rutgers University........303, 306
Honorable Ben S. Bernanke, Chairman, Board of Governors of the 
  Federal Reserve System.........................................14, 20
Richard Berner, PhD., Managing Director, Co-Head of Global 
  Economics, and Chief U.S. Economist, Morgan Stanley..........171, 175
Honorable Erskine Bowles, Co-Chair, National Commission on Fiscal 
  Responsibility and Reform......................................  1037
Honorable Steven Chu, PhD., Secretary, U.S. Department of Energ841, 844
Honorable Arne Duncan, Secretary, U.S. Department of Education: 
  Accompanied by Thomas Skelly, Acting Chief Financial Officer, 
  U.S. Department of Education............................733, 738, 766
Chris Edwards, Director of Tax Policy Studies, CATO Institute..430, 433
Douglas W. Elmendorf, Director, Congressional Budget Office......93, 97
Honorable Timothy F. Geithner, Secretary, U.S. Department of the 
  Treasury.....................................................650, 653
Robert Greenstein, Executive Director, Center on Budget and 
  Policy Priorities..........................................1087, 1090
Scott Hodge, President, Tax Foundation.......................1110, 1113
Simon Johnson, Senior Fellow, Peterson Institute for Internation 
  Econoics and Roanld A. Kurtz Proffesor of Entrepreneurship, 
  Sloan School of Manangement, Massachusetts Institute of 
  Technology...................................................183, 186
Honorable Ray LaHood, Secretary, U.S. Department of 
  Transportation...............................................959, 961
Honorable Jacob J. Lew, Director, U.S. Office of Management and 
  Budget.......................................................470, 474
Lawrence B. Lindsey, PhD., Professor, Rutgers University.......315, 318
Honorable William J. Lynn, III, Deputy Secretary of Deense, U.S. 
  Department of Defense......................................1193, 1196
David Malpass, President, Encima Global........................194, 201
Donald B. Marron, PhD., Director, Urban-Brookings Tax Policy 
  Center, and Visiting Professor, Georgetown Public Policy 
  Institute....................................................290, 292
Robert S. McIntyre, Director, Citizens for Tax Justice.......1100, 1102
Honorable Thomas R. Nides, Deputy Secretary of State for 
  Management and Resources, U.S. Department of State.........1185, 1188
Raymond C. Scheppah, Executive Director, National Governors 
  Association..................................................416, 420
Honorable Alan Simpson, Co-Chair, National Commission on Fiscal 
  Responsibility and Reform..................................1015, 1019
C. Eugene Steuerle, PhD., Institute Fellow and Richard B. Fisher 
  Chair, The Urban Institute...................................276, 278
Till Von Wachter, Phd., Associate Professor of Economics, 
  Columbia University..........................................398, 402
Mark Zandi, PhD., Chief Economist, Moody's Analytics...........372, 378

                         QUESTIONS AND ANSWERS

Questions 63, 148, 259, 357, 528, 696, 813, 895, 1001, 1069, 1162, 1226


  THE U.S. ECONOMIC OUTLOOK: CHALLENGES FOR MONETARY AND FISCAL POLICY

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


                        FRIDAY, JANUARY 7, 2011

                              United States Senate,
                                   Committee on the Budget,
                                                   Washington, D.C.
    The Committee met, pursuant to notice, at 9:31 a.m., in 
Room SH-216, Hart Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Wyden, Stabenow, Warner, Merkley, 
Manchin, Sessions, Enzi, and Cornyn.
    Staff Present: Mary Ann Naylor, Majority Staff Director; 
and Marcus Peacock, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The Committee will come to order.
    I want to welcome everyone to the Budget Committee this 
morning. I especially want to welcome Senator Sessions.
    Senator Sessions has not formally been recognized as 
Ranking Member of the Budget Committee, but that is just a 
formality. He will be as soon as the organizing resolution is 
adopted, and so I intend to treat Senator Sessions as the 
Ranking Member here today, and I think that is the appropriate 
thing to do.
    I very much welcome Senator Sessions as my partner on this 
Committee. He has considerable knowledge of the budget and the 
budget process, and I very much look forward to working with 
him as we confront the significant challenges facing the 
country.
    I also want to welcome Federal Reserve Chairman Ben 
Bernanke back to the Budget Committee. This is Chairman 
Bernanke's third appearance here, and we have always benefitted 
by his wise counsel. I believe that when the history of this 
period is written, you will be one of the heroes of the piece 
in averting what could have been a financial collapse.
    I was in the meetings with the former Secretary of the 
Treasury and with you when you warned us of how serious the 
financial circumstances were in late 2008. Those moments will 
be forever riveted in my memory, I am sure in yours as well. I 
personally believe you and then Secretary of the Treasury Hank 
Paulson, followed by this administration, have taken steps that 
were critically important to averting a financial collapse, not 
only here but globally as well.
    Still, our Nation faces very serious challenges. We know we 
are on an unsustainable course with the budget, borrowing about 
40 cents of every dollar that we spend. Clearly, that cannot 
continue for very long.
    On the other hand, we also face a fragile economy. With one 
in every six workers in this country either unemployed or 
underemployed, that requires our immediate attention as well. 
My own belief is that we need to put in place a plan this year 
to get our fiscal house back in order, and that plan needs to 
be phased in over a period of time along the lines of what the 
Fiscal Commission proposed.
    I think we also understand where we have come. This has 
been an extraordinary period in the country's economic history. 
I would like to just go over a brief history of what we have 
experienced.
    I personally believe the Federal response did avert what 
could have been a financial collapse. I believe it was that 
serious. In the meetings that I was in with then Secretary of 
the Treasury Hank Paulson and you, Mr. Chairman, the risks were 
very clear. We have seen some progress made--in fact, important 
progress made. Private sector job growth has returned, although 
not as much as we would have liked. We heard the numbers this 
morning, something over 100,000 jobs created in the private 
sector, a dramatic improvement of where we were back in January 
of 2009 when we were losing 800,000 private sector jobs a 
month. Now we have had 12 consecutive months of private sector 
job growth. 






    Now, in economic growth the pattern is the same, although 
actually somewhat better. In the fourth quarter of 2008, the 
economy actually contracted, actually shrunk by 6.8 percent. 
More recently, in the third quarter of 2010, we saw a positive 
growth of 2.6 percent--again, a dramatic improvement, while not 
as strong as we would hope. We have now had five consecutive 
quarters of growth. 




    We have also seen a dramatic rebound in the stock market. 
After falling to a low of just about 6,500 in March of 2009, 
the Dow is now over 11,500. And two of the most respected 
economists in the country--Mark Zandi, who was a consultant to 
the McCain Campaign, and Alan Blinder, the former Deputy 
Chairman of the Federal Reserve--did an analysis that measured 
the impact of Federal actions--the TARP and stimulus--and also 
included the Fed's monetary policy actions, and they concluded 
as follows: ``We find that its effects on real GDP, jobs, and 
inflation are huge and probably averted what could have been 
called `Great Depression 2.0.' When all is said and done, the 
financial and fiscal policies will have cost taxpayers a 
substantial sum, but not nearly as much as most had feared and 
not nearly as much as if policymakers had not acted at all. If 
the comprehensive policy responses saved the economy from 
another depression, as we estimate, they were well worth the 
cost.'' 




    This next chart shows Dr. Blinder and Dr. Zandi's estimate 
of the number of jobs we would have without the Federal 
response. It shows we would have had 8 million fewer jobs in 
the second quarter of 2010 if we had not had the Federal 
response--the TARP and the stimulus. 




    We see a similar picture with the unemployment rate. The 
unemployment rate averaged 9.7 percent in the second quarter. 
According to Dr. Blinder and Dr. Zandi, if we had not had the 
Federal response, the unemployment rate would have been 15 
percent in the second quarter and would have continued rising 
to over 16 percent in the fourth quarter of 2010. So, clearly, 
the Federal response to the economic crisis has had and 
continues to have a significant positive impact on the economy, 
but we are not out of the woods. 




    We cannot forget that, as I mentioned before, one in every 
six of our fellow citizens are either unemployed or 
underemployed. The unemployment rate in December, which was 
also announced this morning, was 9.4 percent. This is still far 
too high. And Federal Reserve projections show the rate is 
likely to come down only slowly, averaging still in the high 8-
percentage-point range by the fourth quarter of 2012. 




    But as I noted, we must now also pivot to addressing the 
long-term fiscal imbalances that the country confronts. I 
believe we are at a critical juncture. We have been borrowing, 
as I mentioned earlier, 40 cents of every dollar that we spend. 
That cannot continue much longer. Spending is at the highest 
level as a share of our national income in 60 years; revenue is 
at its lowest level as a share of our national income in 60 
years. I believe that indicates you have to work both sides of 
that equation if we are to make progress. 




    Gross Federal debt is already expected to reach 100 percent 
of GDP this year, well above the 90-percent threshold that many 
economists see as the danger zone. A leading economist came 
before our Commission and has come before this Committee, Dr. 
Carmen Reinhart, who has studied 200 years of fiscal crises 
around the world. She concluded that when government debt as a 
share of the economy exceeds 90 percent--and she is referring 
here to gross Federal debt--that economic growth tends to be 
about one percentage point lower than it would be if debt 
levels were not so high. If that association were applied to 
the United States today, it would translate into a potential 
economic loss of hundreds of billions of dollars and 
substantially fewer jobs for Americans. 




    So I believe the deficit and debt reduction plan assembled 
by the Fiscal Commission could provide a blueprint and a way 
forward. The plan would stabilize the publicly held debt by 
2014 and then lower it to 60 percent of GDP by 2023 and roughly 
30 percent by 2040. I emphasize that is the publicly held debt, 
not the gross debt. 




    The bipartisan Commission voted for the plan; 60 percent of 
us supported it--interestingly enough, five Republicans and 
five Democrats and one Independent. I think that demonstrates 
that we can reach across the aisle to do things that are 
critically important for the country. Facing up to the debt 
threat is something we must do, and we must do it together.
    With that, we will turn to Senator Sessions for his opening 
remarks, and, again, I want to welcome him as Ranking Member of 
the Budget Committee.

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. Thank you, Chairman Conrad. It is an 
honor to be here, to be with you. I respect you very much and 
value our friendship and enjoy being ribbed by you--
effectively, I must add--and look forward to working with you 
to help make our country better. We have some real serious 
challenges ahead of us.
    I also want to note how much I have admired our former 
Ranking Member, Judd Gregg. I know you and he had a great 
relationship. I think his leadership was particularly valuable. 
People listened to him, they trusted his judgment, and I hope 
that I can just come close to being as effective as he has been 
in this position.
    I would like to share some thoughts and concerns. I know 
that when the mortgage crisis hit and the economy was whacked, 
a lot of people got together and tried to make some decisions. 
Mr. Chairman, it would have been better, I think, had we seen 
the mortgage crisis 2 years in advance and taken action to make 
the crisis less real. And I say that because we ought to be 
humble about where we are today.
    I do not think anyone fully understands this magnificent 
world economy we are a part of. I do not think any one person, 
whether it is the Federal Reserve, the Secretary of Treasury, 
or even Congress, can have a little meeting and be sure that 
the actions we take are going to have certain impacts on this 
massive economy of which we are a part. When you are confused, 
in the end you need to return to the fundamentals of blocking 
and tackling, to the fundamentals of paying your bills on time, 
and create some confidence in the economy.
    So today is our Committee's first hearing of the 112th 
Congress. We meet on the heels of a historic election. It is 
important, that election. The American people rebelled against 
wasteful Washington spending and a Government that has grown 
too large and too intrusive. The American people also rebelled 
against a political establishment that has placed our country 
on a path to fiscal decline. Solving our Nation's economic and 
debt crisis is about more than economics. It is about 
protecting our way of life at home and our standing abroad as a 
great Nation, and it is about honest and moral policy.
    Our goal is not an era of austerity but an era of 
prosperity. Restoring fiscal discipline and strengthening the 
private sector is the only way to create growth and opportunity 
for every hard-working American, and it is the only way to 
protect our country's greatness and its vital role in the 
world.
    To solve our problems, we must speak about them candidly. 
Our Nation's debt will soon be equal to the size of our entire 
economy. Forty percent of our budget relies on borrowed funds. 
In 2009, the interest on our debt alone cost $187 billion. And 
the Congressional Budget Office projects that under the 
President's budget these interest payments will climb to $916 
billion in 2020. That exceeds any other part of our budget and 
is growing faster than any other part of our budget--vastly 
superior to the defense budget.
    We are on a path that is unsustainable. The only real 
question is how much road is left between us and the edge of 
the cliff. The American people understand the situation. They 
understand that years of unchecked Federal spending has 
squandered our Nation's wealth and threatened our children's 
future. The American people understand what elites in 
Washington seem to forget, and that is, you can only live 
beyond your means for so long. Eventually the bill comes due. 
Fundamentally it is immoral to take from our children their 
wealth so we can spend unearned wealth today.
    There are other problems, too. Considering the housing 
bubble, for years Congress delayed action to address the 
unfolding catastrophe at Freddie and Fannie. The Federal 
Reserve was asleep at the switch and failed to sound the alarm. 
And then one day the bubble burst, and the whole world changed. 
No one knows exactly what will happen if we continue our 
spending on the current course, but we must not find out.
    James Baker wrote a recent piece in the Washington Times 
describing some of the worse potential consequences, saying we 
need to be more specific about what the consequences will be. 
He said, ``One day the Treasury will hold an auction and there 
will not be buyers. The Federal Reserve will step in as a buyer 
of last resort, conjuring money from the ether to buy bonds. 
The injection of massive liquidity into the financial system 
will trigger fears of hyperinflation, causing the dollar to 
plunge and interest rates to rise. If the resources of the 
European Union and the International Monetary Fund are 
stretched to rescue the finances of tiny Greece and Ireland, 
the United States will not only be too big to fail but too big 
to bail out. Absent emergency action by the Government, the 
economy will plunge into a depression roughly 3 times more 
acute than the recession we just experienced.''
    I do not know if it would happen like that, but Barron's 
also had an editorial by an experienced Wall Streeter of 45 
years warning of a hyperinflationary spiral. The writer 
explained that while the Federal Reserve can monetize the debt, 
historically a ``break point occurs when a government borrows 
an amount equal to 40 percent of its expenditures for an 
extended period of time.''
    In a recent interview, Chairman Bernanke, you said you were 
100 percent confident the Fed could prevent such inflation, but 
I am not sure the masters of the universe--you being maybe the 
master master how confident you can be about that. You have 
been wrong before. And while we can debate just how great and 
imminent the risk is, there is no debating what the American 
people have declared in poll after poll. We are on the wrong 
track.
    But where is the leadership from our administration? Just 
last December, the President would only agree to maintain 
current tax rates if Congress agreed to new spending, all 
borrowed, that would add another $250 billion to the debt. 
Instead of slowing down, President Obama hit the accelerator. 
But simply easing off the pedal will not solve the problem. 
When you are driving toward a cliff at 90 miles an hour, you 
cannot just slow down to 60. You need to hit the brakes and 
steer on to the right road. For too long, Washington compromise 
has changed only the pace and not the direction that we are 
going.
    Last November, the American people said, ``Enough.'' That 
is precisely what they said, I believe. They sent Congress a 
new freshman class with a clear set of instructions. Those 
instructions include a budget that changes our trajectory and 
genuinely reduces the size, cost, and burden of Government. We 
can learn from those who are setting a strong example.
    In New Jersey, Governor Chris Christie has a plan to close 
his State's funding gap without raising taxes.
    In Britain, the new conservative government has taken 
strong action and has a plan to reduce their deficit from 10 to 
4 percent of GDP in just 4 years. As Britain's Chancellor of 
the Exchequer George Osborne said, ``It is a hard road, but it 
leads to a better future.''
    Yet some would argue that reducing Government spending even 
a small amount will reduce the quality of our life, but the 
surest way to lower the quality of life in America is to 
continue on our current course, spending without restraint, 
crushing private enterprise, and mortgaging the inheritance of 
our children.
    The challenges ahead may be difficult, but the choices we 
face are not. We need to limit Government, control spending, 
and create an environment where the free market can thrive and 
flourish. It is a road map our Founders laid out more than two 
centuries ago. There is no doubt it will work again. America's 
progress is not a thing of the past. We can do this. But to 
achieve this progress, we can no longer compromise our Nation's 
founding principles. Instead we must fight for them and in so 
doing hope to find common ground in doing so.
    Chairman Bernanke, I look forward to discussing these and 
other issues with you today, and I look forward to getting your 
thoughts on how you and the administration are working together 
with a plan for strengthening our future.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you so much, Senator Sessions, and I 
just want to say I welcome your analysis. We may not agree on 
every solution. I think the one thing we are agreed on is we 
are on an unsustainable course, and we have an obligation, we 
have a very serious and somber obligation to come up with a 
plan and to do it sooner rather than later, and I look very 
much forward to working with you on that.
    Senator Sessions. Thank you. I value those comments.
    Chairman Conrad. Mr. Chairman, thank you so much for 
coming. I want to tell the Committee that Chairman Bernanke has 
also offered to come up here in a closed session with Committee 
members to discuss what he sees with respect to the economy, 
but we very much welcome your being here as our first witness 
as we embark on the challenge of putting together a budget for 
this year and succeeding years. Welcome.

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

    Mr. Bernanke. Thank you. Thank you, Chairman Conrad, 
Senator Sessions, and other members of the Committee. I want to 
thank you for this opportunity to offer my views on current 
economic conditions, recent monetary policy actions, and issues 
related to the Federal budget.
    The economic recovery that began a year and a half ago is 
continuing, although to date at a pace that has been 
insufficient to reduce the rate of unemployment significantly. 
The initial stages of the recovery in the second half of 2009 
and in early 2010 were largely attributable to the 
stabilization of the financial system, the expansion of 
monetary and fiscal policies, and a powerful inventory cycle.
    Growth slowed somewhat this past spring as the impetus from 
fiscal policy and inventory building waned and as European 
sovereign debt problems led to increased volatility in 
financial markets. More recently, however, we have seen 
increased evidence that a self-sustaining recovery in consumer 
and business spending may be taking hold. In particular, real 
consumer spending rose at an annual rate of 2.5 percent in the 
third quarter of 2010, and the available indicators suggest 
that it likely expanded at a somewhat faster pace in the fourth 
quarter.
    Business investment in new equipment and software has grown 
robustly in recent quarters, albeit from a fairly low level, as 
firms replaced aging equipment and made investments that had 
been delayed during the downturn. However, the housing sector 
remains depressed as the overhand of vacant house continues to 
weigh heavily on both home prices and construction, and non-
residential construction is also quite weak. Overall, the pace 
of economic recovery seems likely to be moderately stronger in 
2011 than it was in 2010.
    Although recent indicators of spending and production have 
generally been encouraging, conditions in the labor market have 
improved only modestly at best. After the loss of nearly 8.5 
million jobs in 2008 and 2009, private payrolls expanded at an 
average of only about 100,000 per month in 2010--a pace barely 
enough to accommodate the normal increase in the labor force 
and, therefore, insufficient to materially reduce the 
unemployment rate.
    On a more positive note, a number of indicators of job 
openings and hiring plans have looked stronger in recent 
months, and initial claims for unemployment insurance declined 
through November and December. Notwithstanding these hopeful 
signs, with output growth likely to be moderate in the next few 
quarters and employers reportedly still reluctant to add to 
payrolls, considerable time likely will be required before the 
unemployment rate has returned to a more normal level.
    Persistently high unemployment by dampening household 
income and confidence could threaten the strength and 
sustainability of the recovery. Moreover, roughly 40 percent of 
the unemployed have been out of work for 6 months or more. 
Long-term unemployment not only imposes exceptional hardships 
on the jobless and their families, but it also erodes the 
skills of those workers and may inflict lasting damage on their 
employment and earnings prospects.
    Recent data show consumer price inflation continuing to 
trend downward. For the 12 months ending in November, prices 
for personal consumption expenditures rose 1.0 percent, and 
inflation, excluding the relatively volatile food and energy 
components, which tends to be a better gauge of underlying 
inflation trends, was only 0.8 percent, down from 1.7 percent a 
year earlier and from about 2.5 percent in 2007, the year 
before the recession began.
    The downward trend in inflation over the past few years is 
no surprise given the low rates of resource utilization that 
have prevailed over that time. Indeed, as a result of the weak 
job market, wage growth has slowed along with inflation. Over 
the 12 months ending in November, average hourly earnings have 
risen only 1.6 percent.
    Despite the decline in inflation, long-run inflation 
expectations have remained stable. For example, the rate of 
inflation that households expect over the next 5 to 10 years, 
as measured by the Thompson Reuters/University of Michigan 
Surveys of Consumers, has remained in a narrow range over the 
past few years. With inflation expectations stable and with 
levels of resource utilization expected to remain low, 
inflation is likely to be subdued for some time.
    Although it is likely that economic growth will pick up 
this year and that the unemployment rate will decline somewhat, 
progress toward the Federal Reserve statutory objectives of 
maximum employment and stable prices is expected to remain 
slow. The projections submitted by the Federal Open Market 
Committee, or FOMC, showed that, notwithstanding forecasts of 
increased growth in 2011 and 2012, most participants expected 
the unemployment rate to be close to 8 percent 2 years from 
now. At this rate of improvement, it could take 4 to 5 more 
years for the job market to normalize fully.
    FOMC participants also predicted inflation to be at 
historically low levels for some time. Very low rates of 
inflation raise several concerns.
    First, very low inflation increases the risk that new 
adverse shocks could push the economy into deflation; that is, 
a situation involving ongoing declines in prices. Experience 
shows that deflation induced by economic slack can lead to 
extended periods of poor economic performance. Indeed, even a 
significant perceived risk of deflation may lead firms to be 
more cautious about investment and hiring.
    Second, with short-term nominal interest rates already 
close to zero, declines in actual and expected inflation 
increase, respectively, both the real cost of servicing 
existing debt and the expected real cost of new borrowing. By 
raising effective debt burdens and by inhibiting new household 
spending and business investment, higher real borrowing costs 
create a further drag on growth.
    Finally, it is important to recognize that periods of very 
low inflation generally involve very slow growth in nominal 
wages and incomes as well as prices. I have already alluded to 
the recent deceleration in average hourly earnings. Thus, in 
circumstances like those we face now, very low inflation, or 
deflation, does not necessarily imply any increase in household 
purchasing power. Rather, because of the associated 
deterioration in economic performance, very low inflation, or 
deflation, arising from economic slack is generally linked with 
reductions rather than gains in living standards.
    In a situation in which unemployment is high and expected 
to remain so and inflation is unusually low, the FOMC would 
normally respond by reducing its target for the Federal funds 
rate. However, the Federal Reserve's target for the Federal 
funds rate has been close to zero since December 2008, leaving 
essentially no scope for further reductions. Consequently for 
the past 2 years, the FOMC has been using alternative tools to 
provide additional monetary accommodation. Notably, between 
December 2008 and March 2010, the FOMC purchased about $1.7 
trillion in longer-term Treasury and agency-backed securities 
in the open market. The proceeds of these purchases ultimately 
find their way into the banking system, with the result that 
depository institutions now hold a high level of reserve 
balances with the Federal Reserve.
    Although longer-term securities purchases are a different 
tool for conducting monetary policy than the more familiar 
approach of managing the overnight interest rate, the goals and 
transmission mechanisms of the two approaches are similar. 
Conventional monetary policy works by changing market 
expectations for the future path of short-term interest rates, 
which in turn influences the current level of longer-term 
interest rates and other financial conditions. These changes in 
financial conditions then affect household and business 
spending. By contrast, securities purchases by the Federal 
Reserve put downward pressure directly on longer-term interest 
rates by reducing the stock of longer-term securities held by 
private investors. These actions affect private sector spending 
through the same channels as conventional monetary policy.
    In particular, the Federal Reserve's earlier program of 
asset purchases appeared to be successful in influencing 
longer-term interest rates, raising the prices of equities and 
other assets, and improving credit conditions more broadly, 
thereby helping stabilize the economy and support the recovery.
    In light of this experience and with the economic outlook 
still unsatisfactory, late last summer the FOMC began to signal 
to financial markets that it was considering providing 
additional monetary policy accommodation by conducting further 
asset purchases. At its meeting in early November, the FOMC 
formally announced its intention to purchase an additional $600 
billion in Treasury securities by the end of the second quarter 
of 2011, or about one-third the value of securities purchased 
in earlier programs. The FOMC also maintained its policy, 
adopted at its August meeting, of reinvesting principal 
received on the Federal Reserve's holdings of securities. The 
FOMC stated that it will review its asset purchase program 
regularly in light of incoming information and will adjust the 
program as needed to meet its objectives.
    Importantly, the committee remains unwaveringly committed 
to price stability and in particular to maintaining inflation 
at a level consistent with the Federal Reserve's mandate from 
the Congress. In that regards, it bears emphasizing that the 
Federal Reserve has all the tools it needs to ensure that it 
will be able to smoothly and effectively exit from this program 
at the appropriate time.
    Importantly, the Federal Reserve's ability to pay interest 
on reserve balances held at Federal Reserve banks will allow it 
to put upward pressure on short-term market interest rates and 
thus to tighten monetary policy when needed, even if bank 
reserves remain high. Moreover, the Fed has invested 
considerable effort in developing methods to drain or 
immobilize bank reserves as needed to facilitate the smooth 
withdrawal of policy accommodation when conditions warrant. If 
necessary, the committee could also tighten policy by redeeming 
or selling securities on the open market.
    As I am appearing before the Budget Committee, it is worth 
emphasizing that the Fed's purchases of longer-term securities 
are not comparable to ordinary Government spending. In 
executing these transactions, the Federal Reserve requires 
financial assets, not goods and services. Ultimately, at the 
appropriate time, the Federal Reserve will normalize its 
balance sheet by selling these assets back into the market or 
by allowing them to mature. In the interim, the interest that 
the Federal Reserve earns from its securities holdings adds to 
the Fed's remittances to the Treasury. In 2009 and 2010, those 
remittances totaled about $120 billion.
    Fiscal policymakers also face a challenging environment. 
Our Nation's fiscal position has deteriorated appreciably since 
the onset of the financial crisis and the recession. To a 
significant extent, this deterioration is the result of the 
effects of the weak economy on revenues and outlays along with 
the actions that we are taking to ease the recession and steady 
financial markets. In their planning for the near term, fiscal 
policymakers will need to continue to take into account the low 
level of economic activity and the still fragile nature of the 
economic recovery.
    However, an important part of the Federal budget deficit 
appears to be structural rather than cyclical; that is, the 
deficit is expected to remain unsustainably elevated even after 
economic conditions have returned to normal. For example, under 
the CBO's so-called alternative fiscal scenario, which assumes 
that most of the tax cuts enacted in 2001 and 2003 are made 
permanent and that discretionary spending rises at the same 
rate as the GDP, the deficit is projected to fall from its 
current level of about 9 percent of GDP to 5 percent of GDP by 
2015, but then to rise to about 6.5 percent of GDP by the end 
of the decade.
    In subsequent years, the budget outlook is projected to 
deteriorate even more rapidly as the aging of the population 
and continued growth in health spending boost Federal outlays 
on entitlement programs. Under this scenario, Federal debt held 
by the public is projected to reach 185 percent of the GDP by 
2035, up from about 60 percent at the end of fiscal year 2010.
    The CBO projections by design ignore the adverse effects 
that such high debt and deficits would likely have on our 
economy. But if Government debt and deficits were actually to 
grow at the pace envisioned in the scenario, the economic and 
financial effects would be severe. Diminishing confidence on 
the part of investors that deficits will be brought under 
control would likely lead to sharply rising interest rates on 
Government debt and potentially to broader financial turmoil. 
Moreover, high rates of Government borrowing would drain funds 
away from private capital formation and increase our foreign 
indebtedness with adverse long-run effects on U.S. output, 
incomes, and standards of living.
    It is widely understood that the Federal Government is on 
an unsustainable fiscal path, yet as a Nation we have done 
little to address this critical threat to our economy. Doing 
nothing will not be an option indefinitely. The longer we wait 
to act, the greater the risks and the more wrenching the 
inevitable changes to the budget will be. By contrast, the 
prompt adoption of a credible program to reduce future deficits 
would not only enhance economic growth and stability in the 
long run, but could also yield substantial near-term benefits 
in terms of lower long-term interest rates and increased 
consumer and business confidence.
    Plans recently put forward by the President's National 
Commission on Fiscal Responsibility and Reform and other 
prominent groups provide useful starting points for a much 
needed national conversation about our medium- and long-term 
fiscal situation. Although these various proposals differ on 
many details, each gives a sobering perspective on the size of 
the problem and offers some potential solutions.
    Of course, economic growth is affected not only by the 
levels of taxes and spending but also by their composition and 
structure. I hope that in addressing our long-term fiscal 
challenges the Congress will seek reforms to the Government's 
tax policies and spending priorities that serve not only to 
reduce the deficit but also to enhance the long-term growth 
potential of our economy, for example, by encouraging 
investment in physical and human capital, by promoting research 
and development, by providing necessary public infrastructure, 
and by reducing disincentives to work and to save. We cannot 
grow out of our fiscal imbalances, but a more productive 
economy would ease the trade-offs that we face.
    Thank you, Mr. Chairman, Senator Sessions. I would be 
pleased to take your questions.
    [The prepared statement of Mr. Bernanke follows:]



    Chairman Conrad. Thank you for your excellent testimony.
    I want to go to your final point. This is the Budget 
Committee. We have a special responsibility to our colleagues 
and the country to propose a fiscal policy going forward. What 
I hear you saying is that it is critically important that we 
adopt a credible plan, longer-term plan, to deal with our 
deficits and debt. Is that an accurate understanding of what 
you are saying to us?
    Mr. Bernanke. That is correct, Mr. Chairman. Our fiscal 
issues are very long-term in nature. They increase-- the 
difficulties increase over time. Merely addressing this year's 
spending is not going to solve the problem. We need to develop 
a plan, and a credible plan, one that markets will accept as 
plausible, to address the longer-term structural budget 
deficits that we face.
    Chairman Conrad. The Fiscal Commission proposed a plan that 
would reduce the debt over time by $4 trillion, which would 
stabilize the debt in the short term, but importantly, bring 
the debt down as a share of the economy to roughly, publicly-
held debt, to 30 percent of GDP. That is over an extended 
period of time. Is that about the magnitude of the size of the 
plan that is necessary?
    Mr. Bernanke. Senator, no one knows exactly what the 
desirable debt-to-GDP ratio is in the long run. You mentioned 
the 90 percent number as an upper level of comfort. In the near 
term, I think we need to focus on stabilizing the debt-to-GDP 
ratio. Under the alternative scenario of the CBO, it just rises 
indefinitely and that is certainly not sustainable.
    If we could achieve, say, in the next decade a two or three 
percentage point of GDP reduction in the deficit, that would be 
sufficient to bring the primary deficit close to zero and would 
stabilize the debt-to-GDP ratio over the next decade. We would 
need additional steps after that. So I think stability is the 
first step. Bringing it down is a bonus, if we can do that.
    Chairman Conrad. You know, that was really the conclusion 
of the Commission. The conclusion of the Commission was, first 
job, job one is to stabilize the debt. You know, we talk about 
these different measures of debt. Publicly-held debt is 
currently roughly 60 percent. The gross debt is currently about 
90 percent. And most of the advice to the Commission was, you 
have to stabilize publicly-held debt at 60 percent, gross debt 
at 90 percent. But over time, you really need to bring it down. 
You should not stabilize it and consider that you have finished 
the job because you need to have a margin to deal with future 
shocks. Is that your judgment, as well?
    Mr. Bernanke. Yes, Mr. Chairman, but stabilizing it would 
be a very important first step.
    Chairman Conrad. Yes. Job one, stabilize.
    Mr. Bernanke. Right.
    Chairman Conrad. My second question is the timing of 
imposing the tough choices that need to be made here on both 
the spending side of the equation, and the Commission proposed 
roughly $2.2 trillion of spending cuts, proposed nearly a 
trillion dollars of new revenue. The rest of the savings was 
savings of interest. In terms of when you pivot, that is a 
critical question. The Commission's conclusion was you ought 
not to take the really tough steps that need to be taken for 
the next several years. You need to begin. You need to adopt 
the plan. But the real tough medicine needs to wait until the 
economy is on stronger ground. What would your recommendation 
be to us?
    Mr. Bernanke. Mr. Chairman, I think the issue is 
credibility. If we can--it is not really sufficient to say, 
well, we are not doing anything now because of the recession 
but we will do something later, but we are not specifying what 
that is. I think if we could adopt a credible plan that is 
specific enough and credible enough to address the long-run 
situation, that would be the most positive thing that we could 
do, and in doing so, we could get really all the benefits 
without having to take actions that would endanger the very 
near-term recovery, which is still somewhat fragile.
    Chairman Conrad. Yes, that was very much the conclusion of 
the Commission. It is not enough to say, yes, we are going to 
do something in the sweet bye-and-bye. You have actually got to 
adopt a plan. You have to put it in place. You have to put it 
in place legislatively so people know, yes, we are going to cut 
spending. We are going to improve the revenue base. We are 
going to have savings of interest costs. And it has to be 
credibly scored. It has to be real. But you should not have the 
bite occur too soon or you endanger this fragile recovery.
    You made another set of comments that I thought was very 
important and that was the composition of the spending 
reductions, the composition of the revenue is also critically 
important to future economy growth. You are saying, look, you 
have to pay attention to human capital, education. You have to 
pay attention to infrastructure because that improves the 
economic competitive position of the United States. But when 
you are imposing these spending cuts, you have to go after 
things that are superfluous, and goodness knows as we look 
across Federal spending there are places we are not doing 
things that enhance economic growth. There are things that 
constitute waste, although the idea that just cutting waste, 
fraud, and abuse is going to solve this problem is--I wish it 
were the case, but it is necessary but not sufficient.
    On the revenue side, the Commission concluded one of the 
best things we could do is broaden the tax base, eliminating 
some of the tax expenditures, but simultaneously reducing rates 
to make America more competitive. Is that what you had in mind 
when you talked about paying attention to the composition of 
the changes that are made?
    Mr. Bernanke. Yes, Mr. Chairman. On the first point, the 
National Income Accounts do not really distinguish between 
government consumption and investment very sharply. I mean, 
there is a technical distinction. But we need to think about 
making investments for the future as opposed to simply spending 
on current needs, and so thinking about government programs, we 
should ask the question, will this provide benefits in the 
future, provide a more productive, competitive economy in the 
future.
    On the tax side, I do not think it is really very 
controversial among economists that rising rates combined with 
a multiplication of exemptions, deductions, credits, and so on 
leads to a tax code which is very complex and can distort 
economic decisions, and I think all of the major deficit 
reduction commissions have taken the opportunity to talk about 
the need to lower rates but to avoid--but to close loopholes so 
as not to lose revenue. So I think that is something, I hope, 
that the Congress will talk about. It is not at all 
inconsistent to both address the long-term deficit issues but 
also to think about making our tax code and our spending 
priorities more growth friendly.
    Chairman Conrad. I tell you, there is nobody that could 
have participated in this process that did not conclude this 
tax system that we have is just completely out of date. You 
know, it does not take account of the world that we live in 
today.
    The other conclusion of the Commission was that you have to 
have everything on the table. Spending, revenue, and every part 
of Federal spending has to be dealt with, and, you know, even 
defense. One of the most startling, I would say to my 
colleague, one of the most startling pieces of information that 
came to the Commission was 51 percent of the Federal workforce 
is at the Department of Defense. That does not count the 
contractors. When we asked the defense analysts who came before 
the Commission, how many contractors does the Department of 
Defense have, they told us they could not tell us, not because 
it was secret but because they did not know. And when we asked 
them, what was the range, they said between one and nine 
million. That is a pretty broad range.
    So we have issues throughout the Federal Government and we 
are going to have to address them. I very much appreciate the 
good advice that you have given us.
    Mr. Bernanke. Thank you.
    Chairman Conrad. Senator Sessions? By the way, we are going 
with eight-minute rounds, a little bit longer than usual 
because of the numbers who are here, and I have tried to 
respect that in my time and hope others will.
    Senator Sessions. Thank you, Mr. Chairman.
    First, Mr. Bernanke, let me pursue the question that 
revolves around your confidence about being able to prevent 
inflation. You note that you remain unwaveringly committed to 
price stability in your statement, and in particular, 
maintaining inflation at a level consistent with the Federal 
Reserve's mandate. In that regard, it bears emphasizing that 
the Federal Reserve has all the tools it needs to ensure that 
it will be smoothly and effectively exit from this program at 
the appropriate time.
    Well, forgive me if I am less confident you can know 
precisely when and how to exit and that you can do so smoothly. 
And I notice that the bond market and the common seems almost 
consensus view now around Wall Street and investors is that 
bonds are a bad investment, presumably because they expect a 
realistic reality of an increase in interest rates in the 
future as a result of quantitative easing deficits and the 
like. Can you assure us? It looks to me like, would you not 
agree, that investors are getting nervous already?
    Mr. Bernanke. Well, Senator, first, on your earlier comment 
about the 100 percent certainty, what I was talking about there 
was not that we would know exactly with certainty the right 
moment. What I was trying to convey was I thought I was certain 
that we have the tools we need. Now, it is always the case that 
when you are reversing monetary policy in a period of growth, 
that as a matter of judgment, you can be too early, too late, 
but that is true for normal monetary policy as well as for 
unusual monetary policy. So I am not trying to claim 
omniscience, and, of course, it is always possible that we will 
be either a little too slow or a little too quick, and we will 
do our very, very best to move at the right time.
    As far as inflation is concerned, though, I mean, again, 
the actual inflation rate is at essentially a post- war low and 
inflation expectations look very stable--
    Senator Sessions. What about--is there a difference between 
interest rates on the Federal debt and inflation?
    Mr. Bernanke. The interest rates on the Federal also are 
quite low, of course, and in the indexed bond market, the 
break-even inflation rates are about where you think they want 
to be if people expect that over the next five to ten years the 
Fed will keep inflation at about two percent, which is about 
where we think we ought to be aiming. We are going to pay very 
close attention to the inflation situation and we take that 
very, very seriously.
    Senator Sessions. But tell me, just trying to bring a 
little common sense and an honest question to you, it does seem 
that the bond market is nervous. It does seem to me that the 
quantitative easing plans continue and may continue again and 
that the deficits continue at an unsustainable rate. Why should 
people not be worried that eventually there could be a tipping 
point reached and a rather dramatic surge in our interest rates 
could occur?
    Mr. Bernanke. Well, on the monetary policy side, as I said, 
we are in a situation similar to where we always are, which is 
we need to find the right moment to begin tightening. You 
mentioned that the bond market is expecting short-term rates to 
rise in the future. That would, of course, be corresponding to 
the Fed tightening and reversing the easy money policies.
    In terms of the fiscal side, there, I absolutely agree with 
you. I think that if the Congress and the administration do not 
find a credible plan for controlling the long-term structural 
deficits, there could be very serious problems in financial 
markets and in inflation. That is the history of many, many 
situations in the past.
    So I do very much urge this committee to look for strong 
and credible actions to control the Federal debt. If that is 
done, then I do not think that inflation will be a long-term 
problem. What we are trying to do, I think, in the short term, 
is to create an appropriate balance between the risks of 
inflation and the risks of deflation, which are not yet gone.
    Senator Sessions. With regard to unemployment, I think you 
made clear in your statement, but it is important for us to 
understand, even though the rate dropped three-tenths, four-
tenths of a point to 9.4, the 103,000 jobs added is really sort 
of treading water about what you have to just maintain the 
current employment rate, is that not right, and that is not 
really a number that we can celebrate today?
    Mr. Bernanke. It is about what we expected, but as you say, 
it is not a number that is going to--if we continue at this 
pace, we are not going to see sustained declines in the 
unemployment rate.
    Senator Sessions. But the predictions were as much as 
275,000 jobs are being added.
    Mr. Bernanke. That was not--certainly not our prediction, 
and not most Wall Street predictions. There was a number that 
came out of--the so-called ADP number, which was very high--
    Senator Sessions. Yes.
    Mr. Bernanke. --but that is only loosely connected with the 
actual number.
    Senator Sessions. I think the American people are deeply 
concerned about where we are heading economically. Their jobs 
are at stake. I believe that that is a legitimate concern. To 
what extent do you have a plan and to what extent does the 
administration, the President have a plan that sees into the 
future and it says, we are going to do A, B, C, and D and those 
things will bring us out of this, and is it written? Can we see 
it?
    Mr. Bernanke. Senator, well, first of all, it was concern 
about the failure of unemployment to decline that motivated us 
back in August and September to adopt more monetary 
accommodation, and my view is that we have already had some 
benefits from that. We have seen some improvements in the 
outlook. We have seen some improvements in financial markets. 
So that is certainly part of what we are trying to do, is 
trying to keep this recovery going.
    In addition, of course, we are working very hard in our 
role as a regulator to try to improve the availability of 
credit to small businesses and to other borrowers. Senator 
Warner, I know, has been very interested in that issue. So we 
are working very hard and that is our top priority.
    Senator Sessions. Well, we have a change-over in the White 
House. Mr. Summers is gone. Ms. Romer is gone. Peter Orszag has 
left. Mr. Lew is there at OMB. We have a new Chief of Staff, I 
hear, today. But I do not sense anywhere in our government that 
we have the kind of clarity of leadership we had under Mr. 
Volcker when we had the crisis in the late 1970s and early 
1980s. One of the Fed members said we knew we were doing the 
right thing. They were protesting Mr. Volcker. Some called for 
his resignation. But we had a plan and we were staying with it.
    Can the American people have confidence that you and the 
administration are on the same page and we have a plan other 
than reacting every month or two to some new change in 
conditions?
    Mr. Bernanke. Well, Senator, the Federal Reserve is 
independent of the administration. I mean, we try to coordinate 
with the administration. We try to coordinate with Congress. 
But the Federal Reserve is independent. We make independent 
decisions.
    Senator Sessions. I know you are independent.
    Mr. Bernanke. So the administration's plan, Congress's 
plan, I mean, those are not our province. That is for the 
administration and Congress to decide.
    In our case, we do have a plan, and like--I have tremendous 
respect for Chairman Volcker, and one of the things that he 
did, as you say, was he did what he thought was right even 
though there was a lot of criticism, and I think that is what 
the importance of independent monetary policy is. At the 
Federal Reserve, we recognize that there are different views, 
but we are trying to do the best thing that we can for the 
American economy and that is the beauty of having an 
independent central bank.
    Senator Sessions. Thank you very much. Mr. Volcker, history 
records, I think, was correct in his plan. I hope history will 
record the same for your leadership.
    Chairman Conrad. Thanks, Senator Sessions.
    Let me just indicate that on our side, it is Senator Wyden, 
Senator Warner, Senator Manchin, Senator Stabenow, Senator 
Merkley. On the Republican side, it is Senator Enzi and Senator 
Cornyn.
    Senator Wyden.
    Senator Wyden. Thank you very much, Mr. Chairman.
    I, too, want to welcome Senator Sessions as our Ranking 
Minority Member. He is somebody I greatly enjoy working with 
and respect very much. I do want to note for the record that I 
do not believe the Auburn Tigers have a realistic chance of 
keeping up with the University of Oregon's fast-moving, 
innovative offense in the championship game, but we will save 
that for another discussion. I just want to welcome my good 
friend.
    Senator Sessions. Well, if you are correct in that, I will 
be pleased to wear that tie you have on for a few days perhaps.
    Senator Wyden. We have an agreement, and I will 
reciprocate.
    [Laughter.]
    Senator Wyden. Senator Conrad, thank you very much, and Mr. 
Chairman, we are so glad to have you here, and I especially 
because you and I share a similar view that the big idea for 
economic growth in our country is fundamental tax reform, where 
you go in there and clean out this job-killing, thoroughly 
discredited mess, and you addressed that, I thought, very well 
in the ``60 Minutes'' discussion that you had back in December.
    Here is my first question. It was clear at the end of the 
year that you had to take some steps with respect to the tax 
code in the short term so that people would not be clobbered at 
the beginning of the year, the middle-class folks and small 
businesses and others. But what I am concerned about is when 
you look at the overall structure of what was done in December, 
it has contributed once again to tax uncertainty, all of the 
two-year provisions, the one-year provisions, the phase-ins, 
the phase-outs. As you know, the tax code has tripled in just 
the number of words in the last decade and that has been fueled 
once again by what was done in December.
    I want to make sure, for the record, it is clear that when 
you are talking about long-term economic growth, you want a 
different tax model than what the Congress passed in December. 
You do not want to see more provisions added and more 
exemptions and deductions. You think, by and large, we ought to 
be draining the swamp, cleaning out a lot of the clutter to 
hold down some rates, keep progressivity and provide some 
certainty. You want a different model than what was passed in 
December for the long term, is that correct?
    Mr. Bernanke. Yes, Senator. What was passed in December was 
understandable, given the exigencies of time and so on. But I 
hope that the Congress will think hard about what long-run tax 
structure will be most beneficial, and lowering rates and 
closing loopholes is, I think, the best approach.
    Senator Wyden. The second question, there has been 
considerable discussion in the last few days, really the last 
week or so, about the idea of instead of the kind of tax reform 
you and I want, comprehensive reform, just going out and 
changing the corporate tax rate. I think that would be a big 
mistake, and the reason why is that most businesses in America, 
probably in the vicinity of 80 percent, pay taxes essentially 
as individuals, some Chapter S, sole proprietors, partnerships, 
the whole host of firms that are not, in effect, C 
Corporations.
    Is there not a real danger if you go in and just make 
changes on the corporate side to have further distortions, 
further complications, and end up with yet more uncertainty 
than you would have if you went in and made a comprehensive 
overhaul, recognizing the connections between the individual 
provisions in the code and the business provisions?
    Mr. Bernanke. Well, Senator, as you know better than me or 
anyone, there are many interactions between the two codes, 
including, for example, the double taxation of dividends and 
many other issues. So, yes, ideally, I hope that you would look 
at the tax system as a holistic single part of policy. I do not 
know what is feasible for politically and so on. That is really 
your call. But ideally, yes, of course, you would like to make 
sure that the entire Federal code is consistent and is 
supportive of efficient growth.
    Senator Wyden. I will keep you out of the politics, but 
colleagues, and we have several on the Finance Committee and 
Senator Sessions is very interested in it, the Chairman is 
making a very important point. There is today such a connection 
between the individual portions of the code and the corporate 
portions of the code, to just split one out as some have been 
discussing, I think, could once again create a whole set of 
additional distortions in the American economy and I appreciate 
what you are saying, Mr. Chairman.
    One other point with respect to tax reform that I think you 
have touched on in the past but would be important to have on 
the record. Today, it is very clear that people loathe the 
Internal Revenue System. I mean, it is just up there at the top 
of all of the Federal agencies and functions of the Federal 
Government people are furious about.
    It seems to me if you got to the point where you had a one-
page 1040 Form--Senator Gregg and I have that in our bill, as 
you know, Chairman Volcker has all but proposed that, it was in 
the Bush proposal, for Pete's sakes, years and years ago--would 
not having a one-page 1040 Form, where most people could 
complete taxes themselves rather than spending their whole 
spring on TurboTax and the like, would that not in and of 
itself be a public good in terms of simplicity and 
understanding and making people feel more confident that the 
American economy and the underpinnings of the American economy 
were sound?
    Mr. Bernanke. Well, as a general matter, simplicity, 
besides being less likely to be distortionary, has benefits of 
lower compliance costs, which are quite significant, and less 
need for the IRS or for accountants to adjudicate complex 
provisions in the code. So certainly simplicity is to be 
desired and I think it would make people more comfortable with 
the tax code because it would be less of a burden and because 
they would feel more comfortable that there were not all kinds 
of loopholes they did not understand that people were taking 
advantage of.
    Senator Wyden. One last question, again, not from a 
political standpoint, from an economic standpoint. One judgment 
I have made, looking back over the last quarter century on 
this, is that a mistake in 1986 was to not have some provisions 
to make it tougher to unravel fundamental tax reform when you 
got it. In other words, over the last 25 years after it was 
enacted, pretty much a few weeks later, the ink on the bill was 
dry and everybody just went back to business as usual. From an 
economic standpoint, how useful would it be when the tax code 
is overhauled this time, so there is more fairness for the 
middle class and take these steps to be globally competitive, 
how important from an economic standpoint is it to make it 
tougher to unravel it as soon as you get the reform?
    Mr. Bernanke. Well, Senator, as you say, there are 
political and probably constitutional issues involved in all 
that, but everything else being equal, greater clarity and 
certainty is obviously beneficial, and to the extent that you 
can create more certainty about where the tax code is going to 
be over a number of years, that would be helpful.
    Senator Wyden. Mr. Chairman, thank you, and I look forward 
to following up with you on these matters, and the fact that 
you have been outspoken on this has really given a boost to 
reformers and we are very appreciative. Thank you, Mr. 
Chairman.
    Chairman Conrad. Thank you.
    Senator Enzi.
    Senator Enzi. Thank you, Mr. Chairman.
    To follow up on what the Senator from Oregon said, our 
Nation's fiscal policy is in tatters. Our projected level of 
Federal spending growth is unsustainable. Our Tax Code is a 
mess. The only constant is that the Federal budget deficit is 
large and likely to remain that way.
    To what extent does the uncertainty that comes with these 
problems undermine economic growth?
    Mr. Bernanke. It is hard to make a quantitative judgment, 
Senator, but I am sure it is a negative. I do think that 
addressing our long-term structural budget deficits would not 
only reduce the risks we face in the future, but would probably 
have near-term benefits in terms of possibly of lower interest 
rates but also in terms of greater confidence and certainty. As 
you say, as it stands the one thing we know about our long-term 
tax and spending commitments is that they are not feasible, 
they cannot happen, they are not sustainable. So we do not know 
how things are going to change. So, yes, the more clarity we 
can achieve, the better we will be, the better off we will be.
    Senator Enzi. Thank you. I was a cosponsor of the Conrad-
Gregg deficit commission bill and was pleased that we got one, 
one way or another, and I think that that sheds some real light 
on what needs to be done by Congress. I am really concerned 
about the rapidly rising debt-to-GDP ratios and watching what 
is happening over in Europe. They have enacted some programs to 
rein in government spending. Some of them did not act quickly 
enough and had to be bailed out by their neighbors.
    During a hearing before the House Budget Committee in June, 
Representative Hensarling asked you whether the United States 
was nearing a similar point given our comparable debt-to-GDP 
ratio, and you responded that you do not know exactly how much 
breathing space we have. Rather than enact austerity cuts as 
the Europeans did, we have seen our gross national debt 
increase by $1 trillion since June. Can you give us any kind of 
an indication of how much breathing room we do have if we 
continue on this course before we reach that tipping point? 
Anything more exact since June?
    Mr. Bernanke. You know, I just think it is inherently 
impossible to pinpoint the exact date or the exact level of 
debt that would create a crisis or a sharp increase in interest 
rates.
    That being said, it would be the better part of valor to 
take action now to make sure that we do not get too close to 
that point. I do not know what the number is, but what I do 
know--and the CBO's projections show this very clearly-- is 
that absent any action, the debt-to-GDP ratio is going to be 
not only rising but rising at an increasing pace. It is going 
to be heading straight to heaven, basically, and that is 
certainly not going to happen--that certainly cannot occur.
    So I do not know at what point exactly, but that point will 
come if we do not take appropriate action.
    Senator Enzi. I also appreciate your meeting with some 
other groups. Senators Warner and Chambliss started a group to 
review these things, and I appreciated your comments about the 
difference between our debt-to-GDP ratio and the Japanese one 
where they have a lot of savings and we do not. There are just 
so many things that need to be taken into consideration with 
all of these things.
    I know that the Fed undertook quantitative easing because 
of a fear of deflation, yet other than housing prices, 
Americans are experiencing inflation in virtually every other 
major household outlay, particularly when it comes to groceries 
and gasoline. America's economy runs to a large degree on motor 
fuel. If as some analysts predict gasoline prices reach $4 a 
gallon this summer, will not this risk choking off the economic 
recovery?
    Mr. Bernanke. Well, first, just the facts are that 
inflation is 1 percent including food and fuel, so inflation 
overall, taking into account everything that people buy, is 
quite low.
    Now, it is true that people are very sensitive to the price 
of gasoline, and we are watching that very carefully. I do not 
think that quantitative easing of monetary policy is the main 
reason that oil prices are up in the past few months. The 
dollar, after all, has been quite stable, and oil prices are up 
in essentially all currencies. I think the main reason oil 
prices are up is the strength of emerging markets, the demand 
for energy from China and other fast-growing emerging-market 
economies.
    That being said, we are watching it very carefully because, 
as you point out, higher gas prices are like a tax on families; 
and if they get too high, then that will, in fact, be a 
negative for growth as well as for inflation. So we will pay 
very close attention to both energy prices and other commodity 
prices as well.
    Senator Enzi. There is discussion among policymakers about 
removing the Federal Reserve's dual mandate of a stable 
monetary policy and full employment. Some have suggested that 
it would make sense to remove your mandate for full employment 
so that you can focus only on monetary policy. Do you have an 
opinion about this matter?
    Mr. Bernanke. Senator, we are not seeking any change. We 
think the current mandate is workable. That being said, I think 
it is entirely appropriate for the Senate and for the Congress 
to consider what mandate they want to set. There are, after 
all, central banks around the world that do focus primarily on 
price stability, and whatever decision the Congress makes, of 
course, we will honor that decision and pursue that mandate.
    Senator Enzi. Thank you. I do not have any further 
questions.
    Chairman Conrad. Thank you so much, Senator Enzi.
    Senator Warner.
    Senator Warner. Thank you, Mr. Chairman, and thank you for 
holding this hearing this morning.
    Chairman Bernanke, let me first of all acknowledge what my 
colleague Senator Enzi has already said and thank you for being 
willing to meet with a growing bipartisan group of Senators. 
Senator Chambliss and I have been working, along with Senator 
Wyden and others, on saying we need to move forward on a real 
plan. And compliments to Senator Conrad and Senator Gregg and 
others. And while imperfect--and I particularly appreciate your 
comments in your testimony about the President's National 
Commission on Fiscal Responsibility and Reform that we ought to 
go ahead and take that work product of the last year and use 
that as a starting point, because I think as both you and 
Senator Sessions have said in your testimonies, simply talking 
about deficit reduction does not get us anyplace. We have to 
have a real plan to work against. And it is the intention of 
Senator Chambliss and me to take that work and put it into 
legislative language and introduce it. I think, again, a point 
that both Senator Conrad and Senator Wyden have made, is that 
if we are going to take on this issue, it is going to require 
dramatic cuts in Government spending, but it is also going to 
require meaningful tax reform. And I think, again, a lot of the 
early attention to the Commission's work focused on the deficit 
reduction piece. It did not focus as much on the tax reform 
piece, which both lower corporate rates and individual rates, 
and actually I would add on the individual side, lent more 
progressivity to the Tax Code. So I think it is a good working 
document, and I look forward to working with colleagues on both 
sides of the aisle to see if we can get as many cosponsors as 
possible to at least move forward on this discussion. And it is 
my hope that we could actually see a plan put forward this 
year, working off of the President's Commission, as I am sure 
it would be amended, and actually get it voted on. Because the 
way I hear you saying--now, you would never be as impolite as 
to use these terms, so let me use these terms. But you are 
basically saying to us, the Congress and the policymakers, we 
have to walk and chew gum at the same time, so that we have to 
continue to do short-term stimulus--you at the Fed have done 
that through your quantitative easing policies, and we in 
certain tax policies that were taken in December, both in terms 
of short-term stimulus, but that short-term stimulus then has 
to be morphed into long-term deficit reduction.
    Going back to some of Chairman Conrad's earlier questions, 
you know, what should we look at as the metrics or other 
indicators of when we should kind of ease off on the stimulus 
and ramp up the deficit reduction piece? Should that be based 
on a timeline? I think the President's Commission, Chairman 
Conrad, you had a lot of your actions starting to click in 
about 2012, 2013, 2014. Should it be on a kind of date line 
process? Should it be based on when growth hits at a certain 
level, unemployment falls to a certain level? What should be 
the indicators, even if we get a plan in place, that would 
trigger the kind of hard choices around deficit reduction that 
we are looking at?
    Mr. Bernanke. Senator, first let me say that I enjoyed 
meeting with your group, you and Senator Chambliss, and I 
commend you for the extra work you are doing on this issue.
    I think there is an important trade-off. We need to--we, 
the American people, the Congress needs to demonstrate a 
credible commitment to solving the long-term fiscal problems. 
The stronger and more credible the plan that is put forward, 
the less need there will be to take sharp short-term cuts in 
order to show your seriousness. So a strong long-term plan that 
kicks in over a period of time will make it less necessary to 
take actions in the short term that would be counterproductive 
from the point of view of the recovery. So that is why it is so 
important to develop a strong plan.
    So that is the trade-off: The stronger the plan, the less 
near-term downpayment you have to make.
    Senator Warner. And, Mr. Chairman, could I just interrupt 
for one second? Based upon your testimony today by referencing 
the National Commission on Fiscal Responsibility and Reform, by 
referencing that effort, is that an endorsement that that would 
be viewed in your mind as a strong plan?
    Mr. Bernanke. Yes. For example, it has the feature that I 
believe that by 2015 there is a stabilization of the debt-to-
GDP ratio which requires, I think, about a two- to three-
percentage-point-of-GDP cut in the deficit starting in a couple 
of years through the rest of the decade.
    In terms of criteria, I think there is no magic number, but 
what we need to see is a sense of momentum, a sense that there 
is enough forward movement and strength in the recovery that we 
can feel confident that it will continue and will not be 
knocked off course by too precipitate fiscal retrenchment.
    Senator Warner. I know you do not want to give me a set 
indicator, but should those indicators be time, growth rate, 
unemployment rates, a combination of all of those? What should 
be our markers if we pass this plan--whether the Commission's 
plan or a like kind serious plan, there has to be some markers 
when we shift course from stimulative activities to serious 
deficit reduction and cost--
    Mr. Bernanke. Well, all of those factors matter, but I 
think a sustained growth rate above sort of the long-term 
average would be an indication that the recovery is proceeding 
and has some momentum. But, again, the stronger, more credible 
the forward-looking plan, the less need there will be to make 
sharp short-term adjustments that might risk the recovery.
    Senator Warner. Let me in my last moment follow up on 
Senator Enzi's comments, and I think he was looking for a 
percentage on when the markets will say ``no mas'' in terms of 
our debt-to-GDP ratio. I guess my feeling is it is not a 
question of if we are going to do deficit reduction. It is 
going to happen. It is really only a question of when, and 
whether we are going to do this on our timetable in a way that 
is not disruptive to the economy or whether it is going to be 
dictated by the markets in terms of their lack of faith in our 
ability to service our debt over the long term.
    And so what I guess I would ask you--and I know my time has 
expired, Mr. Chairman, and this will be my last question. You 
know, we cannot predict that to a specific percentage or date 
certain. But what would be or what could be some of the warning 
signs that we are getting close to that precipice? Could it not 
be some external international, God forbid, terrorist incident 
that might put a shock wave across the economy? Could it not be 
another economy in Europe getting close to a failing point, an 
economy that would be larger than, say, Ireland or Greece? What 
are some of those warning signals? And would you also say that 
if we start going down this precipice it could happen very 
quickly once we get to that unforeseen point?
    Mr. Bernanke. So in terms of market signals, I think I 
would look at things like Government financing, interest rates, 
long-term bond yields, the dollar, indicators of confidence in 
the United States.
    I think it is important to understand, if I may, that 
nobody doubts that the United States has the economic capacity 
to pay its bills. It is really a question of do we have the 
political will to do that, and demonstration of the political 
will, that is what the markets are watching. Are the Congress 
and the public and the administration able to demonstrate that 
they are serious and that they have enough willingness to work 
together to make progress? At the point where confidence is 
lost in that, you could see a relatively quick deterioration in 
financial positions, as we saw in some cases in Europe, where 
things change very quickly based on just the change in 
sentiment about the prospects for those economies.
    Senator Warner. Thank you, Mr. Chairman. I look forward to 
working with you and Senator Sessions and all our colleagues on 
making sure we do not get to that point.
    Chairman Conrad. Yes, we appreciate the effort that you 
have mounted, along with Senator Chambliss, our colleague.
    I just for the record want to point out that the Commission 
proposal stabilized the debt by 2014 and then starts bringing 
it down on a sure path after that.
    Senator Manchin.
    Senator Manchin. Thank you, Mr. Chairman.
    Chairman Bernanke, first of all, from the perspective of my 
home State of West Virginia, I am concerned about the finances 
of our State and all the States, being a former member of the 
NGA. What I would like to know is from your opinion as based on 
the future pension liabilities of both corporate and State 
governments, the recent reports of the financial crisis that 
many of our States are facing in the very near term future, 
have you all looked carefully at the possibility of a default 
on general obligation and municipal bonds by State and local 
governments and the budget strains that would present to the 
overall U.S. economy? We are concerned about that the stimulus 
runs out June of this year. What happens if there is no more 
stimulus to come or Federal bailout, if you will, and they have 
to work on a balanced budget amendment and they cannot meet 
these long-term obligations? Have you all looked into that or 
been spending any time on it?
    Mr. Bernanke. To some extent, Senator, yes. No question 
State and local governments are under a lot of pressure. They 
have been cutting spending and employment over the last couple 
years. The Federal assistance will continue in 2011, but after 
2011, it is going to be pretty much zeroed out, I think. And 
so, on the one hand, the States are seeing some improvement in 
tax revenues as there has been some growth; but on the other 
hand, they could be losing some of the Federal assistance. So 
the pressures on State budgets and local municipal budgets are 
going to continue for a while, and that is going to be a head 
wind for the overall economy as well as for the individual 
States.
    It is also true--this is more a long-run issue--that like 
the Federal Government, the State and local governments have 
some long-term fiscal issues relating primarily both to 
pensions of State employees but also to health care promises, 
which in most cases are almost entirely unfunded. So those are 
long-term obligations that could be collectively as much as $2 
trillion for all the States together in the long run. Now, 
those, of course, are long-run obligations and do not come in 
the near term. So there are some very serious long-term fiscal 
pressures.
    Now, in terms of the municipal bond market, it currently 
seems to be functioning reasonably well. Liquidity is fine. 
Issuance has actually been very high, including issuance for 
capital projects, so we are not seeing extraordinary stress in 
the municipal markets, which suggests that investors still are 
reasonably confident that there will not be any defaults among 
major borrowers. And one reason they might believe that is 
because most States have rules which put debt repayment and 
interest payments at a very high priority, above many other 
obligations of the State and localities.
    So, bottom line, the municipal markets, bond markets, seem 
to be doing okay, but clearly there is a lot of both near-term 
and longer-term pressure on these governments, and it is going 
to be something that is not going to be going away in the near 
term.
    Senator Manchin. Another question I have is that, you know, 
in West Virginia, when families have problems, whether they be 
families or single parents, they cannot really respond and kind 
of understand what we do here in Washington or what Government 
does. They do not sit down and think how much more money can 
they spend or how much can they borrow to get themselves out of 
trouble. They start looking at cutting expenses.
    What expenses could the Federal Government cut that would 
have the longest--or have the most effect on long-term 
stability in your recommendation? What should we be cutting?
    Mr. Bernanke. Well, Senator, I should just say first, very 
strongly that these tough decisions about taxes versus spending 
and the mix of spending and so on are your decisions and not 
mine, and I do not want to inject myself too much. But I will 
say one thing which is just obvious from the arithmetic, which 
is that going forward the costs of health-related programs--
Medicare and Medicaid--are rising prospectively very quickly, 
and on current trends, you know, would be at some point, 
between Medicare and Medicaid and Social Security, would 
essentially be what is now the entire budget of the United 
States.
    So I do think that an important priority for us as a 
country and for the Congress from a fiscal point of view is to 
think about what we can do to achieve better cost efficiency in 
the health care area at the same time that we do what we can to 
maintain quality and access. So that is clearly an area we need 
to look at.
    That being said, of course, we have military spending, 
other discretionary spending. We have the Tax Code. There are 
many other things that you will certainly want to look at.
    Senator Manchin. And I know that there have been some 
Members of Congress who have long advocated for a Federal audit 
on the Federal Reserve System. Would you oppose an independent 
audit of the Federal Reserve System?
    Mr. Bernanke. The Dodd-Frank Act included an amendment, 
sponsored by Senator Sanders and others, that includes an 
exhaustive audit of all the financial aspects of the Federal 
Reserve. In fact, on December 1st, we released all the 
information about our--all the lending programs, financial 
programs, credit programs that we undertook during the crisis. 
So as far as our finances are concerned, we are an open book, 
and if there is any area where you or your colleagues are 
dissatisfied with the information, I would be happy to work 
with you to make sure you get what you need. So in terms of all 
aspects of our finances and operations, I think it is 
reasonable for Congress to want to have that information.
    The one area where I have been concerned--and this goes 
back to my earlier comment to Senator Sessions--is that 
monetary policy independence is very important for the 
stability of our economy and our financial markets, and where 
``Fed audit'' is really a code for congressional intervention 
in monetary policy decisions, that is where I would be much 
less comfortable.
    Senator Manchin. And, finally, is the Federal Reserve 
considering any policy changes that would negatively impact the 
financial viability of local community banks around the 
country?
    Mr. Bernanke. To the contrary, we have a strong commitment 
to community banks, and we have, in fact, recently increased 
our schedule of direct meetings with the Board with 
representatives of community banks. There is obviously a lot of 
work to be done to implement Dodd-Frank and Basel III and other 
changes in financial regulation. It is our objective--I think 
the intent of both Basel III and the Dodd-Frank Act is to focus 
on the largest so-called too-big-to-fail banks and to make them 
not too big to fail. That is where our focus is as well, and we 
want to make sure that we do what we can not to increase the 
regulatory burden that small banks face. And small banks have 
been playing just an incredibly important role. Particularly as 
large banks have cut back on their lending to small businesses 
in other contexts, they have in many cases stepped up and 
proven their worth to the U.S. economy.
    Senator Manchin. Thank you, sir.
    Chairman Conrad. Thank you, Senator.
    Senator Stabenow.
    Senator Stabenow. Well, thank you, Mr. Chairman, and 
welcome, Mr. Chairman.
    Mr. Chairman, thank you for your thoughtfulness, and I 
think what you laid out to us both in terms of where we have 
come from, what we have done, and where we need to go I think 
is very, very important.
    I feel as a member of this Committee now for many, many 
years, though, that I have a need to make sure that we do not 
have revisionist history whenever we are talking about how we 
got here. I think it is really important if we are not going to 
repeat mistakes that have been made before that got us here. I 
think it is important to just say once again for the record 
that when I had the opportunity to come in and serve with you, 
Mr. Chairman, Committee members in 2001, we had the biggest 
surpluses in the history of the country. And so we have not 
always been in this situation, and there were a number of 
decisions made on spending, frankly, without accountability 
that haveten us where we are. And I would argue that, 
unfortunately, the spending in the 8 years in the previous 
administration was not focused on those things that create 
innovation to create jobs, to compete in a global economy or 
focus on opportunity or security for middle-class families. 
Instead it was very much focused on the benefit to a privileged 
few. And at the time, in the last administration, we were told 
deficits did not matter when we were focusing on things that 
would benefit the privileged few. Now, after two very, very 
tough years--very tough years, very slow years--we are turning 
it around. We have not gotten things back on track. People in 
Michigan are still hurting, although it is better, but we have 
a long way to go.
    My concern is that we are now hearing with the new majority 
in the House that, again, deficits only matter when it is 
things that affect middle-class families in terms of 
opportunity, education, innovation; but that when it comes to 
the policies that got us in this mess, focusing on tax cuts for 
the privileged few, supply-side economics, hoping it will 
trickle down, that that does not count. And so we saw this week 
over $1 trillion exempted from the budget rules that will add 
over $1 trillion in debt if we go forward with that, based on a 
way of looking at the economy that frankly did not work and 
then it got us in the last decade, in my judgment, into the 
hole that we are in.
    So, Mr. Chairman, I want to ask you about how we get out of 
this hole, both short term and long term, and I agree we need a 
credible plan, and I very strongly share your view that we have 
to be very careful in the short run. It is a very fragile 
situation. And I do not, frankly, see how we get out of this 
with over 15 million people out of work. I do not know how--how 
do we get out of deficit if we do not first focus on jobs?
    One of the things that I am proudest of is the fact that we 
did not give up on American manufacturing 2 years ago. We did 
not give up on the American automobile industry, and this year, 
for the first time since 1999 all three companies are making a 
profit. They are actually bringing jobs back to this country. 
And because of our investments in innovation, we are going to 
go from 2 percent of the world's battery manufacturing, 
advanced batteries, to 40 percent in the next 4 years.
    But my question, Mr. Chairman, relates to the immediate 
situation for families that are not yet feeling this recovery 
and the fact that we have tens of millions of people who are 
out of work. And, frankly, when we talk about 2008 budget 
numbers, I would like to go back to 2008 jobs numbers and focus 
on that to get us out of deficit. But how would you focus on 
job creation in the short run, knowing that we have serious 
long-term issues that have to be addressed on the deficit? But 
at the same time, I guess I would like your reaction to the 
notion that we will not get out of debt if we have over 15 
million Americans out of work.
    Mr. Bernanke. Senator, you are absolutely right that a 
large part of the deficit we currently have is what economists 
call a ``cyclical deficit.'' It arises because unemployment is 
well above a normal level, and what we need to address is the 
structural component, the part that remains once the economy is 
back to a more normal level.
    Again, I think that we need to think of fiscal policy as a 
piece; that is, we cannot think about short run and long run 
separately. You have to think about them together. And the more 
credible and effective our plans are for addressing the long-
term structural issues, structural deficits, the more scope we 
will have and more flexibility we will have to allow continued 
support for the recovery now that we continue to need as the 
economy remains in a very still weak and fragile condition.
    So my advice, for what it is worth, is, again, not to focus 
only on the short term but think also about the long term, that 
you need to combine those two things. You mentioned things like 
innovation. Again, as I talked about in my testimony, the 
composition and structure of Government spending and the Tax 
Code and so on is also very important. Are we doing enough for 
innovation? We spend quite a bit of money on that, but is it 
well directed? Is it sufficient to keep our leadership position 
going forward?
    So those would be the themes I would note. Long-term 
structural deficits need to be addressed, and in doing so it 
would help the short term, would give us more flexibility in 
the short term. And we need to think hard about what we are 
doing to promote longer-term growth, longer-term innovation, 
longer-term human capital, training, education, and so on that 
makes people able to get better jobs and sustain higher 
incomes.
    So it is a tough set of problems, and they are very much 
interconnected.
    Senator Stabenow. Well, I very much appreciate your 
comments and share your feeling that it is about balance; it is 
putting in place the long-term plan; but also understanding 
that in a global economy--we are in transition now as a 
country--that it is very, very important that we be investing 
in those things, opportunity, education, innovation, that allow 
us to move forward in terms of growing the economy quickly.
    Before my time runs out, just one quick question to follow 
up on small businesses. We passed the small business jobs bill. 
We talked about the importance of supporting community banks. I 
would just ask you--on the one hand, we are saying to banks, 
``Lend more.'' Regulators are saying, ``Don't lend,'' 
essentially, or ``Tighten up things.'' It is critical, I think, 
that the Fed and other regulators help banks, community banks, 
take full advantage of the lending initiatives that we placed 
in the small business jobs bill. And I am wondering what 
actions the Federal Reserve is doing or can do to help small 
business.
    Mr. Bernanke. Senator, as it happens, I am going to be on a 
panel sponsored by the FDIC, I think it is next week, with 
Sheila Bair and with Senator Warner. We will be talking about 
small business credit and talking about all the initiatives and 
things that the Congress has done, the Federal Reserve has 
done, and the other banking agencies have done.
    But just very briefly, we are very attuned to the need to 
have an appropriate balance. On the one hand, we do not want 
banks making bad loans. That is how we got in trouble in the 
first place. But on the other hand, creditworthy borrowers need 
to have access to credit so that they can hire and they can 
expand and help the economy recover. And so we have been 
working very hard with the banks and with our examiners to try 
to get a balanced approach and I think it is beginning to pay 
off. There is some improvement, in my view, in the availability 
of credit and I expect to see more lending this year. So there 
is--the terms and standards have begun to ease a bit. So I 
think there is some progress on that side.
    We have also, and I will not take too much of your time, 
but we have also undertaken a series of meetings around the 
country, more than 40 meetings, where we have met with small 
businesses, lenders, examiners, local officials, trade 
associations, and the like, and tried to identify technical 
problems and other issues that have blocked access to credit 
and we have found some very useful things and we are working--
we are moving forward on the things we learned.
    Senator Stabenow. Thank you. Thank you, Mr. Chairman.
    Chairman Conrad. Thank you very much, Senator Stabenow.
    Senator Cornyn is recognized for 30 seconds. No, that is 
not--
    Senator Cornyn. Mr. Chairman, I cannot clear my throat in 
30 seconds.
    [Laughter.]
    Chairman Conrad. Seriously, we are doing eight-minute 
rounds.
    Senator Cornyn. Mr. Chairman, thank you very much for your 
service in what is, by all accounts, a very challenging job. 
But, of course, we are all volunteers here and no one is 
holding a gun to our head and making us do these jobs. We 
volunteer to do them because we think we can contribute to 
doing things that are in the best interest of the country and 
appreciate very much your service in admittedly a very 
challenging job.
    It strikes me that there are three events coming up which 
will really provide an opportunity for Congress and the 
administration to demonstrate its seriousness at dealing with 
the runaway spending and the unsustainable debt problem that we 
have. One is the President's budget is going to be due the 
first Monday in February. That will be, I think, one of the 
first indications, perhaps, of the President's response to the 
report of the Fiscal Commission, and I want to congratulate all 
of our colleagues who participated in that on a bipartisan 
basis who I think demonstrated great courage in voting for a 
plan, albeit one that we all can find some differences with. 
But again, the time for talk is running out and now it is time 
for action.
    So it strikes me as the first event that will provide the 
President an opportunity to respond to that in a meaningful 
way, to set out his budget for the next fiscal year, will be 
the first Monday in February, or I hear it may slip by a week 
or so.
    The second, it strikes me, is the debt ceiling vote that is 
going to be coming up, and there has been a lot of talk and 
speculation about what might happen, whether there will be some 
additional conditions that would be imposed on voting to extend 
the debt ceiling, which is obviously a very sensitive and 
important issue.
    And then it strikes me that the third sort of watershed 
that is coming up here that will demonstrate our collective 
seriousness of dealing with this, particularly from a fiscal 
policy standpoint, will be the expiration of the Continuing 
Resolution.
    But I want to ask you specifically about something that 
Senator Manchin alluded to briefly in terms of not just the 
Federal Government's problems dealing with its debt, but the 
States and municipalities. Meredith Whitney, an analyst who 
correctly foresaw the mortgage crisis in 2008, now predicts 
that 50 to 100 sizeable U.S. cities could default in 2011. She 
said this could cause hundreds of billions of dollars of 
municipal bond defaults and warns that, next to housing, this 
is the single most important issue in the United States and 
certainly the biggest threat to the U.S. economy. And I would 
note, obviously, many States are in deep fiscal trouble, also, 
and there is the potential--at least the potential, maybe not 
the probability at least imminently, but at least the 
potential--that we could see some defaults at the State level.
    I heard what you said about the municipal bond market not 
showing any imminent signs of crisis, but do you agree that 
this is a very serious issue that needs to be confronted?
    Mr. Bernanke. Well, I do not have a--I am sorry, Senator. I 
do not have a forecast about default risk. I think that sounds 
like a somewhat pessimistic view, but something we need to pay 
close attention to. Clearly, a lot of cities are under--
certainly, no one can question they are under a lot of 
financial stress and it is something we need to pay attention 
to because it would have some spillover effects into other 
markets. But we do not at this point see anything of that 
magnitude happening.
    That being said, I think cities and localities will need to 
take strong measures to avoid default. Default is only, at 
best, a short-term solution for local governments because what 
they find is that it will be very difficult to get back into 
the market, or if they do, they will have to pay a higher 
interest rate, so it would obviously be very much in their 
interest to take the difficult measures to avoid default.
    So I, again, as I said earlier, while there is no question 
that there is a lot of stress at State and local governments, 
at this point, the municipal market seems to be operating 
fairly normally, but we will watch that very carefully.
    Senator Cornyn. That is fair enough. Let me sort of drill 
down a little bit, because this is a point I want to get to, in 
particular. In 2002, you gave a speech before the National 
Economists Club in Washington and you said, quote, and I think 
this is a fair quote, tell me if it is not, quote, ``The Fed 
has the authority to buy foreign government debt as well as 
domestic government debt.'' And we know that under the QE2 plan 
that you are implementing at the Fed, you are buying U.S. 
Government bonds, but would that extend to State and local 
debt, that authority?
    Mr. Bernanke. Only in a very, very limited way. So first of 
all, we have no intention to buy foreign debt. That is really a 
provision to allow us to hold foreign exchange reserves, and we 
are not planning any policy in that direction.
    Senator Cornyn. My interest, obviously, is really on the 
State--
    Mr. Bernanke. On the State and local, we have very limited 
authority there. We do have the authority to buy very short-
term municipal debt that is within certain categories. So we 
have very limited ability to buy State, local, municipal debt. 
And moreover, the Dodd-Frank legislation restricts our ability 
additionally not to lend to any insolvent borrower and not to 
lend to an individual borrower, but only in terms of a broad 
program. So we have no expectation or intention to get involved 
in State and local finance. I think to the extent that there is 
anyone to look at that, it would have to be Congress to look at 
that.
    Senator Cornyn. Well, I do not have to tell you how a 
request for a bailout or for a State or municipality would be 
received here in Washington. So let me ask you, under Chapter 9 
of the Bankruptcy Code, a municipality could go through a 
bankruptcy proceeding. But right now, there is no provision in 
the Bankruptcy Code, as I understand, for a State to go through 
a bankruptcy-like proceeding, a Chapter 11 where, of course, 
the secured creditors, the bondholders and others would 
maintain the highest priority, but there would be a procedure 
by which the State could ultimately wind its way out of this 
crisis situation and get back onto a more sound fiscal basis.
    There has been some suggestion among commentators and 
others that Congress ought to look at a procedure that would 
allow that to happen as one alternative. Would you think that 
that would be a wise or a good thing for Congress to do?
    Mr. Bernanke. I think it would be useful for Congress to 
look at the situation broadly and try to identify what 
potential problems that might be there and what lacunae there 
might be in the bankruptcy law, et cetera. I think it would be 
extraordinarily unusual for a State to default. It has not 
really happened seriously for 160 years or so and I think we 
ought to focus on States meeting their obligations, which they 
do have the tools to do. And again, as I mentioned before, in 
most States, the debt and interest payments are the top 
priority and they would come in front of provision of services 
and so on. So I think we should understand the situation, but I 
am very, very hopeful and expect that we will be able to avoid 
defaults at that level.
    Senator Cornyn. And I share that hope, but if I may 
conclude on this question, what would be the consequence of a 
large State like California or Illinois defaulting on its debt?
    Mr. Bernanke. It is--
    Senator Cornyn. In terms of the national economy.
    Mr. Bernanke. Well, it is difficult to know, frankly, 
because it has not happened for a long time. It would certainly 
be a--it would certainly create a lot of stress and volatility 
in the markets. There is no question about that. It also would 
mean that the State, when it came back into the market, would 
probably have to pay a much higher interest rate for a 
considerable period and therefore it would be, I think, very 
much a last resort for any State to do that.
    Senator Cornyn. Thank you very much. Thank you, Mr. 
Chairman.
    Chairman Conrad. I thank the Senator. I thank the Senator 
for asking the question, because I think this is something we 
need to be paying close attention to. The Senator has raised 
the question of a series of municipalities that may be under 
significant stress. We have also been told that there are a 
number of States, I have been told as many as 20. Governor 
Manchin, maybe you have more recent information--
    Senator Manchin. I just cycled out of being Chair of the 
NGA and we were very much concerned about this, watching the 
fiscal viability of every one of the States, and everything is 
back to 2008 levels, is what we were based off, and that is 
what you all based off in Congress when you set up the help 
that was given as far as the aid to the States. That all goes 
away by June 30. Most of our fiscal budgets are done June 30, 
2011.
    Chairman Conrad. And do you have a rough idea of how many 
States are--
    Senator Manchin. I think upwards more of in the high 20s, 
low 30s, that could be in serious problems. We are concerned. 
We are very much concerned.
    Chairman Conrad. We have an analysis, by the way, underway 
on this question. This may be one of the things we would like 
to talk to you about if you have an opportunity to come up and 
meet with us in a session with all Senators. We do have an 
effort underway based on the conversation I had with Governor 
Manchin earlier.
    Senator Manchin. If I could ask one question, Mr. Chairman, 
and to Mr. Bernanke, is I think what we were asking, and the 
Senator from Texas was asking the same, is there any plan--I 
know it has not happened for many, many years and maybe--but we 
are seeing indications and concerns that we have right now, and 
States have done everything humanly possible because they have 
to meet a balanced budget every year and they have cut to the 
bone, if you will, and if the cash flow is just not there to 
suffice with the amount of services they have to give, is there 
any bailout or any other proposal that you all have or have 
been looking at? I think that is what we are saying. Is there 
any plan available that could help a State, that would prevent 
this from happening, from falling into default, or could you do 
that?
    Mr. Bernanke. I do not think the Federal Reserve has the 
authority and I do not think it would be appropriate for us to 
do that. This is something that would take place over a period 
of time. It would not happen in a day or two and there would be 
plenty of time, I think, for Congress and for the State 
legislature to look at alternative solutions. So I think this 
is really a political fiscal issue. We will watch it very 
carefully because it has implications for the economy and for 
financial markets, but I do not think the Fed really has much 
that we can do about it.
    Senator Manchin. Mr. Chairman, I would recommend that maybe 
as a committee what we should do is check with the NGA. They 
will give you a complete status of what they see in real 
crisis.
    Chairman Conrad. I think we had better think about how we 
get input on this. The more we look, and Senator Cornyn has 
brought to our attention here what we had heard earlier as a 
result of the information you shared with us, this is something 
that is out there on the horizon that we need to pay very close 
attention to.
    Senator Merkley, we apologize to you because we interceded 
on your time. We will give you an additional minute and you are 
recognized.
    Senator Merkley. Thank you very much, Mr. Chair, and I will 
use a few seconds of that to say that, Senator Sessions, I am 
happy to hear that you are willing to wear Senator Wyden's tie 
if Oregon wins. I have a pin right here that maybe you would be 
willing to wear this pin after Oregon wins for a couple of 
days.
    Senator Sessions. I would be glad to, although I am not 
going to lose any sleep over that prospect.
    [Laughter.]
    Senator Merkley. Will you be out there on Saturday?
    Senator Sessions. Having an Auburn team going to Tuscaloosa 
and come out victorious, I am a little confident. But actually, 
it is exciting. It is so much fun and people are so excited. I 
am sure they are in Oregon. It is just one of the great things 
about America, that people can pick out something other than 
politics--
    Senator Merkley. Absolutely.
    Senator Sessions. --and have some fun with.
    Senator Merkley. A little bit of an antidote.
    Well, let me turn to the business at hand, and thank you 
very much for your testimony, Mr. Chairman. I wanted to start 
by asking a little bit around the QE2 policy. As I understand 
it, you could summarize it by saying that in buying these 
bonds, you are injecting more money into the economy. Doing so 
reduces the interest that would be borne on those bonds, which 
encourages people to maybe hold less of those bonds and invest 
more in either corporate bonds or perhaps stocks, if there was 
a substitution effect, to invest in American business. So that 
is kind of one category.
    Another category would be that in doing this, one also 
creates more pressure in terms of those economies such as 
China's which are using a pegged exchange rate with the United 
States to try to reduce the impact of China's currency 
manipulation on our ability to sell our products abroad.
    Do you see both of those as key components of this policy, 
or is one more important than the other, or could you just help 
us get our hands around those two pieces?
    Mr. Bernanke. Senator, first, I want to say the Federal 
Reserve is neutral on the Auburn-Oregon issue.
    [Laughter.]
    Senator Merkley. I am disappointed to hear that, because 
there are two Senators from Oregon here and only one from 
Alabama, so--
    [Laughter.]
    Mr. Bernanke. Senator, your first part of your description, 
I think, was very accurate. I mean, we are trying to ease 
financial conditions to stimulate more economic activity. You 
know, de facto, this policy has been in effect really since 
August, because we, in August, we began to reinvest our 
securities and I began to talk about this in public and the 
markets began to anticipate these actions. And we have seen 
since August significant improvements in stock prices, in 
spreads and volatility, in a variety of areas, and I think we 
are having some positive benefits on financial conditions and 
are contributing to a better outlook for the economy.
    It is not our intention to do anything in particular on the 
international front. Our objectives are focused entirely on the 
U.S. economy, which is what our mandate tells us to do. It is 
true that to the extent that China or other countries 
undervalue their exchange rate or maintain a fixed exchange 
rate, that they import U.S. monetary policy. U.S. monetary 
policy, in my view, which is quite accommodative, is 
appropriate for the United States. It is not particularly 
appropriate for China, given how quickly they are growing. In 
fact, they are dealing with some inflation issues now. So, in 
fact, it is forcing them to take some actions. Letting their 
exchange rate appreciate somewhat would be helpful for them in 
this context because it would reduce the inflation pressures 
that they are otherwise going to experience. But that is not 
the key objective of the policy. The policy's objective is to 
try to meet our price stability and employment goals.
    Senator Merkley. No, I understand that, but the employment 
goals also are impacted by the ability of us to sell our 
products overseas, so there is kind of a complete picture that 
comes to play in that.
    And in that regard, let me turn then to manufacturing, 
because one of the challenges certainly for American products, 
making them here and selling them abroad, is the difference in 
labor rates. But there has also been the argument that in our 
trade agreements, we sometimes end up in a situation where 
foreign producers seem to have full access to the American 
economy while, both through currency manipulation and through 
non-tariff barriers, American products do not seem to be able 
to get into the foreign markets as easily, and that that 
differential has undermined manufacturing in America.
    There has also been a related conversation that I just 
wanted to lay it out because I see it starting to appear here 
and there, and that is that one of the reasons we seem to be 
coming out on the short end of these trade agreements is 
because we also go into these negotiations with other goals 
that are not necessarily economic goals, that is, goals related 
to access, military access, finding a key ally to say, as we 
did within the markets in China when we were involved in the 
wrestling with the Soviet Union, that we take non-economic 
goals into these agreements.
    So I thought I would just see if you would like to comment 
a little bit on these challenges in terms of our ability to 
maintain a manufacturing base and some of the interrelated 
issues regarding trade negotiations.
    Mr. Bernanke. Senator, of course, we remain an important 
manufacturing power. I think we still have the largest 
manufacturing sector in the world. Employment has been 
declining very sharply because of productivity gains. But you 
are also correct, I think, that trade and currency issues are 
an important factor.
    On the currency side, I have been very clear that I believe 
that the policy of China and other emerging markets to 
undervalue their currencies is counterproductive both for those 
countries and also for international imbalances and for global 
trade flows and I hope that we can continue to work with China 
and those other countries to create a more flexible exchange 
rate regime. I think that is very important.
    I am not deeply conversant with the details of trade 
negotiations. I think every country has multiple objectives 
when they engage in these negotiations, but I hope that we will 
be aggressive in pursuing WTO remedies, et cetera, as needed to 
eliminate trade barriers, both tariff and non- tariff barriers, 
and I am very supportive, like most economists, of free trade 
agreements which work both ways, that allow both exports as 
well as imports to flow freely.
    Senator Merkley. Thank you. Let me turn to another issue, 
which is the ongoing impact of the high level of foreclosures 
on housing prices in America. We have had an ongoing rate, and 
I think it is projected through the balance of this year, of 
about 300,000 foreclosure filings a month. Not all of those 
will result in foreclosures, but many will. We still seem to be 
driving down the value of homes, which results in more families 
underwater, more families that are in a situation they 
certainly cannot borrow against the value of their house since 
the house is worth less than they owe.
    How does this--and I will just note that our effort to 
intervene, which was highly debated two years ago when I first 
came here to the Senate, a decision to invest $50 to $100 
billion to assist Oregon--not Oregon, but Oregon and the United 
States homeowners--as a result of an expenditure over these two 
years of less than a billion dollars--I think last I checked it 
was about $500 million. So our intervention has been modest, at 
most. This remains both a huge factor affecting the quality of 
life for families and their ability to look positively on the 
future. How does this play into our monetary policy or 
interrelate in ways that we should understand better?
    Mr. Bernanke. Well, you said it very well. Foreclosures 
continue to be very high. There have been sincere government 
efforts to try to address the problem, but they run into lots 
of bureaucratic and other difficulties, as well as the fact 
that in a weak economy with lots of unemployment, there are a 
lot of folks for whom there really is no solution or good 
alternative, given that income has been lost through job loss.
    This is an important consequence--has important 
consequences for the macro situation, as I alluded to in my 
testimony. The high levels of vacancies, homes that are not 
only empty but are, in fact, reducing the value of the 
neighboring homes around them are driving down prices, which is 
affecting household wealth, which is affecting consumer 
spending and confidence. It is affecting the whole residential 
industry. Construction is very, very weak because with prices 
so low, new construction cannot recover its costs. It has some 
implications for the quality of mortgage assets and therefore 
for our financial system. In our reviews of bank capital 
positions, we are doing stress test scenarios and one of the 
main stressors is what happens if house prices were to fall 
five or ten or 15 percent more and how would that affect their 
mortgage portfolios and their capital.
    So in a number of different directions over and above how 
it is affecting the individual families, at the community level 
and at the broad economic level, it is a very serious problem 
and it is one of the reasons that the recovery, along with the 
problems in credit markets, one of the reasons that the 
recovery is not as robust as it normally would be, given how 
deep the recession was.
    Senator Merkley. My time has expired. I do have another 
question, if it is appropriate.
    Chairman Conrad. Given the fact we intruded on your time, 
go ahead.
    Senator Merkley. Thank you. Well, one of the interesting 
developments is that families started saving a substantial 
amount, recognizing that they needed to prepare for the 
possibility of the loss of a job or the drop in value of their 
home and so on and so forth, which, of course, on the spending 
side that throws a wrench into the economy. But one thing that 
I have heard reference to, but I am not sure if it is right, is 
that the amount of consumer debt has decreased by more than the 
amount the national debt has increased. That is, if you take 
the family debt and the national debt together, our total 
indebtedness has dropped. Is that accurate, and how does that 
play into the macroeconomic picture in terms of the impact of 
our national debt?
    Mr. Bernanke. That is correct, and one way to see that is 
that our current account deficit, which is our foreign 
borrowing, has gone down, meaning that our total need for 
borrowing, public and private, is lower than it was before the 
crisis. That is the opposite side of saying that the aggregate 
demand, that total spending is insufficient to bring the 
economy to full employment. So what you say is exactly right 
and it, again, is consistent with the need for continued, at 
least speaking from the Federal Reserve's perspective, 
continued accommodative monetary policy to help support the 
economy's recovery.
    Senator Merkley. Thank you.
    Chairman Conrad. I thank the Senator.
    We will go to a second round, and I think maybe what we 
will do is reduce this to four minutes so we do not impose too 
much on the Chairman's time.
    Let me just say, I haveten an initial report now on the 
States' situation and I have asked Senator Manchin, as former 
head of the National Governors Association, to get us the 
latest information that is available from that source. Here is 
what I have in an initial review since our conversation on the 
floor, I think it was last week, Governor Manchin, maybe a week 
ago or so.
    In looking at what has happened since enacting their 2011 
budgets, 15 States had new budget gaps open by late November 
totaling $27 billion. Nearly the entire gap is accounted for by 
five States: Illinois, half of it, roughly half; Arizona, about 
ten percent; Washington, seven percent; California, roughly 
seven percent; Texas, five percent. Those are the new gaps that 
opened up in 2011 after they collectively had closed $84 
billion of gaps in working on their 2011 budgets.
    What is, I think, a serious matter is looking at the
    2012 budget gaps. NCSL's survey, the National Committee on 
State Legislatures, projected a gap of roughly $97 billion
    in 2012. The Committee on Budget and Policy Priorities 
reports that gap currently stands at $113 billion and is 
expected to grow to $140 billion once all the States have 
updated forecasts. So we are talking about a significant 
problem here with some 35 States projecting gaps in 2012. Only 
11 States reporting no budget gaps for 2012. I must say, 
proudly, my State has no budget gap. I think Governor Manchin 
left his State in very good shape. I do not think they face a 
budget gap.
    But that--now, looking back in 2011, they closed $84 
billion of budget gaps, so clearly there is capacity there to 
do significant budget gap closing looking at 2012. But, I mean, 
$140 billion is a big number, certainly for those individual 
States, and I think it is--you know, you look at Illinois, for 
example. They are talking about a 2012 budget gap of $15 
billion, which represents 50 percent of their budget. That is a 
whopper.
    And I do think we need to be prepared with a plan in case 
we are approached by one or more States, because clearly, the 
problem is concentrated in a handful of States. As I indicated, 
five States were the significant majority of the 2011 gaps--
Illinois, Arizona, Washington, California, and Texas. We have 
to be ready with a plan if we are approached with respect to 
requests from any or all of those States, and I understand 
fully that is not in your domain, but I think we can reasonably 
anticipate that we may have requests made to us. I can tell 
you, I do not think Congress, the House or the Senate, are 
going to be very interested in bailouts to States.
    Senator Manchin. Mr. Chairman?
    Chairman Conrad. Senator Manchin?
    Senator Manchin. If I may, just in open discussion here, 
the States are going to be in a situation where they are going 
to have to have the flexibility to refinance to put their 
financial houses in order. Everybody bet on the come, if we 
will. They worked off of 2008 levels, the amount of stimulus 
that helped them get through a difficult time, and we thought 
the economy would pick up and it has not. They are still left 
short, if you will, and they are making some really draconian 
cuts and they are all making that effort.
    But with that, our know, our ability--our bond ceilings 
that we have that we as States were able to go out to the 
market with, there might be some creative financing that is 
needed to be done here and we are going to need all the help we 
can get. Can they raise those ceilings to see if there is a 
market so they can refinance zero percent bonds, to go out and 
find out if they can create value within their States. I do not 
think the appetite is here in Congress to just say, okay, here 
is more money to help you. Can we help you help yourself? Can 
we give you some flexibility? Are there some restrictions and 
regulations that we can ease up on?
    I think that is what would be most appreciative, and I 
think we should be looking at it now because it is not if it is 
going to happen, it is when they are going to need our 
assistance and help.
    Chairman Conrad. Well, I think you make a very good point, 
and I think since our previous conversation, I immediately 
asked people to go out and do this survey and I think it is 
something this committee is going to have to be prepared with 
an answer. And what you are saying, I think, makes eminent good 
sense. That is, maybe there are ways to help with creative 
financing. I do not think there is going to be much appetite 
here to send truckloads of money to States.
    I have about used my time on this four-minute round. 
Others? Senator Sessions, would you like an additional round?
    Senator Sessions. I would, Mr. Chairman, and there is so 
much to ask, Chairman Bernanke, I will submit written questions 
to you.
    With regard to the State situation, the States are 
sovereign. They have issued their own debt, and the people who 
loan money to States need to know their likelihood of being 
repaid is based on the financial condition of that State. And 
there is a moral erosion of a significant nature when we 
undertake to start bailing out more. I just think this whole 
bailout mentality has far more ramifications than a lot of us 
think and a lot of people have indicated.
    I understand what you are saying, Mr. Bernanke, and that 
States need to get their house in order. They should not expect 
low-interest loans from the Fed if they get in trouble. Is that 
correct?
    Mr. Bernanke. They should not expect loans from the Fed, 
and I think the numbers that the Chairman referred to are 
prospective gaps obviously. They are a measure of how much 
spending cuts or tax increases are going to be needed to 
achieve balance. It is going to be difficult, but on the other 
hand, there is some improvement in the economy, and tax 
revenues actually have picked up some. So it is a difficult 
situation, but I hope the States will be able to address it.
    Senator Sessions. But I have just got to tell you, places 
like California have been living beyond their means for a very 
long time, even when the economy was in good shape. Our State 
is very frugal. We try to operate a good State, and I think I 
am not inclined to ask my constituents to rescue someone who 
has been improvident.
    I will note what Mr. Christie is doing in New Jersey: the 
agriculture department, reduced 24 percent; banking, 12 
percent; community affairs, reduced 35 percent; education, down 
to 8 percent; human services, 4 percent; law and public safety, 
7 percent; roads, 3 percent.
    Now, I suggest New Jersey is not going to sink into the 
ocean. It is still going to be there. And this idea that cuts--
and even this deficit commission, bless your heart, I hope I 
would have been willing to support the Commission's 
recommendations. It is about as good as anything we have seen. 
But it does not call for anything like a reduction in Federal 
spending like this. It actually does not call for any, really, 
in discretionary accounts of a significant amount. So we can do 
better, and the American people are telling us this.
    Mr. Bernanke, I have criticized some of you folks, 
including President Bush and Mr. Greenspan. I do not think you 
realize the political world we live in, the real world we live 
in. You think, well, we can--in 2001, when we needed to 
stimulate the economy and run a deficit, well, we have had a 
surplus for a few years, we can just ask the Congress to spend 
money, and then when they get to a certain point, we can tell 
Congress to stop. But those of us who committed and were 
elected to try to balance the budget and participated in tough 
votes to balance the budget really had our legs chopped off. We 
were not able then to warn against spending. Even the 
Republicans, some of them, and the Fed seemed to be saying 
deficits do not matter. And now, see how hard it is to turn off 
the spigot? I think the same thing--maybe you and the Fed can 
turn off the spigot just like that within your power. But for 
us politically it is not easy. So we have to get a consensus.
    I think the American people have a sense right now-- don't 
you, Mr. Chairman?--that they want us to do something now. And 
I want to ask you, are you telling us that you think it is 
premature to start reducing some of our spending levels and 
some of the Government accounts because it might hurt the 
economy? The Brits do not seem to think so. In a similar 
situation to our, they are cutting now.
    Mr. Bernanke. What I said, Senator, was that it is a long-
run issue. It has to do with--you know, the problems are not 
just this year or next year. The problems go out decades. And I 
think it is not too soon to have a strong set of measures that 
will bring down deficits over time so that we have at some 
point a stabilizing and then declining debt-to-GDP ratio.
    So I think action is needed, but I think you are not going 
to solve the problem by just making cuts for this year's 
budget. You need to think about the whole future path and all 
the obligations both implicit--I mean, the Chairman talked 
about the debt held by the public and the gross debt and so on. 
All those debt numbers do not include the unfunded obligations 
that we have for entitlements, for example. So the true debt is 
probably 3 or 4 times bigger than what the Chairman is talking 
about.
    So we need to address that, but what I am saying is that we 
want to take--we should take a long-run perspective, and that 
is really what the markets are looking at, and that is what 
economic stability requires.
    Senator Sessions. Fair enough. I do believe we have an 
opportunity to limit waste and spending right now, and it would 
not damage the economy, and in the long run we need to work 
together to try to figure out how to create confidence that our 
economy is under control and our spending is under control.
    Chairman Conrad. Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman.
    Chairman Bernanke, I want to ask about China in a different 
way. I also chair the Senate Finance Subcommittee on Trade and 
Competitiveness, and I want to take you through what I think is 
going on with China and get your reactions in the American 
economy and particularly the cause of creating more good-paying 
jobs.
    A decade ago, when China was admitted to the World Trade 
Organization, in effect there was a commitment made to 
marketplace principles. That was essentially what their entry 
to the World Trade Organization was all about.
    In the last 6 months--and, frankly, we have seen this over 
a considerable period of time--it seems to me we have seen 
considerable backsliding in China with respect to these 
marketplace principles, and two areas I have been especially 
concerned about most recently are rare earth minerals, which 
are so important for American manufacturing, green goods and 
others, where the Chinese in effect are saying, look, we are 
going to keep our rare earth minerals here; and if people in 
the United States want manufacturing, they got to come there. 
And we are also seeing it in what amounts to discrimination 
against American digital goods and services, which is another 
important area of good-paying jobs for our country.
    My question to you is: What is your sense about the 
implications of China backsliding on these marketplace 
principles that they in effect committed to? And I will tell 
you, just in my view, they are violating World Trade 
Organization principles in those two areas, the question of 
rare earth minerals and digital goods. What are the 
implications of what they are doing there? And what is an 
appropriate role that our Government ought to be taking?
    Mr. Bernanke. Well, the WTO agreements have specific rules 
and procedures, and we have actually brought some actions under 
WTO, and I believe we won a couple of them. So within the rules 
that China has agreed to, the WTO process looks like it has 
been working. But I am not so sure that I would agree that 
China is backsliding. I mean, there have been issues all along 
with intellectual property and government procurement and a 
wide variety of--you know, access to--
    Senator Wyden. Well, those are two areas most recently, and 
they are very important to the American economy. Rare earth 
minerals and digital goods, this is a pretty new phenomenon. 
This is the last 6 months, and that is why I am talking about 
the implications for the economy.
    Mr. Bernanke. Well, on rare earth minerals, you know, I 
agree that that is a strategic input. I do not believe the 
United States has any current capacity or has very little 
capacity in that area, so we might want to consider some 
strategic investments in that area. But this is just a number--
there are a number of areas, and the Chinese would raise issues 
with us as well about exports and so on, the technological 
exports and so on, where I think ongoing engagement is really 
going to be important. And, of course, the President of China 
is going to be here in a few days, and I hope that will be an 
opportunity for high-level discussions. But this is part of the 
ongoing process we have had with China for a while, which is to 
try to hold both sides to trade and investment obligations, and 
it has been a struggle in many cases. I am not disagreeing with 
you.
    Senator Wyden. Well, I thank you. I clearly come to these 
trade issues looking for ways to open markets. That is why I 
think that we are at such a critical time. And I have voted for 
every market-opening agreement since I have been in public 
life. But I also think it is important to adhere to principles 
that ensure that in a global marketplace everybody has an 
opportunity to make markets work. And I think we are seeing in 
a number of areas considerable backsliding from the Chinese, 
and I look forward to following up with you on this as well, 
because we cannot meet our target of doubling exports, as we 
have set out to do in this country, and substantially lowering 
the unemployment rate as our constituents are demanding unless 
we have an opportunity around the world to have fair access to 
markets. And I think in a growing number of areas, that has not 
been the case.
    I look forward to working with you in the days ahead, and I 
thank you for your appearance today.
    Mr. Bernanke. Thank you, Senator.
    Senator Wyden. Thank you, Mr. Chairman.
    Chairman Conrad. Thank you.
    Senator Manchin.
    Senator Manchin. Just to follow up very quickly on that, in 
the State of West Virginia we have been blessed with some of 
the highest quality coking coal in the world, and I brought 
this to the attention of people in higher places, that we are 
concerned about most of our assets are being purchased by 
foreign countries. We still have the good fortune of our miners 
working and we are mining the coal and the severance tax the 
State receives. But as the Senator just mentioned, most of this 
product is leaving this country. That is the ingredients of 
making the steel that is needed that builds industry, if you 
will. And I do not know if we know the critical juncture we are 
at, but I can tell you, we can see it every day, the outside 
interests and the amount of money they are paying for these 
reserves.
    With that being said--I know this has been talked about--I 
am the new kid, if you will, in town--the TARP, the whole 
bailout of the banking system. It is still in my area as far as 
in West Virginia, we are very much concerned that small 
businesses do not have access to capital, are having a hard 
time acquiring it. Individuals, if you will, commercial 
developers, the building industry. The thing that is really 
lacking and throwing us back right now is the access to 
capital. And we have heard it, you know, we bailed out Wall 
Street but not Main Street.
    When do we see relief or what do you think needs to be 
done, sir, for us to opening up the banking industry so it can 
start taking, if you will, some calculated risk and putting 
money back in the market?
    Mr. Bernanke. Well, just on the narrow question of TARP, of 
course, capital went out to smaller firms as well as larger 
firms, and Congress just recently passed the small business 
plan that has non-TARP capital going to small banks that are 
willing to make loans to small businesses. So some of this 
money has gone to small firms as well as large firms.
    It is a tough problem because you have small businesses who 
were used to somewhat easier conditions before the crisis. 
Terms and lending conditions have tightened up to some extent 
for understandable reasons given what happened during the 
crisis and given the losses that banks took.
    It is also a situation where the economy has been weak and 
where the value of collateral, the value of stores or 
factories, et cetera, has come down, which makes it more 
difficult to borrow as well. So there are some fundamental 
reasons why credit is harder to come by.
    That being said, I think there is a tendency to overreact. 
There is a tendency after a crisis or in a weak period to 
tighten too much, to swing too far, the pendulum to swing too 
far, and--
    Senator Manchin. Do you think that has been done?
    Mr. Bernanke. I think in some cases that has been the case, 
and that as I have said, the Federal Reserve, we understand--we 
have a responsibility to keep banks safe and sound as best we 
can. On the other hand, we also have considerable interest in 
having the economy grow. And so we have been--and I would be 
happy to give you much more detail at a more convenient time 
and send you a letter or meet with you personally, however you 
would like to do it. But we have taken a lot of actions to try 
to create a better balance for banks to make sure that they can 
make good loans; that if they are following safe and sound 
procedures that we will not criticize them for making a loan to 
a small business or even a business where the collateral value 
has declined. So we are very sympathetic to what you are 
saying, and we have been working hard, and I do think that 
there is some progress. I think there is some improvement. And 
as the economy expands and as credit needs go up, I think we 
are going to see more lending take place.
    But we are very much aware of this issue, and we are 
reaching out to small businesses, we are reaching out to banks. 
And if you have any suggestions or you have--if anyone would 
like--we have an ombudsman who will be happy to take any 
complaints or concerns. We do want to be responsive on this 
issue.
    Senator Manchin. I will do that. I will bring specifics, if 
I may, and maybe you can give us some help.
    Mr. Bernanke. Of course.
    Senator Manchin. Thank you.
    Chairman Conrad. Senator Merkley.
    Senator Merkley. Thank you, Mr. Chair, and I appreciated 
the reference, Mr. Chairman, to the Small Business Lending 
Fund, which was a proposal that I developed in response to a 
problem we saw in community banks in Oregon where they were 
noting that because of the FDIC requirements on leverage being 
firmly applied, healthy community banks were unable to lend. We 
do not yet know the results of that program, but it was one way 
to try to get funds into Main Street banks so that they could 
assist Main Street businesses. And in addition to banks that 
did no have the capitalization to make additional loans, we 
have banks that are not only healthy but do have funds but are 
kind of sitting on them waiting to see what happens with the 
economy. And so we look forward to continuing to brainstorm 
some of the ways we can get liquidity in the hands of small 
businesses, because if they cannot borrow money, they cannot 
seize business opportunities. And they are a job machine that 
we have to put fully to work, and finding the right way to do 
that is very important.
    I wanted to turn back to housing. Oregon produces a lot of 
lumber, and many other States produce lots of products that are 
not being consumed when the housing market is down. There are a 
series of ideas that are still being talked about. Again, a $50 
to $100 billion promise has turned into less than $1 billion of 
spending to assist homeowners. One of those concepts is to do a 
national short sale program in which families who have passed 
an economic distress test or filter, if their home is being 
sold at a far lower value after being foreclosed on or shortly 
before being foreclosed on, that the family itself might have a 
chance to buy it back using lending that is fully underwritten 
based on their ability to pay, but maybe not the complete 
traditional FICO score structure.
    A second approach being talked about is downpayment grants 
to help first-time homebuyers. Of course, we have experimented 
with this program, but to help absorb that inventory of 
foreclosed homes, so that instead of having an empty home on 
the block, you have a family that is in that home, and to help 
arrest the downward direction of house pricing.
    A third is another examination of bankruptcy reform as a 
way to kind of adjudicate the issues involved in homeownership 
where every other contract can be adjudicated by a bankruptcy 
judge, a home contract cannot be. And with appropriate 
protocols that we have been alerted to in terms of being 
backward-looking not forward-looking, great concern to the 
banking community.
    So as we look at this national housing challenge, which I 
think you echoed the concern that it is a major factor in our 
economy getting back on track, if these are not the right 
ideas, what are the right ideas? What more can we do here in 
Congress to take on one of the really big domestic issues 
affecting the quality of life for families and the strength of 
our economy?
    Mr. Bernanke. Well, I am afraid there are no simple 
solutions, as you might imagine, and the ones you mention are 
all interesting ones, and let me just offer in general that we 
would be happy to work--staff would be happy to work with you 
on the details of any of these ideas. If you would like to take 
us up on that, we would be more than happy to work with you.
    The short sale idea has been around. I think it is fairly 
similar to the idea of just having a principal reduction in the 
mortgage, which is something that is now-- which the Federal 
Reserve actually advocated for a number of years, which I have 
talked about in speeches for some time as being a way of 
creating greater incentives for the homeowner to want to stay 
in the home. That is a program that is now currently in place, 
building on a program that was passed a couple years ago. I do 
not know how far along that hasten, but that is one approach.
    Senator Merkley. Not very far.
    Mr. Bernanke. Not very fair. I think--
    Senator Merkley. And there is an important--I will just 
interject here on this. The challenge on the principal 
reduction is that as long as the family looks anywhere near 
viable, financial institutions are very, very reluctant to 
write down the principal. The idea of the short sale is at the 
point that a bank or a mortgage holder has concluded that the 
family is going to go under and the home is going to have to be 
resold, at that point there is no longer kind of this 
competition between writing down an existing loan on the books 
because the loan is going to be--the house is going to be 
foreclosed on, the loan is going to be gone anyway. So that is 
why the conversation has migrated in that direction.
    Mr. Bernanke. Well, again, economists at the Board and 
around the Federal Reserve System have been working on various 
plans, schemes to try to address this problem, and I would be 
more than happy to work with you in more detail on these 
issues. But getting the principal down through some mechanism 
is obviously one approach.
    On the downpayment assistance, I think you would want to 
design it in a way so that--one of the concerns that we had 
about the homeowners--the tax credit was that it created a 
temporary bump but did not seem to have a permanent impact on 
the housing sector. So you would want to do something that did 
not just shift purchases in time a little bit, but actually 
created a more sustainable demand for housing. And that is 
another difficult problem.
    But, you know, I have been--I am a member of the committee 
that oversees the TARP, and so we have been getting regular 
presentations from the Treasury on the various programs, and to 
their credit, you know, they have gone beyond their initial 
HAMP program to look at a number of different experimental 
approaches, giving States money to apply to their own 
strategies. So there are a lot of ideas out there and a lot of 
things that are being experimented with, but clearly, 
particularly in a world where unemployment is 10 percent and 
long-term unemployment is 44 percent of that unemployment, 
there are situations where it is very difficult to find a 
solution.
    Senator Merkley. My time has expired, but can I follow up 
on one piece of this?
    Chairman Conrad. If it is brief, because we have made a 
commitment here that the Chairman would get out of here by noon 
and we are little past that now.
    Senator Merkley. Okay. The concept of a permanent 
downpayment grant at a lower level for first-time homebuyers 
addresses that issue you were talking about of just shifting 
demand forward, but it also addresses something more 
fundamental, which is our primary mechanism of reducing the 
cost of homes for families, is the home mortgage interest 
deduction. But that kicks in primarily when you buy a larger 
house and you are in a higher tax bracket. So the vast bulk of 
the subsidy goes to the families who need it the least in terms 
of actually becoming homeowners. And so the idea of a 
downpayment grant--and it should be in addition to. I am not 
taking anything away from the concept of interest deduction on 
your home. But the idea is that now you have a working family 
of modest means that is buying a very modest house, and we are 
helping them become homeowners, in which they would hardly 
benefit at all from the mortgage interest deduction. And so it 
serves as kind of a fairness factor because we should help 
working families buy homes as well as help successful families 
buy large homes, and yet also help absorb this inventory of 
empty homes. So that is kind of the broader, fuller picture of 
it.
    Mr. Bernanke. The Commission that the Chairman was on 
talked a lot about the interest deduction and lots of, I think, 
interesting ways to think about whether that could be made more 
productive, more constructive.
    Senator Merkley. I will mention I am not addressing the 
interest--
    Mr. Bernanke. No, no. I understand. But it raises the point 
that some people it does not really help very much. If you do 
not itemize, for example, you do not get the interest 
deduction.
    Senator Merkley. Thank you.
    Chairman Conrad. I thank the Senator.
    One final question that we have been asked, and that is, 
with the substantial expansion of the balance sheet by the 
Federal Reserve to make sure the flow of credit continued 
during this downturn, can you anticipate now what percentage of 
that expansion would be realized as losses? I have been told 
that it is very small. Can you give us some sense of that?
    Mr. Bernanke. Well, first, as I mentioned in my testimony, 
this is not deficit spending. We are buying assets which we 
will either sell back to the market or allow to run off. 
Currently we are in a profit position. Our cost of funds is 
very low, so the interest that we are receiving we are 
remitting back to the Treasury. I got a new number this 
morning. For 2009 and 2010, we remitted back to the Treasury 
$125 billion from this program, which is much higher than our 
normal.
    Should it be the case that short-term interest rates rise, 
which, of course, could happen if the economy recovers and we 
need to normalize monetary policy, then those remittances could 
go down. But currently we are in a--you know, this is at this 
point a profitable program from the perspective of the Federal 
deficit.
    Chairman Conrad. And is it your forecast at this point that 
you will then not experience losses on this extension of credit 
that was made during the downturn?
    Mr. Bernanke. As a practical matter, what matters is not 
losses, because those are paper losses. What matters is the 
amount of funds, remittances we send back to the Treasury. 
Under most scenarios, because our cost of funding is so low, we 
will continue to remit back to the Treasury significant amounts 
of money. Under a scenario in which short-term interest rates 
rise very significantly, it is possible that there might come a 
period where we do not remit anything to the Treasury for a 
couple of years. That would be, I think, the worst-case 
scenario. But even in that case, we would have offsetting that 
both the early payments, which are above normal, and the fact 
that to the extent that this is a successful policy, it will 
strengthen the economy and increase tax revenues.
    So I think from a purely fiscal point of view, I think this 
is most likely to be beneficial, not harmful, to the 
Government's financial position.
    Chairman Conrad. The reason I asked the question and 
phrased it like I did is because in common parlance there has 
been a great concern that what the Federal Reserve did was 
going to result in large losses to taxpayers or there was the 
potential for that. And you do not see that.
    Mr. Bernanke. I do not see that as likely, and our record 
so far not only in this program but in all of the lending and 
other special credit programs we have done, you know, has been 
very positive from a perspective of returns to the Treasury.
    Senator Sessions. With regard to quantitative easing on the 
Federal purchases, that money that you pay back is money that 
came from the Treasury. Is that right? It is the interest--
    Mr. Bernanke. Well, yes, but it is, of course--another way 
of looking at it is that it is interest that the Treasury did 
not have to pay to the Chinese.
    Senator Sessions. I am aware of that, but it is a zero sum 
game I guess in that sense. And you believe it is helpful to 
the economy. I understand that.
    Mr. Bernanke. That is the main point.
    Senator Sessions. That is the main point of it.
    On ``60 Minutes'' a couple years ago, you made reference to 
this is the equivalent of printing money. Was that when the Fed 
buys--is quantitative easing the purchase of Treasury bills, is 
that what you meant when you said printing money?
    Mr. Bernanke. So I was actually talking about a somewhat 
different issue at that point. So let me try to explain what 
really happens. What happens is that when we buy securities, 
the money finds its way into the banking system and shows up as 
reserves that the banks hold with the Fed. So currently banks 
are holding a large amount of reserves with the Fed which will 
have to at some point be unwound as we exit from this program. 
However, I think there are some folks out there who think that 
we are literally printing money and putting it in circulation. 
That is absolutely not happening.
    Senator Sessions. But it does have a tendency, does it not, 
to increase the circulation of dollars, which, like more apples 
in the marketplace, makes the apple less valuable? Or does it 
not?
    Mr. Bernanke. The amount of currency and money in 
circulation has not really been affected by this program. Very 
slightly. And, in fact, money growth over the last year or so, 
2 years, has been below normal. So it is not a situation where 
the Fed is dumping money into the economy. That is not what is 
happening.
    Senator Sessions. Thank you.
    Chairman Conrad. Thank you. Thank you very much for your 
appearance. Thank you for your forthright testimony here, and 
we look forward to having you up for a meeting with the members 
as we try to craft a fiscal policy to get us back on track.
    Mr. Bernanke. I look forward to it. Thank you, sir.
    [Whereupon, at 12:09 p.m., the Committee was adjourned.]





        THE BUDGET AND ECONOMIC OUTLOOK: FISCAL YEARS 2011-2021

                              ----------                              


                       THURSDAY, JANUARY 27, 2011

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Wyden, Nelson, Cardin, 
Whitehouse, Begich, Manchin, Sessions, Crapo, Ensign, Cornyn, 
Thune, Portman, Toomey, and Johnson.
    Staff present: Mary Ann Naylor, Majority Staff Director; 
and Marcus Peacock, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    I want to welcome everyone to the Budget Committee this 
morning. I know there are other members who are on their way, 
but they had other business. As you know, this is the day that 
Committee assignments are determined, and so there are members 
who will be here who are involved in that process.
    Today's hearing will focus on CBO's new budget and economic 
outlook. Our witness today is the CBO Director, Doug Elmendorf.
    Director Elmendorf, welcome back to the Committee. I want 
to take a moment to congratulate you on your reappointment that 
was formally made yesterday as CBO Director. That is a well-
deserved recognition for your extraordinarily professional 
work. I just want to say the confidence that you enjoy on both 
sides of the aisle is a testimony to you and to the entire team 
at CBO. Over and over, you have demonstrated your independence. 
I might add that even when I had a proposal that was very 
important to me, you did not give it very good marks, and I 
think that demonstrates pretty clearly your independence. But 
that is healthy. That is what we need here. We need an 
independent scorekeeper who is going to give us their best 
assessment of the effect of the policies that are enacted by 
Congress.
    You have demonstrated, I believe, a very high degree of 
professionalism, as has your entire team at the Congressional 
Budget Office. You have been unbiased and a fair umpire, 
calling it like you see it. Your reappointment by a 
Democratically controlled Senate and a Republican-controlled 
House speaks volumes of the trust and respect that you and your 
team have earned on both sides of the aisle. We look forward to 
your testimony here today.
    CBO's report should be a red light flashing to the Nation. 
Our fiscal situation is serious and becoming more so. We are at 
a critical juncture. We are borrowing 40 cents of every dollar 
that we spend. Spending, as this chart indicates, is at its 
highest level as a share of the economy in more than 60 years; 
and revenue is at its lowest level as a share of the economy in 
more than 60 years.





    Let me just repeat that. Spending as a share of our 
national income is at the highest level in 60 years; revenue as 
a share of our national income is at its lowest level in 60 
years. No wonder that we are headed for the largest deficit 
ever. This is utterly unsustainable, and the sooner we address 
it, the sooner we come to grips with it, the better.
    This next chart depicts CBO's new 10-year baseline 
projections with additional policies added in. It shows that, 
due to passage of the tax extension package and the slow pace 
of the economic recovery, CBO is now expecting to see deficits 
of more than $1 trillion a year continuing through at least 
2012. It shows that deficits will then briefly fall before 
rising again as the bulk of the baby-boom generation begins to 
retire and health care costs continue to climb.






    Under the same scenario, gross Federal debt is expected to 
reach 100 percent of gross domestic product this year and 
continue rising. It is important to remember that many 
economists regard anything above the 90-percent threshold as a 
danger zone. And as disturbing as those near-term deficits and 
debt are, the long-term outlook is even more dire. It is the 
deteriorating long-term outlook that is the biggest threat to 
the country's long-term economic security. The warning signs 
are as clear as they can be.






    Earlier this month, two of the world's leading credit 
rating agencies, Moody's and S&P, warned again that rising U.S. 
debt could lead to America losing its AAA credit rating. If 
such a thing were to happen, it would be a very serious blow 
and could set off continuing tensions in the global financial 
markets.






    In his recent testimony before the Senate Budget Committee, 
Federal Reserve Chairman Bernanke called for a demonstration of 
political will to address the long-term fiscal imbalances. He 
stated, and I quote: ``Nobody doubts the United States has the 
economic capacity to pay its bills. It is really a question of 
do we have the political will to do that. And demonstration of 
political will, that is what the markets are watching. Is the 
Congress and the public and the administration, are they able 
to demonstrate that they are serious and that they have enough 
willingness to work together to make progress? At the point 
where confidence is lost, you could see a relatively quick 
deterioration in financial conditions.''





    That, again, all from the Chairman of the Federal Reserve.
    I hope people are listening. We cannot afford to wait until 
the markets lose confidence in the conduct of our financial 
affairs. We need to act, and we need to act this year. That 
does not mean we need to make steep cuts immediately. All of 
the bipartisan commissions have come back with recommendations 
and have recommended that we begin modestly because of the 
continuing economic weakness, but that we put in place a 
credible plan that convinces markets that we are going to get 
the result that is required. Enacting such a plan now, 
according to the Chairman of the Federal Reserve and others, 
would reassure the markets and help boost our near-term 
economy.
    I believe the deficit and debt reduction plan assembled by 
the President's Fiscal Commission provides one way forward, and 
I want to emphasize I supported the Commission report. I did so 
proudly. There are things in it I do not like, but that is 
really not the point. The Fiscal Commission came back with a 
plan that 11 of the 18 Commissioners supported, five Democrats, 
five Republicans, one Independent. And I can tell you it is not 
very popular, certainly by the phone calls I have received and 
the letters I have received. We understand that. But it is 
necessary. It would reduce the debt by some $4 trillion over 
the next 10 years, and it would get us on a path that would 
take us back from the brink and do so in a very important way.
    The Commission plan was also important because it showed 
how to reduce the deficit and debt in a balanced way. It 
included substantial cuts in discretionary spending. It 
included entitlement reform. It included tax reform--tax reform 
that broadened the base and lowered rates to help America be 
more competitive. If you focus only on non-defense 
discretionary spending, the cuts will have to be so Draconian 
that they will simply not be sustainable. That is my judgment. 
Tax reform that raises revenue also, I believe, must be part of 
the plan.
    The result of this balanced approach was to get the deficit 
and the debt first stabilized and then over time to bring it 
down quite sharply. To solve the long-term challenge, it will 
require real compromise and a great deal of political will. We 
need everyone at the table, and that includes the President of 
the United States. And we need to have both sides, Democrats 
and Republicans, willing to move off their fixed positions and 
find common ground. We cannot continue to put this off. We need 
to reach an agreement this year. It is time for the 
administration and members on both sides in Congress to come 
together to get this done.






    With that, we will turn to Senator Crapo, who is going to 
do the opening statement for the Republican side. I want to 
welcome Senator Crapo. He served on the Fiscal Commission as 
well. He was one of the 11 that supported its conclusions, as 
did I. Thank you, Senator Crapo, for that, and please make 
whatever statement you choose, and then we will go to our 
witness and then open it for questions.
    Senator Crapo. Thank you very much, Mr. Chairman----
    Chairman Conrad. If you would withhold----
    Senator Crapo. Yes.
    Chairman Conrad. I want to welcome--we have not formally 
recognized the new members to the Committee. That will happen 
in a process a little later today, but we now know who the new 
members are going to be, and we want to welcome them here this 
morning. Senator Portman, Senator Toomey, Senator Johnson, I 
know later today you will be formally added to the Committee, 
but we want to include you this morning, and we will extend the 
courtesy of giving you the chance to ask questions as well.
    With that, again, thank you, Senator Crapo.

               OPENING STATEMENT OF SENATOR CRAPO

    Senator Crapo. Thank you very much, Mr. Chairman, and we 
also welcome our new members. We look forward to working with 
them, and as you can see, knowing who they are, they bring a 
high level of new talent to this Committee, and we appreciate 
their willingness to support us.
    I also wanted to give Senator Sessions' apologies. He had a 
conflict that was unavoidable. He asked that I sit in until he 
could get here. He will be the Ranking Member on our side this 
year, and we look forward to his solid leadership as well.
    I agree very strongly with the concerns that you have 
raised as we move forward to deal with America's fiscal 
dilemma. And, Dr. Elmendorf, I have appreciated working with 
you in the past and look forward to working with you very 
closely as Congress moves forward to develop a proposal that is 
credible and that will get us out of this difficult problem.
    I just want to highlight a couple of points, most of which, 
Senator Conrad, you have already made.
    First, the time for delay, the time for gridlock, the time 
for debate is over, and we must take action. One of the 
strongest messages that the economists and experts who 
testified to the President's Fiscal Commission gave was that 
the single act of the United States Government--Congress and 
the President coming together--and developing a credible plan 
that had a realistic expectation of being followed would be one 
of the most significant things we could do to strengthen our 
economy, to give confidence to investors, and to help rebuild 
the revenue side of the equation that we are dealing with as we 
try to build a solution to this problem. We must act, and we 
must act now.
    We must demonstrate the political will that will require us 
to make a lot of tough decisions. The Chairman was correct. 
Those of us who voted in favor of this plan, I do not think a 
single one of us liked everything in the plan. But I do believe 
that every one of us faced very, very serious criticism because 
of the ability to pick apart a proposal to get out of this 
difficult fiscal situation that we find ourselves in, and the 
fact that there are going to be plenty who will pick it apart, 
whatever we choose to do. And we must be prepared to move 
forward aggressively, and I give my commitment. I know that on 
our side and your side there is the will to engage in this 
issue, and we have to move it forward now.
    I also believe that the President must be heavily engaged 
in this process. To his credit, he established a Fiscal 
Commission to deal with the issue. That Fiscal Commission has 
now issued a report. The President has an opportunity to either 
accept or modify that report or propose some other approach and 
give us a detailed plan to move forward on. It will not 
necessarily be the plan that Congress adopts, but the President 
needs to engage. We need to engage. And we must get past the 
politics of the past and deal with this issue, making the hard 
decisions that have to be made.
    As we move forward in that context, I personally very 
strongly believe that all aspects of the spending and revenue 
side of the equation must be on the table. They were in the 
President's Fiscal Commission's approach. I thought some were 
too lightly treated and some were too heavily treated, but they 
were all on the table. And as a part of that, I strongly 
believe that we must have tax reform.
    One of, I believe, the most beneficial developments of the 
President's Commission's activities was the elevation of the 
understanding that our Tax Code today is so complicated, so 
unfair, so expensive to comply with, and puts America as a 
Nation in such an anticompetitive position with the rest of the 
world that we have a tremendous difficulty on the revenue side 
of the equation achieving a solution. We must eliminate those 
problems and create a Tax Code in which Americans can thrive in 
powerful economic activity.
    And I know, Dr. Elmendorf, that your side of that may be 
more focused on the budget numbers, but ultimately I believe as 
a Committee that we need, Mr. Chairman, to guide as we engage 
and put our approach together, we need to guide this Nation in 
a comprehensive path toward a solution, a credible plan that 
can be put into place and implemented today. I mean literally 
this year we have to act.
    The last thing I will say is this: Any plan for us to get 
out of this difficult fiscal hole in which we have put 
ourselves as a Nation must be a plan that will be implemented 
over a period of time, a period of years. And that will require 
that more than just this Congress participate and more than 
just this President participate in implementing this plan. 
Because of that, I believe that process reforms are as critical 
as the substance reforms dealing with spending and tax policy. 
And process reforms are going to have to be strong. What I mean 
by that is we need to not only create the plan we have been 
talking about and pass the plan and make it law, but also make 
it law that Congress must follow that plan and that super 
majorities of votes must be achieved in order to change it so 
that we can send the strong message to our people and to the 
world that we not only have put a plan on the table, but that 
we will implement it.
    So there are a lot of tough parts of the task that we have 
before us, and, Dr. Elmendorf, we are going to be relying on 
you for the numbers and the analysis. We have done that on 
difficult issues before. I look forward to doing it as we move 
forward in this process. But nothing could be more important. 
This is the most critical threat to our Nation, in my opinion, 
and I include the threats that we receive from external 
sources. In fact, the head of the Joint Chiefs of Staff has 
said that the greatest threat to our security is our debt. And 
I believe that we have to get it right. We have to get the 
numbers right, we have to get the policy right, and we have to 
get the process right. And I hope that we will be able to build 
a strong, bipartisan solution to move forward and achieve that 
promptly.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you so much, Senator Crapo, and 
thank you for your strong statement here this morning, and 
thank you for your service on the Fiscal Commission. Thanks, 
too, to the other members from the Senate who supported that 
effort: Senator Coburn, Senator Gregg, who is now retired but 
was the Ranking Member of this Committee, and Senator Durbin. 
Along with my vote, that made five of the six from the Senate 
who supported the Commission report, even though we, I think 
all of us, believe that if we would have done it, we would have 
done a different job and perhaps a better job; but at the end 
of the day, we have to get a result. At the end of the day, we 
have to find a way to get a result, and----
    Senator Crapo. Could I just interject one quick point 
there?
    Chairman Conrad. Certainly.
    Senator Crapo. I think everyone in America knows that the 
Commission's report failed to get the necessary 14 votes that 
would have been required to force a vote in Congress on it. But 
I think it is important to just note that it did get more than 
60 percent of the votes, which is what is sufficient in the 
Senate to pass legislation.
    Chairman Conrad. That is a very important point. Eleven of 
18--again, five Democrats, five Republicans, one Independent--
supported the recommendations of the report.
    With that, we will turn to Dr. Elmendorf. Again, welcome 
back to the Committee, and please proceed with your testimony.

  STATEMENT OF DOUGLAS W. ELMENDORF, DIRECTOR, CONGRESSIONAL 
                         BUDGET OFFICE

    Mr. Elmendorf. Thank you, Mr. Chairman, Senator Crapo. I 
appreciate very much your confidence in me and, much more 
importantly, your confidence in the analysis that my colleagues 
and I at CBO have been doing and will continue to do for you.
    Among my colleagues I want to recognize for one moment Bob 
Dennis, who is sitting behind me and who has led our 
Macroeconomic Division for many years. He has been one of our 
most important people for many years, and he is retiring from 
CBO at the end of next month.
    Chairman Conrad. If we could ask Bob to stand and be 
recognized.
    [Applause.]
    Mr. Elmendorf. Mr. Chairman, I also want to pass on, on 
behalf of my and my colleagues, our unhappiness at hearing 
about your plans to retire at the end of this session, as we 
were unhappy at Senator Gregg's plan to retire at the end of 
the previous Congress. But we look forward to working with you 
very intensively for the next 2 years, and we look forward to 
working with Senator Sessions and Senator Crapo and the other 
members of the Committee throughout this Congress.
    Chairman Conrad. Let me just say that I am not going to 
retire, but I am just not going to run again.
    [Laughter.]
    Mr. Elmendorf. I understand.
    The United States faces daunting economic and budgetary 
challenges. The economy has struggled to recover from the 
recent recession. The pace of growth in output has been anemic 
compared with that during most other recoveries, and the 
unemployment rate has remained quite high.
    Federal budget deficits and debt have surged in the past 2 
years, owing to a combination of a severe drop in economic 
activity, the costs of policies implemented in response to the 
financial and economic problems, and an imbalance between 
spending and revenues that pre-dates the recession.
    Unfortunately, it is likely that a return to normal 
economic conditions will take years, and even after the economy 
has fully recovered, a return to sustainable budget conditions 
will require significant changes in tax and spending policies.
    Let me discuss the economic outlook first and then turn to 
the budget outlook.
    CBO expects that production and employment will expand in 
the coming years, but at only a moderate pace, leaving the 
economy well below its potential for some time. We project that 
real GDP will increase by about 3 percent this year and again 
next year, reflecting continued strong growth in business 
investment, improvements in both residential investment and net 
exports, and modest increases in consumer spending. But we have 
a long way to go on the employment front.
    Move to the next slide, please. The next one after that, 
please. Keep going. I am sorry. And again. So let us focus on 
this.
    Payroll employment, which declined by 7.3 million during 
the recent recession, rose by only 70,000 jobs on net between 
June 2009 and December 2010. The recovery in employment has 
been slowed not only by the slow growth in output but also by 
structural changes in the labor market, such as a mismatch 
between the requirements of available jobs and the skills of 
job seekers.
    We estimate that the economy will add roughly 2.5 million 
jobs per year for the next 6 years, similar to the average pace 
during the late 1990s. Even so, we expect that the unemployment 
rate will fall only to 9.2 percent in the fourth quarter of 
this year and 8.2 percent in the fourth quarter of 2012. Only 
by 2016 in our forecast does the unemployment rate reach 5.3 
percent, close to our estimate of the natural or sustainable 
rate.
    CBO projects that inflation will remain very low in 2011 
and 2012, reflecting the large amount of unused resources in 
the economy, and will average no more than 2 percent a year 
between 2013 and 2016.
    Economic developments and the Government's responses to 
them have, of course, had a big impact on the budget. We 
estimate that if current laws remain unchanged, the budget 
deficit this year will be close to $1.5 trillion, or 9.8 
percent of GDP. That would follow deficits of 10 percent and 
8.9 percent of GDP in the past 2 years, representing the three 
largest deficits relative to the size of the economy since 
1945. As a result, debt held by the public will probably jump 
from 40 percent of GDP at the end of fiscal year 2008 to nearly 
70 percent at the end of fiscal year 2011.
    If current laws remain unchanged, as we assume for CBO's 
baseline projections, budget deficits would drop markedly over 
the next few years as a share of output. If we can go back, I 
think, two slides, the darker line shows the deficit under our 
baseline projections reflecting current law. Deficits would 
average 3.6 percent of GDP from 2012 through 2021, totaling 
nearly $7 trillion during that decade. As a result, the debt 
held by the public would keep rising, reaching 77 percent of 
GDP.
    However, that projection is based on the assumption that 
tax and spending policies unfold as specified in current law. 
Consequently, it understates the budget deficits that would 
occur if many policies currently in place were continued rather 
than allowed to expire as under current law.
    For example, suppose instead that three major aspects of 
current policy were continued during the coming decade: first, 
that the higher 2011 exemption amount for the alternative 
minimum tax is extended and, along with the AMT tax brackets, 
is indexed for inflation; second, that the other major 
provisions in the recently enacted tax legislation that 
affected individual income taxes and estate and gift taxes were 
extended rather than allowed to expire in January 2013; and, 
third, that Medicare's payment rates for physician services 
were held constant rather than dropping sharply as scheduled 
under current law. All of those policies have recently been 
extended by the Congress for 1 or 2 years. If they were 
extended permanently, deficits from 2012 through 2021 would 
average about 6 percent of GDP rather than 3.6 percent--that is 
the lower dashed line in that picture--and cumulative deficits 
over the coming decade would total nearly $12 trillion. Go to 
the next slide, please. Debt held by the public in 2021 would 
rise to almost 100 percent of GDP, the highest level since 
1946.
    Beyond the 10-year projection period, further increases in 
Federal debt relative to the Nation's output almost certainly 
lie ahead if current policies remain in place. Spending on 
Social Security and the Government's major mandatory health 
care programs--Medicare, Medicaid, the Children's Health 
Insurance Program, and insurance subsidies to be provided 
through exchanges--will increase from roughly 10 percent of GDP 
to about 16 percent over the next 25 years.
    To prevent debt from becoming unsupportable, the Congress 
will have to substantially restrain the growth of spending, 
raise revenues significantly above their historical share of 
GDP, or pursue some combination of those approaches. The longer 
the necessary adjustments are delayed, the greater will be the 
negative consequences of the mounting debt, the more uncertain 
individuals and businesses will be about future Government 
policies, and the more drastic the ultimate policy changes will 
need to be. However, changes of the magnitude that will 
ultimately be required could be disruptive. Therefore, Congress 
may wish to implement them gradually so as to avoid a sudden 
negative impact on the economy, particularly as it recovers 
from the severe recession and so as to give families, 
businesses, and State and local governments time to plan and 
adjust.
    Allowing for such graduate implementation would mean that 
remedying the Nation's fiscal imbalance would take longer and, 
therefore, that major policy changes would need to be enacted 
soon in order to limit a further increase in Federal debt.
    Thank you very much.
    [The prepared statement of Mr. Elmendorf follows:]



    
    Chairman Conrad. Thank you, Director Elmendorf.
    You know, one of the things we say a lot on this Committee 
is the current trajectory, projected trajectory on our deficits 
and debt is unsustainable. You have used that language as well. 
What do you mean by that?
    Mr. Elmendorf. As the debt rises relative to the size of 
the economy, so does the burden on the economy, on American 
citizens, of making the payments on that debt, of making the 
interest payments. And as that burden rises, it becomes more 
difficult to prevent a further increase in debt because the 
rising interest payments are tending to squeeze out the other 
forms of Government spending or push up tax revenue in ways 
that are difficult for the country to absorb.
    So the rising debt payments can start to snowball in a way 
that can make the debt rise faster and faster, and one sees 
that in our longer-term projections as one goes out beyond the 
coming decade where the path of debt to GDP can rise quite 
sharply.
    In order to continue the borrowing implicit in those kinds 
of pictures, the Government needs to find investors willing to 
purchase Government securities, both to roll over the existing 
debt as it matures and to acquire the new debt necessary to 
finance the ongoing budget deficits.
    At some point investors are likely to become increasingly 
nervous about whether the Government can, in fact, manage its 
budget. That is what we and others have called a fiscal crisis, 
and we have seen very recently other countries encounter a 
crisis of that sort in which it becomes impossible for the 
Government to finance the trajectory of debt that it has in 
mind at affordable interest rates.
    Now, we have been very clear that we do not have an 
analytic capability of predicting what a tipping point might be 
and when it might happen. But as the debt rises relative to GDP 
and as the trajectory continues to be steeply upward, the risk 
of that sort of crisis increases.
    Chairman Conrad. So part of your analysis and reason for 
the trajectory of our debt being unsustainable is that puts 
upward pressure on interest rates in order to satisfy those who 
loan us money to take on greater risk, and that has the effect 
of slowing the economy. Is that part of your analysis?
    Mr. Elmendorf. Yes, that is right. So as the Government 
needs to work harder to find buyers for its debt, it has to pay 
higher interest rates over time. And more importantly, from an 
economic point of view, the Government's borrowing is crowding 
out the borrowing that private firms or households might do to 
support investment in plant and equipment or to support new 
housing. And it is the crowding out of that private investment 
that makes future incomes lower than they would otherwise be.
    Chairman Conrad. Well, I think that analysis is very much 
in line with what every economist has told this Committee and 
what the Chairman of the Federal Reserve has told this 
Committee.
    Let me go a little bit further because part of your 
analysis of the trajectory of future deficits and debt is tied 
to the question of interest rate levels. And you have a 
projection of what interest rates are likely to be during the 
term of this forecast. What would happen if the interest rates 
were, for example, 1 percent higher than you project? I think 
you did a sensitivity analysis to determine what would happen 
to our debt if interest rates were just 1 percent higher than 
what you project currently. Could you tell us what you found?
    Mr. Elmendorf. Yes, Mr. Chairman, and for others, this is 
in Appendix B of our outlook where we illustrate the 
sensitivity of those budget projections to a variety of pieces 
of the economic forecast.
    If interest rates are 1 percentage point higher than we 
project throughout the entire decade for both short-term and 
long-term rates, we estimate that the budget deficit would be 
$1.25 trillion larger over the coming decade than in our 
baseline projection.
    Chairman Conrad. So you would add another $1.25 trillion--
``trillion,'' that is with a ``T,'' not billion, not million, 
trillion--if interest rates were just 1 percentage rate higher 
than in your forecast?
    Mr. Elmendorf. Yes, that is right.
    Chairman Conrad. Let me ask you this: As you evaluate where 
we are headed, the Chairman of the Federal Reserve testified 
before this Committee in recent days, and basically his advice 
to us on deficit and debt reduction was start modestly but then 
grow the effort in a very determined way once the economy is on 
stronger ground. His argument to the Committee was that this 
recovery is still fragile. One in every six Americans is either 
underemployed or unemployed. And so what he was saying to this 
Committee was you ought to begin the process, but begin fiscal 
discipline in a modest way, but put in place a plan that goes 
way beyond modest to get the debt first stabilized and then to 
bring it down to more manageable levels.
    Is that your advice to this Committee as well? Or what is 
your advice?
    Mr. Elmendorf. Well, as you know, Mr. Chairman, I will not 
make policy recommendations to you and your colleagues. I think 
in judging the speed of policy changes that you are 
considering, you and your colleagues face a difficult trade-
off. On the one hand, as I said, the longer that you wait to 
make those policy changes, the more the debt will mount, the 
greater the negative consequences of that will be, including 
the crowding out other investment, increased loss of 
flexibility to respond to future emergencies that we cannot 
foresee now; the greater will be the burden of interest 
payments and crowding out other forms of spending or pushing up 
tax receipts to keep the debt from growing yet faster; and the 
greater the risk of a fiscal crisis.
    At the same time, the faster that you make policy changes, 
especially those of the magnitude required to fix a fiscal 
imbalance of this size that I have shown and you have talked 
about, those changes can be disruptive to the households that 
are planning for certain sorts of benefits, to the businesses 
that are planning around certain features of the Tax Code, to 
State and local governments that are depending on the Federal 
Government to continue its relationship with them as it has 
been in the past. And the faster you move, the harder it is for 
them to adjust.
    Chairman Conrad. Let me ask you this question: I think that 
analysis that you have given is very much in line with what 
other economists have told this Committee of a broad range of 
philosophical backgrounds. Because when we have witnesses 
before this Committee, we try to provide a broad range of 
philosophical input. Some are telling us that tax cuts are so 
beneficial that if we enact tax cuts, they really will not lead 
to additional deficits because the cost is offset by the 
economic growth that they encourage.
    What is your analysis with respect to the effect of tax 
cuts on the budget?
    Mr. Elmendorf. So the answer, of course, depends to some 
extent on the specific tax cuts that one has in mind. As a 
general matter, reductions in marginal tax rates, which affect 
the incentives faced by households and businesses, reductions 
in those rates can encourage work and savings and, thus, boost 
the economy, and through that provide some offset to the direct 
loss in tax revenue from the reductions in rates.
    For broad-based reductions in taxes, I think the consensus 
in the economics profession is that the offset provided through 
the extra work and saving is significantly smaller than the 
direct revenue loss, and thus that the net effect on the budget 
is a reduction in revenues. As I said, one might reach 
different conclusions for particular changes in tax rates, but 
for broad-based changes, I think that is the professional 
consensus.
    Chairman Conrad. So give us an understanding--and, look, I 
supported extending the tax cuts. I supported extending all of 
them because I believed the economy was in such weak condition 
that we needed some certainty and we needed the additional lift 
that those tax cuts can give in the short term. Isn't the CBO 
analysis that tax cuts have a differential effect short term 
and long term?
    Mr. Elmendorf. Yes, that is right. Again, I do not think 
that is unique to us either. In the results that we presented 
to you in testimony at the end of September about the effects 
of different ways of extending the expiring tax provisions that 
you and your colleagues were considering, we looked at both the 
effects in the next few years and the effects at the end of the 
decade and beyond in future decades.
    In the short term, we think that reductions in tax receipts 
that put more money into the hands of taxpayers that they can 
then spend can stimulate economic activity, the demand for 
goods and, thus, production and employment. And that is 
especially true, I should emphasize, under current economic 
conditions where there is so much unused labor, so much unused 
industrial capacity, and where the Federal Reserve has already 
pushed the interest rates that it controls most directly down 
essentially to their lower bound.
    But over the longer term, as we showed in these results in 
September, reductions in tax revenue that are not matched by 
reductions in Government spending and, thus, lead to wider 
budget deficits tend to reduce the level of economic activity, 
and there are different forces at work there. The lower tax 
rates do spur work and saving, as I said, and we incorporate 
that in our estimates. At the same time, the larger deficits--
again, on the assumption that spending is not cut 
commensurately, the larger deficits crowd out private capital 
formation. And for most of the different parameter values, most 
of the models that we use--and we us a variety to illustrate 
the uncertainties. For most of those approaches that we have 
taken, the loss of future output and income from the extra 
deficits outweigh the boost from the lower tax rates.
    Chairman Conrad. And isn't it your analysis that the tax 
cuts we just enacted in fact do add to the deficit and the 
debt?
    Mr. Elmendorf. Yes, that is correct. The legislation, as we 
report in our outlook, that legislation increased budget 
deficits this year and next and over the entire decade by 
around $800 billion, I believe.
    Chairman Conrad. All right. Let me go to Senator Crapo, and 
then we will go to members for questions in order of arrival. 
We use the early bird rule here, and we will follow that as 
well. I think given the number of Senators, we better do 7-
minute rounds. Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman.
    I want to followup briefly on the last line of questioning. 
In your analysis--and I describe what the Chairman and you were 
talking about as ``dynamic scoring of tax policy.'' I do not 
know if that is the accurate description of it, but do you take 
into consideration the dynamic impacts of tax policy as you 
provide us your numbers? In other words, when you do your 
analysis and come up with that $800 billion number for a 
deficit impact, are you calculating into that the dynamic 
impact of tax policy on the economy and on revenues?
    Mr. Elmendorf. People use these words in different ways. 
Let me distinguish two sets of words and tell you what I mean 
by them.
    Dynamic scoring I think of as incorporating in a revenue 
estimate or a cost estimate a full range of microeconomic and 
macroeconomic behavioral responses.
    The revenue estimates that you get, like all the revenue 
estimates have done for decades in the Congress, are done by 
the staff of the Joint Committee of Taxation, not by CBO. Those 
estimates incorporate a vast array of microeconomic behavioral 
responses. They do not incorporate effects of changing economic 
aggregates like GDP.
    Separately, we and our colleagues on the staff of the Joint 
Tax Committee do dynamic analyses of various sorts, analyses in 
which we do allow the macroeconomic aggregates to change 
through these behavioral changes along with the various sorts 
of microeconomic behavioral effects. And we reported to you 
that sort of dynamic analysis in the testimony I did in 
September about the effects of tax policy. We do this every 
year in an analysis of the President's budget. We have done 
this for the American Recovery and Reinvestment Act. We do this 
in a whole variety of circumstances. It is a great deal of work 
to do. We tend to do it only for particularly significant 
pieces of legislation for which we have weeks or months of lead 
time in terms of your interest. And the staff of the Joint Tax 
Committee does similar sorts of analyses as well.
    Senator Crapo. All right. Let me ask you, what kind of 
revenue growth estimates are you using throughout the decade in 
your projections?
    Mr. Elmendorf. So revenue grows slowly for the next--
certainly for this year, because we have the economy growing 
slowly.
    Senator Crapo. You are at 3.8 for this year, right? That is 
your----
    Mr. Elmendorf. I believe----
    Mr. Booth. 3.1.
    Mr. Elmendorf. So for this year--yes, OK. So for this year 
we have total revenue growing by 3.1 percent.
    Senator Crapo. 3.1, OK.
    Mr. Elmendorf. And then much faster on average for the 
remainder of the decade, but much of that is from the 
expiration of a whole set of these tax provisions at the end of 
this year or the end of next year. So over the next few years 
between now and 2014, tax revenue rises by about 5 percentage 
points of GDP, and three-quarters of that is from the 
expiration of expiring tax provisions, and the other quarter is 
a variety of other effects, including economic growth.
    Senator Crapo. Do you use projections as to what rate of 
inflation you expect in the economy?
    Mr. Elmendorf. Yes. So obviously the nominal growth rates 
of revenues and of spending depend on our projection of 
inflation. As I mentioned earlier and as we describe at greater 
length in the report, we expect inflation to remain low in the 
next few years, then to move up toward the Federal Reserve's 
implicit target, which, according to Chairman Bernanke and 
others, is at 2 percent or a little under. If there were faster 
inflation, that would lead to more revenues. It would also lead 
to more spending, and in particular it would lead to higher 
interest payments on the debt. And in this Appendix C that was 
referenced before, one of the experiments that we did was to 
look at what happens if inflation is higher--I am sorry, 
Appendix B--is higher than it would otherwise be. Higher 
inflation of 1 percentage point a year would add about $900 
billion to deficits over the next decade.
    The important part of that is that with higher inflation 
there tend to be higher interest rates, so this already large 
and growing burden of interest payments would grow even faster.
    Senator Crapo. And are you familiar--I am shifting gears 
here a little bit, but are you familiar with the studies done 
by Rogoff and Reinhart comparing debt to GDP of different 
nations and so forth?
    Mr. Elmendorf. Yes, I am actually. Carmen Reinhart is a 
member of our panel of economic advisers.
    Senator Crapo. You are aware then that they use gross debt 
in their analysis. You have indicated that debt owed to the 
public, which is significantly lower than that, is going to be 
approaching the 90 to 100 percent mark by the end of the 
decade. Could you comment, given the context of their analysis 
and the fact that using literally debt owed to the public as 
opposed to gross debt, we are rapidly approaching those 
markers, on what you expect to be the consequences of our 
failure to change that dynamic, that growth in debt?
    Mr. Elmendorf. U.S. debt, publicly held debt, is already in 
unfamiliar territory for our country, and over the course of 
the next decade, if current policies are continued and debt 
pushes up toward 100 percent of our GDP, we will be entering 
unfamiliar territory for all developed countries over the past 
several decades. Not completely unknown territory. Some 
countries have gone there. Their experiences have usually been 
poor.
    The U.S. is different from other countries in a variety of 
ways that might affect how far we can push up debt before we 
encounter larger negative consequences. People do view the U.S. 
economy as a vibrant one and the U.S. financial system, 
notwithstanding the events of the past few years, as a reliable 
one. That gives us a little more room perhaps.
    On the other hand, we have low private saving rates 
compared with other countries, so our Government debt cannot be 
absorbed as much in U.S. saving. It has to rely on the saving 
and investment of others. That may give us less room than other 
countries.
    Senator Crapo. I want to interrupt because I have one more 
question I am going to ask, and so I would just--well, let me 
just interrupt and move to the next question----
    Mr. Elmendorf. Yes.
    Senator Crapo [continuing]. Because time is so short. I do 
want to followup on that in a future round.
    Quickly, there are four major housing and banking 
activities that are reflected in the Federal budget to various 
degrees: TARP finance programs, the Federal Government's 
obligations to Fannie and Freddie, the premiums paid by and 
loss share payments to banks through the Deposit Insurance 
Fund, and the Federal Reserve's remissions of interest income 
to the Treasury earned on their open market operations and 
other portfolio investments.
    Could you explain to me what the budget numbers associated 
with each of these entities actually reflects? For instance, do 
the numbers for these programs in the budget reflect cash, 
credit scoring, or actuarial costs? And are we treating these 
different aspects differently in our budget analysis?
    Mr. Elmendorf. So the answer to the last part of the 
question is yes, they are treated differently. The Federal 
budget is primarily a cash-flow accounting, money coming in and 
money going out. About 20 years ago, in the Federal Credit 
Reform Act, there were some changes made to try to better 
reflect the true cost of some of the Government's financial 
activities, the credit programs. In fact, that methodology, 
which we apply to credit programs under the law today, does not 
reflect the full cost of the Federal Government, the full cost 
in particular of the risk that the Government takes on in 
credit programs.
    Beyond that, some of these other particular parts of the 
Government's activities that you mention have been put in place 
with different budgetary treatment. The TARP was set in place 
with instructions to us to treat it not exactly under the 
credit reform basis, but under a credit reform basis with an 
adjustment for the extra risk the Government is taking on, and 
we have done that.
    Fannie Mae and Freddie Mac were brought into the Government 
in our assessment through the conservatorship, and the 
ownership and control of the Government has demonstrated. There 
is nothing in law that specifies how they should be treated in 
the budget. We are treating them, after discussion with the 
Budget Committees, on the same risk-adjusted basis that we are 
treating the TARP.
    The administration, however, still views them as being 
outside of the budget. When they record the history of 
transactions, they record cash payments to those entities as if 
they were outside entities.
    Unfortunately, in contrast, our projections, which view 
them as part of the Government, which we think is appropriate, 
treats them more on--does not record the cash transactions but 
imputes to the Federal Government the transactions those 
entities are engaged in.
    So it is a very complicated business, and we are in ongoing 
discussions with the Budget Committee, both sides--here and 
also in the House--to try to think through if there are better 
ways for us to communicate to you and your colleagues what is 
really going on.
    Chairman Conrad. Can I just intercede on this point, 
Senator Crapo? Because I think it is important for members of 
the Committee to know that CBO, when they have a question about 
how to do these things, consults the Chairman and the Ranking 
Member of both the House and the Senate Budget Committees. They 
did consult us on the question of treating Fannie and Freddie 
off the books or on the books. We insisted that they be 
included because we think that is the most accurate reflection 
of the effect on the Federal books. And we were unanimous in 
that view. Senator Gregg was the Raking member here at that 
time. Congressman Ryan was Ranking in the House. And former 
Chairman Spratt, the four of us were consulted. The four of us 
agreed unanimously----
    Senator Crapo. And I agreed with----
    Chairman Conrad [continuing]. That they ought to be 
included.
    Senator Crapo. Thank you.
    Chairman Conrad. And I still believe that was the correct 
decision and that CBO wanted to do it that way, and we thought 
that was the appropriate way, so that we are not having things 
off the books here.
    Senator Crapo. Hopefully OMB will follow that lead.
    Chairman Conrad. I thank you.
    Next, Senator Cardin.
    Senator Cardin. Mr. Chairman, thank you very much. Mr. 
Elmendorf, I very much appreciate your service.
    Mr. Elmendorf. Thank you.
    Senator Cardin. I agree with the comments of our Chairman 
and Senator Crapo that we need a credible plan, we need a 
credible plan now. The support and our enactment of a credible 
plan would have an incredible impact, I think, on our economy, 
and that all factors need to be part of the solution.
    The difficulty is that Congress will normally take up 
issues on a specific matter, and then the discipline seems to 
break down. We will have a true emergency--a natural disaster, 
a Katrina. We will have a national security issue that we 
obviously have to respond to. And then we sort of say, well, we 
will take care of that, and we do it in a different manner. 
Well, we understand that. But then other matters get 
categorized as emergencies or urgent issues, and we make 
separate exceptions.
    I agree that we need to do this in a balanced way, but it 
seems like domestic discretionary spending is always the one 
that is in the focal point and usually takes the brunt of this 
type of discussion.
    So I was pleased that the President mentioned discretionary 
domestic spending first, and I want to try to get the relative 
impact of what the President said. In your CBO baseline, what 
projections are you making in regards to discretionary domestic 
spending?
    Mr. Elmendorf. So the procedure that we follow and have 
followed for years is to take the latest level of 
appropriations that the Congress has approved and then to 
increase that over the remainder of the decade with our 
estimate of inflation so as to maintain the same inflation- 
adjusted or real level of appropriations for those programs.
    Senator Cardin. And the President mentioned the freeze for 
5 years. Would that be different than what you had in your 
baseline?
    Mr. Elmendorf. Yes, that would.
    Senator Cardin. Could you tell us what additional savings 
would be brought in by the President's recommendation if we, in 
fact, did a freeze on discretionary domestic spending over the 
next 5 years?
    Mr. Elmendorf. So we did a calculation that I think is 
relevant. I do not know precisely what the President is 
proposing, and, of course, he has not released his budget. But 
we did a calculation that involved freezing all non-defense 
discretionary spending except that that was directed by the 
Subcommittee on Homeland Security of the Appropriations 
Committee. And if one freezes that for 5 years and then at the 
end of the 5 years increases with inflation, but at a level 
that remains below the level that would otherwise have been in 
place, the savings over the decade are about $400 billion.
    Senator Cardin. Thank you. Now, you mentioned three policy 
issues that are not in your baseline but are actively being 
considered by Congress for extension: the alternative minimum 
tax, the extension of the tax issues that were passed in 
December, and the physician reimbursement under Medicare. Let 
me take them, if I could, separately.
    Could you give me a comparable number as to what negative 
impact each of those three policies would have on your 
projections?
    Mr. Elmendorf. Yes, I think I can. For other people, there 
is a table in our outlook, Table 1-7 on page 22, that gives the 
budgetary effects of a variety of policy alternatives from 
which these numbers are drawn.
    The effect of extending the income tax and estate and gift 
tax provisions, scheduled to expire at the end of next year, is 
about $2.5 trillion over the decade.
    The effect of indexing the AMT for inflation is about $700 
billion over the decade.
    In fact, there is an interaction between those two 
policies. The money collected under the AMT depends on the 
level of regular tax rates. So if one both does the extension 
and indexes the AMT for inflation, there is another almost $700 
billion of revenue.
    So the extension of those tax provisions and indexing the 
AMT together add $3.8 trillion to deficits over 10 years, and 
then additionally there would be extra interest costs as well.
    The effect of maintaining Medicare's payment rates to 
physicians is about $250 billion over the decade.
    Senator Cardin. Thank you. The reason I mention that is 
that, you know, we spend a lot of time on the spending bills 
here, and there is a lot of pain as we talk about bringing down 
Federal participation in programs that our local governments 
need or we need for our roads or we need for those who are the 
most vulnerable. And we have to do that. I think we all 
understand that. Part of bringing the budget into balance is 
that we are going to have to make those types of sacrifices. If 
we do that, we will bring about savings in the budget.
    But then if we talk about the tax issues and just say, OK, 
well, you know, taxes are different, it pales in comparison, 
the extra deficits, what we are doing on the tax side based on 
all the good work we do on the spending side.
    Now, I have not gotten to the military yet. Your baseline 
assumes what for military spending?
    Mr. Elmendorf. Well, as for non-defense spending, we take 
the latest level of appropriations provided by the Congress and 
increase that with inflation. Under the current circumstances 
where a good deal of money is being spent in Afghanistan and 
Iraq, that level may not be a good representation of what you 
or your colleagues would think of as the sort of base level of 
defense spending you would like to provide. And we also provide 
in the same table in the outlook some alternatives that involve 
different paths for defense spending.
    Senator Cardin. So you are taking a lower projection for 
the future than using the current----
    Mr. Elmendorf. No. We are taking the current. That is what 
I am trying----
    Senator Cardin. But you believe there will be some savings 
in the next 10 years as far as the spending in Afghanistan, or 
you----
    Mr. Elmendorf. Well, I am just saying that you and your 
colleagues have often asked us the question about, well, we 
think--you think this is higher than what you anticipate to 
provide in the future, so----
    Senator Cardin. So your baseline starts with the current 
level of military action that we are participating in.
    Mr. Elmendorf. Yes.
    Senator Cardin. So if, in fact, we bring down the military 
action and do not have to spend as much on our soldiers 
overseas, we can bring some back, that in and of itself would 
give us some savings that are not in your baseline.
    Mr. Elmendorf. Yes. In and of itself--let me just add----
    Senator Cardin. I understand there are going to be 
tradeoffs.
    Mr. Elmendorf. Let me just add quickly, when Secretary 
Gates has talked about savings that he would like to implement 
in the base defense budget, not counting those operations, the 
savings that he is discussing is from a higher level than our 
baseline. He is discussing savings relative to the budget plan 
that the Defense Department has put out. So those savings bring 
down that budget plan in the direction of but not all the way 
to our baseline.
    Senator Cardin. Of course, if the recent years are any 
indication, the numbers are going to probably be higher, 
because they have been higher than, I think, your--if we go 
back 3 or 4 or 5 years ago, what CBO's baseline was on military 
spending as to what we are spending today, we are spending 
more, if I am----
    Mr. Elmendorf. Well, so part of the problem is that 
depending on where in the year we have done the projections, 
whether the Congress has at that point enacted the sort of 
supplemental appropriations that have gone for overseas 
contingency operations, we tend to be extrapolating first the 
higher number, then a lower number, then a higher number. There 
has been an odd sort of ping-ponging that I think has been hard 
to follow.
    Senator Cardin. My time is up. I wanted to do the same 
thing with the entitlement spending. I did not have a chance to 
go through the analysis. But I guess my point is this: All of 
the major areas need to be on the table, and that was, I think, 
the credibility of the Debt Commission, Mr. Chairman. I must 
tell you, I think all of us were proud that the recommendation 
was balanced. Again, you know, we do have problems with 
provisions, but you have to have all at the table. Let us not 
just pick on discretionary domestic spending.
    Chairman Conrad. Thanks, Senator.
    Senator Cornynis next. I want to welcome Senator Thune to 
the Committee. He was not here when we welcomed new members. I 
want to extend our welcome to Senator Thune as well to the 
Committee. We look forward to working with you.
    Let me just indicate to members, I try not to interrupt 
Senators when they are questioning, even though they may be at 
the end of their time. If you will kind of look, when I hold up 
the gavel, I prefer not to tap it on members, but if you will 
try to stick close to the time, in fairness to others.
    Senator Cornyn.
    Senator Cornyn. Thank you, Mr. Chairman.
    Dr. Elmendorf, welcome, and let me start out by saying how 
much I, and I know other members of the committee and Members 
of Congress, appreciate the professionalism and integrity of 
your office. I know the numbers that you report are often 
batted around and spun in different ways, which must be a 
source of tremendous frustration to you, but you have always 
seemed to keep your cool despite that, and it is important that 
we get good numbers and thank you for that.
    Mr. Elmendorf. Thank you, Senator. That means a lot.
    Senator Cornyn. You know, unfortunately, when we talk about 
the budget and the economic outlook, though, I feel like Mark 
Twain when he said, ``Everyone talks about the weather but 
nobody ever does anything about it.'' I think Congress is 
guilty of that, and that is why I was pleasantly surprised, Mr. 
Chairman, when you and other members of the President's Fiscal 
Commission came out with what I thought was a bold and dramatic 
and sobering report. And so I hope, and I still hope, that we 
will take the opportunity to deal with this crisis, and I do 
believe it is approaching a crisis. We do not know when the 
tipping point will come, but we are almost there. And so we 
cannot just talk about the economic outlook and the budget. We 
have to do something about it. I do think that there is an 
opportunity, a window for us to do it.
    Now, I heard you say we have to be careful about the pace 
of some of the austerity measures because it could further 
depress the economy, and I hear you loud and clear on that. But 
I think the political reality is we have a short time to do 
this, and if we do not do it within this six to 9 months, then 
the opportunity will be lost.
    So I am anxiously awaiting the President's budget, which 
will come the week of February 13, to see whether the President 
himself is serious about the crisis that was so well documented 
and explained by his own Fiscal Commission, and I hope that 
opportunity is not squandered by the same old, same old sort of 
thing that seems to happen time and time again.
    But just to--I know we have talked a lot about the need to 
cut, but you alluded to the crowding out effect of more Federal 
Government borrowing on private access to private credit and I 
would like to just talk to you briefly about the importance of 
not just cutting, but growing the economy. I know when Senator 
Portman was over as OMB Director at the beginning of 2007, the 
budget deficit was 1.2 percent--1.2 percent. Now, it is around 
10 percent. One reason why it was low is not because we were 
not spending money, because we were, but because the economy 
was booming. Jobs were being created. The coffers, the Federal 
Treasury was getting a lot of money. But now, for the reasons 
the Chairman mentioned, not only are we continuing our bad 
habits in terms of spending, indeed growing spending, the 
amount of money coming in because the economy is hurting, 
because people are out of work, losing their homes, it is a 
double whammy.
    So let me ask you, on page 51 of the Budget and Economic 
Outlook, you have some economic projections in terms of growth 
of our Gross Domestic Product, and I believe I heard you say, 
and this appears to say on page 51, that in 2011, you are 
projecting the Gross Domestic Product to grow at 3.1 percent, 
is that correct?
    Mr. Elmendorf. Yes, that is right.
    Senator Cornyn. Can you tell us at what point, how much 
growth of the Gross Domestic Product is required to see a net 
increase in employment? In other words, I assume with new 
people entering the work force that there is a level--I have 
heard it before, but I cannot recall the specific number--is 
there a range of growth that we need to see before we are going 
to start to see the unemployment rate coming down?
    Mr. Elmendorf. Well, at that pace that we project, Senator, 
we think the unemployment rate will begin to come down, but 
slowly. We think that the potential growth rate of the 
economy--I should explain what I mean by that, that apart from 
the cyclical issues, if the labor force were almost fully 
employed, if productive capital were almost fully in use, that 
the economic output would grow by maybe up to 2.5 percent a 
year. So if economic growth exceeds that rate, then we are in 
the process, we think, of closing the gap a little bit between 
the potential level of output and the actual level of output. 
That means putting people back to work again and putting 
equipment and plants back to work again.
    Senator Cornyn. Chairman Bernanke testified a couple of 
weeks ago that he thought by 2012, we would still see 
unemployment stubbornly high, in the 8 percent range. Do you 
agree with that, or what is your view?
    Mr. Elmendorf. Yes, I do. So we think that the unemployment 
rate will be down to about 8.25 percent by the end of 2012. 
That is better than it is today, but obviously still well above 
the level that we have seen in strong economic conditions in 
the past.
    Senator Cornyn. Since time is so short, let me just 
conclude on some matters that are of grave concern to me, and 
that has to do with energy costs and some of our policies 
emanating here from Washington having to do with our domestic 
energy supply.
    First of all, I do not think it is any secret that the 
moratorium that was imposed on drilling for oil in the Gulf of 
Mexico, and now that the formal moratorium is lifted, what is 
sometimes called the ``permitorium,'' the failure of the 
bureaucracy to issue permits to responsible producers to 
develop domestic energy, that it is having a dramatic negative 
impact on employment, particularly in the Gulf Coast States, 
but the ripple effect throughout the economy.
    Likewise, we have discovered in the last couple of years as 
a result of modern technology a huge amount of natural gas here 
in America that is available from shale formations. I guess as 
I heard the President talk about green jobs, which sounds very 
good, and certainly we are all for conservation, looking for 
ways to protect the environment as we develop energy sources, I 
was concerned that there was not a whole lot of talk about what 
I would call red, white, and blue jobs, and those are jobs 
created from our domestic energy sources.
    Let me just conclude on this, and I know the Chairman has 
held up his gavel, but let me conclude on this and say, what do 
you see in terms of energy costs, rising energy costs, 
particularly gasoline costs? We see $4 a gallon gasoline by 
summer. What are the rising costs of energy going to do to our 
economy?
    Mr. Elmendorf. I do not know offhand what our projection 
is. Normally for oil prices, which are an important economic 
factor, of course, we look to the futures markets as our 
starting point and follow the path that people buying and 
selling the right to have oil in the future, look at the price 
that they are putting on the oil. I do not think that calls for 
further large increases at this point in the price of oil. I am 
not sure about gasoline prices.
    Mr. Dennis. Oil prices are here.
    [Document handed to Mr. Elmendorf.]
    Mr. Elmendorf. OK. So oil prices, we have rising. They are 
now about $90 a barrel. We have them rising to about $100 a 
barrel by 2017 and $110 a barrel by 2020. Of course, as we have 
seen historically, the price of oil can easily shoot up well 
beyond that and can fall well short of that for periods of 
time. So I think this is an aspect of the forecast that you 
could picture having a very large confidence range around these 
numbers. But we think this is consistent with what is in 
futures markets and with the historical experience.
    Senator Cornyn. Certainly, if a conflict broke out in the 
Middle East and people became concerned about it, those numbers 
could skyrocket almost immediately, could they not?
    Mr. Elmendorf. Yes. That is right, Senator.
    Senator Conrad. Thank you.
    Chairman Conrad. Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman, and Dr. Elmendorf, 
thank you for all your good work.
    In the middle 1980s, Democrats and Ronald Reagan got 
together. They got together on taxes, cut taxes, kept 
progressivity, and grew the economy. And we found a startling 
number a few days ago. In the 2-years that followed that 
bipartisan work, the economy created 6.3 million non-farm jobs. 
That is twice as many jobs as were created between 2001 and 
2008, when tax policy was partisan.
    Now, in your analysis, you, of course, just assume that 
between now and 2012, there will be no changes, and then after 
2012, we will see what happens. What could you tell us--and 
this, of course, would just be a very rough analysis--would 
your fiscal outlook be if, say, in the next 2 years, Democrats 
and Republicans picked up on the kind of work that was done in 
the 1980s and grew the economy? Can you give us any sense of 
how your fiscal outlook would change? Obviously, it would 
change because you are not making any calculations based on 
anything else being done. But just what roughly would you 
suggest might be part of the changed fiscal outlook if a tax 
reform along the lines of what was done in the 1980s was 
enacted?
    Mr. Elmendorf. As you know, Senator, my capacity for 
analysis usually falls well short of your questions. As a very 
general matter, it is a widely held view among experts that a 
tax code that had a broader base, with fewer special 
exemptions, deductions, credits, so on, and thereby could have 
lower tax rates to raise the same amount of revenue, would be a 
more effective tax code in terms of raising revenue while 
producing less distortion to private economic behavior.
    So all else equal, and there is a lot being swept into that 
phrase from your question, a tax code with a broader base and 
lower rates is one that we would expect to be more conducive to 
economic growth. But, of course, we would have to look at----
    Senator Wyden. Which would mean that the fiscal picture you 
have painted today would not be quite the bleak one that you 
have offered.
    Mr. Elmendorf. Not quite as bleak. As you understand, the 
gap between spending and revenues under extension of these 
policies that have been extended in the past is very large. 
That is not a gap that the economy can grow its way out of even 
with----
    Senator Wyden. Understood.
    Mr. Elmendorf [continuing]. The world's best tax system.
    Senator Wyden. Let us talk about the international 
implications of tax law for a minute, if we can. I am very 
interested in seeing the corporate rate cut considerably and 
have proposed cutting it from 35 to 24 in order to encourage 
manufacturing in the United States. In effect, that would 
provide us an opportunity to repatriate some of the money that 
is parked overseas back here in the United States again to grow 
the economy.
    Have you all done any analysis with respect to an approach 
that, in effect, would promote that kind of repatriation 
through a tax code that incented job growth in the country?
    Mr. Elmendorf. I do not think we have studied that in 
particular, Senator. We actually are doing some work right now 
on different approaches to taxing international corporations in 
work that we hope to present to the Congress in a few months. I 
do not think we have studied that particular proposal, at least 
as of yet.
    Senator Wyden. I hope you will, and I will followup with 
your staff on it because I think it is important. I think we 
know that billions and billions of dollars are parked offshore 
right now and we ought to make it more attractive to repatriate 
that money through tax law and incent private sector job growth 
in our country.
    I am going to ask you the same question I asked Dr. 
Bernanke with respect to tax law, and that is the effect of 
doing just corporate tax law changes rather than individual tax 
law changes at the same time, because my sense is, because most 
businesses pay taxes as individuals, not as C Corporations, you 
really have many interactions. And Dr. Bernanke said that he 
thought tax reform needed to be done in a holistic way, 
corporate changes and individual changes concurrently. Do you 
generally share that view?
    Mr. Elmendorf. Well, I think from the perspective of an 
analyst, tackling all the aspects of a general problem at once 
seems most effective. Of course, it is up to you and your 
colleagues to judge how many changes you can think through and 
agree upon in a finite period of time. I mean, as you 
understand, both the corporate tax reform and individual tax 
reform agendas are incredibly long and complicated. But yes, I 
think from an analytic perspective, trying to think about all 
the pieces of the tax code together would be most effective and 
most appropriately.
    Senator Wyden. I simply think the interactions between what 
individuals pay and what businesses pay is now so intertwined 
with sole proprietorships, LLCs, partnerships, and others that 
to just say you are going to split off one piece of the tax 
code and touch on reform there is to vastly oversimplify this 
and create a lot of distortions.
    One other question. What are the growth implications of 
doing taxes on a temporary basis? Let me just read you a 
sentence from the Wall Street Journal toward the end of the 
year, and I will quote it. ``The United States now has no 
single permanent tax regime for levies on salaries, capital 
gains and dividends, a Social Security tax, or a slew of 
targeted breaks for families, students, and others.'' So in 
effect, what America has done is to put the tax system on a 
permanently temporary basis. We are phasing things in. We are 
taking things out. We have a permanently temporary tax code.
    What are the growth implications of having something that 
is now a gerry-built, temporary system rather than to look, as 
I tried to do at those 1986 numbers, which to me are just eye-
popping. To think that when Ronald Reagan and Democrats got 
together, in 2 years, they created more jobs than you saw in 8 
years of partisan tax policy, what would be the benefits of 
looking beyond a temporary approach?
    Mr. Elmendorf. I think the temporary nature of our current 
tax system, if you will, is damaging to the economy. We hope 
and expect that businesses and families are planning ahead, 
that they are making decisions now, making investments for the 
future, and it is very difficult for them to make those sorts 
of decisions in an informed and thoughtful way if the tax rates 
that will apply to them a year or two or three or four down the 
road are so uncertain. And I think that resolving that 
uncertainty would encourage and support household decisions, 
business decisions, investment, and hiring, probably.
    Senator Wyden. Mr. Chairman, my time has expired, but 
because we are all going to be working closely under your 
leadership over the next 2 years, I want to touch on this last 
point that Dr. Elmendorf made about the nature of a temporary 
set of tax policies. If we have, Mr. Chairman and colleagues, 
the same debate in the lame duck session of 2012, where we are 
once again talking about extending the tax law today for two 
more years, Dr. Elmendorf has told us that will be damaging for 
the economy and the country. So with your leadership and 
Senator Sessions, my hope is that this time, over the next 2 
years, we can make permanent pro-growth changes to tax law, get 
it done in this Congress, and not just re-litigate another set 
of temporary tax law changes in the lame duck session of the 
2012 Congress which Dr. Elmendorf has just told us would be 
very damaging.
    Mr. Chairman, thank you for that extra time, but I think 
the point Dr. Elmendorf made is especially important there at 
the end.
    Chairman Conrad. Thank you for that.
    Senator Sessions is now back. He was at another hearing 
that required his presence. I think it is probably most 
appropriate that we go to him for any opening statement he 
would want to make and then we will resume questions.

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. Thank you, Mr. Chairman. It was a 
critical hearing that I had to be at involving my State----
    Senator Wyden. Your microphone is not working.
    Senator Sessions. Maybe I can just move over here.
    Chairman Conrad. It is working now.
    Senator Sessions. OK. That is better. Senator Wyden, 
fundamentally, you are absolutely correct. I mean, a permanent 
tax policy is better than an uncertainty, and we have too much 
uncertainty in our economy and we do need more stability. You 
have come forward with some proposals and ideas that I think 
are worth serious consideration and I look forward to working 
with you on it. I truly believe that you are attempting to 
accomplish something in an effective way.
    I congratulate you, Mr. Elmendorf, for your reappointment 
at CBO. You have carried out your duties, I believe, with 
honesty and integrity and I look forward to working with you 
again. You have some rather specific controls on how you score 
and evaluate matters. It is not your fault. They have been 
established and you follow them, I think, objectively, whether 
we like the outcome or not. The rules are set up mostly by 
Congress.
    So we got the new baseline from CBO yesterday. The news was 
not good. Our deficit is expected to reach nearly $1.5 trillion 
this fiscal year as of September 30. That is well above what we 
were projecting not long ago. Our gross debt is expected to 
reach 100 percent of GDP, meaning the amount of all the money 
our nation owes will soon be equal to the value of everything 
our nation produces. That is above the level, the 90 percent 
level that Rogoff and Reinhart can calculate in their fine, 
valuable book and analysis of nations who have defaulted on 
their debts. The 90 percent rate is significant. They find it 
is a significant number, and we are above that.
    Forty cents of every dollar we spend is borrowed. By the 
end of the decade, the interest on our debt is expected to rise 
to nearly $750 billion in 1 year. That crowds out spending. 
People would like to spend more on a host of projects, and I 
would like to do that, too, but we are going to have $750 
billion less because, first, we have to pay interest on the 
surging debt that we have.
    Former Federal Reserve Chairman Alan Greenspan said 
recently that we have almost a 50-50 chance of a bond market 
crisis in the next 2 years. That is the quote up there. It was 
apparently at the Wall Street Journal interview, and I thought 
that was something that we should hear. I mean, this is a man 
of wisdom. He has been around a long time and he said the only 
question is will this debt bond crisis be before--excuse me, 
that the kind of budget numbers that we need be passed before 
or after the crisis. It would be a lot better, I think we would 
all agree, critical, actually, that we do it before the crisis.
    So the path we are in unsustainable, yet I have to say that 
President Obama in his State of the Union Address announced 
fundamentally we would just continue as we are. To hear the 
President's remarks, one would think his speech had been 
written 10 years ago. They were disconnected from the reality 
of the debt crisis that we face.
    Earlier this week, I said his State of the Union Address 
would be a defining moment for his Presidency and I do not 
think he rose to the occasion. It was a timid speech. It 
squandered a historic opportunity to rally the American people 
behind true spending reform. He had the opportunity to look 
them in the eye, say what the real dangers we are facing are, 
and call on us to meet the challenge as Americans will, if 
properly called. It was far short of the standards set by 
Governor Chris Christie in New York and Prime Minister David 
Cameron in the U.K., in Britain, who are making tough choices.
    No one forced Mr. Obama to be President. As my wife says, 
do not blame me. You asked for the job. He asked for this job 
and he has a real tough job now, and I think he did not lead 
effectively. He proposed instead that we continue a 5-year 
plan, and this so-called freeze on domestic spending is not a 
plan to reduce deficits. It is a plan to preserve the deficits, 
really locking in place the very spending levels that had been 
dramatically increased by President Obama in the past 2 years.
    The plan is remarkable not for its strength, but for its 
weakness. In defense of his proposal, the President argued that 
the government spending is the engine of the economy, that the 
government is the engine of the economy, basically, and he had 
this airplane metaphor backward. The engine of our economy is 
the private sector, not the public sector. When the private 
sector grows, it creates jobs, new industries, new ideas, and 
more tax revenue. But when the public sector grows, it simply 
consumes more of what the private sector produces and big 
government waste is funded on the back on small business 
thrift.
    The American people deserve candor and directness from the 
elected officials. The money to sustain the President's big 
government vision, the more investments he called for, is 
simply not there. We do not have the money. Meaningful spending 
reductions are not a choice, they are an obligation. There is 
no serious alternative. We need to take the tougher road, but 
the road that leads to prosperity. Reducing the size and cost 
of government may not be easy, but it is the only responsible 
course, the only one that will lead us to a better future.
    So, Mr. Elmendorf, I look forward to discussing the issues 
with you now and as we go forward through the next years. 
Together, I believe we can make some progress.
    Mr. Chairman, there is nobody that has seen this and 
studied it more carefully than you, and I look forward to 
seeking your advice as we go forward, also.
    Chairman Conrad. Thanks, Senator Sessions. You know, it may 
turn out it just falls to us on this committee to put forward a 
plan. It may be that since the Commission did not get 14 of 18, 
it may just be that we have to go back to a process that worked 
on this committee when I first came here, which is to have a 
real markup and for this committee to lead.
    Frankly, I have never thought that on a problem of the 
dimensions of this one, where we typically do 5-year budgets, 
almost always do, in this circumstance, which really requires a 
plan that extends way beyond 5 years, that this was not the 
forum to sort it out. But I am not sure anymore. I am not 
certain that it is not going to fall to us to put a plan out 
there for our colleagues on the floor. I am going to be having 
discussions with members of the committee on both sides to see 
what the feeling would be about our taking this on and laying a 
plan before our colleagues, because this is the Budget 
Committee. Even though we have typically been limited to 5-year 
plans, maybe we are the only ones who are going to have the 
opportunity to lay out a comprehensive plan absent some kind of 
summit.
    I prefer, I think the thing that makes the most sense is 
there is a summit between the White House leaders and the House 
and the Senate, because at the end of the day, the White House 
has to be at the table, and unfortunately, in the congressional 
budget process, the President is left out. The President sends 
us a budget, but then Congress passes a budget and it never 
goes to the President. It never goes to the President for his 
signature or his veto.
    But if there is not going to be a summit, there is not 
going to be some kind of negotiation, maybe it is going to fall 
to us on this committee to put forward a plan.
    Senator Manchin is next.
    Senator Manchin. First of all, let me congratulate you on 
your reappointment.
    Mr. Elmendorf. Thank you, Senator.
    Senator Manchin. We are glad too that we all agree on 
something. With that being said, sir, a couple questions very 
quickly.
    On health care, as you know, you scored health care, and 
you see where we are right now with the bill being sent over in 
a repeal, and I have heard of the $200 billion score on that 
that it would cost us. Can you elaborate on that and a little 
bit about the mandates, what the mandates would do if they were 
eliminated? And also from a State's perspective, the 133 
percent, Medicaid. And I am not sure if anyone really 
understood where we were--as States at that time, where we were 
coming from, the Governors were coming from. Most States do not 
cover 50 percent of the people that qualify, and we jumped 
from, let us say, the 50 percent all the way to 133, which we 
had a hard time swallowing. If you could talk about that, and 
then I have one final question, sir.
    Mr. Elmendorf. OK. You raise a lot of complicated issues 
there, Senator.
    The original legislation as enacted last March, both the 
Patient Protection and Affordable Care Act and the health care 
parts of the reconciliation act, set in place substantial 
expansion of Federal entitlements for health care and paid for 
that expansion by setting in place new tax revenues and by 
trimming money from existing health program, in particular 
Medicare, and by trimming the money from Medicare in a way in 
which the gains to the Government budget would increase over 
time because the trimming was of a sort of reducing the rate of 
increase of payments to providers. And in our analysis, the 
combination of the extra tax revenue and the reductions in 
spending laid out in the legislation exceeded the cost of the 
new entitlement, so the legislation had in our assessment last 
March a small positive effect on the Federal budget.
    Therefore, in the preliminary analysis that we prepared in 
time for the House vote, we concluded that repealing that 
legislation would have a small negative effect on the Federal 
budget. We are in the process of constructing a full cost 
estimate of the repeal legislation and which we make available, 
of course, as soon as we have completed it.
    One of the many questions we were asked along the way of 
the health debate of the past 2 years, in addition to the 
Federal budgetary effects, was the effect on State government 
budgets. And as you said, the expansion of Medicaid in that 
legislation put additional burden on States. The expansion was 
set in place in a way where the Federal Government would pay a 
larger share of the cost of the new people made eligible for 
Medicaid than it does under the current Medicaid program but, 
nonetheless, would not pay all of that bill. And, in fact, the 
share the Federal Government will pay of those newly eligible 
people actually declines a little bit over time.
    Our latest estimate is that the State's share of the costs 
associated with that Medicaid coverage expansion will be a 
little over $60 billion during the 2011-2021 period, the period 
covered by this latest outlook.
    Senator Manchin. But 2014, that is when the States--it 
basically goes into effect, the expansion of Medicaid?
    Mr. Elmendorf. Yes, that is right. We tend to report 10-
year numbers--11 years counting now, but, yes, it is 
principally 2014 and beyond. It is not our place to judge, of 
course, how States can deal with that or whether it is 
appropriate to do that. I will say that estimate incorporates 
our expectation of changes in State behavior in response to the 
higher burden that they will face. So our estimates cannot 
incorporate changes in law that you and your colleagues might 
implement at the Federal level----
    Senator Manchin. Yes.
    Mr. Elmendorf [continuing]. But our estimates do 
incorporate responses by families and businesses, in this case 
it is doctors, and in this case by State government.
    Senator Manchin. If you would do me a favor, because I want 
to move on to another question, if you would just give me--and 
if you could score the reduction from 133 to 100.
    Mr. Elmendorf. I would have to talk to you about----
    Senator Manchin. 133 to 100, and also if the mandates were 
removed and if there is an offset there. If we could talk about 
that after.
    Mr. Elmendorf. Yes, we will talk with you, Senator.
    Senator Manchin. The other thing, the Debt Commission, I 
was very proud of the Debt Commission. I will tell the Chairman 
that, and everybody that worked so hard and the courageous 
stance you all took, and I appreciate that very much. But, you 
know, in West Virginia every family sits down and works through 
their budgets, and they set a budget and stick with it. Most 
States have a budget balance amendment, and I want to know what 
your thoughts would be for this Federal Government, because it 
does not seem to me that we are ever going to have the will to 
tackle the problems that we have to and the votes that are 
going to have to be made unless there is a balanced budget 
amendment that forces us. And it would do it over a period of 
time because ratification would take some time to do it, and it 
would give us a chance to get our financial house in order. But 
it sets a firm grip, and you know the States are going through 
some very, very challenging, difficult times and making some 
difficult cuts, and they are looking at the Federal Government 
and saying, ``Why can't you all do it? We are doing it. We are 
taking these severe cuts. We are making these tough votes. But 
we do not see anything coming from Washington.''
    If I could hear your response on a balanced budget 
amendment on constitutional change of how we do business in 
Washington.
    Mr. Elmendorf. So, Senator, I do not think it is 
appropriate for me to make a recommendation for or against that 
sort of change, but----
    Senator Manchin. Can you tell me if it would be----
    Mr. Elmendorf. I would make a few observations.
    Senator Manchin. Yes.
    Mr. Elmendorf. I think one is that the set of budget rules 
set in place in 1990 regarding caps on discretionary spending 
and a pay-as-you-go system for mandatory spending and taxes 
seemed to analysts to have been effective at helping to guide 
decisions of the Congress, as long as there was the focus in 
the Congress on the deficit reduction. Once the budget improved 
and that focus dissipated, then those restrictions were no 
longer effective. It was the----
    Senator Manchin. But wouldn't a balanced budget amendment--
--
    Mr. Elmendorf [continuing]. Combination of rules----
    Senator Manchin [continuing]. Hold this check in balance?
    Mr. Elmendorf [continuing]. And the focus in the Congress. 
Amending the Constitution to require this sort of balance 
raises risks that you are aware of. The automatic stabilizers 
that the Government has, the Federal Government has, the fact 
that taxes fall when the economy weakens and that spending and 
benefit programs increase when the economy weakens in an 
automatic way under existing law is an important stabilizing 
force for the aggregate economy. The fact that State 
governments need to work, as you said, against those effects in 
their own budget, need to take action to raise taxes or cut 
spending in recessions undoes the automatic stabilizers 
essentially at the State level. Taking those away at the 
Federal level risks making the economy less stable, risks 
exacerbating the swings in business cycles.
    Senator Manchin. But you would agree that we are very 
unstable right now?
    Mr. Elmendorf. Yes, the automatic stabilizers are not 
perfectly stabilizing, but taking them away would have costs 
that you and your colleagues would have to weigh.
    The other thing to say, of course, is that that amendment 
does not suggest--it does not by itself say how you or your 
colleagues would change taxes or spending----
    Senator Manchin. Would you be asked to score a balanced 
budget amendment?
    Mr. Elmendorf. No, I do not believe that we score 
amendments to the Constitution. We estimate the effects of 
legislation that you and your colleagues are considering.
    Senator Manchin. That would be good. I would like to talk 
to you further about that, but the balanced budget amendment is 
very, very important to me and to every Governor, to every 
State, to every household, especially in West Virginia. And if 
they can do it, they think we can do it also.
    Senator Sessions. Mr. Chairman, I did not ask any questions 
on my first comment. Could I have just 2 minutes to ask a 
question?
    Chairman Conrad. Senator Ensign, is that OK with you?
    Senator Sessions. Without Senator Ensign losing his place.
    Chairman Conrad. OK. We sort of have an unusual situation. 
It is a little unfair to do that, but you are the Ranking 
Member, so we will make an exception.
    Senator Sessions. You are a great Chairman, and I thank 
you.
    [Laughter.]
    Senator Sessions. Magnanimous.
    Governor Manchin, with regard to the score of the health 
care bill, Mr. Elmendorf, the money that you have referred to 
that came in through the bill was Medicare trims or Medicare 
cuts and tax increases, most of which were Medicare tax 
increases, I believe, and that money was used to fund the new 
program.
    But two things are important. First, Mr. Elmendorf has made 
crystal clear you cannot count that money twice. It cannot 
increase Medicare and fund the new program. This is a very 
serious matter that we are talking about. Very serious. And so 
isn't it true that the Treasury--the new health care program is 
not given new money to fund the new health care program, but 
the money they got from the Medicare tax increases and the 
Medicare cuts is borrowed by the Treasury and that the Treasury 
owes that money back when Medicare continues in default or goes 
into default and claims its money back?
    Mr. Elmendorf. So let me try to--so Senator Sessions is 
referring to a set of letters that we sent at his request in 
December of 2009 and January of 2010, and the way I would 
describe this is that the analysis that CBO does of legislation 
is done on a unified budget basis, taking into account all the 
pieces of spending and revenues. And we report the net effect 
of legislation on spending and revenues and the deficit as a 
whole.
    The cutbacks in Medicare spending, which were large in that 
legislation, as I have said, together with revenue increases, 
more than offset in our judgment the extra spending on the new 
health entitlements and expanded health entitlements.
    It is also the case, as you are saying, Senator, that the 
savings in Medicare, and particularly the savings in the 
Hospital Insurance part of Medicare, HI or Part A of Medicare, 
then lead to a greater accumulation of bonds in the HI trust 
fund. As we wrote in the letter to you, those bonds have 
important legal meaning. They are real U.S. debt backed by the 
full faith and credit of the U.S. Government like the debt sold 
to the public.
    They do not have independent economic meaning in the sense 
that the fact that the trust fund has an accumulation of bonds 
does not give the trust fund some separate way to pay Medicare 
benefits, except, as you say, Senator, by coming back to the 
Treasury, redeeming those bonds, and getting that cash in the 
future.
    Another way to say that is just that paying Medicare 
benefits in the future relies on tax revenue that will be 
raised in the future or borrowing that will be done in the 
future, cannot depend directly on the bonds in the trust fund.
    Senator Sessions. I think that is fair. I think all of us 
need to understand that. But I would go a little bit further. 
It increased the internal debt of the U.S. Treasury because the 
money expended for the health care program is borrowed from 
Medicare, at least a substantial portion of it. And when 
Medicare, since we know it is going into default, inevitably 
will call those bonds, the United States Treasury will either 
have to raise taxes or borrow it on the economy or deflate the 
currency, which are the three choices governments have. Isn't 
that basically correct?
    Mr. Elmendorf. I mean, you are right. The money is being 
borrowed from the Medicare Trust Fund, and that----
    Senator Sessions. It increases the internal debt, the gross 
debt of the United States.
    Mr. Elmendorf. And it increases the gross debt of the 
United States, yes, absolutely.
    Chairman Conrad. I thank the Senator, and I thank him 
actually for making the point because we have that same issue 
with Social Security. You know, the hard reality is--I hear it 
all the time. Social Security has trillions of dollars of 
assets. That is true. There are trillions of dollars of assets. 
They are special purpose bonds backed by the full faith and 
credit of the United States. Those are real assets. The problem 
is the only way those bonds are redeemed is out of current 
income, and Social Security is going to go permanently cash 
negative in 5 years.
    So I have to say, those who have--and I have received the 
lash from those who say, well, you should not have to touch 
Social Security because there are trillions of dollars of 
assets. It is true there are trillions of dollars of assets. It 
is true that they are backed by the full faith and credit of 
the United States. It is also true that the only way those 
bonds get redeemed is out of the current income of the United 
States. And we are about to see a dramatic shift in the budget 
circumstance when we go to having hundreds of billions of 
dollars a year of surplus in Social Security that the general 
fund could borrow to having a circumstance in which there are 
hundreds of billions of dollars of debt that has to be serviced 
out of current income.
    Senator Ensign, I apologize to you because you kind of got 
delayed here.
    Senator Ensign. It is OK, Mr. Chairman. The important thing 
is getting some of these issues out on the table. What you just 
talked about I think is of absolute critical importance. You 
talked about the full faith and credit of the United States. 
That is really what we are dealing with here.
    The Chairman held up, at the beginning of your talk, about 
Moody's and Standard & Poor's, talking about the AAA rating of 
the United States. Japan was just downgraded to AA. What would 
a downgrade from AAA to AA of the United States credit rating 
do to the interest rates and do to your budget projections? 
Because, by the way, your budget projections, in my opinion--I 
know you all try to be conservative, but just as we have seen 
last year, I think this year you projected a $1.1 trillion 
deficit last year, the year before for this year, right? And it 
turned out to be 1.5. And some of that was because of the tax 
policy that was passed at the end of the year. I realize that. 
I am going to ask a question on that. But the bottom line is 
these things can change radically very quickly, and this full 
faith and credit idea, this idea of if the bond raters 
downgrade our bonds, if the Fed is successful--and a lot of 
people think they are going to be successful in raising 
inflation, because that is what they are trying to do right now 
with their monetary supply. Those all lead to higher interest 
rates, higher than what you are projecting. And so that is 
basically the question. If it goes to AA, what does that do to 
your projections for this deficit?
    Mr. Elmendorf. So if the Federal Government's credit rating 
were lowered, that would certainly push up the interest rates 
the Government would pay, and thus the interest payments we 
would have to make. We have not attempted to quantify how much 
a given reduction in rating would affect interest rates, but it 
certainly would be an adverse effect for the budget.
    Senator Ensign. And it would not be insignificant. it would 
be very significant. Would you agree with that statement?
    Mr. Elmendorf. I think it would be significant, Senator, 
absolutely.
    Senator Ensign. Yes. And so the point is here we do not--I 
think that you talked about this. The sooner we make these 
changes, maybe the--they are going to be painful. But the 
sooner we make them, maybe a little less painful. As Alan 
Greenspan talked about, we are going to have to make these 
changes. It is just a question of do we do them in the middle 
of a crisis or do we do them to avoid the crisis. And that I 
think is the significant part of this.
    Senator Cornyn mentioned, and, actually, I think Senator 
Sessions mentioned, we need Presidential leadership right now, 
and the Chairman has talked about this, talked about this 
Committee doing its job. I could not agree more. The President 
needs to lead right now. These issues that we are talking 
about--and you have been around. You have seen this, Dr. 
Elmendorf. These cuts--it is much easier to get reelected by 
giving money away, OK? None of us want to make these tough 
political votes. But we have a Democrat President, a Republican 
House, and a Democrat Senate right now. In my opinion, if the 
President would lead, join the two parties together, we could 
do actually what is right for the American people. But it is up 
to him to lead. He is the President. He is the only one with 
the bully pulpit. Our little microphones here do not echo 
through the country. He had it on the State of the Union. I 
think he failed on the State of the Union, personally, but he 
still have plenty of opportunity. We have the CR coming up. We 
have the debt ceiling coming up. There are other opportunities. 
He has his budget coming up. We have plenty of opportunities 
for the President to lead. And forget our party labels. This is 
about the future of our country. The debt that you are talking 
about, the interest on the debt, you have said that is 
unsustainable. It is. It is unsustainable.
    Dr. Elmendorf, the reason you got reappointed by 
Republicans and Democrats is because you do try to call, you 
know, the fair shots. We do not always agree. You know, there 
is always--because what you do is unbelievably difficult to 
predict. But you play within the rules that you are given, and 
some of the rules are not necessarily the best rules for making 
the most accurate predictions as well. But the bottom line is I 
think all economists agree that our country is in serious 
trouble if we do not deal with this debt and deficit problem.
    Four hundred billion dollars that the President talked 
about the other night, what percentage of that is of the debt 
that we are going to accumulate over the next 10 years based on 
your projections?
    Mr. Elmendorf. Well, under the baseline projections in 
which these various tax provisions expire and so on, we expect 
the Government will accumulate about $7 trillion in debt over 
the next decade, so $400 billion is a little over 5 percent of 
that.
    Senator Ensign. It is a drop in the bucket, and actually it 
will probably--we all think it will probably be lower, 
especially if you talk about spending projections, if you talk 
about the alternative minimum tax, if you talk about the doc 
fix, if you talk about all those things that we know are going 
to happen.
    Mr. Elmendorf. So if we extend all of those expiring 
provisions in the way that I talked about at the beginning, we 
look for a debt of $12 trillion under that view of current 
policy over the next decade. And $400 billion is a few percent 
of that.
    Senator Ensign. Yes, and as far as total spending during 
that time, projected spending during that time, what percentage 
of it? My back-of-the-napkin calculations are it is less than 1 
percent.
    Mr. Elmendorf. Yes, that is right.
    Senator Ensign. So the President has basically said, OK, we 
are going to reduce spending by less than a penny out of every 
dollar, OK? When this country--all economists say it is 
unsustainable. This country is literally headed for a financial 
crisis that we maybe have never seen. And for us to sit here--
that is why it is so important for us, in my opinion, to join 
together as Republicans and Democrats with the President to 
tackle this problem.
    You know, Mr. Chairman, what you said with the budget, I am 
willing to join whoever it is, but we have to make such 
difficult--these are going to be painful--politically painful 
is what I mean by painful--politically painful choices to make.
    I agree with Senator Wyden. We have to have the kind of tax 
policy because you cannot just cut your way out of this. You 
have to actually cut and grow. You have to do those at the same 
time. It is the only way you are going to solve this crisis, 
this financial crisis that could be looming on our country.
    So I know there was a lot in there. The only last thing I 
have is State pensions now, Moody's is talking about requiring 
the States to put their pension obligations on their books. OK? 
Now, you talked about these stabilizing factors. What does that 
do potentially to, you know, the whole economic projections 
going off into the future?
    Mr. Elmendorf. So we are actually in the process of 
completing an issue brief on State pensions, which we will 
release very shortly, Senator. I think that is an important 
topic. The issue about the stabilization was mostly in the 
context of sort of year-to-year behavior of State budgets 
during a recession, an economic downturn and a recovery. But as 
you say, a very important long-term financial issue for States 
and local governments is the commitments they have made to pay 
certain benefits to retired government workers and whether they 
have or have not put aside sufficient money to meet those.
    Senator Ensign. Right. Mr. Chairman, I realize my time has 
expired. Just a last comment. It is not in the future. You are 
seeing this. My State is dealing with it right now. My cities 
are dealing with this right now. Cities and States across the 
country are actually dealing with this problem right now. They 
know most of it is in the future, but it is actually affecting 
their State budgets currently.
    Mr. Elmendorf. Yes, that is right.
    Senator Ensign. Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, and thank you for your 
courtesy, Senator Ensign.
    Senator Whitehouse. Thank you, Chairman. And with respect 
to your comment about this Committee becoming a forum for doing 
some of the significant debt and deficit work that we may need 
to do, I can assure you that I am prepared for that work, and I 
think every member of this Committee would be prepared for that 
work. So if it is your judgment to proceed in that way, I think 
you will find that you have both interested and hard-working 
Senators who are prepared to engage in that discussion.
    Chairman Conrad. I thank the Senator for that. You know, I 
have thrown this out as an idea. I think it is going to take 
discussion among all the members of this Committee. Again, I 
personally would prefer that we have a summit that involves the 
President and the leadership of the House and the Senate. But 
if that is not to occur, it has to start somewhere.
    Senator Whitehouse. Director Elmendorf, if you have an 
insurance company and it collects premium in order to make 
payments in the insurance program, it builds up reserves that 
the insurance company holds. And there are times when fires 
take place, Katrinas take place, lives that are insured expire, 
and you have to draw on those reserves. And in those periods, 
the insurance program may go cash negative but remain fully 
actuarially sound.
    As I understand it, our problem with Social Security is 
that it is and has been actuarially sound, will be actuarially 
sound through 2037; but that reserve fund of the incoming 
premium that was set aside was not left alone. Congress took 
it, borrowed it, left an IOU in its place, and spent it on 
other stuff. But I think--I see you nodding. I think it is 
important to point out that Social Security as a program is not 
actuarially at fault for the need that we will have to fund the 
cash needs. The problem that caused the need to fund the cash 
needs is not that there is an actuarial problem with Social 
Security, at least not for a quarter century. And I suspect 
with the President's recommendation that you raise the payroll 
tax cap, that even goes away and it becomes fully solvent 
indefinitely. What has happened is that management went into 
the reserves and took them out and spent them on something 
else. And if this were a private company and I were still an 
Attorney General, I would probably be prosecuting that 
management. But this is Congress, and it is all done in the 
light of day, and everybody was in on it, and it is part of the 
way in which we have done business.
    Is that a fair description of our Social Security problem?
    Mr. Elmendorf. So let me just say, back to the parts that I 
think I understand and that I think I agree with. Social 
Security has sufficient resources, meaning the bonds held by 
the trust fund, that together with the expected inflow of 
payroll taxes it can meet benefits under current law for 
decades to come.
    As you are saying and as Senator Sessions said, and Senator 
Conrad as well, the rest of the Government in a sense used the 
cash, left the trust fund with bonds, which are valuable 
assets. If you were running a private insurance company and had 
U.S. Treasury securities in its vault, you would view that as a 
pretty safe investment for that insurance company. The problem 
is that the rest of the Government used that cash. If, in fact, 
the Government had run surpluses equal to the saving of the 
trust fund over all of those years, then the Government as a 
whole would be in better financial shape due to the surpluses. 
It would be in much better shape to meet those commitments in 
the future. But, in fact, the Government has not run surpluses 
commensurate with the increasing balances in the trust fund, 
and thus, the Government has not improved its financial 
condition using that money. It has mostly used that money for 
other purposes. As Senator Sessions notes, the health 
legislation enacted last March essentially does with the extra 
money building up in the HI trust fund.
    Senator Whitehouse. But it is not an actuarial flaw in the 
Social Security program that causes the need to fund the 
reserves. It is the fact that the reserves were removed and 
spent on other things and now need to be replaced.
    Mr. Elmendorf. I think that is fair, Senator, but I would 
just say again CBO tends to look at the budget in a unified 
budget sense.
    Senator Whitehouse. No, I understand.
    Mr. Elmendorf. In some ways, the underlying problem here is 
to have a trust fund which is building up assets----
    Senator Whitehouse. That has no funds and nobody----
    Mr. Elmendorf [continuing]. Inside a budget that is 
essentially a cash-flow budget. And that is true for the Social 
Security trust funds, and it is true for the Hospital Insurance 
trust fund in Medicare as well. And once one has a trust fund 
building up assets inside a budget that is essentially viewed 
on an annual cash-flow basis, there is intrinsically in that a 
disconnect----
    Senator Whitehouse. It is similar to the----
    Mr. Elmendorf [continuing]. And the risk of the double 
counting that Senator Sessions refers to, just to emphasize, 
not that we cannot keep the numbers straight, but that one has 
to be careful in thinking and talking about----
    Senator Whitehouse. My time is running out. I am sorry to 
interrupt. But is it not similar to the difference between a 
liquidity shortfall and an insolvency problem? You still need--
--
    Mr. Elmendorf. The Federal Government as a whole, there is 
a problem that the total revenues that are expected to come in 
are not up to the total spending expected to go out. And it is 
really at the level of the overall Government that I prefer to 
focus, and I think that budgeteers have focused for a number of 
decades.
    Senator Whitehouse. Let me go on to one other point. I do 
not have a lot of time remaining, but it has been recently said 
that our debt is the product of acts by many Presidents and 
many Congresses over many years. I do want to single out one 
President, and that was President Clinton. As I recall, under 
President Clinton the Nation saw its first budget surpluses in 
decades. And if my recollection is correct, in January of 2001, 
immediately after President Clinton left office and when the 
Bush administration assumed office, it was the finding of the 
nonpartisan Congressional Budget Office, your operation, that 
the Clinton era trends, if they had been continued forward, 
would have led to a debt-free United States of America by the 
end of the last decade. Is that correct? Do I recall correctly?
    Mr. Elmendorf. I believe that is correct, Senator.
    Senator Whitehouse. So I think it is fair in terms of that 
to at least exempt President Clinton from responsibility for 
our deficit. He left us on track to being an actual debt-free 
Nation.
    Mr. Elmendorf. So as you know, Senator, I do not take sides 
on Presidents or Members of Congress. It is worth emphasizing 
that a number of things happened in 2001 that the CBO baseline 
projections in January of that year did not anticipate. One was 
very important changes in tax policy, which our baseline is not 
designed to anticipate. The other was----
    Senator Whitehouse. But those were not----
    Mr. Elmendorf [continuing]. A recession----
    Senator Whitehouse. But those were not the fault of 
President Clinton. He was out of office by then, correct?
    Mr. Elmendorf. Again, I am not--I do not talk in President 
terms. I am talking about----
    Senator Whitehouse. They took place after the President had 
left office.
    Mr. Elmendorf. That is correct, Senator.
    Senator Whitehouse. It is a matter of calendar.
    Mr. Elmendorf. The other thing that happened was that the 
economy fell into a recession, suffered a very large decline in 
the value of stock prices, and then----
    Senator Whitehouse. Again, after President Clinton left 
office.
    Mr. Elmendorf [continuing]. Revenues fell very--well, in 
fact, at the time there was some dispute about exactly when the 
recession had started. The----
    Senator Whitehouse. But as of January 2001, you were 
predicting a debt-free Nation. Your organization was predicting 
a debt-free Nation.
    Mr. Elmendorf. Yes, but the point I am trying to make is 
that there were economic developments and changes in the amount 
of tax revenue collected for a given economy that were also 
adverse to the budget outcomes. And I do not remember offhand--
I think CBO has looked at this, but I do not remember offhand 
how much of the deterioration in the budget that occurred after 
that was due to legislation and how much was due to revisions 
to the economic and technical projections based on----
    Senator Whitehouse. I understand, and I am not trying to 
fault your predictive capabilities, and I am not trying to 
fault the January 2001 report. I am just trying to point out 
that at least one President really did the best that he could. 
And that is not something you need to react to, because I know 
you do not speak in those terms, but for the sake of my 
colleagues.
    Thank you. My time has expired.
    Chairman Conrad. Senator Johnson.
    Senator Johnson. Thank you, Mr. Chairman. I would like to 
just comment on your earlier comments in terms of I believe 
this country hungers for leadership, and I certainly would be 
one willing to step up to the plate, also, and take the lead on 
this budget, trying to restore some fiscal sanity to this 
nation.
    Chairman Conrad. Well, I thank the Senator for that.
    Senator Johnson. Thank you.
    Dr. Elmendorf, just a couple of quick questions. Getting 
back to dynamic versus static scoring, does the CBO ever go 
back and study what estimates it had done from the standpoint 
of revenue and figure out what the actual results were and just 
compare what your estimates were?
    Mr. Elmendorf. We certainly do go back and look at our 
performance as best as we can evaluate it. We do not do the 
revenue estimates. We do the revenue baseline projections in 
this report, but the estimates of the effects of particular 
pieces of revenue legislation are done by the staff of the 
Joint Committee on Taxation, so we do not go back and 
reevaluate those.
    We do look at our economic forecasts and report once a 
year, I think, on how accurate they have been. Every outlook or 
update reports on the revisions from the previous outlook, so 
one can see where--you can see as well as we can see where we 
have gone wrong.
    We also look back when we can at how different pieces of 
legislation have unfolded relative to our estimates on the 
spending side. That can be harder to do than one might expect, 
because many forces are impinging on the outcomes, and the fact 
that the outcome looks different than we thought it would at 
the point the legislation was passed might be that we had the 
wrong estimate of the legislation, or it might be we had the 
wrong estimate of everything else that was going on.
    Senator Johnson. Sure.
    Mr. Elmendorf. So it is harder to tell, but we do try.
    Senator Johnson. I guess I am really trying to zero in on 
revenues, in particular, and I am thinking in reaction to if 
taxes are going to increase, do we really get this tax revenue 
that we were expecting, to do those types of studies. So if you 
know of anybody who has done that, I would be interested in 
seeing that in my office.
    In terms of scoring the health care bill, did you estimate 
how many businesses would probably drop coverage, and as a 
result, how many individuals would be put into the exchanges 
and then what the cost of that effect would be?
    Mr. Elmendorf. Yes, Senator. So our estimate of the effects 
of the legislation on the number of people with employer-
sponsored insurance, which was a small net decline, represented 
the net of a larger gross decline with some offset of 
additional insurance coverage by some employers. And that 
estimate accounted for the new subsidies being created through 
the insurance exchanges and the expansion of Medicaid. It also 
accounted for the existing subsidy provided through the tax 
exclusion for employer-sponsored health insurance. It accounted 
for the penalties that were imposed on individuals and 
businesses and the small business tax credit and so on.
    And we thought that the overall effect of that set of 
provisions would be that some number of people would not 
receive insurance through their employers who otherwise would 
have. Some others would get insurance through their employers 
who would not have otherwise. And the net of those was fewer 
people getting health insurance coverage from their employer 
than would have been the case under prior law.
    Senator Johnson. Do you have some estimated numbers? Is it 
a million people----
    Mr. Elmendorf. We do, actually. So we estimated that in 
2019, that three million fewer people would have employer-
sponsored health insurance, and that reflects the net of eight 
to nine million who would have had an offer of employer 
coverage under prior law and would not under the legislation 
that was enacted, six to seven million who would not have been 
covered under prior law but would have had the coverage under 
the legislation, and another one to two million people who 
would have an offer of employer-based coverage but would get 
covered in exchanges instead either by having an exemption to 
some of the rules or by sneaking around the rules.
    Senator Johnson. Can you give my office the details of 
that?
    Mr. Elmendorf. Yes, of course.
    Senator Johnson. OK. I would like to talk a little bit 
about--you were talking about the automatic stabilizers of a 
balanced budget amendment. Would an amendment that would just 
limit spending to 20 percent of GDP, or 18 or 19 percent of 
GDP, would that kind of circumvent that problem? Would that 
allow us to have those automatic stabilizers still be 
effective?
    Mr. Elmendorf. Well, it would allow the stabilizers on the 
revenue side of the budget to still be effective, but it might 
impinge on the stabilizers on the spending side of the budget. 
The fact that even apart from an extension or expansion of 
unemployment insurance benefits, if more people lose their 
jobs, more people can collect benefits. Under a given set of 
rules for what used to be called Food Stamps and is now called 
the Supplemental Nutrition Assistance Program, more people get 
benefits. So you would still be impinging on that.
    I also, again, do not know what changes in policy you and 
your colleagues would choose to make to bring outlays down from 
the share of GDP they are now to the sort of levels that you 
are talking about. And as we discussed a few minutes ago with a 
number of members of the committee, the discretionary spending, 
and particularly the non-defense part of discretionary 
spending, is only one piece of the budget and not as large a 
piece as I think many people believe. As you understand, most 
of the spending the government does goes to Social Security or 
Medicare or Medicaid, that the defense spending--everything 
apart from those large health programs and Social Security and 
defense and the net interest payments on the debt, everything 
else is about a fifth of government spending at the end of the 
decade, by our projections. So the sort of reduction that you 
are talking about would, as you understand, require changes 
across a large swath of government spending programs.
    Senator Johnson. I guess the point I am getting at, if you 
had a preference to choose between a constitutional amendment 
to balance the budget versus one to just limit spending to a 
certain percentage of GDP, do you have a preference?
    Mr. Elmendorf. I have not thought about that question, 
Senator, and even if I did, we are not--I do not come here to 
discuss my preferences but the analysis that CBO has done, and 
we can look more carefully into that question.
    Senator Johnson. OK. Just one final question. It might 
actually be kind of a long answer, but maybe not. Can you, in 
layman's terms, describe to a family what a debt crisis would 
look like. What is going to be the effect on individuals?
    Mr. Elmendorf. So if--I will try. If the people we are 
relying upon to lend the Federal Government money became 
skeptical that the government would manage its budget in a way 
that they would get repaid and thus would start to demand 
higher interest rates to compensate them for that extra risk, 
that could push up interest rates throughout the economy that 
would make it harder for households to borrow money. It could 
make it harder for the businesses for which they work to borrow 
money to invest and expand.
    It could--and on the Federal side, if the government were 
unable to borrow the money that it was needing to borrow given 
the paths of spending and revenue, it could require drastic 
changes, sudden large changes in the taxes people are paying to 
the government and in the benefits they are receiving from the 
government of the sort that we are seeing in some European 
nations that have hit a fiscal crisis. And the magnitude and 
suddenness of the changes and what the government would have to 
do under those circumstances, combined with the effects on the 
rest of the economy of that rise in interest rates, would 
clearly be damaging to people.
    Senator Johnson. Thank you.
    Chairman Conrad. I thank the Senator.
    Senator Begich is recognized.
    Senator Begich. Thank you very much, Mr. Chairman.
    A couple quick things. First, Mr. Chairman, I think the 
idea of a summit is fine, but I really believe that the role of 
the Budget Committee should--as a former mayor, what we used to 
do, we would present our budget to the Budget Committee. We 
would have to spend the time to explain. Departments would come 
in and go through it. I know there are jurisdictional issues, 
but it is a Budget Committee, and in my view, I think that is a 
role, and rather than wait to find out what the role is, we 
should seize it and do it and I think this is a great year to 
do it. I am a strong believer in that.
    I am happy to sit here and go through departments and try 
to figure out what the heck they are up to and give our 
version, hopefully in a collective way, of how to move this 
budget forward, or future budgets, because the process of a CR 
is damaging and is irresponsible. Those that continue to move 
that forward on 1-month increments, and I think you would 
agree, I am hopefully not speaking for you here, but CRs are 
bad. They are not healthy for any type of government to do. So 
I think it is in our role and ability to do it, so I would----
    Chairman Conrad. If I could just intercede for one moment, 
because I think this point----
    Senator Begich. Do not take too much of my time----
    Chairman Conrad. No, I will not take any of your time.
    Senator Begich. OK.
    Chairman Conrad. I will not take any of your time.
    Senator Begich. I did that so the staff would take note.
    Chairman Conrad. It is the Chairman's time. Here are things 
people on this committee need to appreciate, especially new 
members. No. 1, we typically only do a 5-year budget. Almost 
all of the budgets that have been done by Congress have been 5 
years. And the problem is, the plan that the country needs goes 
well beyond 5 years.
    The second big problem we have is we do not determine the 
specific policies that are adopted by the committees of 
jurisdiction. We give them numerical targets. We tell the 
appropriators how much they can spend. We do not tell them how 
to spend it. We do not have that authority. We tell the Finance 
Committee how much money to raise. We do not tell them how to 
raise it. And one of the difficulties of the Budget Committee 
being the lead on taking on this task is a lot of the 
compromises that need to occur go to the details, and 
unfortunately, we do not control the details.
    So we tell the Finance Committee how much money to raise. 
We cannot impose on them our views of the policy that ought to 
be attached to that. That is, we cannot tell them, OK, broaden 
the base to raise this money and simultaneously lower the 
rates. We might make that assumption, and in anything we pass, 
we can state what our assumptions are. But this committee does 
not have the authority to determine those specifics.
    So it really puts the Budget Committee in a very difficult 
position to reach agreement on a multi-year plan that has many 
dimensions to it because the specifics become critical. You 
know, what do those revenue numbers really represent in terms 
of policy?
    Again, that will not come out of the Senator's time.
    Senator Sessions. But it also is a little bit easier, too. 
So we do not have to tell exactly what to cut. Maybe we do have 
an opportunity to provide a little leadership.
    Chairman Conrad. Well stated. Senator Begich.
    Senator Begich. Mr. Chairman, I agree with both of you on 
that. You know, if we have those discussions, we may have 
assumptions that we can lay down, but then we at least can know 
what those numbers will be, so I would encourage that.
    The second thing, I think, and before I ask you a question, 
I want to echo what Senator Wyden said on a broader sweep, and 
that is if I was to pick two items, if we were limited to two 
items that this committee would focus on, one would be the 
larger budget and the second would be tax reform. The 
discussion of tax reform in the broader sense, not these 
temporary fixes which I think you said earlier, and I know this 
as a small business person, there is no certainty with these 2-
year fixes. Businesses are not going to invest hundreds of 
millions of dollars, let alone billions of dollars, when they 
have no clue what the tax policies of this country are. They 
are going to go to countries that are more stabilized in this 
element and invest there. And so the certainty of what our tax 
policies are, I think, are going to be very critical long-term, 
and these 2-year fixes, again, I do not think are responsible. 
We need to look at the longer term. So I would echo what 
Senator Wyden said in regards to tax reform.
    A couple quick questions, and it may be information you can 
just provide to my office. One is we hear on a regular basis, 
and I do not know if it would be out of your office or maybe it 
is out of Joint Tax, I am not sure which one would be the right 
one, but I want to get a good, clear picture. I think I know 
this answer, but the picture on who really owns our debt, 
because every time you hear it, you hear all these foreign 
countries, which they do own a portion of it. But the biggest 
holders are retirement funds, Social Security, trust funds, is 
that a fair statement?
    Mr. Elmendorf. Yes, and we actually released a report in 
December on Federal debt and interest costs----
    Senator Begich. And who owns it?
    Mr. Elmendorf [continuing]. And it is owned largely by 
people in this country, but also importantly by people 
overseas.
    Senator Begich. Right.
    Mr. Elmendorf. So it is a combination of both domestic and 
foreign----
    Senator Begich. Do you know the percentage ratio, just 
roughly? Is it about 70-30? Sixty-forty?
    Mr. Elmendorf. It is about half-and-half.
    Senator Begich. Fifty-fifty?
    Mr. Elmendorf. Yes.
    Senator Begich. If you could provide that--we may have it, 
but just if you can provide that segment, that would be great--
--
    Mr. Elmendorf. Yes. Of course, we will do that.
    Senator Begich [continuing]. Because every time you hear 
it, it is the foreign countries own ours, and actually, the big 
chunk of our retirement funds--I can tell you, as a former 
mayor, we invested in U.S. securities all the time because it 
is the safest and the right place to put the money.
    The second, and I know Senator Johnson asked this question, 
is it also fair to say to families' impact, it would be on a 
local level, that it would impact direct services and potential 
services that local governments could provide because their 
ability to borrow would diminish if there is a debt crisis. Is 
that a fair-I just want to make sure that is on the record, 
too.
    Mr. Elmendorf. Yes, I think that is right, Senator. I mean, 
it is very difficult to predict what will happen if there is a 
sudden shift of sentiment against buying U.S. Treasury debt. We 
have not seen that in this country. We have not seen it in the 
world's most important financial market. We do not know----
    Senator Begich. But it is a multi-layer effect. It is not 
just the Federal Government----
    Mr. Elmendorf [continuing]. But the effects, I expect, 
would ripple through the financial system in this country and 
would make it harder for borrowing for local and State 
governments as well as families and businesses.
    Senator Begich. Very good. Let me ask you, and it was an 
interesting question that Senator Johnson asked--and I have 
actually, when we have had some meetings, this is a question I 
always have--in these reports, which are great reports, what I 
would love to get, and if it is possible, and some of the 
baseline information, maybe the GDP, maybe unemployment, 
whatever those items are that you kind of utilize as some of 
your base data in projecting, what I want to see is when I see 
a chart like this, I actually--not that I want to question 
necessarily your track record. It helps me get a sense.
    If I look at 2010, it is a flash point. What I want to see 
is projections that were projected and what happened actually, 
and the reason that helps, at least me, have a better 
discussion of--an analysis of it. So, for example, the 
questions you had from Senator Whitehouse, here are some of the 
things that changed. Why is that important for me? Then I know 
policy that we impact has some impact of what you projected 
originally. Is that available? If we said to you, here are four 
or five areas that you project on into the future, can you go 
back 5 years and tell us, when you sat here, or whoever sat 
here, projected, and then what those deviations and what 
happened, is that something that----
    Mr. Elmendorf. Yes. I think we can do that, Senator. We are 
willing to talk with you about exactly which----
    Senator Begich. Sure----
    Mr. Elmendorf [continuing]. Of the thousands of variables 
you are most interested in, but we certainly keep the records 
and look at them ourselves about how these projections have 
turned out.
    Senator Begich. Great.
    Mr. Elmendorf. So we can put together, I think----
    Senator Begich. We will have our staff work with your 
staff.
    Mr. Elmendorf. Yes.
    Senator Begich. And the goal there is, I believe if you get 
information like that, you can kind of look back and then we 
know if we are the cause which has an effect, or is it 
something else, and that helps, I think, form policy or future 
discussions we might have here.
    The last thing, just as I sit on the Armed Services 
Committee and we are going through, and we are going to go 
through a process here from Secretary Gates and all the 
reductions that will be occurring or are projected, do you 
participate in that at any level in the sense of this. As we 
know, 95 percent, approximately, of every Defense Department 
dollar has a U.S. impact, because they are very focused. Have 
you done any cross-analysis of, OK, if that cut occurs as 
projected, this is the kind of job impact it would be, because 
they are one of the highest in every department we have that 
puts money into this economy. Have you done anything like that?
    Mr. Elmendorf. Umm----
    Senator Begich. Or are you equipped? Two parts. Have you 
done it? Are you equipped to do it if you have not?
    Mr. Elmendorf. I think we have not done it. I think we 
could do it.
    Senator Begich. OK.
    Mr. Elmendorf. So we have looked at the economic effects of 
a variety of policies being considered by you and your 
colleagues, including about a year ago we did an analysis of a 
whole collection of policies that were being discussed as 
possible ways of increasing output and employment, boosting the 
pace of the recovery, and we looked at a number of changes on 
the tax side, a number of possible changes on the spending 
side.
    Senator Begich. OK.
    Mr. Elmendorf. We did not look at defense spending 
separately. We looked at infrastructure spending and we looked 
at changes in grants to State and local governments.
    Senator Begich. My time has expired, so maybe we will work 
with you on it, because Defense Department spending, as you 
know, is a huge part of our budget and the cuts that he is 
recommending are fairly significant, probably the most 
significant of any department that will be reviewed. But 
because they have such a high percentage of job impact of any 
department in U.S. jobs, we will talk to you about, maybe 
through the Armed Services Committee or--I just think it is an 
analysis that should be done.
    Mr. Elmendorf. Yes, Senator. We will be happy to talk with 
you.
    Senator Begich. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Conrad. I thank the Senator.
    Senator Portman.
    Senator Portman. Thank you, Mr. Chairman.
    It is good to be here to hear from you, Dr. Elmendorf. I 
appreciated working with the Congressional Budget Office when I 
was on the House Budget Committee, and, of course, at OMB. We 
did not get a chance to work together since you came after 
that, but I appreciate your testimony today.
    We find ourselves here at a very difficult time, do we not, 
a day after you have told us that we are facing the biggest 
deficit in the history of our country, in fact, in the history 
of the world this year. By the way, these projections are 
notoriously wrong.
    Mr. Elmendorf. Yes.
    Senator Portman. Unfortunately, this one looks like it is 
more accurate than some. I think Senator Whitehouse, perhaps 
inadvertently, just explained to us how wrong CBO projections 
can be sometimes, as they were in 2000, but the fact remains, 
we face a fiscal crisis. I am delighted to be on this 
committee. I just found out last night I was going to be 
joining Senator Conrad, Senator Sessions, and others, and I was 
really encouraged as much as I was discouraged by your 
projections, encouraged by what I heard today from my 
colleagues, including you, Mr. Chairman, and you, Mr. Sessions.
    I think what you said earlier, Chairman Conrad, is very 
significant in terms of looking perhaps beyond the 5-year, 
maybe a 10-year budget and also trying in a bipartisan way to 
do what all of us, I think, acknowledge needs to be done, which 
is to find common ground and solve this crisis before we have 
the kind of economic repercussions you talked about earlier.
    I had a couple of questions that I wanted to focus on and 
that really kind of just go to me understanding more how you 
feel about this crisis in your gut. If you were to say what is 
the single largest fiscal crisis or fiscal problem, fiscal 
issue facing our country today, what would you say it is, if 
you had to identify one thing?
    Mr. Elmendorf. Well, Senator, again, I appreciate your 
confidence in my gut, but I rely on the analysis that we do at 
CBO. The risk of fiscal crisis, in our view, comes from the 
imbalance between spending and revenues. That imbalance comes 
in the projections because spending rises to a share of GDP 
that we have not seen before in this country----
    Senator Portman. OK, but what is----
    Mr. Elmendorf [continuing]. And revenues rise above their 
historical average, but not as far as spending, in these 
baseline projections.
    Senator Portman. But what is it in the spending and in the 
revenue side that troubles you most? What is the single thing?
    Mr. Elmendorf. Again, it is not a matter of troubling. It 
has to be your choice and your colleagues' choice what parts of 
the budget you want to address. As an arithmetic matter, of 
course, the part of the spending that is growing very rapidly 
and growing much faster than GDP is spending on the 
government's large health care programs, both because of the 
aging of the population, and much of that money goes to older 
Americans, and because of rising health spending.
    Senator Portman. All right. I am encouraged by your answer, 
because I think it is health care, and I think it is not just 
health care as it relates to Medicare and Medicaid, which 
obviously drives the growth of those programs, and your 
projections here of 7 percent growth is, in the Chairman's 
words, unsustainable. But it also, of course, affects the 
private sector job growth, which leads to lower revenues than 
we would otherwise have. So I am going to take your answer to 
be health care, which I think is the right answer.
    What do you think the most significant risk is in your 
baseline projections?
    Mr. Elmendorf. I have a long list of worries, Senator. You 
know, I think in terms of the budget projection, as you said, 
these projections are notoriously wrong because it is a very 
difficult business. But the crucial underlying factor here, as 
we were just discussing, is the rising number of older 
Americans relative to working Americans and the rising cost of 
health care relative to other things in the economy. And those 
fundamental forces have been foreseen for decades and, I think, 
are inexorable under current policies. So although the 
specifics will undoubtedly not turn out this way, I think there 
is a reason that for many, many reports now, CBO and many 
outside analysts, of course, have been looking at a 
deteriorating fiscal picture. But I do not view that as----
    Senator Portman [continuing]. Your projection, do you feel 
the biggest risk is in the area of government expenditures on 
health care?
    Mr. Elmendorf. So I think that is one very large 
uncertainty.
    Senator Portman. How about interest rates? We talked about 
it earlier, but one of the concerns I have in looking at your 
analysis is, and correct me if I am wrong, but I think the risk 
premium that the private sector is looking at, and this is why 
the Blue Chip estimate, I think, is above yours, I do not see 
embodied in your analysis. Do you feel you take into account 
the risk premium of these higher debts?
    Mr. Elmendorf. Well, in fact, our projection of long-term 
interest rates over this coming decade is actually above the 
interest rates that you can deduce from the current prices of 
Treasury securities in the financial markets. Our projection 
here reflects a combination of what we see in financial markets 
and our own modeling. Our own modeling actually points to 
interest rates being a little higher than the financial markets 
have built in, particularly in the latter half of the decade 
for the longer-term securities. So we have constructed a 
projection that puts some weight on our modeling and some 
weight on the financial markets.
    But I think the point, as we have made a number of times, 
is that the swings in sentiment that drive fiscal crises are 
not usually telegraphed very well ahead of time. They often 
occur very suddenly.
    Senator Portman. Well, I would love some more information 
on the interest rate calculation because I think that is going 
to be, obviously, a big part of the uncertainty going forward, 
and I think it relates directly to the point that has been made 
many times here today, that we need to focus, all of us, our 
constituents, the American people, on this issue, and part of 
it is what is going to happen with rates, because that will 
affect everybody's everyday life as well as our business 
climate.
    Obviously, three issues here. The discretionary side, we 
have talked about today. The entitlement side, which we have 
not talked about enough today. I wish I had more time. The 
third one is growing the economy, and we have talked some about 
that and I applaud Senator Wyden, who has now left, for his 
comments on tax reform.
    I would just ask you one simple question with regard to the 
corporate rate. There is some recent research, and you have 
probably seen it--I think it is Hassett and Brill--that says 
there is a maximization point in the corporate rate of about 26 
percent, and I guess that is somewhat obvious. That is lower 
than or about at the average of the OECD or the developed 
country rates. Have you all looked at that, and do you think we 
are leaving revenue on the table now? In other words, by having 
a relatively high corporate rate, are we getting less revenue 
than we would otherwise get? And do you think we have a 
misalignment here because of the competitive nature of the 
global economy? What is your view on what the right corporate 
rate ought to be?
    Mr. Elmendorf. Senator, I am sorry. I am aware of that 
paper, but we have not studied that analysis carefully, so I 
can't directly answer your question. If you are interested in 
our--I am interested, of course, myself. But more importantly, 
if you are interested, we can take a closer look at that 
report.
    Senator Portman. Since we are both interested, let us get 
some views from CBO on that, because I think it is a very 
interesting analysis, and although, as you said earlier, 
whether tax relief pays for itself or not depends on the tax 
relief, that this is one area where we might be able to find a 
consensus.
    Thank you, Mr. Chairman.
    Mr. Elmendorf. We will be in touch, Senator. Thank you.
    Chairman Conrad. Senator Nelson.
    Senator Nelson. A big part of the discretionary outlays 
that grew during 2010 was the stimulus bill, and a big portion 
of the stimulus bill was the money going to the States, the 
State fiscal stabilization. What do you expect would have 
happened if a lot of that money, for example, such as Medicaid 
money going to the States for 2 years, if that had not gone to 
the States, what do you think would have happened?
    Mr. Elmendorf. We think that States would have had to make 
larger changes to boost revenues or decrease other sorts of 
spending, and that would have had a negative effect on their 
economies, and that is why in our analysis of the Recovery Act 
we think those provisions and others provided an important 
boost to output and employment relative to what would have 
occurred in the absence of that legislation.
    Senator Nelson. In my State, Florida received about $4.5 
billion just for Medicaid over that particular period of time, 
another $2.2 billion for education. So it was huge. But we are 
coming to the end of the 2-year period and we are not going to 
be able to continue that. So what do you think is going to 
happen?
    Mr. Elmendorf. Well, the waning of the effects of the 
Recovery Act on the economy is one of the reasons that the 
economy is not growing more rapidly over the next few years in 
our projection.
    Senator Nelson. So we see less of a robust recovery as a 
result of all this Federal money not going to the States for 
things that are hard to see because they are not roads and 
bridges that are being built. It is Medicaid and education 
assistance from the Federal Government to the States, and as a 
result of that going away, it is going to lessen the 
acceleration of the economic recovery.
    Mr. Elmendorf. I think that is right, Senator. That is 
analogous to what happens with the automatic stabilizers, the 
parts that you did not directly change but that occur 
automatically in downturns. Picture the economy running into a 
hole. The hole is shallower, but on the way out, then the 
recovery is also a little more shallow than it would otherwise 
be. And, of course, the tradeoff that you and your colleagues 
confront is that the large accumulation of debt to pay for the 
Recovery Act and for the automatic stabilizers and other things 
in the past few years has pushed debt to GDP up in a way that 
creates damage and risks itself.
    Senator Nelson. OK. So that is one consequence, that by us 
not being able to send more money to the States, it is going to 
slow the economic recovery.
    All right. Now, let us look on the other side. We passed 
the health care bill, and if you would state this for the 
record, as you have already publicly many times, the health 
care bill as it is passed right now and as it is law is roughly 
going to save the Federal Government in the next 10 years about 
a quarter of a trillion dollars, and your projections for the 
second 10-year period, that the Federal Government spending 
will be saved about a trillion dollars. Is that correct?
    Mr. Elmendorf. So, Senator, you are right that over the 
next decade, pending our actual full cost estimate of repeal 
which is underway, we think that over the next decade, the 
repeal of the health legislation would increase budget deficits 
by something on the order of $230 billion.
    Over the longer horizon, we think that repeal of the 
legislation, assuming that it would be implemented as enacted 
without any future changes, the repeal would widen future 
budget deficits. That is an estimate that we have not offered 
in dollar terms because we think that it is difficult to get a 
good sense of dollars figures over such a long horizon in an 
economy with rising prices and that is growing. We have said 
instead that repeal of the legislation would reduce--rather, 
would increase Federal deficits in that second decade, in a 
broad range around one- half percent of gross domestic product. 
If you want to convert that yourself to dollars, as some 
members of the Committee have, you can do so. But for our 
purposes, we think it is more constructive for us to report the 
number in that sense.
    Senator Nelson. OK. But the average American does not 
understand that percentage of the GDP, and so in our 
calculations, has it not been, Mr. Chairman, widely accepted 
that we are somewhere in the range of $1 trillion?
    Chairman Conrad. Yes, $1.3 trillion. One-half of 1 percent 
of GDP over the second 10-year period. The projected GDP during 
that period is forecast to be about $260 billion, so one-half 
of 1 percent would translate to $1.3 trillion.
    Senator Nelson. OK. Well, then I think it is pretty clear, 
as we are going forward, we are going to have a slowed economic 
recovery because we helped out the States for 2 years with a 
massive infusion of money into the States that people do not 
ordinarily see, such as Medicaid spending as well as education. 
We enact a health care bill that does from a fiscal standpoint 
help the economy by saving the U.S. Government from spending 
close to a quarter of a trillion dollars in the next 10 years. 
So let me conclude by asking you now if you would help--let us 
put a fine point on this, on Social Security. We went through a 
long discussion of that with one of the other Senators earlier. 
But what is it that is happening in or about the year 2037 with 
Social Security that we need to underscore?
    Mr. Elmendorf. Well, in some year out there--and we have 
not updated those estimates since our last long-term budget 
outlook last summer--the Social Security trust fund will have 
redeemed all of the bonds that it holds and will have incoming 
payroll tax receipts that are not sufficient to pay the 
benefits that we project under current law. At that point the 
full benefits could not be paid without some action by the 
Congress to increase the money going into the trust fund or 
reduce the benefits being paid out.
    Senator Nelson. OK, that is 26 years down the road. What is 
going to happen 10 years down the road with Social Security?
    Mr. Elmendorf. Well, as the baby-boom generation retired, 
of course, there will be increasing numbers of beneficiaries. 
We think at the end of the decade there will be about a third 
again as many Social Security beneficiaries as there are today. 
That will increase the benefit payments. But there will be 
enough money coming in and money in the trust fund--actually 
there is a picture at the back of the outlook that shows the 
path of the Social Security trust funds, but the OASI fund and 
the Disability Insurance fund. For those who want to check, it 
is on page 123. And in our estimate, the trust funds together 
will be running a surplus at the end of the decade, including 
the interest payments they receive from the Treasury on the 
bonds in the trust funds.
    I should mention perhaps the disability--as you know, the 
Social Security trust funds--there are actually two of them. 
They are legally separate. The Disability Insurance trust fund 
we think will actually be exhausted in 2017 and would need some 
further action to pay benefits after that point.
    Senator Nelson. At the end of this 10-year period----
    Chairman Conrad. Can I just say to the Senator, he has gone 
beyond his time.
    Senator Nelson. I have. As you have been very generous and 
liberal with other Members of Congress, may I conclude with 
this one question?
    Chairman Conrad. Go ahead.
    Senator Nelson. At the end of this 10-year decade, what is 
the effect of the trust fund of Social Security on the 
operating budget deficit of the U.S. Government?
    Mr. Elmendorf. I am not sure what you mean by 
``operating,'' I am afraid, Senator.
    Senator Nelson. The budget deficit that we are working on.
    Mr. Elmendorf. Well, so the Social Security--there will be 
a surplus, as I said, in the Social Security trust funds 
reflecting the direct flows from payroll taxes and benefits, 
but also interest payments in the rest of the Government. 
Excluding those interest payments, Social Security will be in 
deficit, which is to say that the benefit payments will exceed 
the collections through payroll tax receipts and some other 
sources of revenue.
    So apart from the interest payments from the rest of the 
Government to the Social Security trust funds, Social Security 
will be in a deficit situation. The dedicated revenues will 
fall short of the benefit payments that are promised.
    Chairman Conrad. I thank the Senator.
    We are now past the hour of 12:30, and we had promised to 
get the Director out by that time, so that would mean Senator 
Thune would have no time to ask questions. But because he is 
from South Dakota and I am from North Dakota, that seems fair, 
at least to this Senator. But I am sure it does not sound fair 
to the Senator from South Dakota.
    The Senator from South Dakota is recognized.
    Senator Thune. Thank you, Mr. Chairman, and to you and 
Senator Sessions, I welcome the opportunity to serve on this 
Committee. There will be some big issues debated here, and I 
look forward to engaging in that debate.
    I want to thank you, Dr. Elmendorf, for your service and 
willingness to take on another stint here in what is under the 
best of circumstances a very difficult job, but under these 
circumstances an even more difficult and painful job.
    You have kind of, I think, touched on this a little bit in 
response to some questions already, but Chairman Greenspan 
recently said the odds of a debt crisis in the next few years 
is nearly 50/50. And I know you would probably have trouble 
quantifying that, but what do you view those odds are?
    Mr. Elmendorf. As you said, Senator, I would have trouble 
quantifying that. I think it is very difficult to make an 
assessment of that sort, all respect, of course, to Chairman 
Greenspan. A crisis depends not just on the existing level of 
debt; it depends on, I think, the projections of debt. In the 
cases of some countries, it is dependent on how much debt they 
have had to roll over in a very short period. It depends 
importantly on the willingness of foreign investors to hold the 
assets of this country. And it depends I think most crucially 
on investors' perception of the sorts of policies that Congress 
and the President are inclined to enact.
    So it is a very difficult business, and I think we have 
seen in other countries that have had very high debt-to-GDP 
ratios that things generally turn out badly unless they correct 
course. But exactly what the tipping point might be is just 
beyond our analytic capacity.
    Senator Thune. But the odds worsen the longer we wait, 
correct?
    Mr. Elmendorf. Yes, I think the higher the debt gets 
relative to the size of the economy, in particular the higher 
it gets and still looks to be pointed upward in projections 
like the ones that we show you, the greater the risk of a 
fiscal crisis.
    Senator Thune. You talked, I think, in response to some 
questions about the impact of--I think you were asked about 
energy costs. And if you talk about $100 a barrel for oil, 
which is what we are approximating now, that is one thing. If 
it were to go up to $150 a barrel, have you done some 
sensitivity analysis about how that impacts inflation and how 
much of the inflationary assumptions that you make are based 
upon the cost of energy?
    Mr. Elmendorf. So the energy is certainly important for our 
projections of overall consumer prices. It is not as important 
for core consumer prices, prices excluding food and energy. It 
matters a little bit because some amount of an increase in oil 
prices or the price of energy more generally will end up being 
passed through to the cost of other goods and services in a way 
that might get built into the underlying inflation process of 
the economy. But the evidence is that that passthrough is 
actually pretty small, so that means on a year-to-year basis, 
of course, changes in the price of energy affect household 
budgets, but that those movements tend not to become ingrained 
in the inflation process over the past few decades, based on 
what we have observed.
    A similar point I should say about food prices. It is very, 
very important to households, but they do not seem to get built 
into the underlying inflation process. They rise and they fall 
in a way that seems more or less separate. So we do our best to 
try to project changes in those prices, but I think it is not 
as large a risk for inflation over the longer run as one might 
worry.
    Senator Thune. And it strikes me that what probably the 
biggest factor impacting interest rates--many factors, but 
inflation being one. If inflation starts to pick up, then I 
think the markets are just going to start demanding a premium 
for that, and that impacts our borrowing costs and everything 
else.
    How confident are you in your inflation assumptions? Based 
upon what you are seeing globally right now, a lot of European 
countries and Asian countries are experiencing upticks. We have 
seen a little bit in December, probably not as much as other 
places in the world. But if we have to where we started having 
an issue with inflation, I suspect that the correlation between 
inflation and interest rates is really going to drive borrowing 
costs. What is your level of confidence in your assumptions 
with regard to inflation?
    Mr. Elmendorf. You are certainly right, Senator, that if 
inflation goes up, interest rates we expect would go up, too, 
and that would create further damage to the Federal budget. We 
do not think inflation will get high. It is currently below the 
rate that the Federal Reserve seems to view as consistent with 
their mandate for price stability. It has fallen a good deal in 
the past few years. It has fallen in a way that is broadly 
consistent with a lot of evidence that when tremendous numbers 
of people are unemployed and a tremendous amount of plant and 
equipment is not being used, that firms restrain price 
increases and inflation comes down.
    Now, as the economy recovers, we think that inflation will 
move back up, but we see no reason why it will move above the 
range that the Federal Reserve is aiming for. The Fed balance 
sheet, as everybody understands, is very large, and they will 
need to withdrawn that liquidity to prevent inflation from 
going up. But we see no obstacle to their doing that, and 
certainly the statements of Chairman Bernanke and others show 
that they are very focused on the need to do that when the time 
arises.
    So, of course, all these projections are uncertain, but we 
do not view a large increase in inflation beyond the level we 
have seen over the past decade or two as a significant risk in 
the forecast. It is a possibility, but it is not one of the 
risks that I am more worried about.
    Senator Thune. You said a 1-percent increase in interest 
rates would generate about $1.25 trillion in additional 
deficits over the decade. What does a 1-percent increase in 
interest rates add to the borrowing costs that we have today? 
Which the number I have seen, at least in the 2012 estimate, is 
interest will be at or exceed the amount that we spend on 
national security. So if we are assuming that number or 
thereabouts and you saw a 1-percent increase in interest rates, 
what does that do to the annual finance charges, borrowing 
costs for the Federal Government?
    Mr. Elmendorf. Well, an increase that occurred right now 
would not raise interest costs that much in the near term 
because much of the debt is outstanding, and we have a fixed 
rate. So when one looks at the pattern, we show for a rise in 
interest rates, it rises over time. It gets, for example, in 
2015 to be about $100 billion in that year of higher interest 
payments.
    Senator Thune. At 1 percent----
    Mr. Elmendorf. The 1 percentage point increase.
    Senator Thune. Annually?
    Mr. Elmendorf. Annually. And by the end of the decade, 1 
percentage point higher interest rates is worth about $200 
billion a year. And it is growing so much because the debt is 
growing very rapidly.
    Senator Thune. Right.
    Mr. Elmendorf. In addition to the redemption of maturing 
securities and the issuance of new ones.
    Senator Thune. All right. Mr. Chairman, my time has 
expired.
    Chairman Conrad. I thank the Senator.
    Senator Thune. In deference to the Director, thank you.
    Chairman Conrad. I would like to just for a moment followup 
on this point that Senator Thune is raising, and I talked about 
it in my questioning period, too, because I think it is very, 
very important for people to understand. In a forecast you are 
trying to give us the best assessment on critical variables. 
You are trying to give us an assessment on economic growth, on 
interest rates, on rates of inflation, how all that comes 
together to affect Federal expenditures and Federal revenues, 
to give us an assessment of what is happening to the deficit 
and debt.
    Many economists have told us they do not believe the 
economic world is perfectly predictable with respect to 
especially at the breaks. That is, when something turns, it can 
turn rapidly, and no forecast tends to capture that accurately.
    How would you assess the risk of the basic underlying 
assumptions in the forecast that you provided to us yesterday 
on economic growth, inflation, and interest rates? Of those 
three, which are you most concerned about in terms of your 
underlying forecast not coming true or being at some 
significant variance?
    Mr. Elmendorf. Well, Mr. Chairman, I worry about all of 
them. Interest rates are the ones that can move around most 
dramatically in short periods of time. The inflation rate can 
spike. Economic growth, of course, can slow very sharply in 
recessions. But the variable that is most volatile on an 
average day or a month is interest rates, and all three are 
very important, of course, to the Federal budget. And that is 
why we look--in our appendix that illustrates the effects of 
changes in economic projections, those are three of the four 
experiments that we examined, precisely those three variables 
that you mentioned.
    So I would hate to convey a sense that I am not worried 
about any of them, but I think the interest rates are the ones 
that are intrinsically most volatile and also, I think, given 
the Government's fiscal position and the fiscal trajectory, are 
the ones that are the greatest risk.
    Chairman Conrad. All right. I thank you for that. I think 
it is just important that we have that on the record for the 
benefit of the Committee.
    Senator Sessions.
    Senator Sessions. Isn't it a fact the Fed is artificially 
keeping the interest rates low through their quantitative 
easing and there is a limit at some point on how much that can 
be utilized?
    Mr. Elmendorf. The Fed is keeping interest rates low. I 
would not describe the current situation as any more artificial 
than what they normally do. They move interest rates up and 
down, as you know, to affect inflation and the path of the 
economy. And it is certainly right that they have pushed 
interest rates down. Both the Federal funds rate that they 
directly control, but also interest rates at longer maturities, 
they have pushed down through a variety of measures, including 
the latest quantitative easing. And we do not expect that to 
continue.
    Senator Sessions. There is a limit to how much that can 
be--I just hate to press this health care cost. Someone could 
interpret your testimony as saying that the health care bill, 
if eliminated, would raise the deficit, and under one method of 
accounting, perhaps that is so. But under these circumstances, 
I have to say in my view it is not accurate, because we know 
that Medicare will be going into deficit, and they will call 
their bonds. It is not as if we do not know outside this 10-
year window what is going to happen.
    So when the United States Treasury spends money on a new 
program and that money is borrowed from Medicare, and Medicare 
we know is heading into default, it really increases the debt 
of the United States. It absolutely increases the internal 
debt, and I think any fair reading would suggest it increases 
the overall debt exposure of the United States.
    Mr. Elmendorf. So, Senator, you are correct that it 
increases the internal debt. I certainly agree that Medicare 
will redeem those bonds at some time in the future. And as we 
have discussed, that obligation can only be met by revenues 
that are available in the future.
    When I refer to deficit effects, I refer, as my many 
predecessors as CBO Director have, to effects on the unified 
budget deficit. But you are correct, there are other ways of 
toting up what is happening in the Government's accounts. I 
will try to be more specific about that when I mean unified 
budget deficit.
    Let me go back one more time to the internal debt, the 
gross debt, and I have agreed with you about the effects on 
gross debt. The way that CBO--again, this is not idiosyncratic 
to my leadership of CBO. The way that we look at budgets is to 
focus on the unified budget, the debt held outside of the 
Government, the debt held by the public. And then we show you 
projections of spending for Medicare and Social Security and 
Medicaid and so on going forward. And we think that the best 
way to assess the sort of current financial state of the 
Government in terms of the immediate obligations is debt held 
by the public or perhaps debt net of financial assets, as we 
show in our report; and that the best way to look at what the 
Government is going to encounter financially in the future is 
to look at our projections of spending and revenues and the 
effect that those paths have on future debt held by the public 
relative to GDP.
    So we are consistent in our treatment of that. The future 
Medicare obligations are not lost in the approach that we take. 
They appear in the projections of spending and revenues that I 
have shown and that lead to that path of debt that most of this 
hearing has been about. But I understand, Senator, that there 
are different ways of looking at the pieces of the budget that 
may be useful to you and others for some purposes.
    Senator Sessions. And is it your policy decision to use a 
unified score? Is that statutory or congressionally mandated 
that you produce first a unified budget score?
    Mr. Elmendorf. The focus on the unified budget began in the 
late 1960s. There was a Commission on Budget Concepts, and part 
of what that Commission did was to realize that at the time 
there were lots of different pieces of the Government where the 
money was being kept track of, observed, followed separately. 
And the judgment of that Commission, and I think of most budget 
experts in the subsequent 40-some years, has been that it is 
most effective to look at the budget of the Government as a 
whole in assessing the demands on credit markets and, thus, the 
crowding out of private borrowing and in assessing the 
Government's fiscal trajectory. It does not mean that all those 
people have been right, but I think that has been the standard 
in place for a number of decades.
    Senator Sessions. It clearly has been the standard, and you 
have always made clear how you account for it, so I am not 
criticizing you.
    Chairman Conrad. Can I just followup on what Senator 
Sessions is raising? Because, you know, we have a budget 
responsibility in this Committee, and we understand that 
economists look at this, and they prefer looking at it on a 
unified basis. I think the problem that it leads to is when you 
look at this from a budget perspective, that alters your view, 
because the hard reality is all this debt has to be serviced, 
and it has to be serviced out of current income. And the 
frustration that some of us have had is that the press tends to 
focus on the unified concept. We understand that is because 
that is what affects the overall borrowing by the Government. 
On a unified basis--when you look at everything coming in, 
everything going out, that is a unified basis.
    The problem that we run into in a budget context is those 
bonds that Social Security holds that are real assets, the 
redemption of those bonds can only occur out of current income. 
And what has been happening from a budget perspective is the 
general fund has been borrowing from Social Security, and we 
have borrowed well over $2 trillion. That money has to be paid 
back. How is it going to be paid back? It is going to be paid 
back by the other general expenditures of the Federal 
Government having to be reduced to make way for the payments 
that we are going to have to make on those bonds. And so it has 
a very specific and, we are going to see, dramatic impact on 
budgets because we have been enjoying in effect a subsidy from 
the Social Security trust fund of several hundred billion 
dollars a year. And that is about to change--in fact, has 
changed.
    I want to correct one thing I said earlier, because I was 
working off the old forecast that Social Security is going to 
go permanently cash negative in 5 years. My staff informs me, 
under the new report, Social Security has gone permanently cash 
negative now. Is that the case?
    Mr. Elmendorf. Yes, that is right. As you are viewing cash, 
not counting interest payments from the rest of the Government.
    Chairman Conrad. Yes.
    Mr. Elmendorf. Yes.
    Chairman Conrad. So the budget problem that presents us 
with, instead of having several hundred billion dollars a year 
coming in from Social Security that we could send somewhere 
else, those days are over. Those days are over.
    Mr. Elmendorf. Yes, that is right, Senator. I would just 
emphasize one more aspect of this. The bonds that are held in 
the Social Security trust fund and those held in the Hospital 
Insurance trust fund are much less than the total future 
obligations. That is what we mean by saying the trust funds 
will exhaust their resources at some point. So the projections 
that we do of the spending for Social Security and Medicare 
under current law capture all of the benefits that would be 
paid under current law.
    So in that sense, the gross debt that you are talking about 
is only capturing a subset of the future obligations. If you 
look at our projections of total spending and total budget 
deficits over a decade and beyond, they capture all of the 
benefits that we pay under current law, not just those for 
which there are bonds tucked away.
    Chairman Conrad. Yes.
    Mr. Elmendorf. It is also true there are some things in 
gross debt that may not reflect future obligations. It is not 
just the Social Security trust fund, although that is a big 
part of it. There is right now almost $2 trillion held by other 
Government--bonds held by other Government accounts. Not all of 
that does represent future obligations. So that is why we have 
focused, again, for many years on the overall budget situation, 
but we do report projections of gross debt. We report the 
Social Security surplus and the surplus in--which is almost all 
the off-budget surplus, and the surplus or deficit in the rest 
of the Government for you to use as you think about the budget.
    Chairman Conrad. Well, look, again, we recognize the 
professional job that CBO does, and we respect--there has to be 
an independent scorekeeper, and you are it. We also know that 
these things----
    Senator Sessions. You are all we have.
    Chairman Conrad. Yes. We know that these are based on 
assumptions, and you have to make assumptions about growth, 
about inflation, about interest rates. And we all know they are 
going to be wrong. We all know they are going to be wrong 
because we look back in history and see that they have been 
wrong in the past, and they are very likely to be wrong going 
forward. But they are the best, most professional estimates 
that can be had at the time, and that really has to be what 
governs our decisions.
    Let me just conclude by saying I think we are going to need 
at some point to maybe focus a little more directly on the 
entitlements and on their budgetary effects longer term. We do 
not have that scheduled at this point, but I do think_and I 
will talk to Senator Sessions about this. There is so much 
misunderstanding, I find, in the general public and in the news 
media with respect to the liabilities of the United States that 
I think we may need a hearing just on that. We have a lot of 
new members who may not understand quite how these funds flow 
and what their budgetary impacts are as well as their economic 
impacts.
    With that, thank you very much, Dr. Elmendorf.
    Mr. Elmendorf. Thank you.
    Chairman Conrad. We stand adjourned.
    [Whereupon, at 12:57 p.m., the Committee was adjourned.]




                       THE U.S. ECONOMIC OUTLOOK

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


                       TUESDAY, FEBRUARY 1, 2011

                              United States Senate,
                                   Committee on the Budget,
                                                   Washington, D.C.
    The Committee met, pursuant to notice, at 10:00 a.m., in 
Room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Wyden, Warner, Begich, Sessions, 
Thune, Toomey, and Johnson.
    Staff Present: Mary Ann Naylor, Majority Staff Director; 
and Marcus Peacock, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    I want to welcome everyone to the Senate Budget Committee 
today. Today we will focus on the U.S. economic outlook. This 
is one of a series of hearings on the economy. We are taking a 
close look at how the economy is performing and where it is 
headed. Later this week, we will examine specific challenges 
the economy faces, such as housing, unemployment, and the State 
fiscal crises that are occurring around the Nation.
    Today we are fortunate to have three really outstanding 
witnesses, economists who all have a long history of providing 
valuable testimony to this Committee and others. We look 
forward to hearing from Dr. Richard Berner, a Managing Director 
and Co-head of Global Economics, Chief U.S. Economist at Morgan 
Stanley. Good to have you back, Dick. Dr. Simon Johnson, Senior 
Fellow, the Peterson Institute for International Economics and 
a professor of entrepreneurship at MIT's Sloan School of 
Management. Good to have you back, Simon. And Dr. David 
Malpass, president of Encima Global. Am I pronouncing that 
correctly?
    Mr. Malpass. That is right.
    Chairman Conrad. Thank you, sir. We thank all three of you 
for making yourselves available to the Committee. We deeply 
appreciate that.
    Let me begin by having a brief review of where we have 
been, my own analysis of what has brought us here and where we 
are headed. Let me just start by saying I believe TARP and 
stimulus were critically important to averting a global 
financial collapse. I was in the room when the Secretary of the 
Treasury in the Bush administration and the Chairman of the 
Federal Reserve told us that if we did not act on TARP, there 
could be a global financial collapse in days. Those are the 
words they used to us. They minced no words with us. They were 
as clear and compelling as they could have been.
    So TARP was put in place--and let me just put up the first 
chart that shows what I think is the very clear evidence that 
TARP was effective. This chart shows the TED spread, the 
difference between what the Government can borrow for and what 
the private sector can borrow for. And during the height of the 
crisis, the TED spread was 9 times normal. You can see it at 
the peak. When TARP was put in place, it came back very 
markedly to more normal levels and only now has really gotten 
back to its historic relationship.
    Again, the TED spread is the difference between what the 
private sector can borrow for and what the public sector can 
borrow for, and we have seen a normalization in the TED spread. 
In fact, one of the tipoffs that we had that we were headed for 
trouble in 2008 was we saw erratic behavior in the TED spread 
in the year before. 




    Let me go to the next chart, if we can. Economic growth, we 
had a negative 6.8 percent in 2008, the fourth quarter. We now 
see that economic growth has resumed. In the fourth quarter of 
2010, we saw positive growth of 3.2 percent, and we have now 
had six consecutive quarters of growth. And we see the same 
evidence, evidentiary pattern in the private sector job growth. 
I think we all recall in January of 2009 the economy was losing 
more than 800,000 private sector jobs a month. In December 
2010, the last month we have data for, the economy gained 
113,000 private sector jobs. We have now had 12 consecutive 
months of private sector job growth. 




    Third, we have also seen a dramatic rebound in the stock 
market. After falling to a low of 6,500 in March of 2009, the 
Dow has now risen back up well above 11,000--in fact, 
approaching 12,000.
    Two highly respected economists--Dr. Alan Blinder, the 
former Vice Chairman of the Federal Reserve, and Mark Zandi, 
who was an adviser to the McCain campaign--completed a study 
last summer that measured the impact of Federal action, 
including TARP and stimulus, including both the Fed's monetary 
policy actions and the fiscal policy actions by Congress and 
the administration. Here is a quote from their report: 




    ``We find that its effects on real GDP, jobs, and inflation 
are huge and probably averted what could have been called 
`Great Depression 2.0.' When all is said and done, the 
financial and fiscal policies will have cost taxpayers a 
substantial sum, but not nearly as much as most had feared and 
not nearly as much as if policymakers had not acted at all. If 
the comprehensive policy responses saved the economy from 
another depression, as we estimate, they were well worth their 
cost.''
    The next chart shows Dr. Blinder and Dr. Zandi's estimate 
of the number of jobs we would have had without the Federal 
response. It shows we would have 8.1 million fewer jobs in the 
second quarter of 2010 if we had not had the Federal response, 
specifically the TARP and the stimulus. 




    A similar story can be told by studying the unemployment 
rate. The unemployment rate averaged 9.7 percent in the second 
quarter of last year. According to Dr. Blinder and Dr. Zandi, 
if we had not had the Federal response, the unemployment rate 
would have been 15 percent in the second quarter and would have 
continued rising to 16 percent in the fourth quarter of 2010. 
There is no question that the unemployment rate has remained 
stubbornly high. Just a little over 3 years ago, it stood at 5 
percent. It nearly doubled within a year's time and has 
fluctuated in the 9-percent-plus range ever since. 




    Last week, the nonpartisan Congressional Budget Office 
issued its budget and economic outlook projecting the 
unemployment rate will fall only slightly, to 9.2 percent by 
the fourth quarter of this year, and fall farther, to 8.2 
percent by the fourth quarter of 2012. 




    And the economy is growing at a much slower pace when 
compared to past recoveries. When measured against the nine 
previous recoveries over the past 60 years, we see the current 
recovery lags considerably the nine previous recoveries. Why is 
that? I believe it is because so much damage was done to the 
fiscal and financial system in this downturn. 




    If you look at the previous recoveries since World War II, 
some of them have been relatively sharp, but none have seen the 
damage to the financial system done in this downturn. And so 
that dramatically affected the credit markets, and that 
dramatically affected business. That obviously affected 
economic growth and economic activity.
    You know, I will never forget when Ms. Romer put out her 
forecast that we would see 8 percent unemployment, and I told 
the White House at the time and told anybody listening that 
they could throw that forecast right out the window, because 
that forecast was based on the last nine recoveries since World 
War II. And there was no basis for comparison because there was 
not the damage to the financial system in the previous 
recoveries as we experienced in this one. And so I thought it 
was a forecast that had no merit.
    But we are now at a critical juncture. We have been 
borrowing about 40 cents of every dollar that we spend. That is 
clearly not sustainable. Spending is at its highest level as a 
share of the economy in 60 years. Revenue is at its lowest 
level as a share of the economy in 60 years. It seems to me 
readily apparent we have to work on both sides of the equation. 





    Gross Federal debt is already expected to reach 100 percent 
of gross domestic product this year, well above the 90-percent 
threshold that many economists see as the danger zone. Let me 
just recommend to my colleagues the work that has been done by 
two of our most distinguished economists. Carmen Reinhart was 
the lead author of the book reviewing 800 years of financial 
crisis. In her work and the work of Professor Rogoff at 
Harvard, they concluded that when countries reach a gross debt 
of 90 percent of GDP, they see future economic growth reduced 
substantially. And we are at 90 percent gross debt to GDP. 




    Now, one thing I want to be clear on is in the press 
typically you do not read about gross debt. You read about the 
publicly held debt. Publicly held debt is about 30 percentage 
points lower than the gross debt. So our publicly held debt 
today is in the 60 percentile range, but the gross debt is over 
90 and will be at 100 by the end of this year. And, again, the 
work that was done by Carmen Reinhart at the University of 
Maryland and Dr. Rogoff at Harvard concluded that when your 
gross debt reaches 90 percent, you see future economic growth 
impaired, and impaired in such a way that it translates into a 
million fewer jobs. That at the end of the day, I think, is 
what we must keep in mind.
    I believe that the deficit and debt reduction plan 
assembled by the President's Fiscal Commission on which I 
served got it about right. The plan would stabilize the debt by 
2014, lower it to 60 percent of GDP--let me emphasize that is 
on a publicly held debt measure--by 2023, and roughly 30 
percent by 2040. So publicly held debt would first be 
stabilized, then be brought back from the brink, and over time 
worked down to what most economists say is a far more 
sustainable level. 




    There were 18 members on the Commission. Eleven supported 
the report--five Democrats, five Republicans, one Independent. 
That is, 60 percent of the Commissioners supported the 
conclusions of the report that would reduce the debt by $4 
trillion over the next 10 years. I believe that proved that 
Democrats and Republicans can join forces when we face an 
imminent threat to this country, and I believe this debt threat 
is an imminent threat to the Nation. We can put together a 
credible, responsible, realistic bipartisan budget plan, and 
this year we need to finish the job. It will require 
Presidential leadership, and it will require a Congress that is 
willing on both sides to come together to do things both of us 
would prefer not to have to do.
    I hope very much we face up to this because a failure to do 
so would mean very serious consequences for the country in the 
future.
    We will now turn to Senator Sessions for his opening 
remarks, and I want to thank members for their attendance here 
today, and, again, I thank the witnesses for their 
participation. Senator Sessions, welcome.

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. Thank you, Senator Conrad. You have 
raised the challenge that is facing us very well and I know 
have made a case that a lot of what we have done has been 
successful. I understand that, but there are others who have 
concerns about what we have done and how well it has worked and 
how much we have accomplished.
    I would like to get into a good discussion with our 
excellent panel, and I am sure we will learn a lot from them. 
It does appear we have been kicking the can down the road, and 
I thought that the roundtable discussion in Barron's with some 
of the world's biggest financial investors earlier this year 
raised some of the same problems and questions that you have 
raised and maybe some others also that lead us to a conclusion 
we are facing a very, very serious national challenge that I 
believe this Committee, as you indicated at our last meeting, 
will have to provide leadership for. And I would be glad to be 
with you in that effort.
    I had the honor to meet with Mr. McTeague, former Prime 
Minister of New Zealand, who took over a country that was 
running systemic deficits for quite a number of years, and he 
participated in leading that country to sustained surpluses and 
unprecedented economic growth, growth in sound currencies, and 
he told me recently that he believed we need to have a goal of 
a balanced budget. I think that is a psychological, political 
question for us to ask. It is not easy to get there. I am 
convinced we can get there, but the American people are goal 
oriented, and if we can articulate for them a real substantial 
reduction in this debt and show them how there may be some 
short-term pain but long-term gain, I believe politically we 
are in a better situation to accomplish that than we have been 
in some time.
    I just would quote from that Barron's roundtable interview 
some interesting questions. Mr. Zulauf out of Switzerland said, 
``There are two worlds: the industrialized world and the 
emerging world. The industrialized world continues to live in a 
fiction that it can afford its current lifestyle by going 
further into debt. At some point the bond markets will rot 
against that. The private household sector, not only in the 
U.S. but several industrialized countries, remains stretched 
financially and will continue to deleverage, reduce their debt, 
but the public sector is leveraging up, and there is the 
threat,'' he suggests.
    Bill Gross, who I guess handles more money than any man in 
the world, at PIMCO Bond Fund said, ``Printing your way out of 
this or kicking the can is possible for some countries, but the 
solution is not to create paper. It is to create goods and 
services the rest of the world wants to have.''
    They asked, ``What are the prospects for that?'' And he 
said, ``The Obama administration has failed miserably in that 
regard. It has focused on consumption and fiscal stimulation 
that will give us 4-percent growth in 2011"--his estimate. The 
estimates of these experts were from 2.5 to 4. He had the 
highest growth projection for this year. But then he adds, 
``But it gives us nothing more than that. It is a sugar high 
that quickly disappears in 2012.''
    So we are facing some serious, grim prospects. Unemployment 
has not come back well, as we would like to see it. Indeed, at 
the end of the year, the Government survey indicates that the 
hours worked had not increased, which is an indicator that 
unemployment will go down if weekly hours are going up. That is 
not a good factor. The wage increases were slight, very slight 
this year, and below inflation, so that puts our net wage 
income not in a very good position. The amount of jobs added 
looked better than they are because we have to add 150,000 a 
month to stay level, and so we have seen job increases, but not 
much above the level you have to have to really reduce 
unemployment. And if wages are not increasing, the net money 
circulating is not where it needs to be. So I am worried about 
that.
    And what I think--what I would like to be in a position 
where we were with Mr. Volcker. One of his associates just 
retired from the Fed. Brookings said that Mr. Volcker said, 
``Enough is enough. We have to get off this road. And he stood 
firm. They protested. They asked for his resignation. Tractors 
circled his building, probably some from North Dakota, and 
Alabama, too, probably. But he said, ``We knew we were right.'' 
``We knew we were right.'' And I just do not sense we have that 
kind of leadership today.
    I was disappointed that the new chief of staff, Mr. Daley, 
taunted the Republicans on his show Sunday, saying, ``Where is 
the beef? You tell me where you are going to cut.''
    What did that mean? I say that means that the 
administration is not prepared to lead. They are not prepared 
to discuss the seriousness of the challenge we face and 
suggests that if somebody else steps up and makes suggestions 
about how to reduce this deficit, they may well even be 
attacked by the President and his administration. So I hope 
that is not true, but that is what it seemed to suggest for me. 
And I did not see the kind of leadership I hoped for in the 
State of the Union.
    So, Mr. Chairman, you said a few things political, I said a 
few things political, but the truth is our country is in 
serious trouble. You and I both agree with that, and we are 
going to have to work together to do better. And thank you for 
calling this hearing.
    Chairman Conrad. Thank you, and let me just say to members 
of the Committee, what I said at the last hearing, I think even 
more strongly today, it has to start somewhere. And in the 
congressional process, we are it. I do not know what other 
Committee is going to take this on. The Appropriations 
Committee, they are not in a position to do it. The Finance 
Committee is not in a position to do it. So I think very 
clearly it is going to fall to us.
    Look, I would much prefer that there would be a summit with 
the White House, the congressional leaders, Republican and 
Democrat, House and Senate, sit down and craft a long-term plan 
to get us back on track. I think that would be the best way to 
proceed because I think it is very important this be done 
before we get into a debate on the debt limit extension, 
because if the debt limit extension has to be the way of 
getting a result to get a plan, that in itself has serious 
risks attached to it. We could lose credibility in the bond 
markets globally if that is the leverage that has to be used. 
So we are much better off as a country if a plan is put in 
place prior to getting to the debt limit debate.
    But if there is not going to be that kind of summit, then I 
do not know of an alternative to this Committee and the 
Committee in the House trying to craft a long-term plan and 
begin sort of bottom-up. So, again, I issue again a call for a 
summit involving the leaders of the House and the Senate and 
the President or his designees to come up with a credible long-
term plan before we get to the debt limit crunch, which I think 
will come probably in May.
    But I do not think we can wait for that. I think we have to 
prepare ourselves to begin crafting a plan here. And, look, it 
is not going to be easy. But we have a good beginning. We have 
had an excellent hearing with the head of the Congressional 
Budget Office. We have an excellent hearing today, and we will 
turn now to our witnesses.
    Dr. Berner, welcome back to the Budget Committee, and 
please proceed. I understand that you are going to be retiring 
soon from this position, not retiring but leaving this 
position. You have always been somebody who has been an 
important resource for this Committee. Thank you.

STATEMENT OF RICHARD BERNER, PH.D., MANAGING DIRECTOR, CO-HEAD 
 OF GLOBAL ECONOMICS, AND CHIEF U.S. ECONOMIST, MORGAN STANLEY

    Mr. Berner. Thank you, Senator. Thank you, Chairman Conrad, 
Ranking Member Sessions, and other members of the Committee for 
inviting me to this hearing to discuss the outlook for the 
economy, to outline some things that you can do to improve it, 
and briefly to discuss some of our budget challenges.
    And, Senator Sessions, let me tell you that your anecdote 
reminded me of when I was back at the Fed, because I was in the 
building when the tractors were circling the building.
    In the 6 months since I last appeared before this 
Committee, the economy has improved. Aggressive and 
unconventional monetary policy and fiscal stimulus helped. 
While the recovery remains subpar, recent additional monetary 
and fiscal stimulus will promote faster growth this year.
    But the legacy of the crisis endures. Lenders are still 
hesitant to lend. Home prices are still declining. State and 
local budgets are strained, and we need much faster job gains 
to lower the unemployment rate.
    Now, we expect the economy to grow by 4 percent after 
inflation over 2011 and about 3.25 percent over 2012. Two 
policy-related factors assure at least moderate growth and 
raise the odds of a somewhat better outcome: first, the one-two 
punch from new fiscal stimulus and a Fed committed to achieve 
its dual mandate; and, second, a dramatic reduction in 
political uncertainty after this summer.
    Three key temporary elements in the stimulus package--a 1-
year payroll tax holiday, a 13-month extension of emergency 
unemployment benefits, and expensing of business investment 
outlays--will boost growth this year, as you can see in the 
slide here that I am putting on the screen, but partly at the 
expense of 2012.
    Now, there are four other factors that are already 
promoting more sustainable growth. First, ongoing balance sheet 
healing is easing financial conditions, except in mortgage 
credit. Second, the handoff from rising output to increased 
hours, employment, and income is slowly underway. Third, 
stronger global growth is finally boosting U.S. output. And, 
finally, pent-up demand for capital spending is healthy.
    Thus, however, we have a two-tier economy. Strong 
leadership from exports and capital spending are offsetting the 
drag from weak housing activity and home prices and from cuts 
in State and local government budgets. Low inflation has 
promoted low bond yields. In turn, this has helped restrain 
Federal interest costs. We believe that that will be changing 
as inflation bottoms and begins to move higher. Significant 
economic slack will depress inflation. But rising inflation 
expectations and global pressure on food and energy quotes will 
push it higher.
    Let me talk about six risks that still lurk for the 
economy. Two of those are domestic. Home prices could decline 
by more than the 6 to 11 percent in our baseline forecast, and 
State and local budget cuts could be more intense than we 
expect.
    Four risks are global. There could be more spillover from 
Europe's sovereign credit crisis; more intense policy 
tightening in China and other emerging market economies. Crude 
quotes could surge past $120. That would be a risk. And 
politics could interfere with appropriate policy responses, as 
you alluded to.
    That last risk has a new domestic dimension: The battle 
over budget priorities here does seem likely to crystallize in 
a showdown over increasing the Federal debt ceiling, which 
could disrupt financial markets.
    So the outlook is improving, but we certainly cannot be 
complacent. Congress might consider other policies to improve 
the outlook for housing and employment, and thus the economy. 
Two years ago in testimony before this Committee I argued that 
tax cuts and stepped-up infrastructure outlays really do not 
get to the causes of this downturn. They mainly tackle its 
symptoms and can only cushion the blow.
    Likewise, the recent fiscal stimulus package will boost 
near-term growth, but I will not put our economy on a strong, 
sustainable path. It will boost deficits and debt, netting to a 
negative for the economy over a longer time frame, unless we 
adopt policies aimed directly at the cause of our problems.
    So what are some of those policies? America's housing and 
mortgage markets remain dysfunctional, thwarting recovery. 
Reducing principal is the right remedy. Only when some cushion 
of owners' equity returns and there is less risk of declining 
home prices will lenders readily offer credit.
    Policy options to reduce principal take two forms: those 
encouraging writedowns to avoid default and those encouraging 
short sales, which allow underwater borrowers to sell their 
house at market value without writing a check to the current 
lender.
    Adding incentives for both borrowers and lenders could 
energize such policies. Earned principal forgiveness is one 
such. Streamlining short-sale programs would help the writedown 
process for those borrowers facing foreclosure.
    The recent discussion about fixing housing finance has 
involved the right role for Government and how to reform the 
GSEs. This debate is entirely appropriate, but it does create 
uncertainty for lenders, and it overlooks the critical need to 
sequence policy choices correctly. First, focus on repairing 
the legacy of bad loans. Only then can policymakers implement 
reform.
    What about policies to improve employment? Private payrolls 
have risen by about $1.2 million over the past year, but over 
the past 18 months have been essentially flat. Much of that 
weakness is cyclical. However, there are four structural 
culprits involved: labor immobility from housing lock-in, 
mismatches between skills needed and those available, rising 
benefit costs, and uncertainty around policies in Washington. 
Briefly, fixing housing will improve labor mobility and help 
employment, and better training will improve worker skills. I 
will discuss remedies for benefit costs and uncertainty in a 
moment.
    The economic outlook has clear cyclical implications for 
the Federal budget, and addressing our structural budget 
problems will improve long-term economic prospects. I would 
like to conclude with a couple remarks on each.
    A healthier economy would directly improve the cyclical 
budget outlook, as we all know. More indirectly, fixing our 
housing and employment problems with targeted remedies would 
sustainably boost the economy and narrow the budget gap. Then 
we could safely unwind the fiscal stimulus now in place, 
further reducing deficits. But addressing structural budget 
challenges by reducing entitlement outlays will free up 
resources and capital for productive investment.
    In the long run, the structural budget deficit is almost 
entirely about Federal health care spending, directly through 
Medicare and Medicaid and indirectly through the tax treatment 
of employer-provided health care benefits.
    In addition, addressing health care costs would improve 
employment and the budget. High and rising health care benefits 
provided through the workplace drive up labor costs, reduce 
employment, and hurt growth. The cost of employee health care 
benefits is fixed because benefits are paid on a per worker 
basis. In my view, that helps explain why American employers 
cut payrolls relative to GDP more aggressively than other 
countries.
    The plunge in employment also increased Medicaid 
eligibility, pressuring State budgets. FMAP grants plugged the 
States' budget holes but added to Federal red ink. The upshot 
is that high fixed costs of health care benefits have enlarged 
both our job deficit and our budget deficits at every level of 
Government.
    Reducing health care costs is the next logical step in 
health care reform. The Affordable Care Act includes reforms 
aimed at Medicare cost savings, but more is needed to reduce 
the costs of health care for employers and employees alike. 
Changing the tax treatment of health care benefits would be a 
good place to start.
    We are only starting to debate solutions for our long-term 
budget challenges. We need your bipartisan leadership to tackle 
them and steps that are fair and call for shared sacrifice and 
benefits. Proposals to freeze or cut non-defense discretionary 
spending do not address these challenges. In contrast, the 
Commission that you mentioned, Senator, the Commission's report 
offers sound principles and a balanced menu for action.
    In the heat of those debates, let us remember that 
uncertainty about coming policy changes, including the size of 
prospective tax hikes, may weigh on decisions to hire, to 
expand, to buy homes, and to spend. You can reduce that 
uncertainty by crafting a credible plan to restore fiscal 
sustainability.
    Mr. Chairman and members of the Committee, we have many 
challenges ahead. Our short-term challenge is to enhance the 
odds for a more vigorous, sustainable recovery. Our long-term 
challenges are to promote a sustainable fiscal policy and to 
preserve our important safety nets. Thanks for your attention 
and for the opportunity to offer advice. I would be happy to 
answer any of your questions.
    [The prepared statement of Mr. Berner follows:] 



    
    Chairman Conrad. Thank you very much.
    Now, we will go to Dr. Johnson. Welcome back, Simon, and 
please proceed.

 STATEMENT OF SIMON JOHNSON, SENIOR FELLOW, PETERSON INSTITUTE 
 FOR INTERNATIONAL ECONOMICS AND RONALD A. KURTZ PROFESSOR OF 
  ENTREPRENEURSHIP, SLOAN SCHOOL OF MANAGEMENT, MASSACHUSETTS 
                    INSTITUTE OF TECHNOLOGY

    Mr. Johnson. Thank you very much, Senator, and I would like 
to begin, if it is appropriate, by endorsing your call for a 
summit on these issues before the debt limit comes to a point 
and before we have a crisis.
    I am, among other things, a former Chief Economist of the 
International Monetary Fund, and as you know, the IMF feels 
constrained in what it says to the U.S. Government for fairly 
obvious reasons. I do not feel so constrained. I would like to 
channel that experience and those kind of sentiments you would 
hear from them. They are very worried. They think that you face 
a potential issue with the U.S. debt, particularly as 
international investors shift around the world, which, as I 
will explain in a moment, I think is going to be happening in 
the shorter term towards Europe and in the longer term towards 
Asia.
    And Senator Sessions, I think your citation of Bill Gross 
in this context is entirely appropriate and exactly right. My 
recollection, though, is that Mr. Gross, who was in no way 
responsible, I think, for the financial crisis, was at the 
forefront of people in the fall of 2008 calling for various 
kinds of bail-outs and calling for the public sector to use its 
balance sheet to support the financial sector and prevent a 
second Great Depression. We can go and check the record, but I 
am pretty sure that is where Mr. Gross was. And actually, I 
think at that moment, his advice was fairly appropriate. But 
now, of course, we see people like himself, people who are 
seeking appropriate levels of yield at reasonable and 
acceptable levels of risk, they will start to look elsewhere. 
They start to press us.
    And I absolutely think that the Chairman put the emphasis 
in the right place at the beginning, which is saving the 
financial sector given the alternatives in fall 2008 was the 
only reasonable, responsible thing to do. But the fiscal costs 
of that were enormous.
    I actually like to quote, Senator, the change in net 
Federal Government debt held by the private sector as you 
compare the CBO baseline from early 2008, before the crisis 
really broke in earnest, to the latest one. That is about a 40 
percentage point increase, a roughly doubling of net Federal 
Government debt as a result of the measures the government had 
to take, most of which were the automatic stabilizers, most of 
which were the fall in tax revenue that you get from having a 
massive recession. A very small part of that was the stimulus.
    And I would also remind you that the Bush administration 
had a stimulus in early 2008 and the Obama administration had a 
stimulus in early 2009. We can go back and second guess how 
maybe you would like to redo the composition. It does not 
really matter in terms of the impact on the debt. The fiscal 
issue we face is because the financial system blew itself up, 
and I think on this dimension, the financial crisis inquiry 
commission got it exactly right. The financial system, 
particularly some of the bigger players in the financial 
system, got out of control, captured the hearts and minds of 
the regulators, took on reckless risks, and caused enormous 
damage.
    The Bank of England, by the way, talks of their experience, 
which is parallel to our experience and, of course, part of our 
experience, as part of a ``doom loop,'' where you go through 
repeated cycles of boom, bust, bailout. But, of course, you 
cannot do it indefinitely because you run up against a debt 
constraint, which is what Professors Reinhart and Rogoff have 
pointed out to us. That is the general experience. And there is 
no reason why the U.S. would be exempt from that.
    And if we look at where we are in this cycle, I agree with 
much of what Dick just said, but I am less positive, I am 
afraid, on even this moment in the cycle when we should be 
having some recovery. If you look at what is happening to 
employment and compare the same metric as you used, Senator 
Conrad, but just focus on loss of employment compared with peak 
employment before the recession started, we are down by six 
percent--we went down by six percent. We are still down five 
percent from that peak. That is not like any other recession in 
the post-war period. Every other recession goes down, you go 
down by two or three percent in terms of employment and you 
come back within 12 to 24 months. The 2001 recession was a slow 
recovery, but we did not lose anywhere near as much employment.
    This, I would submit to you, is actually not a recession of 
the post-war variety. It is a mini-depression of the pre-1907 
variety, when there used to be big financial crises in the 
United States, a lot of balance sheet damage, a lot of farmers 
would go bust, for example, out in the West and the Midwest, 
and it would take a long time to climb out of those debt holes. 
I think that is what we are looking at.
    And I think in terms of the employment picture, I am very 
pessimistic. I was in Davos at this World Economic Forum last 
weekend and was asking everyone I could find, where are the 
jobs, because the corporate sector has come back. The big 
companies, the 1,600 companies represented at that forum are 
doing very well. Their CEOs are happy. There are plenty of 
profits, but they are not hiring in the United States. They are 
hiring elsewhere. And I think even this part of the recovery is 
not going to go very well for us. We are going to struggle.
    And we have not fixed the problems in the financial sector. 
The financial sector still has too little capital. Again, this 
is the view of the Bank of England. David Miles, a member of 
the Monetary Policy Committee of the Bank of England put out a 
very influential paper last week. The Financial Times has its 
lead editorial on it today. We do not have enough capital. We 
did not fix the other dimensions of risk within our financial 
sector. Even after we propped them up and put them back on 
their feet on extremely generous terms, they do not want to 
lend, at least to the small- and medium-sized business sector. 
So that is not a good deal for the rest of the economy. It is 
not supporting the recovery and employment. And there is, I am 
afraid, an incentive for them to take on exactly the same kinds 
of risks as they had before.
    Professor Admati at Stanford University and about 24 
colleagues have been working on this issue and writing about it 
very clearly and very forcefully. We do not have enough equity 
in our financial system. We did not have before. We did not 
learn that lesson. And this is not just about the United 
States. It is a global problem, but we should be the leaders of 
this and we are not. We are, if anything, the laggards, at 
least compared to the British and compared to the Swiss, who 
are moving more decisively on this question.
    In summary, I would say that while we are in a recovery 
phase, while we should expect the next four months to improve 
and we should expect some jobs to come back, this is going to 
be very slow and very painful. It is already worse than any 
other recession we have seen. It is primarily because the 
financial sector got out of control, and unfortunately, when we 
had the opportunity to fix it, we did not do it completely.
    The Financial Stability Oversight Council, which has a 
macroeconomic responsibility--financial stability, we have 
learned, is absolutely critical to overall macroeconomic 
policy. You cannot separate it from monetary policy and from 
fiscal policy in the way we thought we could separate it over 
the past 40 years. The Financial Stability Oversight Council, I 
am afraid, is not so far doing a very good job on these 
dimensions. There is too much trying to push the banks forward 
with very thin capital levels and there is too much 
encouragement of or allowing them to take on what begins to 
look again like irresponsible levels of risk and excessive 
leverage, which, of course, again, will come back and hurt us.
    Whether or not we fix the fiscal problem--and I share your 
worries that we will not fix it in the short term--the 
financial sector will come back and hurt us again and again and 
again unless we really reform it.
    [The prepared statement of Mr. Johnson follows:] 



    
    Chairman Conrad. Thank you very much.
    Now, we will go to Mr. Malpass. Again, welcome.

      STATEMENT OF DAVID MALPASS, PRESIDENT, ENCIMA GLOBAL

    Mr. Malpass. Thank you very much, Mr. Chairman and Senator 
Sessions and others on the committee. It is a great pleasure to 
be here, and thank you for the invitation to testify.
    I think we have a full-blown fiscal crisis. We have been 
kicking the can down the road and it is time now for action to 
hold the line on spending. I think we need a full upheaval in 
the culture of spending and deficits that is controlling our 
government processes.
    Before turning to my testimony, I would like to give a 
little background. My slides are available on EncimaGlobal.com 
and also GrowPAC.com, which is dedicated to smaller 
governments, so people watching can follow on. I am going to go 
through some of the slides.
    As an aside, Senator Sessions mentioned Paul Volcker. I was 
in this room--before I worked for the Reagan administration, I 
was on the staff of the Senate Budget Committee, like many of 
the people here, and I was in this room when Paul Volcker said, 
``Enough is enough.'' And I think we are at that point where 
people need to be saying, we cannot afford it, even though it 
might be a good program.
    If I may, I will go to the first slide. My testimony is 
broken into four parts. One is the economic outlook, which is 
for moderate growth. The second is the fiscal outlook, which is 
for lots more debt and deficits. The third part, I address the 
risks of this high a debt-to-GDP ratio. The question is whether 
we are at a turning point--a tipping point where we could see 
investors turn away from U.S. debt, so I am going to address 
that in some detail.
    And then in my testimony, I give some policy suggestions. 
In particular, I think we need to start cutting spending now 
rather than the summit approach which has been tried so often. 
I think the goal should be to find a cut that you could make 
tomorrow or late this week and find a process that can actually 
implement that. You will have the Continuing Resolution 
expiring on March 4, so that gives a very good opportunity to 
begin cutting spending.
    A second policy suggestion is that we need a debt-to- GDP 
limit that is not there right now. When they wrote the 
Constitution, they had no idea that people would be able to 
borrow $9 trillion, as we are now, and CBO's numbers put us up 
to $24 trillion. So if the Founding Fathers had known that that 
was possible, they would have put a limit on that into the 
Constitution, and I think they also would have said that the 
maturity of the debt needs to be long-term, because we make 
ourselves riskier by having a short maturity for the debt. I am 
going to show you a graph on that.
    And then two more policy points. I am very concerned about 
the Fed's policy of quantitative easing where it is buying up 
the government debt. This is a huge new role for the Federal 
Reserve that should be wound down without delay.
    And fourthly, tax reform is critical, and I advocate 
putting a permanent extension of the existing tax rates into 
the baseline so that there can be an actual process where 
growth-oriented tax reform could be produced by Congress. With 
the baseline the way it is now, with many of the tax rates 
temporary, it is too high a hurdle for Congress to actually 
come up with growth-oriented tax reform.
    So in the next slide here, I show you the economic outlook. 
You know, we have had a very severe recession. What this shows 
you is the GDP of the country and the hammer blow that was hit 
in 2008 and 2009. I expect GDP growth to rise from 2.8 percent 
in 2010 to 3.5 percent in 2011, but that is still not going to 
be enough to make up for the losses.
    We have structural problems. I will mention three, the tax 
code, the labor barriers, and the regulatory expansion. So 
those slow down the private sector.
    Secondly, we have growth of the Federal spending and debt, 
which is a burden on the private sector. And third, the debt 
and credit problems which still plague, and I will show you a 
graph on that.
    The next slide here gives you a little bit of good news. 
Tax receipts are rising. This is the fourth quarter of 2010 
divided by the fourth quarter of 2009. We are up eight percent 
in tax receipts.
    The problem is--
    Senator Sessions. Of what period?
    Mr. Malpass. So that is the fourth quarter of 2010 over the 
fourth quarter of 2009. So it is up through December, eight 
percent growth, eight percent higher money coming into the 
Federal Government. The problem is, as you can see, that was 
from a very low base, and so in our next slide, you can see the 
dip in receipts. Under CBO's very optimistic projections, that 
is going to gradually be made up, but even so, the debt is 
yawning widely. And so the problem is that the growth that we 
are envisioning does not really reduce the magnitude of the 
deficit.
    You can see that the budget moved into surplus in the 
Clinton administration. It narrowed in the Bush administration, 
the expansion in 2007 and 2008. And so what we need is to get 
it much narrower than what the current CBO projections are 
doing. Unfortunately, in their work last week, in their new 
baseline, they increased the deficit to $1.5 trillion just for 
this current fiscal year. This is a yawning deficit.
    This is the total debt of the United States, and one point 
for concern is even though the private sector is deleveraging, 
the government is borrowing as fast as the private sector is 
deborrowing, is deleveraging, and so we have 245 percent of GDP 
in debt.
    The next slide shows you the break-up of that debt. So as 
we break down, where is that debt, so it is $35 trillion of 
debt in the country and it is broken down here. Household debt 
is roughly $13 trillion. The Federal, State, and local debt is 
$11.4 trillion, but let us pause. Where is that number going to 
go? The Federal, State, and local debt is going to $28 
trillion, meaning way up in the ether of this hearing room, way 
off the chart, in just the next five or ten years because of 
the large deficits. And you can also see the non-corporate 
businesses at the bottom here are shrinking. They are losing 
credit and they are getting taken over by bigger businesses. We 
have an economic policy that favors big government and big 
business right now and that is hurting jobs.
    On the next slide here, you can see the projection, Federal 
Government marketable debt going to 100 percent of GDP, 
assuming the Bush tax cuts are extended.
    And on nine--I will go quickly through these first ones 
because I want to dwell on the maturity of the debt later on. 
This shows you the detailed numbers, $35 trillion, and the 
breakdown of the various debt, including $9 trillion of 
marketable Federal debt and then an additional $4.6 trillion 
that is in the Social Security Trust Funds. So that shows you--
this is a way to tie out where the national debt really is 
residing.
    The next slide shows you a barrier on--
    Chairman Conrad. David, can I just stop you on that point--
    Mr. Malpass. Yes.
    Chairman Conrad. --so the people that are listening maybe 
are able to understand. I think the point that you have just 
made is the total debt in the United States, Federal, State, 
local, corporate, individual, about $36 trillion.
    Mr. Malpass. Yes.
    Chairman Conrad. So if we were to have a one percent 
increase in interest rates, that would add $360 billion a year 
in burden to this economy. That would be like a tax increase, 
right? It would be the effect of a tax increase. If we had a 
one percent increase in interest on $36 trillion of debt, it 
would be like a $360 billion tax increase.
    Mr. Malpass. That is true. It would be a burden on people 
who are borrowing money. Now, the good news on an interest rate 
increase is the U.S. household sector--I will show you a graph 
in a minute showing that the U.S. household sector is the 
biggest net creditor in the world, and so much of that interest 
would be paid to the people in the United States who are saving 
money. And so you are right that it would be a burden on the 
people who are now maybe growing, expanding, borrowing money, 
but it would sure help a lot of seniors who are right now 
getting nearly zero interest on their savings.
    I actually favor some increase in the short-term interest 
rates by the Fed in order to bring some stability in the short-
term credit markets. It is very odd to have a country running 
with interest rates near zero.
    But the point is exactly right. There is a giant debt 
burden out there, and so as we think our way through this 
crisis, one of the hard parts is we have not reduced the total 
amount of debt at all and probably will not and it makes us 
sensitive to interest rates.
    So what are the banks doing? Here, the large banks are 
beginning to lend a little more. The top line is large banks. 
The bottom line is small banks. And you can see there is no 
loan growth going on from the smaller banks. They are still 
under the regulatory thumb. It is a very harsh regulatory 
environment--
    Chairman Conrad. David, can you just tell us, in terms of 
the chart, what is the period of time we are dealing with? I 
cannot read the--
    Mr. Malpass. This runs from December of 2008 through 
present. So just in 2009, large banks reduced their lending 
from $850 billion down to $650 billion--
    Chairman Conrad. So very dramatic. That is what I was 
referencing earlier in terms of financial crisis, dramatic 
effect on credit markets, huge effect on the economy.
    Mr. Malpass. That is exactly right, and we are still, as 
these show, not exactly digging our way out of that. Most of 
the new credit that is being created in the economy is coming 
from the government, which may have been stabilizing as it goes 
along, but it creates its own set of risks.
    To wit, the next chart shows us CBO's various forecasts. So 
every couple of years, CBO says the debt-to-GDP is going to 
stabilize at an ever-higher level. So in 2005, they said it 
looked like 30 percent debt-to-GDP. In 2009, they said 50 
percent debt-to-GDP. Just in August of 2010, the debt was 
expected to stabilize at 65 percent of GDP, and now CBO is up 
to 77 percent of GDP. This is not--I am not making the point 
that CBO cannot forecast. No one can forecast. I am making the 
point that the government debt is growing at a huge rate and 
CBO is recording it.
    The next chart shows us two kinds of debt. The lower line 
is the publicly held debt, the marketable debt, and that is the 
$9 trillion number--
    Chairman Conrad. What page is that in your--
    Mr. Malpass. This is on page 12 in the graphs, and in the 
testimony, it is on page nine.
    Chairman Conrad. Okay.
    Mr. Malpass. And the testimony gives the background and the 
numbers to it. And so what we see is that the debt limit, the 
statutory debt limit is now up at $14.3 trillion, almost at the 
size of the GDP, and certainly going to go above it. My own 
view is that the debt limit has to be increased. It is not the 
right debt limit to try to regulate because it goes up with 
inflation. It goes up with the growth of the economy and also 
with the Social Security Trust Funds and the other trust funds. 
And so that number, Congress really, I think, could not use as 
an appropriate limitation on the amount of debt and I am 
recommending that we shift over to marketable debt-to-GDP as a 
ratio that you could limit for the next 100 years. That number 
should be decided on and then used as a limitation on 
government debt.
    On page 13, then, this shows you--and I will not dwell--you 
know better than I the various breakdowns of spending, but I 
will note, this shows you the spending per GDP for various 
parts of the budget, and notable is that the interest costs are 
going to go up very dramatically, even in CBO's really 
optimistic--they are assuming interest rates stay really well 
behaved, nothing like what has gone on in Greece, well behaved 
interest rates. The interest costs shoot up, and look where the 
loss comes from. Defense spending is--this is the President's 
budget from fiscal year 2011, and also all other spending, 
meaning you are not controlling Medicare costs, Medicaid costs, 
or Social Security. It is going to come out of huge cuts just 
in the next five, eight years for all the other government 
spending and services that come out of the Federal Government.
    The next chart shows us the same kind of presentation, but 
in dollar terms. So what you can see is the Medicare and 
Medicaid costs are $1.6 trillion, and notable on this graph is 
interest costs will almost overtake the entire defense budget 
by 2021 in the CBO ten-year budget window.
    One point I will make on this graph is I think Congress 
should be looking at spending this way, meaning that there are 
all these things that you spend money on, and it does not 
matter so much whether it is an entitlement, whether it is a 
mandatory, whether it is discretionary. It is all just dollars 
and it goes out very rapidly.
    So rather than dividing the debate into what we do about 
entitlements and what we do about the rest, just find a way to 
cut $1 billion this week and $2 billion next week and we would 
be ahead of the game. And whatever it comes out of, the public 
will cheer and say, good job, and then you will get some 
support for doing the next round of restraint.
    On 15--I only have a few more here--on 15, this shows you--
I am going to show you two or three graphs that are the 
optimistic side of the CBO forecast. CBO is assuming that tax 
receipts go above the 20 percent level that we have never gone 
above before. So look how much it does. By 2016, 2017, 2018, 
2019, we are above 20 percent of the economy in tax receipts. I 
do not think we can achieve that. I think once you get up to 
that barrier, you kind of hit a wall for the economy. So I 
doubt--you know, we have been talking about how huge the debt 
projections are coming out of CBO. I am afraid it is going to 
be worse than that.
    The next page shows you--I mentioned one saving grace for 
the United States that is not available in Southern Europe is 
we have a huge amount of assets that have been built up. This 
country has been growing for 200 years and people put it away 
in houses where the mortgage has been paid off, in corporations 
where you have a lot of assets. And so it is 425 percent of GDP 
in household assets versus that 245 percent debt. So that 
should give us some hope. We can dig our way out of this hole 
if we start restraining spending.
    The next chart shows you, again, an optimistic CBO 
forecast. Again, these are legitimate forecasts. I am not 
saying anything wrong with CBO doing it this way. They get 
guidance from the committee, from Congress itself. What I am 
saying is that we will be lucky if we get the deficit and debt 
numbers that they are projecting because it can be worse.
    This shows you the net interest per debt goes up to 4.5 
percent or maybe five percent of debt, which is a lower 
interest rate. They are assuming the interest rates are lower 
on this coming debt than what we have had on the past debt, 
which is hard to imagine since we have so much more debt. 
Normally, as your debt grows, you have to pay more on it. We 
are assuming in their forecasts that we pay less than 
historical.
    I want to shift now to the tipping point. The next chart 
shows you the difficulty here. Here is CBO's forecasts. What 
they shows you is that interest rates are expected to rise to 
the four to 4.5 percent yield curve. That means at the short 
end, by the end of this budget window, we will be borrowing at 
four percent on the short end and 4.5 percent on the long end.
    That sounds good, but as the next--but challenging that is, 
and the next chart shows this, the very short maturity of our 
debt. This is a key point, that we have not only a huge, record 
amount of debt, but it is also a record short-term nature of 
that debt, which means that if we get into a hiking cycle, we 
are in deep trouble, and I am worried that that is what we will 
get to.
    What this chart shows you is the effect of the Fed now 
buying back the long-term debt. Look, the Treasury has issued 
long-term debt which stabilizes the country because it means we 
do not have to roll it over. The Fed is buying precisely that 
safest debt and buying it back into the U.S. Government. And so 
the effective maturity on the national debt has gone down to 40 
months, which is--we are back to the 1970s level of risk in 
terms of the short nature of the debt.
    A couple more charts. If we think about how a crisis 
happens, a tipping point happens, the yield curve for Greece--
next chart--shows you what happened to Greece. They were going 
along happily in 2007 with that low-yield curve, and then 
whammo. They hit a tipping point and the debt exploded higher.
    And the same thing happened on Greece--excuse me, on 
Ireland. When they went above 90 percent, as the Chairman 
noted, the Reinhart and Rogoff book points out what happens 
when you hit 90 percent, and the U.S. is headed there. They hit 
that in 2010, and look what happened to their interest rate. 
They spiked interest rates in the middle of 2010 and that just 
created a catastrophic problem in the budget deficit as they 
hit that.
    So as we think about the tipping point, my concern is that 
we are going to be stuck with such slow growth that the living 
standards will continue going down. Look at the two periods. 
The 1970s and the 2000s have seen a decline in the median 
household income and that puts us at risk. If we are not an 
economic superpower that adds to the median household income, 
we are in trouble as a country, and that is where we stand 
right now.
    The next chart shows you that we do not want to get to this 
point. This is Europe hitting the tipping point and the 
interest rates shoot up, the deficits explode, and they cannot 
roll their debt. So that is what we are trying to avoid, and 25 
shows you the Fed's explosion of assets, which is one thing 
that has been distorting the markets because the Fed is 
absorbing such a huge amount of the fiscal deficit right now. 
They are using extreme leverage, 40-to- one type leverage. The 
Fed now has its balance sheet up to, or is heading toward $3 
trillion of assets with little oversight from the normal 
Congressional appropriations process.
    So in conclusion, I will mention four policy points of 
view. I think you should use the opportunity of the Continuing 
Resolution on March 4 to cut spending. Just do a little, or do 
more. Do more every day, if you can. Second, you should use the 
opportunity of the debt limit increase-- which I support, you 
have to increase the statutory debt limit--but use that 
opportunity in a thoughtful way to add new controls to the 
national debt.
    I recommend a debt-to-GDP limit as opposed to the current 
nominal debt limit. A debt-to-GDP limit, say, at 50 percent and 
also a limitation or a requirement that the average maturity of 
the debt stay at five years or longer. We are cheating 
ourselves by having the current government issue short-term 
debt, putting us at risk.
    And then, thirdly, the Fed should wind down its asset 
purchases. They are shortening the effective maturity of the 
debt. They are causing substantial market disruptions and they 
are climbing rapidly.
    And finally, tax reform is a high priority and I think in 
order to get it done, what you should do is make the extensions 
of the current tax rates permanent in the baseline, and that 
way you could have a legitimate discussion about what to do 
about future tax rates.
    Thank you very much, Mr. Chairman and Senators.
    [The prepared statement of Mr. Malpass follows:] 



    Chairman Conrad. Thank you. Let me just go to each of you 
and ask you in turn, look, we have--this Committee is the 
Budget Committee, and our obligation is to provide a budget 
outline to our colleagues. We have a lot of decisions to make. 
One of the fundamental questions is how quickly do we impose 
fiscal discipline, fiscal austerity.
    The Commission concluded--and it is interesting. Not only 
did the President's Fiscal Commission conclude this; the 
Domenici-Rivlin Commission concluded this, and the Esquire 
Commission concluded this--all of them bipartisan Commissions. 
All of them concluded for the next 18 months to 2 years we 
ought to make modest changes, but put in place a plan that over 
time, over the next 10 years, substantially reduces the debt, 
on the rate of the President's Commission, $4 trillion of debt 
reduction. Domenici-Rivlin was even more aggressive on deficit 
reduction, as was the Esquire Commission--all of them 
bipartisan Commissions.
    What would your advice to us be in terms of a 10-year plan? 
How aggressive should we be on the front end with imposing 
austerity? How big a chance should we be seeking to achieve 
over a 10-year budget window? Dick?
    Mr. Berner. Well, Senator Conrad, I think that I would 
generally endorse the timetable and the general tone of each of 
those three Commissions, namely, that we do not have a short-
term debt problem; we have an enormous long-term debt problem, 
and we need to come to grips with that. If we had a short-term 
debt problem, then the market and market participants would be 
reflecting that.
    One of the things we can use as a barometer to gauge 
whether we have a short-term debt problem is the response of 
markets, and when markets start to question whether or not you 
can service your debt, then you will see a rise in interest 
rates and a widening in spreads relative to other benchmarks in 
the marketplace on a global basis. We do not have that yet, so 
we enjoy low interest rates, and we enjoy favorable borrowing 
terms right now. But, of course, that is going to run out, and 
I think, as I emphasized in my testimony and as you just 
mentioned, the important thing is to craft a credible plan to 
address our long-term problems. And I just want to emphasize 
that credible does not mean saying that we are going to cut 
$100 billion here or that we are going to have a 5-year freeze 
on discretionary spending. Credible means that we are going to 
attack those long-term problems. We are going to look at them 
specifically and address the root cause of our long-term fiscal 
problems.
    Chairman Conrad. Dr. Johnson, what would your advice be to 
us with respect to the question of timing?
    Senator Sessions. Mr. Chairman, could I ask him to do that 
in an economic sense, not adjusting your comments to what you 
might think the political realities are, because that is up to 
us to try to face. But we would like to have your best opinion 
on what we should do.
    Mr. Berner. Senator, if I could just add, my comments were 
not adjusted for political reality.
    Senator Sessions. I felt that. Thank you.
    Mr. Johnson. Well, I think we are--I am not in favor of 
precipitous, immediate fiscal austerity of the kind the British 
Government is now embarked on, and we will see in the quarters 
ahead how that program does. The data from the last quarter is 
rather shocking. They had a decline in GDP far below all the 
private sector forecasts in the U.K. Partly it was bad weather 
in December, but also October and November were very bad 
months.
    As Dick said, we do not need--they do not need also, but we 
do not need that kind of immediate cuts, but I think we do need 
something over the medium term, in my opinion, that is even 
more aggressive than I think where Dick is and certainly than 
where David is. I think when you are carrying massive financial 
sector risk, which is what we are carrying--and it is also, by 
the way, what the Irish carry. If you look at page 21 in 
David's charts, the Irish were considered to have responsible 
fiscal policy. They blew themselves up on the fiscal side 
because three banks went rogue and destroyed themselves and 
were taken over by the government, because the government felt 
they did not have an alternative. That is where we are. So 50 
percent of GDP or 60 percent, the number commonly used, I think 
is to high when you have--unless you want to deal with the 
financial risk. But we did not do that. So when you are 
carrying this amount of implied contingent liability over a 10-
year period, I want to get the debt down even lower because I 
fear that the markets can turn very quickly. This is the Bill 
Gross test, Senator Sessions. Next time you or I see Mr. Gross, 
we should ask him: How long would it take you to change your 
mind and shift your portfolio, for example, towards the euro 
zone if they sort out their fiscal financial problems? Which I 
think they will do in the next 12 to 18 months. I think he 
would tell you it takes, you know, 20 minutes for him to move 
his portfolio. That is how fast the yield curve can move 
against this, and that is what happened, as David said, to the 
Irish.
    Chairman Conrad. That is what Tom Friedman called ``the 
electronic herd.''
    David?
    Mr. Malpass. I think the goal is to avoid that electronic 
herd and actually to get the private sector to start hiring 
people. So I think I feel a little differently than many 
economists, that if we cut a lot now in the Federal Government, 
people would perk up and take notice. Global investors would 
start putting their money into the United States rather than 
moving it to Asia and elsewhere. So I want to emphasize that 
positive feedback mechanism from going on a diet now. If you 
are going on a diet, do not say, well, 3 months from now we 
will have our plan laid out. Just stop eating as much this 
evening, and then if you can, start your exercise program.
    Chairman Conrad. But, David, let me just say to you, you 
know, the problem is that is not the way the schedule of 
Congress works.
    Mr. Malpass. Yes.
    Chairman Conrad. You know? We have a schedule here, and the 
schedule is we have to have a budget resolution that guides the 
Appropriations Committees. I happen to agree with you. I think 
it would be wonderful if we could do it. But it does not work 
with the schedule of Congress. So we have to deal with that, 
and that is why, again, I asked for a summit. I think if we 
want to send a signal that America is going to face up to this 
problem and we are going to put together a credible plan, 
nothing would be more effective than the leadership of this 
country sitting down and coming up with that plan and not wait 
for the debt limit. You know what I am saying? I mean, we are 
not going to have appropriations bills for months because they 
come later in the cycle. So we cannot do what I think you would 
like to see happen, what I think would be helpful to 
credibility, because, you know, we just do not get to that 
stage until a little later.
    Mr. Malpass. Yes, this is a tough fix. I agree with all of 
you that we need the longer-term cuts and rethinking of how we 
spend money, and it needs to be rather substantial. So a wonder 
in the markets right now is whether there will be any ability 
by the U.S. Government to actually do some of these cuts. So is 
there some middle ground between what the U.K. did and doing 
nothing over the next 6 months. That at least would, I think, 
begin to change the minds--right now U.S. corporations are 
taking their money outside the United States. They borrow in 
the U.S. at very cheap rates and invest in Asia because they 
are worried that the U.S. cannot cut spending. So if there 
could be some symbolic or concrete types of changes to give 
them reassurance, I think we would start getting jobs right 
away.
    Chairman Conrad. All right. My time has expired.
    Senator Sessions.
    Senator Sessions. Dr. Johnson, I would just say that the 
TARP bailout has not cost the taxpayers a lot, but the stimulus 
bill cost $900 billion at 4 percent interest. that is $36 
billion a year we will pay for the rest of our lives, I 
suppose, because of this one effort. Nobel Laureate Gary 
Becker, whom I quoted on the floor before that bill passed, 
said he did not think it would be sufficiently stimulative, and 
I believe he is proven to be correct. He said it would be far 
less than--I think he said 0.7 and should try to be above that 
if you could get there. But anyway, neither here nor there.
    I guess in one sense you could say this is not a crisis 
now, but I would contend that a $1.5 trillion deficit is a huge 
thing, and we will pay interest on that forever, presumably. 
Interest is crowding out so much of our future potential to 
invest, as the President would say, in things we would like to 
spend money on. It is just going to be a huge thing even if the 
interest rates stay at the rate CBO projects.
    Mr. Malpass, you did not comment, I do not think, on the 
Rogoff-Reinhart theory, but it is that if you get debt so high, 
it reduces growth and puts you in a serious stagnant position. 
Do you agree with that theory? Does that provide greater 
urgency for us at this point in time?
    Mr. Malpass. I think it definitely does. So as more and 
more of the economy is directed by the Government, as the debt 
goes up, that reflects the Government directing more parts of 
the economy, and your growth rate goes down. And I think we are 
already seeing that in the slower average growth rate for the 
U.S. over recent decades. It is a grave concern.
    Senator Sessions. The income, revenue to GDP, you referred 
to--I believe you referred to it.
    Mr. Malpass. Yes.
    Senator Sessions. 14.8 percent. One thing I believe causes 
that--and I have not seen any research done on it, but we have 
skewed our revenue to high-income individuals whose income 
tends to be more volatile. So now I understand it is down to--
is expected to be 14.8 percent of GDP by 2015, and Moody's is 
concerned with our debt rating. How would you comment on that, 
Mr. Malpass?
    Mr. Malpass. The slower economy hits people that were 
earning more, and so that is showing up in this lower rate-- or 
smaller percentage of taxes coming from high earners. I think 
it also means and helps explain why job growth has been so 
weak, that we really depend a lot on new businesses and small 
businesses for creating jobs. And so in the current 
environment, they are not doing that as much. They are not then 
scoring, you know, creating things like Google. We are going to 
have this dry period of entrepreneurism and innovation. So that 
will be costly to us in the long run, too.
    Senator Sessions. Dr. Berner and Mr. Malpass, to follow up 
on Dr. Johnson's comment about what the U.K. is doing, I think 
a fundamental question is: Are they taking their medicine now 
that will put them in the longer term on a healthy growth path? 
Or is their reduction in spending and increase in taxes--I 
think it is three to one revenue cuts to tax increases. Is that 
too much austerity? And I would like the two of you to add your 
views on that.
    Mr. Berner. Well, you know, Senator, each country has to 
determine the pace at which they decide to impose austerity, 
and in the U.K. they have decided to stretch out over a 4-year 
time frame the kind of austerity that we are seeing. I think 
the U.K.'s particular problems right now in terms of growth 
relate to other things besides the fiscal austerity that they 
have imposed. But one thing we know is that they also have an 
inflation problem in the U.K., which is higher than ours and 
higher than most of the developed world's, and so that limits 
their flexibility to maneuver as well. So they have a little 
bit less flexibility to maneuver than we do. Right now we have 
low interest rates, low inflation, a Federal Reserve that is 
very supportive of growth. We may not have that flexibility in 
the future.
    So the answer, I think, is to--
    Senator Sessions. Well, with regard to the U.K., just 
looking at them, do you think in the long run they will benefit 
from the austerity measures?
    Mr. Berner. In the long run, they will benefit from those 
austerity measures. The question is whether they have the right 
balance given their other policies. That is absolutely right.
    Senator Sessions. And, Mr. Malpass, you comment.
    Mr. Malpass. I agree with that. I think we would be better 
off if we could move faster even in the short run on fiscal 
austerity. I take to heart the Chairman's point that our system 
is not a parliamentary system. They have a way where a small 
group of people can say, look, let us change the fiscal course. 
Ours is going to take a lot of work among a lot of Senators, 
Congressmen, the administration, and so on to get it done.
    I would note the pound strengthened quite a bit when the 
U.K. made this change, and that helps them in terms of their 
living standards. If you think of the dollar per capita incomes 
in the U.K., they have gone up while ours are going down 
because of that change. And, also, I do not think we should 
measure it only in terms of their GDP growth rate, which was 
weak in the fourth quarter. We have to look at jobs and future 
jobs that are being created, and I think by the Government 
showing some discipline, that is attractive to the business 
environment, and we will see the job growth doing a little bit 
better even in the short run for the U.K. than what we have 
been experiencing here.
    Senator Sessions. Well, to you economists, thinkers, 
Masters of the Universe, as I affectionately call you, the 
political world is unusual. It is not quite the same. And the 
idea that we can just move in and out and make changes is not 
accurate. It happens that there are opportunities to make 
changes. My firm belief is right now there is an opportunity to 
go further than Wall Street thinks is possible in reducing 
spending and put us on a sound path. Now, we do not want to do 
something that, you know, would be disastrous to the economy, 
but I think we better take advantage of the opportunity to 
reduce spending now.
    I criticized the Bush administration. We had surpluses, and 
somehow it got around that deficits do not matter. They forgot 
the political world. I am in here saying we cannot spend more 
because it is going to run up the debt and we will lose our 
surpluses, and they are saying it does not matter. But once you 
politically get that ideology going, it runs out of control. 
And so the American people are at a point of wanting to be more 
frugal right now. I think we better go meet them halfway and 
push them a little further and take the gain that we can get 
now.
    Thank you.
    Chairman Conrad. Thank you.
    Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman, and I thank all 
three of you for a fine presentation.
    Before this meeting, there was an extraordinary discussion 
that you do not see very often in the Senate. Senator Conrad, 
Senator Coburn, and others put together a meeting on the debt 
and where the economy is headed. At a little after 8:00, there 
were more than 30 United States Senators there interested in 
actually getting into the details. You do not see many meetings 
like the one that was held this morning.
    And what I was struck by--because the numbers are just a 
clear wake-up call. I mean, if you are spending $3.7 trillion 
and you have receipts of 2.2, it is not hard to figure out that 
math and what the implications are. And what I was struck by 
was the sense that the single most important thing here is to 
send a major message to the country and to the financial 
markets that you are getting serious, that you are doing 
something significant. And what Senators seemed to get focused 
on was the idea that you would make a substantial downpayment 
this year in deficit reduction and deal with at least one major 
long-term problem, one major structural problem.
    I admit that I think the structural issue ought to be tax 
reform. Senator Gregg, Senator Sessions' predecessor, and I 
introduced legislation that would create, according to the 
Heritage Foundation, 2.3 million new jobs per year, and I think 
because of what you have described in terms of the economy, 
what is done in terms of the long term has to give a shot in 
the arm to the economy.
    But I would just like to go down the row and ask each of 
you to give us your sense, first of all, of a number, an actual 
number that would constitute a real message that you are making 
a downpayment this year in terms of deficit reduction, and then 
your take on what would be the major long-term issue that 
Congress would actually tackle this year and enact it into law. 
And you have already heard my judgment that it ought to be tax 
reform because of growth.?
    So we will just go all three of you, and I would also note 
Mr. Malpass spent years in Oregon, and we are glad to have an 
Oregonian before the panel. We will claim you.
    Mr. Berner.
    Mr. Berner. Thank you, Senator Wyden. You know, we do not 
know exactly what the number is, but--
    Senator Wyden. Just a ballpark.
    Mr. Berner. --$100 billion is not impressing financial 
markets. Something, you know, quite a bit larger than that, 
something on the order of $400 or $500 billion. And I think 
what is really important here is not so much, as the discussion 
has revolved around, that that be implemented today, but that 
you commit to a large number and you have a plan to make that 
number understandable and to make it credible so that financial 
markets will take it on board and will be positively surprised 
by that number.
    And I want to say I fully support--and I support David's 
argument and yours for tax reform. I think that would have 
enormous benefits for the economy in a number of respects, and 
I hope you find a co-sponsor on the Republican side--
    Senator Wyden. We will.
    Mr. Berner. --to support your proposal, because I strongly 
support it.
    Senator Wyden. Very good. Mr. Johnson.
    Mr. Johnson. I think this is absolutely the right question 
at the right time. Clearly something on the order of tens of 
billions does not do anything in this context, and I doubt that 
even if you are talking about hundreds of billions that makes 
that much difference. I think you need to be talking about the 
big trillion-dollar items over a 10- to 20-year horizon, and 
there are two. One is tax reform, where the good news is our 
tax system is so antiquated and so messed up that even if you 
do not want to raise revenue as a percent of GDP over the 
cycle, there are plenty of ways to improve incentives. And when 
you are improving incentives, you will actually get some 
additional revenue. We take in, in terms of taxes relative to 
GDP, 10 to 15 percentage points less than other industrialized 
countries that have better-run tax systems. So you decide 
whether or not the revenue--it certainly makes the tax system 
better.
    And the second is health care, Medicare in particular. That 
is a big budget buster by 2030, 2040. I doubt that you want to 
take on Medicare in this Congress, but those are really your 
two choices. Those are the two things that would really make 
the difference here. And I have to say in this context I did 
not support the tax deal at the end of last year. That was a 
big number over the next--over the foreseeable future. That was 
a big number in the wrong direction. That was a bipartisan 
consensus away from fiscal responsibility, quite contrary to 
the spirit of everything that has been said here this morning. 
And I am sorry that Senator Sessions stepped out because he 
said that somebody said deficits do not matter during the Bush 
administration. I believe that was Vice President Dick Cheney 
who specifically said, ``Ronald Reagan taught us that deficits 
do not matter.'' And I hope as we approach Ronald Reagan's 
100th anniversary next week we all reflect on how far from 
being appropriate for today's reality is that message.
    Senator Wyden. I do think one other part of your testimony 
that is very helpful is you are conveying a sense of urgency, 
because in this town it is all about the politics of 
procrastination. What I wanted as part of the end-of-the-year 
agreement was a 1-year extension of the Bush tax cuts so that 
you would force Congress to step up this year and actually deal 
with these kinds of issues, because my concern is unless you 
all and others can help us convey this sense of urgency, we 
will have exactly the same debate in the lame duck session of 
the 2012 Congress as we had during the lame duck session of the 
2010 Congress. And that was why I wanted something that would 
force action this year.
    Mr. Malpass, your thoughts, the number and the question of 
the big structural issue, if you get to pick one.
    Mr. Malpass. Thank you for representing Oregon. The markets 
are cynical about how much can be done here in our system, and 
so I think as you go through this, one of the most heartening 
things, if 30 Senators this morning were together, as you 
mentioned, that is a big step. That is the kind of change that 
people want--I mean that markets will be looking for and say, 
Golly, if you got all those people in the room, something might 
come out of it.
    My view is--and I think you are hitting on it--that short 
extensions of existing spending where you take many bites at 
the apple I think would be a procedure that might work. So as 
the continuing resolution discussion comes up, whatever the 
amount of spending cuts that can be done in that resolution, if 
you can do it multiple times in a given year, that is going to 
get you a lot of credibility in terms of the financial markets 
and job creation from the private sector.
    So I think $100 billion in near-term spending cuts would be 
very useful. Whatever the number is, then kind of make a 
promise or a pinky promise of some kind that you are going to 
come back 2 or 3 months later and try to do another round of 
things that you can work on.
    As far as what is structural reform longer term, I think 
tax reform would be--Wyden-Gregg was very good, if you can get 
another co-sponsor and go forward with that, and I recommend a 
baseline where you look at directing the baseline so that it 
gives a more level playing field. Otherwise, you are swimming 
up this fast current. The CBO scoring undercuts the tax reform 
process to such a degree, the normal scoring, that you will not 
be able to get a growth-oriented reform.
    The other procedural change I am suggesting is that you 
fill this vacuum of limits. A debt-to-GDP limit would be very 
comforting to markets because markets' concern right now is you 
are going from 60 percent debt-to-GDP, marketable debt-to-GDP, 
right up to 90, and it looks like we might go to 110, meaning 
right across that threshold that the Chairman mentioned. So if 
we could have some new kind of limitation other than the 
statutory debt limit, that would give some underlying 
confidence.
    I need to make one defense of President Reagan. There was 
the idea that his economics were not the right economics. 
Remember what he was saying, that we cannot look at the deficit 
alone; we have to look at the tax rates and at the spending. 
And so we needed to cut both of those to enable the private 
sector, and my view is that worked very well in the 1980s, and 
we created a huge amount of jobs and growth out of good, sound 
economic policy in those years.
    Senator Wyden. My time has expired. Thank you.
    Chairman Conrad. Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman. I would like to 
thank the panel for their testimony as well.
    I have several questions. The first is I would like to 
follow up on something that Mr. Malpass addressed, which is the 
increase in the debt limit. You have advocated that we make 
some structural changes essentially to get this escalating 
deficit and debt under control. I happen to share the view that 
we should make structural changes. We might have a difference 
as to exactly which ones to make, but I do think it is very 
important that we use this occasion to begin to get our long-
term spending problem under control.
    So I am not in the camp that argues that under no 
circumstances should we raise the debt limit. I also accept 
your general premise that it is a rather blunt instrument, and 
the disruptions that would occur are to be avoided, if we can. 
However, I think it is very important as we approach this that 
we understand exactly what might occur and what would not occur 
if there is some period of time during which we do not raise 
the debt limit upon reaching it.
    So my first question is a simple and factual, historical 
question, and that is, is it true that we have had recent 
episodes in the past several decades where we have reached our 
debt limit, we have not raised it immediately upon reaching it, 
and we nevertheless did not default on the marketable debt 
securities issued by the Government?
    Mr. Malpass. To me, sir? Yes. In the late 1990s, there was 
a period of roughly 4 years. It is on page 9 of my testimony. 
My view is those were rather unique years. One of the things 
that was happening was defense spending was being cut sharply. 
Another thing that was happening was there was a temporary 
slowdown in the entitlement spending. It had to do with the 
generation--you know, the baby-boom generation had not yet 
started to retire. So on page 9 it goes through those.
    Also, in those years something was happening--yes, here it 
is on the screen. Fannie Mae and Freddie Mac were really 
ramping up, which operated almost like Government spending. 
Remember they were kind of off-budget, and yet they are really 
ending being taxpayer liabilities. So that helped paper over 
that particular period of time.
    I do not think we could mimic that right now.
    Senator Toomey. Well, if I could interrupt for just a 
second, the point is that for a short period of time the debt 
limit was not raised.
    Mr. Malpass. Correct.
    Senator Toomey. And when the debt limit is not raised, is 
it true the tax revenue still comes in?
    Mr. Malpass. That is right. Money floods in.
    Senator Toomey. Right. And next year, for instance, if my 
numbers are right, something on the order of 70 percent of all 
the money that the Government is expected to spend is going to 
come in in the form of tax revenue. Is that true?
    Mr. Malpass. Yes.
    Senator Toomey. And something on the order of 6 percent of 
all the money the Government is going to spend is currently 
scheduled for interest on our debt.
    So I guess the question is: Is it possible for the 
Treasury, in the event that the debt ceiling is not raised, and 
acknowledging that this is in some ways a disruptive thing if 
that does not happen, but that the Treasury could, 
nevertheless, ensure that those people holding the marketable 
securities of this Government would receive their interest 
payments and that those payments can be made?
    Mr. Malpass. Yes, that is plausible. The fiscal deficit is 
large now, so each month, the government is in a negative cash 
flow of roughly $120 billion. So what would happen each week is 
someone, meaning the Treasury Department or you, members of 
Congress, would have to be deciding who not to pay--
    Senator Toomey. Right.
    Mr. Malpass. --and my concern is the disruption as--
    Senator Toomey. I understand this is very disruptive and I 
have acknowledged this. The point is a narrow point, and that 
is do those people holding securities necessarily need to not 
get their interest and principal payments, and I think you are 
acknowledging that.
    Yes, sir?
    Mr. Johnson. Senator, I think you are playing with fire in 
this scenario. One point that was not covered in David's 
otherwise comprehensive review of the debt situation is 
borrowing from abroad. You have to remember that it is not just 
an internally funded debt. We are the world's largest borrower 
and this is very dangerous. There are alternative assets out 
there in the world. I know that the Eurozone does not look very 
appealing right now, but I think they will turn themselves 
around. The Chinese are working very hard to create alternative 
reserve assets--
    Senator Toomey. Right.
    Mr. Johnson. --including the Renminbi. I really do not 
think that you want to create potential disruptions of this 
kind, because there is nothing that says that the dollar has to 
be the number one reserve asset forever, and the British pound 
lost this position earlier in the 20th century exactly through 
fiscal irresponsibility and global overreach.
    Senator Toomey. I would simply argue that I think the 
fiscal irresponsibility is what hasten us into this situation, 
and the refusal to do anything about it is the worst message we 
could send to the market. The fact that revenue will be more 
than ten times the expected cost of interest makes it very 
clear to me that no responsible Treasury Secretary would ever 
allow a default to occur on our debt. It would be so disruptive 
and so damaging to our entire economy, to the millions of 
savers, Americans as well as others, that I cannot foresee how 
a Treasury Secretary would permit that to happen when he or she 
would have more than ten times the revenue needed to prevent it 
from happening.
    Let me move on to another question, if I could, and that is 
as alarming as the magnitude of the debt that we have discussed 
today is, I may have missed this, but I do not recall a 
discussion about another component that worries me, in fact, I 
would argue is even bigger than what we have talked about, and 
that is the unfunded liabilities implicit in the promises we 
have made through the big entitlement programs. If you 
quantified the present value of that shortfall, is it true that 
that is actually several multiples of the actual publicly 
traded debt that we have?
    Mr. Berner. Yes, it is, Senator. It is, and obviously 
different calculations will give you different results, but I 
think everybody agrees that the present value of those 
liabilities is enormous. In fact, if you add up Medicare, 
Medicaid, and Social Security, you come up with an unfunded 
liability, when added to the debt, really would exceed the 
value of the assets that David showed in his charts.
    Beyond that, if you look at another issue, which is the 
unfunded liabilities of State and local governments, those that 
are on the books as the gap between the promises they have made 
for their pensions and the assets that they have, as well as 
the unfunded liabilities for the health care promises that they 
have made, that would add, on top of the Federal liabilities, 
to what you are talking about. So the answer is definitively 
yes and resoundingly so.
    Mr. Johnson. But we also need to add and score 
appropriately the contingent liabilities that arise out of the 
financial sector--
    Senator Toomey. Right.
    Mr. Johnson. --because we just pushed up debt by 40 
percentage points of GDP because of the way the financial 
sector--
    Mr. Taylor. Agreed.
    Mr. Johnson. So I think all of this needs to be included, 
and I think we agree on that.
    Mr. Malpass. And can I add one more? I agree with those 
points. The actual size of government is going to go on. Fifty 
years from now, there is going to be a defense budget and there 
is going to be probably a Federal education budget and so on. 
So I think as you think about the problem, I am not as focused 
on dividing entitlements from discretionary spending. They are 
all commitments to the people that there is going to be a 
government in the next generation and the next and we just do 
not have the money for it right now.
    Senator Toomey. Thank you very much. I see my time has 
expired. If there is time in a future round, I would like to 
address yet another respect in which I think this problem is 
even worse, and that is something that Mr. Malpass mentioned 
briefly, which is what strikes me as potentially a very 
optimistic forecast about the level of interest rates, and 
when, of course, you have a huge debt, if you are wrong about 
your optimistic forecasts about interest rates, then that has 
devastating consequences.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you for that point, because I think 
that is one of the critical points, somehow, we need to be able 
to persuade our colleagues of. What is the risk of a failure to 
act?
    You know, we have a very benign interest rate environment 
now, very low interest rates, even record low interest rates. 
Some are saying that is an indication we do not need to act. My 
own view is it is giving us a period of time within which to 
act. A failure to act within that period of time could lead to 
much more serious consequences. And if you look at that ten-
year CBO outlook, they are projecting a low interest rate 
environment for a decade. Well, maybe that happens, maybe it 
does not. If there is one thing that is clear, we have seen it 
in the case of Greece, it was clear in Mr. Malpass's 
presentation, Greece, Ireland, everybody else that has run into 
one of these situations, the change in your interest rate 
environment can happen like that and then you are really in the 
soup.
    Senator.
    Senator Toomey. Mr. Chairman, thank you. Just a quick 
observation about how very optimistic this interest rate 
assumption strikes me, and that is the assumption is that 
interest rates revert to something less than their 20-year mean 
over the last 20 years. That, despite the fact that the Fed is 
embarking on an absolutely unprecedented program, the very 
purpose of which is to increase inflation expectations. It is 
my fear that they will be very successful at increasing 
inflation expectations, quite likely increasing inflation 
itself, and it is very hard to fathom how interest rates do not 
respond by going considerably higher. If that happens, all of 
these numbers change pretty dramatically.
    Mr. Berner. Senator, if I could--
    Chairman Conrad. Yes, go ahead.
    Mr. Berner. If I could add a point to that, I think one of 
the--beyond the inflation issue, it seems to me that one of the 
biggest issues that is out there is that in this global 
environment, market participants around the world view us as 
the best credit around the world. If they start to question our 
ability to service our debt and our ability to meet our 
obligations, that is when interest rates adjusted for inflation 
will start to rise and the risk premium on our debt will start 
to rise, and as you put it so eloquently, that is when we are 
really in the soup.
    Mr. Johnson. But Senator--
    Chairman Conrad. Simon?
    Mr. Johnson. Let me pile on. It is worse than this, I 
think, because again, thinking globally, I would commend to you 
this new report by McKinsey Global Institute on real interest 
rates. So what are global savings going to be? What is global 
investment going to be? In their assessment_this is a very good 
report led by Michael Spence, a Nobel Prize winner--their 
assessment is, just in real terms, looking globally, interest 
rates will head up. So you should add your concerns about 
nominal interest rates, about inflation expectations onto the 
real rate, and they say we are coming out of a period where we 
have had unusually low real rates globally because we have had 
savings that were higher than investments for reasons that are 
now receding.
    Mr. Berner. And let us be clear. If real rates go up 
because economic performance is good, and as Simon just put it, 
if we see strong growth around the world, then real rates 
actually should go up. But if real rates are going up because 
there are concerns about our creditworthiness, then that is 
where our economic performance on a long-term basis will really 
suffer and where the spiral becomes quite negative.
    Chairman Conrad. Can I just make this point? One of the 
concerns I have in listening to the discussion that is 
unfolding in this town is the focus on non-defense 
discretionary spending, because non-defense discretionary 
spending is about 16 percent of our budget. The President used 
the number 12 percent in his State of the Union because he had 
an unusual treatment of Homeland Security and some other things 
that he put in the defense pot that normally would not be 
there. I think he put international in the defense pot.
    But let us go back to that basic formulation. Non- defense 
domestic discretionary spending is about 16 percent of our 
budget, and yet it is getting almost all the attention for how 
we solve this problem. And we are borrowing 40 cents of every 
dollar we spend. If you eliminate it all, you have not solved 
this problem.
    So the part of our budget that is growing as a share of the 
size of the economy are our entitlement accounts-- Medicare, 
Social Security, primarily the health care accounts, much 
bigger than Social Security. That is seven times the problem of 
Social Security. And yet, you know, somehow, we do not want to 
talk about it. I think I know why we do not want to talk about 
it, because if you ask the American people, they say you do not 
need to touch Medicare. You do not need to cut Social Security. 
You do not need to touch defense. You do not need to touch 
revenue.
    Well, I just say this. If that is really the conclusion, 
that Social Security does not have to be touched and it is 
cash-negative today, Medicare does not have to be touched, 
defense does not have to be touched, revenue does not have to 
be touched, you cannot solve the problem. There is a 
mathematical certainty you cannot solve the problem.
    So some of us are going to have to help the American people 
understand the unfortunate reality here, and the unfortunate 
reality is, I believe, all those things are going to have to be 
touched, and the sooner we do it, the better, because the less 
draconian the solutions will be later on. The worst time to 
deal with this is when you are in a crisis. If there is 
anything Greece should have taught us and Ireland should have 
taught us and Portugal should teach us is the worst time is 
when you are in a crisis.
    Dr. Johnson, you are the former Chief Economist at the 
International Monetary Fund. Probably nobody that I am aware of 
has a deeper understanding of global economics than do you. 
What would be your advice to this committee with respect to the 
question of how you deal with this in a systematic way? What 
parts of the budget have to be dealt with over the longer term? 
Does domestic discretionary spending, non-defense, does that 
get you out of this hole?
    Mr. Johnson. No, Senator, it obviously does not. The IMF 
advice would be, or maybe will be if we get sufficiently 
desperate and we need to take their advice, would be you need a 
medium-term fiscal framework. You need some very clear agreed 
upon rules. You need your summit. You need a bipartisan 
consensus. You need to say, this is what we are going to do on 
tax reform. This is what we are going to do, particularly on 
Medicare. Social Security is a problem, I agree, but that can 
be addressed in a relatively straightforward way. Medicare and 
medical costs explode as a percentage of GDP.
    And by the way, compared with other countries like, for 
example, in Europe, they have the same problem. They just do 
not account for it as honestly as we do. If they scored their 
future medical spending like the CBO scores for us, we would 
see the same problems in most of Western Europe, also, if that 
is any consolation.
    But if you had that framework, if you had rules that were 
agreed upon, then you have the flip side of the point David 
made about us not being a parliamentary democracy, which is it 
is not easy to change our rules. So if you have locked into 
those rules in the U.S. constitutional framework, the markets 
are going to know it would take a lot to undo them and you can 
lock into something five, ten, 15 years down the road which the 
markets would respect because it is hard to undo. Now, it is 
also hard to get there, I understand, but that is, from a 
global comparative perspective, the advice that you would get.
    And honestly, that is what the Chinese--we are very big 
creditors to the Chinese. I guess the Chinese President paid us 
a visit recently to see how his money is doing and felt okay 
about that. But ultimately, they will not feel okay. 
Ultimately, our creditors will demand this kind of change, too. 
This is what the IMF has demanded on behalf of the IMF to 
highly indebted countries around the world.
    So we should do it ourselves now, as you said, before we 
are rushed and before we are in a situation where it is a 
crisis and you can only do really, really damaging cuts that 
hurt a lot of people.
    Chairman Conrad. Let me say one other thing and then we 
will go to Senator Sessions. I hope very much when we deal with 
these opportunities this year we are not just dealing with 
short-term non-defense domestic discretionary spending. We are 
talking about $60 billion, $100 billion. In one year, we got a 
$1.5 trillion problem. And while that may send a useful signal, 
it does not touch the problem.
    We need a multi-year, comprehensive plan that reduces the 
debt over the next ten years by, I believe, at least $4 
trillion. Now we are talking on the scale that really has some 
credibility.
    Senator Sessions.
    Senator Sessions. Thank you. This is a very difficult 
issue. I have been with my staff since I have been Ranking 
Member and I still do not have a handle on it, but I can tell 
you, anybody who thinks it is easy to get this house in 
financial order is not correct, as you indicated, Mr. Chairman.
    I would note, though, we ought not to think that we should 
ignore discretionary spending. I feel very strongly about that. 
We had 35 percent in the State Department just last year, 35 
percent increases for EPA, double-digit increases for 
agriculture. President Bush was criticized for agriculture 
increases. I saw his ten-year budget. I do not think he had a 
single year over a two percent increase. We had a 12 percent--I 
think it is a 12 percent increase. I am just saying, we have--
2010 levels are unusually high and we are going to have to go 
back to 2008, if not lower.
    I criticize the Debt Commission and their work on one 
point. They certainly served a national purpose and I may well 
have voted for the product if I had been on the committee. But 
I would just say, their goal as given to them by President 
Obama was to reduce the deficit to three percent of GDP over 
ten years, and that is what they did. I understand that 
projected--that deficit in ten years, three percent of GDP, is 
$700 billion to $1 trillion. So I would ask the three of you 
first, is that a sustainable deficit, first, just briefly, if 
you would.
    Mr. Berner. Senator, if that is the end of the story, then 
the answer is no.
    Senator Sessions. It would be good progress.
    Mr. Berner. It would be good progress, absolutely, if the 
story continued and there was a continuing credible commitment 
to make further progress so that you got that deficit down, 
because ultimately, in order to stabilize the debt in relation 
to our economy, you are going to have to make further progress 
on it over time and that is really what is important.
    Chairman Conrad. Could I just make a point on--
    Senator Sessions. Yes.
    Chairman Conrad. I just want to make a correction. In terms 
of the Commission, the President gave us the goal of three 
percent, but we exceeded it.
    Senator Sessions. Oh, you did?
    Chairman Conrad. We went to 2.3 in 2015 and then down to 
1.2 in 2020 because we believed, and I think it was a strong 
consensus, that we had to go further.
    Senator Sessions. Well, thank you, Mr. Chairman. I am glad 
to correct that because it was depressing me more than I should 
have been depressed.
    Mr. Johnson. Senators, could I--
    Senator Sessions. Yes, Dr. Johnson?
    Mr. Johnson. Look, I think you should push this as far as 
you can. It is a question of the risks in the global economy, 
where you do not know--you are going to want to borrow this 
money from somebody else. They may have a better use for their 
money. They may prefer to keep their funds in another currency. 
Over a 20-year horizon, I would be very surprised if the U.S. 
dollar has the same level of predominance as a reserve currency 
as it has today, and I would not be surprised if we shared the 
stage with a stronger Euro and a much stronger and liberalized 
Renminbi, the Chinese currency.
    You quoted earlier that somebody said during the Bush 
administration, deficits do not matter. I think that was Vice 
President Dick Cheney--
    Senator Sessions. I heard--I was on the--
    Mr. Johnson. But I wanted to make sure--I said you were in 
the room, and I think, did he not actually say, Ronald Reagan 
taught us that deficits did not matter?
    Senator Sessions. I am not sure, but I think that was a 
private conversation that sort of leaked out and became part of 
the agenda. But Mr. Greenspan recently said to a luncheon I was 
at that, well, in the early 2000s, we had surpluses. We could 
handle a little extra debt. So even, I think, the Fed was in 
the view that when we went into the recession in 2001, a little 
deficit would not hurt us. But the truth is, politically, once 
you lose the high ground-- when you lose the political high 
ground in Congress, it is hard to get it back.
    Mr. Johnson. If I could just reinforce that point, Senator, 
with regard to David's proposed debt-to-GDP limit. Certainly 
debt-to-GDP is the right way to think about this, but if you go 
with a 50 percent limit, or, of course, the Europeans have a 60 
percent limit under the Maastricht Treaty, an intergovernmental 
treaty, it has not done them any good at all. It is far too 
high. In the modern world when you are hit with these nasty 
shocks and you want to be able to use fiscal policy to respond 
and to offset something that just strikes you completely out of 
the view, 50 or 60 percent of GDP, I think, is too high because 
the shocks are going to be big, very big, and push you over the 
90 percent level that we are all worried about.
    Mr. Malpass. I take that point well, and maybe a lower 
number, 40 percent debt-to-GDP ratio, would be more acceptable. 
What you need to do, I think, is have escalating penalties if 
you are above it, in other words, some discipline on the 
budgeting process, on OMB to produce budgets that bring us down 
below the debt-to-GDP limit or some kind of mechanism to give 
it some teeth.
    If I may, I have written down several--I think in terms of 
this problem as one where you should begin today making small 
decisions, or they are not really small, but do the things that 
you can, so I will list several things that we have talked 
about.
    One is I think the Fed should wind down its buying of 
Treasury bonds. This is a huge problem where the Fed is buying 
the long-term debt and therefore shortening the maturity of our 
national debt. That puts us at risk.
    Second, in the same vein, Treasury should be issuing more 
long-term debt. We have to get our debt maturity longer to be 
prepared for what comes in the future.
    Third is the directed baseline in order to open a window 
for tax reform. Right now, the way Congress procedures work, it 
is not credible to embark on tax reform because you have to 
soak up the--making permanent the existing rates. The 
Alternative Minimum Tax, for example, expires, and yet everyone 
knows it is going to have to be patched into the future. That 
should not be part of the baseline, the cost of that. And so 
you need a directed baseline in order to create a more level 
playing field.
    Fourth is using the Continuing Resolution--
    Chairman Conrad. David, can I just stop you on that point?
    Mr. Malpass. Yes, sir.
    Chairman Conrad. This is one--the only thing I have heard 
you say today with which I strenuously disagree--
    Mr. Malpass. Uh-huh--
    Chairman Conrad. --and the reason I do is if it is not in 
the baseline, what does that say to Congress? That it is free. 
And you and I know it gets added to the debt. And I will tell 
you, I am in the Sessions camp on this. As soon as you send a 
signal around here that you can cross lines and it does not 
matter and things are for free, that psychology takes a hold 
around here. When we crossed the line on Social Security and 
went back to raiding the Social Security Trust Fund--and I use 
those words, I know economists have a different view--I tell 
you, that broke a discipline around here. I begged Chairman 
Greenspan not to take that position because it is, yes, it is 
psychological, but it matters around here. And when you cross a 
line around here, Katy, bar the door.
    Mr. Berner. Senator, if I could just interrupt for a moment 
and agree with you on that point. One thing we have not 
discussed today is budget process, and back when David and I 
were working in Washington together, budget process was really 
important and Congress had a process in both Houses. That 
process was stuck to. Your predecessors, really Gramm, Rudman, 
and Hollings came along and reinforced that process. That is 
something we have not discussed today and something we need to 
restore to the discussions about the budget, because if we 
think in terms of credibility, what will help restore our 
credibility besides the commitment to really deal with our 
long-term structural problems is a game plan for getting there 
and the process--
    Chairman Conrad. Let me just say that the dirty little 
truth in this town is that people do not want to deal with 
budget process disciplines because the truth is, they do not 
want the discipline.
    Mr. Berner. Right.
    Chairman Conrad. They want to be free to cross every line, 
and it is on both sides of the aisle, I regret to say. And you 
are right. We should have, I think, a return to some of the 
strict disciplines we had that helped us get out of the hole in 
the 1980s and in the 1990s that really proved to be quite 
effective. But, you know, absent will, absent will, no process 
solves the problem.
    Now, I took away from your time.
    Senator Sessions. No. Well, this is fabulous. These are 
really serious, important issues, I think. Senator McCaskill 
and I offered legislation, and we got 59 votes, that would have 
made statutory caps using the President's budget and it would 
take a two-thirds vote to violate that. It would have been a 
firewall, although in truth, now, I think we realize that those 
numbers were too high. We will have to wrestle with it.
    This is about the economy, and one question I would like to 
pursue a little further--Mr. Malpass made reference to it--is 
the QE2 and the Fed's action. That same Barron's article I was 
reading, Mr. Hickey, the editor of High-Tech Strategist in 
Nashua, New Hampshire, said we continue to print money, and am 
I not correct, Mr. Malpass, that the Fed buying Treasuries is 
printing money? Is that fair to say?
    Mr. Malpass. It risks that. I will make maybe a rhetorical 
point or a mild point here. Technically, the Fed borrows it 
from banks, and so as long as--and creates excess reserves at 
the Fed. So as long as we have this stoppage in the regulatory 
process where banks are not lending, then there has not been an 
actual expansion of the amount of money in the private sector. 
So--
    Senator Sessions. But with the leverage that the Fed uses--
    Mr. Malpass. All that has happened so far is the Fed is 
taking on the risk of the private sector by owning long- term 
debt. So they are exposed if interest rates go up. We, the 
taxpayer, are exposed. But from the standpoint of the actual 
lending going on by banks, it has not expanded.
    Now, this may be a distinction without a difference. So I 
think the point is well taken that by the Fed going down this 
line, people worry about the Fed. They worry about the dollar. 
They worry about the United States, and that is not good for 
us.
    Senator Sessions. Mr. Bernanke answered similar to you at 
the hearing a few weeks ago when I asked that question. He 
said--I quoted him as being 100 percent certain that he could 
pull back and not allow inflation to take off. But he said he 
really said he is certain he has the tools to avoid that.
    Mr. Malpass. And I would say we should not be taking this 
risk. His original goal was to lower the interest rates on 
corporate bonds. That has not worked. And what we are exposing 
ourselves to is this shorter maturity of--they are buying the 
long-term bonds in. That is the opposite of the direction we 
should be going.
    Senator Sessions. Leaving us more exposed to short- term.
    Mr. Malpass. That is right, and so it is like you are 
taking--here you are, worried about keeping your job, and the 
banker calls up and says, hey, would you not like to move from 
a 30-year mortgage down to a three-year floating rate mortgage? 
Now, you know what to do. Do not take that choice. And that is 
what the Fed is doing. They are moving the country from a long-
term fixed rate mortgage to a short- term floating rate 
mortgage at a time when we are already a little bit shaky.
    Senator Sessions. Well, with regard to this question, maybe 
I will let any of you who would like to comment on it do so. I 
think it is a matter out there in the public and in the 
financial markets. Mr. Hickey says that in 2000, easy money led 
to gross imbalances. In the mid-2000s, one percent interest led 
to a housing bubble, and then the credit crisis, and now rates 
are zero. To get a response from the economy, the Fed must 
print ever more money. It did, and everything looks great right 
now. But as of June when the $110 billion they are printing per 
month ends, things might not look so rosy. The economy has 
structural problems and we are not dealing with them. Money 
printing will not work, yet that is the prescription we 
continue to give the patient. If the Fed keeps printing after 
June, we will have higher gasoline and food prices and more 
imbalances until this ends, and at some point, it will end 
because the dollar will fall apart, and what we are now doing 
makes everything appear rosy, but it is devastatingly terrible 
policy for the long run.
    I think that is a perception out there by a lot of people. 
You guys are really sophisticated. Let me ask you to respond to 
that.
    Mr. Malpass. May I interject one thing briefly? Paul 
Volcker in this room in the 1980s, facing a big fiscal deficit, 
said, ``The Fed could have a looser monetary policy if Congress 
would have a tighter fiscal policy,'' meaning spend less and we 
will have the looser monetary policy. We are breaking that rule 
now in the way that you said. We are putting a near zero 
interest rate on top of a massively stimulative fiscal policy. 
So this is simply not the right mix.
    Chairman Conrad. Can I just intercede on this point? 
Because when I go back to what led to the financial crisis in 
2008, my own reading of economic history is it was a 
combination of an overly loose fiscal policy--we were running 
massive deficits then, even in good times--an overly loose 
monetary policy because the Fed was very accommodating after 9/
11 for an extended period of time, coupled with a failure to 
regulate very risky financial instruments. You know, Warren 
Buffett called derivatives ``a nuclear time bomb waiting to go 
off,'' and in some ways that occurred, certainly with AIG.
    And so you had a perfect seed bed for bubbles to form, and, 
boy, did we get bubbles. We got a housing bubble. We got a 
commodity bubble. Wheat went to $20 a bushel. We got an energy 
bubble. Oil went to $100 a barrel. So we did not just have a 
housing bubble. We had a whole series of bubbles in which we 
had really laid the foundation by loose monetary policy, loose 
fiscal policy. Unusual to get them at the same time. That is 
another whammy to the economy. And here we are cleaning up the 
economic wreckage. Dr. Johnson?
    Mr. Johnson. Morgan Stanley has a very nice report on the 
so-called global carriage rate which is fed by this very low 
interest rate environment. I do not have my copy with me. I am 
sure Dick can send it to you. I think you should look at that, 
Senator Sessions, and think about these dynamics.
    The points, by the way, that the two of you are making 
strike me as just incredibly parallel to the debate we had in 
the United States between 1907 and 1913 before the founding of 
the Federal Reserve. One the one hand, there was Nelson Aldrich 
who was making very similar points to you, Senator Sessions, 
worrying about the fiscal implications and the inflationary 
finance that would be facilitate by an overloose Fed. On the 
other hand, there was the Pujo Committee and Louis Brandeis, 
Senator Conrad, who was articulating a position very much like 
yours, which was that the financial sector, without a surety 
that the financial sector was going to be reined in and 
regulated and controlled--they did not use exactly those 
words--financial stability would be the ruin of us all. And I 
have to say, a hundred years later both of those individuals 
were right.
    Mr. Berner. And I agree with that, Senator. I would say 
beyond that, you know, we are using monetary and fiscal tools, 
which are blunt tools, to try to solve our problems. But as we 
have all talked about, we are just still experiencing the 
legacy of this financial crisis. And as I indicated in my 
testimony, we have not employed the tools that we could to 
clean up the legacy of that financial crisis. If we did, then 
the Fed would not have to run the kind of monetary policy it is 
running. And as I also indicated, we would have a better-
performing economy. We could unwind some of that fiscal 
stimulus that we have used to help the economy in the short 
run.
    Mr. Malpass. Mr. Chairman, your statement was one of the 
best, succinct statements of the causes of the crisis. You 
mentioned loose monetary policy, loose fiscal policy, poor 
regulatory policy, and I would add in mistakes on Wall Street, 
and that is the sum of it. And if everyone would accept that 
and then try to avoid that in the future, we would be a step 
ahead. A very good statement of it.
    Chairman Conrad. Senator Toomey. Could I just say to my 
colleagues, we promised to end this hearing at noon for our 
witnesses, but Senator Toomey has not had his second round, and 
we will go to him now.
    Senator Toomey. Thank you, Mr. Chairman, and I will just be 
brief. It seems to me that if you look at many traditional 
measures of monetary policy, we are currently embarking on a 
very unusual and, it seems to me, dangerous course. Please 
correct me if I am wrong, but my understanding is prior to the 
recent huge purchases of Treasuries by the Fed, the traditional 
measures of money supply were already growing significantly, M1 
and M2 and so on.
    If you prefer to look at the Taylor Rule, for instance, 
which some do and some do not, but by that measure interest 
rates are well below where they ought to be.
    If you look at commodity prices across a very broad range--
precious metals, agricultural, other commodities--we are seeing 
very, very high rates, in some cases record rates. Does not the 
cumulative evidence here suggest that there is a very 
significant risk of much higher inflation? And when CBO 
projects less than 2 percent, I believe, over the next several 
years, could each of you just suggest whether you think it is 
likely that inflation in the United States will remain at or 
about 2 percent in the coming years?
    Mr. Malpass. I think it will be above. I think you are 
exactly right in describing the problem. I will add in we 
already see the inflation in other countries where they are 
closer to commodities in their CPI baskets, so that evidence is 
there. And I will add in the point that the Fed has been very 
wrong on that inflation estimate in the past. So, in 2003, 
2004, and 2005, when the Chairman was describing the 1-percent 
interest rate policy and the small increases, the Fed 
drastically underestimated the core PCE deflator that would 
come out and--
    Chairman Conrad. David, can we just stop you on that? For 
people who are listening, the core PCE, can you explain what 
that is?
    Mr. Malpass. Yes. PCE is the personal consumption 
expenditures, and that just means consumption, and the Fed uses 
the core measure, meaning excluding food and energy, let us 
measure inflation by core prices.
    Chairman Conrad. And they underestimated at the time that 
increase.
    Mr. Malpass. There is, I think, a huge mistake in the 
technique the Fed is using because when they look at the number 
today, it is based on what people bought last year and the 
prices of those old items. And because people are very fad 
oriented, meaning they want to buy the hot items, when you 
measure your inflation based on what people bought last year, 
those prices are going down. That is like taking the sale 
items, the old model cars, where the new model cars are going 
up in price. And what happened very distinctly in 2003, 2004, 
and 2005--and 2005, really--is after revision, the inflation 
was above the Fed's top limit, above the 2- percent ceiling 
every quarter from 2003 to 2007. And yet the Fed kept saying 
and promising during that period that inflation was moderating. 
So it is making Senator Toomey's point that we really should 
not be so confident of that--I mean, I am not confident at all 
that we are avoiding inflation. Now the Fed is very loose.
    Mr. Johnson. I think we are definitely not avoided 
inflation. To state this in a slightly different way, headline 
inflation, which is the inflation that you care about, is going 
up, and there you will feel it. The Fed takes food prices and 
energy prices out of its measure of core inflation. Other 
central banks do not do that. The Canadians, for example, take 
out the most volatile items, but those are different items from 
what the Fed takes out. And this is a very conscious decision 
based on the historical view of what drives inflation over a 
longer period of time. We will see whether that turns out to be 
right, but certainly in terms of purchasing power of consumers, 
David's point, people who consume particularly things that are 
really commodity intensive, relatively poor people have a 
larger pot of--their consumption goes on food, for example. 
They are going to be hurt by what happens.
    Mr. Berner. Inflation is partly set globally. We are 
clearly seeing commodity prices and food and energy prices 
rising. It is already rising, as my colleagues have pointed 
out, in other countries. And so, you know, the Fed, as you 
pointed out, Senator Toomey, is trying to boost inflation 
expectations. We do have a tug of war going on. There is a lot 
of slack in the economy, and that is keeping inflation in 
check. But those global forces together with rising inflation 
expectations are going to lift not just headline inflation but, 
in my view, core inflation over time.
    Now, a little bit of that in the next year is not a bad 
thing. What would be a bad thing is if we got a lot of it, 
obviously, we would see not only inflation rise, but we would 
see the interest on Federal debt, as you pointed out earlier, 
rise very significantly.
    Senator Toomey. Thank you, Mr. Chairman. I would just point 
out that we learned in the 1970s that we can have a lot of 
slack, weakness in the economy, and still have very high 
inflation. So it is a real concern of mine. But I thank you all 
for answering the question.
    Chairman Conrad. Thank you, Senator Toomey.
    Senator Sessions.
    Senator Sessions. Well, forgive me if I do not think they 
are Masters of the Universe that fully understand the 
complexities of the market. You would all be billionaires 
instead of millionaires, I suppose. It is hard to predict what 
is going to happen, and I certainly do not think Mr. Bernanke 
has had--I do not think he deserves credit for advising Mr. 
Greenspan to prolong easy money too long. And I would just--Mr. 
Zulauf in the roundtable added this--and I will ask this as a 
final question since we made reference to Mr. Volcker. ``In the 
late 1970s and 1980s, Paul Volcker crunched inflation by 
applying very real high interest rates for several years. Now 
we are seeing the same process just in reverse. Just as it took 
several years for the market to see that Volcker's policies 
would lead to declines in inflation and interest rates, it will 
take years for the market to realize the Fed's current policies 
are highly inflationary.''
    Any comment on that?
    Mr. Malpass. I agree with that concern, and I think the Fed 
should stop buying bonds. It is a high priority from both a 
fiscal standpoint and a monetary policy standpoint that they do 
that.
    As far as the risk then for us of higher inflation, one 
problem that we run into is whenever the problem is distant, 
then people will not focus on it. So if I say when do I think 
we are going to go over 5 percent inflation, probably not for 1 
or 2 years, and so that does not give you the urgency.
    So one of the things we are doing today is trying to say, 
look, we do not know what is going to happen next month or next 
year, but what we do know is we are too close to the brink on 
the tipping point. So if you can, please stop spending. Try to 
find procedures that give us some confidence about the 10-year 
outlook on spending as well.
    Mr. Berner. I would just reiterate, Senator, the points I 
made earlier. Number one, if we adopted the right policies to 
fix our economic problems and housing and other problems, then 
the Fed would not be running the policy that it is running 
today. And I agree with David that, you know, inflation is a 
process that works gradually, and that gives us a little bit of 
leeway in terms of where it is going to go. But, of course, 
because it has a lot of inertia to it, once it gets going then 
we need to be careful, and the market reaction to higher 
inflation will not be kind to the Federal budget.
    Mr. Johnson. Senator, I think there is a floor in the 
Federal Reserve Act. The Federal Reserve Act says that the 
mission of the Board in this instance is to aim for full 
employment and price stability. There is no mention about 
financial stability. None of the discussion that you were both 
putting before us in terms of the financial dynamics and how 
things went wrong and what is likely to happen in the cycle, 
none of that is seen as their top priority. And as a result, 
they feel the need to pursue this policy that makes you 
uncomfortable, and I think you are right to feel uncomfortable 
and very nervous about it. This is a very bad place to be. It 
would be better if we had had more fiscal space coming out of 
the last boom. Then you would--I mean, you could still argue 
whether you want to do the tax cuts or the spending increases. 
Fine. But you would have had more space within which to react 
to the financial crisis without pushing up against the 
Reinhart-Rogoff limit or David's debt limits. But that is not 
how we ran things in the boom, and as a result, we have over 9 
percent unemployment. The Fed's job is to get that down, and 
that resulted in this monetary policy that is a huge Hail Mary 
pass, if I may use a Super Bowl metaphor.
    Chairman Conrad. Thank you. Thank you all. We appreciate 
very much your contributions to this Committee, and I think 
this has been an excellent hearing. I want to thank Senator 
Sessions for his contributions as well.
    We will stand adjourned. 





 TAX REFORM: A NECESSARY COMPONENT FOR RESTORING FISCAL RESPONSIBILITY

                              ----------                              


                      WEDNESDAY, FEBRUARY 2, 2011


                                       U.S. Senate,

                                   Committee on the Budget,

                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:01 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Murray, Wyden, Nelson, Stabenow, 
Cardin, Sanders, Whitehouse, Warner, Merkley, Begich, Coons, 
Sessions, Grassley, Enzi, Crapo, Ensign, Cornyn, Graham, 
Alexander, Thune, Portman, Toomey, and Johnson.
    Staff present: Mary Ann Naylor, Majority Staff Director; 
and Marcus Peacock, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The Committee will come to order.
    I want to welcome everyone to the Senate Budget Committee 
today. Today we focus on tax reform and the important role that 
many of us believe it can play in addressing our Nation's long-
term budget challenges.
    We are fortunate to have four outstanding economists with 
us this morning who are deeply knowledgeable about tax reform.
    Dr. Gene Steuerle, Senior Fellow at the Urban Institute. 
Gene has been before this Committee many times. He is somebody 
that enjoys credibility on both sides of the aisle. Dr. Donald 
Marron, the Director of the Urban-Brookings Tax Policy Center, 
somebody who is very familiar to the Committee as well, and we 
very much respect his advice. Dr. Rosanne Altshuler, Professor 
of Economics at Rutgers University, who testified before the 
President's Fiscal Commission, as did Dr. Marron and Dr. 
Steuerle. And Dr. Larry Lindsey, President and CEO of the 
Lindsey Group, very well known in economic circles as well. We 
thank all of you for agreeing to give us some of your time. We 
deeply appreciate it.
    Let me just begin by reviewing the State of our fiscal 
affairs. Last week, the Congressional Budget Office released 
its annual outlook report. That report should serve as a wake-
up call to everyone who is concerned about the Nation's 
finances. The chart depicts CBO's new 10-year baseline 
projections, with additional policies added in, those policies 
that are most likely to be adopted. We all know that CBO does 
not do a forecast of what might be adopted. They do a forecast 
based on current law. Then we try to add to that things that 
are most likely to be adopted to get the most realistic look at 
where we are headed.




    That shows that due to passage of the tax extension package 
and the slow pace of economic recovery, CBO is now expecting to 
see deficits of more than $1 trillion a year continuing through 
at least 2012. It then shows that deficits will briefly fall 
before rising again as the bulk of the baby-boom generation 
begins to retire and health care costs continue to climb. Now, 
if this is not a sobering picture of where we are headed, I do 
not know what would be sobering.
    Make no mistake. We are at a critical juncture. We are 
borrowing 40 cents of every dollar that we spend. Spending is 
at the highest level as a share of our economy in 60 years. 
Revenue is at its lowest level as a share of our economy in 60 
years.
    Many of us believe that tax reform must be part of an 
approach to addressing our fiscal problems. The current State 
of the Tax Code is simply indefensible. Our Tax Code is out of 
date and clearly hurts U.S. competitiveness.
    No. 2, it is hemorrhaging revenue. The tax gap, tax havens, 
and abusive tax shelters undermine the effectiveness of the Tax 
Code, depriving the Treasury of revenue. I believe the combined 
effect of the tax gap, offshore tax havens, and abusive tax 
shelters is leading us to lose more than $500 billion a year. 
More than $500 billion a year.
    In addition, the Tax Code is riddled with expiring 
provisions. This creates enormous uncertainty for citizens and 
businesses, making it difficult for them to plan. If we took 
steps to simplify and reform the Tax Code, we could reduce tax 
rates below where they are today and still get more revenue.
    Now, let me repeat that. If we were to broaden the base and 
fundamentally reform the tax system, we could actually lower 
rates, helping America be more competitive and generate more 
revenue. Along with lower tax rates, the tax reform would then 
allow us to increase revenue to help reduce the deficit.




    I think we also need to be realistic about what is 
necessary to meet the needs of the Nation and return the Nation 
to a sustainable, long-term fiscal trajectory. Looking at 
revenues has led some to argue that revenues should be held at 
the historic level over the past 40 years, about 18 percent of 
GDP. Revenues, I want to point out, at that level would not 
have produced a single balanced budget in all of that time 
because spending exceed 18 percent of GDP in every year. In 
fact, on the five occasions when the budget has been in surplus 
since 1969, revenues have ranged between 19.5 percent of GDP 
and 20.6 percent of GDP. It is this higher level of revenue 
that I believe provides a more useful guidepost for what is 
needed if we hope to dig ourselves out of the fiscal hole and 
set the budget on a sustainable path. Let me indicate that 
would mean we would have to have very significant cuts on the 
spending side because we are well over 21 percent of GDP on the 
spending side. We are over 24 percent of GDP on the spending 
side.




    Tax reform gives us an opportunity to lower tax rates at 
the same time we are raising revenues. Tax reform achieves this 
goal by broadening the tax base by eliminating or scaling back 
so-called tax expenditures. Tax expenditures are all of the 
deductions, exclusions, credits, and set-asides in the Tax 
Code. They are costing the Treasury more than $1 trillion in 
revenue a year. That matches all of domestic discretionary 
spending, and many are no different than traditional spending 
programs. They are simply spending through the Tax Code.




    Here is how well-known conservative economist Martin 
Feldstein described tax expenditures in a recent piece in the 
Wall Street Journal, and I quote--this is, again, from Martin 
Feldstein: ``Cutting tax expenditures is really the best way to 
reduce Government spending. Eliminating tax expenditures does 
not increase marginal tax rates or reduce the reward for 
saving, investment, or risk taking. It would also increase 
overall economic efficiency by removing incentives that distort 
private spending decisions. And eliminating or consolidating 
the large number of overlapping tax base subsidies would also 
great simplify tax filing. In short, cutting tax expenditures 
is not at all like other ways of raising revenue.''
    I think this is a critically important point.



    
    The President's Fiscal Commission, of which I was a member, 
issued its report last December, and I believe that tax reform 
may be the most important component of the Fiscal Commission's 
plan. Here are the key elements of tax reform included in the 
Fiscal Commission's plan:
    One, eliminates or scales back tax expenditures and lowers 
tax rates. This promotes economic growth and dramatically 
improves America's global competitiveness. It makes the Tax 
Code more progressive. The Commission's report included an 
illustrative tax reform plan that demonstrates how eliminating 
or scaling back tax expenditures can lower rates. Instead of 
six brackets for individuals, the plan includes just three 
brackets of 12, 22, and 28 percent. The corporate rate would 
also be reduced from 35 to 28 percent, helping improve the 
competitive position of the United States.
    Capital gains and dividends are taxed at ordinary rates. 
The mortgage interest and charitable deductions would be 
reformed, better targeting these tax benefits. The child tax 
credit and earned income tax credit would be preserved to help 
working families. And the alternative minimum tax would be 
repealed. That is the kind of tax reform that I believe we need 
to adopt.




    The Commission plan was also important because it showed 
how to reduce the deficit and debt in a balanced way. It 
included cuts in discretionary spending, entitlement reform, 
and tax reform. You need to have those three fundamental 
components to be successful. At least I believe that is the 
case.
    In total, about two-thirds of the deficit reduction between 
2012 and 2020 in the plan resulted from reductions to spending. 
The proposed spending cuts were significant. I would even argue 
on the domestic side probably went too far. Taking revenues out 
of the equation would have made it impossible to obtain the 
desired deficit reduction goals. Cutting spending alone or, as 
some would suggest, only cutting non-defense discretionary 
spending would require such Draconian reductions that they 
simply could not be sustained.




    Let me just conclude on this chart. Chairman Ryan's road 
map that he has laid out--this is the Chairman of the House 
Budget Committee--I believe proves the point that revenues have 
to be part of a plan to reduce the deficit and the debt. He 
proposes discretionary and mandatory spending cuts, but 
actually makes things worse on the revenue side. The result is 
that his plan increases the debt as a percentage of GDP for the 
next 30 years. In fact, he does not achieve balance for 53 
years. He does not achieve balance for 53 years. He 
dramatically increases the debt, both in dollar terms and as a 
share of GDP.
    To solve the long-term challenge, it will require real 
compromise and a great deal of political will. We need everyone 
at the table, and we need to have both sides, Democrats and 
Republicans, willing to move off their fixed positions in order 
to achieve a result important for the Nation. We cannot 
continue to put this off. We need to reach an agreement this 
year. It is time, I believe, for the administration and leaders 
of Congress, Democrats and Republicans, to sit down and hash 
out a long-term plan.
    We will now turn to Senator Sessions for his opening 
remarks. I apologize to my colleagues for the length of that 
introduction, but I thought it was important in light of the 
subject we have before us today. Senator Sessions.

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. Thank you, Mr. Chairman. I am glad to see 
your passion and leadership showing itself on this issue 
because we have to do some things. We cannot continue business 
as usual. The article in the Wall Street Journal in which the 
International Monetary Fund--I believe it was in the Washington 
Post, in which the International Monetary Fund called on the 
United States to get its house in order like other nations in 
the world, used the phrase that all the other developing 
nations who are facing debt crises--and most of them are--are 
entering into a dialog with their people to explain to them why 
changes have to occur. So I have been critical of the 
President's State of the Union address in which he spent very 
little time in an honest, direct, open way discussing with the 
American people why business as usual cannot continue.
    I so much appreciate your Statement that this Committee may 
be where the leadership has to come, and I would be there with 
you.
    I am totally appreciative of the concept that you, Senator 
Wyden, the Deficit Commission, and others--conservatives, 
writers, and intellectuals--who favor tax simplification. Mr. 
Lindsey, I was really--I hope you do not mind me quoting from 
your remarks. But you quote a number of economists who say that 
sensible, revenue-neutral tax reform could result in 5 to 10 
percent more of GDP growth over 10 years in one study, an 18-
percent increase in GDP output. Larry Summers, the recent 
former adviser to President Obama, found in another study that 
there was 19 percent more growth. These are stunning numbers. 
So we would leave that on the table. Frankly, I doubt they are 
that high, but if we could get close to that, if we could get a 
third of that, that would be marvelous for us because it would 
be, as you indicated, sort of free money, Mr. Chairman. In 
other words, it would create more growth which would create 
more revenue.
    President Obama in his State of the Union address said, 
``For example, over the years, a parade of lobbyists has rigged 
the Tax Code to benefit particular companies and industries. 
Those with accountants or lawyers to work the system can end up 
paying no taxes at all. But all the rest are hit with one of 
the highest corporate tax rates in the world. It makes no 
sense, and it has to change. So tonight, I am asking Democrats 
and Republicans to simplify the system. Get rid of the 
loopholes. Level the playing field. And use the savings to 
lower the corporate tax rate for the first time in 25 years--
without adding to our deficit. It can be done.''
    Well, I think if we simplify the corporate tax rate 
properly, we can in a revenue-neutral way probably create more 
revenue.
    But let me tell you, the problem is far more serious than 
that. We have, even in the real rate terms, one of the highest 
if not the highest corporate rate in the developed world. 
Corporations are making decisions every day where to expand, 
where to hire workers. We learn things in airports. I happened 
to be on the plane with a very impressive CEO of an 
international corporation. CEO North America had an Alabama 
plant, and he was so frustrated. I ended with an empty seat, 
and he came by and sat by me and told me this story. This is 
the story he told: that they had competed within their plants 
worldwide in this big company to do a new chemical process that 
would create 200 jobs. They had worked extremely hard at the 
Alabama plant and had won the competition. He submitted it, and 
they had the lowest cost per gallon of chemical stuff, and the 
plant was going to be expanded in Alabama, we were going to 
gain 200 jobs--until the people back in Europe said, ``We have 
to calculate the taxes,'' and they recalculated the bid based 
on taxes. We lost 200 jobs.
    This is not academic. This is going on every day. We have 
an unemployment rate that is unacceptable, and to have the 
highest corporate tax rate virtually in the world, and other 
nations are seeing the light and reducing it, and we remain 
high. So even if we eliminate certain deductions and have a 
flat rate that appears lower, it seems to my simple mind that 
we have no less real burden on the corporate community than we 
had before. So I think we need to figure out a way to reduce 
the rates. And if it has to be paid for by some tax increase in 
some other area, I am willing to consider doing that.
    So I believe we need to simplify, but I also think it would 
be a big mistake if we do not reduce the rates. Of course, the 
U.K. is reducing their rates. Canada, I understand, is going to 
16 percent. So if we are at 28, 27 after we have adjusted, we 
are still way above that, and a company making the decision of 
where to produce a product might well choose another country 
than our own country to produce that product and cost us jobs.
    So, Mr. Chairman, that is kind of where I am. I do not 
think I am prepared to support just a tax simplification of the 
corporate rate because I believe the entire world is 
recognizing that the corporate rate is a job factor, a big job 
factor. And I think in terms of the Laffer factor, if you want 
to call it that, reducing the corporate rate I believe is--one 
of our colleagues said the other day a study has come out and 
shown that if you reduce that rate, you get more economic 
growth than you would in almost any other place in the economy.
    Thank you for your leadership. Thank you for this good 
hearing. I look forward to the testimony of our excellent 
panel.
    Chairman Conrad. Thank you very much, Senator Sessions.
    Now we will turn to our panel. We will start with Gene 
Steuerle, Senior Fellow, the Urban Institute. Welcome back to 
the Committee, Gene, and please proceed.

 STATEMENT OF C. EUGENE STEUERLE, PH.D., INSTITUTE FELLOW AND 
          RICHARD B. FISHER CHAIR, THE URBAN INSTITUTE

    Mr. Steuerle. Thank you, Mr. Chairman, Mr. Sessions, and 
members of the Committee. Many tax and budget reforms know no 
ideological or party boundaries. No one favors the unequal 
justice, inefficiency, and complexity we see in our Tax Code 
today. Neither does anyone really favor the ways that 
tomorrow's scheduled deficits threaten our economy and our 
children.
    You have asked that I concentrate my remarks on what makes 
reform most likely. Reform often starts from a common consensus 
that a variety of fixes would be better than what we have. 
Bipartisan agreement led to past successful tax reforms such as 
in 1986, 1969, and 1954. Such bipartisan consensus also 
informed close to two-thirds of the members of President 
Obama's own Debt Commission. And such agreement, I would 
suggest, with admitted bias, is displayed by the panel before 
you. Three of us are from the Tax Policy Center. We are former 
Deputy Assistant Secretaries and heads of CBO, and senior 
economists on advisory panels, appointees by both Republicans 
and Democrats, often come to very common conclusions. We are 
not led by any party identification.
    The more general point is that good Government at either 17 
percent or 23 percent of GDP trumps bad Government at both 
levels. When Theseus, the mythical founder-king of Athens, went 
into the Labyrinth to slay the half-bull Minotaur, he was able 
to escape only by following a ball of string back to where he 
had entered. If we are ever to escape the tax labyrinth into 
which we have journeyed, I suggest that, like Theseus, we 
follow the string back along four dimensions that define our 
larger budgetary problems.
    First, we must move to an era of more fundamental reform. A 
simple explanation of the Tax Code's evolution in recent 
decades is that it broke away from its narrow revenue-raising 
foundation and began to evolve much like the spending side of 
the budget. Yet large systemic reforms require fundamentally 
different strategies than the tax cuts and benefit expansions 
that seem only to identify ``winners.'' Many domestic reforms--
like Social Security reform in 1983, tax reform in 1986--are 
the harbingers of the types of tradeoffs that modern Government 
must increasingly engage.
    Second, we must limit how much any Congress can commit for 
the future--before that future arises. I no longer divide the 
budget balance sheet into spending and taxes, but into give-
away and take-away. Especially after the 1990 and 1993 budget 
administrations, both political parties have increasingly come 
to believe that it is political suicide to operate on the take-
away side of the budget to balance the sheets. The consequence 
of fiscal democracy I have developed shows that in 2009, for 
the first time in U.S. history, all revenues were committed 
before the new Congress even walked in the door.
    Third, we must account for and report to the public in a 
more honest way. Right now, for instance, tax subsidies show up 
in the budget as a reduction in taxes when they are bigger 
Government in disguise.
    And, fourth, we must cut across institutional boundaries. 
Even today, tax reforms are unable to replace an education tax 
credit with the higher Pell grant or a housing tax credit with 
a housing voucher. At the same time, I believe that serendipity 
arises by playing the odds in the right way. Tax reform's 
probability of success can be increased by the following steps.
    First, we must seize today's and not yesterday's 
opportunities. Yesterday's included large individual tax 
shelters, very high tax rates, and ever increasing taxation of 
families with children on children and the poor. Today's 
include the deficit, high corporate rates, and the 
extraordinary complexity of the tax system.
    Second, we must base reform on well-established principles 
of public finance. Principles like equal justice have powerful 
appeal and lead logically to a whole host of reforms.
    Third, we must comprehensively tackle the problem. Yes, 
reforms create headlines over who loses some subsidy and who 
pays more tax. But the size of the headline is often 
indifferent to the size of the reform. If one is going to take 
a political hit, one ought to achieve something valuable, such 
as a simpler Tax Code or a more sustainable budget.
    Fourth, we need to shift the burden of proof. Let opponents 
argue why they oppose a standard based on equal justice or 
simplicity. When the standard is current law, the burden of 
proof resides with reformers who appear to be picking on 
particular groups.
    Fifth, we must form coalitions based on legitimate liberal 
and conservative principles. Tax reform in 1986, for instance, 
in no small part was supported by two broad coalitions: pro-
poor and pro-family, and lower rates and reduction in tax 
shelters.
    Sixth, we must seek better ways to present information. In 
1986, the old way of presenting tax burdens would have treated 
those with tax shelters as poor people with large tax 
increases.
    Seventh, we must empower knowledgeable, non-partisan staff 
to navigate the complexities before too many political 
constraints are placed down. The tax reform acts of 1986 and 
1969 came out of studies of the Treasury Department that were 
conducted mainly with non-partisan staff, with most of the 
political decisionmaking held off until later.
    And, finally, at the political level, we must encourage 
elected officials, A, to lead; B, to be held accountable; and, 
C, to be empowered. In 1986 tax reform, Dan Rostenkowski and 
President Reagan led by agreeing not to criticize each other. 
Also, as the effort moved through at least four different 
stages, someone was always held accountable and feared being 
shamed by the failure to enact tax reform. At the same time, 
tax reform succeeded because leaders were empowered to execute 
a strategic plan as they moved through the political minefield.
    Thank you, Mr. Chairman.
    [The prepared Statement of Mr. Steuerle follows:]



    Chairman Conrad. Thank you, Gene. Excellent testimony.
    Dr. Marron? It is good to have you back.

STATEMENT OF DONALD B. MARRON, PH.D., DIRECTOR, URBAN-BROOKINGS 
 TAX POLICY CENTER, AND VISITING PROFESSOR, GEORGETOWN PUBLIC 
                        POLICY INSTITUTE

    Mr. Marron. Thank you, Mr. Chairman, Ranking Member 
Sessions. It is a pleasure to be here to talk about the 
important issue of fundamental tax reform.
    Kind of echoing some of the things that have already been 
said, America's tax system is clearly broken. It is needlessly 
complex, economically harmful, and often unfair. It fails at 
its most basic task, which, lest we forget, is raising enough 
money to pay for the Federal Government. And increasingly, it 
is unpredictable, with large temporary tax cuts not only in the 
individual income tax, but also in corporate payroll and eState 
taxes.
    For all of those reasons, our tax system cries out for 
reform. Such reform could follow many paths. Some analysts 
recommend the introduction of new taxes, such as a value-added 
tax, national retail sales tax, or pollution taxes to 
supplement or replace our current system. Those ideas are worth 
serious discussion, but in today's testimony, I would like to 
focus on a more traditional approach to tax reform, redesigning 
our income tax.
    I would like to make seven main points. First, as has 
already been mentioned, tax preferences pervade the tax code. 
These preferences total more than $1 trillion annually, which 
almost as much as what we collect from individual and corporate 
income taxes combined. These preferences narrow the tax base, 
reduce revenues, distort economic activity, complicate the tax 
system, force tax rates higher than they would otherwise be, 
and are often unfair.
    Second, the first step in any tax reform should be to 
broaden the tax base by reducing or eliminating tax 
preferences. Doing so would help level the playing field among 
different economic activities, reduce the degree to which taxes 
distort economic behavior, and make taxes simpler to file and 
administer.
    Third, policymakers can use the resulting revenue, 
potentially hundreds of billions of dollars each year, to lower 
tax rates, reduce future deficits, or both. Lowering tax rates 
would further reduce the economic distortions created by the 
tax system and would encourage economic growth. Reducing future 
deficits would help tame our Federal debt, which threatens to 
grow to unsustainable levels in coming years and thus poses a 
significant risk to our economy.
    Fourth, many tax preferences are effectively spending 
programs run through the tax code. That poses a challenge for 
how we talk about tax reform and the size of government. Any 
cuts to these spending-like preferences will increase Federal 
revenues, but will reduce the government's influence over 
economic activity. Advocates of smaller government are often 
skeptical of proposals that would increase Federal revenues. 
When it comes to paring back spending-like tax preferences, 
however, an increase in revenues actually means that the 
government's role is getting smaller.
    Fifth, other tax preferences, however, are not spending 
programs in disguise. More and more observers have embraced the 
idea that tax preferences resemble spending through the tax 
code. That is a promising development. Unfortunately, that 
enthusiasm has sometimes led to the misconception that all 
items identified as tax preferences are akin to spending. That 
is understandable, given that these items are often called tax 
expenditures, but it is not correct. Preferential tax rates on 
long-term capital gains and qualified dividends, for example, 
are an admittedly imperfect effort to limit the double taxation 
that can occur when investment income is subject to both 
personal and corporate taxes. Such provisions should be viewed 
and evaluated as tax measures, not as hidden spending programs.
    Sixth, many tax preferences provide benefits to millions of 
taxpayers. They are not just tax breaks for special interests. 
For example, the three largest tax preferences are the 
exclusion for employer-provided health insurance, preferences 
for retirement saving, and the mortgage interest deduction. 
Americans should understand that to get the benefits of tax 
reform, lower rates, simpler taxes, and a more vibrant economy, 
they will need to give up some popular tax breaks.
    Seventh, policymakers should reevaluate the design of any 
tax preferences that they decide to keep. Some preferences are 
needlessly complex and could be simplified. That is true, for 
example, of the preferences aimed at low-income workers and 
families. Other preferences might operate more efficiently as 
credits rather than as deductions or exclusions. Credits can 
provide more uniform incentives to particular activities, for 
example, home ownership, than deductions or exclusions whose 
value depends on whether a taxpayer itemizes and what tax 
bracket they are in.
    Bottom line: By reducing, eliminating, or redesigning many 
tax preferences, policymakers can make the tax system simpler, 
fairer, and more conducive to America's future prosperity, 
raise revenues to finance both across-the-board tax cuts and 
much-needed deficit reduction, and improve the efficiency and 
fairness of any remaining preferences.
    Thank you. I look forward to any questions.
    [The prepared Statement of Mr. Marron follows:]



    Chairman Conrad. Thank you.
    And now we will go to Dr. Altshuler. Welcome.

   STATEMENT OF ROSANNE ALTSHULER, PH.D., PROFESSOR, RUTGERS 
                           UNIVERSITY

    Ms. Altshuler. Thank you. It is an honor to appear today to 
discuss the need for and the benefits of fundamental tax 
reform.
    Building the case for tax reform is easy. The current 
system is riddled with tax provisions favoring one activity 
over another or providing targeted tax benefits to a limited 
number of taxpayers. These provisions, as you know, create 
complexity, generate large compliance costs, breed perceptions 
of unfairness, create opportunities for tax avoidance, and 
encourage the inefficient use of our economic resources.
    The many changes we have made to the tax code, more than 
4,400 over the past 10 years, have made the income tax even 
more difficult for taxpayers to understand, less stable, and 
increasingly unpredictable. We seem to have forgotten that the 
fundamental purpose of our tax system is to raise revenues to 
fund government. Reducing the deficit to an economically 
sustainable level, as we must do, will require both a scaling 
back of expenditure programs and an increase in tax revenues.
    The question I address today is how best to reform the tax 
system so that it can raise revenue in a manner that is simple, 
efficient, and fair. I will make three broad points.
    First, the fiscal challenges ahead require that we reform 
our income tax system or turn to new revenue sources. Raising 
significantly more revenue from the current tax system is 
politically infeasible and would be damaging to economic 
growth.
    Second, we must broaden the base of our income tax. 
Although politically difficult, this type of reform is 
implementable and follows a wave of similar base-broadening, 
rate-reducing tax reforms that have been enacted in developed 
countries over the past 30 years.
    Third, the current U.S. approach to international corporate 
taxation needs to be updated to reflect the increased 
competition our U.S. multinationals face from foreign-based 
corporations. Broadening the base and lowering the rate are 
essential and straightforward first steps to international tax 
reform. We should also consider updating our system to reflect 
the international tax rules used by our major trading partners. 
The remainder of my testimony elaborates.
    Before considering fundamental reform, you might ask, can 
we not just dial up the current system, increase statutory 
marginal tax rates to raise the revenue required to bring the 
deficit under control? A 2010 Tax Policy Center study suggests 
that the answer is no. We considered illustrative changes to 
the current system aimed at reducing the deficit to an average 
of 3 percent of GDP. Let me briefly summarize the results.
    It cannot be done. We cannot reduce the deficit to a 
sustainable level with personal income tax increases alone. It 
is not feasible. We looked at the revenue raised by 
proportional increases in all of the current marginal tax 
rates. Roughly speaking, if the system we have today were 
extended, we would have to increase all statutory rates by 50 
percent to reach our deficit target--all statutory rates. What 
if we tried to protect low- and middle-income taxpayers from 
these marginal tax increases? This would result in top rates 
that would stifle economic activity. The two top rates would 
need to rise to 84 and 89 percent. It is shocking. And we did 
not even take individual behavior into account. Changes must be 
made to the tax base if we hope to raise much more revenue from 
the current system.
    What about the corporate tax? Can it raise significant 
revenues for us, significantly more than now? In my written 
testimony, I argue that the answer is no. Most revenue from 
today's corporate income tax comes from corporations that are 
competing in a global market. Increasing the corporate rate is 
problematic given how high our rate is. In 2010, the average 
combined national and State corporate tax rate in the OECD was 
25 percent. The U.S. rate was 39.2 percent, second only to 
Japan. But do not worry. On April 1, Japan will reduce its 
corporate rate by 5 percentage points and we will have the 
dubious honor of imposing the highest corporate tax rate in the 
OECD.
    Keep in mind that any increase in the corporate tax rate 
can be expected to induce tax avoidance through transfer 
pricing and other methods of income shifting. This leakage in 
revenue, along with the small role played by the corporate tax 
in the current U.S. revenue structure, suggests that corporate 
rate increases can, at best, move the deficit only marginally 
toward a sustainable path. Our fiscal challenges require either 
more comprehensive income tax reforms or new sources of 
revenue.
    What are the economic benefits of base-broadening reforms? 
The income tax imposes efficiency costs on the economy when 
taxes distort the economic decisions of individuals and 
businesses and divert resources from productive uses. 
Economists call the efficiency cost the excess burden, and 
economic theory shows, while it is hard to understand that, 
roughly speaking, if you double the tax, you quadruple the 
excess burden. So as you increase the tax, the burden on the 
economy increases more than proportionally.
    It is easy to understand that raising a set amount of 
revenue with a narrow base requires higher tax rates, but what 
is often ignored is the drag on the economy created by higher 
rates. The National Commission on Fiscal Responsibility and 
Reform demonstrated that cutting back tax preferences and 
broadening the base--by doing so, the current system could 
generate revenues of about 21 percent of GDP, with top 
individual and corporate statutory rates of 28 percent.
    Stripping away tax provisions that distort economic 
activity and lowering the rates would leave us with a system 
that is less costly to our economy. It would be fairer than the 
current system, less complex, and easier to administer. 
Senators Wyden and Gregg also have a plan that shares these 
attributes.
    Let me focus on the corporate base for a second. Broadening 
the base and lowering the rate could reduce a number of 
distortions caused by the current system. It will not be easy 
to cut corporate tax preferences to raise revenue for a 
corporate rate reduction, however. While some preferences 
benefit only a limited number of businesses, and we hear about 
those a lot, others cut taxes for a broader set, and in 
addition lower the costs of domestic investments. But it is 
just not possible for us to stay competitive and grow our 
economy with a tax rate that is 14 percentage points above the 
OECD average.
    One often hears that the statutory rate, the fact that it 
is high is not important, since our narrow rate reduces the 
effective tax rate. But this argument ignores the important 
role that statutory rates play in business decisions. They 
influence where our corporations do business, how they finance 
investments, how much they invest, and their incentives to 
shift income to avoid taxes. Retaining a corporate rate that is 
significantly out of line with our competitors is just not a 
viable path for increasing U.S. investment, jobs, and economic 
growth.
    What about the international tax system? You will not be 
surprised to hear ours is very complex and induces inefficient 
behavioral responses. Under our system, all income of U.S. 
corporations is subject to U.S. corporate tax whether it is 
earned at home or abroad. A number of reform proposals have 
recommended a territorial tax system, which would exempt 
foreign-source income from U.S. corporate income tax. All other 
G-7 countries and all but six other OECD countries have adopted 
territorial tax systems. Abandoning our worldwide approach 
would be a major policy move and it deserves careful analysis. 
We should be doing this analysis now.
    The fiscal challenges ahead are daunting. Instead of 
spending the next 2 years engaging in an endless debate of 
whether to extend the 2001 and 2003 tax cuts, I urge you to 
instead focus on building support for and designing a base-
broadening reform of the current system that can reduce our 
future unsustainable debt burdens and enhance the growth of the 
U.S. economy and the well-being of Americans.
    Thank you. I look forward to questions.
    [The prepared Statement of Ms. Altshuler follows:]



    Chairman Conrad. Thank you very much.
    Dr. Lindsey, thank you for coming, and please proceed.

 STATEMENT OF LAWRENCE B. LINDSEY, PH.D., PRESIDENT AND CHIEF 
              EXECUTIVE OFFICER, THE LINDSEY GROUP

    Mr. Lindsey. Thank you, Mr. Chairman. I appreciate your 
invitation and that of the members of the committee.
    It is amazing, listening to my colleagues. I have to tell 
you, we did not collaborate in writing our testimoneys and I 
will change what I am going to say, in part to avoid 
redundancy.
    As Senator Sessions pointed out, there is a broad consensus 
in the economies profession that substantially more economic 
growth can be had through a sensible tax reform. I would add to 
that that in addition to the growth issues, it is important to 
take a look at the static behavioral issues that my colleague, 
Professor Altshuler, mentioned, and that is she observed that 
the excess burden of a tax doubles--is proportional to the 
square of the tax rate. So if you double the tax rate, you 
quadruple the excess burden.
    Senator Sessions. What does that mean?
    Mr. Lindsey. Well, it is how much----
    Senator Sessions. It sounded important when I heard her say 
it.
    Mr. Lindsey [continuing]. you distort the taxpayers' 
behavior, how much more you make them worse off on top of the 
rate that he has to pay. So you not only have to send a check 
to the government, but because you face these high rates, you 
have to do things you would not ordinarily do just to comply 
with the tax code.
    Just to put it into context, in the current income tax, 
when you add all taxes in, including things like the Medicaid 
tax, we are now debating whether we should be at 40 percent or 
50 percent. When you go in that range, the excess--the burden 
on the taxpayer, the total, the tax check he has to pay and the 
excess burden is at $1.70 for every dollar the government 
collects. When you start going over 50 percent, the numbers 
become quite high. You make the taxpayer four times as worse 
off as you make the government better off.
    So no sensible person should think, you know, let us make 
the government as well off as we can simply by taxing the 
population when we know we are making the people we are taxing 
one-and-a-half, two times, three times, four times worse off 
than we are making the government better off. That is not the 
way to enhance the wealth of the Nation.
    Where I would separate myself from my colleagues, and I 
certainly endorse their ideas of trying to make the income tax 
better, I think looking at the problem here, we really have to 
move away from an income tax-based system toward something 
else. The current high economic cost of the tax system is due 
to a number of factors that I think lead me to that conclusion.
    The first is complexity. A lot of the tax code is really a 
judgment call about what income should be taxed and what should 
not. Now, in the context of our various financial problems in 
the last two decades, a line came up that we should all bear in 
mind. Cash is a fact. Income is an opinion. And in our income-
based system, a tax system is really about creating an opinion 
about what should be taxed and what should not.
    We have a lot of opinions out there. There is GAAP 
accounting, Generally Accepted Accounting Principles. Those, by 
the way, are not fixed over time. They change. The SEC has 
certain modifications to GAAP accounting to get another opinion 
about what income is. And then our tax code has a third opinion 
about what income is and that changes over time. It seems a 
little bit odd that the government at one time is rendering 
three or more different opinions about what income is. We have 
to move toward a cash-based system.
    Let me give a very simple example. I have a small company 
and just one of the peculiarities I face every year has to do 
with my health insurance premiums for my company. Now, I am 
obviously an employee of my company and that cash item is 
considered deductible. It is a business expense for my 
employees. I am in exactly the same health system. It is not 
considered a business expense, what I pay for myself and my 
family. And then when I take that, it is considered an 
adjustment on the income tax, but it is fully taxed on the 
payroll tax side, but not to my employees. So here you have one 
cash item, identical across the board, two different taxes have 
a different opinion about it, and they have a different opinion 
depending upon whether you are the owner of the company or 
whether you are an employee of the company.
    That leads to the second problem, which people have talked 
a lot about. It is horizontal inequality. Because you have all 
these different taxes and each has a different opinion, 
essentially, similarly placed individuals pay radically 
different amounts of tax. I know Mr. Buffett is often up here 
talking about tax reform and he has admitted that his taxes are 
too low. He has an average tax rate of about 16 percent, if I 
believe the papers. That is about half what other entrepreneurs 
have.
    Now, how do you fix that? Well, you do not fix it by 
raising the taxes on the other entrepreneurs. You fix it by 
moving toward a system that defines the income he gets in a way 
that is similar to what others receive, and that is why I think 
we have to move to a cash-based system.
    The third problem has been touched on by a number of 
comments, and that is that our income-based system, because of 
the nature of the opinions that it renders about what should be 
taxed, encourages economic activity to go abroad. So, for 
example, an item that is manufactured in China but purchased in 
America has a cost structure that involves no U.S. income or 
payroll taxes on its labor content or on the profits that are 
rendered. China, of course, does have a tax system, but its 
rates are quite low relative to ours. The Chinese individual 
income tax produces just 1.2 percent of GDP. Ours produces 7 
percent. So our income tax burden is six times what China's is. 
The largest tax in China is the value-added tax, which produces 
a third of their revenue and is rebated on the exports they 
send here.
    So having an income-based system while most other countries 
in the world, including Europe and Canada, are moving away from 
an income-based system and toward value-added taxation or 
indirect taxation, puts us at a competitive disadvantage. We 
complain a lot about the advantages the Chinese give themselves 
through their exchange rate, but we have a major self-inflicted 
wound that we cause ourselves because we have income-based 
taxation.
    So again, I do not believe that these fundamental problems 
with our tax structure can be adequately addressed by changes 
to the income-based system. Rate reductions within the current 
system have been economically successful because the excess 
burden within that is so great. But further revenue reductions 
are not possible. America must move away from its income-based 
system toward a cash-flow system.
    This should not be done as an add-on. We do not need extra 
complexity. We need simplification. So adding yet another layer 
of complexity is inappropriate.
    Goods that are imported from abroad, even those that find 
their way into products produced here, would not have to pay an 
American business receipts tax, and so would not be available 
for such a deduction by an importing firm.
    Governments and nonprofit entities could be given separate 
treatment so that only the labor component of their expense 
structure would be covered by the tax.
    The problems of horizontal inequality in such a system 
would be minimized by having all receipts taxed once and at a 
single source, regardless from where they were derived. Issues 
of vertical inequality, making sure that the rate was higher 
for higher-income individuals, could be accomplished through 
the two-tier business receipts tax system, where the higher tax 
rate exempted employee compensation below a certain amount. The 
problem with encouraging lower taxes for very low-income people 
could similarly be incorporated in there.
    We certainly need to address our budgetary challenges, but 
I do not believe that we can move forward tackling those issues 
with a tax system that imposes such high economic costs when we 
raise our rates to produce additional revenue. Our tax system 
is limiting American prosperity through needless complexity, 
horizontal inequities, and implicit subsidies of economic 
activity outside of our borders. A switch to a cash-flow-based 
tax system, such as a business receipts tax or even a value-
added tax, would greatly facilitate our ability to address 
these budgetary issues.
    Thank you very much, Mr. Chairman. I would be happy to take 
your questions.
    [The prepared Statement of Mr. Lindsey follows:]



    Chairman Conrad. Thank you. Thank you. Really excellent 
testimony, Mr. Lindsey. All of the members, I think, have made 
a real contribution to the beginning of this discussion.
    Let me go, if I could, to a concept that was proposed by 
Professor Graetz at Yale. I think he is now at Columbia. He 
made a proposal that we go to a system that is really a hybrid, 
which is what most countries do. He proposed we go to a 
consumption tax for the vast majority of people, take 100 
million people off the income tax system completely, 
substantially reform and reduce the corporate rate, broaden the 
base, and he argued that this would dramatically improve the 
efficiency of collection, that is that we would have less 
leakage in the system; No. 2, that it would make America far 
more competitive.
    Let me just go down the line and ask if you have looked at 
Dr. Graetz's work and what you think of his proposal and what 
it would mean for both helping us reduce the deficit and at the 
same time improving the competitive position of the United 
States. Dr. Steuerle?
    Mr. Steuerle. Well, as I tried to outline very briefly in 
my testimony, I think there are actually a variety of fixes 
that would be better than current law, so I would certainly say 
what Michael Graetz suggests is better than what we have now. 
The question is how far you want to go in adding on what would 
be essentially a VAT, a value-added tax, which is the basic tax 
that he would use to collect revenues from the majority of 
people.
    My principal concerns with Mr. Graetz's proposal, and I 
think it actually is very illuminating, is at the very bottom 
of the income distribution, the very top, and not the middle, 
so he solves and simplifies a lot of things in the middle of 
income distribution.
    At the bottom, I do not think he has really grappled with 
the very tough issue of how you integrate things like Earned 
Income Credits and Child Credits--we could have separate 
testimony on this--with Food Stamps and TANF and now health 
subsidies that phaseout when your income goes up. So we have 
all these indirect tax systems at the bottom that are based on 
income and I do not believe that he actually has solved that 
problem for the bottom.
    And at the top, he leaves in place all of these deductions 
and credits for high-income people, so the notion of high-
income people getting a home mortgage interest deduction and 
low-income people not getting any subsidy for their housing, it 
seems to me, does not quite work, either.
    But if you asked for the base, the core of the proposal, 
would you consider replacing a significant portion of the 
current income tax with a value-added tax, I think that a lot 
of economists might not agree that that is the reform they 
would favor--Mr. Lindsey indicated another way he would go 
about it--but I think they would say it is better than the 
current law.
    Chairman Conrad. If you were to move in that direction, how 
do you protect the most vulnerable among us? How do you protect 
those that are at the lowest end of the income scale?
    Mr. Steuerle. This is a subject that has not gotten much 
attention lately, but as I say, we now have low-and moderate-
income tax payers and so many phase-outs of so many programs 
that their marginal tax rates are among the highest in the 
Nation. Some of them face 70 or 80 percent rates. Forty or 50 
percent rates are very common. You lose your Food Stamps. You 
lose your--the new health law, there is a ten cents or more 
phase-out of your health benefit. You lose your Earned Income 
Credit. You lose your Child Credit. All these phase-outs 
basically start adding up, and then you add on the Social 
Security and the income tax rate.
    I think we have to actually think about reform of what we 
want to do at the bottom of the income distribution, in the 
middle of the income distribution, and at the top of the income 
distribution, almost think about them separately so we take the 
progressivity issue on the side. We decide how much we are 
going to collect or how much we are going to get from these 
groups and then we try to simplify for each group. I think that 
requires a reform effort that even goes beyond what we are 
discussing today.
    Chairman Conrad. Dr. Marron.
    Mr. Marron. Thanks. I guess my approach is to say that 
there are several things we are trying to accomplish in a tax 
system. One is to raise as much revenue, the revenue we need to 
pay for the government without harming the economy, and the 
best way to do that is to go toward a consumption tax.
    One of the other things we would like to do is achieve 
certain progressivity goals. The tax system is a very important 
way that we think about the distribution of after-tax income in 
the United States, and frankly, income taxes tend to be a 
better lever for doing that. And what the Graetz proposal is 
trying to do is, in essence, find a compromise sweet spot in 
there that is recognizing that for the economy as a whole, it 
is better to have more of the tax base be consumption-based--
that is why he introduces a VAT--but then recognizing that if 
you want what I think is widely held as kind of a fair 
conception of what the distribution of the tax burden ought to 
be, that you are going to need something like an income tax at 
the higher level to collect that, and he is trying to strike 
that balance.
    My sense is that he succeeds in the sense of creating a tax 
system that would strengthen the economy, be beneficial for 
competitiveness. As Gene says, there are a lot of difficult 
details about how you actually implement that and accomplish 
all the goals throughout the income distribution, but as a 
basic structure, I think it is an interesting one to think 
about.
    Chairman Conrad. Dr. Altshuler.
    Ms. Altshuler. Yes. I agree with Donald. I am a fan, and I 
very much believe that all roads lead to a VAT. I just think 
that that is where we are going to have to end up. Adding a VAT 
onto the system would allow for lower rates, so you get all the 
benefits of the lower rates. You would have a system that is 
much less complicated, I believe. You would have much less 
incentives for income shifting.
    It is implementable. We can do this. Canada, I mean, all 
other countries in the OECD have a VAT. This is how they raise 
their revenue. Virtually every other country in the world has a 
VAT. So it is something that could be done.
    Chairman Conrad. But how do you protect those who are at 
the lowest end of the income distribution, those who are the 
most vulnerable among us? How do you protect them in that 
system?
    Ms. Altshuler. That is the difficulty and that is what Gene 
and Donald have also talked about. Now, remember that you are 
going to be retaining the income tax, so you can run refunds 
and transfer programs through the income tax. So by retaining 
the income tax----
    Chairman Conrad. You could keep the Earned Income Tax 
Credit----
    Ms. Altshuler. Absolutely.
    Chairman Conrad [continuing]. you can keep the Child Care 
Credit-----
    Ms. Altshuler. Exactly. So you can help the distributional 
consequences of moving to a VAT through the income tax system. 
I know--I believe the Tax Policy Center is studying this right 
now, and as Gene said, with more study into this, I do think 
that we could get the distributional consequences to be 
something that we desire, and I think what we need to remember 
is that we are keeping the mechanism of the income tax, so that 
is going to help us out at the bottom of the income 
distribution.
    Mr. Lindsey. Well. first of all, I think we all agree that 
almost anything would be better than what we have, and that 
would be what I would think about Mr. Graetz's comment.
    I also agree that, as I said in my testimony, I think we 
have to move toward a business receipts tax or VAT.
    I would reject retaining the income tax along with it 
because I do not see where adding yet another definition of 
income or another calculation everyone has to do is a net gain. 
I think within the context of a business receipts tax, you can 
have substantial progressivity.
    For example, you could have a base business receipts tax 
rate, call it 20 percent.
    Chairman Conrad. Explain that for those listening and for 
the members of the Committee. What do you mean by that? How 
does that work?
    Mr. Lindsey. Well, a business receipts tax or a VAT are 
very similar concepts. Essentially, the base would be total 
receipts by the company minus what was paid and taxed to a 
different company. So, for example, if I am making a car and I 
buy steel, I send the steel company a check to buy the steel, 
and the value-added tax on that steel is part of that. So to 
avoid double taxing, if I can show that I have---basically it 
is called an invoice. If I have an invoice that says you paid 
tax on that once, you do not have to pay tax on it a second 
time. So the base would be all the money coming in minus the 
cash going out that you paid a tax on.
    Now, if I bought that steel from China, I did not pay a VAT 
on it or a business receipts tax, no deduction, and so we would 
be leveling the playing field between purchases of goods here 
and purchases of goods from overseas.
    Chairman Conrad. So that would help the competitive 
position of the United States vis-a-vis taxes with respect to 
one of our toughest competitors, and all of our competitors who 
have a similar system.
    Mr. Lindsey. Absolutely. And if you think of it, that is 
the central issue, and I think that it really is our central 
economic issue. You have to say why wouldn't I want to throw as 
much--if I am going to move to that system anyway, why wouldn't 
I want to move as much of our tax base into that system as 
possible? If I know I am going to gain competitiveness by doing 
it, why would I only want to gain competitiveness on half my 
tax system? Why wouldn't I want to gain competitiveness on all 
of my tax system? And that is why I would move to the one tax. 
Now----
    Chairman Conrad. This one goes to--it takes us right back 
to this fundamental question. If you do it all on that side of 
the ledger, how do you maintain progressivity in the system so 
that especially those who are the least vulnerable who benefit 
from the current tax system through the earned income tax 
credit, child care tax credit, how do you maintain that support 
for that end of the spectrum?
    Mr. Lindsey. Sure. Let me mention the high end as well. 
There is no reason why--again, you have the business filling 
out its tax form. They do the calculation on the base I just 
said. Then you have a second line that says subtract the first 
$10,000 a month you paid to every employee; in other words, 
wages up to $10,000. You get another line. You put another tax 
on top of that. So that high-end wages and profits, including 
interest and dividends, would be subject to the higher rate. I 
think that is how you get progressivity on the higher end.
    On the lower end, this is not a hard problem. I mean, there 
is no reason why you cannot have wage subsidies built into an 
EIC--an EITC. Right now we incorporate the EIC right into the 
payroll checks of most companies. You can get--I think it is 
called pre-paid. There is a way. We have it in the tax system 
where you can get--you do not have to wait for April 15th to 
get your earned income tax credit now. You can get it in every 
paycheck you file. There is no reason why you cannot do that in 
the VAT system either.
    The other aspect of the help for people on the lower end of 
the income distribution, it has been pointed out that right now 
we have among the most complicated set of rules because we have 
different rules for food stamps, for health care, for what have 
you. So that is something that you can reform separately. You 
can run it through the tax system. You can run it through a 
direct payment system, which is what a lot of what we do now 
is. When you think about ``welfare'' in the old days, it had 
nothing to do with the tax system. It was a direct payment to 
people based on their income and based on the number of 
children they had. So I do not see where there is an obstacle 
toward providing progressivity in our combined tax transfer 
system by moving to a value-added tax or a business receipts 
tax.
    Chairman Conrad. All right. Senator Sessions.
    Senator Sessions. Thank you. Mr. Chairman, I would yield my 
time to Senator Portman. I would just note that we have three 
new Senators that have joined our Committee. Senator Portman 
was, of course, at OMB, which is the heartbeat of Federal money 
management, and a member of the Ways and Means Committee in the 
house for a number of years. And Senator Toomey was on the 
Budget Committee in the House for a number of years and was a 
businessman. And Senator Johnson, who is not with us now, is a 
full-time career businessman who got elected to the Senate. So 
I think they all three are going to add some real experience 
and perspective to our debate. Senator Portman, thank you for 
being with us, and I yield my time to you in the first round.
    Senator Portman. Thank you, Senator Sessions. I appreciate 
your yielding your time. You know, we have all got four or five 
things going on at once here, so I am going to have to step out 
after my questions. But I really enjoyed the testimony, and, 
Mr. Chairman, thank you for bringing this panel together. It 
looks like we need to get Michael Graetz here next time so he 
can talk about his ideas. You know, I did read his book, and I 
am intrigued by his concepts. I will tell you, I think in the 
politics of today and with the urgency of addressing our fiscal 
crisis, I am not sure where to make that leap.
    I will also say to the Chairman's question that one of the 
thoughts that came up in relation to the Graetz ideas was to 
deal with progressivity among lower-income workers by 
offsetting the payroll tax, which is a good way, I think, to 
both simplify the Tax Code and also to provide relief because 
most low-income workers are working and do pay payroll taxes. 
Those who do not, there are other ways to do it, as the panels 
have talked about.
    But I kind of want to take us maybe back to the kinds of 
proposals that the Commission has looked at and the kinds of 
proposals that the Wyden-Gregg legislation would indicate, and 
that is simplifying the current code. Again, as interested as I 
am in what Dr. Lindsey and others are talking about in terms of 
moving to a VAT tax, I am not sure I see that as politically 
viable here in the short term.
    But perhaps we could move to an income tax that is simpler, 
that has fewer economic distortions, that makes us more 
competitive, that moves us toward eventually looking at some of 
the more dramatic changes in terms of a consumption-based tax. 
So a couple questions for you.
    One, what should the corporate rate and the individual rate 
be? There is a study we talked about in the last hearing that 
is out recently by Alex Brill and Kevin Hassett from AEI 
indicating that we are leaving money on the table right now 
with the corporate rate being so high. In fact, I think they 
say the optimal corporate rate is in the mid-20s, and the point 
has been made here this morning that we are not competitive 
with our OECD trading partners. Japan is going to relinquish 
first place to us in terms of the highest corporate rate come 
April. And this is a jobs issue.
    What should the rate be? And what should the interaction be 
between the individual rate and the corporate rate? The 
question I, of course, have is: Given the fact that most 
businesses in America do not pay their taxes at the C rate but 
rather at the sub-chapter S or as partnerships and sole 
proprietors, what kind of behavior will result if the corporate 
rate, let us say, were at 26 percent and the individual rate 
was relatively higher? Would you see that shift back to the C 
corporations? And is that good for taking the economic 
distortions out of our system? I do not think so because then 
you would have more double taxation on the corporate side.
    So I will start with you, Gene, if you do not mind and just 
go down the panel, if you all could tell me again in sort of a 
realistic scenario here of getting a corporate rate down, what 
is the right corporate rate? And what should the right top rate 
be for individuals?
    Mr. Steuerle. Well, thank you, Senator Portman. It is good 
to work with you on this side of the Congress this time.
    Let me answer your second question first, which I think is 
the easier one. I think the individual rate and the corporate 
rate should be fairly near to each other. That is the 
conclusion we came to in the mid-1980s, and I think it is the 
right conclusion today. And I think if you ask me personally 
where I would come, I would actually try to keep the rates down 
into perhaps the high 20s.
    But here is my dilemma. I believe that the effective rate 
of tax on the public is equal to the spending rate, and the 
spending rate right now is about 24 or 25 percent of GDP. The 
typical tax base, the income tax, Social Security, value-added 
tax, is only about half of GDP. So you are really running 
rates. If we really add them all together, so you add in how 
you come in the back door, through Social Security taxes, you 
phaseout this, you phaseout that, most people are facing 40, 50 
percent rates if you really look through the system. So the 
statutory rate is hiding the effective rate that they are 
facing from being phased out of all these programs, from having 
all these combined tax systems. And so it is very hard for me 
to give you a rate in the individual and the corporate tax that 
get balanced. And the system is so out of balance--in fact, one 
thing, Mr. Chairman, I hope you will consider that I think you 
could even work with the House Budget Committee on is ways to 
report to the public better. I really think that one way to get 
at the deficit issue is to start reporting to the public that 
the tax rate is equal to the spending rate, that what we are 
spending as a society now and what we are spending in the 
future is the taxes we are collecting, just as if it were a 
household, and we're spending $100,000 and borrow $50,000, we 
are still spending $100,000. We still have to pay that 
$100,000, and somebody is going to pay it, and we need to 
report that unidentified payer, which is the person who has to 
pay for that deficit in the future. We need to start reporting 
that as a tax or a burden on future generations or on future 
taxpayers.
    So to answer the question, I would put the rates near to 
each other, but I have to solve the question of where you want 
the system as a whole to come out. I think that the rate of tax 
we pay should be equal to the spending we promise the public as 
a way to get the deficit in order. And even if that makes the 
tax rate way too high for where I want Government to be, at 
least it is an honest system, and we are not trying to hide the 
rates in the deficit.
    Senator Portman. We also need to do both. The Chairman 
talked about that earlier, on the spending side as well.
    Dr. Marron.
    Mr. Marron. So perhaps not surprisingly, I will be in a 
similar place to Gene. On the corporate side, the pressures 
around the world are such that the world is moving into, you 
know, tax rates that have a 2 at the beginning of them, and 
that would seem to be where the United States ought to go if it 
can figure out a way to get there. You would like the 
individual rate, the personal rate to be near that. I am not 
sure they need to be necessarily identical, so it could 
possibly be somewhat higher. But you are going to want them to 
be similar.
    But you have the challenge that Gene said, which is, you 
know, we have to pay for the Government that we are going to 
have and whether that is going to be possible with those lower 
rates. And I would say, you know, going back to my testimony, 
the emphasis on the tax preferences, that how one feels about 
being able to bring the rates down by a sizable amount I think 
is going to depend a lot on how aggressive folks can be in 
rolling back tax preferences, both in finding what will count 
as revenue, although often I think as effectively spending to 
offset any budget impacts from that. And then also if you are 
concerned about the distributional impacts, you know, if you 
are bringing down top rates, you are going to want to find--
look at the tax preferences in particular that systematically 
benefit those folks as an offset to that.
    Senator Portman. Let me just ask, Dr. Altshuler, before you 
answer, just a simple year or no. Does it make sense to reduce 
the corporate rate, which I think there is a broad consensus on 
now, without dealing with the individual rates? Yes or no. The 
answer is no. Just say it.
    [Laughter.]
    Ms. Altshuler. I am going to lead the witness.
    Ms. Altshuler. It is going to be difficult.
    Senator Portman. But, seriously, if you still have a top 
rate of 35 percent and you do reduce the corporate rate to the 
mid-20s, that creates----
    Ms. Altshuler. I think there is going to be a problem, yes. 
Yes, yes.
    Senator Portman. So yes, no.
    Ms. Altshuler. I guess the answer is no, right.
    Senator Portman. Thank you.
    Ms. Altshuler. And so can I go on to----
    Senator Portman. Yes.
    Ms. Altshuler. OK. Now I am confused as to what yes and no 
mean.
    Well, just getting back to the question that you asked me 
directly, I think it is going to be hard through revenue-
neutral corporate income tax reform to get the corporate rate 
down to 25 percent. So I do not really see that--I would love 
to be able to do that, but just looking at corporate tax 
expenditures and just cleaning up the base, I do not think we 
get to 25 percent. And I think that is where we do need to go.
    So in answering your question, you know, it makes sense to 
try to get to the OECD average because of the competitive 
pressures that we face that are not going away. Other countries 
besides Japan, Canada and the U.K. are also lowering the rates. 
I am not saying that we should engage in a race to the bottom. 
I do not think that is good for the world either. But the 
reality is that our rate is 14 percentage points higher than 
the OECD average right now.
    As Donald said, the two rates do not have to be identical, 
but they should not be too far apart. What you are pointing out 
is absolutely right. If you have a corporate tax rate that is 
much lower than the individual tax rate, then all of a sudden 
the corporation becomes a tax shelter for high-income 
individuals, and there are tax lawyers that are just going to 
jump all over that and advise people how to deal with that. But 
you should keep in mind that once I incorporate myself to get 
money out, I am going to be paying the corporate rate along 
with the individual rate, and that is why there is room for 
there to be a little bit of a difference between the two rates.
    How do we get to these rates that begin with a 2? Well, I 
think we have all been saying the same thing, and the 
Commission showed us: broaden the base. Take a deep breath; 
broaden the base.
    Senator Portman. Larry.
    Mr. Lindsey. Yes, the answer to your question is I think 
you do have to lower the rate. What has increasingly happened 
since S corporations have become common is that the corporate 
rate is really a way to purchase--it is a convenience for the 
business organization to be structured that way. And the only 
people for whom it really makes sense anymore are large 
institutions that are internationally competitive.
    So I actually think that although it would be ideal to 
lower both, the damage done would probably be manageable in 
part for a reason that Professor Altshuler mentioned, which is 
if you are now a sub-chapter S and you switch over to a C, you 
pay the 25-percent rate that a C corporate rate would be. But 
then your money is stuck in the firm, and you have to take it 
out somehow; and as soon as you take it out, you are subject to 
the personal rate. So the advantages, I think--I mean, this 
gets back to the main point that an income-based tax system 
really, really does not make sense, because you get into all 
these complexities. Is it going to be taxed once, twice, two 
and a half times, three times? And I know it is politically 
difficult, but in the end, as Rosanne said, we have no choice. 
All roads are going to lead to a VAT. If we intend to be 
competitive, that is where we are going to end up.
    Senator Portman. Thank you, Mr. Chairman, for the time.
    Chairman Conrad. Thank you.
    Let me just say to colleagues we are at 11:10. We have a 
good turnout. We have more colleagues coming, so I think we are 
going to have to go to 5-minute rounds, and we will start with 
Senator Wyden. Senator Portman was on Senator Sessions' time.
    Senator Wyden. Thank you, Mr. Chairman, and I thank all the 
panel.
    As far as I can tell, reforming the Federal income tax is 
the only major policy response with an actual track record--an 
actual track record of creating millions of private sector jobs 
without adding to the deficit. And here are the numbers.
    Two years after a big group of populist Democrats and 
Ronald Reagan worked together, the economy created 6.3 million 
non-farm jobs. That is twice as many--twice as many jobs as 
were created between 2001 and 2008, the period of time when tax 
policy was partisan.
    So my question particularly for you, Mr. Steuerle, because 
you have this great history of 1986: Is there any reason why 
the principles of tax reform that were pursued in 1986 would 
not be once again an engine for job growth? The Heritage 
Foundation scored Senator Gregg's proposal with me as creating 
2.3 million new jobs per year. That is in the here and now. We 
have to create more good-paying jobs, and because of your 
history, the first thing I want to ask is: Do you see any 
reason why the principles of 1986 tax reform would not be an 
engine for job growth again?
    Mr. Steuerle. Well, you sort of set me up, Senator Wyden. I 
agree with your conclusion. I think tax reform, lowering the 
rate, broadening the base, is good for the economy.
    Now, how far and how fast it goes, I am one of these people 
who is always a little reluctant to make that type of 
prediction, but it is in the right direction. And I believe 
that there are so many areas of tax and budget reform where we 
know what to do, and if we do them and move in the right 
direction, we often get surprised. And what actually happened 
in 1986, we actually thought that perhaps there was a 
transition period where we might have actually had a little bit 
of a slow growth to be able to compensate for the reform. And 
you may remember, by 1986 we were already into about the third 
or fourth year of an expansion at a time when we often slow 
down. Instead, what happened after tax reform was that things 
actually sped up.
    So, yes, I think tax reform especially is good for long-
term growth. What happens in the short term is hard to predict, 
but the lessons of 1984 to 1986 actually are fairly positive.
    Senator Wyden. Well, those numbers are just stunning. I 
mean, twice the job growth in the 2 years after bipartisan tax 
reform compared to the whole period between 2001 and 2008, and 
that is a matter of public record.
    The second question I want to ask, we will get you, Mr. 
Marron, and you, Professor Altshuler. I will tell you, I find 
it pretty alarming how short shrift small business is getting 
in this whole discussion about tax reform. Now, in the 
proposals Senator Gregg and I put together, we get the 
corporate rate down to 24 percent. That was scored by Joint 
Tax, so, again, that is a matter of public record. But small 
business, that is 80 percent of the businesses in this country, 
sole proprietorships and partnerships and the like. And it 
seems in much of the discussion small business is almost 
getting to be an afterthought. And I am going to do everything 
I can to keep that from happening.
    I wonder what your sense is about how small business is 
fitting into this discussion, Professor Marron and Professor 
Altshuler.
    Mr. Marron. Well, the first point, which is I think where 
you are going, is that, as was discussed before, we now have 
many businesses that are structured so that they pay their 
taxes through the individual income tax, and that as 
passthroughs--as you think about tax changes, it may make life 
easier for businesses to create jobs, you are going to want to 
think not just about corporate tax reform but possibly about 
the benefits of, say, lowering rates and what-not on the 
individual side.
    Now, the caveat with that is that while many, many 
companies and businesses show up on personal income taxes, the 
really, really large ones and the multinational ones are still 
over on the corporate side.
    Then, with the security and safety of being a think tank 
and academic guy, I will inject the one thing that there has 
been a lot of interesting recent research on what are the key 
things for creating jobs and moving the economy forward. And it 
turns out that small business is not exactly the slice that 
drives it; that it turns out that there are a lot of small 
businesses that do not grow--I mean, the perfectly respectable 
businesses we like, but that if you are interested in kind of 
what are the job creators, the things that move the economy 
forward, it is a small subset of them that turn out to be 
really the gazelles that really create a lot of jobs. And one 
of the challenges in thinking about public policy is how do you 
design things particularly if you want to help those.
    Senator Wyden. I would only say--and I want to get you into 
a different area, Professor Altshuler, because I know my time 
is up. That is where most of them are, and certainly small 
businesses can become big businesses because of the 
entrepreneurial ingenuity, and that is why I just do not want 
them forgotten.
    A question for you, Professor Altshuler and Dr. Lindsey. 
More than 90 United States Senators voted against a VAT, and as 
far as I can tell listening to the debate, the only surprising 
part was that it was not more than 90. And I think the big 
concern for those who have been for a VAT is there is a sense 
that it is just a back-door plan to hike taxes, and 
particularly taxes that are seen as regressive.
    Since both of you are for this, how would you deal with the 
politics today of more than 90 United States Senators coming 
out against this concept? And, of course, the Volcker 
Commission did not bring forward a proposal that was in favor 
of it. I look back at the Bush proposal, and they said, well, 
you can talk about it, but they certainly did not come out for 
it. How would you deal with trying to bring people around to 
your point of view given that recent Senate vote and certainly 
the product of the other reports.
    I thank you for this extra time, Mr. Chairman.
    Chairman Conrad. Let me just say it is very clear 5-minute 
rounds are not going to work, so we will go to 7-minute rounds.
    Senator Wyden. Great. Thank you, Mr. Chairman.
    Ms. Altshuler. Senator Wyden, thank you for the question. 
The answer is perseverance; education, education, education; 
helping people understand that the current income tax is broken 
and that the VAT is an efficient tax, and it is not necessarily 
a money machine. This is what people are afraid of. There is 
this idea that it is a hidden tax. It absolutely does not have 
to be a hidden tax. You just put it right on the receipt like 
Canada did. Speak about the Canada experience. They are just 
north of us. They adopted a Federal VAT. It is not a perfect 
VAT, but if you talk to Canadian policymakers, they will say 
that it works very well for them.
    So I think education--I mean, the problem is that when you 
support a VAT, it is politically very difficult.
    Senator Wyden. My time is up, but, Dr. Lindsey, the people 
of my State have voted against a VAT something like 850 times, 
which is barely an exaggeration. So you should know that your 
education challenge will be great.
    Mr. Chairman, you have given me lots of time. Can Dr. 
Lindsey just respond quickly?
    Chairman Conrad. Go ahead.
    Mr. Lindsey. Thank you. First of all, if it were an add-on 
VAT--in other words, you were adding it on to what we already 
have--I think the 90 Senators were correct. Why do we want to 
add another layer of complexity? But I do think in the end, if 
you want to regain competitiveness, that is going to be the 
only avenue that is available.
    Chairman Conrad. Senator Toomey. And we will go to 7-minute 
rounds now for everybody.
    Senator Toomey. Thank you, Mr. Chairman. I just want to 
followup on a point that Dr. Steuerle made earlier with which I 
fully agree, which is the idea that we ought to really equate 
and think about the total tax burden by looking at the total 
amount of spending. Ultimately, all spending has to be funded, 
and it is all going to come from taxes, whether the--at any 
given point in time there is a combination of debt and taxes. 
The real measure of the burden on the economy is the level of 
taxes.
    Now, to just connect a few dots here, it is also 
interesting to hear the discussion about how there is a 
disproportionate negative impact--in other words, the negative 
impact from higher taxes exceeds the revenue benefit to the 
Government from an increase in taxes. If we are saying that 
taxes are essentially equivalent to spending, then what we are 
saying is that as Government spending grows and, therefore, the 
corresponding taxes, we are doing harm to our economic growth, 
which is what--I think we are well within the range at which 
increases in spending are doing net negative consequences to 
our economy.
    The question I have is also about the VAT. Now, Dr. Lindsey 
has argued against a combination of income taxes and VAT, and I 
think if I understand you correctly, it is because of a concern 
about an additional layer of complexity. But I wonder about 
something else also that concerns me, which is if we had both, 
we could at least initially have both at what would appear to 
be nominally relatively low rates since you have two different 
sources of revenue. And I worry that that would make it easier 
politically to raise rates and to increase the total tax burden 
on the economy, which we have already established from this 
panel has a disproportionately negative impact on economic 
growth and, therefore, job creation.
    So I wonder if those of you who, I think, you might support 
a combination of a VAT and an income tax, if you share that 
concern that it could lead more easily to a higher total tax 
burden and, therefore, poorer economic performance and lower 
job creation.
    Mr. Steuerle. Well, Senator, again, part of the dilemma is 
our spending rate is so much higher than our tax rate where 
basically for every $2 we collect in taxes, we are spending $3 
now. And, actually the spending rate goes up in the future, 
particularly because we have these mandatory spending programs 
that have growth rates that are faster than the economy and 
they are unsustainable--as well as, by the way, a number of tax 
subsidies as well that have very high growth rates.
    So we have a dilemma here, and I go to some elaborate ways 
in my testimony a little bit, but the dilemma for both 
political parties is that there is a sense that if they do not 
control the future, the other party will. So for Republicans, 
it is often--you know, if I actually raise rates to balance the 
budget, all that is going to happen is that is going to keep 
spending higher. And for Democrats, you know, our experience is 
if we basically get spending under control, which some of them 
believe that they did in the 1990s, well, then all that happens 
is we end up financing these tax cuts. And, actually, I think 
both parties are right. I mean, in technical academic language, 
they are in what I call a classical prisoner's dilemma. Without 
going into the details of it, it is basically you always want 
to argue for one side because if you do not, somebody else is 
going to take advantage of you. But it is an unsustainable 
situation, and so to me, the answer to your question, which 
sort of goes beyond tax policy, is I think you have to come up 
with budget rules that limit both political parties, whether 
they are in power or not in power, from controlling the future. 
So that, yes, if the public wants to vote for higher spending 
in the future and finance it with a higher VAT, then they get 
it, but they cannot do it in a way that they vote for higher 
spending now that forces the taxes to go up. But, similarly, on 
the other side of the aisle, you cannot vote for tax cuts now 
that basically try to force spending cuts into the future 
because of these deficits, because what both political parties 
have succeeded in doing is creating not only this enormous 
deficit but boxing themselves in so much that, as I say, we 
have now got a Government where when you walk into the office--
when you walk into the Congress, both this Congress and the 
last Congress, every dollar of revenue was already committed. 
You did not have a single dime of discretionary to spend on 
discretionary spending or to do any reform because it had 
already been committed by your colleagues in the past.
    Senator Toomey. I understand. I am wondering if we could 
focus a little bit on the narrower question I am trying to 
pose, the danger of escalating--the increasing danger of 
escalating taxes if we had both a VAT and an income tax.
    Mr. Steuerle. I guess the bottom line is I am saying, yes, 
I think the danger is there. The danger is on both sides of the 
aisle unless you figure out ways to constrain both parties as 
to how much deficit they can do now that they ended pushing the 
tax rate up or, if you want, the spending rate down.
    Senator Toomey. Dr. Marron.
    Mr. Marron. So a couple of thoughts. First, as Rosanne 
said, I would invoke the example of Canada as an interesting, 
important one to keep mind, where they introduced a VAT in the 
early 1990s at a 7-percent rate. They made it very visible. And 
then eventually, over time, they actually brought it down to 6 
percent and, I believe, 5 percent, which shows that a country 
that is relatively similar to ours in many regards was able to 
introduce a VAT as an add-on and not let it grow like Topsy.
    The other would be I would just sort of echo some of what 
Gene said. Ultimately, the challenge is that we have to afford 
the government that we are going to choose. What you discover 
if you look internationally is that societies that have chosen 
to have larger governments tend to choose more efficient tax 
systems. So they tend to do more consumption taxation in 
relative terms and less income taxation in relative terms.
    And I think the reason folks here have been talking about a 
VAT as a possibility is that we think that given the pressures 
of an aging population and rising health care spending, that 
that may be what the future looks like for the U.S., and that 
rather than try to pay for that by just racheting up income 
taxes, it would be much better to go to a mix and more toward 
the consumption end.
    Ms. Altshuler. I do not think I can add much more to what 
Donald just said. I think I agree with everything that he just 
said. I think the idea that by having a VAT you automatically 
have a bigger government is based on this idea that it is a 
hidden tax and that people will just let that tax go up and up 
because they do not feel it or because they do not see it, and 
I just do not see that as being the case.
    Senator Toomey. But Dr. Marron did seem to be suggesting 
that there is certainly at least a correlation between big 
governments and a VAT and that some here who are advocates for 
expanding government see that as a good way to get there. My 
concern is that ever-bigger government, however you fund it, 
leads to slower economic growth and lesser job creation and a 
lower standard of living.
    Dr. Lindsey, I would if you could comment.
    Mr. Lindsey. I think you are exactly right on the hybrid 
system. Because you have two apparently lower rates, it makes 
it easier to raise one and then the other. So I think you are 
right.
    I was struck by Senator Wyden's question. I had an answer 
which I will direct to you, but it is really to his, on a 
political issue. You know, there is a large movement in the 
country for something called a fair tax. Now, I personally do 
not think that is as effective as what I am suggesting, but 
economists disagree. But there is an example of something that 
is close to a VAT that has a large political constituency for 
it in a place you would not expect. And so I do not think it is 
at all an impossible task.
    Chairman Conrad. Thank you. Let me go to Senator Coons. 
Senator Coons, I want to welcome to the committee. He is a new 
member here, actually filling out the term of Senator Biden, 
who was a founding member of the Senate Budget Committee. 
Senator Coons was the County Executive of Newcastle, the 
largest county in Delaware, so he has actually balanced budgets 
and worked on ways to promote economic growth. We are delighted 
to have you join the committee, Senator Coons, a graduate of 
Amherst, a Bachelor of Science in Chemistry and Political 
Science. He holds a graduate degree from Yale in Law and 
Divinity, so maybe we can get some spiritual guidance here, as 
well. That would be valuable to the Budget Committee. And he is 
the first Truman Scholar to serve in the Senate.
    Senator Coons, welcome to the committee.
    Senator Coons. Thank you very much, Mr. Chairman, and thank 
you for your leadership on these very important issues. I very 
much look forward to working with you and with Senator 
Sessions.
    As you both said in your opening Statements, we recognize, 
I think, across the partisan divide of the Congress and broadly 
across the country, regardless of region, background, 
experience, or education, that we have, as this panel has so 
uniformly and compellingly testified, a simply unsustainable 
and unworkable tax system in the United States. We face a 
crushing national debt burden, a challenging deficit. You have 
all worked clearly very hard in putting together a series of 
proposals, and as the questioning so far has surfaced, one of 
our big challenges is taking insightful, detailed, thorough 
proposals and actually moving them into political reality, and 
we have some very real challenges doing that.
    In my role as County Executive, as you mentioned, Chairman 
Conrad, I did balance six budgets. It was not easy. It required 
a broad recognition of a need for shared sacrifice, both 
reductions in spending and broadening our base and increasing 
revenue. And before that, I spent 8 years as in-house counsel 
for a multi-national corporation that is one of Delaware's most 
innovative manufacturers.
    I will focus my questions, if I might, on the question of 
corporate taxes. I am very interested in how we might 
successfully encourage or incentivize through repatriation of 
foreign-earned profits, increase corporate investment in R&D, 
in manufacturing, and in new hiring in the United States, and 
in what our longer-term trajectory for it ought to be on 
treating corporate tax rates, and I am really more interested 
in this exchange, in larger corporations who have significant 
offshore balances.
    One of the comments that was made, I think it was by Dr. 
Marron, was about the sort of distorting effect of temporary 
tax programs. As a participant in the lame duck session, I was 
particularly disappointed that we made some large tax moves 
that were for 1 year. As someone who was long concerned about 
or interested in the R&D tax credit, for example, it makes 
absolutely no sense to me that it is here, gone, here, gone. We 
do not do long-term sustainable tax policy.
    So if I might, to every member of the panel, please, I 
would really appreciate a response. If we are in a global 
situation where, as I have heard from you, most of our 
competitors are at a VAT style system, a cash system rather 
than an income system, and we do have, or will have the honor 
as of April of having the highest of the OECD countries 
combined corporate income tax rate, what is the best path 
forward to incentivize both in the shorter term the 
repatriation or the mobilization and deployment of capital from 
American-led corporations, and then in the longer term, what is 
the balance that makes us most competitive as a national 
economy, given the political realities that were pointed to by 
the panel of the difficulty of moving easily to a VAT.
    Is it to dedicate the VAT to particular purposes? Is it to 
apply it only to narrow classes of economic activity? Some have 
proposed a repatriation of foreign-earned profits holiday or 
for limited purposes. How do we strike a balance here that 
allows us to most effectively access and mobilize the 
innovative capital reserves of the American corporate sector? 
Please.
    Mr. Steuerle. Senator Coons, I confess that when it comes 
to international, my complication is I do not think there is 
ever a perfect answer. You start with inconsistent tax 
systems----
    Senator Coons. Of course.
    Mr. Steuerle [continuing]. because different countries have 
different tax systems. So you never can get all the neutrality 
you want across the systems. You start with inconsistency and 
then you have to decide how can you try to minimize some of the 
distortions that result. So I can only make some suggestions 
that I think move in the right direction without giving you a 
perfect solution.
    I should comment that in tax reform in 1984, I went around 
to every staff member--I had divided up tax reform into 20 
modules with like several hundred pieces, which is an issue we 
have not even gotten to here today. There are thousands of 
provisions we are talking about here and we are talking in a 
very shorthand basis. I went to the national people. They 
hesitated. They hesitated. They hesitated on what form to 
propose. They ended up suggesting something. We finally got it 
in our proposal at the last minute. Three weeks after we got it 
in the proposal, they came and they said, you know, we do not 
think we got that right. So ever since then, I have been 
skeptical about getting a perfect solution.
    So my colleagues, especially Rosanne Altshuler, who is a 
real expert in international, have made several suggestions. If 
you lower the rate, you move in the right direction. Nothing 
else that really helps a lot. Just lowering the rate moves it 
in a long direction. With the value-added tax, you can do 
border tax adjustments to the extent that makes a difference.
    The repatriation issue, I think, is a bit of a bogus issue. 
You know, basically, that is where the people put a little 
check mark on where they are keeping their account. I mean, the 
money is accessible in a lot of different ways regardless of 
whether they repatriate. I do think that we have not given much 
attention to the way that our current system allows people to 
arbitrage----
    Senator Coons. Right.
    Mr. Steuerle [continuing]. moving debt abroad. But it is 
not just corporations that can do it. We individuals can do it, 
too.
    Senator Coons. Individuals do it, too.
    Mr. Steuerle. We borrowed to put money in our pension 
accounts, and that is one way of getting at some of the 
arbitrage in the system.
    So I think there are several things we can do to move in 
the right direction. I am less enamored of whether--I am not 
opposed to it, but I do not necessarily favor whether going to 
a territorial or not makes a difference.
    Senator Coons. And Dr. Altshuler in her testimony said that 
we really should not have a race to the bottom in terms of 
lowering corporate rates. Is there a point below which--I mean, 
this is obviously a hypothetical--is there a point below which 
you should not keep reducing income tax rates for corporate 
income?
    Ms. Altshuler. Is this a question----
    Senator Coons. Sure.
    Ms. Altshuler [continuing]. a question for me? Is there a 
rate--boy, then what you are thinking about is we are all in 
this together as a world and how are we all going to behave as 
a world, and I think that you are not going to get----
    Senator Coons. No, I am pretty narrowly interested in how 
we are going to----
    Ms. Altshuler. Yes, exactly. You are not going to get 
cooperation. The point is, just to answer your original 
question in terms of what can we do, as Gene pointed out, step 
one, lower the rate.
    Step two, look at that rate. If the rate is low enough, 
then it really does not matter if you are territorial or if you 
are worldwide. That becomes less important. Getting the rate to 
that level is going to be very difficult. You could not do it 
without a VAT.
    So step three is deciding--is stepping back and saying, 
incremental reform at this point does not work anymore. We 
cannot just do a repatriation tax holiday. As Gene mentioned, 
it does not necessarily lead to firms bringing back money and 
then investing it in the economy. It is just--it keeps us going 
down this temporary tax holiday path that is very unhealthy, 
unpredictable, and not good for the economy. It is time for us 
to sit down and get the information that we need to decide 
whether or not territorial would be good for us, and that does 
depend on what rate we get down to, or should we go to a 
worldwide system, for instance, that gets rid of deferral. But 
we need to be thinking about fundamental reform of the 
international tax system, not incremental reforms.
    Senator Coons. Thank you.
    Chairman Conrad. Thank you, Senator.
    Senator Coons. If I might, Mr. Chairman, any other comments 
from the panel just in response to that?
    Chairman Conrad. I think we had better, in fairness to the 
colleagues who are here, we should go----
    Senator Coons. Thank you very much.
    Chairman Conrad. Senator Whitehouse.
    Senator Whitehouse. Thank you.
    Chairman Conrad. Oh, I am sorry. Wait a minute. I skipped 
Senator Sessions. He had ceded his time initially, so we have 
to go back and forth here.
    Senator Sessions. I will followup on Senator Coons's 
excellent line of questioning. It is something I do not fully 
understand. Mr. Lindsey, you did not get to comment on it, but 
maybe you could start. I understand we are one of the very few 
nations that tax out-of-territory income, and is this good for 
jobs in America? Is it good for the economy? And do you have 
any comments to followup on Senator Coons's question?
    Mr. Lindsey. I am going to give you an answer that you are 
going to hate and I hate, and the answer is it depends, and I 
think that was the comment about whether or not we should move 
to a territorial system. We set it up that way. Remember, we 
tax everything, but then we give a credit against the foreign 
income taxes paid, and then we tax the money when it is 
repatriated. It gets to be very complicated.
    If one looks at why we did what we did when we did it, it 
was really a decision post-World War II to encourage the global 
participation of American firms in the rebuilding of the world. 
At that point, it made sense because we did not have 
competition. It makes less sense now.
    I think, Senator Sessions, that the theme you heard here 
was the single first thing you can do here is lower the rate, 
and as evidence, in all the agony that Ireland has gone through 
recently, the one thing they refused to give on, with all the 
pressure on them, was their 12.5 percent corporate rate, 
because for them, that is a key competitive advantage and it 
just underscores the importance of us lowering our rate as a 
first step if that is what you are going to focus on.
    Senator Sessions. I have heard it Stated, some might 
suggest that that low rate was somehow a problem in causing 
their economic difficulties. I have been told that is really 
not so. Do you have an opinion on that?
    Mr. Lindsey. Well, they have--most of their problems are 
self-inflicted and has to do with their financial system.
    Senator Sessions. Financial condition.
    Mr. Lindsey. But what they have been able to do is attract 
a lot of headquarters from manufacturing companies, 
particularly the European headquarters, by offering that low 
rate and it is of enormous competitive advantage to Ireland. We 
are not Ireland, but I think lowering the rate would be the 
consensus first thing you could do. And again, there is a lot 
of evidence that you could raise revenue without broadening the 
base simply by lowering the rate here to something that is more 
of an international norm.
    Senator Sessions. A lot of people do not realize how close 
the competition is among businesses in the world for market 
share. Let us say Canada goes to 16.5, as I think they are, and 
we were to reduce our rate to 28 or 27. Companies seeking to 
build a plant along the border, would that be a factor in 
whether or not they built that plant in the United States or 
Canada?
    Mr. Lindsey. It would certainly be a factor, and it might 
be a decisive factor, but there would be a lot of issues.
    Senator Sessions. There would be a lot of factors, but I do 
not think there is any doubt that it has the potential to cost 
economic growth in our country. A corporate tax higher than the 
worldwide rate is a threat to us, and at this point in history, 
job creation is so important. Everybody is saying the 
corporation is doing pretty well and this is happening, the 
stock market is doing well, but jobs are not moving much and we 
cannot have tax policies that depress job creation.
    Briefly, let me ask you, committee members, as part of 
complexity, should not we consider the uncertainty of our tax 
situation, the temporariness of it? For example, we have the 
rates just for 2 years. The death tax is set for 2 years. The 
AMT comes up every year. Nobody ever knows for sure. Physicians 
are worried over their doctor fix on Medicare. Are those 
factors that have an adverse impact on our economy, the 
uncertainty of what will be in the future? Mr. Steuerle?
    Mr. Steuerle. Mr. Sessions, the answer is clearly yes, and 
I think everybody at the table will say that. I am going to 
give one caveat, though. Sometimes people say, well, let us 
deal with this uncertainty by making permanent everything in 
the code, and there is this tendency to look at mandatory 
spending and say, well, gee, we have all this stuff on 
automatic pilot. We need to get it off of automatic pilot. I 
think we have to be careful when we talk about getting rid of 
the uncertainty. We do not want to put everything in the tax 
code, including a lot of things we do not like, say five 
educational subsidies instead of one or none if we put it in 
the direct spending budget, to put those on automatic pilot, 
too.
    So when you go toward certainty, that not mean you have to 
make something permanently growing. You may put it on a 5-year 
fix or 10-year fix or something like that. I am hesitant on 
solving that problem by making everything permanent.
    Senator Sessions. I recognize that is a fair point, but I 
think all of you would agree that that uncertainty is another 
negative factor for our economy.
    Mr. Marron. Yes, if I can, absolutely. I think, as I said 
in my opening remarks, I think it is quite striking today that 
every single significant component of the U.S. Federal tax code 
now has significant temporary tax cuts in it. That is not 
something that we should aspire to in the long run. We ought to 
eventually settle in for everyone understands what the tax code 
is, and as Gene says, make sure you have a system in place so 
you can review important provisions periodically to see if they 
make sense, but allow people to have some notion of what is 
coming.
    The one caveat I would put on that is just the elephant in 
the room is the unbalanced fiscal situation we have, which even 
if we allegedly passed a permanent tax system today, unless we 
have some solution to that so that we are going to be able to 
avoid the unsustainable buildup of debt, there is still going 
to be uncertainty out there about where we are going. So 
solving the long-run fiscal challenges is going to be part of 
eliminating uncertainty.
    Senator Sessions. Well, Mr. Lindsey, you have been there in 
the government. To do tax reform and deficit reduction all at 
the same time sounds almost unthinkable, but in a way, 
politically, sometimes it may come together better in a crisis 
than in a non-crisis. Do you agree, Mr. Chairman?
    Chairman Conrad. I do.
    Senator Sessions. So would you agree with that, Mr. 
Lindsey?
    Mr. Lindsey. Yes. I think that we have no choice. Sometime 
in this decade, economic circumstances are going to force us 
into solving our problems.
    Senator Sessions. Briefly, let me just say, Mr. Chairman, 
that I think Senator Toomey is correct, and for you thinkers, 
the reality politically is that it is not that American people 
oppose something like a value-added tax. The Neal Boortz Fair 
Tax idea is very popular with a lot of average American people. 
But what they believe, and I think they are correct, if we make 
another revenue stream possible for the government to extract a 
larger percentage of their wealth to send to Washington, they 
are not happy about it.
    So, Mr. Lindsey, you suggested you could solve that 
problem. Briefly--maybe we should not go there, Mr. Chairman, 
but do you think you could do it in a way that would give 
confidence that we were not just adding a new way to extract 
more money from the American people?
    Mr. Lindsey. Well, I am not the expert at the politics of 
it, but it would seem to me one of the concerns is if you add 
on another tax, not only is it bad from an economic point of 
view because of the complexity, but you also have the issue 
that you are talking about. And so, again, I would stress of 
getting rid of all of the current taxes, and I would add the 
payroll tax, as well. If we are disadvantaging American workers 
because we do not have border adjustability, you want to make 
everything border adjustable. Throw as much of the tax system 
into something that is rebatable at the border as you can.
    Senator Sessions. And you think that is doable? I mean, we 
could actually accomplish such?
    Mr. Lindsey. Well, the members of the panel might be able 
to think it is doable. We do not have to run for reelection, 
so----
    [Laughter.]
    Senator Sessions. Thank you.
    Chairman Conrad. All right. Senator Whitehouse.
    Senator Whitehouse. Thank you, Chairman.
    I noticed the other day that the IRS had reported that the 
400 top income earners in the country, who averaged income each 
of $344 million in the year that they were reporting, had paid 
total Federal taxes of 16.6 percent. So I asked my staff to 
tell me at what point in the income level an ordinary working 
American got to start paying 16.6 percent. It turns out it is 
$28,100. So I said, well, what are some regular jobs that are 
in that area? Give me an example I can use. Well, a hospital 
orderly in Providence, Rhode Island, earns, on average, $29,100 
a year.
    So if you look at our current tax system and you start with 
the average taxpayer, who makes $60,000 a year and pays about 
20 percent in taxes into the system. And then you drop to my 
orderly who makes less and so he pays less. He pays 16.8 
percent, it turns out. Then you drop to the 400 highest income 
earners in the country, who pay less still. They pay only 16.6 
percent. Then you drop to General Electric, which on $11 
billion in income paid 14.3 percent. Then you drop to 
Prudential Financial, which on three-plus billion dollars in 
income over 5-year averaging here paid 7.6 percent. And if you 
go to the Ryan plan, those $344 million earners will drop to 
around zero percent, maybe one or 2 percent at highest because 
of the elimination of the capital gains.
    I cannot help but agree that the facts show that we have a 
tax system that is upside down and that the better off you are 
and the more powerful you are, the less taxes you pay as a 
percentage of your income, with the poor hospital orderly in 
Providence, Rhode Island, paying a higher percentage of his 
income than the average of the top 400 income earners in the 
country at $344 million a pop. So I applaud your direction. I 
think we need to go there.
    In evaluating the VAT tax, which a great number of you have 
talked about, my question is this. Could you tell me a little 
bit more about the trade and competitiveness effect of the VAT 
tax, particularly in light of how many other nations have gone 
to one, and given what appear to be its trade and 
competitiveness benefits, do you believe that the huge move by 
other nations which export a great deal into our economy was 
done strategically to take advantage of those trade and 
competitiveness effects? So in a nutshell, are there valuable 
trade and competitiveness effects to a VAT tax, and do you 
think other nations that have gone to it did it with that 
purpose?
    Mr. Steuerle. I think most economists would argue that 
competitiveness is not driven by whether you have a VAT. The 
competitive--if you want to call it the competitive advantage 
of a VAT is that it keeps you from raising high tax rates 
through an income tax. That is----
    Senator Whitehouse. Well, let me give you an example----
    Mr. Steuerle [continuing]. if that makes sense.
    Senator Whitehouse. Let me give you an example. Let us say 
that you have a car made in Sweden or Germany and they have a 
VAT tax. So the revenue that they are collecting from the VAT 
tax, it never attaches to that product. It leaves their country 
tax-free and it comes over to our country and is sold tax-free 
here in our country, in effect, from their home tax burden.
    We, on the other hand, have home companies that pay 
corporate income tax and various other taxes. That tax burden 
gets put into the price of the car, so when the Ford comes up 
against the Volvo in the American market, the Volvo is, in 
fact, tax advantaged versus the Ford because Sweden chose to 
collect revenue in a VAT tax that we choose to collect through 
a corporate tax. The VAT tax does not go into the price of 
their export product. The corporate tax does go into the price 
of our competitiveness product. And if that is accurate, does 
that not create a competitiveness effect, at least as to that 
transaction?
    Mr. Steuerle. Again, your analysis is correct. I think that 
the higher tax rates on the income taxes do create some minor 
competitive disadvantages. I do not want to overState the case, 
however, because I do want to emphasize that a lot of issues of 
competitiveness have to do with wage levels, have to do with 
entrepreneurship, have to do with education levels, and so I 
just do not want to over-emphasize----
    Senator Whitehouse. I was trying to isolate that.
    Mr. Steuerle. The advantage of the VAT that I see--I do 
favor a VAT for those reasons, but I do not want to over-
emphasize that I see the main advantage is that it keeps you 
from raising rates outside the VAT. It is not that putting on a 
VAT gives you a competitive advantage, it is avoiding some of 
these high rates.
    Senator Whitehouse. Dr. Altshuler?
    Ms. Altshuler. Let me answer the question about why the 
other countries had a VAT. I think when you look back at 
history, what happened was they had very inefficient cascading 
retail sales taxes, and the reason that they went to the VAT 
was to replace those retail sales taxes with a more rational 
system of VAT as a more efficient sales tax.
    If you look at Canada, and I have looked at that 
experience, it really was, we have a big deficit problem. We 
need this revenue.
    I do not think that us adopting a VAT on its own is going 
to have huge competitiveness--if we were to just take the 
system today and add a VAT on, what would happen is, over time, 
exchange rates would adjust and it would not add to 
competitiveness. What Gene said is exactly right. What the VAT 
would allow us to do is buy down--the VAT in combination with 
broadening the base would allow us to buy down our corporate 
income tax rate and that would have a big competitiveness 
impact for us.
    And do keep in mind that those other countries do have 
corporate income taxes, also. It is not like they do not have 
corporate income taxes. They do.
    Senator Whitehouse. Thank you all very much.
    Chairman Conrad. Senator Sanders.
    Senator Sanders. Thank you very much, Mr. Chairman. These 
hearings are like a narcotic to me. I can be here all day. I 
really get hooked on these things because they are absolutely 
fascinating, and I appreciate the panelists who are here. As we 
mentioned the other day, Mr. Chairman, I do applaud the 
panelists, but they have a perspective and I hope at another 
point we can bring in some economists who have a somewhat 
different perspective.
    I think Dr. Steuerle made a point a moment ago which I 
agree with, that you cannot just look at one--if you are 
talking about international competitiveness, for example, you 
just cannot look at tax rates, for example, or a dozen other 
factors. I live an hour away from Canada and my Canadian 
friends would be very impressed by the degree to which you laud 
Canada. We do not always hear that. The Canadian health care 
system costs about half of what our health care system does.
    By the way, do you think that moving to a single-payer 
national health care system, as they have in Canada, would help 
our economy? I mean, if we are going to talk about the Canadian 
government and their policies, they have a single-payer 
national health care system which spends about half per capita 
that we do. Health care is a huge burden, as you all know, on 
our economy. How is the Canadian health care system? Should we 
adopt that? Dr. Steuerle?
    Mr. Steuerle. Well, I would not necessarily say that it is 
that Canada is successful because it has a single-payer system, 
but the simple fact that they have a much lower health spending 
rate----
    Senator Sanders. Right. That is what I am talking about.
    Mr. Steuerle [continuing]. means that they can keep a much 
lower tax rate, which is an advantage.
    Senator Sanders. And everybody who has studied the issue 
understands that if you wanted to go forward with a cost-
effective health care system--and I do not want to get into a 
health care debate now--single payers, Canada versus the United 
States. Should we look at that?
    Mr. Steuerle. I guess what I would suggest is that--this is 
the Budget Committee. My own belief is what--we always have a 
debate over what health system we will adopt----
    Senator Sanders. But you told us----
    Mr. Steuerle. To me, the simple answer I have is whatever 
health system we adopt, no matter what the hybrid, it should be 
within a budget, and you----
    Senator Sanders. But that is not my question. My question--
--
    Mr. Steuerle. You cannot have an open-ended system.
    Senator Sanders. But you talked about the Canadian tax 
system. You lauded certain provisions of that.
    Dr. Marron, should we look at the Canadian single-payer 
system which provides health care to all of their people at 
about half the cost of the American----
    Mr. Marron. I am trying to figure out the right words to 
wiggle out of this question the same way Gene did.
    [Laughter.]
    Mr. Marron. it is absolutely true that there is a lot of 
wasted spending on health care in the United States, and if we 
could eliminate that, that would be broadly----
    Senator Sanders. All right. You wiggled out of it. 
Canadians are doing just great. How about our health care, Dr. 
Altshuler?
    Ms. Altshuler. I am not an expert on health--on health 
care.
    Senator Sanders. But economically you will all agree that 
health care is a huge burden on our economy. No one disagrees 
with that. Canadians seem to have done substantially better.
    Dr. Lindsey, something we should look at?
    Mr. Lindsey. Oh, we should look at everything, and I think 
what really decides competitiveness is cost-effectiveness. So 
you could have a--I mean, the worst thing you can have is a 
high-tax, low-benefit system. If you have a State, for example, 
in the United States with, you know, relatively modest taxes 
but efficiently delivered public services, those States are the 
ones that are gaining population and jobs. So I do not think 
you can look at anything in isolation, but we need to improve 
efficiency.
    Senator Sanders. And that is my point. I think we look at--
for example, we could talk about Canada again. Again, I live an 
hour away from Canada. When Wall Street collapsed here, their 
banking system did not collapse because of much heavier levels 
of regulation. Right?
    Mr. Lindsey. Senator, that is something I do know something 
about, and I would not wish the Canadian banking system on 
America. It is basically a four-company oligopoly and----
    Senator Sanders. Good point.
    Mr. Lindsey [continuing]. and that is what protects----
    Senator Sanders. All that I am saying--all that I am saying 
is that on these issues you cannot isolate--if you are talking 
about international competitiveness, not to talk about wages, 
not to talk about environmental protection, not to talk about 
trade policy, they are all lumped together. I do not think 
anyone disagrees with that.
    All right. The other point that I wanted to make, not to 
talk about a Canadian single-payer system, is what I have not 
heard discussed, while taxes are enormously important, 
everybody agrees that our current system is not working, needs 
fundamental reform, we have to look at it within other contexts 
as well.
    For example, during the Bush years, we saw substantial tax 
reductions given to the wealthiest people in this country, and 
yet we had perhaps the worst record of job performance at any 
time since Herbert Hoover. So it is not quite so clear, and 
other factors may be involved in that. But under Bush in 8 
years, we lost 500,000 private sector jobs. We gave tax breaks 
to the very wealthy. Gentlemen, we lost jobs. Dr. Steuerle?
    Mr. Steuerle. Well, Senator, there are a lot of factors 
involved. At the end of the Bush years, we went into a 
recession. When politicians in the executive branch brag about 
the job growth they have had, 90 percent of what they are 
talking about is the influence of demographics. And what we 
have dodged for several decades is when we moved into the--
after 2008 and we have all these people starting to retire 
almost at the rate that we are bringing people into the work 
force, it is going to dramatically decrease the amount of jobs. 
And I would suggest----
    Senator Sanders. And I am not arguing--I am just saying 
that--my only point was that these things are complicated.
    Mr. Steuerle. Yes, but as a matter of revenues, I mean, I 
have emphasized in a lot of other testimony it is something 
that has been hard to get into the budget calculus. But if we 
can figure out ways to get older workers to work who I think 
are the largest group of potential workers, the most--the 
largest pool of underutilized human capital in our economy, 
people 55 to 75 to 85, it has a revenue effect that right now 
we do not score--a potential revenue effect we do not score----
    Senator Sanders. When we have such a----
    Mr. Steuerle [continuing]. when we talk about revenue. So 
there are other reforms that can affect revenues beyond----
    Senator Sanders. I do not have a whole lot of time. Great--
that is what I mean, I get hooked, Mr. Chairman. We could go on 
for many hours.
    Dr. Lindsey, you mentioned that you thought it might be 
advantageous to eliminate the payroll tax. You just said that a 
couple of minutes ago, if I heard correctly.
    Mr. Lindsey. What I said was that if you go to a value-
added tax, you want to roll everything into it.
    Senator Sanders. OK.
    Mr. Lindsey. Because the value-added tax--again, it gets 
back to the competitiveness issue and how you play it out. If 
you are going to take advantage of the competitiveness 
advantages of the value-added tax--and I think there are some, 
and I also acknowledge exchange rate issues--then why wouldn't 
you want to do it for all our taxes? I mean, it is American 
labor that gets----
    Senator Sanders. All right. But because we live in the real 
world and as of today, to the best of my knowledge, Social 
Security is completely funded by the payroll tax, what would 
you do with Social--do you believe in Social Security?
    Mr. Lindsey. Of course.
    Senator Sanders. OK.
    Mr. Lindsey. What I am suggesting is that if you are going 
to take advantages of tax reform, you want to roll as much of 
the Tax Code as you possibly can into the most efficient tax 
you can. And obviously you would continue to fund Social 
Security with that new tax. I do not see where there is any 
inconsistency there at all.
    Senator Sanders. Well, the----
    Mr. Lindsey. Also, Senator----
    Senator Sanders. Let me--one second. Excuse me. I----
    Mr. Lindsey [continuing]. you said something about the 
Bush----
    Senator Sanders. Hold it, hold it. Hold it, hold it. Mr. 
Chairman, I do not have a whole lot of time here, so let me 
just ask you the questions, OK? My point was that right now we 
are having a major debate about the future of Social Security.
    Mr. Lindsey. Yes.
    Senator Sanders. And Social Security is funded 
independently of the U.S. Treasury by the payroll tax. 
Lumping--let me finish. That is a fact. Lumping all--you can 
certainly fund a retirement program for the elderly in ways 
other than the payroll tax. I am not arguing that. But right 
now the strength of the payroll tax in terms of protecting 
Social Security is that it has nothing to do with the deficit. 
If you lump everything together--and there are guys around here 
who say, well, you know, we have to make cuts. You will agree 
with me that one of the areas that could be cut if you are 
funding a retirement program for seniors out of the general 
Treasury could be programs for the elderly. Is that a fair 
Statement?
    Mr. Lindsey. This Congress has cut Social Security any 
number of times, even though it is funded by the payroll tax. 
So there is no linkage between how a program is funded and 
whether or not it is cut.
    Senator Sanders. Oh, I would not say that.
    Mr. Lindsey. 1981, 1978, those would be two good examples. 
Changes in the tax on Social Security benefits, I forget which 
year it was passed. Mr. Chairman, you may remember.
    Senator Sanders. 1983, I think.
    Mr. Lindsey. So, yes, there were many, many times when we 
have adjusted Social Security----
    Senator Sanders. You adjusted Social Security, yes.
    Mr. Lindsey. Cuts. We cut Social Security benefits without 
changing the payroll tax one bit, so I----
    Senator Sanders. Well, actually, we raised the payroll tax 
in 1983 so that it is now a viable program. All right. I do not 
want to belabor the point.
    I guess I have run out of time, Mr. Chairman. Thank you 
very much. Thank you.
    Chairman Conrad. Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair, and thanks 
to the panel for your presentations. I want to compliment my 
colleague from Oregon, Senator Wyden, for consistently and 
effectively raising the issue of tax simplification and putting 
forward the bill he has this year.
    One dimension of this is that Oregon and our Federal taxes 
may have something in common; that is, a fairly high marginal 
rate, but then tons of exceptions in terms of deductions and 
credits. A few years ago, when I was in the State legislature, 
I went to the Portland Development Agency and said, you know, 
Oregon is 47th in the Nation--in other words, one of the lowest 
States in terms of the tax burden it places on business. Is 
this a selling point in attracting business to the State of 
Oregon? And the answer was, no, it is not. And I said, well, we 
are 47th, one of the lowest effective tax systems in the 
country. Why isn't it a selling point? And the answer was, 
well, we have a very high marginal rate, and companies largely 
look at that marginal rate. They do not count on getting the 
exceptions and the credits of the deductions and the credits, 
and so it has proved of little value in attracting business to 
our State.
    So I said, well, wouldn't it make a lot more sense for us 
then, if we are going to be 47th, to be 47th with a very low 
marginal rate and fewer deductions and credits, and wouldn't 
that prove more attractive? And the answer was, yes, that would 
be a much better sell. And I think the United States as a whole 
seems to have a parallel problem. So I just wanted you all, as 
you would like, to comment on this question of whether we 
become much more attractive to companies deciding whether to 
site themselves in the U.S. or overseas if we had--we collected 
the same amount of tax we do now, but did so with a far lower 
marginal rate.
    Ms. Altshuler. Just a quick answer. Absolutely, and that is 
what I wrote about in my testimony. You hear a lot of people 
saying, well, you know, the statutory rate is really high, but 
once you take all of those credits and deductions and loopholes 
into account, the effective tax rate is really low. So we 
really do not have to do anything about the statutory rate.
    I have two problems with that. One is that I think if you 
look at effective tax rates, they are not as low as you may 
think. They are not that much lower than the statutory tax 
rate. But most importantly is it depends--it is very individual 
firm-specific. The statutory rate is an important factor as you 
just pointed out. It affects location decisions. It affects 
financing decisions. It affects how much wasteful tax planning 
you do. It affects how much you invest. So it is a very 
important policy lever, and it does make sense to lower the 
corporate tax rate.
    Senator Merkley. Anyone else want to comment on that?
    Mr. Steuerle. Senator, I think we would all agree. I have a 
somewhat tangential point, but a lot of the discussion we have 
had at this table has gone to issues like international tax, 
which can be very complex. But I would like to bring us back to 
where maybe all our testimoneys began, which is there are a 
whole variety of tax changes that appeal to both sides of the 
aisle that are not--when we have these debates on taxes--but, 
remember, taxes is the entire revenue side of the budget and a 
quarter of the expenditures, so we are talking about thousands 
of programs. There are so many things that cut across the aisle 
that both sides would agree we do not need five educational 
subsidies, we do not need ten capital gains tax rates. We could 
report on the burden on taxpayers is including the deficits we 
are putting on them. This is the type of thing Senator Wyden I 
think went through when he did his tax reform, is you can 
narrowly--you can start with the issues on which there is a 
consensus, and then build out to the issues on which there is 
not a consensus. And one of them is the one you are including, 
that if we can broaden the base--at least to the extent we 
broaden the base and lower the rate, that there are a lot of 
common elements. There is a certain beyond which--well, that 
does not work because, as Dr. Altshuler keeps mentioning, there 
are certain rate reductions that are hard to finance with the 
base broadened. That does not mean you cannot go as far as you 
can with the type of proposal you are suggesting.
    I think there are a lot of things that we can agree to 
across the aisle if we are just willing to sit down and do 
them. Start with them as a base and hold off the issues on 
which there is more controversy across the aisle.
    Senator Merkley. Let me turn to another topic. When I was 
here in 1976 as an intern, there was a tax reform up that 
addressed a lot of various exemptions, deductions, credits, and 
so folks from Oregon were writing in with all their 
perspectives on could their home office be deducted and blah, 
blah, blah and so forth. Just a lot of anxiety over each and 
every one of those potential changes.
    But a number of changes were made, and then in 1986, 
Senator Packwood led a major effort, a much larger effort, to 
do the same, to simplify in large degree. But it appears to me 
that between 1986 and now we basically have had a 24-year 
period where we have not gone back. So instead of having 10 
years of handing out credits and deductions and then kind of, 
OK, let us come back to some form of sanity, we have had 24 
years in which we have been handing out complexities in the Tax 
Code without coming back. Are we long overdue for this type of 
major discussion?
    Mr. Marron. Yes, absolutely. And I think going back to one 
of the issues I raised in my testimony, I think one of the 
things that has driven that over the last 25 years is that you 
can dress up special deductions, exemptions, and credits as tax 
cuts, which are often politically more palatable than if you 
form them up as spending increases. Nonetheless, many of them 
look from an economic and budget point of view basically to be 
the same thing, where you are using the Federal Government to 
direct resources to a certain kind of activity, but politically 
they have looked to be tax cuts.
    And going back to one of the things that Gene has 
emphasized several times, I think there is a challenge in the 
way we communicate about these issues and that clarifying that 
some of these provisions really are effectively spending 
programs will be part of the steps toward addressing them.
    Mr. Lindsey. Senator, in addition I would point out we took 
the top statutory rate up from 28 to 39.6 over that same period 
of time, and the two go hand in hand. And so both I think is 
what is on the table.
    Senator Merkley. OK. I want to slip in one final question--
oh, go ahead.
    Mr. Steuerle. It is just that when I have looked at the 
numbers, what has increasingly happened over the years you are 
talking about is that Congress has increasingly gone to what I 
call the give-away side of the budget, that is, on both 
spending and--both tax cuts and spending increases, which is 
what one wants politically, and the challenge always for the 
Budget Committee is you recognize there is the other side of 
the ledger. And we have to figure out a way to raise the 
importance of what that means. We cannot let deficits act as if 
they are free money when we do spending increases and tax cuts.
    Senator Merkley. Mr. Chair, I think I am out of time. Is 
there a possibility of slipping in one more question?
    Chairman Conrad. Yes, sir.
    Senator Merkley. OK. Thank you.
    I have asked my team to help identify specific examples of 
how our Tax Code subsidizes the export of manufacturing or jobs 
overseas, and one specific example that they have put forward 
is that when an American company decides to build an overseas 
factory, if they take their loan out to build that factory in 
the United States, the interest becomes tax deductible. So 
essentially the American taxpayer is, therefore, subsidizing 
the financing of the overseas construction that then 
incentivizes the shifting of jobs overseas.
    Is there a rational argument for this? Or is this just 
plain out a crazy thing to do, to subsidize the construction of 
factories that compete with American factories?
    Ms. Altshuler. Do you have an hour to get into this and a 
lot of headache medicine?
    Senator Merkley. It sounds like we are going to have a 
followup discussion.
    Ms. Altshuler. Yes. It is not the case that all 
corporations are able to deduct all of their interest expenses 
that support foreign investment from the U.S. rate. We do have 
a system where interest on domestic lending is allocated abroad 
so that you are not allowed to deduct 100 percent of your 
interest on foreign--domestic interests to--you are not allowed 
to deduct 100 percent. There are interest allocation rules. 
They are very, very complicated. We have a better rule that 
actually is on the books to be enacted, but we just keep 
pushing it out. I am not sure when it is. It is called 
worldwide fungibility. Maybe it has been pushed out to 2018 
now? I am not sure, but we keep pushing it out.
    What you raise is a really interesting issue because if a 
firm can deduct interest on loans that they take out in the 
United States to build a company abroad, they have generated 
for themselves a negative marginal effective tax rate, which 
means that we are subsidizing their investment abroad.
    The difficulty of this is understanding the extent to which 
this is happening to specific corporations. It is complicated.
    Chairman Conrad. But it is happening. I mean, I have had 
people come to me who are in very large multinational 
accounting firms who have had clients who were doing precisely 
this. And it so troubled them that they came to me, and they 
did not divulge the company because that would be a breach of 
their confidentiality agreements. But they showed me very 
specifically companies from the United States developing a net 
marginal negative tax rate and in effect being subsidized by 
American taxpayers to put jobs overseas. And I tell you, this 
is, I think, a bigger problem than has been acknowledged. It 
is, according to people who have come to me from very large 
accounting firms, they believe, a rapidly growing problem as 
people figure out this mechanism.
    Before I go to Senator Wyden for an additional question, 
just as a factual matter, earlier on we were talking about 
Canada's deficits, so I asked to look into that. They were at 
101.7 percent of GDP in 1996. They brought that back down to 
69.7 percent of GDP, partially with the institution of a VAT. 
It was not exclusively a VAT, but they used a VAT in 
combination with other taxes. You do not see many countries 
that have exclusively a vat. Almost always they are hybrid 
systems, part income tax, part VAT. And there was an earlier 
question from Senator Whitehouse with respect to the 
competitiveness advantage. One part of the competitiveness 
advantage is those taxes are rebatable at the border. And so 
the example that Senator Whitehouse was giving is quite 
accurate. We have our taxes built into our products that we are 
trying to compete with foreign countries. They have a tax that 
at least partially is rebatable at the border, so when those 
goods come into this country, they have less of a tax burden on 
them. That confers a competitive advantage.
    Now, we have tried to counter that with DISC and FSC and 
how many iterations. Mr. Lindsey, you would probably know. And 
the problem is we keep getting ruled GATT illegal on the things 
we do to try to level the playing field for our manufacturers. 
Many of us believe that we are on a course here that at some 
point we are going to lose our ability to try to make our 
people competitive. That is, we are going to get ruled GATT 
illegal. We are not going to be able to fix it. And then we are 
going to face a 20-percent, 25-percent, depending on what the 
VAT is, advantage going to the foreign manufacturer.
    So, you know, one of the reasons we wanted to hold this 
hearing today, I mean, these are serious, serious matters for 
this country's competitive position. And I do not think we want 
to allow ideology on either side here to get us away from the 
practical reality of what we confront as a country, and that is 
the competitive position of the United States.
    Senator Wyden.
    Senator Wyden. Thank you very much, Mr. Chairman. I think 
you make an important point. My friend and colleague from 
Oregon, Senator Merkley, as usual does as well. These 
international questions are enormously important, and I thank 
my colleague for making it.
    That was the one I wanted to ask you about, Dr. Altshuler, 
and that is transfer pricing. Just to kind of put this in a 
little bit of context, Senator Gregg and I went at the tax 
reform issue week after week for 2 years in order to get where 
we were, essentially a modernized version of 1986, and my guess 
is we could have probably spent another 5 years working through 
the territorial and the international situation.
    I think we got to where we were by asking the 1986 
question, which was how low would you have to get the business 
rate to be in order to get rid of some of what you are doing in 
terms of deferral and credits. And that is how we got to the 
corporate rate of 24 percent and junked a lot of what currently 
goes on internationally in terms of deferral and foreign 
credits.
    Transfer pricing takes this to a whole different level, and 
here is the question for you, Dr. Altshuler. In effect, the 
definition here is you can create paper transactions between 
subsidiaries of the same company to allocate expenses and 
profits to selected companies. That essentially seems to be the 
consensus view of the definition of transfer pricing.
    What we found is people like Ed Kleinbard, who was then the 
head of the Joint Tax Commission, who said, look, if all you do 
is go to the territorial system, you are going to make these 
problems of transfer pricing worse, and we are already losing 
$60 billion offshore and it is a significant problem. 
Territorial will not do anything about it.
    The question for you, Dr. Altshuler, and I appreciate the 
time the Chairman is giving me. Dr. Altshuler, do you agree 
essentially with that Kleinbard theory that pure territorial 
tax approaches as constituted today would not do anything about 
transfer pricing, could make the problem worse? And if you do, 
what would you do about it? Because that is where we bog down, 
and a lot of my colleagues clearly are interested in this. I 
want to be responsive to them. But if you agree with that 
Kleinbard theory, what would you do about it in order, again, 
to try to bring folks together like they did in 1986 and 
actually get something done?
    Ms. Altshuler. This is a tough one. Going to a territorial 
tax system does increase transfer-pricing pressures, income-
shifting pressures, but only to the extent to which the 
repatriation tax is a burden in the first place. So let me just 
be simple. Yes, income-shifting incentives will go up with the 
territorial tax system. How much they go up is an open 
question, which, again, I guess I am saying yes to you. And the 
question that I have these days is: How much worse does income 
shifting and transfer pricing get if we go territorial and 
lower the rate to 24 percent? Because the studies that I have 
been looking at and the studies that have been done in the past 
always look at territorial with the 35-percent rate. But if you 
are lowering the rate to 25 percent to the OECD average, you 
are taking some of the pressure off. Of course, there is still 
zero percent taxes out there.
    Both solutions to the international tax problem are not 
perfect. I like your solution quite a bit. I wrote a paper on 
it. It is elegant because by getting rid of deferral, you get 
rid of the transfer-pricing problem faced by--with U.S. 
multinationals. That does not mean--but there are two problems 
that we have and territorial has problems, too, but just to 
bring them up.
    What I worry about is if we were to get rid of deferral and 
what we would be doing is going in the--and I am playing a two-
handed economist here, OK? So if we were to get rid of deferral 
going in the opposite direction of other countries, yes, we get 
rid of this transfer-pricing problem with our U.S. 
multinationals. But we are still at, you know, this 24-percent 
rate. The OECD average is 25 percent. Are we going to lose 
headquarters? In other words, you are going to have foreign 
multinationals that are going to be able to enjoy our lower 
rate, OK, but not face worldwide taxation. So do we lose U.S. 
headquarters? And I do not have the answer to that question, 
but I think it is really important.
    Senator Wyden. Mr. Chairman, you have given me a lot of 
time, and I think Dr. Altshuler puts her finger on really a 
very appropriate point as we wrap up. What the whole exercise 
is about is creating incentives for this economic renaissance 
that this country wants so much at this time. And, in fact, the 
reason, if you go to a labor union meeting or a business 
meeting, that you can get applause for a 24-percent rate, is 
you are junking these incentives for taking jobs overseas in 
order to get red, white, and blue jobs here in America by the 
incentives for bringing those kinds of operations back and 
having the headquarters you are talking about.
    Mr. Chairman, thank you so much for all this time. It has 
been a great hearing.
    Chairman Conrad. Yes, I think it is very important time. 
Let me just say I used to be tax commissioner; I used to be 
chairman of the multi-State tax commission. I engaged in 
negotiations in the Reagan Administration on the question of 
these multinational jurisdictional issues. I have spent a lot 
of time in it. When I was tax commissioner, we found some 
amazing things. I will never forget. We followed transactions 
of a major grain company and found that one shipment of grain 
changed hands eight times before it left the continental United 
States before we lost track of it offshore.
    I have seen other examples, not in my tax work but in 
conjunction with the revenue service, where a company showed no 
profits in the United States, a series of transfer-pricing 
transactions showed $20 million in profits in the Cayman 
Islands where conveniently there were no taxes, with one 
employee. And I always said that one employee was the most 
efficient worker in the world to produce $20 million of 
profits, and he actually produced nothing. The only thing he 
produced was tax returns and corporate Statements showing that 
they had had periodic board meetings to meet the requirements 
of that.
    So, look, these are enormously complex subjects, but we 
have an obligation to sort through them, and I think this has 
been an especially valuable meeting. I also want to commend my 
colleague Senator Wyden. I said this in another forum. There 
are very few members who have come up with such significant 
contributions in tax reform and health care reform, operating 
with just his own individual staff, not a Committee staff, not 
a Committee chairmanship, and really sweeping, well-thought-
out, bipartisan proposals. And he deserves tremendous credit 
for that, and I am glad we pursued the questions here today.
    I thank this panel so much. I think you have been terrific 
and really thought provoking. I appreciate all of your 
participation here today.
    The Committee will stand in adjournment.
    [Whereupon, at 12:23 p.m., the Committee was adjourned.]




               CHALLENGES FOR THE U.S. ECONOMIC RECOVERY

                              ----------                              


                       THURSDAY, FEBRUARY 3, 2011

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:01 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Cardin, Whitehouse, Merkley, 
Begich, Sessions, Thune, and Portman.
    Staff present: Mary Ann Naylor, Majority Staff Director; 
and Marcus Peacock, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    I want to welcome everyone to the Senate Budget Committee 
today. Today we will focus on challenges that are facing the 
U.S. economic recovery. We are going to look specifically at 
challenges in the areas of unemployment, housing, and the State 
fiscal crises. We are really fortunate to have four outstanding 
witnesses with us today:
    Dr. Mark Zandi, Chief Economist at Moody's Analytics. Dr. 
Zandi has been very helpful to this Committee and has testified 
here several times in the past. We are grateful to have you 
back again today.
    Dr. Till von Wachter, Associate Professor of Economics at 
Columbia University, and I would just say parenthetically my 
daughter is getting a Ph.D. there. I was up there a few weeks 
ago. She was teaching a great books class. It was very 
interesting.
    Dr. Ray Scheppach, the Executive Director of the National 
Governors Association. We understand that after nearly 30 years 
he is retiring and going to go to UVA. I commend you on your 
years of public service, Ray. Always somebody that has enjoyed 
credibility on both sides of the aisle for his professionalism.
    And Mr. Chris Edwards, Director of Tax Policy Studies at 
the Cato Institute. Good to have you back as well. Thank you 
very much.
    Let me begin by providing a brief overview of my own on the 
economic challenges that we currently confront. The Federal 
response to the recession and the financial crisis successfully 
pulled the economy back from the brink. In the fourth quarter 
of 2008, the economy was showing negative growth of 6.8 
percent. Economic growth has since returned, although not as 
strongly nor as quickly as we would have liked. In the fourth 
quarter of 2010, we saw positive growth of 3.2 percent.




    Private sector job growth has also returned, although not 
as much as we would like. In January 2009, I think it is 
important for us to remember, the economy was losing more than 
800,000 private sector jobs a month. In December of 2010, the 
last month we have data for, the economy gained 113,000 private 
sector jobs. So we now have 12 consecutive months of private 
sector job growth.




    Despite this improved picture, it is clear the economy is 
growing at a much slower pace than in past recoveries. When 
measured against the nine previous recoveries over the past 60 
years, we see the current recovery lags considerably the 
typical recovery. I personally believe a key reason for that is 
the damage done to the financial sector.




    And the unemployment rate has also remained stubbornly 
high. Just a little over 3 years ago, it stood at 5 percent. It 
nearly doubled within a year's time and has fluctuated in the 
9-percent-plus range ever since. The Congressional Budget 
Office now projects the unemployment rate will fall only 
slightly to 9.2 percent in the fourth quarter of this year and 
still remain stubbornly above 8 percent in the fourth quarter 
of 2012.




    Another concern is the number of long-term unemployed, 
those unemployed for 27 weeks or longer, which is 
extraordinarily high. The average rate of long-term 
unemployment over the period from 1948 to 2007 was eight-tenths 
of 1 percent. Just prior to the recession, in December of 2007, 
the rate was very similar, at nine-tenths of 1 percent. Now the 
rate of long-term unemployed has surged to 4.2 percent. This is 
a clear sign of the persistent economic weakness experienced by 
Americans across a broad front.




    We also continue to face a crisis in the housing market, 
the sector of the economy that sparked the recession. One out 
of five mortgages remains underwater, meaning the home is worth 
less than the remaining balance on the mortgage. And in some 
markets, that number is much higher. In addition, one out of 
eight mortgages is delinquent or in foreclosure, and home 
prices have fallen 31 percent from their peak in 2006 and are 
expected to continue falling in the near term.




    We can see that new home building has fallen dramatically 
and remains low. In January of 2006, we had 2.3 million housing 
starts. In December, we had just 529,000 housing starts.
    Finally, the Nation's economic recovery also faces a 
challenge from the fiscal crises occurring at the State and 
local level. Here is a recent headline from the New York Times. 
It reads: ``Mounting Debts by States Stoke Fears of Crisis: 
Costs remain hidden; analysts who predicted mortgage meltdown 
see a similarity.''




    Since most States have balanced budget requirements, they 
are forced to close their budget gaps with layoffs and cuts in 
social services and tax increases. Such cuts have a ripple 
effect through State and local economies. This undercuts the 
recovery efforts underway nationally.
    I think it is very clear there is little appetite in 
Congress for providing further help to States, so we need to 
consider what else can be done to help States get through this 
challenging period. I hope this hearing can shed light on all 
of these issues.
    Senator Sessions is not here yet. He is delayed. So I think 
what we will do is go right to the witnesses, and we would ask 
you to limit your stated remarks to 5 minutes or thereabouts, 
and then we will have a chance to get to questions.
    Again, thank you very much for participating. This is an 
important day for the Budget Committee because we are trying to 
deal with a series of challenges that the country faces all in 
one hearing. I cannot think of a better panel of witnesses to 
do that.
    Mr. Zandi, why don't you proceed.

   STATEMENT OF MARK ZANDI, PH.D., CHIEF ECONOMIST, MOODY'S 
                           ANALYTICS

    Mr. Zandi. Thank you, Mr. Chairman, and thank you and the 
rest of the Committee for the opportunity to participate in 
today's hearing. I should say that the views I express are my 
own and not those of the Moody's corporation. And you should 
also know, because I will be speaking about the housing 
mortgage markets, that I am a Director of MGIC, the largest 
private mortgage insurer in the country.
    I will make three points in my remarks.
    Point No. 1 is that I am optimistic with regard to the 
economy's prospects; that after 3 very lean economic years, a 
year and a half of recession, a year and a half of weak 
economic recovery, I think we will experience much stronger 
growth this year and in 2012.
    Just to give you a sense of what that means, in terms of 
GDP, the value of all the things that we produce, that fell 2.6 
percent in 2009, obviously a very bad year; grew 3 percent, 
almost 3 percent in 2010. I expect GDP growth to be near 4 
percent this year, and roughly the same in 2012.
    In terms of jobs, we created 1.35 million private sector 
jobs in 2010, December to December. I expect double that in 
2011 and roughly the same in 2012. And I agree with the CBO's 
projections on unemployment. The unemployment rate should end 
this year closer to 9 percent and closer to 8 percent by 2012--
still, obviously, a pretty deep hole. It will be a number of 
years before we get back to anything anyone considers to be 
good, but we are making our way in the right direction.
    There are a number of reasons for this optimism. I will 
just mention two quickly.
    First is businesses are very profitable. Big companies, 
mid-sized companies in particular, their balance sheets are 
very strong. I do not think it is any longer a question of can 
they invest and hire more aggressively. I think it is just a 
question of willingness. And I think they are going to become 
more willing. Sentiment is improving quite rapidly, and I 
expect conditions to improve.
    The other key reason for the optimism is policy. I think 
the policy response by the Federal Reserve, by you and Congress 
and the administration has been excellent and has made all the 
difference; that without your policy response, the downturn 
would have been measurably worse, the cost to taxpayers 
measurably greater. I think you did the right thing. We can 
take exception with any individual aspect of the response, but 
the totality was, I think, quite impressive.
    Point No. 2 is, despite my optimism, obviously there are 
challenges and risks, and I clearly could be wrong, and we are 
going to talk about a few of those today. State and local 
governments obviously face very serious challenges. The 
European debt situation remains very unsettled. Policymakers 
there need to do more, and until they do, obviously that is a 
concern.
    The events in Egypt and the Middle East remind us of the 
risks posed by higher oil and other energy prices, and that is 
worthy of concern.
    But at the top of my list of concerns, at least for the 
near term, the next 6 to 12 months, is the ongoing problems in 
the housing market, the foreclosure crisis, and let me just 
turn to a few slides to make the point clearer.
    The foreclosure crisis continues on. You can see here the 
number of first mortgage loans that are in default, somewhere 
in the foreclosure process, or headed in that direction. They 
are seriously delinquent and likely to go into default. That is 
close to 4 million loans. For context, there are roughly 50 
million homeowners with first mortgage loans, so 4 million is a 
lot of loans.
    You will note that the good news here, if there is any good 
news, is that the problems appear to have peaked. But the 
concern is, at least in the near term, that there are many, 
many loans now coming to the end of the foreclosure process. 
REO, which is the last stage in foreclosure before a distressed 
sale, is building again, and you can see that here. This shows 
the number of properties in REO, and I have broken that down 
for you----
    Chairman Conrad. What does REO stand for?
    Mr. Zandi. Other real estate owned. So it is when the 
lending institution takes back title from the homeowner. That 
is now in their inventory, and that is the last point before 
they actually sell it into the marketplace as a foreclosure 
sale. And you can see it is building. And this is very 
important because these distressed sales will put further 
downward pressure on housing values.
    Chairman Conrad. Can I stop you on this point? Let me just 
say we are going to run this hearing a little differently than 
we typically do. If you are wondering why I am the only one 
here, the Prayer Breakfast is this morning, and the Prayer 
Breakfast is running long because of events, as you know. Our 
colleague Gabby, her husband is giving the final prayer. The 
President is at the Prayer Breakfast. We were informed that it 
would be concluded by this time. That is why we scheduled the 
hearing for this time. But because of the unusual 
circumstances, the Prayer Breakfast is running quite long. So I 
apologize to you that we do not have the typical turnout we 
would, but people will be here.
    Let me just say this to you: I have been watching the 
question of short sales, and it is very clear that short sales 
where the property is underwater--they owe more than the 
property is worth--requires a two-level negotiation. First you 
negotiate with the homeowner, and then it goes to the bank for 
approval. And I am being told by people in the real estate 
industry that the gap in time is losing a lot of sales; that 
is, that the inability to turn around the decision at the 
lending institution leads a lot of people to just get 
frustrated. They need a house. They bail out. They go in 
another direction.
    Is that an accurate assessment of part of the problem here? 
And is there anything that could be done about short sales?
    Mr. Zandi. Yes, that has been a problem, in part because 
the lending institutions, the banks, are very nervous of being 
defrauded, and they need to make sure that the short sale is an 
arm's-length transaction.
    Moreover, many institutions really did not have the 
infrastructure necessary to engage in a significant number of 
short sales. They had not done many in the past, and to ramp up 
has been difficult. It is not an easy thing to do, to do well.
    My sense is that the impediments to short sales are 
abating, that we are seeing more short sales. I will just give 
you a sense of the magnitude, and these are rough orders of 
magnitude.
    If you go back to, say, 2007, 2008, in the start of the 
crisis, we were getting 25,000 to 50,000 in short sales per 
annum. We are now running probably closer to 250,000, 300,000 
per annum--which is still small in the context of all the 
problems that we have, but it is moving in the right direction. 
And some of the major institutions have established within 
their organizations groups that are focused solely on the 
short-sale process.
    Also, the administration, in its HAMP efforts to facilitate 
loan modifications and short sales, has provided incentives to 
all the various parties involved--homeowners, mortgage 
servicers, mortgage owners--to engage in more short sales. This 
is much preferable to everyone involved than going down the 
road to a foreclosure sale. That has not been nearly as 
successful as HOPE IV, but it is helping, I would say. So I 
think we are moving in the right direction.
    With regard to what else can be done in this regard, I 
think the best thing that can be done is vigilant oversight. So 
I would continue to ask very strong questions of the lending 
institutions: Where are we? Where were you? Where do you think 
you are going to be? What are you doing to facilitate this? 
Just to make sure that, you know, they understand that everyone 
is watching this very, very carefully.
    I think all the tools are in place, the policy tools are in 
place to make this work better. I just think it needs a little 
bit of oversight push to make sure that it works in a 
reasonably orderly way.
    Chairman Conrad. OK.
    Mr. Zandi. So as you can see, the REO inventory is--would 
you like me to proceed with----
    Chairman Conrad. Yes.
    Mr. Zandi. OK. So the REO inventory is rising. There has 
been, I would say, a reasonable effort to try to forestall 
foreclosures and short sales through loan modification efforts. 
But I would say I think it is now widely understood, and I 
think appropriately so, that the modification efforts have been 
inadequate or they have certainly not lived up to anyone's 
expectations. And you can kind of get a sense of the 
modification efforts here. They have improved. If you go back 
to 2007 at the start of the foreclosure crisis, we had 250,000 
in loan mods, private sector loan mods. That has ramped up. We 
are now seeing loan mods of somewhere between a million and a 
half and 2 million per annum, which is helpful but, you know, 
in the context of all of the problems we have, it is still 
quite small.
    My own view here, though, is I do not know that 
policymakers should do anything else with regard to the HAMP 
program, which is a major effort of policymakers to facilitate 
loan mods. One of the problems has been that the HAMP plan has 
been changing so much; it has been very difficult for servicers 
and lenders to get their arms around it and to implement it. I 
think we have it where it needs to be. We just need to let them 
use it as best they can. And, again, vigilance here would be, I 
think, very therapeutic to make sure that they are remaining 
engaged.
    But, nonetheless, having said that, the mods are not going 
to solve our problem. We are going to see a lot of loans go 
through the foreclosure process to a foreclosure or short sale, 
and I would anticipate more house price declines. You can see 
that here. This shows house price growth per annum.
    Chairman Conrad. Somehow we are not getting it on the 
screen here. We have a little technical issue here.
    Mr. Zandi. OK. Well, I will just describe it.
    House prices, as you pointed out in your slides, are down 
from the peak just over 30 percent. I would anticipate this 
year another 5-percent decline in national housing values. If 
that is all it is, I think, you know, we are going to be OK, 
and my script for the economy will roughly hold. But this is 
where the risk lies, a significant risk, and that is, we have 
14 million homeowners underwater. If house prices decline 
more----
    Chairman Conrad. 14 million underwater.
    Mr. Zandi. 14 million homeowners underwater.
    Chairman Conrad. They owe more than the house is worth.
    Mr. Zandi. Yes. The value of their home is less than the 
mortgage debt they owe on that home.
    Just to flesh that out a little bit more for you, of the 14 
million, 4 million are--and these are my estimates, and they 
are approximations. Four million are underwater by more than 50 
percent. That is deeply underwater, and obviously that is the 
fodder for default.
    You know, in many cases these homeowners want to hold onto 
their home, but suppose you spring a leak in your roof and you 
are told you have to put $3,000, $4,000 in your home. I mean, 
does that make any sense to anybody for them to do that? Or 
your air-conditioning unit breaks, you know, and it is another 
$2,000, $3,000.
    So with house prices falling more people will be 
underwater. That is fodder for more default. You get more 
default, that puts more foreclosure short sales, more downward 
pressure on prices, and you can construct a scenario where you 
get into a very vicious cycle--the very same vicious cycle we 
were in back in 2008 and early 2009 before the policy response. 
In this go-round, it is not clear how you would respond to 
that. I do not think this is the most likely scenario, but 
certainly it is a very significant threat and risk, a challenge 
to the economic recovery.
    So point No. 2 is that at the top of the list of concerns 
is the ongoing foreclosure crisis. I do not think the coast is 
clear.
    So this goes to point No. 3, and that is, well, what can 
policymakers do to try to mitigate this potential threat, this 
potential risk. We talked a little bit about some policy, but 
let me mention a few things. In fact, I will focus on--am I 
taking too much time?
    Chairman Conrad. No.
    Mr. Zandi. OK. So I would focus on three things.
    First is I think there are things that can be done to 
facilitate the loan modification/foreclosure process, and let 
me mention a few aspects of what I mean there.
    First, I think it would be very important if mortgage 
servicing companies appoint one person as a point of contact 
for the homeowner. So right now, if you are a distressed 
homeowner and you call a mortgage bank, each time you call, you 
get someone else. They have no idea who you are. It is just a 
nightmare and very frustrating for everybody involved. You get 
documents lost. The loan officer says, ``Send me this 
information, this information, and this information.'' You send 
it in. You hear nothing. You call back. You get a different 
person, and they do not know what you are talking about. They 
say, ``Oh, you sent it to the wrong department. You should have 
done this. Send it here.'' And so the process is very elongated 
and very cumbersome, and I think it would be prudent for--and 
this is a regulatory, I think, point of contact to require 
servicers to have one person in charge of each loan file.
    Another aspect of this is there is so-called dual tracking 
that creates a great deal of confusion in the foreclosure 
process. That is, when you are a distressed homeowner, you are 
considered for a loan mod, but you are also put in the 
foreclosure process at the same time. They are both occurring 
at the same time. So you could be talking to one person in the 
institution about your modification. Then you get a notice in 
the mail saying, you know, ``You are in default, and we are 
going to take you to court.'' So this becomes incredibly nerve-
wracking, frustrating, everyone is very upset by this.
    I would suggest, another regulatory point of contact, to 
end the dual tracking. You go through loan modification. If you 
do not make it through loan modification, you cannot get 
through these programs. Then you go through the foreclosure 
process, and that gives everyone enough time to sort of get 
their minds around what is happening, get all the loan 
documents in place, and really make a good decision here.
    The other thing I would suggest is third-party review. Some 
States--Connecticut, I believe New York, New Jersey, Florida--
are now asking mortgage companies to work with a third party, 
and this third party would help the homeowner to go through the 
process: makes sure that the homeowner knows all of their 
rights, knows all of the options open to them, helps them get 
all their loan information together, and shepherds them through 
the process. They are an advocate for the homeowner. This is an 
incredibly complex, difficult, messy thing. Most homeowners 
really do not have the skill sets to do it well, and I think 
they should be given resources to do that. It would not be very 
costly, and I think it would make the entire process more 
efficient, and we would get better results.
    Finally, Sheila Bair, Chairwoman of the FDIC, has made a 
very good proposal that I would advocate, and that is, 
establishing a fund financed by the mortgage servicers that 
would compensate homeowners that are shown to be wronged in the 
foreclosure process. As we know, there is a range of problems, 
affidavit signing issues and other related issues. I think this 
would be a way to light a fire under the industry and say, you 
know, if it is shown to be that you messed up here, then you 
have to compensate these individuals for the screw-up.
    So these are foreclosure modification process changes that 
can be, I think, tweaked in the regulatory process that would 
make this a much better process.
    I will mention one other thing because I am taking a lot of 
time. One other policy response which would be helpful in the 
next 6 to 12 months is to try to facilitate mortgage 
refinancing activities. As you know, fixed mortgage rates are 
very low. They are below 5 percent for the prime borrower. Part 
of this reason is because the Federal Reserve is engaged in 
quantitative easing and keeping--the whole intent of 
quantitative easing is to keep long-term rates, particularly 
fixed mortgage rates, down. And one of the key conduits through 
which low rates help the economy is through refinancing, 
mortgage refinancing.
    The level of refinancing is incredibly low. One of the 
reasons for this is that for borrowers with poorer credit 
scores and who are underwater, they do not get that interest 
rate. They get a much higher interest rate. Fannie Mae and 
Freddie Mac, for example, charge much higher rates for people 
with lower credit scores and higher LTVs, even if they own the 
loan. Even if they own it in their portfolio or they insure it, 
they own the credit risk. But they are still charging these 
higher rates, which is forestalling refinancing activity. So I 
would suggest that there is a requirement on Fannie and Freddie 
not to charge those higher rates to facilitate more refinancing 
activity. And it will cost Fannie Mae and Freddie Mac in 
interest income, but it will benefit them in the form of fewer 
foreclosures, because these homeowners are going to have lower 
monthly mortgages payments and be less likely to go into 
default. And they own the loan. I am not suggesting this for 
anyone but Fannie Mae and Freddie Mac. So net-net it is not 
clear to me that they would lose money, right? And this would 
facilitate more refinancing now when mortgage rates are still 
low before they start to rise. And they will definitely rise by 
the end of the year. And this will put money in their pocket to 
distressed homeowners, like a tax cut, and it costs the 
Government nothing. And I think this is a very efficacious way 
to help very, very quickly.
    So there are other things, but I will stop there.
    [The prepared statement of Mr. Zandi follows:]



    Chairman Conrad. Well, this has been very useful. You have 
given us a lot of good ideas in a very short period of time.
    Senator Sessions is now here. I was explaining the National 
Prayer Breakfast was this morning, and that was running long.
    Senator Sessions. Yes.
    Chairman Conrad. Would you want to make your statement at 
this point, or would you prefer that we continue with 
witnesses? What is your preference?

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. I will just briefly say thank you for the 
hearing. I thank the witnesses for being here. We did have a 
good breakfast this morning. The President spoke eloquently, as 
he usually does. And I guess I have given him a hard time 
lately about not leading on the budget, and I think that was a 
valid criticism, but we all have some challenges. We have to be 
honest about it and see how we can work our way through this 
deficit cycle, and I appreciate the insights each of you bring 
to the key issues that face us.
    Mr. Chairman, we have had a lot of hearings this week. This 
is the third one this week. I believe you are correct to push 
us because these are critical issues facing the country. We do 
not have time to put off decisionmaking, and it is well that we 
are moving forward, and I support your strong leadership.
    Chairman Conrad. I thank you so much, Senator Sessions. I 
appreciate you being a partner in this effort to really get 
serious about our deficit and debt.
    This morning, we really are focusing on these special 
areas: State debt, housing crunch, long-term unemployment, 
these special challenges to the economy and what could be done.
    We will now go to Dr. von Wachter for your testimony. Dr. 
von Wachter, Associate Professor of Economics at Columbia.

 STATEMENT OF TILL VON WACHTER, PH.D., ASSOCIATE PROFESSOR OF 
                 ECONOMICS, COLUMBIA UNIVERSITY

    Mr. von Wachter. Chairman Conrad, Ranking Member Sessions, 
it is a great honor to be with you today. I am going to read my 
testimony, but feel free to ask any questions at any moment in 
time.
    Unless we see an unprecedented job growth in the near 
future, our best available estimates, as we have seen earlier, 
suggest the process of reintegrating the large number of 
unemployed into employment is going to be very long lasting and 
gradual. During this process, many individuals are at risk of 
permanently leaving the labor force. Those most likely to drop 
out are older, partially disabled, and less educated workers. 
This development is potentially costly for society, since these 
workers, while able to work, do not pay taxes, are more likely 
to draw Social Security benefits early, or enter costly 
programs, such as Federal disability insurance.
    Moreover, in the process of searching for jobs, many 
workers are likely to exhaust unemployment insurance benefits. 
It is well known that upon exhaustion of unemployment insurance 
benefits, families' consumption falls and the incidence of 
poverty rises. Moreover, only a very limited fraction of 
individuals exhausting UI actually find a job.
    Upon finding a job, for those who do, experience from 
previous large recessions has suggested earnings of laid-off 
workers are substantially lower. For example, the average 
mature worker losing a stable job with a good employer in the 
last big recession saw earnings reduction of 20 percent lasting 
15 to 20 years. So there seems to be a permanent decline in 
earnings of job losers.
    And during this period of earnings decline, job losers can 
also experience a decline in health. So in severe downturns in 
the past, these health declines have led to significant 
reductions in life expectancy of one to 1.5 years.
    The effects of unemployment and job loss are also felt by 
workers' children, who can suffer from the consequences even as 
adults and by their families. Similarly, evidence from past 
recessions suggests that entering the labor force in a large 
recession such as this one can lead to reduced earnings for 
young workers for ten to 15 years.
    Now, the rest of my comments will focus on government 
policies that I think can reduce the impact of extended 
joblessness on both affected individuals and possibly on 
government finances. So my recommendations fall into the 
following four areas.
    My first recommendation, and this is not news, to extend 
unemployment insurance benefits for those who are about to 
exhaust. On the one hand, extensions of unemployment insurance 
benefits prevent large declines in consumption for the 
substantial number of workers who are at risk of exhausting 
benefits. On the other hand, research implies that the negative 
effects of extending unemployment insurance benefits on 
employment are not that large in a large recession such as this 
one. So on balance, if you count the benefits for those workers 
who are about to exhaust benefits and the cost to society for 
lower unemployment, the net suggests that extending UI benefits 
in recessions are likely to outweigh the costs.
    Extension----
    Senator Sessions. Extensions are raising benefits. The 
phrase ``unemployment benefits''----
    Mr. von Wachter. Say that again?
    Senator Sessions. Your written remarks said that raising 
unemployment insurance. Does that mean raising the amount 
received or extending the time that they are received?
    Mr. von Wachter. Thank you, Senator Sessions, for 
clarifying. I mean extending the time, not the amount of 
benefits. So my research is focused on the typical policy, 
which is extensions and the durations, and what this means is 
that you target those workers who are really at the risk of 
going to zero after exhausting, not the workers who have 
already benefits and then would consume more.
    Now, one added advantage of extending the duration of 
benefits is that it can prevent some of those individuals who 
are at risk of permanently leaving the labor force from doing 
so and possibly apply for disability insurance or claim Social 
Security benefits. Now, these possible cost savings should be 
incorporated into the calculations of the overall costs of UI 
extensions, and the available approximations we have suggests 
that cost savings from UI extensions through these channels 
could be substantial. However, although the exact 
quantifications of these mechanisms is in principle possible 
using available data, this data is currently not available to 
researchers. So we cannot really exactly say, tell you how much 
we would save in terms of Social Security benefits or 
disability payments by extending UI, but we could.
    My second policy recommendation is the need to prepare an 
exit strategy for unemployment insurance recipients once the 
labor market shows signs of recovery, and there are several 
policies that have been evaluated within the current UI system 
that seem to be cost effective. These policies would make sure 
that once the labor market improves, both the unemployed would 
benefit and also the finances of the unemployment insurance 
system would benefit.
    One of these mechanisms is job search assistance, and job 
search assistance has been widely shown to be very cost 
effective and efficient in getting workers back to employment, 
and this is very helpful because searching for a job in 
environments such as this one is very time consuming and also 
frustrating and uncertain, because many individuals do not know 
where the economy is leading. Now, we all do not know where the 
economy is leading, but there is a lot of potential information 
that can be provided to workers in this long and time consuming 
process, starting with that it is a long and time consuming 
process. If workers want to go back to work at the level that 
is not too low in terms of earnings, they really have to do a 
lot of work and stay in the game of searching for five to 10 
years.
    Now, research has also suggested that the current 
infrastructures of one-stop shopping or career centers could be 
improved and extended. So we have a system in place that could 
provide services to workers, but it could do a better job, and 
we can talk about what fixes have been proposed.
    Another typical suggestion is that workers could be 
trained, and not all training programs work as well as others, 
and so finding out which training programs really work and then 
advising workers what training programs to take is a really 
important step. And again, I think the data is there to 
evaluate these training programs, but not all of it is 
available to researchers.
    For some workers, a long period of time may elapse before 
finding a job, and especially for those workers on unemployment 
insurance, providing them with bonuses to find jobs might 
actually be cost saving from the point of view of the 
unemployment insurance system. Workers may have lost touch with 
the labor market, lost touch with what they can expect in the 
new labor market, may search for too long, and providing them 
incentives to take the job earlier may be cost savings. And if 
these incentives are targeted to the workers who are most 
likely to exhaust benefits, they have been shown to be cost 
effective.
    Now, although these mechanisms to help workers to find a 
job help raise employment, at least that is what our past 
experiences say, none of these mechanisms have been shown to 
actually help reduce the earnings loss of job losers, meaning 
even once workers find a job, partly because of these programs, 
because of the economy recovery, their earnings will be lower 
for a very long time.
    And so a recommendation I have made before--that is my 
third recommendation--it is worth considering trying to reduce 
the massive amount of layoffs that we have seen in this 
recession in the future, and there is a program in place to do 
that that is called work sharing, and 17 States have work 
sharing, but it is currently underutilized. It is partly 
underutilized because it is not a very generous system, partly 
because it is not well known. And more research into how we 
could prevent such costly layoffs in the future is very useful.
    My fourth recommendation concerns assistance for those who 
are unlucky enough to be looking for a job for the first time 
in this recession. One way to help those workers who are bound 
for college is to provide financial aid. Financial aid can be 
an important buffer against labor market shocks that affect 
parental income or students' own ability to work while in 
school. But it turns out that not all eligible students apply 
for the aid that they could have, and current research suggests 
that reducing the complexity of financial aid and informing or 
even assisting students with applications will probably raise 
the take-up of financial aid and raise college attendance.
    And another concern which I only touch on briefly is that 
many resources available for low-income college students are 
provided at the State level. This is subsidized community 
college or merit scholarships. And these resources are at risk 
as State budgets are being cut, and so it is worth considering 
how one could maintain these resources for young college 
graduates at the risk of dropping out.
    Let me just conclude. Something could also be done for 
those young individuals not bound for college. In particular, 
recent research has shown that sectoral training programs--
these are relatively small programs in which the program 
cooperates with an employer to find out what type of training 
is needed--these programs have been evaluated in randomized 
studies and have been shown to be very effective in placing 
young workers into jobs.
    An alternative, of course, is to encourage the use of 
financial aid, such as Pell Grants, to send individuals to 
private institutions, private vocational schools, and that has 
been a tremendous growth area in the past. But again, we know 
very little how these private colleges and private vocational 
programs really affect workers' earnings outcomes later. And so 
mandating scientific evaluations of the returns of private 
schools receiving Federal funding through financial aid would 
be a useful policy.
    To conclude, job loss and unemployment during severe 
recessions, such as this one, can impose substantial and long-
lasting costs on affected workers, their families, in terms of 
earnings, health, and other outcomes. This testimony has 
focused on potentially cost effective ways to alleviate the 
burden for these workers. It is also recommending making data 
and information available to allow researchers to give a better 
assessment of the full costs and benefits of these programs. 
Thank you.
    [The prepared statement of Mr. von Wachter follows:]



    
    Chairman Conrad. Thank you. We appreciate very much your 
testimony. I think you have given us some interesting ideas 
that we can hopefully pursue as we go through the budget 
process this year.
    Next, we are going to turn to Dr. Ray Scheppach, Executive 
Director of the National Governors Association. One of the 
things that has come before the attention of this committee and 
other committees is the fiscal crisis at the State level, There 
is probably nobody better positioned to help the committee 
understand the dimensions of that challenge than Ray. Welcome. 
It is good to have you here, and please proceed.

STATEMENT OF RAYMOND C. SCHEPPACH, EXECUTIVE DIRECTOR, NATIONAL 
                     GOVERNORS ASSOCIATION

    Mr. Scheppach. Thank you, Mr. Chairman and Senator 
Sessions. I am pleased to be here on behalf of the nation's 
Governors.
    Let me say first, if you drop back and look at the long-run 
growth of State revenues, really over the last 30 years, 1978 
to 2008, it grew about 6.5 percent per year, relatively robust. 
There was only 1 year during that period, 1983, when revenues 
were negative, and it was only negative by about less than 1 
percent.
    If you look now about what happened during this so- called 
great recession, we had five quarters in a row of negative 
revenues and the numbers went from 4 percent, to 12.2 percent, 
to 16.8 percent, to 11.5, and then 4 percent again, so huge 
declines in revenues over that five quarters.
    There is some good news. Really, we have now had positive 
revenue growth over the last four quarters. The first three of 
those, it was about 3 percent. But just yesterday in a 
preliminary way, it seems to be that revenues for the fourth 
quarter of 2008 were up 6.9 percent. Now, that is based on 
about 41 or 42 States, so it can be modified, but it is an 
encouraging number. I will say, however, in spite of that, we 
have to remember that revenues in 2010 versus 2008 are down 
about 9 percent.
    States reacted to this by cutting spending by $75 billion 
and raising taxes and fees by about $33 billion, so close to 
well over a $100 billion swing. Those cuts would have been much 
more draconian if the recovery package had not provided States 
with an additional about $103 billion in Medicaid and about $48 
billion in education money, and then there was an additional 
$10 billion that went through States to locals.
    In spite of that money, however, the States are still 
looking at a shortfall over the next two-and-a-half years or so 
of about $175 billion, and that includes the so-called cliff 
when the Federal Medicaid money goes away at the end of State 
fiscal year 2011.
    When I look at this impact, this great recession was so 
deep and so broad that, unfortunately, it is going to send 
implications through State government for almost the rest of 
this decade. I think of it really in terms of three stages.
    The first is we know from the previous downturns the 
biggest impact on States is one, two, and sometimes 3 years 
after the recession has been declared over, and that is largely 
because that is when you lose the maximum amount of income tax 
revenues and that is when you see the explosion of Medicaid. I 
think we are still in the end of that stage.
    The second stage, however, is going to be the so-called 
jobless recovery. We do not expect States to come back to the 
2008 revenue level until 2013 or 2014, and in some cases 2015. 
That means, Mr. Chairman, literally five to 6 years of zero 
revenue growth relative to a baseline where we were getting 6.5 
percent per year. So that is virtually over that period, like 
at the end of it, a 30 percent swing.
    The third stage is that at some point, they have to go back 
and take care of some of the unmet needs that they did not fund 
during the downturn. So that goes all the way from maintenance, 
rebuilding rainy day funds. I think the big one, of course, is 
the pension thing because States did not pay into the pension.
    States have always had what I would call long-run 
structural problems, largely because they have antiquated tax 
systems on one hand, and you have had Medicaid, which is about 
22 percent of State budgets growing at nine or ten or 11 
percent. Unfortunately, what has happened with the great 
recession is that that long-run structural problem is a lot 
worse now. I would probably argue that the revenue path going 
forward over the long run is not going to be 6.5 percent. I 
suspect we may see slower economic growth.
    But the revenues that are being lost in the sales tax now, 
which is about 40 percent of State taxes, is quite significant 
because we do not tax services, we do not tax downloads from 
the Internet, we do not tax goods sold over the Internet. In 
other words, if it is a new economy good and growing, we do not 
tax it. If it is an old economy good and contracting, the odds 
are we tax it. The erosion of this tax base over time now, I 
think, is getting to be a particularly big problem.
    Medicaid is the 400-pound gorilla. It continues to be that. 
If you just look at the actuaries from HHS estimates, they say 
that the rolls will increase by 11.6 million people in 2014 and 
almost 20 million people by 2019. And the numbers that they 
have are essentially between 2010 and 2014, States will have to 
pay an additional $90 billion, and between 2014 and 2019, an 
additional $100 billion. So you are looking at States' growth 
over the next 10 years of virtually $190 billion.
    Now, you might ask, why is that so big? There are three 
things coming together at the same time. No. 1, because of the 
recession, the case loads are higher and therefore you start 
with an increase with that. The second problem is, of course, 
that the enhanced Federal match goes away at the end of fiscal 
year 2011. And then you have the impact of health care reform.
    So when you add those three impacts together, they make a 
huge change. I would have to say, as we get on the telephone 
with State budget directors every other week, what they will 
tell you is we do not know how to get from here to there, 
largely on the Medicaid issue.
    On the unfunded pension liabilities, the numbers here are 
always a little bit suspect depending on the discount rate 
assumption and so on. But clearly, as of the year 2000, I would 
argue States and municipalities were in pretty good shape. It 
began to deteriorate. I think we probably have an unfunded 
liability of about 23 percent of obligations now, so it is 
significant. On the other side----
    Chairman Conrad. Can I stop you on that point?
    Mr. Scheppach. Sure.
    Chairman Conrad. Can you repeat--I want to make sure I 
understood this last point, the 23 percent.
    Mr. Scheppach. Well, that is sort of the unfunded portion 
of it. So if you are assuming that whatever that commitment is, 
and the numbers change a little bit depending. If it is a 
trillion dollars, then you are down $230 billion in terms of 
the unfunded portion of it. But the pension contributions are 
generally less than 4 percent of State budgets.
    Chairman Conrad. What is the--can you help us understand, 
because this became a source of discussion in a previous 
hearing when we had Chairman Bernanke before the committee. It 
seems to be concentrated in a relatively small number of 
States. Is that your understanding? That is, a disproportionate 
share of the unfunded liability is in a relatively small number 
of States.
    Mr. Scheppach. Yes. It is not four or five, but it is eight 
or ten, I would say, yes.
    Chairman Conrad. Eight or ten States that are really in----
    Mr. Scheppach. Right. And some of those are--I mean, 
Connecticut is one, for example, Hawaii, or smaller States. But 
then there is also the New Jerseys, the Illinois, and so on. As 
I remember, actually, California is better on this issue than 
in a lot of others.
    Chairman Conrad. My recollection was Illinois was in the 
most serious shape.
    Mr. Scheppach. Correct. I think that is right.
    Senator Sessions. This shortfall, some of that is tied to 
the stock market?
    Mr. Scheppach. That is correct. There are two things-----
    Senator Sessions. The market being down, so it is not 23 
percent if the market were to continue to go up?
    Mr. Scheppach. That is exactly right.
    Senator Sessions. So it is hard to exactly estimate, but it 
is dangerous. The numbers are so high that it should raise red 
flags, that number.
    Mr. Scheppach. No, you are right. It is the return in the 
markets, in bonds, and then it is States did not pay in during 
this crisis. It is a twofold issue.
    But as I said, it is probably less than 4 percent of State 
budgets. And I will say that we tend to track what is going on 
in States here and you will find that 30 States have made 
changes in pensions over the last 5 years and we have 20 States 
that have made pension changes this year. So they are really 
beginning to face up to it. What is happening is that they are 
forcing current employees to pay in more. They are making 
adjustments on COLAs. They are extending the number of years. 
So there is a lot of activity in this particular area right 
now.
    Chairman Conrad. Ray, could we stop you on the point, 
because Senator Sessions and I were wondering, how could States 
fail to pay into their pension plans during this period? What 
legally allowed them not to pay in?
    Mr. Scheppach. Well, it differs by State, but some States 
just do not have requirements on it. In fact, I think some 
actually borrowed from the fund. So you will find them 
sometimes borrowing from different trust funds when times, you 
know, highway trust funds or such.
    Chairman Conrad. We know a lot about that here.
    [Laughter.]
    Mr. Scheppach. I did not want to say that.
    [Laughter.]
    Mr. Scheppach. So in terms of what else is going on, I do 
think, as I said, the shortfall is about $175 billion, and----
    Chairman Conrad. And what period is that over?
    Mr. Scheppach. It is really over the next two-and-a-half 
fiscal years. But I do see a commitment among Governors that 
they--you know, initially, I think, there was a feeling that 
they needed to cut, furlough, consolidate, and eventually the 
economy would come back and sort of save them. I do not think 
anybody believes that now. I mean, I think the feeling is among 
Governors that they have to continue to do this to make the 
long-run sustainability.
    In fact, we do not really believe we can cut our way out. 
We think we have to really redesign State government in terms 
of how it delivers services. So--but I think this group of 
Governors are moving on it and I think that I am fairly 
optimistic that they will work through this problem, including 
the pension problem.
    In terms of things that you can do, I would say the first 
thing is please do no harm. As you begin to cut budgets, please 
do not cap the Federal share of Medicaid and shift it to 
States. I would encourage you to look for things, and there are 
a number of them where we could both save money, both the 
Federal Government and States, and so please do not do any 
harm.
    And then the other areas are more around flexibilities on 
programs. Maintenance of efforts are causing big problems. So 
to the extent waivers in certain areas, all would be very 
helpful.
    I will reiterate that the Governors are not requesting any 
additional assistance, financial. They are appreciative of what 
has happened. But they feel that they need to work their way 
through it and make these programs sustainable.
    The only final comment, again, is that all roads lead back 
to Medicaid. This is a serious problem. I think that it has to 
be dealt with, where the Feds and the States sit down and try 
to make this program much more efficient. Plus, I am not sure 
States can continue to pay for the long-term care of the dual 
eligible portion of it as the demographics changes. There is 
just not the tax base going forward to support it.
    With that, thank you very much, Mr. Chairman.
    [The prepared statement of Mr. Scheppach follows:]



    
    Chairman Conrad. Thank you very much.
    Mr. Edwards, thank you for your patience and thank you for 
being here. Dr. Edwards--I am not sure it is Doctor, is it?
    Mr. Edwards. I am not a doctor.
    Chairman Conrad. But, you know, you have that credibility. 
You seem like a doctor.
    Mr. Edwards. I appreciate that very much.
    [Laughter.]
    Chairman Conrad. Chris Edwards, Directors of Tax Policies 
at the Cato Institute. Welcome back.

  STATEMENT OF CHRIS EDWARDS, DIRECTOR OF TAX POLICY STUDIES, 
                         CATO INSTITUTE

    Mr. Edwards. Thank you very much, Chairman Conrad and 
Senator Sessions, for having me here today. I am going to talk 
a little bit about challenges for Federal spending and then a 
little bit about challenges for State budgets. federally, we 
have seen an extraordinary increase in spending over the last 
decade, from 18 percent under President Clinton's last budget 
to 25 percent today. I believe the spending explosion really is 
sucking the life out of the private sector economy, and the 
real problem I see is that the United States is no longer 
really a small government country. In my testimony, I have OECD 
data showing that total Federal, State, local spending in the 
United States is now 42 percent. We used to be about 10 
percentage points smaller than the average OECD country in 
terms of spending. Over the last decade, that gap has closed to 
just 5 percent.
    So I think, historically, our uniquely high living 
standards in this country were built partly on our relatively 
smaller governments and I think we are really risking becoming 
sort of just another stagnant welfare state in the years ahead, 
which I think is mainly going to result in less opportunities 
and higher tax burdens for young people.
    So we need to cut spending. Obama's fiscal commission, of 
course, had lots of great spending cut ideas. I know, Chairman, 
you have been a real supporter of that report, as I am. I put 
together all kinds of spending cut ideas at Cato's website, 
downsizinggovernment.org. And here is the thing that really 
strikes me, is that other countries have cut spending when they 
haveten into crisis. We see cuts in the U.K. right now.
    And I think Canadian reforms in the mid-1990s are a real 
model that we can look at. In the mid-1990s, Canadian 
government spending was up to 53 percent of GDP. Their debt was 
exploding. Then their liberal government really changed course 
and they chopped spending from their Federal budget 10 percent 
in 2 years, which would be like us chopping $370 billion in 
just 2 years. Then they held spending flat for a number of 
years after that. The result was dramatic. The Canadian 
economy----
    Chairman Conrad. What years----
    Mr. Edwards. Yes?
    Chairman Conrad. And I apologize for stopping you, but----
    Mr. Edwards. No, that is fine.
    Chairman Conrad [continuing]. This is very interesting to 
us. We were talking about this actually in the committee 
yesterday. Canada, with respect to a VAT, because they imposed 
a VAT at 7 percent, actually have reduced it to 5 percent----
    Mr. Edwards. Right.
    Chairman Conrad [continuing]. And during this period, 
brought their debt as a share of GDP down from over 100 
percent, 101 percent of GDP----
    Mr. Edwards. Right.
    Chairman Conrad [continuing]. Down to 69 percent. So it was 
this combination of revenue and spending cuts, and the spending 
cuts were quite tough, were they not?
    Mr. Edwards. They were, again, 10 percent in 2 years. They 
brought the VAT in in the late 1980s under a conservative 
government. Then it was the left-of-center liberal government 
in the 1990s that dramatically cut spending, as well as they 
privatized a lot of their government corporations. This was the 
liberal party, and the liberal party did two rounds of 
corporate tax cuts. So the politics are really kind of strange 
up there. But the Canadian economy boomed for 15 years and I 
think we really need to look at what they did.
    Let me switch over to State and local budgets for a couple 
of minutes, and my views will, I think, contrast pretty sharply 
with Ray's, I think. There have been a lot of horror stories in 
the papers over the last couple of years about how States are 
in a crisis and drastically slashing their budgets, and it is 
true State general fund budgets have been cut pretty 
substantially in 2009 and 2010, although they are growing 
again. But if you look at total State and local spending in 
Bureau of Economic Analysis data, it was never cut. Total State 
and local spending, according to the BEA, rose 55 percent 
between 2000 and 2008. Then it was flat for 2009. Now it is 
growing again, 2010, 2011. So I do not----
    Chairman Conrad. Does this----
    Mr. Edwards. Yes?
    Chairman Conrad. I apologize. I just want to make sure I 
understand. You are talking now all States?
    Mr. Edwards. Yes, all States and local governments. So, you 
know, general fund budgets are only about half or so of State 
budgets. So if you look at total State budgets as well as the 
local together, it has been a lot more stable than just the 
State general fund budgets, which as you know, they have to 
balance every year.
    So I think the States can solve their short-term problems. 
The real challenge, as has already been touched on here, is 
this long-term problem with debt. State bond debt, State and 
local bond debt has doubled over the last decade, from about 
$1.2 trillion to $2.4 trillion.
    Unfunded pension liabilities, depending on what the 
accounting assumptions here, are $3 trillion or so. On top of 
that, as you probably know, there is the problem of unfunded 
retiree health plans in the States, which I think is about 
another $1.5 trillion problem on top of the pension problem.
    I agree with these comments, and this is something I think 
the media often misses. These problems vary dramatically by 
State. So if you look at bond debt, you get States like 
Massachusetts that have very high bond debt. Other States, like 
Nebraska, have virtually no bond debt. I mean, Nebraska----
    Chairman Conrad. Let us talk about North Dakota.
    Mr. Edwards. You know, I should have brought the North 
Dakota numbers. I do not know off the top of my head. Maybe you 
know, but----
    Chairman Conrad. Very low.
    Mr. Edwards. Right.
    Chairman Conrad. Very low.
    Mr. Edwards. And so a lot of States, they rely on--their 
capital budgets rely on pay-as-you-go financing more than 
issuing debt.
    Pension debt, according to figures by economist Andrew 
Biggs, vary from 11 percent of GDP, again in Nebraska, up to 49 
percent in Ohio.
    And I would say something else that is interesting is that 
State worker unionization rates vary dramatically in the States 
and this affects fiscal policy. So California, New York, two-
thirds of State and local workers are unionized. Other States, 
like Virginia and North Carolina, they do not have unionization 
in their public sectors. So this affects fiscal policy because 
I think unions can affect the flexibility of managers to cut 
costs and make needed reforms.
    So I think the upshot here is that the States have taken 
widely divergent paths, which is OK. We have a Federal system. 
I wish the poorly managed States would learn more from the 
well-managed States. But ultimately, I think, the States should 
be left to solve their own problems. I do not believe in 
Federal bailouts because I think that is unfair to the frugal 
States.
    But I must say, I also do not favor this idea that has been 
talked about in the last couple of months about a new Federal 
statute for State government bankruptcy that some conservatives 
have been pushing. I think that is interference in State local 
affairs that we do not really need. I think the States have the 
tools at their disposal to solve their own problems without 
that sort of intervention.
    So that is all my comments, and thanks again.
    [The prepared statement of Mr. Edwards follows:]



    
    Chairman Conrad. Thank you. I am going to diverge from 
typical practice because I have been asking questions as we 
have gone along here. So we will go to Senator Sessions for his 
questions, and then we will go to other members of the 
Committee, and I will withhold my questions until others have 
had a chance.
    Senator Sessions. Thank you, Mr. Chairman. It is, I 
believe, pretty much a truism of State and local and even the 
Federal Government that financial crises provide the 
opportunity for improvement of efficiency and productivity. 
While money is flowing in generously, we just add, we spend 
more, and we do not focus on the difficult task of 
productivity.
    Forgive a personal story. I was elected Attorney General, 
and my predecessor mismanaged the finances very badly. That is 
probably the only reason I could get elected. And it came out 
he was not able to pay the light bill right before the 
election. And it turned out to be a $5 million deficit on a $15 
million budget. This was 1994, and people were not happy with 
Government them like they are today. And I did not want to ask 
the legislature for more money until I had done everything I 
could.
    So we examined the office. We found that one-third of the 
people had been hired outside the merit system. It was a 200-
person offices, and I terminated 70 people and brought on seven 
new people. We closed offsites. We got rid of automobiles that 
people were driving home, lawyers were, and we reorganized 
entirely, and the office today--and that was in 1994--is well 
below 200 employees today, and I think doing at least as good, 
or better job of serving the taxpayers.
    So I just want to say that State governments are 
challenged, we are challenged. The idea that we cannot reduce 
10 or 15 or 18 percent spending on most of our agencies is not 
accurate. We will be leaner, more effective, and more 
productive if the leaders get on board and do what they should 
do instead of, as the Interior Department does, close down the 
Smithsonian when you ask them to cut their budget. So this is 
big-time stuff. So I am not timid about the challenge and 
opportunity of tight budgets.
    Mr. Scheppach, the spending on the States, it has been 
suggested, has been too often driven by matching funds from the 
Federal Government, and this has lured the State to commitments 
that now they are not able to meet, Medicaid I suppose being 
one of them. I see Governor Christie was having to make the 
choice about the tunnel, and he was attacked for turning down 
Federal money. And he said, ``Well, I do not have the money to 
build a tunnel. I do not have the money. I cannot help it if we 
are turning down money.
    In your opinion, have Federal policies seduced or encourage 
the States to undertake expenditures that they might not 
otherwise have? Is that part of the problem that we have?
    Mr. Scheppach. Yes. It is particularly acute, I think, in 
the Medicaid area. If you trace Medicaid historically, what 
happened was the Federal Government would provide options to 
States, and those States who were a little wealthier than some 
others would exercise those options. And then you would have 25 
or 30 States exercising the option, and then Congress would 
say, ``Well, if it is easy for those 35, let us make a 
mandatory.''
    And so we have been in this iterative process around 
Medicaid, and now, depending on how you measure it, you have 60 
million people in Medicaid, and you are picking up another 20 
million. So that is going to be 80 million people in Medicaid. 
And it is an engagement, and there are very few cost control 
strategies that States can utilize, and particularly around the 
long-term care and the dual eligibles.
    I mean, you would never build a system from scratch to say 
if you are in relatively good health and relatively high 
income, you are in Medicare. Now your health deteriorates and 
your income deteriorates, and you get half of your services 
from Medicaid and the other half from Medicare. It makes no 
sense. People are confused. The incentives are all wrong 
because we do not do certain things to save money because we 
end up saving money from Medicare. And you do not do things in 
Medicare that make sense because the savings come to Medicaid. 
So you have expanded this program that at its very fundamental 
basis has huge problems.
    Now, we could talk about some of the other areas, you know, 
discretionary grants. There are like 200 discretionary grants, 
from the big ones in education and highways right down to a lot 
of small ones. But it is true that at some point there are some 
of those that certain States really cannot utilize the money. 
Moving to broader block grants in areas where States had a lot 
more flexibility would increase efficiency.
    So, you know, I think you are right, but I think Medicaid 
is the biggest problem.
    Mr. Edwards. Can I make a comment on that? You know, 
another example of this is like in transit systems where the 
Federal Government has traditionally funded the capital costs, 
the new light rail systems and now new fancy high-speed rail 
systems. And the problem is that States get induced to build 
these really expensive systems, but the Federal Government does 
not fund the operating costs. So these cities and States are 
going to be left down the road with these very fancy new 
systems when bus systems would have been cheaper with, you 
know, lower operating costs, and now they are stuck with all 
this expensive infrastructure. So there are others areas where 
this is a problem.
    Senator Sessions. I would agree, and I might as well be 
frank about it. I am going to oppose the high-speed rail idea. 
We do not have the money. I do not believe it is going to be 
effective. And you cannot pour money into projects that are not 
going to prove to be effective. We do not have the money. We do 
not have the money to do things we have to do much less new 
programs even though they may appear to be popular.
    I do want to say, Dr. Scheppach, that many of the Governors 
are doing great work. If we were running the Federal Government 
like many of the Governors are running their States, we would 
be a lot better off. I know Governor Riley in Alabama faced up 
to his problems. I saw where Haley Barbour in Mississippi 
reduced spending 9 percent. I see California now, a bit late, 
but they are stepping up some real reductions, and others are. 
Governor Christie I mentioned in New Jersey. And that kind of 
leadership is what we need in Washington, and I do not think we 
have been getting it.
    Dr. Zandi--my time is up--thank you for your work, and I 
just would say I saw the Case-Shiller housing index predicts 
another bad year for housing. Are you in agreement with that?
    Mr. Zandi. Yes, I think there will be more house price 
declines, on the Case-Shiller probably another 5 percent 
nationally. That would make the peak-to-trough decline in 
housing values about 35 percent. So it will be another tough 
year for housing, yes.
    Chairman Conrad. I am going to in my questioning time want 
to come back to that question, because as I look across the 
horizon here and we look at potential threats to this economic 
recovery, housing, the State and local, the European debt 
situation, and the Middle East, I would put those four at the 
top of the list. This Committee, we cannot do much about the 
Middle East. State and local, really I think Ray and Mr. 
Edwards have described very well the States are really taking 
on their own challenges. The European debt situation we cannot 
do a thing about on this Committee. The one thing where we 
might be able to make a difference is in the housing, and so I 
want to come back to that.
    With that, we will go to Senator Whitehouse. Then it will 
be Senator Begich, Senator Merkley, Senator Thune on this side. 
So we will go to Senator Whitehouse, and then come back to 
Senator Thune.
    Senator Whitehouse. Thank you, Mr. Chairman. I would urge 
the distinguished Ranking Member to at least keep a bit of an 
open mind as to the potential for high-speed rail. I think if 
the same approach that he indicated toward high- speed rail had 
been applied to high-speed road back when we were trying to 
build the highway system and we were trying to move goods and 
people around this country on local road, through stoplights, 
you know, over bumpy surfaces, and through local intersections, 
you would find that it actually was worth spending that money 
because it carried follow-on economic effects that were far 
more than----
    Senator Sessions. I recognize the Northeast could justify 
it more than a lot of the places I see it is being projected to 
go.
    Senator Whitehouse. That is all I needed to hear. I 
appreciate it very, very much.
    [Laughter.]
    Senator Whitehouse. Mr. Zandi, you have talked a little bit 
about the housing market, and when I look at the failure of the 
HAMP program by its own standards, let alone any outside 
standard, when you look at the foreclosure crisis, when you 
look at the horrible nature of the short- sale market--I had 
Rhode Island's realtors in yesterday, and it is completely 
defective across the country. They come in over and over again 
with stories about having a short sale ready at a price, the 
bank cannot get its act together, the short sale disappears; 
the bank then says, ``OK, we are ready.'' Sorry, buyer gone. So 
then they come back to the same bank with the same property 
later. Now it is $100,000 less. They try again. The bank cannot 
get its act together. Again, they do not get through the 
process. And finally, you know, here you are with $200,000 in 
value out of a house, the bank still in the state of confusion.
    Wherever you go in this process, whether it is through the 
HAMP or through foreclosure or through short sale, you see the 
same thing, which is that no matter who you are, almost no 
matter who you are, you cannot get a person representing the 
owner of the mortgage who can make a decision.
    I had a witness in the other day in a Judiciary hearing who 
had been 20 months fighting through the HAMP program and 
through his bank's modification program to try to get a change, 
and for 20 months he never once got in touch with somebody who 
would even give him his last name or you could even call back 
to.
    I mean, if there is something that is sort of basic and 
American, it is that when you are dealing with somebody else, 
you ought to be able to get a person on the phone who can make 
a decision in your case instead of being stuffed into this 
nightmarish bureaucracy. And for me that is confirmed by what I 
see at home in Rhode Island, which is that the local banks that 
held the loans, that have bank officers in the community, are 
not the problem. We do not have short-sale problems with them. 
We do not have foreclosure problems with them. All of the 
problems are in the big banks that sold off these mortgages, 
and now there is this incredibly complex infrastructure, and 
there is no way to cut through it. And whether it is you are a 
person in danger of foreclosure trying to keep your home, your 
realtor being driven nuts by having to spend 3 or 4 hours on 
the phone trying to get an answer on a deal that they are 
beginning to lose faith would ever happen anyway, the HAMP 
applicant trying to work through the process--they are run, 
whack, into this same bureaucratic nightmare. And I think it is 
a little bit like--you know the story about the men who each 
find an elephant, and one finds a leg and they think that the 
elephant must be a column, and one finds a trunk and they think 
the elephant, you know, must be a snake hanging in a tree; the 
other one finds a tail and thinks it must be a broom. It is all 
the same elephant.
    And I wonder what your thoughts are--you have observed 
this--on this being a same elephant of a vast and completely 
unapproachable bureaucratic meltdown, basically, a nightmare 
that prevents intelligent decisions from being made, that 
prevents properties from being cleared, that discourages 
participants, and that is in many ways a vicious cycle, because 
you are driving property values down when that first buyer 
cannot get an answer from the bank on the short sale in time. 
The second buyer is going to be more fed up, and the seller is 
going to be more discouraged.
    So I think we are creating some of our own negative energy 
by not clearing the fundamental problem of the system, which is 
that at some point somebody should be able to have a human 
being with a first and a last name who can make a decision, who 
they can get in touch with. It seems to me it is as simple as 
that, and I would love your thoughts.
    Mr. Zandi. Well, I think your characterization of the 
problem is excellent, very good, and the frustration that you 
have expressed I have heard many times as well from----
    Senator Whitehouse. Every one of us has heard it from our 
constituents.
    Chairman Conrad. This is how we started the conversation, 
actually.
    Mr. Zandi. So I completely sympathize with what you were 
saying, and I agree----
    Senator Whitehouse. So how do we fix it?
    Mr. Zandi. I think there are few things that can be done to 
improve the modification/foreclosure process. I think Senator 
Merkley has actually done a fair amount of work in this area, 
and I will mention a few things.
    To your point about a point of contact, I think it would be 
prudent if mortgage servicers who are on the front line with 
the homeowner are required to have one individual as point of 
contact for each homeowner so when you call you get that same 
person. Right now you call, as you say, you can get numerous 
people, each one in a different part of the elephant, and they 
do not even understand the elephant. So it makes for a----
    Senator Whitehouse. And each telling you to submit the same 
paperwork you have already submitted four times again.
    Mr. Zandi. And telling you you sent it to the wrong person 
the last time you did it.
    Senator Whitehouse. Right.
    Mr. Zandi. So I think this is a regulatory fix, I think. 
You can go to the--I do not know if it is legislative, but it 
is certainly regulatory. Put pressure on the servicers to adopt 
one point of contact.
    Another thing that can be done, I think, to improve the 
process is end the dual tracking that is going on. Right now a 
person comes in with a problem; you are put through 
modification and foreclosure at the same time. So you are 
talking to someone about trying to get a mod, and then you get 
a letter in the mail saying you are in default, we are going to 
take you to a sheriff's sale.
    Senator Whitehouse. I met with maybe 14 of our realtors in 
Rhode Island a couple of months ago. Every single one of them 
had the experience of a short-sale agreement with the bank 
pending, and in the middle of it, another part of the bank 
whacked them with a foreclosure notice, blew up the short sale, 
and it ended up going into foreclosure inventory for way less 
than the short sale that the bank had itself agreed to. I mean, 
it is nutty out there.
    Mr. Zandi. Another fix, you do not dual track; you go 
through modification. If you fail the modification, then you go 
through foreclosure. They both do not occur at the same time.
    A third thing that could be done is a third-party review. A 
number of States have adopted this approach. You know, this is 
a very complex process. Homeowners are ill equipped to navigate 
through this process. They need help. You know, I think there 
are TARP funds that are sitting out there that were, at least 
in theory, allocated for HAMP and HARP that will never be used. 
They could be redirected to provide some help in this area, and 
I think it saves everybody a lot of money if, in fact, they----
    Senator Whitehouse. Dr. Zandi, I am going to cut you off 
there out of respect for my colleagues because we have gone 
over my time. But I am happy to follow the discussion 
afterwards and appreciate the thought you have given to this.
    Mr. Chairman, thank you.
    Chairman Conrad. Thank you, Senator.
    Senator Thune.
    Senator Thune. Thank you, Mr. Chairman. I appreciate the 
testimony of our expert witnesses today, and like many of my 
colleagues am very concerned about steps we can take to get the 
economy back on track and to deal with these problems of 
spending and debt which continue to explode on us; and if we do 
not start making some of the hard decisions now, I think the 
decisions will get that much harder.
    Mr. Zandi, I would like to ask you a question about how 
much you believe that the debt and the deficit is currently a 
drag on our economy. And if you do not believe it is today, 
when does that effect begin?
    Mr. Zandi. I think the Nation's fiscal challenges are our 
No. 1 long-term economic challenge, that if we--you--do not 
address it quickly in a clear and credible way, it will have 
significant negative implications for financial markets and our 
economy quickly. I do not think it is this year, but I 
certainly think by 2012 and certainly 2013, we are going to be 
seeing the ill effects of inaction.
    I would counsel, however, that while it would be very 
prudent to lay out a clear, credible path to fiscal 
sustainability--and we can talk about what that means if you 
would like now--I would not begin that process in 2011; that 
the recovery is still very fragile. And, in fact, imposing 
fiscal austerity in 2011, calendar year 2011, would be working 
at cross purposes with your own actions. The tax cut deal that 
you came to at the end of last year, in my view, was a very 
important piece of legislation, very positive, and for me 
sealed the deal for 2011 and 2012 that the economy is going to 
do measurably better because of that piece of legislation.
    It would also be working at clear cross purposes with the 
Federal Reserve. The Federal Reserve is maintaining a zero 
interest rate policy and quantitative easing through the mid-
part of this year, at least. So I do not think it would be 
prudent to begin this process in 2011 but by 2012 and 2013, 
certainly. And, moreover, to lay out a path for the future to 
achieve fiscal sustainability in 2011 would be incredibly 
therapeutic.
    Senator Thune. And you say we can talk about what that 
means. What does that mean, in your view, path to fiscal 
sustainability?
    Mr. Zandi. Yes, I believe that your bogey, your target 
should be to reduce the deficit-to-GDP by 2.5 to 3 percentage 
points out 5 to 7 years. I will explain how I get there.
    The deficit this year, in fiscal year 2011, will wind up 
being, in my view, somewhere around 9 percent of GDP. When the 
economy is functioning properly--and I think we are headed in 
that direction--and functioning reasonably well, the deficit 
will settle in close to 5 percent of GDP.
    The deficit-to-GDP that we can manage--and I am not saying 
this is what I would espouse, but we can manage--is about 2.5 
percent. At 2.5 percent of GDP, our interest payments will not 
swamp us. We can manage that.
    So we have to go from 5 percent in a well-functioning 
economy to 2.5 percent. You have to close that 2.5-percent gap. 
You have to close that in the next 5 to 7 years. If you can lay 
out a clear and credible path to doing that, then you will 
forestall the consequences that will occur in financial markets 
and into the broader economy.
    We do not solve our problems forever. There is Medicaid and 
Medicare and health care costs that need to be readdressed, but 
I think the immediate target should be reducing the deficit by 
2.5 percent of GDP.
    Senator Thune. You talked about the potential for sovereign 
debt crisis in the euro zone. What do you think the potential 
is for a debt crisis here in the U.S.?
    Mr. Zandi. I think if there are no significant policy 
changes over the next couple years, certainly over the next 
couple, 3 years, then those risks would be very, very high and 
rising quite quickly. So I think we have a window. We have 
latitude. Our economy is moving in the right direction, but we 
have 2 to 3 years to get our act together.
    Senator Thune. You mentioned the Fed's policies on 
quantitative easing. What effect do you believe those are 
having on both inflation and growth?
    Mr. Zandi. I think the quantitative easing was the 
appropriate thing to do. I think it is a net positive. There 
are negatives. You know, obviously it has contributed to higher 
commodity prices. It complicates the conduct of monetary policy 
overseas, particularly in emerging economies. But the 
positives, including lower long-term interest rates, the 10-
year Treasury yield is 3.5 percent, fixed mortgage rates are 
below 5 percent, and the stock market is up significantly, and 
I think in part because of the QE, the positives trump the 
negatives in a measurable, meaningful way, and it was the 
appropriate thing to do.
    I do not think we will need--based on what is happening to 
the economy today and my expectations, I think we do not need 
any further QE. And I think it would be appropriate for the 
Federal Reserve to start tightening monetary policy, probably 
sometime in 2012. But what they have done so far, in my view, 
has been entirely appropriate.
    Senator Thune. Mr. Edwards, in order for the markets to 
think that Congress is credible on cutting spending, what do 
you think those reductions have to be? And when do they have to 
take effect?
    Mr. Edwards. Well, I mean, the basic mathematics is we have 
to get the deficit down to about 3 percent of GDP in order to 
stabilize debt.
    I disagree with Mark really on the timing of this. You 
know, the view that we have to wait until we start growing 
again to start cutting spending does not make any sense to me, 
because, you know, we all assume that--you know, we look at the 
CBO projections and we all assume that everything is going to 
be hunky-dory again in a few years because we are going to be 
growing again. But we might have another recession in 2014, 
2015, and, again, folks like Mr. Zandi are going to be coming 
and saying, oh, no, we need to, you know, spend more money and 
we cannot cut spending now.
    So there is always going to be an excuse for not cutting 
spending. The longer we wait, the higher Federal debt becomes. 
It is going to be harder to solve the problem. And I think 
cutting Federal spending moves resources from the less 
efficient Government sector to the more efficient private 
sector. So I think it helps growth.
    I talked a few minutes ago about Canada. Canada's 
experience was that they dramatically cut government as a share 
of GDP by about 10 percentage points. The economy did not go 
into recession. It boomed for 15 straight years.
    Senator Thune. What does $4 gasoline or, worse yet, $5 
gasoline do the economic recovery?
    Mr. Zandi. I think that would be--if that were to occur 
now, in the next 6 to 12 months, I think that would be--I do 
not think $4-a-gallon gasoline would be enough to put us back 
into a recession, but it would be awfully painful. It is a tax 
increase, right? If you put more into your gas tank, you have 
less to spend on everything else. And just for context, every 
penny increase in a gallon of gasoline costs the American 
consumer $1.5 billion over a year. So, you know, you add it up, 
you go from $3 a gallon to $4, that is a $150 billion tax 
increase in 2011. That would be very difficult, particularly 
for lower-income households who obviously do not have a lot of 
latitude. In parts of the country like the South, the hardest-
hit group will be low-income households in the South because 
that is where they drive the most, and a high share of their 
budget goes to gasoline.
    Senator Thune. Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, Senator.
    Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair, and thank 
you to all of you for sharing views. It is very helpful.
    Dr. Zandi, there was a quote in your testimony which was, 
``Nothing works well in the economy when house prices are 
falling.'' And you placed a lot of emphasis on addressing the 
housing market, and I appreciate that you are bring that to the 
forefront. We are still in this period where we have had 
300,000 foreclosure filings a month for the last 20 months, and 
certainly in my home State, every community is affected by 
this. And it is not just a disaster for the family, but that 
empty house is helping to further drive down the value of 
adjacent homes, certainly discouraging consumer confidence, and 
it is certainly having a broader impact since the construction 
industry is not going to recover as long as there is a lot of 
empty homes.
    I do appreciate your drawing attention to the several 
different ways of helping to take on the foreclosure crisis, 
the single point of contact, and ending the dual track. I want 
to note that, after talking with a lot of homeowners back in 
Oregon, it is not simply that the bank cannot complete the last 
stage, which is the actual foreclosure on the dual track; it is 
that they suspend all the steps on the dual track during a time 
period in which they review and conclude up or down whether a 
modification is going to work. And I assume that that is the--
but I wanted to ask if you are talking about suspending the 
entire track or just the final step.
    Mr. Zandi. Precisely what you say. I think the entire 
foreclosure process, from default through to sale, should be 
suspended until it is determined that the borrower cannot 
qualify for any form of modification, HAMP or private mod.
    Senator Merkley. And then there were three ideas that I had 
put out in the paper that you referred to about further 
intervention, and one was the fire break before foreclosure, 
mediation, mandatory mediation that you addressed--in other 
words, an expansion of short refi programs, which you 
addressed. A third was to revisit the power of bankruptcy 
judges, at least in a very constrained format with appropriate 
sideboards on it, maybe take it in a little narrower direction 
than we did last time Congress took a look at it, primarily not 
because those judges will exercise that power, because they do 
not exercise that power much in the other areas that they can 
modify contracts, but because it gives an incentive to close 
the deal.
    And so since that was one point that I brought forward that 
you did not address, I just wanted to get your thoughts on 
that.
    Mr. Zandi. I think that it is a good idea. As you know, 
right bankruptcy judges can reduce the debt owed for everything 
but a first mortgage, and that, in my view, should be changed.
    Now, there had been some effort in times past during this 
crisis to make that change on a historical basis, so loans that 
were already originated, allow bankruptcy judges to change the 
terms on those loans. At this point, I do not think that is 
appropriate. But changing the bankruptcy reform law for the 
future, you know, for future loans, I think that would be 
entirely appropriate. In fact, I think that would be 
therapeutic and would make for a better system.
    Senator Merkley. So let me press that a little bit because 
the problem seems to be--and we have folks calling our offices 
every day in Oregon describing how difficult it is to deal with 
the servicers--is to create a little bit of countervailing 
incentive for the servicers to close the deal. And, in fact, at 
this point I want to mention that there seemed to be a number 
of perverse incentives for the servicers.
    I just did a tour of Oregon in four different cities where 
I did a presentation with homeowners who have been affected, 
and I heard the same stories we have been hearing in our 
office, which is, ``I called the bank to tell them we had a 
decrease is income. They said, `Hey, you are preapproved. Stop 
making your payments for 3 months.' '' And, really, they were 
calling the servicer, if you will, and not always a bank.
    But it turned out that the servicer charged a huge amount 
of fees once they reduced their payment or stopped making their 
payments, fees that the servicer would not otherwise have had 
access to.
    Then there was a recent article also noting that servicers 
make a tremendous amount of money when they put on substitute 
property insurance, sometimes charging up to 10 times what a 
homeowner would normally pay, and the servicer gets a huge fee 
back, hidden to the homeowner in that regard. And so servicers 
kind of have an incentive to get families into trouble, almost, 
and I am not sure that has been thoroughly explored. It is 
certainly a new element to me. I had not come to think that 
this was part of the challenge with servicers. But any comment 
on that would be helpful, but, also, that is why I felt 
lifeline bankruptcy power, even on existing loans, would be 
helpful because it creates a countervailing incentive to close 
the deal and help address these problems.
    Mr. Zandi. Well, this is what I would suggest. FDIC 
Chairwoman Sheila Bair has recently proposed the establishment 
of a fund financed by the mortgage servicers and mortgage 
companies designed in the same way as the BP fund. So if you 
are a homeowner who has been wronged by this process, you can 
go before this commission and air your grievances, and if it is 
determine that you have been wronged, then the fund would pay 
you a fee.
    I think this would be an appropriate way of getting the 
attention of the servicers and the mortgage companies, and it 
would provide, as you said at the beginning of your comment, 
the catalyst for getting them to work on this process in a more 
effective and prudent way.
    So that would be my approach as opposed to there are 
potentially significant unintended consequences from going back 
and rewriting bankruptcy law on existing mortgages that are--
you really have to think that one through. You know, in deep 
crisis, I was sympathetic to that argument, particularly when 
the private label securities market was at the heart of the 
problem. But, increasingly, that is no longer the problem. It 
is the loans on the books of the banks, at Fannie Mae, Freddie 
Mac, and the FHA. So I am less sympathetic to that, and I do 
not think that would be the way I would go.
    Senator Merkley. I would ask everybody else to weigh in 
except my time has expired, so thank you very much.
    Chairman Conrad. Thank you very much.
    Senator Begich.
    Senator Begich. Thank you, Mr. Chairman.
    I want to followup on----
    Chairman Conrad. Can I just say, for Senator Cardin's 
benefit, Senator Begich was here earlier.
    Senator Begich. I apologize. I had to rush out and make a 
quick call, so thank you, Mr. Chairman.
    Let me, if I can, followup on a couple of things. One, Mr. 
Edwards, I agree with you in regards to States and bankruptcy 
that we should not go down that path. That would be very--I 
mean, even the talk of it right now, from what I understand, 
talking to multiple people who deal in the business of 
municipal bonds, State bonds, tax-free bonds, it is having an 
effect on the market, and I know States are probably feeling 
that, even though they will not say that the rates have been 
adjusted upwards, but there is some risk now being calculated 
into what we might do or not do. So even the notion of talking 
about it, I think, is not very healthy for what we need to get 
through. So I want to say I agree with you in that regard, that 
we should not be going down that path.
    I would be interested in each one of your quick comments on 
that. Obviously, Mr. Edwards, you have already made a comment. 
If each one of you could just quickly comment on the idea of 
States walking down that path of declaring bankruptcy, which 
again, I think it would be a huge mistake.
    Mr. Scheppach. Senator, I can tell you that we have 
discussed it and we have--basically, Governors are pretty 
united in opposition to that legislation. Nobody is asking for 
it. Nobody wants it. And we agree with you that the mere 
conversation around it is foreseeing a small risk premium to be 
built into the bonds. So we are very strongly opposed to it 
across the board.
    Senator Begich. I know they call it on the market sometimes 
headline risk. Go ahead.
    Mr. von Wachter. So I second the views of Mr. Edwards and 
Dr. Scheppach. I agree that we should not talk about bailouts. 
However, there are some areas where there is a close connection 
between Federal and State funding. When I give an example, it 
is the unemployment insurance system----
    Senator Begich. Sure.
    Mr. von Wachter [continuing]. Where the Federal Government 
stands in by design of the system after the States run out. And 
one thing that this administration has already done, has given 
an impulse to the reform of State-level unemployment insurance 
systems to funding from the ARRA. And one additional step that 
could be taken to help the long-term sustainability of these 
programs and sort of then relieve both State budgets and the 
Federal budget is to mandate a higher wage base. The wage 
base----
    Senator Begich. I do not want to get into the program. I 
specifically narrowed in on the fact that States could declare 
bankruptcy. In other words, I understand the program. You are 
right. There are partnerships and relationships that the 
Federal Government has.
    Mr. von Wachter. The UI system is particular because 
inherent in the system is the States can essentially lend--
would borrow from the government----
    Senator Begich. Sure.
    Mr. von Wachter [continuing]. Once the trust funds went 
out, right.
    Senator Begich. Right.
    Mr. von Wachter. So there is a typical system where you see 
them in a small way. So States have not an incentive to buildup 
sufficient trust funds because they know they can come get more 
from the government. So this is a system where it is more 
concrete, but concrete steps could be taken to avoid the 
behavior that the incentive--the availability to borrow later 
on creates setting too low a tax base and collecting taxes. So 
the same thing happens, then, at a broader level, the State 
budgets. But the possibility to possibly be bailed out. But it 
probably leads to a pay-as-you-go in situations where you 
really should be building up funds----
    Senator Begich. Building up a fund.
    Mr. von Wachter [continuing]. In good times for bad times, 
and in many States, you see the opposite. Taxes are low in good 
times and then they have to rise in bad times. And so talking 
about bailouts would encourage that and we want to go in the 
other direction, and UI is a particular example.
    Senator Begich. Dr. Zandi?
    Mr. Zandi. Yes. I do not think that is a good idea. I think 
the bankruptcy----
    Senator Begich. Bankruptcy.
    Mr. Zandi. Yes. I think that the States have all the tools 
they need and that this would be an error.
    Senator Begich. And I appreciate that. I just, again, want 
to kind of put that out there because I think we create a 
problem by going down the path of discussion when we know 
Governors are not asking for it. No one is asking for it, 
really, and it is just a very bad thing.
    Let me go into two other areas, but first, I want to give a 
thought. I, like Senator Sessions, in a different way, I was 
elected a mayor of a city that walked into a $215 million 
budget with a $33 million hole in it and we had to resolve it. 
We had a three-prong attack. One was spending issues. One was 
revenue. One was also investment in basic core infrastructure--
water, sewer, roads, so forth. I have turned down--when I was 
mayor, I turned down the Federal resources when offered for the 
simple reason we do not have the money, and so you cannot do 
it, and also sustainability of those resources.
    I guess I want to--Senator Sessions brought up a good 
point, and you are right, there is kind of this addiction, and 
the reality is, it is really up to the Governors and, I would 
say, mayors, which have actually a larger amount of the debt 
out there than States do in the sense of what is out there, but 
they have just got to say no. It is about leadership. For them 
just to say, well, maybe I will get 10 percent from the Feds, 
there are many times I just said no. And what we did, we 
actually changed our policy. We never used one-time resources 
for ongoing expenses. That was--I had to tell the local city 
council, which was hard for them to get off of that gravy 
train. Once we did that, we created stability, and that is--I 
mean, Governors, mayors--mayors, and I am biased, I am a former 
mayor, I am not a Governor, never have been--we have to do it 
because otherwise we will get yelled at at the grocery store. 
So we do not get really a choice. There is no more hiding us.
    So I guess part of it is this gap of sometimes leadership 
just to say no, even when your constituents may think it is a 
wise thing, but getting off these one-time moneys are, to me, 
the right way to deal with budget, even from the Federal end. 
You know, we use one-time moneys to kind of solve a problem and 
then hope it all works out next year. That is very dangerous.
    But one thing I want to mention and make sure I heard you 
right, because I think I heard the same statistic, the pension 
issue--and our State had to deal with it. We dealt with it. 
Cities dealt with it. We are more sound than ever before. But 
really, when you figure it all out, it is about 4 percent or 
whatever the percent is. It is a small percentage of the 
overall budget and I want to echo and make sure I heard what 
you said.
    States are managing their way kind of through it painfully. 
But should there be a more consistent rules of the game on how 
they do this, because each State does it differently. And you 
are right. It is very convoluted, and especially to the bond 
markets, to understand how stable is that State, how stable--
can you give some thoughts on that? I am not suggesting more 
regulation, but I am just trying to figure out, how do you get 
some more uniformity here so the financial markets can respond 
the right way when crediting and scoring States for their bonds 
as well as cities.
    Mr. Scheppach. The problem is that the pension things are 
pretty much considered to be legal contracts----
    Senator Begich. Correct.
    Mr. Scheppach [continuing]. And each State----
    Senator Begich. Ours is actually vested in our 
Constitution.
    Mr. Scheppach. OK. Yes, you are right.
    Senator Begich. That is how legal it is.
    Mr. Scheppach. But sometimes it includes issues. A lot of 
times, for example, the COLA is not in the contract, so you 
have a lot of flexibility there. Or it may be that the age is 
not in it and other components of it.
    So I think they are working through it. As I say, we had 30 
States in the last 5 years and we have ten now, and they have 
moved from sort of these small incremental to bigger. The basic 
problem, though, is that they still have defined benefit as 
opposed to defined contribution----
    Senator Begich. Right.
    Mr. Scheppach [continuing]. Although some, like Utah, are 
beginning to move at least hybrid types of systems.
    Senator Begich. That is what we have done.
    Mr. Scheppach. So, I mean, I think the rating agencies are 
able to look at the liabilities there and the liabilities on 
bonds and make informed decisions. So I do not know that 
uniformity is really necessary. I am pretty confident in this 
area that there is serious focus on this right now.
    Senator Begich. And I will end on this, because my time has 
expired, but I know there are always these headlines about the 
crisis in the States. But really, what you are stating, and I 
want to make sure I am hearing you right, the majority of the 
States have really started to deal with this because they 
recognize the ongoing cost is not millions, but billions. Is 
that a fair statement?
    Mr. Scheppach. Yes, I think it is, and it is--I think 
States should be given some credit. They have cut spending by 
$75 billion over the last two years. That is not from what I 
would argue is CBO's sort of inflated baseline. That is against 
actuals.
    Senator Begich. That is real dollars.
    Mr. Scheppach. That is pretty tough stuff. And I think they 
understand that they have a lot more to do, but I think they 
are prepared to do it.
    Senator Begich. Very good. Thank you.
    Thank you, Mr. Chairman. I know my time is up.
    Chairman Conrad. I thank the Senator.
    Senator Cardin.
    Senator Cardin. Thank you, Mr. Chairman. Let me thank you 
for the series of hearings that we have held on the national 
deficit, and I want to thank this panel.
    Dr. Scheppach, I want to followup on Senator Begich's point 
because we have talked about the States, but I do not think we 
have talked enough about the risk factors of municipal and 
county governments. And if you are a Governor, you have 
proprietary interest to avoid a problem with a county or a 
municipality within your State. Today, our State governments 
have limited capacity as to how they can respond. They have to 
take care of their own budgets. So they are not as well 
prepared as perhaps they would need to be to avoid a 
consequence in their State that could have impact not just on 
that town or on that county, but could have impact on the 
entire State, in fact, could have impact well beyond the 
borders of one State.
    So I just want to get your assessment as to how much 
attention the Governors are paying to the problems of municipal 
and county governments, as they are obviously in a more 
difficult position.
    Mr. Scheppach. I hate to say this. In a sense, they are 
into survival for themselves, to some extent, focusing on their 
own problems. There are some States, like Pennsylvania, who 
actually had laws that did not necessarily require but allowed 
them to help municipalities and so on, but a lot of States do 
not have that. So I think that they are not focusing on that 
issue a lot, although personally, I think, because I looked at 
it to some extent relative to the States, it is a bigger 
problem. But again, I think if there are some that go into 
default, my sense is that they are going to be fairly small, 
that, again, you look historically and there has not been a lot 
of defaults in this particular area. So particularly if we 
begin to get some positive revenue growth, I think they will be 
able to work through this, as well.
    Senator Cardin. I think that is a pretty direct, honest 
answer, and I appreciate that. We are all in a mode right now 
of survival, and that is true at the national level, also. But 
I would just like to remind my colleagues of the concept of 
federalism, that the Federal Government has responsibility as 
it relates to the States, working with the States. But I also 
believe that our municipalities and counties, which are 
creatures of our State, the State has a responsibility to work 
with our municipal governments. They have no other place to go.
    A lot of Governors are now--at the national level, we are 
clearly going to be providing less resources to our States. 
There is no question. At the State level, you are going to be 
providing less resources to the counties. The counties are 
going to be providing less help to municipalities. The 
municipalities do not have anywhere else to go.
    So I think we all need to understand, as we look for this 
credible plan to deal with our national debt, that it is the 
same people who live in municipalities, counties, States, and 
the Federal Government and that it does not do a person in 
Baltimore City any good if the plan is credible at the national 
level but dumps its problems to the taxpayers of Baltimore City 
and the people who live in Baltimore City and they have no 
chance of survival under the policies taken by the Federal 
Government and the State government.
    So I like the language that our Chairman has used, and I 
think this is worth repeating. The Chairman said that we need a 
credible plan. It does not have to be a radical change 
overnight. We need a credible plan that gets us to the numbers 
that, Mr. Edwards, you were referring to. We want to get to 
those numbers. So I think we need to be mindful that we do not 
want to see the people of our nation harmed because we have 
taken care of our own problem at the national level, but we 
have dumped everything off on the States, or the States have 
dumped it off on local governments.
    Dr. Zandi, I want to get back to the mortgage issue because 
it is still a huge problem in our community and all 
communities, and your exchange with Senator Merkley. Do we have 
a structure in place that could implement the policy that you 
are suggesting? That is, do we have a credible way of being 
able to determine whether a potential person who is subject to 
foreclosure quickly could determine whether they are entitled 
to some form of help?
    Mr. Zandi. No. I do not think we have a mechanism in place 
that is appropriate and is helpful enough. Some States have 
been more aggressive than others. I think the State of 
Connecticut, New York, I think probably New Jersey put in 
processes with third parties involved to try to facilitate this 
for homeowners, but it is not something that is being done 
nationwide or in parts of the country where the foreclosure 
problem is particularly acute. It is a problem coast to coast, 
but in some places, it is obviously very acute. So, no, I do 
not think that we have addressed that adequately enough.
    Senator Cardin. So if we were just to put in a moratorium 
without having a process in place, is that really going to help 
the situation or not?
    Mr. Zandi. No. I am not advocating that we have a 
moratorium. I am advocating that we, through the regulatory 
process, require some changes in the way the mortgage services 
conduct their business. So one point of contact, no dual 
tracking, a third-party review, a fund established to 
compensate homeowners that are shown to be wronged in the 
process. I think if you do those things, and I do not think--it 
is going to be very difficult to do this legislatively, but 
through the regulatory process, I think that that would be 
helpful and make a difference in facilitating the foreclosure 
modification process.
    I think we are at a point now where we have some tools. We 
have just got to make them better. We need to work through this 
process as fast as we can. We need to get on the other side of 
this so that the housing market can begin to function properly 
and house prices start to rise. And we need to work through the 
foreclosure modifications.
    Senator Cardin. Well, I agree. We are still in a very, very 
difficult position on these issues, and there is uncertainty in 
the marketplace, also, which is not helpful. So the further we 
could clarify this, and I agree with you, I think we have 
enough tools out there. We just need to make sure that they are 
used and that the regulators do their jobs.
    Thank you, Mr. Chairman.
    Chairman Conrad. Let me--I had deferred my questioning 
time, because we were late because of the prayer breakfast this 
morning, to members being here, so I kind of asked questions as 
we went along, but I want to come back to some of the 
fundamental questions I wanted to ask.
    As I see it, in terms of the work of this committee, one of 
the most important things we can do is contribute to getting on 
a more sustainable course. How serious a threat do you believe 
it is to our long-term economic strength to having deficits of 
10 percent of GDP this year and being on a course to a debt 
that would be 233 percent of GDP, according to CBO, if we stay 
on the current trend line? Dr. Zandi, how big a threat do you 
see that to our long-term economic security?
    Mr. Zandi. It is lethal. I mean, I think if you do not make 
changes to change those forecasts in a substantive way, our 
nation's economy will be--and our living standards will be 
diminished for generations to come. So I think it absolutely, 
positively has to change.
    Chairman Conrad. Well, that is about as clear as it can be. 
Lethal is pretty strong. And, frankly, I agree with it. I 
believe that.
    So then the question becomes a matter of timing. I 
personally believe, and the commissions, all of the bipartisan 
commissions have come to roughly the same conclusion, that is, 
do not make big changes right now, but put in place a plan that 
makes big changes over this decade. In the case of the Fiscal 
Commission, we reached a determination we needed to reduce the 
deficit $4 trillion over that period of time--four trillion. 
That is real money. What do you say with respect to timing and 
size of the changes that are required?
    Mr. Zandi. I think the Fiscal Commission laid out a very 
good road map for you. There are two commissions, and both 
roughly came to the same place and laid out roughly the same 
path, and I think we should move in the direction that they 
have laid out for us.
    So the deficit-to-GDP, let us call it nine, 10 percent this 
fiscal year. If we can get that down to two to 3 percent of GDP 
by the end of the decade and do that in a way that everyone 
believes we are going to do that--and we do not have to do it 
in 1 year. We can do it over that period.
    And we do not have to begin now, and we should not. We 
should start that process when the economy is moving forward in 
a clear and definitive way, and my benchmark for that would be 
a falling unemployment rate. As soon as the unemployment rate 
is definitively moving south, I think at that point we can 
conclude that we are off and running and we need to then 
refocus and start imposing real fiscal discipline and 
austerity. Before that point in time, I think it would be--we 
will probably make our way through, but it would be, I think, a 
risk that we should not take.
    And so, therefore, in 2011, I think you have done what you 
need to do. I think we are in good shape. I would not change 
fiscal policy, the thrust of fiscal policy for calendar year 
2011. But beginning in 2012 and through the end of the decade, 
I think at that point, we need to very, very disciplined with 
respect to reducing those deficits, get it down to 2 percent of 
GDP.
    Chairman Conrad. So in dollar terms, what size of package 
would be required?
    Mr. Zandi. So if you meet my, sort of the numbers I gave 
you earlier, and your bogey is two-and-a-half percent of GDP, 
that is $375 billion a year in today's dollars, right. So to 
get that down to zero, that $375 billion to zero in five to 7 
years, that is $50 billion a year in today's dollars. 
Obviously, it is more dollars in the future, but that is 
roughly what you need to do. It has to be very clearly done.
    Chairman Conrad. It has to be credible that it is going to 
be done.
    Mr. Zandi. Credible, and I think there are many elements of 
credibility. I mean, one is, and again, I am hearkening back to 
the commission----
    Chairman Conrad. So we are talking--just in dollar terms of 
the total package, you are very close to the kind of $4 
trillion number that the commission came up with.
    Mr. Zandi. Yes. Exactly.
    Chairman Conrad. Dr. Scheppach?
    Mr. Scheppach. The only point I would make is that, let us 
face it, 95 percent of our problem is health care costs. We 
kind of know what to do in Social Security when we get the 
political will. So I think the structure of the package is also 
very, very important. Again, you can cut domestic discretionary 
and get the generated savings there, but I suspect you are not 
going to get the impact on financial markets if it is a package 
of domestic discretionary. It seems to me it has to be health 
care, and that is a problem because I do not think we know how 
to do that and we have some more experimentation. But I think 
90 percent of that problem is health care.
    Chairman Conrad. You know, let me just say this. All roads 
lead to health care, but what the commission concluded, and I 
think correctly so, everything has to be on the table. You have 
to do revenue. You have to do domestic discretionary spending 
on both the defense and non-defense side. I will tell you, 
testimony before the commission on some of the things that are 
happening at the Department of Defense was startling in terms 
of cost. You have to do the entitlements. And obviously, the 
biggest entitlement, the place where we have the biggest 
unfunded liability is in the health care accounts.
    Now, I know I do not want to reopen the health care debate, 
but I would say this to my colleagues. I was deeply involved in 
that effort, however imperfect it is. We took every idea, 
virtually every idea for reducing health care expenditure that 
analysts gave us from whatever perspective.
    So the best analysts--in fact, Senator Gregg and I wrote a 
letter to CBO and asked them, what are the things that we could 
do that would give us the biggest bang for the buck at reducing 
health care expenditure? CBO came back and told us, No. 1, you 
have to change the tax treatment of health care, and economists 
from almost every philosophical perspective said that is the 
case because you are encouraging over-utilization.
    No. 2, they told us, you have to change the payment 
methodology. You have to quit paying for procedures and you 
have to move to paying for health care outcomes.
    Third, they told us, you have to put in place some ongoing 
mechanism to get the ideas that work in terms of bringing down 
costs, getting them implemented. And so we put in place this 
whole new institution to try new things, and if they work, to 
implement them nationally.
    I am sorry. Did you want to add a point to that?
    Mr. Scheppach. Well, the only point I would mention, and 
this is not a position of the organization, but having spent a 
fair amount of time on this, I almost think one thing that you 
ought to look at is to--because we now have all-payer data 
systems in a bunch of States which means we have a much better 
sense of what is driving the cost of health care, and it has to 
be done for everybody. One of the things I am concerned about, 
if you cut Medicare or Medicaid, it just gets shifted to the 
ERISA firms and so on.
    I almost think it has to be done State by State now, and 
one thing that may be worth looking at is you provide some 
incentives to States if, in fact, they begin to reduce the rate 
of increase in health care costs for everybody in the State, 
because I think it has to be addressed across the board. Some 
States may want to regulate. Others may want to do 
transparency. But I think it is an approach that may be worth 
looking at.
    Chairman Conrad. All right. Senator Portman has joined us. 
Welcome. Why do you not take your time. And let me just 
indicate that Dr. Zandi needs to leave here at right about 
noon, so why do you not proceed, Senator Portman.
    Senator Portman. Thank you, Mr. Chairman, I appreciate it, 
and thank you for allowing me to come and speak. I have not 
figured out how to be at three hearings at once yet, so I 
apologize I did not get to hear all of your testimony, but I 
really wanted to come by and have the opportunity to speak 
briefly and hear from you.
    I love the fact we are talking about health care, and I 
think, Ray, you just mentioned the 95 percent figure. I am not 
sure that is accurate, but you should know that at this very 
table last week, Dr. Elmendorf said that health care is the No. 
1 fiscal concern he has, and that is not a surprise because it 
is and it does drive the cost of Medicare and Medicaid, of 
course.
    I have a more sort of fundamental question for you about 
the impact of current deficits on our economic growth. There is 
all sorts of data out there about the future impact of the 
enormous debts that we are building up, and the CBO projections 
are sobering, to say the least. But what is the impact today? 
What we do not talk about enough, I think, and maybe you can 
correct me on this, but I believe that we are crowding out 
private investment. I believe that with a $1.5 trillion debt 
this year projected, or deficit this year projected and a debt 
that is on track to double in the next 10 years, that we are 
impacting our ability to get out from under the difficult 
economic conditions we have been in over the last couple of 
years.
    I just wonder if you could comment on that. I have heard 
people say that with a $1.5 trillion deficit, building on the 
$1.3 trillion and $1.4 trillion the last couple years, that 
there is maybe a point or point-and-a-half off of GDP. Do you 
agree with that? And if you could take it to the next level for 
me in terms of its impact on the economy, which would be the 
impact on jobs. What does that mean in terms of job growth in 
this country as we are struggling to deal with this 
exorbitantly high unemployment number even as the economy is 
beginning to grow?
    So I would start with Dr. Zandi, if it is OK, and then if 
we could work down the panel.
    Mr. Zandi. I do not think the current budget deficit is 
crowding out private investment. I do not see evidence of that. 
The 10-year Treasury yield is 3.5 percent. B-double-A corporate 
borrowing yields are incredibly low. Even junk corporate bond 
yields are very low by historical standards. I do not think the 
cost of financing is an issue for companies.
    In fact, I think the large budget deficit is helpful in 
that it is supporting demand. For example, the tax cut deal 
that you came to at the end of last year, I think, has a very 
important provision that will cost money but will be very 
important to supporting investment in 2011, and that is 
expensing of any investment, and I think that is a very under-
appreciated aspect of that deal that will provide a lot of 
investment and actually will add a lot of jobs. Businesses will 
go out and buy an airplane and they have to fill it, or they 
buy a piece of machinery and they have to install it and they 
have to man it. So I think that was very appropriate and very 
good policy.
    Now, having said all of that, I think I would entirely 
agree that we need to reduce these budget deficits moving 
forward when the economy is clearly off and running, and I 
think we are very close. If everything sticks to my script, by 
next year, we should be in a measurably better place and the 
fiscal austerity that I think is important should begin at that 
point and we should engage in the kind of discipline necessary 
to ensure that we do not crowd out private investment because 
we will if the Federal Government does not pull back quickly 
once the economy is moving forward.
    Senator Portman. Dr. von Wachter?
    Mr. von Wachter. So I agree with what Dr. Zandi said 
earlier, that we should be ready, or put mechanisms in place 
today to gain fiscal stability conditional on the unemployment 
rate falling. We should not start tightening our belts at a 
moment when we may need to do important investments, for 
example, support unemployed workers and help them when the time 
is coming, when their businesses are starting to hire to help 
them get out in the labor market.
    For example, we were talking earlier about the housing 
market. The difficulty, the regulatory difficulties in the 
housing market may take longer to fix. So if job growth is 
picking up beforehand, we want to be ready to, for example, 
give people unemployment insurance mobility bonuses to take up 
jobs in other regions. So we have to be able to spend and 
invest in areas that allow us to grow, to get out of the 
current situation, to then achieve fiscal sustainability when 
the unemployment rate is down.
    Senator Portman. Dr. Scheppach?
    Mr. Scheppach. Yes. I would probably agree with Mark, but I 
do think the faster you can enact the changes, the better, even 
if they are not going to go into effect really for a year or a 
year and a half. So to the extent that you can put together a 
package now and do it, I think that is very, very positive.
    Senator Portman. Mr. Edwards?
    Mr. Edwards. I think the way--you know, I agree with Mark 
that the usual way economists think about crowding out is 
through interest rates. The government borrows more. Real 
interest rates go up. Less investment flowing to the private 
sector. But you can also think about it--and I agree that you 
do not really see that now.
    But Federal spending crowds out real resources in the 
private sector. You can think about it this way. If the 
Department of Defense is--the procurement budget is going way 
up or the size of our force structure is rising, you are taking 
very high-skilled and talented people out of producing stuff 
for the private sector for private markets and they are 
producing in the government sector. So the spending crowds out 
real resources, even as a separate sort of a mechanism from 
interest rates.
    I would say, in going back to the previous question on when 
we need to make these cuts, we should not think about this in 
terms of one big change, one big giant reform. We obviously 
have to do incremental stuff over time. This year, Congress can 
cut some defense. Next year, we can raise the Social Security 
retirement age, and on and on. I do not envy the job of House 
and Senate members over the next few years. It is going to be 
very painful to be a Member of Congress because you are going 
to have to cut every year. There is no more getting elected and 
just promising all kinds of goodies. That is all going away, I 
think, for----
    Senator Sessions. Well, as for paying and not cutting, as 
the past election showed, some people got shellacked in the 
past election----
    Mr. Edwards. Right.
    Senator Sessions [continuing]. And a lot of that was 
because we spent too much. So the myth that somehow it is 
harder to cut than it is to spend----
    Mr. Edwards. Right.
    Senator Sessions. I should not have interrupted. Excuse me, 
Mr. Chairman.
    Mr. Edwards. So one----
    Chairman Conrad. No, I think that is a very important 
point, because, frankly, we have--one thing Senator Sessions 
and I absolutely agree on is the need to put in place a 
credible plan as soon as possible. A place where we may have a 
difference is the timing and the make-up of the plan. We do not 
have a difference on the absolute essential need to put in 
place a plan that is serious and credible.
    Now, the place where I might differ from what I just heard 
you say is I think you need to have a plan that takes a series 
of votes now that makes these changes over time. That is, I do 
not want to see us in a situation where we do a little bit here 
and then we hope somehow that there is going to be a little 
more done, because my experience around here is you had better 
act while you have the window of opportunity and you had better 
put in place a multiple-year plan that has real discipline 
associated with it. This operating year by year around here is, 
I think, one of the things that gets us into trouble.
    Mr. Edwards. Yes. I mean, I sort of partly agree with that, 
and I think you can think about mechanisms you can put in place 
to kind of force changes. I think David Malpass might have 
testified here the other day that he is proposing an idea that 
he puts sort of a cap on public debt as a share of GDP which 
would force sort of constant annual changes to get under that 
limit.
    I proposed the idea in my testimony of putting a cap on the 
growth in total annual outlays. You pick a number, three or 4 
percent, put it into a statute. Congress has to make sure 
outlays do not rise more than that every year, which would sort 
of be like the 1990 BEA, except it would be the overall budget. 
And again, that would force change, force Congress to focus on 
discipline every year.
    Chairman Conrad. We need to shut down because we had 
promised witnesses that they would be out by about noon, and I 
apologize we are a little beyond that. But I want to thank this 
panel, just outstanding and we very much appreciate your taking 
the time and energy to present to us here this morning. Thank 
you.
    The committee is adjourned.
    [Whereupon, at 12:06 p.m., the committee was adjourned.]


            THE PRESIDENT'S FISCAL YEAR 2012 BUDGET PROPOSAL

                              ----------                              


                       TUESDAY, FEBRUARY 15, 2011

                                       U.S. Senate,
                                   Committee on the Budget,
    The committee met, pursuant to notice, at 2 p.m., in room 
608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman 
of the committee, presiding.
    Present: Senators Conrad, Murray, Wyden, Stabenow, Cardin, 
Whitehouse, Merkley, Begich, Coons, Sessions, Enzi, Crapo, 
Ensign, Cornyn, Graham, Thune, Portman, Toomey, and Johnson.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    I want to say for my colleagues, there will be a full 
turnout of the committee for this hearing, but we have a series 
of things going on simultaneously. The Tuesday caucuses of both 
parties are still underway. There is an event at the White 
House that has members. The Finance Committee is meeting with 
the Secretary of Health on the President's budget 
simultaneously. And we have a vote scheduled at 2:35.
    Senator Sessions. But you are minding the store.
    Chairman Conrad. We are minding the store, Senator 
Sessions.
    I want to indicate that because of the kind of turnout we 
are anticipating and because of the interruption for the vote, 
my intention will be to do 5-minute rounds, and then if we get 
a chance, we will go deeper, have a second round. But with all 
these hurdles, I think that is the only way we can get through 
this afternoon.
    I want to welcome everybody. Today's hearing focuses on the 
President's budget proposal for 2012. Our witness today is the 
OMB Director, Jack Lew. Welcome back to the committee, Jack. 
You are no stranger here. Thank you again for agreeing to take 
on this very challenging task at this difficult time. I am sure 
when you finished your first term, you never imagined you would 
be serving again and that it would be at a time when the Nation 
faces a 1-year deficit of over $1.5 trillion. When you last 
left, you left a balanced budget. In fact, you left surpluses, 
and I think you can be forever proud of your legacy.
    This is a challenging time for the country and the budget 
certainly reminds us of that fact. I have said consistently 
over the last 2 years that during the financial crisis and 
economic downturn, I think the administration acted quickly and 
decisively to make decisions that rescued us from a financial 
collapse. And I would credit the ending days of the previous 
administration for starting to put in place those policies to 
prevent what I believe would have been a financial collapse.
    At the same time, I have been critical about the need for 
similarly decisive action now to pivot to dealing with our 
long-term debt threat. Make no mistake, we are at a critical 
juncture. We are borrowing 40 cents of every dollar we spend. 
Spending is at the highest level of a share of our economy in 
more than 60 years and revenue is at its lowest level as a 
share of the economy in over 60 years. Not surprisingly, we are 
seeing deficits, then, at record levels. Deficits are now 
projected to be over 10 percent of GDP this year.




    This next chart depicts the gross Federal debt as a percent 
of the economy under the President's 2012 budget. It shows the 
debt reaching 100 percent of GDP this year and rising slightly 
throughout the remaining budget window. It is important to 
remember that many economists regard anything above 90 percent 
as the danger zone. And let me repeat what I have said at every 
meeting. The findings of economists Carmen Reinhart and Ken 
Rogoff in their book about 200 years of financial crisEs, and I 
quote, ``We examine the experience of 44 countries spanning up 
to two centuries of data on central government debt, inflation, 
and growth. Our main finding is that across both advanced 
countries and emerging markets, high debt-to-GDP levels, 90 
percent and above, are associated with notably lower growth 
outcomes.''




    So, look, these deficits and debt are not just numbers on a 
page. They are the fundamentals that have a lot to say about 
our future economic prospects. What is the economic opportunity 
going to be for our people? What are the job creation 
opportunities going to be? What is the economic position of our 
nation going to be?




    And unfortunately, as disturbing as the current situation 
is, the long-term outlook is even more dire. It is this 
deteriorating long-term outlook that is the biggest threat to 
this nation's future economic strength and security.
    Now, let me give credit where credit is due. The 
President's budget does include modest steps for addressing the 
fiscal situation. Here are a few key savings that I have 
identified in the President's budget.
    No. 1, a 5-year non-security discretionary freeze with 
estimated savings of $400 billion. That is not insignificant 
and I praise the administration for it.
    They also have paid for the doc fix for 2 years with 
specific offsets. That, too, is an advance.
    Third, they have advocated significant changes to the Pell 
Grant program, eliminating the second Pell Grant payment and 
ending in-school interest deferment for graduate students.
    Fourth, they have improved the ability of States to repay 
the unemployment insurance fund.
    And five, they have authorized the Pension Benefit Guaranty 
Corporation to raise premiums to better ensure the program's 
long-term solvency.




    Critically important steps. I applaud the President for 
those proposals. I wish there had been even more. I supported 
the deficit and debt reduction plan assembled by the 
President's Fiscal Commission, and while not perfect, continue 
to believe that it provides a better way forward beyond the 
next 2 years. I give the President good marks for the next 18 
months to 2 years. What I am concerned about is the longer 
term, and over the next decade, I believe we need a package of 
debt reduction approaching what the Fiscal Commission laid out 
of some $4 trillion.
    What we need, I believe, is an entire package with 
everything on the table that deals with fundamental reform of 
our tax system, and we have to address the entitlements, 
because with a doubling of people eligible over the next coming 
years, we are on an unsustainable course. I believe what is 
needed is bipartisan recognition that we have to face up to the 
budget realities. Both sides have to be willing to move off 
their fixed position and find common ground, and that means we 
must look beyond the mere 12 percent of the budget that is 
being focused on when we look at just non-security 
discretionary spending. That is only 12 percent of the budget. 
That cannot carry the full load of facing up to the debt 
threat. You cannot solve this problem by looking at just 12 
percent of the budget. This problem is too large and too 
important.




    Let me conclude by citing recent testimony from Federal 
Reserve Chairman Bernanke in which he cites the benefits of 
acting now. Specifically, he stated, ``Acting now to develop a 
credible program to reduce future deficits would not only 
enhance economic growth and stability in the long run, but 
could also yield substantial near-term benefits in terms of 
lower long-term interest rates and increased consumer and 
business confidence.''




    I hope people are listening. I hope my colleagues are 
listening. We cannot afford to wait until markets collapse, and 
I say to my colleagues, that is the course that we are on. I 
believe it without question, that we are on a course that will 
lead to a financial disaster, and it is our responsibility to 
bring the country back from the brink. It is our obligation and 
it has to start here.
    With that, we will turn to Senator Sessions for his opening 
statement, and I want to at this point thank Senator Sessions 
and his team for the courtesy that they have given us in 
working out the scheduling of hearings going forward. It has 
been a very positive and constructive working relationship. I 
want to thank Senator Sessions and your entire team for the 
cooperation.

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. Thank you. Thank you. We have a lot to do 
and you have had a lot of hearings and a lot of work. We have 
no choice but to support you in that and we will continue to do 
so.
    Mr. Lew, thank you for joining us at this hearing, and it 
is an important one at a critical point in history.
    Yesterday, the President submitted his formal budget to the 
Congress, as law requires. It is the President's third budget 
and the last budget that will cover a full year of his current 
term in office. It was one of his last chances to put forward a 
serious proposal to address our growing financial crisis.
    Our crushing debt undermines confidence in our economy, 
weakens our standing in the world, and results in devastating 
job losses to Americans. A recent study showed that our debt 
may already be costing us a million jobs a year. Nearly every 
expert that has testified before this committee has sounded the 
warning call. So, too, has the International Monetary Fund, 
Moody's, our own Federal Reserve. All have cautioned us to turn 
back from the abyss of runaway spending and debt.
    And yet the President has submitted a budget yesterday that 
fails to change course. It was a very un-serious response to a 
very serious problem. The President's budget would increase 
spending every single year, doubling the nation's debt by the 
end of his first term and tripling it by the end of his budget. 
It would also impose $1.6 trillion in new taxes on families and 
businesses, a further barrier to jobs and growth.
    Erskine Bowles, the Democratic Co-Chair of the President's 
own Fiscal Commission did not mince words Sunday. Speaking to 
the Washington Post, Mr. Bowles said that the budget goes, 
quote, ``nowhere near where they will have to go to resolve our 
fiscal nightmare.''
    Across the nation, editorials rebuked the President for not 
rising to the occasion. The Washington Post said the President 
punted. The Los Angeles Times said the budget landed with a 
thud. USA Today said the budget was a shame and economically 
risky. The Wall Street Journal said it was transparently 
cynical. The New York Times said the budget is most definitely 
not a blueprint for dealing with the real long-term problems 
that feed the budget deficit. Investors Business Daily said the 
President's plan, quote, ``will lead inevitably to a weaker 
economy and perhaps even default.''
    My goal here is not to excoriate the President, but for me, 
it is a point of sadness, not satisfaction, that we have seen 
such a weak response. A historic opportunity has been lost. 
Maybe it can be recovered, but at this moment, it has been 
lost. Like when President Nixon went to China or President 
Clinton signed welfare reform, this could have been the 
President's moment to rally diverse political factions behind a 
common cause. I believe the country is ready.
    Our nation is confronted with a defining challenge. Our 
financial future hangs in the balance, but the President has 
suggested he is waiting for Congress to put forward a serious 
proposal first. That is not leadership. It is going to be hard 
for Congress to fulfill that role without Presidential 
leadership.
    Did Winston Churchill say he was waiting for Parliament to 
come up with a plan to win the war? When a nation is faced with 
any threat, great or small, financial or military, it is the 
job of the nation's chief executive to step forward with a 
plan. But not only has the President failed to lead, but his 
administration, sad to say, has consistently attacked 
Republicans when they do step up and put forward bold ideas to 
reduce spending or address our spiraling debt.
    In recent days, it seems the White House has been more 
interested in spend than in honest conversation about the 
serious challenges we face. What the President does not seem to 
realize is that the fight over our budget is about much more 
than politics. It is about economic survival.
    But while I am deeply disappointed, my confidence in the 
future is not diminished. If Washington does not change 
direction, the American people will change the direction of 
Washington. We see Governors like Governor Christie and 
Governor Cuomo in New York gaining popularity and strength from 
making tough choices. Significant spending reductions may not 
be easy; they are, indeed, not. But they will make us stronger 
and more prosperous. It is a tough road, but it is the right 
road. It is the road which leads to a better future. It is the 
road we have to be on, Mr. Chairman.
    Chairman Conrad. Thank you, Senator Sessions.
    Now we will turn to Director Lew for his opening statement. 
Then we are going to go to questions.
    I would say to my colleagues, again, because we face a vote 
at 2:35 and because of the notice by our colleagues that all of 
them intend to be here, we are going to do five-minute rounds 
and we will try to get to a second round.
    Director Lew, please proceed. And again, welcome back to 
the committee.

 STATEMENT OF HONORABLE JACOB J. LEW, DIRECTOR, U.S. OFFICE OF 
                     MANAGEMENT AND BUDGET

    Mr. Lew. Thank you, Mr. Chairman, Senator Sessions. Thank 
you both for the kind words personally about me. It is good to 
be back here. I remember very fondly my last testimony as 
Director on the last day I was in office and I had a chart that 
projected a surplus of $5.6 trillion over the next 10 years. 
How far away that seems, and that is what we are going to be 
talking about today, how we can turn the tide.
    After emerging from the worst recession in generations, we 
face another historic challenge. We need to demonstrate to the 
American people that we can live within our means and invest in 
the future. We need to work our way out of the deficits that 
are driving up our debt and at the same time make tough choices 
to out-educate, out-build, and out-innovate so that we can 
compete with our rivals around the world. This is what it is 
going to take to return to robust economic growth and job 
creation in the future.
    This is the seventh budget that I have worked on at the 
Office of Management and Budget and it is the most difficult. 
It includes more than $1 trillion of savings from policy, two-
thirds from lower spending, and it puts the Nation on a path 
toward what we are going to call for the moment fiscal 
sustainability. That means that by the middle of the decade, 
the government will no longer be adding to our debt as a share 
of the economy. Clearly, it is not far enough. We all agree 
there is more work to do. But in order to start bringing down 
the debt, we have to stop adding to it, and this budget would 
get us there.
    By the middle of the decade, we will be able to pay for our 
current bills and remain in what is called primary balance for 
many years after that. The President has called this budget a 
downpayment because there is still going to be work to do to 
deal with our debt and to address the long-term challenges. But 
we cannot start to pay down the debt until we stop adding to 
it.
    The budget lays out a strategy for significant deficit 
reduction. It is the most significant deficit reduction in a 
comparable period since the end of World War II. It will bring 
our deficit into the range of 3 percent of the economy by the 
middle of the decade and stay there for the rest of our budget 
window.
    Changing this trajectory of our fiscal path is a 
significant accomplishment, but to do it, it will take tough 
choices and I would like to just highlight a few of them.
    The budget, as you have noted, includes a 5-year freeze on 
non-security discretionary spending. This will save $400 
billion over the next decade and it will bring spending for 
this part of the budget down to the level it was at when 
President Eisenhower was in the Oval Office. To achieve savings 
of this magnitude, it is going to require more than just 
cutting waste and fraud and abuse and duplicative programs. We 
clearly need to start there, but we will not get the job done 
if that is all we do.
    We are going to need to make cuts in places where, if we 
were not facing the kinds of difficult fiscal challenges that 
we face, we would not be making cuts, places like the Low 
Income Home Energy Assistance Program and Community Development 
Grants for cities and counties.
    In national security, where we are not freezing the budget, 
we are also making real cuts. Defense spending over the past 
decade has been growing faster than inflation and we can no 
longer afford to sustain that. This budget will cut $78 billion 
from the Pentagon spending plan over 5 years, which will bring 
defense spending down to zero real growth. This is a level that 
the Secretary and the military leadership believe we can do 
without harming our national security, but it will require 
reductions, and reductions in weapons programs that we do not 
need and we cannot afford.
    We also have additional savings that come from bringing our 
troops home. The troops coming home from Iraq will mean that 
the spending on overseas contingency operations will go down, 
and when you look overall at our defense spending, that means 
they will be 5 percent--more than 5 percent below the request 
level last year.
    As has been noted before and I think we hopefully all agree 
is the case, just cutting discretionary spending will not solve 
our fiscal problems, and this budget deals with many other 
issues and it deals with mandatory spending and revenue to help 
deal with our fiscal challenges.
    I would like to use two examples of what we are doing in 
this budget to confront these fiscal challenges. For the past 
number of years, there are two areas where Congress has year 
after year taken legislative action for reasons that have 
bipartisan support. I think there is, for good reason, 
bipartisan support that we should not see Medicare 
reimbursement rates for doctors go down by 30 percent and we 
should not see middle-class families be pushed into the 
Alternative Minimum Tax. The problem is that the legislation to 
deal with that has not been paid for, and until last December 
when, frankly, there was a very good and right decision to pay 
for the doc fix, it had not been paid for.
    This budget says we have to stop that. We have to start 
paying for this. And we have specific savings proposals, as the 
Chairman noted, that would pay for the doc fix for the next 2 
years. That means $62 billion of savings in mandatory programs, 
dozens of specific program changes so that we can have a $62 
billion offset to pay for 2 years of the doc fix, so between 
action taken last year and that, we will be able to have time 
to work toward a new sustainable set of reimbursement policies.
    In the case of the Alternative Minimum Tax, it has not been 
paid for in the past. This budget proposes to pay for it and it 
proposes to do so by putting into the tax code a provision that 
would limit the value of itemized deductions for the top 
taxpayers, that is families of $250,000 and above, so that they 
would get the same benefit for their itemized deductions that 
the bracket just below them gets. This would return the value 
of deductions to where it was in the Reagan administration. It 
would be a step toward doing something that the Commission 
proposed, which is that we start to control spending in the tax 
code. These are both downpayments on long-term reform to reduce 
the deficit further and the administration looks forward to 
working with the Congress.
    The President has in the State of Union and the budget made 
clear that we are going to need to work together to solve a 
number of additional problems. In the State of the Union and 
the budget, the President called for deficit-neutral corporate 
tax reform so that we can simplify the system, eliminate 
special interest loopholes, level the playing field, and 
importantly, lower the corporate tax rate for the first time in 
25 years so that American businesses will be more competitive.
    And while it does not contribute to our deficits in the 
short- or medium-term, the President has laid out his 
principles to strengthen Social Security and he has called on 
Congress to work in a bipartisan fashion to address this 
compact for future generations.
    As we take these steps to live within our means, we also 
invest in areas critical to the future economic growth and jobs 
creation. We invest in education, innovation, clean energy, and 
infrastructure. But even in those areas, we have had to make 
tough tradeoffs in order to fund our high-priority programs.
    As the Chairman noted in his opening remarks, we worked 
hard to maintain the Pell Grant levels that we worked together 
to put in place so that nine million students can get a Pell 
Grant of $5,550 a year. We pay for it in this budget with $100 
billion in savings, primarily from ending the summer school 
Pell Grant and by changing the way we treat interest when 
graduate students have loans while they are in school.
    In the area of innovation, we support $48 billion in 
research and development, which includes $32 billion for the 
National Institutes of Health and it meets visionary goals to 
bring a new clean energy economy into place. To help pay for 
these investments, lower-priority programs are cut, and we do 
eliminate 12 tax breaks for the oil, gas, and coal companies 
that will raise $46 billion over 10 years.
    And to build the infrastructure that we need to compete, 
the budget includes a proposal for a $556 billion Surface 
Transportation Reauthorization bill, and the plan consolidates 
over 60 duplicative programs which have often been earmarked 
into five, which demand more competition for funds, and we 
insist that it be paid for, because we cannot afford to do this 
if we do not pay for it.
    Mr. Chairman, I have no illusions, and we have very 
difficult challenges ahead. We need to make tough choices if we 
are going to put our country back on a sustainable fiscal path. 
As we make these choices, it is important that we not cut the 
areas that are critical to helping our economy grow and make a 
difference in families and businesses.
    Finally, cutting spending and cutting our deficits is going 
to require that we put our political differences aside and that 
we work together. I look forward to working with you as we 
craft a set of policies so that we can live within our means 
and invest in the future.
    I thank you and look forward to answering your questions.
    [The prepared statement of Mr. Lew follows:]



    Chairman Conrad. Thank you, Director Lew.
    Let me start with what I see as the best news in the 
proposal of the President, and that is that he brings down the 
deficit as a share of the Gross Domestic Product quite sharply, 
from almost 11 percent of GDP down to just over 3 percent of 
GDP during the 10-years. That is critically important because 
that does stabilize the debt.
    But let me go to the question of the level of our gross 
debt, because as I see the President's proposal, we get to a 
gross debt of over 100 percent of our GDP and just stay stuck 
there. So it is true the debt is stabilized, but it is 
stabilized at a level that is too high. Why do I say 100 
percent of GDP is too high? Because the best information we 
have available to us, the Reinhart-Rogoff study of 200 years of 
fiscal history and 44 countries say when your gross debt is 
over 90 percent of GDP, the chances increase that your future 
economic growth will be substantially reduced.
    And this is what we see in terms of the gross debt as a 
share of GDP the 10-years of the President's budget. It is over 
100 percent the entire time. That, to me, is just not wise. It 
is not acceptable. It is not a fiscal strategy that the country 
should embrace.
    I understand that the President's budget is an opening bid. 
We all know there is a negotiation that will have to ensue. It 
will have to involve both houses of Congress, both parties and 
the President.
    The question that I would have for you is how does that 
serious conversation get started? We have a budget, but a 
budget resolution, as you know, is purely a Congressional 
document. It never goes to the President for his signature or 
veto. So the question I have for you and the question I think 
many of us are struggling with is how do we get to the serious 
discussion of getting not only the debt stabilized--I will 
grant you, you do that. To me, that is not enough, because the 
second step is we have to work this debt down, and just 
stabilizing it for 10 years at a level that is too high, that 
cannot be the answer. At least, to me it cannot be the answer. 
So how do we get, in your judgment, this more serious 
negotiation started?
    Mr. Lew. Senator, I think that, first, stabilizing the debt 
is not something that we can take for granted. There are a lot 
of hard decisions that we are going to need to make in order to 
bring the deficit down to 3 percent of GDP. If we do not take 
the tough actions that are laid out in this budget, we will be 
closer to 5 percent of GDP, not 3 percent of GDP.
    So I think as a first matter, it is not just a question of 
building confidence. It is kind of like you have to walk before 
you run. We have to do this in order to get to the next step. 
So I think that when we describe this--when the President has 
described this budget as a down payment, I think it is 
important to note that getting that down payment is in and of 
itself going to be a hard accomplishment and it is something we 
are going to need to work together on, because I know there are 
a lot of things in our budget that will not be immediately 
accepted and we are going to have to work toward a set of 
policies that get us there.
    In terms of the long term, you know, I think the process 
always begins with the President putting a budget on the table. 
The President has a comprehensive responsible budget. That is 
the first, not the last, step in the process. The President has 
worked very hard to try in the State of the Union, in his 
budget, in his remarks today, to establish an atmosphere where 
we could start to build trust that builds on the success we had 
at the end of last year where I think there was a process of 
beginning to learn how to work together across party lines.
    I have worked on bipartisan agreements from both ends of 
Washington, from the Congress when I was in the Speaker's 
Office in the Democratic Congress and a Republican White House, 
and from a Democratic President's White House working with a 
Republican Congress. Developing that relationship of trust is 
the key to there being success. And I think that we have tried 
very hard in everything we have done in this budget to put 
things on the table to expand the range of things that can be 
discussed, but it is not always the case that putting a 
specific proposal out there advances things most quickly. I 
personally believe that if you look at the last 20, 30 years, 
sometimes putting out a proposal slowed things down because it 
polarized the sides and they dug in. We need to figure out a 
way to have a conversation that gets the parties talking 
together.
    So I cannot give you a date or a time. I think that we have 
put a budget forward. We have a lot of immediate issues facing 
us in terms of the funding of the government after March 4, the 
extension of the debt ceiling in the spring, the budget 
resolution that Congress has to pass. I would say that one of 
the things I believe is that we have to separate these issues. 
We should do the things that we have to do to keep our business 
going. And we have to figure out how to engage on this as 
different plans are put down and we see what the differences 
are and look toward working together toward the middle where we 
can agree.
    Chairman Conrad. Let me just say this to you, because I am 
going to try to follow 5-minute rounds. You know, I have 
enormous respect for you. I know what you did. I know the role 
you played in getting us back on track previously. In that 
answer, I do not hear a plan for how we get to a serious 
discussion. I hear the reasons for doing the budget proposal 
that is out there. I understand that. I might even accept it. 
But I cannot accept that if I do not hear a way forward that 
gets us to the discussion we have to have because it cannot be 
the answer that we are going to have a debt over 100 percent of 
GDP throughout the next decade. That cannot be the answer for 
this country's fiscal future.
    Senator Sessions?
    Senator Sessions. Thank you, Mr. Chairman. I agree with you 
100 percent. This idea that you are balancing the budget 
somehow when you are not is the Washington theory that got us 
into this fix, and stabilizing the debt is so dangerous because 
we are at the upper limit already and we could have an economic 
shock at any time. Another recession is not projected in your 
budget that I know of. It is not in there. So it is a high-risk 
thing, and as leaders, I agree with the Chairman, we have to 
take the steps that we know need to be taken today to protect 
our people from danger in the future.
    Have you, Mr. Lew, explained the budget to the President an 
do you think he fully understands the choices of the decisions 
and direction it undertakes?
    Mr. Lew. Senator, this is the President's budget. I have 
the honor of presenting his budget. So he understands and has 
made the decisions to drive this budget.
    Senator Sessions. Well, in his radio address to the Nation 
Saturday, he said, so after a decade of rising deficits, this 
budget asks Washington to live within its means, and that is 
what our country has to do. That is what families do. Does this 
budget say that we are going to live within our means at any 
single year in the 10-year plan you have set forth?
    Mr. Lew. Senator, this budget would get us to the point 
where in the middle of the decade, we will be paying for our 
current expenses and we will be in what is called primary 
balance. That means that the only thing that is putting us into 
deficit is payments of interest on the national debt. And if I 
could put it in terms that--a family's terms, it is like saying 
we are going to cut the credit card, not add to the balance, 
and then we will work on paying down the old bill.
    Senator Sessions. But we are adding to the balance and we 
are not cutting up the credit card. That is just the fact. Do 
you believe that the American people who heard the President on 
his radio address Saturday say that this budget calls on 
Washington to live within its means, do you think that it is 
misleading in the sense not in the lowest deficit year of the 
ten, by your own budget, the deficit will be over $600 billion 
that year?
    Mr. Lew. Senator, having sat in this chair and presented 
three budgets with surpluses, I know the difference between a 
surplus and a deficit. We are not going to get to a surplus 
until we can pay down the debt because of the interest 
payments.
    Senator Sessions. Oh, you mean reducing the debt is paying 
down the debt? Is that Washington-speak?
    Mr. Lew. What I said was we are going to stop adding to the 
debt. Our spending will not add to the debt.
    Senator Sessions. Well, what year can you say that under 
your budget it gets below $600 billion a year in added debt?
    Mr. Lew. Senator, I understand the arithmetic of paying 
interest on our national debt. We have accumulated a lot of 
debt. This has been a very deep recession. We have had an 
enormous number of decisions made that have caused the deficit 
to grow. We are going to have to work together to reverse that, 
but we cannot----
    Senator Sessions. Are you just saying that----
    Mr. Lew [continuing]. We cannot make the debt go away and 
we have to pay the interest on it until we start reducing it.
    Senator Sessions. Well, I know there is some idea that 
somehow you can say you are in balance when you do not pay your 
interest, you do not count the interest payment, which is 
obviously not a legitimate way to analyze it. There is no 
dispute that I can see that your budget costs for not a single 
year in which we add less than $600 billion to the debt, and 
you said in your interview Sunday with Candy Crowley, our 
budget will get us over the next several years to the point 
where we can look the American people in the eye and say we are 
not adding to the debt any more. We are spending money that we 
have each year and then we can work on bringing down the 
national debt. Was that an accurate or misleading statement to 
the American people Sunday?
    Mr. Lew. Senator, I think it is an accurate statement that 
our current spending will not be increasing the debt. We do 
have interest payments. It is going to take us a while to work 
down those interest payments and----
    Senator Sessions. Well, you did not say that. You said that 
we will be bringing down the debt during the period of this 
budget and that we can look them in the eye and say we are not 
adding to the debt any more.
    Mr. Lew. And that----
    Senator Sessions. That is not accurate, is it?
    Mr. Lew. No, I believe it is accurate. Our current 
programs, the things we are doing that we are making decisions 
on, we have stopped spending money that we do not have. We 
cannot just wish the national debt away.
    Senator Sessions. Well, I think the American people----
    Mr. Lew. They are going to have to make hard decisions----
    Senator Sessions [continuing]. Heard it and----
    Mr. Lew. It is going to take hard decisions to bring that 
down.
    Senator Sessions. My time is up, and Mr. Chairman, I would 
just add one comment, that the budget says it will save a 
trillion dollars over 10 years. The way the budget is scored by 
your own analysis, that means we will reduce the total debt 
added to the American people over that 10 years from $14 
trillion to $13 trillion, which is an insignificant amount in 
the scheme of that number and does not get off the trajectory 
we are on, which is toward a financial abyss.
    Chairman Conrad. I thank the Senator.
    Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman.
    Director Lew, to drive the deficit down dramatically, we 
need more economic growth, and you have talked about corporate 
tax reform. I am certainly in favor of taking tax breaks away 
for companies that are doing business offshore and using that 
money to dramatically lower rates for companies that do 
business here. But what troubles me is that your comments mean 
that there will not be real tax relief for 80 percent of 
American businesses that are organized as sole proprietorships 
or partnerships, or the typically hardware store, the 
electronics firm. And, in fact, my concern is the approach that 
you are going without trying to get these small businesses that 
pay taxes as individuals is going to create more complexity and 
more uncertainty for those small businesses that are a vital 
part of the economic engine we need for growth.
    What is the plan to make sure that we have broader tax 
reform and particularly pick up the 80 percent of business 
entities that pay taxes as individuals?
    Mr. Lew. Senator Wyden, I think when the President put the 
proposal for corporate tax reform out there, he did not mean 
for that to be the end of the conversation. We have to start 
somewhere. We have a corporate tax system where it has been a 
long time since we have gone through and taken away the special 
provisions, where in order to lower the rates without 
increasing the deficit, we are going to need to broaden the 
base. And that is going to be a hard process.
    He has also said that he wants to work together on a 
broader basis to deal with the tax system, but we do have to 
start somewhere, and the corporate tax reform proposal is the 
first place.
    Senator Wyden. We should not start in a place that is going 
to further distort the code and make it more complicated. Dr. 
Bernanke said you have to recognize the interactions between 
the individual portions of the code and the corporate portions 
of the code. I just hope--you talk about the conversation. 
Right now small business is getting short shrift in the 
conversation. That is not right, and we cannot generate the 
economic growth that the President wants to see and you want to 
see.
    Let me ask you about a Pacific Northwest matter, and that 
is timber payments. We are glad that it is in the budget, but 
it falls dramatically short of the historic obligation. In 
fact, let me tell you what the President said during the 
campaign in 2008. He said, with respect to county payments, ``I 
completely agree it is an obligation we have to meet. I think 
we are not meeting it well right now because we are doing it 
piecemeal year after year by year.''
    That is exactly what you are proposing again. You are 
talking about giving us one more year, then having a study, and 
in effect putting in place the uncertainty that the President 
correctly said in the campaign that we ought to move away from 
to get these rural communities--and there are hundreds of them 
around the country--off the fiscal rollercoaster.
    So what can we tell our folks in the Pacific Northwest is 
the plan to really provide a way to meet the historic 
obligation and get these rural communities off the 
rollercoaster?
    Mr. Lew. Senator Wyden, we have had many discussions about 
this provision, and I hope you can see the impact of those 
discussions on this proposal. What we have done is we have 
tried to put in a funding level that would meet the immediate 
need. We proposed different things that we have discussed in 
the past which create economic alternatives so that there would 
be real economic vitality in the areas and ultimately not as 
much of a need for the payments. And we have indicated an 
openness to being flexible in terms of working through doing it 
either as a discretionary or mandatory program.
    So we think we have put together something that is a very 
solid starting point. It is a proposal. And it is obviously 
going to be something we have to work with Congress on over the 
coming year, and I look forward to working with you on it.
    Senator Wyden. We are glad it is in the budget, Director 
Lew. I just want you to know that if you are talking about the 
historic obligation--and we recognize that times have changed. 
We are trying to get into new areas, biomass opportunities for 
the private sector. I am concerned that with the proposal that 
you are offering now in the rural West we are going to see 
rural counties go bankrupt. And we have to do better than that. 
We will work with you. It will be a bipartisan effort. I am 
glad it is in the budget. We have a long way to go.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, and thanks for respecting the 
time. Thanks to all colleagues for respecting the time with the 
number of colleagues here.
    Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman.
    Director Lew, I have to join in what a number have said. As 
I reviewed the President's budget when it came out, I was 
discouraged. I felt the President took a pass. And, frankly, as 
one of those who served on the Fiscal Commission and voted for 
the recommendations that the President's Fiscal Commission 
made, I saw very little of the recommendations in the budget, 
and, frankly, when comparing the numbers that we see in the 
budget to what I think are going to be the reality, it appears 
to me that the budget that is proposed does not even go as far 
as it has claimed to. And I want to get into a couple of 
aspects of that with you.
    First, you use the term ``primary balance,'' and I think we 
all understand that here in Washington in the Budget Committees 
and so forth. But when the American people hear that, I am not 
sure they quite understand what it is we are saying.
    Is it not accurate to say that when you use the words ``the 
budget comes into primary balance,'' is means that if you do 
not pay any interest on the national debt, you can say that you 
are covering the ongoing expenditures?
    Mr. Lew. Yes. It means that the only deficit is coming from 
paying the debt.
    Senator Crapo. And is that the entire budget, including 
mandatory spending?
    Mr. Lew. That is the entire budget.
    Senator Crapo. And can you tell us what the amount of 
interest adding to the debt is throughout the totality of the 
10 years?
    Mr. Lew. I would have to look up the number. I can get back 
to you with the number.
    Senator Crapo. Well, I have what I think are some of your 
charts here. Would it be fair to say that the gross debt of the 
United States over the 10 years of this budget will grow from 
about $13.5 trillion to $26.3 trillion?
    Mr. Lew. That would be the total debt, not the debt held by 
the public.
    Senator Crapo. Understood.
    Mr. Lew. The debt held by the public is a lower----
    Senator Crapo. That is the gross debt. And the debt held by 
the public would grow from about $9 trillion to about $19 
trillion. Is that not correct?
    Mr. Lew. Correct.
    Senator Crapo. So I think it is just important that, as we 
talk about this, you understand the reason for the frustration 
that many of us have is that this does not change the course 
that we have been on. Our debt, whether you count the public 
debt or the gross debt, is going to double in the next 10 years 
under this budget, and that is not sufficient. As I think the 
Chairman said, this may be a good opening bid, but we should 
not be in a bidding process here. We should be engaged with 
solid leadership from the White House, and we should, as 
Congress, be engaged heavily in that process as well.
    A couple of other aspects of the report that I would like 
to highlight, if I can. As I look at the budget report as we 
have analyzed it so far, you are projecting about a $1.7 
trillion increase in revenue relative to the same baseline that 
the Congressional Budget Office projected in January, as I 
analyzed the two differences there. Can you tell me why the 
difference?
    Mr. Lew. Over what period are you----
    Senator Crapo. I understand that to be over the period of 
the budget.
    Mr. Lew. There are differences in our budget because, first 
of all, we have policy proposals, but there are also some 
differences because of economic assumptions. And I can tell you 
what the impact of the policy proposals are in our budget, and 
I can also tell you what the impact of the economic is. But----
    Senator Crapo. Would it be fair to say the policy proposals 
you are talking about assume over $1 trillion in new taxes? Is 
that correct?
    Mr. Lew. Well, I apologize for being a little bit 
complicated, but we consider the baseline to leave the tax 
rates from the top bracket where they will be when the 2-year 
extension expires. So we are not counting the savings that come 
from leaving that provision in place as savings. That would be, 
you know, roughly speaking, $700 billion of savings. We are not 
counting it as savings because it is in the baseline.
    Senator Crapo. Understood.
    Mr. Lew. We have $368 billion of net additional revenues in 
our budget.
    Senator Crapo. But aren't you signaling that you want to 
see those taxes----
    Mr. Lew. Oh, yes. No, our policy position is they should be 
allowed to expire.
    Senator Crapo. All right.
    Mr. Lew. But we do not count them in our $1.1 trillion of 
deficit reduction because they are in the baseline.
    Senator Crapo. All right. And because of time, I want to go 
on here. I know there are other policy matters we could--in 
fact, I would like to get into. I would love to, but also with 
regard to your economic projections, it appears to me that you 
are projecting a significantly increased economic performance 
over what either the private sector in, say, the blue chip 
reviews show or CBO's projections that came out in January. Is 
that not----
    Mr. Lew. I am not sure I would agree that they are 
substantially, but they are somewhat more optimistic. The 
assumptions that we have are in the middle range of what the 
Federal Reserve looks at when it looks at economics, and it is 
consistent with the recovery from past financially led 
recessions. In fact, it is a little bit slower in getting to 
recovery. The basic difference between the two is that we 
assume that over a longer period of time we will get back to 
the economic growth we had before the recession.
    The other assumptions assume that we are permanently going 
to be lower. We think that our assumption there is right. The 
trajectory may or may not be right. We may be year-to-year--you 
know, it is hard to hit these things on a bull's eye. But 
conceptually I think we have the right assumption.
    Senator Crapo. Thank you. Again, I would love to go deeper, 
but I am out of time. Thank you.
    Chairman Conrad. I thank the Senator for respecting the 
time.
    Senator Coons.
    Senator Coons. Thank you, Mr. Chairman.
    Director Lew, thank you for your presentation so far today. 
I am hopeful that this budget--that this conversation at this 
Committee and elsewhere will serve as a catalytic event, that 
the members of this Committee who are expressing disappointment 
at the failure to sort of grasp the larger challenges in front 
of us in this budget will be able to work in a bipartisan way 
to find a path forward.
    I do find there are some things in this budget about which 
I am encouraged. R&D tax, credit permanence is something I have 
championed, and the domestic spending freeze, and the 
willingness to make differing cuts, deep cuts in some areas, 
but still sustain innovation, education, and infrastructure 
investments I think is wise, and being willing to pay for the 
doc fix and the AMT fix I think are good moves, and there are a 
number of things I would love to get into--the pay-for-success 
bonds, the race-to-the-top methodology, and Federal property 
disposition--if we have time later.
    But your written testimony and the comments of two Senators 
before me really focus on the Commission. The written testimony 
you submitted says that while the administration does not agree 
with every recommendation in the Commission's report, there are 
many areas of this budget that reflect the work of the 
Commission. I would be interested--I think the Bowles-Simpson 
Commission laid out the kind of strong, broad vision that we 
need to take on to tackle not just the deficit but, as was 
mentioned before, the debt for the long term.
    Where does the administration differ with the Commission's 
proposals? And where do you see them incorporated in this 
budget? Because I think in large part, the strongest, toughest 
work of the Commission is absent from this budget.
    Mr. Lew. Well, let me give you a few examples of ideas from 
the Commission that are in the budget: the move toward 
reforming medical malpractice policies so that we can deal with 
the impact that that has on health care costs; the approach to 
the corporate tax reform issue; our pay freeze for the Federal 
work force; the approach to tax expenditures. The way we are 
paying for the alternative minimum tax is essentially scaling 
back on spending on the tax side in a way that is consistent 
with the report.
    You know, I think if you look at the----
    Chairman Conrad. Could I stop you for a minute? Just to 
alert colleagues, a vote has started, and we are going to 
continue the operations of the Committee. Senator Murray has 
gone to vote. So I would recommend, looking at the line-up 
here, Senators Toomey and Johnson might want to go vote now so 
that you could come back and be in line. It might work best. I 
think others, you know, can stay because Senator Graham is next 
on this side, and on our side Senator Whitehouse is next. But I 
do think it would be wise for the two gentlemen to go vote now 
so they do not lose out on time.
    Senator Sessions. We need the official to add some time to 
the game clock here.
    Mr. Lew. Now I have to remember where I was in answering 
your question.
    Senator Coons. You had gotten to tax reform as being an 
approach for paying for----
    Mr. Lew. So, you know, I think if you look at what the 
charge to the Commission was, the charge to the Commission was 
to come up with a plan that would reduce the deficit to 3 
percent of GDP, not because we believe that that is an 
endpoint, but because we believe in order to get beyond that to 
do deficit--debt reduction, you have to first get to the place 
where you get to what we are calling primary balance.
    I think that, you know, there has been a lot of debate 
about Social Security, a lot of debate about Medicare. Let me 
say a word about Social Security.
    The President has indicated very clearly that he would like 
to work on a bipartisan basis to deal with Social Security, but 
not because it is contributing to the deficit in the short 
term. It is not contributing to the deficit in the next 5, 10 
years. The Social Security Trust Fund is in surplus until 2037. 
A lot of the expenses in the budget are driven by Social 
Security. As more of the baby boomers retire, they are going on 
to the Social Security program, as they have a right to and 
should, and that is driving spending up. And we have to be sure 
that we are funding Social Security so that it can keep that 
promise for this generation and the next generation. But it 
would not affect the window of this 5 to 10 years, and we need 
to keep them separate. The President would like very much to 
work together on a bipartisan basis to be able to deal with 
that.
    Senator Coons. So, Director, my question to you was which 
of the recommendations of the Commission has the administration 
rejected or differed with and unwilling to accept as we get 
going with the broader conversation about how to tackle not 
just sustainable deficits but what is a sustainable national 
debt.
    Mr. Lew. And I have to respond that you have heard a 
reticence to say what is unacceptable because it is important 
to leave ideas on the table. It is important that if we are 
going to have the serious bipartisan conversation, we not take 
hard lines on either side of an issue and that we allow the 
conversation to continue. I actually think that that is part of 
leadership in terms of how do you prepare the environment for 
the kinds of discussions that I hear so many people in this 
room--and we ourselves agree--believe need to happen.
    The easiest thing to do in Washington is to take an idea 
that is controversial and to kill it. The hardest thing to do 
is to create an environment where it is safe to have 
conversations and look for middle ground where reasonable 
people can agree.
    Chairman Conrad. I thank the Senator.
    Senator Graham is next.
    Senator Graham. Thank you, Mr. Chairman. And before I 
start, I would like to congratulate you and Senator Crapo and 
all the others who participated in the bipartisan Commission to 
kind of get us out of this mess. I really appreciate what you 
did.
    Mr. Lew, I want to pick up on your comments about Social 
Security. You sort of made an invitation on behalf of the 
President to see if we can find some common ground in saving 
Social Security from--I do not know if ``bankruptcy'' is the 
right word, but certainly a collapse down the road. Am I 
hearing you right, you would like us to work together?
    Mr. Lew. I can only point to the President's word in the 
State of the Union.
    Senator Graham. OK. Well, I am going to take you up on it 
right here in front of the whole country, anybody who is 
watching C-SPAN, cannot sleep. I really do believe that this is 
the year for Social Security reform and that the age adjustment 
from 65 to 67 was accomplished by Tip O'Neill and Ronald Reagan 
working together.
    Do you believe that adjusting the age for Social Security 
is something the President would be interested in if it was in 
a bipartisan fashion?
    Mr. Lew. Senator, I had the honor of working for Speaker 
O'Neill in 1983, advising him on Social Security, and I think 
the reason they were able to reach an agreement in 1983 was 
that for a prolonged period of time there were conversations 
going on where ideas were thought through and developed where, 
after a very, very bruising political battle in 1981, some 
trust was built up and there was the exploration of middle 
ground. I think that is what we need to do now. I do not think 
this is the time for----
    Senator Graham. Are we there yet for the middle ground, 
like means testing? You know, when I speak about this back 
home, I talk about my personal situation. When I was in 
college, my Mom died and then 15 months later my Dad died, and 
my sister was 13, my family owned a restaurant and a liquor 
store, and if it were not for survivor benefits coming into our 
family from Social Security, it would have been very difficult 
for us to make it. That check mattered. Well, I am 55, no kids, 
not married. When my time comes to retire, I could accept less 
benefits than those promised. I think a lot of people would 
probably do what I just said. Do you think the administration 
is open to talking about a means test in some realistic way?
    Mr. Lew. Well, I am going to be reluctant to address 
positions because I do not think it would be helpful to the 
process.
    Senator Graham. OK.
    Mr. Lew. But I would say this about 1983: The reason there 
could be an agreement in 1983 was that there was a provision 
that had not been law before which subjected Social Security 
benefits to income taxation. That was essentially saying that 
if you had other income and it put you in a place where you did 
not need the benefit as much, it was subject to taxation. One 
side considered it a tax increase. The other side considered it 
a benefit cut.
    Senator Graham. I understand the idea.
    Mr. Lew. It took a lot of work to get to that point.
    Senator Graham. Sure. What do we need to do to get to that 
point?
    Mr. Lew. I think having the kinds of conversations that we 
are having, continuing it. There will be----
    Senator Graham. Well, we are having a good conversation, 
but, you know, every time I put something on the table, you say 
we have to talk about--we need to talk about it behind closed 
doors. That makes sense. But you had a Commission--get back to 
me because I have only got a minute left and tell me where I 
need to go and who I need to meet with about finding a way to 
save Social Security from what I think is an unacceptable 
demise.
    Very quickly, to the President, this is the year--there are 
a lot of Republicans who understand entitlements have to be put 
on the table. We are reluctant to go by ourselves because, you 
know, this issue is easily demagogued. So I am just suggesting 
to you that there is a moment in time in 2011, before we get 
into the 2012 cycle too deeply, to find a way to do something 
meaningful on Social Security that would help our long-term 
indebtedness. Do not let that opportunity pass.
    Now we are going to go to a different issue right quick. 
Are you familiar that in 2014 the Panama Canal is going to be 
widened and deepened to allow sort of super cargo tankers to 
come through the canal?
    Mr. Lew. I will confess that I am not familiar with the 
current policy on the Panama Canal.
    Senator Graham. Well, I understand that, but there is a new 
way of shipping goods coming, and harbors on the east coast 
have to be deepened to accept these ships. The Charleston 
harbor needs $400,000 for the Corps of Engineers to study how 
deep the harbor will be. There is no money in the President's 
budget for that harbor. Only one million out of a hundred and 
something million dollars was spent on east coast harbors in 
the President's budget to get these harbors ready for the super 
tanker. Could you please study this and get back with me? 
Because if we do not deepen the Charleston port, that is the 
economic engine for the State of South Carolina and for the 
Southeast. These ships are coming. I want to make sure America 
is a place for them to dock. So could you get back with me 
about a plan to make sure we can service these ships coming 
through the Panama Canal?
    Mr. Lew. I am happy to look at it, and I do know that in 
terms of our general policy, we were very constrained because 
of the savings that we were looking for in the discretionary 
budget, and there are things that would be good policy and 
things we would like to do that we just did not have the 
resources to do. So not knowing that particular project, I 
suspect we did not put enough money into the category and, 
therefore, a good project could not get funded. But I will get 
back to you.
    Senator Graham. I look forward to working with you.
    Mr. Lew. Likewise.
    Senator Murray [presiding]. Senator Whitehouse.
    Senator Whitehouse. To followup quickly on Senator Graham, 
would you mind including me in his report as well? Because we 
have the port at Quoset Point and the port of Providence that 
are also in a similar situation.
    Mr. Lew. Sure.
    Senator Whitehouse. On the question of Social Security, 
when you were working for Speaker O'Neill back in 1983 on that 
compromise, the perils facing Social Security were imminent, 
were they not?
    Mr. Lew. They were imminent. There was----
    Senator Whitehouse. And now Social Security is sound at 
least until what year?
    Mr. Lew. 2037.
    Senator Whitehouse. 2037, OK. I want to shift to the 
question of the revenue and tax side, and I want you to imagine 
a hospital orderly who is pushing a trolley late at night down 
the halls of Rhode Island Hospital and is earning $29,100 a 
year, which is the average pay for a hospital orderly in the 
Providence area. That person will pay about 16.7 percent of 
their income in total Federal taxes. At the same time, the IRS 
just reported, based on the most recent information available, 
that the 400 top income earners in the United States of America 
who earned on average $344 million each that year, more than a 
third of a billion dollars each that year, actually paid taxes 
to the Federal Government at the rate of 16.6 percent; i.e., 
the hospital orderly pushing the trolley down the halls of the 
hospital at 2 in the morning is paying a higher tax rate right 
now in this country than the 400 top income earners who are 
bringing home a third of a billion dollars a year.
    Now, I have nothing against people making a third of a 
billion dollars a year. That is America and this is wonderful. 
But does it make sense for the hospital orderly to be paying a 
higher Federal income tax rate all in than they do?
    Mr. Lew. Is that a question you want me to answer?
    Senator Whitehouse. Yes.
    Mr. Lew. I think you have put your finger on something that 
is a real issue, that we have a tax system that is very 
lopsided, and the proposals that are in this budget to let the 
rate cut for the highest earners, the top bracket, not remain 
at the lower level but to revert. The proposal we have to limit 
the value of itemized deductions in the top bracket would do 
something to kind of rebalance the system.
    I do not know what it would do to that specific comparison. 
I would have to go and look. But it certainly would affect it.
    Senator Whitehouse. And if you look at corporate taxes and 
take a sort of long view through history, if you go back to 
1935, for every dollar that an American chipped in to fund the 
Federal Government, an American corporation chipped in a dollar 
to fund the Federal Government. By 1948, for every dollar that 
an American chipped in, an American corporation was only 
chipping in 50 cents. It was two bucks in individual revenue 
for every one dollar in corporate revenue. In 1971, it got to 
$3 in individual revenue for every dollar in corporate revenue. 
In 1981, it got to $4 in individually paid--regular Americans 
paying taxes, revenue, for every $1 that corporations paid. And 
in 2009, we hit 6:1. So for every dollar that an American pays 
in, a corporation only pays one-sixth of a dollar. Or otherwise 
said, for every dollar that an American corporation pays in 
revenue to support the Government, American human beings have 
to pay $6.
    There is a pretty clear trajectory on this. Where do you 
think that trajectory should end? And if you could put that in 
the context of the $123 billion in corporate tax loopholes that 
the Joint Committee on Taxation calculated in the 2010 fiscal 
year 2009, I would appreciate it.
    Mr. Lew. Senator, this budget does a number of things. 
First, it has a number of proposals that would limit certain 
corporate deductions, things like in the fossil fuel area that 
I mentioned in my opening remarks, some of the provisions with 
regard to companies that move jobs overseas. So it would have 
an effect on the margin of shifting that balance. I do not know 
that it would shift it materially because there are, as I say, 
individual proposals.
    At the core of what this budget says on corporate taxes is 
that we need to do corporate tax reform so that we can be more 
competitive and can create jobs in the future. And to us, what 
that means is that we have to in a revenue-neutral way--we 
cannot increase the imbalance. We have to broaden the base by 
reducing the deductions, the special interest provisions, and 
lower the rates.
    That is something that we think is critical to our economic 
future and to our competitiveness, and that is why the 
President spoke to it both in the State of the Union and the 
budget.
    Senator Whitehouse. Thanks, Mr. Lew. My time has expired.
    Thank you, Chairman.
    Senator Murray. Senator Ensign.
    Senator Ensign. Thank you and, Director Lew, thanks for 
being here. I, too, want to compliment you for your service in 
the past, and we all have a great deal of respect for you and 
understand you are working within the constraints of an 
administration.
    We have talked about this, and many of us have said that 
these votes that we are going to take politically are going to 
be very, very difficult votes. It is much easier to get re-
elected when you are giving money away, basically. When you are 
creating new programs, new initiatives, you go back home and 
you tout those. Those are much easier to get re-elected. And I 
realize the President is very concerned about his re-election, 
as all Presidents going toward a second term are. But this is 
not a time in our country where we can afford to worry about 
our elections nearly as much as we can the country. And I 
actually--this was not a time for, in my opinion, political 
cowardice. I believe that this budget misses the mark 
dramatically because the ideas, the cuts, there are no 
entitlement reforms in this bill, and we are still adding 
massive amounts of debt.
    You said we are living within our means. Now, let me just 
try to ask you, if you were a family--you used the family 
credit card as the example. OK? And you said that, well, we 
first--and I agree with you. We first have to tear up the 
credit cards. But tearing up the credit cards means you are not 
increasing spending. OK? You are not increasing spending. Does 
this--not as a percentage of the economy, does this bill 
increase spending?
    Mr. Lew. If I could just use the example again, if you stop 
adding to the balance on your credit card, you still add 
interest while you are paying it down.
    Senator Ensign. That is right. So----
    Mr. Lew. The analogy is the same.
    Senator Ensign. It is correct, and so we are getting 
further in debt because of our interest rates.
    Mr. Lew. Yes.
    Senator Ensign. Every family knows that. So this bill, 
because the spending cuts are not enough, allows the interest 
rates to take us further into debt is the point. Is that 
correct?
    Mr. Lew. I do not disagree with that.
    Senator Ensign. OK. I just wanted to make sure because some 
of the other stuff to me is double talk because we are still 
going further into debt massively.
    Mr. Lew. The terminology that we use in Washington of 
primary balance is a little confusing, but----
    Senator Ensign. Well, it is because I believe it is 
dishonest. It is the way politicians, Republicans, Democrats, 
for years have talked about things in order to not have to make 
the tough votes. It is critical, I believe, because the debt 
that we are facing and the interest payments on the debt--the 
CBO Director sat there and said it is unsustainable. He has 
said Government spending is actually crowding out private 
sector investment to create jobs.
    The report that the Chairman talked about in his opening 
statement, or maybe it was in his questions, he said that when 
gross debt equals 90 percent of a country's economy, which is 
where we are today, that is a decrease, a net decrease of 1 
percent of GDP, which translates into about a million jobs in 
America. So we are hurting future prosperity of Americans 
because of this overspending that we have, and that is why I 
said we are willing to join the President on entitlement 
reform. Republicans are standing ready for the President's 
leadership. I hope you take that message back to him. We will 
make the tough votes. We will take--but we cannot do it alone. 
Republicans are in the minority in the U.S. Senate. We need to 
join with Democrats to do this. I think the Chairman has shown 
leadership on this. But we need desperately White House 
leadership, and this budget, this State of the Union address, 
did not do it. We have two more chances this year--we have the 
CR and we have the debt ceiling--to show Presidential 
leadership where we are going to be serious about spending. And 
I hope that you will take that message back to the President 
that we are willing to join him so that neither side is taking 
as much political heat as would normally be taken in a 
situation like this, so we can both show the political courage 
to do what is right for the country.
    Mr. Lew. Senator, if I may, you know, I think that in order 
for there to be bipartisan agreement at any point, you need 
bicameral and bipartisan participation. I think there are 
different kinds of conversations happening in different places, 
and that is not unusual that you do not just get to the point 
where you have an agreement. You have to work your way to it.
    I have to take issue with your characterize of the budget. 
I do not agree that it is a budget that has the flaws you 
describe.
    Senator Ensign. Then answer me this: What percentage of 
total spending over the 10 years did you decrease? What 
percentage of total spending did you decrease in this budget?
    Mr. Lew. I mean, obviously there is a lot of different 
categories of spending and----
    Senator Ensign. Total spending. Just total spending.
    Mr. Lew. The reason I am resisting just accepting the 
framing of your question----
    Senator Ensign. How about it is less than one penny out of 
every dollar?
    Mr. Lew. But it is important to unpack what is driving 
spending.
    Senator Ensign. I asked the CBO Director that question, and 
that is what he said. It is less than one penny.
    Mr. Lew. But if I may just take 1 minute to answer?
    Chairman Conrad [presiding]. Let me just say that the 
Senator's time has expired, but you can answer this question, 
and then we have to go.
    Mr. Lew. Thank you, Mr. Chairman.
    The spending that we control on an annual basis is coming 
down quite dramatically. The $400 billion that we save in the 
non-security discretionary part of the budget would bring 
spending in that category down to its lowest level as a 
percentage of the economy since the 1950s. There is continuing 
growth of spending in programs like Social Security and 
Medicare because the baby boom is retiring, people are taking 
the benefits that they have paid for, and there is nothing 
wrong with that. So spending will go up during this period even 
while we are taking action to cut spending that we control. And 
I think we just have to be careful to separate those issues.
    I do not think that the solution to spending as a 
percentage of the economy going down is simply to put an 
arbitrary number in there because what that would have the 
effect of doing, it would mean that you would say that people 
turn 65 or 67 and they cannot get their benefits. And that is 
not what anyone means.
    Chairman Conrad. Senator Murray.
    Senator Murray. Thank you very much, Mr. Chairman, and 
thank you, Director Lew, for your experience and credibility on 
bringing this budget to us.
    I wanted to just mention on the Veterans Affairs funding, I 
see that the President has requested an increase of $2.7 
billion over the current year, and that appears on my first 
review to be sufficient. I did want to say, as Chair of the 
Veterans Committee I believe construction money does have to 
follow a vision on health care spending. And I am going to be 
talking with Secretary Shinseki over the coming few weeks about 
the mental health and women veterans' issues and making sure 
that some of the cost-saving proposals do not affect the 
quality of VA care.
    I did want to ask you specifically while you are here a 
real immediate concern that I do have on the veterans 
caregivers benefits. As you might know, VA's implementation 
plan for that bill that we passed here in Congress without one 
negative vote was overdue, and once the VA did submit it, it 
veered dramatically from the bill that we cleared here in the 
House and Senate. Rather than following Congress' intent, the 
administration set some overly stringent hurdles that are 
really going to deny help to caregivers that we intended that 
bill to be for. We are talking about a very small population of 
wounded warriors, and I cannot think of any reason why the 
administration would err on the side of diminishing that 
benefit. And I wanted to ask you while you were here if you 
would commit to taking another look at the VA's plan, compare 
it to the law that we passed, and remove some of those 
unnecessary benefits.
    Mr. Lew. Senator, I am familiar in general with the 
provision. I have to apologize. In the 8 weeks I have been at 
OMB, I have followed this issue some. I know there are 
conversations going on now that I frankly have not been able to 
participate in because of my work on putting the budget out. 
But I will get back into that conversation.
    Senator Murray. OK, and I think I said ``benefits.'' I 
meant eliminate the barriers. If you could look back at that 
and come back to me within 30 days, I would really appreciate 
it. There are families out there waiting for this benefit that 
passed, and we want to make sure it is implemented accurately.
    I did want to ask you about the work force section of your 
budget. There are about 14 million people today in this country 
that are unemployed. More than 40 percent of them have been 
without a job for 6 months. So I am very concerned that the 
administration is choosing to cut funding for job training 
programs. I was at home recently and talked to a small business 
owner who serves on a local work force investment board, and he 
was telling me about a recent hire that he did make through a 
one-stop career center, and the success of that, particularly 
because it was a veteran that he hired through that. And it 
just seems to me at this time when we are trying to match 
skills and get people with the skills that they need with an 
unemployment this high that job training is really a critical 
part of our investments. So I wanted to ask you if you can give 
us the administration's rationale for cuts when jobs and 
economic recovery should be our central focus.
    Mr. Lew. Senator, we have had obviously many difficult 
decisions to make in this budget to live within the spending 
restraints, and one of the things we have done is consolidated 
programs in areas where there was duplication. We have looked 
to try and fund programs that were high- performing programs, 
and this is a case where, you know, we have training and 
employment services funded at roughly the level they were at in 
2010. It is a little bit higher.
    In general, we looked at 2010 as kind of the base because 
we do not know what 2011 is with the appropriations still 
undecided for the year. So we looked to put together a program 
that was overall balanced and investing in the programs that 
work and consolidating, and I would be happy to get back to you 
with more detail.
    Senator Murray. OK. I would appreciate that. I just think 
it is really important that we do not leave that out when that 
is what is getting people jobs today.
    And real quickly in just my last minute, I really wanted to 
tell you thank you for the EM budget. I know it is something 
you and I have talked about for a long time, and I think the 
administration recognizes it has legal obligations when it 
comes to that funding. And I really appreciate the effort you 
put into that.
    I think we still have work to do moving forward. I see that 
the administration is committed to modernizing our nuclear 
weapons facilities in the coming years. I notice that OMB has 
said it will ensure that future allocations to that effort are 
going to occur in the required amounts, and that is something 
that is unusual for OMB to commit to. So like I have been 
saying for a long time, it is exactly where we need to go with 
the EM budgets for fundamental legal reasons and because there 
is also massive amounts of human and monetary capital wasted 
when EM does not have a stable budget. We have to make sure 
that those budgets are effectively done right for the long 
term. So that is something I am going to keep working with you 
on, but I wanted to thank you for your commitment in this 
budget.
    Mr. Lew. Thank you, Senator.
    Chairman Conrad. Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman.
    Director Lew, thank you very much for being with us today. 
I have to share the concern and disappointment that several of 
my colleagues have already expressed about what I see as a real 
lack of leadership here, a lack of taking this critical moment 
to seize the opportunity. I really think the American people 
want us to make the big, tough decisions that assure us that it 
will restore a fiscally sustainable path. And I do not think 
this budget does that.
    By your numbers, the total debt held by the public levels 
off somewhere in the mid to high 70s as a percentage of GDP, I 
guess around 76 percent or thereabouts. It starts to move up 
toward the end of your 10-year outlook. My suspicion is it is 
on a trajectory that continues to rise higher after that.
    But what really concerns me is I think there is a 
significant likelihood that the numbers are actually 
considerably worse than what we are looking at here, and three 
things come to mind. I want to make sure that I have these 
things factually correct, though.
    The first is the way you are dealing with the AMT. My 
understanding is that for a limited period of time, I think 3 
years, the assumption is that the AMT will not capture the new 
group of people that it would otherwise capture. There are 
offsets to that. But, thereafter, the assumption implicit in 
these numbers is that the AMT will not be patched anymore and 
that there will be this revenue coming in to the Government as 
it goes unfixed in subsequent years. Do I have that right?
    Mr. Lew. Not exactly, Senator. What we have done is we have 
paid for 3 years of the so-called patch so that the AMT will 
not cover middle-class families. We have said we think it 
should be paid for permanently. We have not taken the credit 
for that, so our deficit projections assume that it is fixed 
and not paid for. Were we to pay for it, which is what we would 
like to do on a bipartisan basis, it would reduce the deficit 
by an additional 1 percent of GDP.
    Senator Toomey. OK.
    Mr. Lew. So there is a substantial upside if we can do the 
right thing on the AMT.
    Senator Toomey. If we did. So your numbers assume that no 
middle-class family is ever captured by the AMT.
    Mr. Lew. It assumes the patch continues, but it is only 
paid for for 3 years.
    Senator Toomey. OK.
    Mr. Lew. We thought it was a bit of a heroic assumption to 
assume we paid for it over the whole period.
    Senator Toomey. Right. I would agree.
    Mr. Lew. We put in the offsets for the first three.
    Senator Toomey. Right. With respect to the doc fix, my 
understanding is that there is a period of time--I think it is 
2 years--for which the assumption is that the doctors would not 
experience a draconian cut in reimbursement rates. After that 
2-year period, is it implicit in these numbers to assume that 
the doctors will, in fact, have that cut?
    Mr. Lew. So the doc fix is a little bit different. In the 
case of the doc fix, first, Congress last year paid for it. So 
we have, unlike the AMT, a first case of Congress saying even 
though the budget rules did not require it to be paid for, the 
right thing to do was to pay for it, and I applaud the Congress 
for doing that. We worked with the committees to make that 
happen.
    We have now put in $62 billion of specific offsets to pay 
for two more years of the doc fix, and what we have said beyond 
that is that we need to work together to come up with a 
reimbursement system that does not have to be patched from year 
to year. And we think that the pattern and practice of paying 
for the doc fix last year, delineating specific offsets for the 
next 2 years, and working together to reform the reimbursement 
system and pay for it, we do not--we assume that it is fixed 
going forward.
    Senator Toomey. I am not sure I understood your answer, 
because the question--my question fundamentally is do these 
numbers assume that the doctors take the cut in reimbursements 
that is currently projected in law but the Congress has always 
postponed.
    Mr. Lew. What it assumes is that we fix the system so we do 
not have to cut the rates.
    Senator Toomey. So does it assume the savings to the 
government----
    Mr. Lew. Well, it assumes net zero because it assumes we 
would work together to fix it and pay for it.
    Senator Toomey. Although we have not figured out how we are 
going to do that.
    Mr. Lew. We now have 3 years to do it if we get this.
    Senator Toomey. I think that is quite an assumption to make 
given the circumstances.
    The other concern that I have is the assumptions that go 
into calculating our interest expenses, our projections on 
interest expenses. My understanding is, right now, the average 
cost of servicing our debt is something less than 3 percent, is 
the average weighted cost of our Treasury securities.
    Mr. Lew. Right. Our current rates are lower than that----
    Senator Toomey. Closer to two, in fact, right?
    Mr. Lew. Yes.
    Senator Toomey. The average rate that you assume in these 
numbers is a little bit higher than that, right?
    Mr. Lew. Umm----
    Senator Toomey. I think it is on the order of a little over 
4 percent.
    Mr. Lew. I think so, yes.
    Senator Toomey. I think, historically, over the last 20 
years, it has averaged closer to 6 percent. My point is----
    Mr. Lew. I have to confess, the economic assumptions were 
locked while I was awaiting confirmation, so I am not quite as 
familiar with them as I otherwise would be.
    Senator Toomey. Here is my concern. We are at a time where 
we are accumulating an unprecedented amount of debt. We have a 
Federal Reserve that is pursuing a policy of unprecedented easy 
money. They are creating a staggering amount of money. We have 
a huge growth in the money supply. We have a spike in commodity 
prices. And it is, I think, extremely optimistic to think that 
we are not going to have at least a reversion to the historical 
average of interest rates and a distinct risk that it would be 
much higher.
    I understand you have to pick a number and you have to make 
an assumption, but my point is that I think there is a very, 
very dangerously high risk that our interest expense ends up 
being much, much higher than these numbers.
    Mr. Lew. You know, obviously, the economic assumptions are 
based on a number of factors. We think they are in the middle 
range in terms of being reasonable assumptions. There is one 
aspect of our assumptions on the growth side where there is a 
conceptual difference, but on the interest rate assumptions, I 
think they are in the mainstream, and we can get back to you 
with details.
    Senator Toomey. Thank you. Thank you, Mr. Chairman.
    Chairman Conrad. Senator Stabenow.
    Senator Stabenow. Thank you very much, Mr. Chairman.
    First, I would followup on my colleagues, Director Lew. I 
would just answer, as the person who had the legislation to 
completely fix the doc fix, or what has been called the 
sustainable growth rate problem, which does not work at all. I 
would say I am going to assume, and you can assume, that 
doctors are never going to get that cut because I cannot 
imagine that happening. So we have to get that fixed, and I 
appreciate that you at least put in a 2-year fix going forward.
    There are a number of things that I would like to ask. I 
will focus on a couple, but first start by saying that I 
appreciate the work that has been done. I know that cutting 
discretionary spending back to the percentage of GDP under 
President Eisenhower is no small thing, and so I appreciate 
very much what you are focusing on. It is tough. There are 
things that we know we need to do. Every family has to cut 
their budget, has to tighten their belt, and we do at the 
Federal level, as well, and so we have to start from that 
premise but also be smart about it. And so I think those are 
the challenges for us, as to what we need to strategically 
invest in.
    The first point goes to something specific to the Great 
Lakes. The President cares about the Great Lakes. I care about 
the Great Lakes. We have had a significant investment in Great 
Lakes restoration in this budget that is cut. My question is 
whether or not you believe that there are the resources 
available to protect the Great Lakes from Asian carp coming 
into the Great Lakes. This is, as you know, a serious issue 
that would undermine our tourism and boating industries and 
cost us jobs and would have a tremendous impact, the fact that 
these fish are coming up through the Mississippi River and are 
dangerously close to the Great Lakes. And so whether it is 
Great Lakes restoration or the Army Corps of Engineers, I need 
to know that there are sufficient resources available to make 
sure that stopping the Asian carp is a top priority for the 
administration.
    Mr. Lew. Senator, the funding level for the Great Lakes 
Initiative obviously is reduced, but it is not eliminated. We 
continue with the initiative. I would have to go back and check 
on exactly what the status of preventing the carp from swimming 
upstream, as it were, is. I am happy to check and get back to 
you.
    Senator Stabenow. Thank you. Let me turn now to the other 
important piece of this and that is the fact that we have a 
serious deficit. I was proud in 1997 to cast a vote with many 
of my colleagues to balance the budget for the first time in 30 
years under President Clinton and very dismayed that we are 
right back in a worse position now and we will dig our way out 
of it again. We have to.
    But we also know that we are never going to get out of 
deficit with more than 15 million people out of work.
    Mr. Lew. Absolutely.
    Senator Stabenow. And so that is why we have to focus on 
jobs, as well. Andrew Liveris, who is the CEO of Dow Chemical 
Company, based in Michigan, is the author of a new book called 
Make It In America, which I would recommend you taking a look 
at. In his book, he says, at a time when U.S. companies run by 
patriotic people are moving offshore at the fastest rate in 
history, we should, at a minimum, recognize that the model we 
are relying on is not working. It is time to recognize that if 
we do not act soon, if we continue to let markets rule in every 
instance, we will become the global economy's biggest bystander 
and potentially its biggest drain. Our U.S. companies are 
competing with countries that are subsidizing entire 
industries. As Mr. Liveris says in his book, we need to get 
into the game and play to win.
    I believe that the budget makes some important steps in 
that direction, focusing on smart investments like clean energy 
technology and advanced manufacturing, education, work force 
development. So I am wondering, Director Lew, if you could 
please explain how the administration analyzed the various 
programs in the budget and how you determined which programs to 
invest in to strengthen our competitiveness and to create jobs 
making things in America.
    Mr. Lew. Thank you, Senator. I think if you look at the 
investments in this budget, in education, in innovation, in 
building our infrastructure, they are all tied to answering 
that question. When you talk to CEOs, as I have over the last 
months, one of the things they say is they need to get high 
school and college graduates who have the skills in science, 
math, engineering, technology to do the work. It is becoming 
more of a challenge. So that is something that our education 
system, we can do that.
    Innovation, we know that in innovation, America has been 
the leader in the world and it is drive by a great partnership 
between Federal funding, government funding of basic science 
and innovation in the private sector, adapting it and taking it 
to commercial application.
    And in terms of infrastructure, we have to have both the 
ports and roads that make it possible to be connected to the 
world, but also the electronic connections so that we can 
communicate and create virtual hubs in any part of our country, 
and the budget invests in all those things.
    Senator Stabenow. Thank you.
    Chairman Conrad. Senator Johnson.
    Senator Johnson. Thank you, Mr. Chairman.
    Director Lew, nice to meet you.
    Mr. Lew. Nice to meet you, Senator.
    Senator Johnson. I am hoping you are hearing, at least from 
our side of the aisle, that there is a real readiness here to 
seriously address these problems, and I guess I agree with my 
colleagues that we are not seeing real leadership being 
presented by the President here and it is disappointing. So if 
the President is willing to show real leadership, I think you 
have an awful lot of people on this side that are really 
willing to work with him and take the hard votes.
    As the new kid on the block here, I might have some nuts 
and bolts questions that I would like to ask. First of all----
    Mr. Lew. That usually precedes the hardest questions.
    Senator Johnson. Oh, I do not think so. These should be 
easy.
    I am looking at your proposed budget spreadsheet form here 
and I am seeing numbers that go from a deficit of $1.645 
trillion out to $774 trillion. That adds up to $8.9 trillion 
cumulative deficit over that 11-year period. But the gross debt 
is growing by $12.9 trillion, or $12.8 trillion. Can you 
explain that $3.9 trillion difference to me?
    Mr. Lew. Well, the gross debt includes both debt held by 
the public and the trust fund debt, so--and from now until 
2025, the Social Security Trust Fund will be building up 
balances, and then it will only be actually in deficit after 
2025. So from now until 2025, we have additional Social 
Security balances being built up. I do not know if it explains 
the whole amount, because there are other trust funds, but that 
is probably the phenomenon.
    Senator Johnson. How realistic is that, though, because 
have we not for the first time slipped into deficit imbalance 
in terms of Social Security payments versus payouts?
    Mr. Lew. Social Security is drawing on the trust fund, but 
it is not in deficit, no.
    Senator Johnson. OK. So again, that 3.9, you are saying, is 
probably--most of that would probably be Social Security Trust 
Fund.
    Mr. Lew. Yes.
    Senator Johnson. What is the rationale for even----
    Mr. Lew. I can get back to you and check.
    Senator Johnson. OK. What is the rationale of even talking 
about a primary balance?
    Mr. Lew. So primary balance is a term I did not invent, and 
I can say after today it is probably not the most artful turn 
of phrase. The concept is a sound one. The concept is that we 
need to have spending and revenue policies such that our 
current obligations, not counting interest, are all paid for. 
And then you have your built-up debt and you have to start 
paying down your debt. Until you pay down your debt, it still 
accrues interest. So primary balance means you are at the point 
where the only reason you have a deficit is that your built-up 
debt is still earning interest, paying interest.
    Senator Johnson. Yes, but you have to pay the interest----
    Mr. Lew. You have to pay the interest, yes. Yes.
    Senator Johnson. So it seems kind of silly to me to even 
talk about it because----
    Mr. Lew. Well, it is----
    Senator Johnson [continuing]. We are obligated to pay those 
interest payments, correct?
    Mr. Lew. Yes, but it is a very meaningful--if you think of 
a road that we have to be on where our goal is ultimately to 
pay down the debt, where ultimately to get to balance and then 
surplus, we have to cross through the point of stopping 
spending more on real expenses now and being in the place where 
we can freeze the principal, and if the interest is 
compounding, start to pay it down so it can be reduced.
    Senator Johnson. Well, again, we are a long ways from that 
because we are----
    Mr. Lew. A long ways.
    Senator Johnson [continuing]. We are not getting serious 
about it.
    Let me--in business, when you are putting together a 
budget, generally, you kind of look at worst-case scenario. I 
mean, you do not put in the most rosy scenario. From my 
standpoint, this is maybe not totally rosy, but certainly not 
the worst case scenario. I look at three areas of pretty 
primary risk here: Interest payment on the debt, the health 
care law--I believe you are probably still assuming that that 
will actually decrease the deficit, and then just your growth 
assumptions. What do you, of those three, which one do you 
think is the greatest risk in terms of not actually coming to 
fruition?
    Mr. Lew. You know, I think with any long-term economic 
assumptions, there are risks on both sides. In our budget 
documents and in our analytical perspectives volume, we show 
the risks, positive or negative. I cannot actually tell you--
none of us know whether we are going to be above or below in a 
lot of these areas. We have tried to come in in each of the 
cases with middle-of-the-line assumptions.
    In the one case that I described before, we have a 
conceptual difference and I think ours is right. We believe 
that the economy will return to where it was before the 
recession. It is just a question of how long it takes to get 
there. If you assume the economy will forever be reduced 
because of the recession, that will be the first time that we 
did not have a full recovery from a recession.
    On the others, I would be reluctant to hazard a kind of 
higher or lower than risk. We have tried to use middle-of-the-
range assumptions so that they can balance each other out.
    Senator Johnson. One quick question. Do you really believe 
the health care bill will reduce the deficit? Do you really 
believe that?
    Mr. Lew. Yes, I do.
    Senator Johnson. OK.
    Mr. Lew. So does the Congressional Budget Office.
    Chairman Conrad. Senator Nelson.
    Senator Nelson. Good afternoon.
    Chairman Conrad. Oh, I am sorry. Senator Cardin is back. 
Senator Cardin is--I apologize, Senator Nelson. Senator Cardin 
is back.
    Senator Cardin. Thank you, Mr. Chairman. Senator Nelson and 
I both serve on the other committee that we were balancing back 
and forth, but I promise I will not take very long.
    First, Director Lew, I want to ask the question following 
up on the confirmation hearings dealing with the Title 17 Loan 
Guaranty Program Senator Crapo and I both asked about during 
your confirmation hearings and that is the scoring the OMB does 
for these loan guarantees. And I will ask that you get back to 
me and ask whether you can handle this administratively or 
whether legislation is going to be needed in order for us to be 
able to move forward with these loan guaranty programs so that 
we can advance on the nuclear power front. So would you get 
back to me on that?
    Mr. Lew. I will get back to you, Senator. I mean, we have 
worked--in the brief time I have been back at OMB, we have 
worked on all these loan guaranty programs trying to get to a 
place where it is more transparent what is going on, and the 
responsiveness is clear, and if you have questions, I would be 
happy to respond.
    Senator Cardin. Well, we believe--it is really causing a 
problem, the way that the scoring has been done, and 
discriminates against certain States over others based upon 
their regulatory structure. That was never our intent. So I 
would ask that you would take a look at this again----
    Mr. Lew. I will take a look at it.
    Senator Cardin [continuing]. So that we can move forward. 
Thank you.
    I want to sort of get to the overall thoughts. 
Unfortunately, your budget is being released at the same time 
we are dealing with the Continuing Resolution in the House, and 
we will have to deal with that also in the Senate, and there is 
a lot of focus right now on discretionary spending because of 
the Continuing Resolution that needs to be passed. Now, I think 
you have come in with a rather aggressive approach for 
discretionary spending. The $400 billion savings, to me, is a 
significant part of the overall strategy to bring the deficit 
under control. A freeze is a freeze. It is going to cause us to 
make some very painful judgments. And we saw in your budget 
that you made some painful suggestions. I disagree with some of 
those and I am hoping that we can adjust the priorities. But I 
think the overall goal that you have set is attainable and can 
be done without disruption to our economy and to our programs.
    But at the same time, you need to look at the other major 
factors, whether it is entitlement spending or the revenue side 
and tax reform. It is interesting that your budget extends a 
lot of the tax policies, whether it is AMT or the rates for 
under $250,000. Do you have a dollar amount associated with how 
much the extension of those tax provisions will cost over the 
next 10 years so we can try to put this in proper perspective 
as to what we are doing with the budget deficit?
    Mr. Lew. Senator, do you mean the AMT pay for or----
    Senator Cardin. The AMT pay for. You also extend some of 
the other tax provisions, particularly for those under $250,000 
income----
    Mr. Lew. The AMT is $321 billion over 10 years, and the 
others, I would have to--I can look them up.
    Senator Cardin. But they are substantial.
    Mr. Lew. Oh, yes, yes, yes----
    Senator Cardin. I mean, they are going to be----
    Mr. Lew. They are substantial.
    Senator Cardin. We are getting into the trillion dollar 
range, if not higher than that.
    Mr. Lew. The extension of the middle-class tax cut that is 
in the baseline is very substantial----
    Senator Cardin. Substantial--trillions.
    Mr. Lew [continuing]. And were we to extend the upper-
income tax cut, which we do not, it is very substantial, as 
well.
    Senator Cardin. I think that was about $700 billion----
    Mr. Lew. Seven-hundred-and-nine billion.
    Senator Cardin. Yes, if I remember correctly.
    Mr. Lew. And the additional cost of the estate tax 
provision that was enacted in December for 2 years compared to 
the 2009 policy is another $98 billion. We assume that it goes 
back to the 2009 policy.
    Senator Cardin. And the reason I mention that is that we 
are getting into this debate on the discretionary spending 
side, and I think the proposal that you brought forward is one 
that is going to cause some really difficult choices to be 
made, but it is the right policy for us to achieve. But if we 
do not achieve that by also reforming our tax code, we are 
never going to get to the type of results that are going to be 
fair for the American people in balancing the budget but also 
balancing our priorities.
    And I think that we need to know how much money we are 
spending, for example, on tax expenditures. We do not exercise 
anywhere near the same discipline on tax expenditures as we do 
on discretionary spending. So if we are going to be able to 
have a credible plan for the deficit, we cannot just talk about 
the discretionary spending side. We really need to get beyond 
that.
    Mr. Lew. I totally agree, Senator, and the reason that we 
have put forward as a way to pay for the Alternative Minimum 
Tax, limiting the deductions in the top bracket, is because it 
begins to get at that question of tax expenditures and 
curtailing how much we are spending on the tax side. It is 
obviously not the last word on the subject, but it is an 
important step.
    Senator Cardin. We need tax reform, and we desperately need 
it. We are going to need leadership from the White House and we 
are going to need bipartisan leadership here in Congress in 
order to be able to achieve that.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you.
    Senator Portman.
    Senator Portman. Thank you, Mr. Chairman, and Director Lew, 
having been in your shoes 4 years ago, I remember this being a 
very hectic week. You seem more relaxed than I was at the time, 
probably because you have been through it before.
    You probably heard some of the commentary from my 
colleagues today and from me about this budget. I am very 
disappointed because I do not think it rises to the challenge 
that you yourself have set out or the President had set out, 
and I wish I could say otherwise. By the way, I think there are 
some opportunities, and Senator Cardin just talked about one, 
and the Chairman has talked about this, as well, which is tax 
reform that is not in the budget that would help in terms of 
creating the economic growth that enabled us 4 years ago to be 
able to propose a balanced budget over 5 years because we had 
substantial revenues coming in and a deficit that was roughly 
one-ninth of today's deficit.
    So at the risk of doing sort of the specific critiques that 
used to drive me crazy, let me give you some critiques that I 
see in this budget and get your response, because I may be 
misreading it. As I look at it, getting into some of the 
details, I see about $960 billion in what I would call either 
imaginary or unspecified savings, in one case wishful savings, 
and we have talked about some of them today, but not all of 
them.
    The doc fix we have talked about, and Senator Stabenow said 
she was pleased to see that you covered the doc fix through 
2013, I look at that very differently. I see about $62 billion 
in savings, but those are 10-year savings, and actually on an 
annual basis over those years it covers only about 8 percent of 
the costs for those two fiscal years and I wonder how that is 
considered a doc fix. If you look at the $315 billion in 
unspecified savings that you have for the doc fix, I am not 
sure where that comes from.
    You look at the trust fund for transportation, it is called 
the Bipartisan Financing for Transportation Trust Fund--I guess 
that means Democrats and Republicans are both going to pay 
higher taxes--but I am not sure what that means. I have been 
told it is a gas tax hike, but that is not what it says in the 
budget, and I have been told by others it is not a gas tax 
hike, so it seems to me that is unspecified.
    And last, of course, the AMT relief. We have talked about 
that. I guess you have clarified today for me that it is a 
reduction in tax expenditures related to limiting deductions on 
high-income individuals. That has always been considered a 
dead-on-arrival proposal, as it was last year in the budget, so 
I think that may not be imaginary or unspecified but may be 
wishful.
    If you add all these up, you get to a deficit that would be 
higher by about $964 billion, almost $1 trillion. Of course, 
that virtually eliminates the, I think, $1.1 trillion savings 
that you all are claiming in the budget. So I am just--I am 
concerned about the overall budget and the big picture we have 
talked about today because it does not address the fundamental 
issues. It does increase the debt substantially, doubles it 
over the 10-years. But also, even the savings here, I wonder if 
you could tell me why you think these are real savings.
    Mr. Lew. Senator, I am happy to. You know, I think if you 
take these items individually, the offsets that we use to pay 
for the 2-years of the so-called doc fix are very real savings. 
There is in the program integrity area 16 specific line item 
proposal. We have policy behind each of them.
    I think the notion of pay-as-you-go rules are that you can 
take savings over 10 years and apply them to spending within 
the 10-years and that is how we pay for it. So it is consistent 
with pay-as-you-go scoring and I think that is a very solid set 
of proposals.
    Senator Portman. These are Medicare savings over 10 years--
--
    Mr. Lew. It is a combination of Medicare, Medicaid, Federal 
Employee Health Benefit Program. It is a variety of very 
specific policies.
    Senator Portman. You pay for the 2-years----
    Mr. Lew. I would say that on the surface transportation 
bill, we are very clear in the budget that if we can work 
together on the policy for the investments, we need to also 
work together on the policies of paying for it because we do 
not get one without the other. So I do not think that--it does 
not increase the deficit. It just increases the risk of whether 
or not we can fund the surface transportation priorities. There 
are a lot of different ways that one could fund them, and in 
the past there has been--it has been an area where there has 
been the ability to work together on a bipartisan basis. We may 
have disagreements on the priorities. It may not be that the 
program is one where we all agree.
    Senator Portman. No, I think--let us assume we agree on 
that, but there is----
    Mr. Lew. The pay-fors will have to follow or we do not get 
the investment.
    Senator Portman. This is a budget that claims the pay for 
and you are just out there that the pay for, we will figure 
out.
    Mr. Lew. On the AMT, we do not count savings beyond the 
provision I have described. And on the doctor fix in the out 
years, you know, it is--there is going to need to be a debate 
on what to do to resolve this so that we do not have to deal 
with it on an annual basis, so we have a reasonable policy on 
reimbursement and we do not keep going back to something that 
everyone agrees cannot happen. And that is what we are 
proposing that we work together to do in this 3-year window 
that we pay for.
    Senator Portman. Mr. Chairman, I do not know how much time 
you are allotting us. It went down to zero and back up to 3 
seconds----
    Chairman Conrad. No, that means you are 32 seconds over.
    [Laughter.]
    Senator Portman. OK. All right. Well, I have a number of 
other questions. Again, thanks for being with us today, 
Director Lew, and I hope we will have a chance for a second 
round.
    Chairman Conrad. Senator Nelson.
    Senator Nelson. Thank you for your public service. Putting 
this together has been tough for you. It is a good first step, 
but we have a long way to go.
    And one of the President's stated goals is to expand the 
economy by expanding exports through our trade, and it was 
raised earlier and I want to underscore it. With the Panama 
Canal being expanded so that it can accommodate the very 
largest of the cargo ships coming from Asia so they do not have 
to dock in California and then incur the cost of taking the 
cargo off and putting it on rail or trucks and sending it to 
the East Coast, these large ships are going to be able to come 
right through the Panama Canal and come to East Coast ports and 
that is going to increase a good bit of activity both coming in 
and going out, a lot of economic activity.
    But most of the ports on the East Coast cannot receive the 
new large cargo ships because you have to get the channels 
dredged deeper. There are just about three ports on the East 
Coast that can accommodate the deep ships and there are others 
that want this, and yet there was no, despite pleas and begging 
on my knees for a de minimis new start, which we can match 
local and State funds for deepening channels, there are none in 
here. So this has already been addressed. I want to add my 
comment and you are to get back to us and I would appreciate it 
if you would get back to me, as well as to the other Senators 
who raised the issue. Thank you.
    OK. Now, you go through and you make up a budget. These are 
the President's priorities. In the case where there is an 
authorization for appropriations, what is the guidance that the 
President gives you in following an authorization?
    Mr. Lew. Senator, the--in general, the policy is to look at 
each program and each department and to look to what the right 
policy for the next year is. An authorization in some cases is 
going to be the upper limit. In some cases, you propose than 
more it. In other cases, you propose lower than it. Senator, 
the President's budget often proposes policy. If there is a 
specific program that you are asking about, as I suspect there 
is, I would be happy to address it.
    Senator Nelson. Well, for example, the President signed the 
NASA authorization bill last September and yet the budget does 
not necessarily follow the authorization bill. I am not talking 
about the overall level of funding. I am talking about the 
allocation of the dollars within the agency. Do you want to 
comment on----
    Mr. Lew. Well, I think that, in general, we did try and 
fund programs in a manner consistent with the authorization. 
There is a general tightness in this budget where we did not 
have as much money to allocate as----
    Senator Nelson. That is not what I am talking about.
    Mr. Lew. I understand, and we have tried to reflect the 
policy in the authorization and the budget. If there are 
specific areas where we have not, I am happy to discuss them 
with you.
    Senator Nelson. Yes. For example, in the authorized budget 
for the new heavy-lift rocket, you all in fiscal year 2012 have 
cut it over a billion dollars. You cannot build a rocket 
cutting it a billion dollars. And I am talking about the 
capsule, as well. But, on the other hand, when we put this 
delicate balance together between the heavy-lift and also the 
commercial rockets, which we support, and Senator Cornyn's 
colleague from Texas is the one that helped me put this thing 
together, the fact is that you all decided, well, the 
commercial rockets ought to have more money than was 
authorized, and I am just wondering why you are not following 
the law.
    Mr. Lew. Well, I think the President's budget is an 
opportunity to propose funding levels that are consistent with 
the policy requirements. We looked at the authorization and 
tried to track it. We had lower total funding levels. We saw 
there as being real need for the commercial satellite. We tried 
to hit the right balance. I understand that that may be 
something that we have some different views on and I look 
forward to working with you on it.
    Senator Nelson. OK. And the law is the law, and the good 
news is, Mr. Chairman, the President proposes and the Congress 
disposes.
    I know my time is up. I am going to submit a question for 
the record about the difference in the budget that you assume 
the cost of acquiring the takeover of Fannie and Freddie, and 
that is much different from the Congressional Budget Office 
estimate, and so I will submit that for the record. Thank you, 
Mr. Chairman.
    Chairman Conrad. Thank you. Thanks for your respecting the 
time.
    Senator Thune is actually next.
    Senator Thune. I see everybody is really happy about that.
    [Laughter.]
    Chairman Conrad. Let me just say this for colleagues. I am 
not going to be able to do a second round. I have to stop at 4. 
So we have three left and we are going to have to press ahead.
    Senator Sessions. Mr. Chairman, I know you do have a very 
serious schedule problem, but I had hoped that we would have a 
second round. I do not think we have begun to sufficiently 
inquire into this budget at this critical point in time. 
Perhaps if you cannot extend it, could you extend the time by 
which we could file written questions?
    Chairman Conrad. Yes, I would be glad to do that, and I 
apologize. Normally, it is my practice here to go as long as 
people want to go. Today, I cannot do it, so we have to close 
at 4. Obviously, we are not going to quite meet that.
    Senator Thune.
    Senator Thune. Thank you, Mr. Chairman, and Director Lew, 
thank you for being here today. I know that--I do not want to 
rehash a lot of the old ground because everybody has been very 
critical of the budget proposal, and forgive me if I ask 
questions that have been asked already. I have not been in the 
room when some of the others have asked.
    But it does seem like everybody knows this entitlement 
thing is just a time bomb waiting to blow up and that there 
would be some proposal, particularly given the fact that there 
was a debt commission that made a number of recommendations, at 
least on Social Security reform. I understand that the 
Medicare-Medicaid aspect of that which is health care 
attributable is a more difficult nut to crack. No less, we need 
to get after that, as well. But why is there not any attempt to 
deal with these long-term problems? I mean, you have a budget 
which literally goes from $13 trillion in gross debt, or $14 
trillion in gross debt, which is where we are today, to $26.3 
trillion in gross debt.
    Mr. Lew. Senator--and I apologize if I repeat for others 
what I said in response to an earlier question--the Social 
Security issue is a very complicated one, but I think it is 
important to understand that it is not contributing in the 
short run to the deficit problem. And I just want to correct 
something I said before, because I may have used a number 
incorrectly.
    The Social Security Trust Funds will not be exhausted until 
2037. You know, they do not--they continue to grow because of 
both the balances that have been built up and the interest that 
is paid on those balances until 2025. And it is something that 
we ought to deal with because it is the right thing to do. We 
ought to be able to tell our children and our grandchildren 
that they can rely on Social Security just like our parents 
could. We need to separate it from the short-term deficit 
discussion. I actually think that will be the only way that we 
can have the kind of serious bipartisan conversation, because 
it is not contributing to the problem in this window.
    The President said in the State of the Union that he wants 
to work on a bipartisan basis to do it. He laid out some 
principles there. Those principles are repeated in the budget.
    It is a challenge to have a conversation about Social 
Security in a bipartisan way. I have worked on the issue for 30 
years. It has always been a challenge. The easiest thing in the 
world to do is to polarize the debate over Social Security. The 
President has worked very hard to extend a hand to have a 
conversation, and I think that is leadership. I think it is 
leadership to say we need to have that kind of adult 
conversation.
    Now, we have to figure out how to do it. I understand that, 
you know, there is an impatience to get on with it. But we 
ought to look at when the problem really hits. If you have a 
problem where the trust fund will be exhausted in 2037 and we 
are saying in 2011 that we want to have a conversation about it 
now, we think we are taking a pretty long look, and I hope we 
can work together on it.
    Senator Thune. Well, we are putting IOUs, like we do all 
the time, into these trust funds. I mean, it is operating at a 
balance with less coming in and more going out. But I guess 
that was my point.
    Mr. Lew. I would just take issue with the IOU description 
because they are Treasury bonds and the Federal Government has 
always honored bonds.
    Senator Thune. But it is debt. But my point, though, is 
this: I understand, OK, so Social Security, let us say that 
that is not as big of a factor as perhaps the other two are. 
Why would you wait? I mean, the adult conversation occurred 
during the Debt Commission. The Debt Commission made 
recommendations. The President appointed this debt Commission. 
You have all the experts who got together and said this is what 
we need to do, and to me, saying we need to have a conversation 
somewhere down the road about this, that is not leadership. And 
why would you--if Social Security--if your perception is that 
it is not a problem until some point in the future, what about 
Medicare and Medicaid? I mean, we all know that this is 60 
percent, and growing, of the budget all the time.
    Mr. Lew. The administration has done quite a lot in the 
area of health care in the first 2 years. There may be 
different views about the merits of what we have done, but the 
Congressional Budget Office agrees with us that we save 
hundreds of billions of dollars in the first 10 years and $1 
trillion in the second 10 years. In addition to that, in this 
budget we have $62 billion of additional savings in health 
programs. So we have put quite a lot forward in health 
programs.
    We are open to new ideas. The President made it clear; he 
does not think that we have a monopoly on good ideas. He wants 
to work together to move forward in this conversation. But I do 
not think it is fair to say that the President has not taken 
leadership on health care. He has taken a lot of leadership.
    Senator Thune. Well, I think we disagree about that 
question, but quickly----
    Mr. Lew. We may disagree on the policy. I do not think we 
can disagree that he has taken leadership.
    Senator Thune. On a technical point, the economic 
assumptions about growth that you come up with are at least a 
point higher annually than are those that come up--that the CBO 
came out with. How do you come that far apart? That is a 
significant amount.
    Mr. Lew. Our assumptions are in the middle range of the 
Federal Reserve Board's analysis. The basic difference between 
the Congressional Budget Office assumptions and ours is that we 
believe that, consistent with past history, we will recover 
from this recession, and as in all financially led recessions, 
we will ultimately get back to the level of economic growth 
that existed before the recession.
    CBO assumes that we will permanently have a loss of 
economic capacity. We disagree with that assumption. One can 
disagree about the trajectory, and, you know, we may be right 
or wrong on how many years it gets there. But we believe 
strongly that we will get back to that rate of growth.
    Senator Thune. Thank you, Mr. Chairman.
    Chairman Conrad. I thank the Senator.
    Senator Sanders.
    Senator Sanders. Thank you, Mr. Chairman. I apologize for 
being late. I was chairing a hearing.
    Mr. Lew, the President has proposed in his budget to let 
the Bush tax cuts for the wealthiest 2 percent of Americans 
expire at the end of 2012.
    Mr. Lew. Correct.
    Senator Sanders. Now, a few months ago, when the Democrats 
controlled the House, when Democrats had a larger majority in 
the Senate, the President conceded that point to the 
Republicans and extended the tax breaks for 2 years. Why do you 
have any belief whatsoever--and maybe my Republican colleagues 
would like to chime in on this--that, in fact, these tax breaks 
will be terminated when Republicans, who are adamantly for 
these tax breaks, are in power in the Senate?
    Mr. Lew. Senator, when we worked on the tax bill in 
December, the President made it very clear that his position 
had not changed, that he believes that these tax rates should 
not be extended permanently. In the context of trying to work 
together to do something that was very immediate so that we 
would have economic growth this year and not have a tax 
increase this year, we had a 2-year extension. This is 
consistent with the position he took then, and we are going 
to----
    Senator Sanders. But I asked you a question. Given the 
dynamics of politics, when Democrats controlled both bodies, I 
do not think any of my Republican friends would disagree, it 
ain't going to happen.
    Mr. Lew. But I think there were very few who predicted that 
the tax agreement would happen, so I think in the area of 
predictions, lots of times----
    Senator Sanders. Well, many people did not predict that 
that tax agreement, which gave hundreds of billions of dollars 
in tax breaks to the top 2 percent, would have happened. Many 
of us wish it did not happen.
    Let us talk about Social Security. When the President ran 
for office, he was very clear in saying that Social Security 
has been an absolute success for the last 75 years, it is vital 
to the well-being of the working people of this country, and 
campaigned and saying that he wanted to extend the life of 
Social Security and its financial solvency by lifting the cap 
on taxable income coming from people who made more than 
$250,000 a year. He saw that as the solution. He saw that as 
fair. I happen to agree with him. Is that still his position?
    Mr. Lew. You know, Senator, I think that what the President 
said is that he thinks we ought to work together on a 
bipartisan basis----
    Senator Sanders. No, I asked you a question. Is that still 
his position?
    Mr. Lew. I think his position, as he stated it then, that 
there is room to raise the cap and that will help extend 
solvency remains true.
    Senator Sanders. That will extend it. That will solve the 
problem.
    Mr. Lew. The challenge we are going to have to work 
together for a bipartisan solution is going to be to find 
something we can all agree on. And I think he has tried to 
indicate that it is not necessary to cut benefits for current 
retirees or to----
    Senator Sanders. For current retirees.
    Mr. Lew [continuing]. Benefits in the future. And that is a 
framework for a conversation.
    Senator Sanders. A framework for a conversation. Let us 
stay on that point a little bit. Is the framework for a 
conversation cutting benefits for younger workers?
    Mr. Lew. I do not want to address hypothetical provisions. 
I think that the issue of Social Security is one that ought to 
cross party lines. I think we----
    Senator Sanders. What position are the Republicans stating 
that you feel that we can work with them on?
    Mr. Lew. I think that there is going to be a need for us to 
look at options where----
    Senator Sanders. What options?
    Mr. Lew. Senator, it is premature for me to address the 
specific----
    Senator Sanders. Are we going to cut benefits for workers?
    Mr. Lew. The President said clearly that we are not going 
to cut benefits for current retirees, and we are not going to 
slash benefits for future retirees.
    Senator Sanders. ``Slash'' is a big word. What does 
``slash'' mean?
    Mr. Lew. I am going to stick with the words the President 
used.
    Senator Sanders. Slash? Or we can cut. You can cut but not 
slash. Well, let me ask you this question----
    Mr. Lew. Senator, I really----
    Senator Sanders [continuing]. About Social Security.
    Mr. Lew. I really think I should leave the President's 
words to say it.
    Senator Sanders. All right. Let me ask this question. Has 
Social Security, which is funded by the payroll tax, 
contributed one nickel to the deficit of this country?
    Mr. Lew. Social Security is fully funded through 2037.
    Senator Sanders. Has it contributed one nickel to the 
deficit?
    Mr. Lew. No, it has actually been helping with----
    Senator Sanders. That is right.
    Mr. Lew. Yes.
    Senator Sanders. If Social Security has not contributed one 
nickel to the deficit, why are we looking at it within the 
context of deficit reduction?
    Mr. Lew. I agree. Senator, I have said four times at this 
hearing it should not be looked at in that context.
    Senator Sanders. OK. How many years will Social Security 
pay out every benefit to every eligible American?
    Mr. Lew. If we take no action, the trust fund is exhausted 
in 2037.
    Senator Sanders. So that is another twenty--and there are 
varying opinions, 23, 24 years. Some say longer.
    Mr. Lew. These numbers----
    Senator Sanders. Some say----
    Mr. Lew. When the trustees do new estimates, the numbers 
could change.
    Senator Sanders. Right. Exactly. At which point it would 
pay out about 75 or 80 percent of all benefits. How does----
    Mr. Lew. Because current revenue will fund benefits, 
correct.
    Senator Sanders. Right. How does that issue of paying out 
every nickel owed to every eligible American for the next 23, 
25 years, whatever it may be, compare to the fact that in real 
terms unemployment today in terms of official plus people who 
have given up looking for work, people who are working part 
time who want to work full time, is at 16 percent? I mean, is 
that more of a crisis than worrying----
    Mr. Lew. Mr. Chairman, should I----
    Chairman Conrad. For you to answer the question----
    Mr. Lew. Mr. Chairman, I am looking for direction as to 
whether I should go on.
    Chairman Conrad. Answer the Senator.
    Mr. Lew. Senator, the President has made clear that he 
views getting the economy moving and creating jobs is an 
immediate priority. This whole budget is built around the 
premise that we need to build an economy for today and for the 
future to create jobs. We have to be able to handle multiple 
challenges, and we are not comparing the immediacy. The fact 
that Social Security is important and we should look at it as a 
long-term issue, we should not wait until it is on the eve of 
crisis, shows a real concern that we have a compact across 
generations that we need to keep. It is not a deficit reduction 
question, and we have not tried to suggest that it has that 
kind of urgency. It does have that importance, though.
    Chairman Conrad. Senator Cornyn.
    Senator Cornyn. Mr. Lew, assuming the Federal Government 
spends $3.7 trillion but only receives $2.2 trillion in 
revenue, that leaves an annual deficit of $1.5 trillion, 
correct?
    Mr. Lew. That would be the arithmetic.
    Senator Cornyn. Well, that is about as sophisticated as I 
get when it comes to arithmetic, so bear with me. But the 
cumulative effect of that annual deficit represents the debt, 
which is currently roughly $14 trillion. Isn't that right?
    Mr. Lew. Right.
    Senator Cornyn. So here is my question, and it is not a 
trick question, I assure you. We are talking about cutting 
spending--and I agree with my colleagues that I am disappointed 
that the President's proposed budget does not do a better job, 
and I trust that the House and the Senate will do a better job. 
In fact, from 2008 levels this budget represents a 33-percent 
increase in discretionary spending, leaving out emergency and 
the Department of Defense spending. But, really, I do not want 
to talk to you so much about the cuts, in other words, what 
that top line should be. I want to talk to you about what do we 
do to grow that bottom line, because that is the gap we need to 
close, right, both within sensible cuts or limits in Federal 
spending but also how do we get the economy growing again to 
bring that bottom line up? Would you agree with me?
    Mr. Lew. If you look at our projections over the next 10 
years, the most important single thing is getting the economy 
moving. If we do not get the economy moving, there is no way 
for us to make enough policy to close the gap. So----
    Senator Cornyn. Thank you. You and I agree----
    Mr. Lew. Which is why this budget is built around keeping 
the economy moving.
    Senator Cornyn. Well, you and I may disagree about that.
    Mr. Lew. I thought we might.
    Senator Cornyn. You project the unemployment rate or assume 
the unemployment rate next year will be 8.6 percent, right? In 
other words, it is still going to be stubbornly high. Would you 
agree?
    Mr. Lew. Yes, the unemployment rate is higher than we want 
it to be now, and it remains too high for too long.
    Senator Cornyn. And that is because the private sector is 
not creating jobs adequate to hire enough people to bring that 
number down. Wouldn't you agree?
    Mr. Lew. It is because we are recovering from the deepest 
recession in a generation, and historically the recovery period 
and the job creation after financially led recessions is 
longer. So we are on a path, but we are doing everything we can 
to push that path harder.
    Senator Cornyn. But with all due respect, you are not 
answering my question. My question is: The reason why 
unemployment rates are high is because the economy is not 
growing faster in a way that would create those jobs and bring 
unemployment rates down, correct?
    Mr. Lew. To be clear, the economy is now in recovery. We 
are growing at rates that are, you know, 3 to 4 percent. That 
is not good enough. But we see a return to growth rates in this 
immediate forecast period that starts to get back on our feet.
    Senator Cornyn. Well, I would say that most Americans would 
believe that 8.6 percent unemployment next year is unacceptably 
high, and we need----
    Mr. Lew. And we agree with that.
    Senator Cornyn. And we need to find ways to grow the 
economy, primarily by encouraging the private sector to invest 
and to expand businesses and create jobs.
    I want to ask you, how in the world is the private sector 
supposed to do that when this budget assumes tax increases of 
$1.6 trillion?
    Mr. Lew. You know, I think if you look at the tax policies 
in this budget, they are consistent with the tax policies that 
were in place when we had the longest period of uninterrupted 
growth in our Nation's history.
    Senator Cornyn. And that is not my question. How is 
economic growth consistent with the tax increase of $1.6 
trillion? Are you going to say the economy is going to grow in 
spite of that anti-stimulus effect of increased taxes or 
because of it?
    Mr. Lew. The challenge we have is coming out of a deep 
recession, dealing with a structural deficit that was caused by 
a series of a policy decisions that were made to have tax cuts 
and spending increases and not pay for them. We are now paying 
that price, and we have to work together to close that gap, and 
we have to do it by having everything on the table. We cannot 
do it by just cutting, as people said, the 12 percent of the 
budget that goes to annual appropriations.
    Senator Cornyn. But you are not saying, are you, that a 
$1.6 trillion tax increase will stimulate that economic 
recovery? Are you saying that?
    Mr. Lew. I am saying that we have tax policies in this 
budget that are consistent with economic growth. We have tax 
incentives to encourage economic growth. We have spending 
policies to encourage economic growth. We may disagree on some 
of the composition. We do not disagree on the goal, and I hope 
we can work together on working through the differences--
    Senator Cornyn. I agree we disagree that this budget does 
encourage economic growth, and indeed I think it discourages 
it. But let me ask you my last question since we have just a 
short time together.
    You project in this budget that interest on the debt will 
over a 10-year period of time total $5.7 trillion. I wonder if 
you would comment on a Bloomberg article that reports a 
Treasury Department meeting with a 13-member committee of bond 
dealers and investors where they say that interest expense on 
the debt will rise to 3.1 percent of gross domestic product by 
2016 from 1.3 percent in 2010 with the Government forecast to 
run cumulative deficits, so forth and so on. My question is: We 
are right no seeing relatively low interest rates because the 
Fed is trying to help with the recovery. But if interest rates 
double or triple, the assumptions that you make on the debt 
service, the interest that is paid on that debt could well--
will double and triple along with that, correct?
    Mr. Lew. And our economic assumptions do assume an increase 
in interest rates over the period consistent with the economic 
growth that we forecast.
    Chairman Conrad. I thank the Senator.
    Senator Enzi.
    Senator Enzi. Thank you, Mr. Chairman, and thank you, 
Director Lew. I was a strong--I was a cosponsor of the Deficit 
Commission, the Conrad-Gregg Deficit Commission, and I voted 
for it. And I was pleased that the President picked up the 
reins on that and appointed a committee. And I was pleased with 
almost everything that they proposed and think that probably 
all of them could be passed if they were done in steps rather 
than as one lump sum. I think the opposition--but I noticed in 
the budget that there are provisions for repealing a bunch of 
the oil and gas tax expenditures, and that was a proposal of 
the Deficit Commission, but it was in exchange for lowering the 
corporate rate so that we could be more competitive 
internationally. Instead, we are taking that money and 
utilizing it as a pay-for, and we are going to drive up the 
cost of energy. Can you explain to me why we are stealing it 
from there instead of doing what the Deficit Commission 
suggested?
    Mr. Lew. Senator, we do have policies in this budget to 
undertake corporate tax reforms that will be deficit neutral, 
broaden the base, and lower the rates. We also have policies in 
the budget that we think make sense on their own, and these 
oil, gas, and tax provisions are a part of them. I think that 
as we engage in the conversation, we are going to have to work 
through these issues together and see if they should be treated 
together or apart. But I----
    Senator Enzi. If the expenditure has already been made, 
then it cannot be used to do the other piece there. I noticed 
there was a piece in there about LIFO, too, and I do not think 
they realize the impact that that will have on small business 
having to put cash up front to pay for the things there, just 
as the small oil and gas companies would have to put cash up 
front to do what has been proposed in this.
    When I talked to the Commission, primarily the two co- 
chairs, I suggested that any of these provisions were done had 
to be done over a period of time for the businesses to be able 
to adjust. The cash up front is not available for anybody right 
now. So it looks like it would put a lot of people out of 
business and raise prices. So we will be getting a little more 
information on that, too.
    I have a whole series of questions. I will not ask them 
all. I do want to mention that in 2006 we reauthorized the 
Abandoned Mine Land Trust Fund. That was done over a point of 
order because it was mandatory spending. That is a trust fund 
like the Social Security Trust Fund. If we default on that 
debt, I think we are saying something about how valuable our 
trust funds are.
    One of the things that we passed just recently was a Form 
1099 reporting under health care, and that covered both the 
$600 in a calendar year for corporations and for property. And 
I noticed in the budget that you only did the part that applied 
to corporations. Why is the administration rejecting the Senate 
amendment and offering a proposal--and it is an amendment that 
has come up before and had very substantial support--offering a 
proposal that only gets half the job done?
    Mr. Lew. Senator, we support addressing the 1099 provision 
and look forward to working together on that. This budget was 
put together before the Senate provision that recently was 
passed, and I would have to go back and study the two to 
understand the difference.
    Senator Enzi. Well, the President in his State of the Union 
speech even promised that the 1099 would be gone, but only half 
of it is going to be gone. I appreciate the question that 
Senator Wyden asked about the effect the budget is going to 
have on the 750,000 small businesses. And I know we are in a 
hurry, so I will submit the rest of my in written form.
    Chairman Conrad. I thank the Senator for his courtesy.
    Senator Merkley.
    Senator Merkley. Thank you, Mr. Chair, and thank you for 
your testimony. And I wanted to start with the county payments, 
and I know from the conversations that we have had and other 
Senators have had with you that you understand the basic 
framework in which BLM lands were set aside to produce timber 
and to produce revenues for the counties. The Federal 
Government has come along and said, well, we are going to put 
some restrictions on this, but we will compensate for those 
restrictions. And now the Federal Government has come along and 
said, well, maybe we will not compensate you for those 
restrictions.
    I do want to applaud the fact that you have this in your 
budget for 2012. We are still trying to understand exactly what 
that number is. There is a little bit of a cryptic nature to 
it. But it also appears that it has been moved from the 
mandatory funding into the discretionary funding, which is an 
item of tremendous concern. It has always been a mandatory 
funding because it was a contract between the Federal 
Government and the timber counties. And so I just wanted to ask 
that question of you and try to get some sense of whether we 
are reading this correctly, that it has been moved to 
discretionary, and if so, why.
    Mr. Lew. Senator, we did fund it on the discretionary side, 
but we also indicated an openness to working with Congress to 
resolve the matter in the course of the legislative process and 
did not take a firm position that it had to be discretionary 
versus mandatory. We thought that fitting it within the tight 
caps, given the pressures, saving $400 billion over 10 years, 
was a way to make a real commitment to the funding request. And 
we look forward to working with you and Senator Wyden and 
others as we go forward.
    Senator Merkley. Thank you. Then for now I will just 
register that that is of significant concern because it 
suggests that it is not being viewed as a contract as it has 
been in the past. And, of course, we are calling upon the 
Federal Government to honor its contract with the counties.
    I wanted to turn to the President's support for renewable 
energy and energy efficiency and clean energy technology in the 
budget request, and there are several pieces in there I am 
delighted to see. One of them is related to the funding of low-
cost loans for energy renovations. Another is related to 
electric vehicles. And I am coming at this from the point of 
view of trying to think of our economy the way you would think 
about positioning a company. And if we are in a world where we 
are importing $1 billion a day of oil and sending that money 
overseas, there are national security issues associated with 
that. There is certainly the fact that those dollars do not 
stay in our grocery stores and our retail outlets and create 
additional jobs for Americans. And then there is the fact that 
as we substitute for oil, we can also produce less carbon 
dioxide and read some of our goals for addressing global 
warming.
    So I would like to see all of that, and I just want to know 
if you know of any potential barriers, either in budgeting or 
in procurement procedures, that would be problematic as we 
attempt to undertake one piece of that, which is electrifying 
the Government fleets.
    Mr. Lew. Senator, we have put in a broad range of proposals 
from research and development to incentives for 
commercialization to try and get the United States into the 
leadership position we should be in, both in terms of 
developing and producing these technologies and in using them.
    I am happy to take a look at the provisions regarding the 
Government fleet. That is not a provision I off the top of my 
head remember the details of, but I am happy to get back to 
you.
    Senator Merkley. Well, I have really come to this point of 
view of applauding the administration of taking this seriously. 
We have had administrations in the past that have talked about 
attacking our dependence on foreign oil and our addiction to 
oil in general. And we have not been able to follow through 
with coherent American policies to end this. I think we can 
simply look at the turmoil of these last few weeks in the 
Middle East and recognize that not only are we sending a ton of 
money to governments abroad, but many of those governments are 
governments that do not always share our national interests and 
end up funneling some of that money into groups that we are 
actually in opposition to around the world.
    So for a whole host of reasons----
    Mr. Lew. We win in three ways if we succeed in this policy.
    Senator Merkley. Absolutely.
    Mr. Lew. We reduce our dependence on foreign oil, we create 
American jobs, and we have environmental benefits. That is why 
we think it is so important to do it.
    Senator Merkley. And thank you so much for your effort in 
the budget to take on that area.
    In the 6 seconds I have left, community development block 
grants, I just want to express a lot of concern about the cuts 
that are there. Many of these benefit low-income people through 
affordable housing projects and many other projects within 
communities. We are still facing a situation with 300,000 
foreclosure filings a month across America, and I look forward 
to working with you all to make sure that we do not balance 
this budget on the backs of those who are struggling in their 
community and are hardest hit by this recession, which was 
caused by the deregulatory policies of the Bush administration, 
with predatory lending and runaway Wall Street gambling, and we 
should not solve this problem by further kicking those who have 
been hurt by this economy.
    Chairman Conrad. That will have to be the last word. Let me 
just thank Director Lew. I thank all colleagues. Because of the 
inability to get to a second round given the number of 
colleagues who participated today, instead of closing out 
questions at the end of today, we will extend that until noon 
tomorrow, give colleagues a chance----
    Senator Sessions. How about all day tomorrow, Mr. Chairman?
    Chairman Conrad. Would you prefer that we do it until the 
end of tomorrow?
    Senator Sessions. Yes, if you would, at least.
    Chairman Conrad. All right. We will do that. So, Director 
Lew, I would ask you to take up those questions expeditiously.
    Mr. Lew. I would be happy to.
    Chairman Conrad. Senator Sessions.
    Senator Sessions. Briefly, Mr. Lew, I want to stress again 
my displeasure with your statement that our budget will get us 
over the next several years to the point where we can look the 
American people in the eye and say we are not adding to the 
debt anymore, we are spending money we have each year, and then 
we can work on bringing down the national debt. I believe that 
is inaccurate. I believe any American that heard that would 
believe that this budget balances. It does not come close to do 
so. And this chart up here, I know it is on this primary 
balance theory that does not count the interest, but under your 
plan, the President's plan, at the end of your 10-year budget 
the interest will be $844 billion in 1 year, dwarfing all of 
these other agencies and departments and expenditures--
something which we have never seen before in our country, and 
it threatens our debt structure and our economy.
    Mr. Lew. Senator, I do not disagree that we have to take on 
the debt and we have to pay down the debt and reduce the 
interest payments. The only thing I take issue with----
    Senator Sessions. Does this budget do it?
    Mr. Lew. I think we get to the point where we----
    Senator Sessions. Does it do it?
    Mr. Lew. It gets us to the point where we stop adding to 
the problem with our new spending, and that is----
    Senator Sessions. The debt goes up every year, and the 
deficit is--the debt has increased--doubled over this period.
    Mr. Lew. I just think that if we are going to have the kind 
of conversation we need to have to resolve this, we have to 
have it in a way where we respect each other, and I respect 
your position, Senator.
    Senator Sessions. Well, I cannot respect a position that 
suggests this budget reduces the debt. If you take that 
position, we are talking beyond each other. The Wall Street 
Journal said about this budget----
    Mr. Lew. I said we stop adding to the----
    Senator Sessions [continuing]. That it is as detached from 
reality as----
    Mr. Lew. No, we stop adding to the debt----
    Senator Sessions. --Mr. Mubarak.
    Mr. Lew [continuing]. With our new spending. We do have 
interest payments. We have to control those interest payments 
in the future. This is a downpayment. We have to finish the 
job.
    Senator Sessions. Forgive me, Mr. Chairman, but this is a--
I do not think it is a matter of opinion. I believe, Mr. Lew, 
it is flatly in error, and it cannot continue. And I hope the 
President and he never repeats that this budget balances at any 
point in the 10 years.
    Chairman Conrad. Director Lew, do you want to respond?
    Mr. Lew. No, I mean, I really do not mean to be 
argumentative about this. I think there is a very complicated 
idea here that we are trying to work through together. You 
know, in order for us to get to the point of reducing the debt, 
there are several things that have to happen. We have to have 
taxes and revenues that cover our current spending, and then we 
lock in an amount of the debt that will continue to have 
interest. That interest compounds until we pay down the debt. 
We have to then reduce the principal of the debt so the 
interest stops compounding. I think we agree on that in 
principle, and if the language of Federal budgeting is 
confusing, I apologize for that. I did not invent the language. 
And I would like- -I really would like to work together, 
because I do not disagree with you in the core principle that 
we have not solved the problem until we have really brought 
down the debt. And I think what we have put on the table is a 
huge step to put us in a place where we have the kind of 
stability to then go forward and take the next step.
    Chairman Conrad. Let me just conclude on my own. Senator 
Sessions has expressed himself clearly. Let me express myself 
clearly. I believe in the near term this budget has it about 
right. I believe as passionately as Senator Sessions does that 
for the long term we are going to have to do a whole lot more. 
I do not believe it will happen next year in an election year. 
I personally believe we have to have a long-term plan agreed to 
this year. I believe it has to be on the range of what the 
Commission proposed, which is $4 trillion of debt reduction 
over the 10 years. The administration's description of its plan 
is $1 trillion. We will see what CBO says when they do a re-
estimate.
    But, honestly, we have a responsibility to this country 
that is sober and somber and serious, and I believe history 
will condemn us all. I believe history will condemn us all if 
we do not do substantially more for the decade than is in this 
budget. I believe it fundamentally puts at risk the economic 
security of the country. And I believe that. I believe the 
evidence is quite strong that the risks that are being run are 
unacceptable risks.
    So I give you good grades for a beginning. Somehow--
somehow--we have to find a way--and the administration has a 
big responsibility here--to help us understand their vision of 
how this process comes together. And, you know, we do not have 
a whole lot more time. Sometime very soon there is going to 
have to be a negotiation that involves the leadership of the 
House and the Senate, Republicans and Democrats, and the White 
House. And, honestly, I think the seriousness of this to the 
country cannot be overstated.
    With that, we will adjourn the hearing.
    [Whereupon, at 4:22 p.m., the Committee was adjourned.]





     THE PRESIDENT'S FISCAL YEAR 2012 BUDGET AND REVENUE PROPOSALS

                              ----------                              


                      THURSDAY, FEBRUARY 17, 2011

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:02 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Cardin, Sanders, Whitehouse, 
Begich, Coons, Sessions, Ensign, Cornyn, Thune, Portman, 
Toomey, and Johnson.
    Staff present: Mary Ann Naylor, Majority Staff Director; 
and Marcus Peacock, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    I want to welcome everyone to the Senate Budget Committee 
today. Today we will focus on the President's budget and 
revenue proposals. Our witness today is Treasury Secretary Tim 
Geithner.
    Mr. Secretary, welcome back to the Committee. We look 
forward to your testimony. We also value your wise counsel as 
we have come through some of the most difficult times in our 
economic history. I believe history will record the steps that 
were taken at the end of the Bush administration and the 
initial days of the Obama administration were absolutely 
critical to averting a financial collapse. I believe that 
history will make that clear. And I believe you played a hugely 
constructive role, as did Secretary Paulson at the end of the 
Bush administration.
    I believe the President's budget gets it about right. In 
the first year or 18 months, even as it moves to cut spending, 
it continues critical investments in the areas of education, 
energy, and infrastructure. These near-term investments will 
help strengthen economic recovery and lay the foundation for 
long-term economic growth.
    I was raised by my grandparents, and my grandmother was a 
school teacher. We called her ``Little Chief.'' She was 5 feet 
tall, but she commanded respect. And in our family, she told us 
over and over, ``There are three priorities in this household: 
No. 1 is education, No. 2 is education, No. 3 is education.'' 
And she meant it and we got the message. So I know that she 
would feel very strongly that education has to be the 
cornerstone for future economic growth.
    But I do take issue with the President's budget in the 
medium and long term where I believe we simply have to do more 
to address our deficits and debt. According to the 
administration's estimates, the budget brings the deficit down 
from 10.9 percent of GDP to 3.1 percent by the end of the 10-
year budget window. So that is the good news of this budget, as 
I see it.




    The President's budget does make substantial progress in 
bringing down the deficit as a share of the gross domestic 
product, which most economists say is the most valid measure. 
So a very substantial improvement in our deficit path by that 
measure.
    Let us go to the next, if we can.



    
    If we are looking at dollar terms, the changes to the gross 
Federal debt under the President's budget goes from $15.5 
trillion to more than $26 trillion at the end of the 10 years. 
So over 10 years, we are averaging an increase in the gross 
debt of $1 trillion a year. That to me cannot be the path.




    If we look at gross debt as a share of the economy under 
the budget, we can see it reaches 100 percent and continues 
rising slightly throughout the remaining budget window. Why is 
this important, that the debt is now--the gross debt, I want to 
emphasize, the gross debt, not the publicly held debt that you 
often see in the newspaper. The gross debt, taking all of the 
debt of the United States, is over 100 percent of GDP. Why does 
that matter?




    Well, it matters because the best analysis that has been 
done of financial history, work done by the economists Carmen 
Reinhart and Kenneth Rogoff, found this: We examine the 
experience of 44 countries spanning up to two centuries of data 
on central government debt, inflation, and growth. Our main 
finding is that across both advanced countries and emerging 
markets, high debt-to-GDP levels--gross debt above 90 percent--
are associated with notably lower growth outcomes for the 
future. That is why this matters. A debt that is too high acts 
like an anchor on the economy, reduces future economic growth, 
reduces opportunity for the American people, reduces job 
prospects for those seeking employment.
    So these debt figures are more than numbers on a page. This 
matters to real people and their lives. It matters to the thing 
I think everyone around this table cares the most about, which 
is future economic opportunity for the people of our Nation.




    Make no mistake. We are at a critical juncture. We are 
borrowing 40 cents of every dollar that we spend. Let me repeat 
that. We are--you know, this is reality. We are borrowing 40 
cents of every dollar that we spend. Spending is at its highest 
level in 60 years as a share of the economy. Revenue is at its 
lowest level as a share of the economy in 60 years. Revenue the 
lowest it has been in 60 years, spending the highest it has 
been in 60 years. No wonder we have record deficits.
    This has to be addressed, I believe, on both side of the 
equation. Yes, we have to cut spending. Yes, we have to reform 
entitlements. But, yes, we also need tax reform to help reduce 
the deficit and make America more competitive. We need to be 
realistic about what is necessary to meet the needs of the 
Nation and return the budget to a sustainable long-term fiscal 
trajectory.




    Looking at revenues in isolation has led some to argue that 
revenue should be held to the historical level of 18 percent of 
GDP. That has been the level over the last 40 years. Let me 
point out revenue at that level would not have produced a 
single balanced budget in a single year in all of those 40 
years. In fact, on the five occasions when the budget has been 
balanced or in surplus since 1969, revenues have ranged between 
19. 5 percent of GDP and 20.6 percent of GDP. So I would just 
say to those who say, you know, revenue, no more than 18 
percent of GDP, we would not have balanced the budget ever in 
the last 40 years--not one time.




    The five times we have balanced, revenue has been from 19.5 
percent to 20.6 percent of GDP. I would argue it is going to 
have to be at the high end of that range given the retirement 
of the baby-boom generation.




    Fundamental tax reform must be a part of the approach to 
addressing our fiscal problems. The current state of the Tax 
Code is simply indefensible. As a former State tax commissioner 
and chairman of the multi-state tax commission, I am acutely 
aware of what has happened to the Tax Code, and it is a Chinese 
riddle. You know, you have to be a contortionist to deal with 
this Tax Code. It is out date, this Tax Code. It is hurting 
U.S. competitiveness. It is hemorrhaging revenue. The tax gap, 
offshore tax havens, abusive shelters undermine the 
effectiveness of the Tax Code and cost confidence in the 
fairness of it.




    This Tax Code is riddled with expiring provisions. This 
creates enormous uncertainty for citizens and businesses, 
making it difficult for them to plan ahead. If we took steps to 
simplify and reform the Tax Code, we could reduce tax rates 
below where they are today and produce more revenue. Tax 
expenditures are running at over $1.1 trillion a year. That is 
as much as all of domestic discretionary spending.
    Although the President's budget called on Congress to work 
with the administration to begin the process of tax reform, it 
did not include any significant tax reform recommendations. I 
believe the only way we are going to solve the Nation's long-
term fiscal imbalance is by enacting a comprehensive debt 
reduction plan. We need a plan in size and scope of what was 
proposed by the President's Fiscal Commission.
    Here are the key elements of tax reform that were included 
in the Commission's plan. It eliminated or scaled back tax 
expenditures and lowered tax rates to promote economic growth 
and dramatically improve America's global competitiveness, 
which needs to be a goal. We are in a different world. When 
this Tax Code was written, we did not have to worry about the 
competitive position of the United States. We were dominant. 
Now we are in a tough, competitive global environment, and we 
have to be competitive.
    The Commission proposal makes the Tax Code more 
progressive. I was proud that we made the Tax Code more 
progressive. The Commission's report included an illustrative 
tax reform plan that demonstrates how eliminating or scaling 
back tax expenditures can lower rates. Instead of six brackets 
for individuals, the plan includes just three: 12 percent, 22 
percent, and 28 percent. The corporate rate would be reduced 
from 35 to 28. Capital gains and dividends would be taxed as 
ordinary income. The mortgage interest and charitable 
deductions would be reformed, better targeting those benefits 
to people that actually need them. The child tax credit and 
earned income tax credit would be preserved to help working 
families, and the alternative minimum tax would be repealed. 
The Commission's plan also increased revenue to 21 percent of 
GDP by 2022. That is the kind of tax reform I believe that we 
need to adopt.
    Let me just conclude on that point. I have gone longer than 
I would normally, but I do think that it was important to lay 
out some of the elements of what the Commission said and what I 
strongly believe. I will be quick to say there are many things 
that I disliked intensely about the Commission's report. I 
remember one of my colleagues called me the night before we 
were to vote and said to me, ``What are you going to do?'' I 
said, ``I tell you, the only thing worse than being for this is 
being against it.'' And, you know, at the end of the day here, 
we are going to have to put together a package nobody is going 
to like. It is going to be controversial. Nobody is going to be 
happy. But it has to be done. It has to be done.
    Senator Sessions.

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. Mr. Chairman, thank you once again for 
your wise comments, your warnings to us. I think they 
absolutely should be heard, and the most important thing I 
think cannot be overemphasized is that we are not here fighting 
over spending and other issues and sacrifices that would have 
to be made for academic or political reasons, but because of 
the reasons you stated, our economy is in danger as a result of 
the path we are on.
    Thank you, Secretary Geithner, for appearing before us in 
the Committee today and discussing the budget. I know you did 
face a serious challenge after our financial crisis, but it 
would have been better if Mr. Paulson and Mr. Bernanke and the 
Chairman of the New York Fed had seen it coming before the 
financial crisis hit, and maybe we could have avoided it. And 
so now we have some suggestions that we could be heading to 
another one, and we need to take steps now to avoid it.
    It is clear that the plan submitted by the President does 
not seriously address the Nation's growing fiscal crisis. Here, 
Mr. Geithner, is how you described our fiscal situation earlier 
this week, correctly: ``Our deficits are too high. They are 
unsustainable and, left unaddressed, these deficits will hurt 
economic growth and make us weaker as a Nation.'' Admiral 
Mullen said it is the greatest threat to our national security.
    But the President's budget does not confront this danger. 
In fact, the President's budget continues the unsustainable 
course. The plan creates 10 straight years of deficits that 
never once fall below $600 billion and adds $13 trillion, at 
least from 2010, overall to our gross debt. Under the 
President's plan, interest alone on the debt will rise to $844 
billion in 1 year, more than we pay for Medicare or Medicaid. 
It is almost unthinkable that the President would put this 
budget before Congress and the American people as a long-term 
plan for our Nation. But to hear his supporters and certain 
administration officials describe the budget, you would think 
they had achieved balance and brought the debt crisis, the 
deficit crisis to an end.
    Here is what the President's Director of Budget Jack Lew 
said over the weekend: ``Our budget will get us over the next 
several years to the point where we can look the American 
people in the eye and say we are not adding to the debt 
anymore. We are spending money that we have each year, and that 
we can work on bringing down the national debt.''
    And here is what President Obama said just 2 days ago: 
``What my budget does is to put forward some tough choices, 
some significant spending cuts, so that by the middle of this 
decade our annual spending will match our annual revenues. We 
will not be adding more to the national debt.''
    Clearly, these statements, as heard by the American people, 
are incorrect, false. Yet, remarkably, the President's new 
press secretary, Jay Carney, was asked about the President's 
claim yesterday whether it would withstand scrutiny, and he 
said, ``Absolutely.''
    In what fantasy world do we double our gross debt to $26 
trillion and then say we are not adding to the debt? This is a 
serious matter, and to tackle our fiscal challenges, we need to 
work together and the President needs to lead the Nation in an 
honest conversation.
    But we have not seen from our President the willingness to 
look the American people in the eye and have a candid 
conversation about the challenges and what we will have to do 
to solve them. The message seems to be there is no problem; we 
have it taken care of; we are going to be living within our 
means under this budget.
    So I do think the President is taking a risk here with his 
credibility. During the same press conference, he complained 
about the--he expressed a desire to work with Republicans 
toward meaningful reforms. I do hope that can be accomplished. 
But I have to note it was kind of a mixed message when a couple 
of hours later he threatened to veto if Republicans took steps 
to reduce current spending by $59 billion, which is $100 
billion less than his proposal for spending in that year.
    So let us remember, those arguing that we cannot reduce 
spending are the same ones who argued 2 years ago that the 
massive stimulus plan would speed our economic recovery. I 
believe they were wrong. Our recovery has lagged behind past 
recessions. Unemployment has remained painfully high. The 
failed effort to revive the economy through a surge in 
Government spending has instead imperiled our economy with a 
crushing debt that stifles job growth today, as economists have 
shown, and threatens our prosperity tomorrow.
    So, Mr. Geithner, you will forgive me if I am unconvinced 
that arguments that are being made that we must preserve every 
cent of this year's $1.65 trillion deficit is critical and we 
cannot change the course we are on. So we need to stop growing 
the Government and start growing the economy. That means 
reducing spending now. The situation is too urgent and the need 
for a new direction too great for us to delay action any 
longer. Significant reductions in spending may not be easy, but 
the reason they are not easy is because we have been heading in 
the wrong direction for so long. So, yes, we will have to make 
some tough choices, but they will put us on the right road, the 
road that leads to a better future.
    And, Mr. Chairman, we absolutely need to reform taxes. 
Thank you for raising that point. But I do want to emphasize 
that historically periods of frugality have helped us achieve a 
balanced budget also.
    Chairman Conrad. I thank the Senator.
    Now we will turn to our witness. Secretary Geithner, thank 
you for your patience in listening to us. Thank you for your 
service. I have had a chance to work with you, and I have high 
confidence in you. And I know we are at really a defining 
moment in many ways for the fiscal future of the country. So 
please proceed with your testimony.

STATEMENT OF THE HONORABLE TIMOTHY F. GEITHNER, SECRETARY, U.S. 
                   DEPARTMENT OF THE TREASURY

    Secretary Geithner. Thank you, Mr. Chairman, Ranking Member 
Sessions, and members of the Committee. Thanks for giving me a 
chance to come talk to you about these important questions, and 
I want to compliment both of you for running a very high 
quality debate, conversation, discussion of options on this 
critical issue.
    The President's budget presents a comprehensive strategy to 
strengthen economic growth and to expand exports, with 
investments in education and innovation and infrastructure. And 
alongside these investments, the budget presents a 
comprehensive, detailed multi-year plan to cut spending and 
reduce deficits.
    As you quoted me saying, Senator Sessions, our deficits are 
too high. They are unsustainable; left unaddressed, they will 
hurt economic growth and weaken us as a Nation. We share a 
critical obligation to restore fiscal sustainability, fiscal 
responsibility, and go back to living within our means as a 
country.
    Now, the President's budget cuts the deficit he inherited 
in half as a share of GDP by the end of his first term. These 
cuts are phased in over time in order to protect the recovery, 
the expansion. And in order to make it possible for us to 
invest in future growth and to reduce future deficits, the 
President proposes to reduce non-security discretionary 
spending to its lowest level as a share of the economy since 
Dwight Eisenhower was President.
    To achieve this, as you know, the budget proposes a 5-year 
freeze of non-security discretionary spending at its 2010 
nominal level, which will reduce the deficit by more than $400 
billion over the next 10 years. But the President also proposes 
to cut defense spending, to freeze civil service salaries, and 
to improve efficiency in Government by eliminating and reducing 
a very substantial number of Government programs.
    These savings create the necessary room for us to make 
targeted investments in support of reforms that will help 
strengthen future growth. The most important things we can do 
for future growth are to improve the quality of our education 
system, to invest in innovation, and to rebuild America's 
infrastructure. Without these investments, America will be 
weaker and less competitive.
    Now, as part of this strategy for growth, the President 
proposes reforms to our tax system that are designed to 
encourage investment. We proposed to put in place a permanent 
and expanded tax credit for research and development; to 
eliminate capital gains taxes on small businesses; to encourage 
advanced manufacturing in clean energy technologies; to keep 
taxes on investment income, dividends, and capital gains low; 
to reform and extend the Build America Bonds program; to make 
college more affordable for middle-class Americans.
    Now, these tax incentives are accompanied by reforms that 
would reduce incentives to shift income and investment outside 
of the United States and to close loopholes and tax preferences 
that we cannot afford.
    Now, in addition, we propose to pursue comprehensive 
corporate tax reform that would lower the corporate tax rate. 
Our present system, as you all know, combined a very high 
statutory rate with a very broad range of expensive tax 
preferences for specific industries and activities. We need a 
more competitive tax system for businesses that allows the 
market, not tax lobbyists and tax planners, to allocate 
investment, a system which businesses across industries pay a 
roughly similar share of earnings in taxes, a system that 
provides more stability and certainty and is more simple to 
comply with. And we need to do this without adding to our 
future deficits.
    Now, we have begun the process of trying to build support 
for a comprehensive corporate tax reform plan, and I hope we 
have the chance, the opportunity to move forward on that soon.
    The President's budget also outlines some responsible 
reforms on the individual side. We propose, as we have in the 
past, to allow the 2001 and 2003 tax cuts for the wealthiest 2 
percent of Americans to expire on schedule; to limit certain 
deductions for those same high-income Americans; to restore the 
estate tax levels and exemptions to 2009 levels; and to close 
the carried interest loophole. These proposals--and I want to 
emphasize this. These proposals are designed to help ensure 
that the savings we achieve together in reducing spending are 
devoted to deficit reduction, not to sustaining lower tax rates 
for the most fortunate 2 percent of Americans.
    Now, this budget would achieve the dramatic reductions in 
our deficits over the next decade that are necessary, that are 
essential to stop the national debt from growing as a share of 
the economy and to stabilize the debt burden as a share of the 
economy at a level that will not threaten future economic 
growth.
    Could I just pause there for a minute to make the following 
point clear? When CBO scores these proposals in the next few 
weeks, they will show higher deficits than we project. And, 
therefore, they will show deficits that are unsustainable over 
time. They will show debt rising as a share of the economy even 
in these next 10 years.
    Now, we recognize, as you do, that these reforms, even if 
enacted, would represent only a first step, only a downpayment 
on the longer-term reforms that are necessary to address our 
long-term deficits. To address the deficits we face beyond the 
next decade, over the next century, we have to build on the 
progress we achieve in the Affordable Care Act to substantially 
reduce the rate of growth in the costs of entitlement programs, 
health care costs. And although Social Security is not a 
contributor to our short- or medium-run deficits, we have to 
work together across the aisle to try to strengthen Social 
Security for future generations.
    Now, it is very important to understand that we cannot grow 
our way out of these deficits. They will not go away on their 
own. They will not be solved by cutting deeply into programs 
that are critical to future growth and competitiveness. And we 
have to find consensus on a multi- year plan that cuts where we 
can so that we invest where we need to and that reduces 
deficits over time. Making a multi-year commitment will allow 
us to make sure that these changes are phased in as the 
expansion continues, as the economy recovers from the crisis, 
and making a multi-year commitment will give businesses and 
individuals the chance to plan to adjust, to prepare for the 
impact of those changes on the economy over time.
    Now, these proposals, as I said, represent a starting point 
for the discussion. We recognize that there are different 
ideas, different proposals from both sides of the aisle for how 
to achieve the necessary reduction in our deficits. And we 
know, as you know, that we need both parties and both Houses of 
Congress to come together to enact solutions.
    Now, in December of last year, we were able to find 
bipartisan consensus on a very strong--not perfect in 
everybody's views, but very strong package of tax incentives to 
help sustain the recovery and restore confidence. We have to 
bring that same spirit of compromise, of bipartisanship to the 
challenge of fiscal responsibility.
    Thank you.
    [The prepared statement of Secretary Geithner follows:]



    
    Chairman Conrad. Thank you very much for your testimony.
    Let me go to the--not that one, but that. This to me is 
kind of the nub of the issue. It is true that the President's 
budget is stabilizing the debt, that is, that you are bringing 
down the deficits in a way that the debt as a share of the 
gross domestic product does not continue to increase.
    The problem that I see is that it is stabilized at a level 
that is too high, that it is stabilized at a level of gross 
debt of over 100 percent of GDP.
    I go back to the Reinhart-Rogoff study. Two hundred years 
of financial history, 44 countries, their conclusion: When you 
have a gross debt of over 90 percent of GDP, future economic 
growth is diminished, and pretty significantly.
    Have you assessed the Reinhart-Rogoff study? Do you agree 
with it? Do you think that they are correct in terms of high 
levels of debt affecting economic growth adversely?
    Secretary Geithner. Absolutely. It is an excellent study, 
and you could say in some ways from what you summarize 
understates the risks, because it is not just that governments 
or countries that live with very high debt-to-GDP ratios are 
consigned to weaker growth; they are consigned to the damage 
that comes from periodic financial crises as well.
    Now, could you put that chart back up there for a second?
    Chairman Conrad. Yes.
    Secretary Geithner. Let me just say two things about this. 
In some ways, that overstates the near-term problem because, as 
you know, we hold substantial financial assets, and you really 
want to look at debt net of financial assets, and you want to 
look at debt held by the public. But in many ways, that still 
understates the problem because that does not capture the 
future liabilities that are embedded in Medicare, Medicaid, and 
Social Security, which, of course, grow at a very rapid pace in 
the decades beyond that.
    So if you are going to look at a true measure today of our 
full obligations to our citizens, the commitments we have made, 
of course, as you know better than anybody, it would be much 
higher than that.
    Chairman Conrad. You know, having served on the Commission, 
having served here on the Budget Committee for 24 years, if 
there is one thing I am absolutely persuaded of, the risk to 
this country is untenable. Absolutely untenable. So that takes 
me to the next one.
    If we have agreed that this is too high a level of debt, 
that this does compromise future economic growth, then the 
question is: How do we go beyond what the President has 
proposed? I give him credit for stabilizing the debt, but it is 
stabilized at a level that is too high. And I am not one that 
expected the President to lay out a detailed plan in his budget 
because I know how this town works. Had he done that, the other 
side then spends all their time lacerating the plan.
    The question is: How do we get to the table to have a 
serious negotiation between the House of Representatives, the 
U.S. Senate, the White House? What is your vision of how in the 
coming days and weeks we find a way to get to the table for a 
serious negotiation?
    Secretary Geithner. Excellent question. I know you have 
thought a lot about that and offered a lot of ideas on that. I 
guess I would say that what we are going to see in the next few 
weeks is the following: In the House, the Republican leadership 
will have to propose and pass a budget resolution that lays 
out, like the President's budget does, a comprehensive plan, 
revenues and outlays to bring deficits down over the next 10 
years. And they in that context will have to make the kind of 
choices we make in this budget, which is to answer the 
question: How far do you have to reduce the deficits? How far 
do you have to go? How deep do you have to go? How quickly or 
how gradually should you get there? What should be the 
composition of tax changes and reductions in spending to 
achieve that objective? What are you doing about things that 
matter to how we grow as a country in the future? So they will 
lay out those basic fundamental choices.
    Now, there is a process in the Senate that is engaged in 
looking at a way to adapt the kind of comprehensive framework 
you saw on the Commission and see if you can translate that 
into consensus here. That, when it comes, will provide another 
contrasting vision about strategy. And then you will have a 
chance at that point for people to confront the tough choices 
you have to make in choosing among those basic paths.
    Again, I think it is important to recognize that the 
President's budget does not solve all the problems facing the 
country. It is not a budget for the next century. What it does 
do is tell you how to get to a level over the next 10 years 
that leaves us with a level of debt as a share of the economy 
that is probably stable and would not weaken future growth. 
But, of course, it does not solve the questions beyond that.
    If the Congress finds the will to go deeper, lower deficits 
over that 10-year period of time, which, as you said, would be 
desirable because it would start to bring the debt-to-GDP on a 
downward path, then--like the Commission did, the Commission 
achieved that--then people will say--will be able to look at it 
and they will say, Are we prepared to make the choices 
necessary to go beyond that?
    And I think, again, the fundamental reality that I think we 
all have to confront--and it is both the Executive and the 
Congress--is that the current process we use for making these 
choices does not work. It has not worked. It is completely 
dysfunctional, in part because it leaves us with year-by-year 
incremental uncertainty creating changes to taxes with no 
clarity on spending. And the reason Rogoff-Reinhart produced 
the study that shows this effect on growth, opportunity incomes 
from high deficits, is because you leave the American people 
and American businesses to deal with a deeply uncertain future 
about what is going to happen to things that deeply affect 
their income and their business prospects.
    So the costs of leaving that uncertainty out there are 
very, very high, and to resolve that you need something beyond 
a year-by-year political fight on incremental change. You need 
something that locks in comprehensive, multi-year reductions. 
That way people can look at it, and they can plan. They say, 
OK, I know what is going to happen now, I now know Congress is 
going to solve the problem, and I can plan and adjust and 
prepare for those changes.
    Chairman Conrad. Well, let me take you right--my time has 
almost expired. Let me just take you right to the Commission, 
because we did get 11 of 18 to agree--five Democrats, five 
Republicans, one Independent. And we reduced the debt $4 
trillion over the next 10 years--$4 trillion. The President 
said about $1 trillion. Not only did we stabilize the debt, we 
started bringing it down as a share of GDP and over time 
brought it down markedly to a place where you would not only 
be--you would be guarding against--you would be hedging against 
future economic risk.
    Is the size of what the Commission recommended a package 
that you believe would make sense, that is, $4 trillion of debt 
reduction, if we could get it on a bipartisan basis?
    Secretary Geithner. I think you have slightly overachieved 
in terms of what is necessary, but, again, our risk, of course, 
as a country is that we do too little, not too much at the 
moment. So I admire you for laying out that path. But what----
    Chairman Conrad. So if $4 trillion is overshooting, what do 
you think? Three trillion?
    Secretary Geithner. Again, I think the minimum test is to 
get the deficits comfortably below 3 percent of GDP for a 
sustained period of time.
    Now, again, as you know, the basic----
    Chairman Conrad. But that does not reduce the debt. I mean, 
that will just----
    Secretary Geithner. Right. But if you----
    Chairman Conrad. That will keep it from growing.
    Secretary Geithner. You have to get them there soon enough 
that you stop the debt from growing as a share of the economy 
at an acceptable level. Again, I admire you for going further, 
and if we can do that, that would be excellent. But what is 
driving, you know, the 10-year deficits is not Medicare, 
Medicaid, and Social Security. What is driving the 10-year 
deficits is just a gap between resources and commitments 
outside those basic programs. It is beyond the 10-year window 
where you start to see those commitments, you know, eat an 
excessively large share of GDP. And so what really matters, if 
you want to go deeper than 3 percent of GDP, is what do you 
lock in for those entitlement programs outside that 10-year 
budget window.
    Could I say one more thing, Mr. Chairman? There is a chart 
that I would like you to put back up which shows outlays and 
revenues to GDP, because I think that is the right way to think 
about it. If they are gone, then I will not do it. But what the 
President's budget does is to propose some changes in revenues 
that would leave revenues as a share of GDP slightly above the 
historic average. I think in the President's budget they rise 
to a little bit below 20 percent of GDP--a little bit less than 
what the Commission proposed. And outlays in the President's 
budget minus interest fall to around 20. Interest is about 3 
percent of GDP at the end of that period if you do that.
    So the reason I say that is because when you think about 
the choices we face, they are about like, What do you want 
Government to do? How large a share of income do you want the 
Government to take and spend? And what the President's budget 
does is get you to the point where revenues are not high at a 
level that would threaten future growth and outlays minus 
interest, which is just the cost of the cumulative mistakes of 
the past, are at a level that is really quite low in the 
historical period. You know, I said 20 percent of GDP minus 
interest, and, of course, the discretionary non-defense share 
is much, much lower as a share of GDP at the end of that 10-
year window.
    Chairman Conrad. You know, I would like to continue the 
discussion. My time has expired, so we will go to Senator 
Sessions. But I would like, if we have a chance to get to a 
second round, to come back to this point.
    Senator Sessions.
    Senator Sessions. Well, that is a big national discussion. 
I do not think the American people want to see the percentage 
of the take of the Government increase substantially. That 
charts shows that it is now 25 percent, well above where we 
have ever been in this kind of environment. And it is very 
dangerous, and people are not happy about it. They think this 
is a limited Government of limited responsibility.
    Senator Conrad, your chart, the one you have emphasized the 
most, having wrestled with these numbers, I think that is 
pretty close to the core chart. I have to give you credit. You 
have wrestled with it really hard, and when we are over 100 
percent of GDP, we are in a danger area.
    Mr. Geithner, you indicated not only could it reduce our 
growth, but you have indicated it makes us more susceptible to 
crises, debt crises, perhaps like the one we had in 2007, like 
Greece and other countries have had. Is that correct?
    Secretary Geithner. I am very confident you are going to 
help us prevent that, but I am saying the reason why debt-to-
GDP matters is not just because growth is weaker, but because--
and if you look at all those countries in the past, they 
suffer--they are much more prone to crises in that context. 
But, of course, we are going to avoid that as a country.
    Senator Sessions. Well, we need to take some steps to do 
so. In my opinion, we are too close, and as responsible 
Government officials we have a duty to help our country avoid 
risk that is unnecessary.
    Let me just briefly run through this plan, because we are, 
I think, talking past us on the numbers. You do not contend 
that the 10-year budget calls for a single year, do you, in 
which we will not be adding more to the national debt?
    Secretary Geithner. No. You are exactly right. The debt in 
aggregate terms does keep growing over this period of time, 
even if you achieve this deficit reduction, but the measure 
that economists use, just like families use, they look at the 
amount of debt they have relative to income.
    Senator Sessions. Well, one of the reasons we got into 
trouble is that kind of logic. I admit it started with 
President Bush. But when you start politically allowing and 
accepting substantial deficits, it is hard for those of us who 
try to contain spending to have any moral basis on which to 
make that assertion. It is always that you are hurting somebody 
when you try to contain spending. I think it is a dangerous 
theory. It is part of the reason we are here, this GDP 
argument. The debt goes up.
    Now, the administration does insist that the plan will 
reduce the total debt by $1 trillion over 10 years, but isn't 
it a fact that the debt is increasing substantially during that 
period and it is just $1 trillion less than it would otherwise 
have been? And I guess it otherwise would have been $14 
trillion, and you are suggesting that it increases about $13 
trillion.
    Secretary Geithner. Well, I do not think those numbers are 
quite the way to think about it, and I want to----
    Senator Sessions. Well, I am just asking you. The $1.1 
trillion simply reduces the total debt by $1 trillion projected 
to accrue over the 10 years and that that is a $13 trillion 
range.
    Secretary Geithner. What I am saying is that that slightly 
understates the amount of deficit reduction. Let me just make 
one clarifying point. That does not count the revenue gains of 
allowing what we call the Bush tax cuts for the top 2 percent 
to expire. If you allow those to expire and you preserve the 
rates and exemptions for the estate tax at 2009 levels, then 
you achieve another roughly $1 trillion in deficit reduction.
    So, Mr. Chairman, if you look at the deficit reduction in 
our proposal relative to the Commission's, we are closer to $2 
trillion relative to the Commission's $4 trillion. It is not 
really like $1 trillion versus $4 trillion.
    The reason why, Senator Sessions, that is so important, of 
course, is that if you are not going to let those tax cuts for 
the high end expire, if you are going to extend them, and you 
want to achieve the same deficit reduction, you are going to 
have to find another $1 trillion in spending cuts to achieve 
that.
    Senator Sessions. Well, my time is running, but I would 
just say to you that I am using your numbers, as I believe, and 
it is about $13 trillion, and it is not a very large reduction 
of the surge in debt, and we are still on the road to doubling 
it. And the plan, let me ask you, does not call for any change 
in Medicare, Medicaid, and Social Security as you mentioned?
    Secretary Geithner. You are right that this budget does not 
propose changes to Social Security, and it does not propose 
detailed changes beyond the cost savings in the Affordable Care 
Act. But I would just restate, of course, that CBO does 
estimate very, very substantial savings from the Affordable 
Care Act over the next two decades, about $200 billion the next 
decade and $1 trillion in the second decade. And those 
represent the largest cost-saving entitlement reforms than we 
have considered or adopted as a country----
    Senator Sessions. Mr. Geithner, we will continue to debate 
that issue. I believe that CBO's final letter right before the 
vote that it double counts the money is correct, and it is a 
miscalculation. And I do believe that it is driving up the cost 
of health care as CBO has said, not reduced it.
    Let me ask you this: It has been repeatedly suggested that 
discretionary spending has been cut and tough choices have been 
made. But isn't it a fact that total discretionary spending 
increases every single year except maybe with the reduction in 
the military effort next year? But 2012 through 2021 
discretionary spending increases every year is not reduced.
    Secretary Geithner. I do not think that is quite right. I 
am sure what I am about to say is correct, which is that if you 
freeze non-security discretionary spending at the 2010 nominal 
levels and you do that for 5 years, and then after that you let 
it grow with inflation, then you do reduce the deficits by $400 
billion over that 10-year period of time.
    Senator Sessions. Well, let me just note that Table S. 10 
shows that 2013 through 2021 there is an increase in 
discretionary spending every year. I think that is 
indisputable.
    Secretary Geithner. I do not think that is quite fair, but, 
Senator Sessions, one of the great things about our system here 
is that CBO will resolve these debates for us, and we will have 
a chance to----
    Senator Sessions. They will, and they are not dispute the 
numbers I read, I do not think.
    Now, the budget plan calls for average annual deficits over 
this 10 years of $720 billion, that the lowest deficit in the 
10-year period is $607 billion, and that in the last 4 years of 
your 10-year budget, the deficit is increased from 619 to 681 
to 735 to 774, substantially increasing deficits. Would you 
disagree with that?
    Secretary Geithner. Those numbers are exactly right. But, 
again, I think you have to look at them as a share of the 
economy as a whole, as a family would do. They look at debt to 
income.
    Senator Sessions. We are not inclined to use a share of the 
economy anymore. That is why we are broke.
    Now, let us talk briefly, as my time is winding down, about 
our interest situation. Under your budget the interest 
increases each year. It was $187 billion in 2009. Under your 
proposal it increases to $844 billion. I do not know if we have 
a chart here. Would you not agree that that is a stunning 
figure, perhaps the fastest-growing item in it, and all of that 
is a direct result of the debt we are running up and only a 
modest expectation of interest rate increases?
    Secretary Geithner. Senator, absolutely. It is an 
excessively interest burden. It is unsustainable.
    Senator Sessions. Well, it is your plan for the 10 years. I 
mean, that is the one the President has submitted. That is what 
he has asked us to vote on. It will result--and those are your 
numbers off your budget.
    Secretary Geithner. Senator, you are absolutely right that 
with the President plan, even if Congress were to enact it and 
even if Congress were to hold to it and reduce those deficits 
to 3 percent of GDP over the next 5 years, we would still be 
left with a very large interest burden and unsustainable 
obligations over time. That is why we are having the debate. I 
completely agree with you. But the question, though, is, just 
to be direct about it: What is the alternative plan? And, 
again, the way our system works- -this is a good thing--you 
will be able to see from the House, we will be able to see from 
this body, whether people can find the political will here to 
go deeper. And if you can find----
    Senator Sessions. But what your plan is, that plan is the 
one you are required by law to submit, and that is what you 
call for, and it is not acceptable. I am sorry. It is a plan 
not for winning the future but losing the future.
    Secretary Geithner. No, I----
    Senator Sessions. I am disappointed, really.
    Secretary Geithner. No, Senator, I would just disagree 
again. But, again, the test of this is let us see the 
alternative. You know, we have laid out something that goes 
very deep, much deeper than we have gone as a country ever 
before.
    Now, in terms of the scale of deficit reduction in a short 
period of time, if Congress can find a way to do that without 
gutting basic programs, killing investments, hurting growth, 
then we would welcome the chance to join you in embracing those 
reforms. But, again, the way our system works, we are 
proposing, and you will have the chance to see if you can do 
better.
    Senator Sessions. Well, obviously you----
    Chairman Conrad. Senator----
    Senator Sessions. That is your plan.
    Chairman Conrad. Senator, we have gone way over now.
    Senator Cardin.
    Senator Cardin. Thank you, Mr. Chairman.
    Secretary Geithner, once again it is good to be with you. I 
think we all agree the deficit--we need to have a credible game 
plan to bring the deficit under control. That requires the 
administration and Congress to work together. It requires 
Democrats and Republicans to figure out a way to come together 
on a budget plan that will be in the best interest of our 
country. I think we all agree on that.
    Now, there may be one area where we have some agreement, 
but from different sides, in that we all disagree with the 
Congressional Budget Office. My friends are telling me that 
they just want to ignore it in the House even though it is our 
impartial referee as to the scoring of costs.
    I am disappointed that the Congressional Budget Office has 
not scored a lot of the savings that will come from the health 
reform that you pointed out. I think it is intuitive to the 
people of this Nation that if we can really get access to care, 
if we can have people out of the emergency rooms and into 
primary care, if we can deal with readmissions to hospitals and 
better management of people with serious illnesses, that 
America does not have to stand out alone with the highest cost 
burden to any economy on health care, that we can bring it more 
into line and we can reduce our health care spending to help 
bring not only our budget into balance but our economy into 
better performance.
    So, yes, we do need action on spending, and I agree with 
Senator Conrad. I think the President's proposal for a freeze 
on domestic discretionary spending and the way he is handling 
the military is a way that is a very credible plan on the 
spending side and that we need to lead on the spending side. 
But even if we get those savings and even if we get the savings 
from the health care bill that I expect that we will get, you 
cannot do it on that alone. If we extend all of the tax 
policies that are currently in place in this outdated income 
tax structure we have, we will not only negate all the 
savings--all the savings we are talking about--but we will also 
be further in debt.
    So you have to have a comprehensive plan that deals with 
all these, and quite frankly, I do not think the action in the 
House of Representatives this week is particularly helpful. I 
do not think it is helpful because I think it will negate the 
potential savings in the health care bill the way that they are 
restricting us to put in place good common-sense ways to try to 
keep people healthy in America. But also I think it is 
unrealistic, it is budget cuts, and will not produce the type 
of deficit reduction that is needed for this Nation.
    So I just really want you to know, I think that the 
President in his budget has put forward a good-faith approach 
to dealing with the discretionary spending areas. And, yes, we 
need to work together and supplement that, as the Debt 
Commission did, in looking beyond just the discretionary 
spending in this country. We need to look at the entitlements. 
We need to look at the revenue side. And we need to come 
together for this country and not just make partisan speeches.
    Now, I want to touch on one particular area that we had 
some questions on yesterday before the Finance Committee, but I 
want to move forward on it as it relates to small business. In 
your budget, you are moving forward with the initiatives on 
small business, particularly as it relates to the availability 
of credit. That is an area that, when we first attacked the 
problem on our economy, in my view the small business community 
was not given the type of attention it needed in order to have 
credit. We all know that job growth is going to come primarily 
from the small business sector. Innovation is higher in the 
small business sector.
    Can you just give us the status of both the program at the 
national level that will extend credit to small businesses as 
well as the moneys that are made available to leverage State 
programs to help credit for small businesses?
    Secretary Geithner. Again, I am happy to do that, but let 
me just start with the tax changes. At the end of the year in 
the tax package, there is a very powerful, sweeping set of 
incentives for small businesses that provide a lot of help and 
assistance at a time when they want to be able to have a chance 
to take advantage of growing demand for their products. They 
are very powerful, and they are very good economic sense, very 
practical, very creative. But the two programs you referred to 
we think will help, again, make sure that small businesses are 
going to be able to get access to credit and, therefore, bring 
more people back to work, bring more production online as 
demand improves. And those two programs are, first, a program 
to give small banks the chance to come and get capital from the 
Government for a very economically attractive price. We have 
about 250 applications in. We are going to be approving those 
for eligible banks as quickly as we can, and they will help 
leverage a substantial amount of borrowing capacity available 
to small businesses.
    We also have approved three States now for some additional 
financial support to help reinforce their own small business 
credit programs. A lot of creativity around the country at the 
State level in those programs, and what Congress authorized 
last year was to provide a little additional financial 
resources for those programs, too. We think those will help, of 
course.
    But, you know, a lot of small banks across the country 
still have themselves way overexposed to commercial real estate 
and have a lot of digging out to do still, and that is going to 
be a problem for those small businesses that were, frankly, 
unlucky in their choice of bank. But what these programs will 
do is help provide alternative sources of credit, make sure 
there is enough capital in the system to, again, help reinforce 
this recovery that is happening.
    You are seeing loan demand start to increase again for the 
first time, and you want to make sure that banks are able to 
meet that demand.
    Senator Cardin. There is clearly a need out there, and 
there are clearly banks that are still sitting on the sidelines 
as it relates to making loans available to small businesses. If 
there is an existing relationship, it is a little bit easier 
for a bank and a small company. If you do not have that 
existing relationship, particularly if you are new company, it 
becomes very, very difficult.
    We had that debate last year as to whether we should be 
using leveraging the private sector lending or whether we 
should try to do direct, and we went with leveraging the 
private sector. I would really appreciate you keeping us 
informed as to how well that is working so that we clearly need 
to pay attention to this issue, and we want to make sure that 
the money really is being leveraged to more activity.
    I could speak for the program in Maryland. Governor 
O'Malley is one of those Governors that has a program and is 
requesting Federal participation. They leverage the public 
dollars at a very high ratio level. So for a relatively small 
investment of Federal funds, we leverage a lot of loans to 
small companies. That is critically important to companies that 
are having a hard time getting loans today.
    Secretary Geithner. And I think the loss rates on those 
programs are really very low.
    Senator Cardin. Extremely low.
    Secretary Geithner. I think on net they make money for the 
State, not lose money. So if you design them well, then you can 
make a big difference.
    Senator Cardin. Thank you.
    Thank you, Mr. Chairman.
    Chairman Conrad. Senator Ensign.
    Senator Ensign. Thank you, Mr. Chairman.
    I want to go back to what you were talking about, the 
exchange that you had with the Chairman about the gross debt, 
the 90 percent gross debt, because you said something that I 
thought was fairly interesting when you talked about the 
unfunded liabilities that are not on our balance sheets, 
because you said the situation was actually much more dire than 
what your budget or anybody else is really talking about. And 
even when we go back to the study, the Reinhart study, the 200 
years that they talked about the 90 percent of gross debt, 
almost none of those countries had those unfunded liabilities.
    So if you actually put those on the books, that 90 percent 
is much higher, and where you get to 110 percent is much higher 
with this country when you put the unfunded liabilities. And 
the reason I make the point is because this situation is much 
more dire. The criticality of us working together with 
President Obama on entitlement reform is so critical, and that 
is why I think that some of us on this side of the aisle are so 
disappointed with this budget, that the President did not show 
bold leadership.
    It is politically risky. I will acknowledge that. And, Mr. 
Chairman, the one point that I disagree with you on is you said 
we would attack the President if he would have put that in his 
budget. I disagree, because you are showing--Paul Ryan, the 
Chairman of the Budget Committee in the House of 
Representatives, put out a proposal last year on entitlement 
reform, and he is putting it in his budget this year.
    I am encouraging you, I am encouraging Senator Sessions, to 
put entitlement reform in this year's budget, so even though 
the President has not shown the leadership, the Congress needs 
now to show the leadership, and then to ask the President to 
join us, because we all know that these are politically, you 
know, third rails of American politics, but it is critical, 
because the numbers--and you agree, everybody agrees, everybody 
knows this is unsustainable. And if we do not show political 
courage right now, we are doomed as a country. We really are.
    Secretary Geithner. Well, Senator, I agree with you, but I 
would just try to make sure I emphasize one key thing, which is 
that you are absolutely right about entitlements, and if you 
look beyond the next decade, they again gradually, 
progressively, but at an alarming rate start to eat too large a 
share of national income. But do not forget the next 10 years, 
because if we do not get these deficits down over the next 3 to 
5 years to a level that is sustainable, then we will face the 
risk of a significantly weaker expansion.
    I know everybody is showing a lot of ambition on 
entitlements now, which is good because it helps underscore the 
importance of making sure the Affordable Care Act reforms are 
allowed to get some traction, because they do reduce cost 
growth. But remember, the next 10 years are really important, 
too.
    Senator Ensign. Absolutely, and let me just interrupt you 
for a second. I actually disagreed with one of your statements, 
too, where you said Medicare and Medicaid are not contributing 
to the deficit. They have been growing at such a rapid rate, 
they are absolutely contributing to the deficit right now. And 
so we need to get control of these entitlements, not just for 
the next decades to come. We need to get control of these 
entitlements for today. We need to design better systems.
    I believe that, for instance, Medicaid, what we did on 
welfare reform in a bipartisan fashion during the 1990s, we 
block-granted it to the States because they were these 
institutions that had shown the ability to reform them and do 
it in a way with flexibility. And if we get the Federal 
Government out, we can cap the amount that we are sending. We 
know how much that could potentially save into the future. It 
could be huge amounts of money. And designing a better Medicare 
system that focused more on, you know, healthier behaviors for 
seniors and getting things under control, you know, chronic 
types of conditions. But we need to do that for this decade as 
well.
    I do not have a heck of a lot of time, so I do want to go 
to one other thing, because we know we need to do this. I am 
just encouraging you to get the President to join us and 
actually show some Presidential leadership.
    The comment, small business is the engine that drives the 
economy, do you think that that is a fairly true statement?
    Secretary Geithner. Well, sometimes we get a little carried 
away, because big businesses matter, too.
    Senator Ensign. It does, but----
    Secretary Geithner. But in general, you are right, that 
there is a lot of innovation and job creation that comes from 
small business.
    Senator Ensign. OK. The reason I bring this up is because 
in your budget, most small businesses--I was a small business 
owner. Most small businesses owners pay ordinary income because 
they are Subchapter S corporations, sole proprietors, LLCs, in 
various forms like that. And while I applaud you, I totally 
agree that we need to reform our corporate Tax Code. We need to 
bring it down. We need more of a territorial system. And I 
appreciated your comments yesterday about repatriating money 
back to the United States in a much easier way. All of that is 
good stuff.
    But if you allow the tax rates to go up, now corporations 
can be paying a 24-percent tax rate where, you know, most small 
businesses in the country could be paying almost a 40-percent 
tax rate. And if it is really the engine that grows the 
economy, I think that you are going to stifle a lot of growth 
in small businesses with these high tax rates. And so, you 
know, I would like to hear your comments on that.
    Secretary Geithner. I believe that if you are going to do a 
serious job of looking at corporate tax reform, comprehensive 
tax reforms, you have to look at business income more broadly 
defined, and you are going to have to look at how we treat 
income of businesses that are not corporations under the Tax 
Code. So I agree with that point.
    But could I make one qualifying point?
    Senator Ensign. By the way, I hope we can work together. I 
am actually working on something that treats them the same. It 
is a little expensive, and we are going to have to work on it, 
but I appreciate that comment.
    Secretary Geithner. I would welcome a chance to do that. I 
do want to make sure, though, we put in context what the 
implications are for small businesses of letting the top 2 
percent tax cuts expire, and this is very important because 
that would only affect less than 3 percent of small businesses. 
The average earnings of the less than 3 percent of small 
businesses affected are about a million. The median is about 
$700,000. And most of the small businesses that fall into that 
category--again, it is less than 3 percent--are really what we 
would typically look at as law firms or partnerships or 
investment companies in that context. So we are not talking 
really about a significant number of the hardware stores on 
Main Street or the small manufacturing companies. We are 
talking about partnerships, law firms. But----
    Senator Ensign. You need to get out there in the real world 
and talk to folks. The reason I am saying this, because I have 
been out there in the real world. It is the veterinary clinics, 
it is the dental offices, it is the--and they want to expand 
their businesses. They want to create jobs. And if taxes are 
part of the thing that they are looking in the future, if their 
taxes are going up, business owners--and, by the way, those 3 
percent produce about a quarter of the jobs, the new jobs. And 
so that is a significant thing, and if they want to grow their 
business and we all want more jobs in America, we have to 
understand that small businesses do create jobs, and we are 
going to hurt job creation, which hurts the growth curve of 
revenues coming into the United States.
    My time has expired. I apologize.
    Secretary Geithner. Mr. Chairman, could I just say--of 
course, I understand this concern, but, again, just two other 
context notes about--you know, we are proposing to restore the 
rates that prevailed in the 1990s. That was the best record of 
small business job growth, small business creation that we had 
seen in a long time and have seen since. It is something that 
is manageable, that we can afford as a country. We do not have 
unlimited choices, and we are proposing in the budget alongside 
those changes some very well designed, very powerful incentives 
directly related to small businesses, like, for example, zero 
capital gains on investments in small businesses. And we are 
proposing to keep taxes on overall investment quite low as a 
whole.
    But, anyway, happy to work with you on reform. You are 
right to say you have to look beyond corporates, although it is 
kind of difficult to do politically.
    Chairman Conrad. I thank the Senator.
    Let me just say we are on 7-minute rounds to Senators. You 
know, typically with this number of Senators we do 5 minutes, 
but we went to 7 minutes today given having the opportunity to 
have the Secretary. So I am going to try to drop the gavel 
right at 7 minutes in fairness to the other colleagues who are 
here and waiting.
    Senator Sanders.
    Senator Sanders. Thank you very much, Mr. Chairman. And 
welcome, Secretary Geithner.
    I find this to be an extraordinarily strange conversation. 
We hear a lot of discussion about great concerns about the 
deficit and the national debt. But the people who talk most 
loudly and vigorously about this issue are those people who 
helped create this national debt. So let us be clear about how 
we got here in the first place. We might want to talk about 
that.
    This Senator voted against the war in Iraq, for a number of 
reasons, not the least of which it was unpaid for. Three 
trillion bucks. That is a lot of money. I did not hear too much 
discussion a few years ago about that war.
    This Senator voted against huge tax breaks for the 
wealthiest people in the country. And you know what? Budgets 
are two things. I know this is a radical concept. It is not 
just spending, but it is also money coming in. And if you give 
hundreds and hundreds of billions of dollars in tax breaks to 
the very wealthiest people, lo and behold, deficits go up. I 
voted against that. Most of my friends on the other side of the 
aisle voted for it.
    I voted against the Medicare Part D prescription drug 
program written by the drug companies and the insurance 
companies, not because we do not need a good program for 
seniors; that was a very wasteful, ineffective way to go. Most 
of my Republican colleagues who are now jumping up and down 
about the deficit, they voted for it.
    I voted against the Wall Street bailout, and I do 
understand much of that money has been paid back. But, 
nonetheless, I did not hear at that point when we bailed out 
the largest financial institutions of the world whose illegal 
behavior, whose reckless behavior drove us to a recession, I 
did not my Republican friends say, ``Oh, we cannot give them 
$800 billion. That will drive the deficit up.'' Maybe I missed 
that discussion. But I did not hear it too much.
    So that is one of the reasons we got to where we are right 
now. Under Bush, as we all know, the national debt almost 
doubled.
    The second part of the discussion I am not hearing about is 
we talk about America like we are all in this together. Well, 
let me give you some startling news. We ain't all in this 
together. The people on top, the top 1 percent, the top 2 
percent, are doing phenomenally well at the same time as the 
middle class in this country is collapsing.
    Mr. Geithner, when you respond, you tell me what I am 
missing here. All right?
    The United States today has the most unequal distribution 
of income and wealth of any major country on Earth. The top 2 
percent earns more income than the bottom 50 percent. And I 
hear the words about political courage. Oh, we need to be 
really tough. We can throw old ladies in the State of Vermont 
off the heating assistance program when it gets 20 below zero. 
Man, that is real political courage. Well, how about some 
political courage about taking on the big money interests who 
fund our campaigns, who provide millions of dollars and want 
tax breaks for the very wealthiest. Let us see some political 
courage there rather than throwing senior citizens off the 
LIHEAP program or low-income people off of life and death 
programs for them.
    Now, Mr. Secretary, in 2007 the top 1 percent earned 23.5 
percent of all income in this country. The top one-tenth of 1 
percent took in 11 percent of all income. The percentage of 
income going to the top 1 percent has nearly tripled since the 
1970s. Is that right, Mr. Secretary?
    Secretary Geithner. I think that is largely right.
    Senator Sanders. From 8 percent to 23 percent. Between 1980 
and 2005, 80 percent of all new income created in this country 
went to the top 1 percent.
    Now, when we talk about how we move toward a balanced 
budget, I would appreciate my friends listening to this. In 
2007, the wealthiest 400 Americans made an average of $345 
million a year. Under the Bush administration, these 400 top 
earners saw their incomes double while their effective Federal 
tax rate was cut almost in half over the past 15 years.
    So here is the dynamic that you have which must be thrown 
into this discussion. The middle class in many ways is 
collapsing. Real unemployment in America today--I have not 
heard a word about unemployment yet, by the way--is 16 percent 
if you talk about people who have given up looking for work and 
people who are working 20 hours when they want to work 40 
hours. Meanwhile, we have cut substantially taxes for the very, 
very wealthiest people in this country, and in this agreement, 
this very poor agreement that the Obama administration agreed 
to with the Republicans, those are extended again for another 
couple of years.
    So I would suggest that when we talk about sacrifice, maybe 
some of the campaign contributors and the wealthiest people in 
this country might want to make some of that sacrifice rather 
than just the middle class.
    Let me ask Secretary Geithner a couple of questions. I was 
glad to hear you--and just let us go through this again. You 
would agree with me that Social Security has not contributed 
one nickel to the deficit and that Social Security has a $2.6 
trillion surplus right now?
    Secretary Geithner. I think that is largely right, yes.
    Senator Sanders. OK. And would you agree with me that, 
according to all the studies done, Social Security can pay out 
every benefit owed to every eligible American for roughly the 
next 25 to 30 years?
    Secretary Geithner. I would have to check that, but I 
assume if you are quoting it, it is right.
    Senator Sanders. Yes, it is. And after that, it can pay out 
about 75 to 80 percent of all benefits.
    Secretary Geithner. That is true, but I would not be so 
comfortable about that because, as you know, the minimum 
benefit is not a very rich benefit for many Americans.
    Senator Sanders. I know it. During the campaign, when 
President Obama was elected, he suggested that the solution to 
the long-term solvency of Social Security was to lift the cap 
on upper-income folks above $250,000, which I thought was 
exactly the right thing to do. Is that still the 
administration's or the President's position?
    Secretary Geithner. Well, I want to be careful in how I say 
this because, again, we want to preserve some capacity for 
people to come together on something that is going to work, but 
I will be direct about it. You cannot do this in a way that is 
fair and responsible by simply cutting benefits, even if you do 
it in a progressive way. You have to go beyond benefits if you 
are going to do it in a way that is fair and has any realistic 
prospect of people coming together around the plan.
    Senator Sanders. I agree with you, and let me just say 
this. This is a quote from Candidate Obama during the campaign. 
He said, ``John McCain's campaign has suggested that the best 
answer for the growing pressures on Social Security might be to 
cut cost-of-living adjustments or raise the retirement age. Let 
me be clear. I will not do either.''
    Do you think that that is still the President's position?
    Secretary Geithner. Well, I think the President's position, 
again, is he just wanted to be very careful, as you heard him 
say in the State of the Union, to not be solving Social 
Security in a way that cuts deeply into benefits for people who 
need it or puts an undue burden----
    Senator Sanders. You make me nervous when you say 
``deeply.'' That is not what the President campaigned on.
    Secretary Geithner. Well, I did not mean to change his 
words, but the President has spoken on this several times in 
the last few days, few weeks. His words govern. I cannot quote 
them for you directly. But, of course, those are his choices 
and his words.
    Senator Sanders. OK. Thank you very much.
    Chairman Conrad. Thank you, Senator. Thank you for 
respecting the time.
    Senator Thune. Thank you, Mr. Chairman. Mr. Secretary, 
welcome again. We had Secretary Geithner in front of the 
Finance Committee yesterday, and I appreciate your willingness 
to endure our questions.
    I asked you yesterday about the individual mandate and 
whether you thought it was a penalty or a tax. You said that 
was up to the lawyers to decide. And I assume you have an 
opinion about that, but I will not go into that. I do have a 
question, though. Do you know how much that raises in your 
budget in terms of revenues?
    Secretary Geithner. I have to respond to you in writing. I 
do not know the number. I do not have it at my fingertips now.
    Senator Thune. OK.

    Senator Thune. Well, my own view on where we are today, I 
mean, obviously we have a big problem which has been 
contributed to over the years by a lot of different factors. I 
think in a fantasy world where we were not fighting a war on 
terror, we might not have had to spend money fighting a war on 
terror, which would be great. But the fact of the matter is we 
have had to do that. We have had the debt grow just in the last 
2 years alone by $3 trillion.
    Now, my own view is that that is understated significantly 
because I believe that the health care bill, notwithstanding 
your assertions that it is actually going to reduce the debt 
and the deficit over time, is actually going to add 
significantly to it for a couple of reasons. One is I do not 
believe that this Congress is really going to cut $1 trillion 
out of Medicare. Now, maybe I am wrong, but when I first got 
here in 2005, we had a vote to try and achieve savings of 
somewhere on the order of $40 billion, and I think Vice 
President Cheney had to come back from Pakistan in order to try 
and break a tie on that. And at the end of the day, I do not 
think it ever happened. So I am very skeptical about whether or 
not we are actually going to reduce Medicare spending.
    Second, there are a number of things, as was alluded to 
earlier by the Senator from Alabama, about the way that was 
scored, which I think--and we have heard testimony from the CBO 
about that, that it double counts revenue. Medicare, Social 
Security Trust Fund revenue being credited to the trust funds 
as well as being used to pay for the new entitlement program on 
the order of hundreds of billions of dollars.
    The CLASS Act, which was scored in the near term as a 
revenue raiser, is, I think, going to be a huge deficit 
increaser in the out-years. That, too, is something that in my 
view is going to dramatically understate the fiscal picture, 
particularly when you look at the long run. And the SGR, which 
was not included in that, there are 2 years of offsets, I 
think, in this budget for the SGR, but the SGR is going to have 
to be dealt with as well.
    So you have all this spending associated with the 
Affordable Care Act, and everybody says, well, it is going to 
be budget neutral or, better than that, it is actually going to 
generate surpluses over the years. I just do not subscribe to 
that. So I think this situation is much worse than actually 
most of us believe.
    The other thing I would argue is that the growth rates that 
are assumed in the budget, which are significantly higher than 
the CBO's growth rates--4.4 percent I think in 2012 is what OMB 
assumes, and CBO says 3.1 percent. That makes a huge difference 
in the deficits that we are going to be looking at and the debt 
that we are going to be looking at.
    So having said all that, I think this picture is much more 
grim than many of us realize, and it does come back, in my 
view, to a spending issue. You can look at--and the Chairman 
put up the chart. Over the period of time that he looked at, 
the five times the budget was balanced, the revenue was 
actually exceeding the historical average. But the other thing 
you have to look at, there was only one of those years that I 
saw where spending was not below the historical average. If we 
balance the budget, the assumption was that spending had to 
have been below the 20.6 percent average that we have seen over 
the past 40 years, too.
    And what are we spending today as a percentage of our GDP? 
25.3 percent. That is this year's number. The historical 
average over the last 40 years is 20.6 percent. This is a 
spending issue fundamentally. And we have to deal with it. And 
as painful and hard as some of those choices are--and I think 
the only way you do that is with the long-term structural 
changes in these entitlement programs that are going to explode 
in the out-years. And this budget just does not address that.
    Again, I mean, I cannot tell you how disappointed we all 
are in that, and I know that they are saying, well, you guys 
come up with your plan. Well, there will be, I think, some 
suggestions made when the House Budget Committee does their 
budget resolution. But you still have 535 Members of Congress 
and only one President. The President is the CEO. The President 
has to lead. The President has to say, ``This is what I would 
do to fix this problem.'' And kicking the can down the road for 
another 2 years until we get past the next election just does 
not cut it. So I think many of us up here are prepared to work 
with him to address the long-term problem we face.
    Just a couple of quick questions for you. And, again, as we 
look at what we are going to be facing in the years ahead, the 
Treasury Department, of course, is tasked with running the 
auctions of U.S. securities, and I am wondering if you have any 
concern that any of the auctions are going to fail anytime 
within the 10-year budget window if we follow this budget.
    Secretary Geithner. No, there is no risk of that. In fact, 
if Congress were to enact these proposals, meaning bring about 
this level of deficit reduction as a share of the economy in 
this period of time, you would see a dramatic improvement in 
investor confidence about the political will in Washington to 
deal with these problems, recognizing that it does not go far 
enough. But if Congress would enact it, go this far, it would 
be historic deficit reduction on a scale we have never as a 
country even been able to consider. And I say that 
acknowledging that it does not solve all our problems.
    Senator Thune. Maybe I am going to take issue with that, 
but it just strikes me that when you are--that the gross debt 
is going to grow to $26.3 trillion at the end of the decade. It 
is $14.3 trillion today. It is hard to see how you can get to 
where you are 100 percent debt-to-GDP, and in the second decade 
it goes above that, that the bond markets are going to 
recognize that and say this is something that we believe is 
actually going to get the fiscal situation of the Federal 
Government back in line. I have a hard time understanding how 
that would be interpreted by the bond markets to be a positive 
thing.
    Secretary Geithner. Well, again, you know, Senator, this is 
all--you know, these things about confidence are all a judgment 
about the strength of political will in a country. And people 
do look at this country over history, and they say ultimately 
in the end Washington figured out how to fix it and get ahead 
of it. Right now, if we do not actually do that, we will suffer 
the risk of gradual erosion in confidence, and that will hurt 
us as an economy.
    But I want to state, I know that people would like us to go 
further, and, again, if Congress can find a way to go deeper 
and further in a way that does not gut basic programs critical 
to our capacity to grow without creating growth, then we will 
join you in that cause. But what troubled me about where you 
began is the following: You said that you are concerned 
Congress will not have the will to enact the cost savings in 
Medicare and Medicaid that are in the Affordable Care Act. So I 
guess I would ask in response to that, if you are troubled 
about those cost savings, then what does that mean about what 
plan you are going to provide us for how we get this deficits 
down? Because then if you are going to say we cannot actually 
do that, then you are going to have to look at other things, 
and that is going to put us in the position where, I think--I 
do not know where else you are going to go, because you have to 
go to defense, or you are going to have to go dramatically 
deeper than the House on discretionary, non-defense 
discretionary, or you are going to have to go to revenues, like 
the Commission did on a substantial scale. But, you know, it is 
just a question about where you make those choices.
    Senator Thune. And if I could, Mr. Chairman, just in 
response to that, look, I do not disagree. I do not think 
Congress has the appetite to deal with some of these issues. 
But it was a fundamental mistake, in my view, to go after 
Medicare to fund yet a new entitlement program rather than 
using those savings to reform Medicare. I think you would have 
plenty of support up here for doing that.
    Secretary Geithner. But, Senator, again, I think I agree. 
That is an interesting strategic question. But you could also 
take the other view, which is that apart from the basic 
rationale of extending coverage to all Americans, and apart 
from the other changes that are designed to improve how we use 
health care, you could ask yourself, Would Congress have 
legislated those reforms without that? It seems to me highly 
unlikely.
    Again, if you jeopardize that law, then you will take off 
the table what is more than $1 trillion of cost savings for the 
taxpayer over the next two decades. And if you take that off 
the table, you have to say where are we going to find that 
revenue, where are we going to find those savings. And you will 
have to go places I think you are going to find it much, much 
harder to go.
    Chairman Conrad. Senator Whitehouse.
    Senator Whitehouse. Thank you, Chairman. Welcome, 
Secretary.
    Secretary Geithner. Mr. Chairman, could I ask one question? 
Well, I do not want to take your time up. Go ahead. Sorry, 
Senator. Go ahead.
    Senator Whitehouse. I am happy to defer my 7 minutes for a 
moment if the witness has a question he wants to ask the 
Chairman. We can restart the clock--
    Secretary Geithner. It is up to the Chairman. I can do it 
at the end, if you want.
    Chairman Conrad. Yes, I think we should keep going because 
we have a lot of members left here.
    Senator Whitehouse. Mr. Secretary, you have described in 
the past the importance of the housing market to the economic 
recovery, that you opposed the foreclosure moratorium basically 
on those grounds, and so I would like to ask a few questions 
about the housing market and specifically the mortgage 
situation, the foreclosure situation that is out there. And it 
strikes me that a lot of different arrows are pointing to a 
catastrophic bureaucratic failure on the part of the banks and 
the servicers in dealings with distressed homeowners.
    The HAMP program is operating at one-fifth of its self-
defined level of success, which was about less than half of the 
actual foreclosure liability that we face as a country. So that 
cannot be seen as anything resembling a success.
    When I talk to my realtors in Rhode Island, to a person, 
literally at meetings with a dozen or more realtors, they have 
had short sales on the books with a bank, and that same bank 
has foreclosed on the property during the short sale, with the 
result that a property that was going to be sold for 90 percent 
of value is now trashed and is in the foreclosure pool at 40 to 
50 percent of value.
    When you deal with, as we all do, our constituents who are 
trying to work their way through mortgage modifications, it is 
a nightmare. I have had people who have been dealing for 19 
months. They never found a person who would give them their 
last name. They never had anybody involved who could make a 
decision. And recently in Rhode Island, to sort of put a fourth 
arrow on this, the local bankruptcy court has made findings 
that in virtually every case there is literally no response on 
the part of the banks when these problems come in, and so they 
have had to develop a special program to try to do something 
incredibly simple: get a human from the bank who will make a 
decision in the room with the homeowner before you throw him 
out of his house. That is so offensive to Deutsche Bank that 
they have actually challenged the regulation in court, and we 
are trying to resolve that legislatively.
    But when all those arrows point in the same direction--the 
HAMP failure, the foreclosure nightmare that people experience, 
the court decisions, the realtors' short sale experience--they 
all point to a huge bank bureaucracy that is incompetent, that 
is tormenting people, that is doing great damage to the 
investors--I mean, who got hurt when the short sale got wiped 
out because the bank foreclosed on its own short sale? The 
investors did.
    We have been corresponding about this, and you have been 
sending me all these cheerful letters about how, you know----
    Secretary Geithner. Not cheerful.
    Senator Whitehouse [continuing]. Do not worry, good news is 
around the corner.
    Secretary Geithner. Not cheerful. Never cheerful.
    Senator Whitehouse. And I do not see good news around the 
corner. We have been doing this for more than a year. Have you 
analyzed the extent to which the HAMP incentives are 
overwhelmed by the existing financial incentives that the 
servicers have for dealing with foreclosure, dealing with 
programs? My take is that they are insignificant and, 
therefore, have not--that is one of the reasons the HAMP 
program has failed.
    And the second thing is you have kept issuing these sort of 
memoranda and suggestions as to the timeframe within which 
banks should be acting. They are not. They just are not. I do 
not care what timeframe you have said. They are not doing it.
    Where are you in terms of enforcement? Have you punished 
anybody for not doing it? And have you looked specifically at 
whether they are phonying up the file by continuing to demand--
one of the things we hear all the time is that people have the 
same records asked of them six, seven, eight times. It strikes 
me that there is at least a reasonable case to be made that 
because your suggestions for the timing on this start with the 
close of the file, they have figured out that if you keep 
asking people for the same information over and over again and 
chucking it in the file or whatever they are doing, they can 
wait and never have the file closed and never start your clock.
    So either your suggestions to them for timing are just 
failing, or they are not being enforced, or they are being 
gamed. Please tell me where that is, because I do think that is 
important to the underlying economic recovery.
    Secretary Geithner. Senator, you are absolutely right that 
this is a tragic, terrible mess across the country still, and 
we are not coming to the end of that amount of pain and risk 
and trauma to homeowners caught up in this crisis. And many of 
them are completely innocent victims of the failures of the 
system before this.
    Now, you are also right that servicers and banks on the 
whole I would say are still doing a terribly inadequate job of 
meeting the needs of their customers, helping customers 
navigate through this basic process. And we are going to have 
to do a better job of trying to reach as many people as we can 
reasonably reach with these programs.
    Now, one thing about what we have accomplished, because it 
is important to recognize this, it is--about 4 million people 
have benefited from mortgage modifications since these programs 
were launched. Now, a relatively small number of those are 
permanent modifications in HAMP, but do not understate, please, 
the impact that it has had on millions of homeowners in 
reducing their monthly payments.
    There are people we are not going to reach with these 
programs because a lot of the people facing foreclosure are 
individuals for whom it is their second home, it is----
    Senator Whitehouse. I get it. Let me interrupt, because I 
understand your point. All foreclosures cannot be prevented. 
That is not the point. And that was not the point when I urged 
you to do a foreclosure moratorium. The point of the 
foreclosure moratorium was not to stop all foreclosures. The 
point of the foreclosure moratorium was to smack the banking 
industry and the servicers up the side of the head and let them 
know there are not going to be foreclosures until they sort out 
this mess that has been for 2 years a bureaucratic nightmare 
that is ensnaring millions of Americans. And it is that 
bureaucratic nightmare that is the focus of my question, not 
the fact that for some people foreclosures are inevitable.
    Secretary Geithner. I was going to agree with you, not 
disagree with you, in your characterization of the problem. You 
asked why isn't it stronger, why isn't it better, and you are 
right that this is always a mix of compulsion and incentive, 
and the incentives----
    Senator Whitehouse. Who have you whacked for failing?
    Secretary Geithner. Under the law, we do not have the power 
under the law to compel. We have the capacity financially to 
provide incentives. Now, I think those incentives have not been 
powerful enough in all cases to overwhelm the rest of the muck 
these servicers have created. I agree with you about that. But 
we do not have the power to compel, Congress did not give us 
that power, and that limits our leverage over the outcome.
    However, we are doing as much as we can given the tools 
Congress has given us to try to reach more people, and we are 
going to be able to reach substantially more people, although 
we will not come close to those initial estimates we laid out 
at the beginning of the program.
    Senator Whitehouse. My time has expired. Thank you, 
Chairman.
    Chairman Conrad. I thank the Senator for respecting the 
time.
    Let me just indicate to members, they have told us now- -we 
expect a vote at 11:50. We have five members left. We are doing 
7-minute rounds. The math does not quite work. So I am just 
going to ask everybody please come right in at the 7 because I 
will stay here until we have 5 minutes left on the vote so 
everybody gets a chance.
    Senator Johnson.
    Senator Johnson. Thank you, Mr. Chairman. I can talk fast.
    Mr. Secretary, nice to meet you. There were a couple of 
interesting statements you made. The first one is basically it 
would be excellent if we could go further in deficit reduction. 
If you believe that, I guess my question is: Does the President 
believe that? And if he does, why doesn't he lead?
    Secretary Geithner. Again, the question is how you do it. 
The challenge is not principally or only about how fast or how 
far you bring down the deficits, though that is really 
important. The question is how you do it. And the how matters 
because, again, you have to care a lot about the basic 
strength, competitiveness growth of the country, what you do to 
invest in incentives, education, things like that, but also you 
have to ask yourself what can you legislate. Because, again, if 
we sit here and we just talk about it forever and we do not 
legislate----
    Senator Johnson. It would be far easier to legislate if 
there was leadership from the President.
    Another comment you made was--this is maybe an unfair 
paraphrase, but you said, ``What is your plan?'' I mean, is 
this just political--are we playing a game of chicken here?
    Secretary Geithner. No. Again, the way our system works--
and, again, our system has a lot of strengths, but a lot of 
weaknesses, and I would say, as I said at the beginning, our 
current budget process does not work, has not delivered 
sustainable outcomes in this context. The way our system works 
is the President has to propose. We have to take the burden, as 
we have done, to lay out a plan for how we choose, how we 
propose to address these challenges.
    Now, that is just the start of the process, and the way the 
process works is everybody else has the obligation and the 
opportunity to say we think here is a better way to do it. And 
then the process begins. So it is just the first stage of the 
process, and, again, we are not asking you to like the plan. 
You do not have to embrace it. But what we do want to see is if 
you want to go deeper or get there on a different path, tell us 
how you think we can do it.
    Senator Johnson. We only have one President, and I am just 
going to tell you, I think the American people is hungering for 
leadership. The reason I ran for the Senate is because I 
believe we are bankrupting this Nation. You mentioned the 
unfunded liability. The figure I look at is the U.S. debt 
clock, that website. They list the top three entitlement 
programs. The total unfunded liability of those programs are 
$112 trillion. Total U.S. assets--household, small business, 
corporate assets--is $73 trillion. That is a $39 trillion 
shortfall. That is a huge problem.
    And, again, what numbers do you use in terms of the 
unfunded liability?
    Secretary Geithner. Well, Senator, again, I assure you, you 
cannot make me more concerned than I am as Secretary of the 
Treasury about the unsustainability of these commitments. And, 
again, I welcome, as everyone should, the fact that after years 
where people said deficits do not matter, these things pay for 
themselves, we do not have to care about the cost of this kind 
of stuff, people are coming around today and saying we are for 
trying to deal with this basic challenge. So that is a good 
thing to happen. We are seeing it at the State level. That is a 
very good thing to happen. So we have a chance now to try to 
translate that hunger for change on this kind of stuff into 
stuff that will actually matter over time.
    But, again, we are not trying to put the burden on you. The 
Constitution puts the burden on you. What we did is lay out 
this is our path. Happy to work with you. And, again, we 
recognize there are different ways to do this, but you have to 
make choices about what you are going to do to programs and 
about growth and about fairness.
    Senator Johnson. OK. Let me ask a couple nuts-and-bolts 
questions. I asked Director Lew the same question. I look at 
your--on your Table S. 1, your total cumulative deficit over 
that 10- or 11-year period was $8.9 trillion. Gross Federal 
debt increases $12.8 trillion. That is a $4 trillion 
difference.
    Now, I know about $1 trillion, as I am looking at the 
figures, looks like it is an increase in financial assets. 
Where is that other $2.8 trillion increase in debt? Do you 
follow my question?
    Secretary Geithner. I do not. I am sorry.
    Senator Johnson. Total cumulative deficit increases $8.9 
trillion, but our debt over that same period is growing by $4 
trillion--I mean, by $12.8 trillion, an additional $4 trillion 
in debt over the deficit. I do not have a good explanation. 
Director Lew said that it was an increase in Social Security 
surplus. That makes no sense.
    Secretary Geithner. Can I think about that and then respond 
accurately in writing? I just need to think about it a little 
more carefully. I do not know how to explain it----
    Senator Johnson. We will submit that in writing.
    Senator Johnson. I am concerned about three areas of risk 
in your budget. First of all, economic growth. Would you agree 
with the basic statement the more you tax something, the less 
you get of it?
    Secretary Geithner. No, I would not agree with that. I 
think that--well, let me put it differently. If you want to 
think about revenues and the effect on growth, you have to 
think about it in the context and the size of our deficits. You 
need to look at not just the overall level of revenues relative 
to GDP. You have to look at what is the resulting deficits you 
are still left with. And so, again, what we propose is 
something that brings revenues back to a level slightly above 
their historic average. Only slightly above. Only slightly 
above, and we think that is sustainable over time.
    Senator Johnson. The historic average is about 18.8 
percent, correct? Regardless of marginal tax rates, isn't that 
kind of Hauser's Law? And what you are looking at is the last 
half of the 1990s when we had an incredibly strong economy and 
we did increase tax rates, and people could not basically 
shield their income. But then it did end up resulting in a 
recession.
    Aren't you relying on unhistoric rates of percent of GDP in 
terms of revenue?
    Secretary Geithner. No, again, the numbers are what they 
are. Again, you can disagree about what the impact is, but we 
are talking about rates overall that prevailed at a time when 
the economy was doing incredibly well relative to what we saw 
in the succeeding decade. So, again, I think our economy would 
do fine under those rates----
    Senator Johnson. Now we have an extremely weak economy. How 
would increasing taxes produce that type of revenue? I think 
that is a really bad assumption?
    Secretary Geithner. No, I am not--again, I do not--I am not 
going to try to change your view about the economics. I am 
saying what we are proposing is a reasonably balanced set of 
revenue changes and spending proposals to achieve very 
substantial deficit reduction. And if you want to go deeper, 
then you have to figure out whether you do more revenues or you 
do more spending cuts, and those have consequences for growth. 
Again, you know, this is not--no one will say any plan is a 
perfect plan.
    Senator Johnson. I understand.
    Secretary Geithner. But it is a proposal.
    Senator Johnson. Let us talk about the risk in your health 
care projections. Basically the CBO, the way you gave them the 
figures, they are scoring it as a $1.5 trillion deficit 
reduction over two decades.
    Secretary Geithner. Well, again----
    Senator Johnson. Are you familiar with the ex-CBO's Douglas 
Holtz-Eakin's study where he is talking, instead of 3 million 
people moving into those exchanges----
    Secretary Geithner. Senator, again, a great strength of our 
system is you and I do not get to decide these numbers. We have 
an independent, nonpartisan office that makes these judgments 
for us. So you do not need to take my word before anybody 
else's. Only one word governs, which is a good thing for the 
country, and it will be CBO's judgments. All I was doing is 
repeating them. They are not mine. They are theirs.
    Senator Johnson. Do you agree only 3 million versus--OK.
    Chairman Conrad. Senator Coons.
    Senator Coons. Thank you, Mr. Chairman, and thank you, Mr. 
Secretary, for being with us today for this engaging 
conversation.
    This morning, families in Delaware woke up to more tough 
news. About 100 folks are getting notice from Perdue they are 
getting laid off in our poultry industry. About 80 people due 
to A&P's ongoing bankruptcy are going to lose their jobs in my 
home county in the grocery store. As I think Senator Sanders 
strongly pointed out earlier in this hearing, this continues to 
be a very tough time for working folks in this country.
    What in this budget gives them and should give me some 
optimism about the investments you are making to try and 
strengthen this recovery?
    Secretary Geithner. Well, I think you would have to look at 
the proposals for a very, very substantial improvement in 
public infrastructure, which is very good for you to think 
about these challenges, because a lot of the unemployment 
caused by the crisis was concentrated in construction. So that 
is one plan.
    A second piece of this I would look at is the tax 
incentives that are there for investment. It is very important 
we do everything we can to make sure the Tax Code is making it 
more likely that the great American companies, small and 
large--and foreign companies, too--are building their next 
facilities here so that we are creating and building more jobs 
in the United States.
    We are proposing a substantial set of changes to help 
improve export growth. There has been very good export growth 
in the early part of the recovery, and it is very broad-based. 
Manufacturing, industrial production, agriculture, high 
technology--there is a lot of job growth with that.
    There is a whole range of other proposals in there to help 
encourage innovation, education. That is what I would focus on.
    Senator Coons. Some have criticized your growth estimates 
as being overly ambitious. I am optimistic, given some of the 
proposals in here, that they are potentially achievable. Things 
like the zero capital gains and small business investment I 
think are particularly a good idea. Making permanent the R&D 
tax credit I think is an excellent idea. You testified 
yesterday in the Senate Finance Committee and touched on 
repatriation of foreign-earned profits and the possibility of 
tax reform, which I think has to be a piece of the solution 
here moving forward.
    Help me understand how you think it might be possible to 
change our current corporate rate, encourage repatriation in a 
way that would reinvest in hiring and in capital and in R&D 
rather than simply in bonuses or dividends, and how you might 
structure that. You also--I was interested--suggested that we 
could make fundamental change in the corporate rates and the 
corporate structure without doing it on the individual side. As 
Senator Ensign mentioned before, there are some complexities to 
doing that. I would be interested in hearing your views.
    Secretary Geithner. Well, I guess I would just stay with 
these simple, basic principles, elements about design. Again, 
you want to bring the statutory rate, which is now the highest 
in the world, down very substantially. You want to bring it 
closer to the range that prevails across our major competitors. 
To do that, you have to substantially reduce, scale back a set 
of very broad-based tax preferences that go to businesses. You 
need to do that in a way that makes clear that we are reducing, 
not improving, opportunities to shift income and investment 
outside the United States. You want to change those incentives 
in the other direction to the extent you can. And you cannot do 
that responsibly if you are going to be adding to future 
deficits. You have to do it in a way that is revenue neutral.
    Senator Coons. Right.
    Secretary Geithner. You cannot, I think, offer the hope of 
raising more revenue from business as a whole over time because 
we live in a much more competitive world. But you cannot take 
the other risk, which is that we lose revenue.
    Senator Coons. And for those very folks I mentioned who 
today are getting bad news, how do I reassure them that by 
making that dramatic reduction in at least the statutory 
corporate rate I am not simply--were I to be supporting that, I 
am not simply encouraging more offshoring, more loss of 
American manufacturing jobs? You do have some specific 
incentives targeted at manufacturing, I think are a strong part 
of this plan. But I am very concerned about how we make sure 
that we do not further lose manufacturing in this country.
    Secretary Geithner. Well, again, the critical test we apply 
to any reform program that we are presented with or that we 
propose would be we improve, not reduce, the incentives to 
invest here; we reduce, not increase, the opportunities to 
shift income outside of the United States. That is a critical 
test. And it is very important, as you are implying, that when 
you look at these proposals for changing how we tax worldwide 
income, territorial options, you do not--not just risk losing 
revenue, but you do not want to create the incentives to have 
more of that stuff happen outside the United States.
    Senator Coons. There are a number of things about how 
budget scoring works here at the Federal level that are new to 
me. I got familiar with how to balance budgets at the county 
level. The Federal budget is fundamentally different. There are 
a number of things folks have brought to me that I am trying to 
get my head around. One of them is the idea that the student 
loans, when they have been moved to direct lending, are scored 
as being without risk, essentially presumed to be fully repaid, 
and that that creates the impression, the false impression of 
savings, when, in fact, any realistic assessment would include 
some risk. Can you comment on that?
    Secretary Geithner. You know, I need to think about that a 
little more carefully, but I would be happy to respond to you 
in writing about that.
    Again, I think the general principles we try to abide by 
and we should abide by are that you need to show on the budget 
the full costs, the potential risks of loss associated with any 
type of loan or guarantee program, whatever its basic form. And 
obviously it is important we try to achieve--hold to that. But 
I would be happy to think about that more carefully and get 
back to you.
    Senator Coons. Please.
    Senator Coons. Then, last, there are some, I think, strong 
moves in this budget in terms of the sustainable growth rate, 
the doc-fix, so-called, and the changes to the Pension Benefit 
Guaranty Corporation. Could you just give me a little more 
detail on the PBGC changes and how that will ensure stability 
or solvency farther into the future and, thus, reduce some of 
the future liabilities that I think all of us on both sides 
here are quite concerned about?
    Secretary Geithner. Well, the way the current PBGC, the 
benefit scheme works is, just to be direct about it, we do not 
give the PBGC the capacity, the authority to charge a guarantee 
fee that covers their liability. And what that means is all 
sorts of other people pay the costs of those unfunded pension 
funds when companies fall into bankruptcy. So, again, a basic 
test of responsibility is you want to make sure, if you are 
providing guarantees, you need to charge for them. They need to 
be risk based, and they need to be fair in design. We do not 
allow them to do that now. We think that is important for 
Congress to do.
    Again, if you think about the consequence of getting that 
wrong, think about Fannie and Freddie.
    Senator Coons. I think the point and that model also should 
be applied to the student lending work that the Federal 
Government is now more directly involved in.
    I will close, if I might, Mr. Chairman, by saying, you 
know, while Senator Sanders I think laid out a very compelling 
case about how we got here, I was encouraged by Senator 
Ensign's tone, which really focused on how do we solve the 
problems that all of us have. And I do think that we need to 
look to leadership across both sides of the aisle, by this 
Committee and by the other chamber of Congress, and invite the 
President to join us.
    Thank you very much, Mr. Chairman.
    Chairman Conrad. Thank you, Senator.
    Senator Toomey.
    Senator Toomey. Thank you very much, Mr. Chairman, and 
thank you, Mr. Secretary, for joining us today.
    I would like to address the debt limit debate that is upon 
us, but I want to start with a little bit of context, and we 
have touched on some of these things. But it is very important, 
I think, to inform our judgment as we debate the debt limit. 
And I want to emphasize a point that Senator Thune made 
earlier. While we rightly focus on the level of our deficits 
and our debt, it is spending that hasten us here. Since 2000, 
just since 2000, total Federal spending has doubled. And so we 
have debts now--deficits now far greater than deficits we were 
running recently. In 2007, for instance, as you know, Mr. 
Secretary, our deficit was only 1.2 percent of GDP. This year 
it is over 10 percent. It is over $1.5 trillion.
    This is a recent phenomenon. The public debt that we had in 
1988 was about 41 percent of GDP. In 2008, public debt was 
about 40 percent of GDP. Today it is 64 percent, and by October 
it is going to be 72 percent of GDP. The debt has doubled in 4 
years. It is scheduled to triple in 11 years. And as we 
discussed briefly earlier, but I really want to stress, this is 
a fraction of the problem that we have. The unfunded 
liabilities that we have, the contingent liabilities through 
the guarantees of Fannie and Freddie, the big entitlement 
programs, you know, we could argue about how to do the math and 
how to discount this unfunded liability, but anyway you do it, 
within reason, it is a number that is at least well into the 
tens of trillions, and it might be, as Mr. Johnson says, over 
$100 trillion. So any way you look at it, those obligations 
dwarf the numbers that we have seen on the board, the actual 
publicly traded debt.
    So I think we have an enormous problem, and it is already 
upon us. And what concerns me is what this administration has 
done in this environment. What have we seen? The administration 
created a new trillion dollar entitlement program, launched an 
$800 billion stimulus spending, pushed huge increases in 
discretionary spending in recent years. The President is now 
calling for another--basically a stimulus bill, $50 billion to 
build high-speed rail, which I think would be a shocking waste 
of money. The President is threatening to veto a CR because the 
Republicans want to cut back the spending that was added in the 
last couple of years. And the President proposes a budget that 
increases our debt every year, and I think you acknowledge that 
CBO will observe that it increases it even as a percentage of 
GDP. And the President, as we have observed repeatedly this 
morning, does absolutely nothing about the entitlements that 
are ultimately driving this whole train wreck.
    In fact, I think part of the problem is the administration 
is populated with people who think at some level that the more 
Government spends, the richer we all become. And I just have to 
say this just is not working, and I think this is dangerous. 
And I think the administration thinks it is working, but I do 
not.
    So when the President says that now that the country has, 
metaphorically speaking, reached the limit on its credit cards 
and we should just give it a new one and not make any changes 
to the process, talk about that later, I just do not think that 
is a good decision.
    Now, let me emphasize--and I have said this before, and I 
have said this to you, Mr. Secretary--I am willing to vote to 
raise the debt limit. But I am only willing to do that if we 
are going to make the cuts in spending and the changes in 
process that got us here. You have acknowledged that the 
process is broken. I just do not think we can kick this can 
down the road anymore.
    Now, we apparently disagree about whether we should make 
increasing the debt limit contingent on getting the kind of 
process reforms that fix this problem. But there is one thing 
that I know we do agree on--and this is something I have also 
written about--and that is, under no circumstances should the 
United States ever even get close to defaulting on the debt 
that we have issued. And I know you agree with that. It would 
be a complete disaster. It is unnecessary. We have a moral 
obligation to repay people who have lent us money.
    And so, as you know, I have introduced a bill that would 
simply guarantee that as we try to resolve our differences over 
what to do about the debt limit, if we have not got it resolved 
at the time at which we reach it, we would at least not default 
on our debts. And my bill would do that by simply requiring 
that the Treasury make as a priority payments on interest and 
principal, with the ample resources the Treasury would continue 
to have.
    Now, you have argued that my bill does not work, and while 
at least implicitly you have acknowledged that, yes, you could 
continue servicing the debt, even delays in payments to vendors 
would be perceived by the markets as much of a default as a 
missed payment on a Treasury bond. So basically you are telling 
us that if we have to delay a payment to the guys who mow the 
lawn around The Mall, that would have the same kind of impact 
and cause the same kind of financial crisis that would result 
if we failed to make an interest payment on a Treasury 
security.
    I have to tell you, Mr. Secretary, that is just not true. I 
spent years as a professional in the bond market. I was trading 
fixed-income securities, including U.S. Treasuries. But whether 
you are a bond trader or whether you are a pension fund manager 
in Pittsburgh or a senior citizen in Allentown investing your 
IRA savings, the market knows the difference between delaying a 
payment to a vendor and defaulting on our Treasuries.
    Chairman Bernanke was asked last week at the Budget 
Committee in the House if he thought it would be a good idea 
for the Federal Government to adopt this kind of bill. His 
answer was, and I will quote: ``Well, it would reduce the risk 
of the debt limit, that's for sure.''
    So I have to say I think it has been inappropriate for the 
administration to raise the specter of a default on our debt in 
the context of this debt limit, because you and I both know 
there is no circumstances in which we are going to default on 
our debt. We should not even really have to have this 
discussion because we know this. But since the administration 
has raised this specter, I felt it was necessary to try to 
clear this.
    I believe that we are already in the early stages of a 
fiscal train wreck. I think the problem is very, very serious. 
It is a spending problem that both parties are responsible for 
to varying degrees. The debt level, if you ask me, is already 
at dangerous levels. I just do not think we can kick this can 
down the road any further, and I think what the administration 
is implicitly asking us to do is to just go ahead and give them 
another credit card without making the fundamental process 
reforms that we need to get onto a sustainable path.
    Secretary Geithner. May I respond, Mr. Chairman?
    Chairman Conrad. Certainly.
    Secretary Geithner. Senator, you and I probably disagree on 
less than you think, and I appreciate very much your review of 
history about what produced this big acceleration or debt 
burdens, because that is a very helpful context for everybody, 
and I very much appreciate your commitment to making sure that 
people understand we will meet our obligations to the country. 
You are right to emphasize the cost of not doing so, and we 
should not let the markets start to build any risk that 
Congress will not ultimately pass that increase we need.
    But I just want to make sure that I clarify one thing that 
is very important which is that we agree that we have to work 
together on a plan that Congress can enact that will start to 
deal with these very daunting, very formidable deficit 
challenges. A hundred percent agree with you. That is 
critically important. We cannot put that off. And again, we 
look forward to working with the processes that are set up to 
try and make sure we achieve that.
    But I would caution everybody against taking any risk that 
Congress does not act to increase the limit within the 
timeframe we need, because for the reasons you said, we cannot 
afford to let the market lose any confidence that ultimately 
Congress will act well in advance of any time we are going to 
hit the limit, because that would be catastrophic, would cause 
grave damage to the recession, to the expansion underway, to 
our capacity to dig out of this recession, and we cannot afford 
to take that risk.
    Chairman Conrad. Senator Portman.
    Senator Portman. Thank you, Mr. Chairman. And, Mr. 
Secretary, thank you for your testimony today. I want to 
associate myself with the comments of Senator Sanders, 
actually, which might seem unusual to you. But he said he 
thought this was an extraordinarily strange conversation, and I 
agree with him for different reasons, as you might imagine.
    I just think we are at the point in our country's history 
where we can't afford to play politics, and I think this budget 
presentation, which has been talked about a lot, and Senator 
Toomey just talked about some of the numbers, it is a political 
statement and it does not rise to the challenge. In fact, it 
does not rise to the very challenge the President has laid out, 
including the challenge you have laid out and Director Lew has 
laid out and others.
    So that is what I find strange about this conversation. You 
said to us today that by doubling the gross debt between last 
year and 10 years from now, which is in the budget, by ending 
up with interest payments on the debt alone that are in excess 
of all of the discretionary spending, by the fact that we have 
this fiscal time bomb on our doorstep and we are not dealing 
with this in this budget, you called it unsustainable today.
    You have acknowledged that there will be weaker growth in 
our economy because of the debt that is building up under this 
budget.
    Secretary Geithner. If we do not act.
    Senator Portman. Well, under your budget, you are saying, 
you have acted----
    Secretary Geithner. No, no, absolutely not.
    Senator Portman. You have put forward your----
    Secretary Geithner. No, no, no.
    Senator Portman. You said that there will be weaker growth 
because of the debt which will be--the gross debt will be over 
100 percent of our GDP----
    Secretary Geithner. No, if Congress does not----
    Senator Portman [continuing]. Under this budget.
    Secretary Geithner. If Congress does not act, then we face 
that risk, but----
    Senator Portman. No. I am talking about the numbers in your 
budget. This is unsustainable. I assume you still agree with 
that. If you do not, this is an extraordinarily strange 
conversation, if the Secretary of Treasury does not believe 
that 100 percent of GDP is going to limit growth in our 
economy.
    And then you ask us, well, we are waiting to see what you 
provide us. Look, this has to be an effort, again, that gets 
away from the politics. We cannot afford it and we have to 
start solving the problem. I would say that, unfortunately, as 
you have noted yourself today, and I appreciate your candor on 
this, your budget is worse than it looks. CBO will end up 
saying that these deficits are higher than you have projected. 
In fact, I suspect they are going to end up saying that it 
grows our deficit not just in nominal terms, but as a percent 
of GDP.
    Let me give you one concern that I have here. Your growth 
assumptions are too high, and we have talked about this. But if 
you use the CBO growth assumptions and the Blue Chip, the 
private forecasters' growth assumptions, compared to yours, and 
I am extrapolating here from CBO's rule of thumb which is a 
lower growth rate of .1 percent, it would result in a 10-year 
deficit of about $310 billion. If you assume .5 percent lower 
growth, which is what the difference is between the Blue Chip, 
CBO, and yours, we are talking about a higher deficit of over 
$1.5 trillion over the next 10 years.
    Now, that wipes out all of the claimed savings in your 
budget, that alone. So this situation is even worse than, 
again, being stated in your budget and I think we will see this 
through the CBO analysis.
    My other concern, obviously, is that the growth side of the 
equation is not addressed. You and I have talked about this. 
And I commend you yesterday for talking about the necessary 
expansion of exports we need to get this economy growing again, 
and, in fact, you had specifically talked about your support 
for the three trade open agreements that have already been 
negotiated and giving the President the ability to negotiate 
further trade openings.
    I would ask you today to talk a little about the pro- 
growth side of things. We are looking at 9.6 percent 
unemployment in Ohio today. We have lost over 170,000 jobs in 
Ohio since the stimulus was signed into law 2 years ago today. 
Today is the anniversary.
    We still do not have the kind of growth we need, coupled 
with the spending restraint, to get this deficit and debt under 
control. I would just ask you about what you would support. I 
know you claim there are some things in the proposal on growth 
and on taxes that will help the economy. I see just the 
opposite. I see the tax increases. I see the lack of any tax 
reform, a huge opportunity missed.
    In fact, I look at your budget and you actually continue 
this assault on deferral, which is where you have a U.S. 
company that does business overseas being taxed more under your 
budget. There is a recent report out on this by Robert Shapiro, 
who was a Clinton administration official, and AEI that says 
the elimination of deferral would cost U.S. companies 159,000 
jobs.
    In Ohio, by the way, there is a separate study that has 
been done by an economist at Kenyon College that says it is 
17,000 jobs lost in Ohio. And yet, your budget continues a 
number of changes to an international tax system that limits 
this practice.
    So if you could address, what do you think we ought to be 
doing in terms of taxes? Can we lower the rate and broaden the 
base and make our tax system more efficient and therefore add 
more to economic growth, which in turn will add more revenues? 
And why is that not in the budget? And what else would you 
propose to get this economy moving?
    Secretary Geithner. Senator, let me just start by again 
acknowledging that you have a long distinguished career in the 
Executive branch. It is nice to see you back here helping solve 
these problems.
    When I left the Treasury at the end of 2000, the CBO was 
projecting us to have surpluses in the range of, I would say, 
north of $5 trillion over the next 10 years, and when I came 
back in on January 1, 2009, CBO was projecting, I think, a $13 
trillion swing in the projected deficits facing the country as 
a whole. And I think it is very good to hear, across the 
political spectrum now, a recognition that we have a deep 
imperative to recognize deficits matter and we have to fix them 
over time. Again, we are looking forward to working with you on 
how best to achieve that.
    I want to say a couple things in response to your points 
you made in your questions. A few things on the growth 
assumptions. CBO's are lower in part because they have to 
assume that the Bush taxes, all of them, expire in 2013. That 
is a big hit to GDP. We are not proposing that. It forces CBO 
to show lower growth estimates because of that.
    Now, when they score our proposed policies, they will show 
a higher GDP growth than they did initially because of that 
basic change. Again, you have had the privilege of doing these 
assumptions before. Nothing perfect in them.
    Senator Portman. How about Blue Chip?
    Secretary Geithner. And you are right. Our growth scenario 
is just a little above Blue Chip, but I actually look back and 
compare them to yours when you were OMB Director, and my 
suspicion is, you will find when you look at them----
    Senator Portman. When the deficit was one-tenth of what it 
is today.
    Secretary Geithner. No, but--well, again, not dramatically 
higher than when I left the Treasury.
    Now, if you look at our growth assumptions over the next 10 
years, we are assuming, as we should, that growth on average is 
significantly lower than it is in past recoveries, as we should 
expect given the nature of this basic crisis.
    But again, the good thing about our system is, CBO will 
govern. It is their assumptions that govern. You and I do not 
need to debate the future. They will decide for the Congress.
    Now, on deferral, just one quick thing on deferral. I know 
this is unpopular proposals for a lot of people in the business 
community, but let me explain what they are designed to do. 
They are designed to, again, reduce the incentive to shift 
investment outside the United States.
    So as you know better than anybody, if there are two 
companies in your state today and one builds their next plant 
outside the United States, one builds their next plant in your 
state, that first company gets a lower effective tax rate. That 
means they have incentives to make that next marginal 
investment outside the country.
    We do not think that makes sense at a time when we want to 
encourage more job creation investment here, so we want to 
redress that, at least get it back to neutral. But again, I 
think our view is the best way to get there, is through a 
comprehensive reform that lowers the statutory rate very 
substantially, but does it in a way that is deficit neutral.
    Senator Portman. That would have been great to have seen in 
the budget and we can talk about this, but what it does is it 
hurts jobs in this country because we are not able to sell as 
many products overseas. That is the point of growth.
    Chairman Conrad. Senator Cornyn.
    Senator Cornyn. Thank you, Mr. Secretary, good to see you. 
Is it correct to say that this proposed budget relies, in part, 
on a $1.6 trillion tax increase over the next 10 years?
    Secretary Geithner. Well, the way I encourage you to look 
at this, you should look comprehensively at the tax proposal in 
the budget, and I will just do the numbers for you.
    Senator Cornyn. With all due respect, would you answer my 
question?
    Secretary Geithner. Three trillion in net tax reductions 
for individuals.
    Senator Cornyn. I am not talking about--I am asking, does 
it increase taxes for some taxpayers on $1.6 trillion?
    Secretary Geithner. Oh, absolutely. As I said, we are 
proposing to allow the tax cuts for the top 2 percent to 
expire. We are proposing to reduce tax expenditures for the top 
2 percent. And there is a series of other changes, more modest 
changes, that do raise revenues, but you have to look at the 
overall----
    Senator Cornyn. Let me ask you specifically, Mr. Secretary, 
because time is limited. $90 billion of tax increases in the 
President's budget are going to be imposed on the domestic 
energy industry under this budget. This is a sector that is one 
of the largest employers in the country supporting more than 
9.2 million jobs, contributing 7.5 to GDP, and which is already 
contributing $100 million a day to the Federal treasury.
    How does that tax increase on the domestic energy industry 
reduce our reliance on imported oil?
    Secretary Geithner. Well, Senator, you know the arguments 
in this context. What we are proposing to do is to scale back 
what are very expensive tax expenditures that go to a limited 
number of industries and distort overall investment and require 
all other businesses to pay more tax as a result. And that is 
one proposal in that direction.
    Senator Cornyn. Well, if you increase taxes on domestic 
energy supply, that will translate into increased costs of 
gasoline for consumers and diesel, will it not?
    Secretary Geithner. No, it will not have that effect 
because the price of oil and gas as a result is set in the 
world markets and modest changes in the subsidies we give the 
domestic oil company will not affect the price.
    Senator Cornyn. So you can increase taxes on an industry 
and it will have no impact on price to consumers, is what you 
are saying?
    Secretary Geithner. In a market like this, I believe almost 
any economist would tell you that there will be no impact on 
the broad price of oil to the U.S. consumer.
    Senator Cornyn. Will you agree with me, if you increase 
taxes on domestic production of energy, it will necessarily 
increase our dependence on imported energy because they will 
not bear that same tax burden and it will be cheaper?
    Secretary Geithner. No, probably not materially at all. But 
you are right, we are proposing to reduce the subsidy we give 
through the Tax Code to that industry. Now, they still will 
benefit a whole range of other subsidies, but we are proposing 
to reduce those again because we do not have unlimited 
resources. And again, if we do not do that, we are going to 
have to raise taxes on somebody else.
    Senator Cornyn. Let me go on to another question, which I 
continue to be amazed that there is any really disagreement, 
that increasing taxes on an industry will not have an impact on 
consumers. But I hear your answer.
    Senator Sanders asked a number of questions about tax, who 
pays taxes, and isn't it true that about 97 percent of the 
income taxes that are paid in America today are paid by the top 
50 percent of income earners?
    Secretary Geithner. Well, again, you know these numbers. I 
think what the Senator was pointing out, which is true, which 
is if you think about----
    Senator Cornyn. Well, I am asking what I am--my question, 
not his.
    Secretary Geithner. Again, what I would look at is, what is 
the effective tax rates for people who make, for example, in 
the top 1 percent of income. What is their effective tax rate 
versus the effective tax rate of middle class America. And that 
is the question he was speaking to and I think he is right in 
that.
    Senator Cornyn. Well, but my question is, isn't it true 
that 97 percent of income taxes are paid by the top 50 percent 
of income earners in America?
    Secretary Geithner. Well, I am not sure exactly what those 
numbers are, but I would be happy to provide them in writing.
    Senator Cornyn. Well, if you are not sure about the exact 
number, isn't that approximately correct?
    Secretary Geithner. I am not sure. Again, you are right to 
say that a large fraction--because income inequality is so high 
in the United States, a large fraction of tax revenues come 
from the relatively well-off, but their effective tax rate is, 
in many ways, sort of strangely much lower than the average, 
you know, a less fortunate American.
    Senator Cornyn. Mr. Secretary, I do not expect you to know 
the exact numbers, but I am, frankly, astonished that the 
Secretary of the Treasury would not know generally where the 
tax burden lies.
    But let me just ask another way. Would you agree with me 
that the top 20 percent of income earners in the country pay 
approximately two-thirds of Federal taxes?
    Secretary Geithner. Again, that sounds broadly right, but I 
think what you are debating a little bit is what is the 
distribution of the effective tax burden, and one way to 
measure that is what is the rate they pay relative to income.
    Senator Cornyn. Well, I am not debating it right now. I am 
just asking for information from you to answer those questions.
    One of the hardest things I have found in Washington, D.C. 
is to get the facts because it seems like everybody spins. Once 
you get the facts, then it is a whole lot easier to figure out 
how to solve the problem.
    Secretary Geithner. I would never dispute the facts. Facts 
are easy to agree on.
    Senator Cornyn. So may I make just a respectful suggestion? 
Under the Budget Act, it is the President's statutory 
obligation to produce a proposed budget.
    Secretary Geithner. Yes.
    Senator Cornyn. And we have talked about that and, frankly, 
I am among those who are disappointed that the President did 
not go further and deal with more than 12 percent of all 
Federal spending that included a $1.6 trillion in new taxes, 
and it appears to not engage is own fiscal commission's 
recommendations, which I found to be dramatic and sobering and 
bold.
    And so, I hope that we will engage on these issues. The 
only way we are going to get a resolution of the crisis facing 
our country is if the President is engaged. And if the 
President is disengaged, it will not happen. It will not 
happen. We will sort of fall back into the traditional 
demagoguery--
    [sic] that occurs whenever we talk about dealing with 
important and large fiscal matters.
    So if I could just make a respectful suggestion, we saw in 
the expiring tax provisions in the end of December that the 
President and the Vice President got very directly engaged with 
the Republican leader and with the assistant Republican leader, 
Senator McConnell and Senator Kyle. My suggestion to you is, 
that if the President would invite those two individuals, along 
with House leadership, over to the White House and say, How can 
we work together to fix this problem, it would be a 
dramatically constructive move and help move this in the right 
direction, rather than to resort into the same old he said/she 
said and blame game.
    Thank you, Mr. Chairman.
    Chairman Conrad. Let me just say that this is something I 
have repeatedly asked for. I do not see any way around, and the 
question is timing. I understand that. We, in Congress, have an 
obligation to lay out our plans and we will do that. But some 
time very soon I believe it is critical that there be a summit, 
a negotiation, whatever one calls it, that involves the 
leadership of the House and the Senate, Republican and 
Democrat, and the President.
    That was really at the heart of the proposal Senator Gregg 
and I made for a commission that involved the Secretary of the 
Treasury and the head of OMB. That was our proposal. We got 53 
votes for that proposition. We did not get 60.
    Senator Cornyn. I was one of them, Mr. Chairman, and I 
admire your leadership, along with Senator Gregg's leadership, 
on this issue. But the fact of the matter is, unless the 
President is willing to engage on this--and I am not suggesting 
they do it in public. I am suggesting they have a meeting and 
get to the solution, because as you have noted many times, we 
cannot kick the can down the road. Unfortunately, I see this 
history repeating itself.
    Chairman Conrad. Let me just say that I do not think 
anybody who has listened to me does not know that I deeply 
believe this can can be kicked down the road. I appreciated the 
Senator's support.
    I want to go to one point before we leave. I have heard 
over and over that what we have is a spending problem. Deficits 
are the result of spending and revenue, the difference between 
the two. We do not just have a spending problem, although we do 
have a spending problem, we also have a revenue problem.
    I am so, frankly, tired of hearing that there is just one 
side to the calculation of the deficit. There is not just one 
side. There are two sides. There is revenue and there is 
spending, and the reality is, the truth is, we have a problem 
on both sides of the equation. The spending is the highest it 
has been in 60 years, as a share of the GDP. The revenue is the 
lowest it has been in 60 years, as a share of the GDP.
    So let's get real. Let's get real. Yes, we have to do 
spending and yes, we have to do revenue. If people are not 
going to be serious about what has to be done here, we are not 
going to solve the problem. With that, I thank the Secretary.
    Senator Sessions. Mr. Chairman, I would agree with that. 
Both are factors, but we see as the economy comes back, revenue 
will come back to its historic levels. But if we get entrenched 
in spending at 25 percent of GDP, we are going to have a very 
difficult time getting back there.
    Chairman Conrad. Look, nothing could be more clear. Anybody 
who has listened to me for 5 minutes knows I am serious about 
cutting spending and I voted to do it on the Commission. I wish 
others had. Five of the six Senators did. Five of the six 
representatives of the President did. Five of the six 
Representatives of the House took a walk.
    Senator Sessions. Thank you, Mr. Chairman.
    [Whereupon, at 12:11 p.m., the Committee was adjourned.]




           THE PRESIDENT'S FISCAL YEAR 2012 EDUCATION BUDGET

                              ----------                              


                         TUESDAY, MARCH 1, 2011

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:01 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Sanders, Whitehouse, Merkley, 
Begich, Coons, Sessions, Cornyn, Thune, and Johnson.
    Staff present: Mary Ann Naylor, Majority Staff Director; 
and Marcus Peacock, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    I want to welcome everyone to the Senate Budget Committee 
today. Today we will continue our series of hearings on the 
President's budget. Before the recess we heard from OMB 
Director Jack Lew and Treasury Secretary Tim Geithner. Today 
our witness is Secretary of Education Arne Duncan. Tomorrow we 
will hear from Energy Secretary Chu, and on Thursday our 
witness will be Transportation Secretary Ray LaHood.
    Next week we will also be holding a hearing on Defense and 
State Department budgets. I want to alert members that both of 
those Departments have asked to testify together.
    I am very pleased to welcome Secretary Duncan to the Budget 
Committee today. This is the Secretary's first appearance 
before the Committee, and we look forward to his testimony.
    I personally believe that education is the key to our 
country's economic future. The importance of education is 
something that was ingrained in me at a very young age. I was 
raised by my grandparents. My grandmother was a school teacher, 
Mr. Secretary. She was 5 feet tall, and we called her ``Little 
Chief'' because she commanded respect. And in our household, I 
will never forget, she said, ``In this housing there are three 
priorities: No. 1 is education, No. 2 is education, No. 3 is 
education.'' And we got the message, and she was right.
    So even as we look to cut spending to bring down the 
deficit, which we must do, we also need to ensure that we get 
our priorities right, and education needs to be a priority as 
we proceed with reducing Government expenditure.
    We need to be careful not to cut education in a way that 
would come back to hurt the Nation's long-term economic growth 
and security. We simply must maintain a strong education system 
if we want to keep pace with our global competitors.
    Let me just go through quickly a couple of charts that I 
think raise concern.





    First of all, we are now falling behind competitors in key 
areas. American students no longer are at the top of their 
class. We rank 25th out of 34 Organization for Economic 
Cooperation and Development countries in math, well below the 
OECD average. We rank 17th out of 34 OECD countries in science. 
Our global competitors are making education a priority.




    The contrast with China is striking. In the mid-1980s, we 
produced nearly as many engineers in graduate schools as China, 
but now China is producing far more engineers than we do, as 
this chart depicts.




    The education achievement gap that has opened between the 
United States and its global competition is already hurting our 
economic strength. Here are the findings of the study done by 
the consulting firm McKinsey & Company in which they quantified 
the economic impact of the education gap. They wrote, in part, 
``The persistence of educational achievement gaps imposes on 
the United States the economic equivalent of a permanent 
national recession. The recurring annual economic cost of the 
international achievement gap is substantially larger than the 
deep recession the United States is currently experiencing.''




    Let me go to the next chart.



    
    The reality is that we have not been focusing our Nation's 
resources as productively as possible. This chart, which was 
made with data from the President's budget, shows that our 
combined investment in infrastructure, research and 
development, and education has fallen as a share of GDP from 
6.1 percent in 1962 to 3.6 percent in 2012. That is, even while 
deficits and the share of debt to GDP has grown, our commitment 
to these areas--infrastructure, education, research and 
development--has shrunk.
    How can that be? Well, it can be because what is happening 
is the entitlements, the mandatory side of the budget has grown 
and displaced much of what has been traditionally domestic 
discretionary spending. So as a share of the economy, we are 
spending a smaller amount of education than these other 
critical areas than we did in the 1960s.




    One of the key challenges we face in education funding is 
the Pell Program. It is important to remember that even the 
maximum Pell award of $5,550 offsets only a small portion of 
the cost of college, less than one-third of the annual cost of 
a public 4-year college. That portion hasten smaller as the 
rising cost of college has outpaced the increases in the Pell 
award.




    At the same time, due to the recession and increased demand 
for Pell grants as well as changes that we made as to who 
qualifies, the cost of the program has increased. So we are 
paying a smaller share of the cost, but the overall cost of the 
Pell Program has increased.
    In 2008, the Pell Program cost $14.2 billion. CBO now 
projects that, without changes to the program, Pell costs in 
2012 will be $37.8 billion.




    Here is what the Obama administration has proposed in its 
budget for the Pell Program. It proposes to maintain the 
maximum Pell award at $5,550. It proposes savings within Pell 
by eliminating the second Pell payment, which was established 
to help students pay for summer school. It also proposes other 
savings in education accounts to help pay for Pell, including 
ending in-school interest deferment for graduate students, 
incentivizing conversion to direct lending, and modernizing the 
Perkins Loan Program. I look forward to hearing more from 
Secretary Duncan on these proposals.




    I want to end by emphasizing again the importance of 
education to our Nation's economic strength. Here is a 
statement from Harvard economist Claudia Goldin and Lawrence 
Katz from a paper they wrote entitled, ``The Future of 
Inequality: The Other Reason Education Matters So Much.'' They 
wrote: ``An educated population is a key source of economic 
growth, both directly through improved labor productivity and 
indirectly by spurring innovation and speeding the diffusion of 
advanced technologies. Broad access to education was, by and 
large, a major factor in the United States' economic dominance 
in the 20th century and in the creation of a broad middle 
class. Indeed, the American dream of upward mobility both 
within and across generations has been tied to access to 
education.''
    I think they have it right. Education is a key to our past 
success and our future strength.
    With that, we will turn to Secretary Duncan. Before we do 
that, I will turn to my colleague Senator Sessions for his 
opening comments, and then we will go to Secretary Duncan for 
his initial testimony. Then we will go to questions. We are 
going to have a large turnout today, so we are going to go to 
5-minutes rounds.
    Senator Sessions, welcome.

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. Well, 5 minutes will be short, but maybe 
that will be satisfactory, Mr. Chairman. We have so much to do.
    Thank you, Secretary Duncan. Thank you for your service and 
for raising some tough questions about maybe some of the sacred 
cows in the education establishment. I appreciated your recent 
comments to the Governors' conference, for example, noting that 
somewhat large classrooms with better teachers outperform 
smaller classrooms, and that is good, honest talk and can 
result in saving and improving education at the same time.
    And I was also pleased you met with Dr. Katherine Mitchell 
of Alabama. She designed the Alabama Reading Initiative. That 
program, with very little cost except training and startup, has 
transformed teaching and learning and reading proficiency in 
Alabama. In just a few years, Alabama's K-4 schools led the 
Nation in reading improvement. Massachusetts and Florida used 
the same type program. They were No. 2 and three in reading 
increase in 1 year. That kind of technique that costs less 
money is what we need--does not cost more money is what we need 
more of. It was technique and not funds, I think, that made 
that difference.
    So I strongly believe our education focus should be on 
advancing learning, increasing those magic moments in the 
classroom when a child gets it and learning occurs. For too 
long, we have judged our education system on whether the 
building is new, what kind of equipment they have, classroom 
size, and how much we spend. But just throwing money at the 
problem is clearly not the answer. The test for education can 
only be whether learning is occurring adequately.
    I think you believe this, and I see you nod at that. We are 
spending more, Mr. Chairman, than those countries that are 
beating us in education achievement, spending a good deal more 
than most of them. So I think it is time now for honest, fact-
based budgeting. Everyone knows we are in a financial crisis. 




    Admiral Mullen, Chairman of the Joint Chiefs, said our debt 
is the greatest threat to our national security. This year's 
deficit alone is projected to be $1.65 trillion. That amounts 
to $7,500 for each American adult over the age of 25.
    While the President tells the American people that the 
budget asks Washington to live within its means, the facts show 
the opposite. The President's budget adds $13 trillion to our 
gross national debt, doubling it by the end of the decade. Over 
the next 10 years, the smallest annual deficit the budget calls 
for is over $600 billion, and the number rises to $800 billion 
in the tenth year. We borrow that money, of course.
    Interest on our debt was $196 billion last year, three 
times as large as the education budget this year.




    Interest was three times the education budget this year. 
But in 10 years, under the President's plan, because of the 
increased debt, the annual interest payment will be $844 
billion, 10 times the size that the budget calls for education 
spending in that year.
    Interest, the fastest-growing item in the budget, will 
crowd out our future hopes for education and for all other 
programs. It is an unsustainable path. That is why I am 
flabbergasted by the education budget. I think it only could 
have been written in Washington in a bubble detached from the 
reality I have just described.
    Over the last 3 years, we spent 68 percent more on 
education than the 3 years before that from the Federal 
Government.




    The budget now calls for an 11-percent increase in Federal 
spending on education. Sir, we do not have the money. Everyone 
knows that. American families are tightening their belts every 
day, doing more with less, as are cities, counties and States. 
It is time for the Federal Government to do the same. We have 
to.
    All of us favor education, but we cannot continue these 
large increases in spending, every dollar of which is borrowed.




    This request for an 11-percent increase, more than 30 
percent more than we were spending in 2008, is an affront to 
common sense, an affront to the will of the voters. These 
charts show that education has been the beneficiary of 
unprecedented increases in recent years without, let me add, 
any significant increase in student performance. And with the 
stimulus money, education has risen by stunning unprecedented 
amounts. Your prepared statement acknowledges a 4-percent 
increase in education spending, discretionary spending, but you 
note that that does not include increases in discretionary Pell 
grants. Well, that is not fact budgeting. That is beltway 
budgeting. When you consider Pell grants--and we should--it is 
an 11-percent increase.
    What we need is leadership that focuses on why our 
education system is not meeting our expectations. This funding 
crisis I think is an opportunity to challenge our educational 
establishment, to thoroughly and honestly review the plain 
facts, what works, what does not work. We owe that to our 
children today for their education. And we owe our children a 
country that is not burdened by crippling debt. The President 
says his budget is a plan for winning the future, but you 
cannot win the future for our children with borrowed money.
    As Secretary Geithner acknowledged last week, our surging 
debt threatens our economic growth, jobs for young graduates, 
and even economic turmoil. It would be wrong to leave our 
country weaker and diminished because we lack the courage to 
confront the fiscal crisis we are in.
    So we need a dramatic course correction. We need to get the 
message. We need to get in sync with reality of what is 
happening in the world today. We need to trim bloated 
Government. We need to start now, and it goes without saying 
that the Education Department is not exempt. We will vote this 
week on a continuing resolution to fund the Government for some 
period of time. No continuing resolution to fund the Government 
that fails to reduce spending will pass. It will not pass the 
House or the Senate. We are going to fight for spending cuts 
this week, next week, next month, next year. We are going to 
fight for spending cuts in this Budget Committee and the 
Appropriations Committee and on the Senate floor. We are going 
to keep fighting for a leaner, more productive Government until 
we have restored confidence in our economy and put our country 
back on the right path--the path to prosperity.
    So this battle over the budget is just beginning. I respect 
your leadership. I think you have some great ideas. But we 
cannot approve, and I do not think will approve, an 11-percent 
increase in education funding.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you. It sounds to me like you have a 
bit of a cold there.
    Senator Sessions. I do.
    Chairman Conrad. So we hope you will recover.
    Senator Sessions. Thank you.
    Chairman Conrad. We want to welcome the Secretary. Please 
proceed with your testimony, and then we will go to the rounds. 
Let me just say that I initially said 5-minutes rounds. If the 
turnout is the same as the turnout that we see here, we will go 
to 7-minute rounds. We have indicated from Senators ten more 
Senators would be here. If that were the case, we would need 5-
minute rounds, but we will just wait and see.
    Secretary Duncan, welcome.

    STATEMENT OF THE HONORABLE ARNE DUNCAN, SECRETARY, U.S. 
 DEPARTMENT OF EDUCATION; ACCOMPANIED BY THOMAS SKELLY, ACTING 
     CHIEF FINANCIAL OFFICER, U.S. DEPARTMENT OF EDUCATION

    Secretary Duncan. Thank you, Chairman Conrad, Ranking 
Member Sessions, and members of the Committee. Thank you so 
much for this opportunity to come before the Committee and to 
talk to you about President Obama's fiscal year 2012 education 
budget.
    This proposed budget reflects our administration's dual 
commitments to reduce spending and to be more efficient while 
investing to secure our future, and at the very top of that 
list of investments we must make is education. Education is the 
foundation for a free and a democratic society. It is the 
blanket of security for the middle class and the only path out 
of poverty for millions of Americans who have been left behind 
by a changing economy.
    Education gives immigrants and their children the chance to 
be productive citizens and contribute to our collective wealth. 
Education enables us as a country to compete in a global 
economy with other countries that are heavily investing to 
prepare the next generation of innovators and leaders in 
business.
    Education is not just an economic security issue. It is a 
national security issue, which is why retired General Colin 
Powell devotes so much of his energy today to education. Last 
year, military leaders stood with me and called for more 
education funding because only one in four, only 25 percent of 
young high school graduates today, is educationally or 
physically equipped to serve in the military.
    Today all across America people are meeting the challenge 
of improving education in many different ways, from creating 
high-quality early learning programs to raising standards, 
strengthening the field of teaching, and aggressively attacking 
and closing achievement gaps.
    While the Federal Government contributes less than 10 
percent of K-12 funding nationally, our dollars play a critical 
role in promoting equity, protecting children at risk, and more 
recently supporting reform activities at the State and at the 
local level.
    In terms of reform, the last administration focused on 
charter schools and performance pay, two programs that 
benefited our students when I was a CEO of the Chicago public 
schools. Our administration has used competitive dollars to get 
State and local educators to think and to act differently. Our 
administration's Race to the Top program has prompted Governors 
and educators to jointly embrace bold and courageous reform 
programs. With our support, 41 States adopted higher college 
and career-ready standards, and several States passed new laws 
and policies around teacher evaluation. Several States altered 
charter laws and policies to foster creation of new learning 
models.
    Race to the Top also prompted us to rethink the Federal 
role. As I said, the Department was established to promote 
equity in education and to protect students most at risk. To 
that end, we have steadily boosted our commitment to formula 
programs like Title I and IDEA.
    The Federal Government also has a long history of 
supporting higher education from the land grant colleges in the 
19th century to the GI bill and the Pell Grant Program in the 
20th. This budget further increases our investments in higher 
education through both student lending programs and grants.
    But today our most critical role is in supporting reform at 
the State and local level by providing increased flexibility 
and incentives, while holding States and district accountable 
in a fair, honest, and transparent way. In fulfilling this 
role, we must strike the right balance, providing as much 
freedom and flexibility as possible to schools and districts, 
while ensuring that children are learning what they need.
    I have spent 2 years traveling the country, visiting many 
of your States and districts and talking with your teachers and 
your parents. I have visited schools in rural, urban, and 
suburban communities, and there is a lot of dissatisfaction I 
hear across the country with the current Federal law around 
public education.
    Many people feel the Federal Government went too far with 
sanctions, mislabeling schools as failures, and issuing one-
size-fits-all mandates. That's why we're asking Congress to 
rewrite and to fix No Child Left Behind, and I look forward to 
working with you on that in the next couple months as we move 
forward.
    But there is also a deep appreciation for the Federal 
commitment to children and to learning. They are grateful for 
our support of the STEM subjects. Americans know that even in 
challenging times, particularly in challenge fiscal times like 
these, we must prepare our young people to compete in 
tomorrow's economy. They know that even as States face greater 
financial pressure than at any time in recent history, we 
cannot put our children and our country's future at risk. So 
our budget proposal reflects these aspirations and commitments.
    Overall, we are seeking a $2 billion increase in non- Pell 
spending. That includes a modest increase in formula programs 
like Title I and IDEA, while maintaining programs for English 
language learners and other at-risk populations, such as rural, 
migrant, and homeless students.
    We are calling for a new round of Race to the Top funds, 
though we would change the program in two significant ways: 
targeting school districts rather than States, and including a 
carveout for rural communities.
    We will continue to invest in innovation and research. We 
want to support a well-rounded education that includes the arts 
and foreign languages, literacy, STEM, and physical education. 
We want to strengthen the teaching profession in a number of 
ways and work harder to attract the top students to pursue 
teaching degrees.
    We proposed a new competition to strengthen early learning 
program, and we are challenging every single State to boost 
college completion rates. Today more than half of our young 
people who go to college fail to earn a degree. As a Nation, we 
cannot sustain that any longer.
    There is a lot more in our budget outlined in the written 
testimony, but before I take questions, I just want to 
highlight how we have been and continue to be more efficient. 
In the 2010 budget enacted by Congress, we eliminated four 
programs, saving $360 million. In our proposed 2012 budget, we 
propose eliminating 13 additional programs, saving another $147 
million. Together these savings total more than $500 million 
annually, which is helping fund our other priorities. Mindful 
of the significant paperwork burdens we placed on local school 
districts, we are proposing to consolidate 38 separate 
elementary and secondary education programs into 11 simpler 
funding streams. These common-sense reforms will make it easier 
for school districts to focus on educating their community's 
children rather than dealing with bureaucrats here in st.
    We are also proposing to reduce our investment in career 
and technical education, not because we do not believe in CTE 
but because we feel the current program is not getting the 
results we need. Even with the reduction, we are still seeking 
$1 billion for CTE, and we are committed to working with States 
to reform these programs for the new economy.
    This year, we have also identified efficiencies in the 
student aid program that, coupled with a change in Pell grant 
policy, will help close a $20 billion shortfall in the Pell 
grant program and save $100 billion over the next decade. Those 
savings mean we can protect the $5,550 maximum Pell grant award 
and help millions of young people meet rising tuition costs.
    Those savings also mean that we can meet the skyrocketing 
demand for Pell grants, which has risen from less than 4 
million grants in 2000 to a projected 9.6 million grants next 
year. In the last 2 years alone, an additional 3 million 
students received Pell grants. In my view, this is a good 
problem--this is actually a great problem for our country to 
have. We desperately need more young people going to college, 
and in this economy they desperately need our help. But we must 
do more to make sure they finish college and earn their 
degrees.
    Let me close by saying that we share with you the 
responsibility for being efficient and smart in how we invest. 
But we also share an even greater responsibility, which is to 
prepare the next generation to lead. We share the 
responsibility for the 20 million disadvantaged students served 
by Title I, the nearly 7 million students served by IDEA, the 5 
million English language learners, and the 16 million college 
students who benefit from student aid programs.
    In his recent speech to Congress, the President talked 
about winning the future. To emphasize the point, he announced 
his budget at a STEM-focused elementary school in Baltimore. He 
believes, as I do, that winning the future starts in the 
classroom. He also believes the Government spends too much, and 
he has outlined more than $1 trillion in deficit reduction over 
the next decade.
    This is an important national conversation that will take a 
great deal of time, energy, thought, and courage. It will take 
real courage on the part of Congress and the administration. We 
have to be truthful with each other and truthful with the 
American people about what is and is not working. We have to 
take the heat together for the cuts that we are making. To win 
the future while cutting spending, we must be absolutely 
vigilant about how we invest and how we support reform at the 
State and local level. We must be responsible in what we say 
and do, and we must show results.
    Responsibility, reform, and results are the hallmarks of 
our budget and our administration and our guiding principles as 
we move forward. And this applies at the State level as well. I 
spoke with Governors this weekend, and we are now sharing ideas 
with them for more flexibility and productivity in spending.
    I just want to close by thanking Congress for supporting 
education over the last 2 years. Because of you, we helped 
protect millions of children in classrooms all across America, 
from the greatest economic crisis since the Depression.
    Because of your leadership, we helped States and districts 
all across America advance their reform agendas, raise 
standards, and challenge the status quo in significant ways.
    Because of you, almost 1,000 underperforming schools have 
launched radical restructuring plans to improve the lives of 
children and many more in the process.
    Because of you, there is a greater determination than ever 
before to ensuring that our children can compete and win in our 
globally competitive economy.
    And because of you, we face a brighter future and a greater 
prospect that the world we leave behind will be better than the 
one we inherited.
    Soon behalf of 80 million students of all ages, their 
parents, our hard-working teachers, principals, and 
administrators, and all the people of America who value 
education and recognize its importance, I thank you for your 
leadership.
    I will stop now, and I am happy to take any questions you 
might have.
    [The prepared statement of Secretary Duncan follows:]



    Chairman Conrad. Thank you, Mr. Secretary.
    You know, this really is a difficult time. Looking back, I 
believe that history will record that we averted a fiscal 
collapse. I think we can very, very close to a global financial 
collapse. I will never forget being called to a meeting in the 
Majority Leader's office with the then Secretary of the 
Treasury, Hank Paulson, and the Chairman of the Federal 
Reserve, who told us they were taking over AIG the next 
morning, and they told us that if they did not do it, they 
believed there would be a financial collapse within days. Those 
were the exact words they used, and they gave us plenty of 
evidence to support that conclusion.
    So I believe that the steps that were taken, as unpopular 
as they have proven to be--TARP, stimulus--taken together 
averted a financial collapse. I believe the work of Mr. Zandi 
and Alan Blinder that concludes that if we had not done those 
things, unemployment today would be at 15 percent, there would 
be 8 million fewer jobs.
    But with all that said, we are now left with the residue, 
and the residue is not just the recovery effort. It is also 
what came before in the previous administration, a doubling of 
the debt, a tripling of foreign holding of U.S. debt. And now 
we face a circumstance in which we are borrowing 40 cents of 
every dollar that we spend.
    Let me repeat that. We are borrowing 40 cents of every 
dollar that we spend. Spending as a share of our national 
income is the highest it has been in 60 years. Revenue as a 
share of our national income is the lowest it has been in 60 
years. Those are facts, and that means we have to take action.
    There have been three bipartisan commissions who have come 
back with recommendations on what we do going forward. All 
three of them said make modest changes now, this year, as 
things are still weak, but make big changes over the next 10 
years--big changes in spending, big changes on our revenue side 
of the equation, big changes to entitlement programs, reform 
them.
    I supported the President's Fiscal Commission 
recommendations, the Commission on which I served, and I 
believe--though there are a lot of things I do not like about 
that set of recommendations, I think in terms of size they got 
it about right. They have talked about $4 trillion of debt 
reduction debt reduction over the next decade.
    So I say this as an opening frame, Mr. Secretary. When we 
are borrowing 40 cents of every dollar we spend, all of us--all 
of us--have to be in on the solution, and that includes 
education. Even though I personally would put education at the 
top of the list for prioritization, our problem is so big, 
every part of the budget has to be in on the solution.
    Here is the thing that is so striking to me. As I have gone 
to my State dozens of times and asked students, How many of you 
do 2 hours of homework a night?, almost no hands go up. When I 
go to Asia, Russia, Europe, I ask that question. Almost all the 
hands go up.
    When I asked back home, I asked the principal and the 
teachers, Why are almost no hands going up when I ask who is 
doing 2 hours of homework a night?, they say, well, it is not 
assigned. Why isn't it assigned? It is not assigned because if 
they assign homework, the parents complain. What's the nature 
of their complaint? They say, well, the kids do not have time 
to do homework. I said, Why not? Because they got a job. And, 
of course, why do they have a job? Because they have to pay for 
the car.
    I mean, frankly, we have something that goes beyond money 
here going on, and it is a very, very serious problem, I 
believe, to America's future competitive position. As I say, I 
have been in Asia number of times. I have asked the question 
there in every school I went to, How many of you do 2 hours of 
homework? The hands shoot up, virtually every hand. In Europe, 
the hands shoot up. In Russia, the hands shoot up.
    So, you know, if our kids are not doing homework--guess 
what?--and these other kids are, it is no wonder than when we 
stack it up, our kids are falling behind in math, they are 
falling behind in science in terms of global competition. What 
do we do about it?
    Secretary Duncan. Let me give you a couple other facts that 
add to your compelling sense of urgency, almost crisis. Our 
dropout rate in this country is 25 percent. That is about a 
million young people leaving our schools for the streets each 
year, and in many of our minority communities--African 
American, Latino--it is often closer to 40 to 50 percent. As 
everyone in this room knows, there are no good jobs out there 
today--none--for high school dropouts. There are basically no 
good jobs with a high school diploma. Some form of higher 
education--4-year universities, 2-year community colleges, 
trade, technical, vocational training--has to be the goal for 
every single child.
    You talked about the PISA results internationally. The fact 
of the matter is our 15-year-olds on average are a year behind 
our counterparts in Canada. Other folks are out-working us, 
they are out-educating, they are out-investing. One generation 
ago, we led the world in college graduates. It is interesting. 
It is not that we have dropped. We have stagnated. We have 
flatlined. And nine other countries have passed us by. We are 
now tied with four other countries for ninth. And then we 
wonder why we have a tough economy.
    The final thing I will say is at a time of desperately high 
unemployment, we have about 4 million good jobs in this country 
that are unfilled because we are not producing the talent to 
fill those jobs. When the President and I met with a number of 
CEOs from around the country last week, it was staggering how 
many said: We would love to hire tomorrow; we have jobs we 
simply cannot fill because the talent is not there.
    So we have to address those brutal facts openly and 
honestly. The President has talked about this being our Sputnik 
moment. We are simply being out-educated, and we are going to 
be out-competed if we do not change pretty significantly.
    On the cultural side of this equation, the President often 
tells the story of when he visited the President of South 
Korea. He always asks about education. He says: What is your 
biggest educational challenge? And immediately the South Korean 
President said: My biggest challenge is my parents are too 
demanding. Even my poorest parents demand a world-class 
education. He said: I am spending millions and millions of 
dollars to import teachers to teach English to our students 
because our parents refuse to wait until second grade for their 
children to learn English. They have to start learning in first 
grade.
    So this is about investing very differently, but it is also 
a cultural component that we have to address very openly and 
honestly that other folks revere education. In South Korea, 
teachers are known as nation builders. I think our teachers are 
and should be known as nation builders.
    Our teacher work force has been beaten down. We have to 
work harder. Your success in what you do, so many of you are 
successful at what you do because you work hard. And if someone 
else is working two or 3 hours harder than you every single 
day, week after week, month after month, year after year, guess 
what? They are going to be in a very different place than we 
are. And so we have to invest differently. We have to invest 
wisely. We have to address the lack of competitiveness of where 
we are relative to our international peers. Jobs are not 
confined to a district or to a State or to the country. Jobs 
are going to follow where the good workers are, where the 
knowledge workers are. And we have to think very differently 
about how we invest, and w have to challenge parents and 
challenge the community to put a much larger priority on 
education.
    The final thing I would say is I wish we had more parents 
beating down our doors demanding better education. I would love 
that problem. What I often get is we are moving too fast, we 
are being too radical. And when we have a 25-percent dropout 
rate that is unsustainable, I think we have to be radical. We 
have gone from first in the world to ninth in college 
graduates. We have to be radical. But we need to encourage 
parents and the community to challenge us to do more and to 
improve faster than we ever have in the history of this 
country.
    Chairman Conrad. Let me just say that my time has expired, 
but, you know, it does not cost money to do homework. That is a 
matter of the homework being assigned and the kids doing the 
homework and that the parents insist that the schools are 
demanding something from their kids.
    Secretary Duncan. Let me add----
    Chairman Conrad. I cannot go further on this because it is 
unfair to my colleagues. We will go to 7-minute rounds. Senator 
Sessions.
    Senator Sessions. Thank you, Mr. Chairman. That was a very 
important question. We blame teachers, I think, too much for 
problems in education, and like you said, Mr. Secretary, in the 
cultural situations in which students refuse to do homework or 
parents will not insist that they do and efforts by teachers to 
insist on excellence are not affirmed, it is a deep thing.
    I would note that your praise for Canada is good, but 
Canada spent $8,500 per student last year on education, and we 
spent $11,500 on students. So we are spending much more and 
need to get more for what we spend as we are. The President 
says--you said he believes that the Government spends too much, 
and you are taking heat for cuts. But we are not cutting. You 
are increasing spending across the entire board, and that is 
the problem.
    I know Admiral Mullen of the Joint Chiefs said our debt is 
the greatest threat to national security. Secretary of State 
Hillary Clinton said the same thing. Do you agree with that?




    Secretary Geithner said that the debt we are leaving could 
leave us with a very large interest burden and unsustainable 
obligations. Do you share those concerns?
    Secretary Duncan. I think those are valid, absolutely valid 
concerns. As I said in my statement, the President is committed 
to $1 trillion in deficit reduction over the next decade. As 
the Chairman said, as we move forward, I think there are lots 
of sacred cows that collectively the administration and 
Congress have to look at very seriously.
    Senator Sessions. Well, over the next decade, the deficit 
will double from $13 trillion to $26 trillion, and you can say 
that cuts and saves $1 trillion, but it does not seem like it 
to me. That is plain fact, and that is the budget fact.
    For example, under the programs here of interest, Pell 
grants, under the President's budget total Pell grant aid 
available for 2012 would be $36 billion, double the amount 
available in just 2008. Is that correct?
    Secretary Duncan. We can go through the numbers. We are 
going to save--we have a way of closing the Pell shortfall $20 
billion. But let me be very, very clear. What our country 
desperately needs is many more young people going to college 
and graduating. Again, we have 4 million unfilled jobs today in 
a tough economy. They are unfilled because we are not producing 
the skilled workers that our country needs at a time when going 
to college has never been more important, has never been more 
expensive, and our Nation's families have not been under this 
kind of financial duress in a long, long time. So the fact that 
we have a 50-percent increase over the past couple years of 
students accessing Pell grants I think is hugely important.
    Senator Sessions. Well, I think we can all agree that 
funding and money does not necessarily improve education. We 
have seen that dramatically. We are going to be--in 2008, we 
provided Pell grants for 6 million. Now we are providing Pell 
grants under your proposal for 9.6 million, increasing that, 
doubling the entire budget, and we do not have the money.
    Now, with regard to student loans, we have now taken over 
the student loans; 100 percent of it is Federal. But according 
to our calculations, the total student loan, total in billions 
of dollars will go from $98 billion in 2008 to $167 billion in 
2012, a 68-percent increase. Is that correct?
    Secretary Duncan. I do not know that exact number. What I 
will say is when we took over the direct lending, we did that 
for one very simple reason----
    Senator Sessions. Well, I know we took it over. We had a 
fight over that.
    Secretary Duncan. Well, let me just----
    Senator Sessions. But I am talking about the total direct--
comparing guaranteed and direct loans have increased from $98 
billion in 2008 to $167 billion.
    Secretary Duncan. We have many more people accessing higher 
education, which as a country we desperately need. The only way 
we strengthen our economy long term is to produce the 
innovators, the entrepreneurs, the knowledge workers, the----
    Senator Sessions. Well, why don't we just spend three times 
as much?
    Secretary Duncan. On Pell grant?
    Senator Sessions. On Pell grant. Won't that just help us 
fix it all?
    Secretary Duncan. Well, actually we made some very tough 
cuts in Pell grants, and so we asked for a $5 billion increase 
but we are reducing costs by $15 million.
    Senator Sessions. Well, this is Washington math. You have 
not cut Pell grants. Pell grants are increasing dramatically, 
Mr. Secretary. The numbers are plain.
    Secretary Duncan. That is correct, and they would have 
increased even more substantially, more significantly, had we 
not made the tough and painful decision to eliminate----
    Senator Sessions. You are proposing to increase that much. 
They are not going to be increased that much because we do not 
have the money.
    Secretary Duncan. So what we have proposed is to eliminate 
two Pell grants each year. That is a tough cut. That is a 
painful cut. That is not one that I wanted to do, but we think 
it is a responsible way to close the Pell shortfall.
    Senator Sessions. You talked about program consolidation, 
consolidate 38 K-12 programs into 11 programs as part of the 
ESEA reauthorization. I think consolidation and program 
efficiency is a worthy goal. I believe you are a strong 
administrator. I think you have the ability to do that. You 
note that some of this program structure is fragmented and 
ineffective and there is little evidence of success. But the 
total budget that you submit for the consolidated activities is 
$900 million more. Instead of saving money, you are spending 
more money. That is not what we have to have today. Since we 
are so short of funds, we need to see some real efficiencies 
that actually enhance education without driving up costs. Don't 
you agree?
    Secretary Duncan. Well, I hear your concerns, and we have 
tried to do a couple things. Our goal in consolidation--these 
are tough cuts and tough consolidations, and not everyone 
supports them, but we think it is the right thing to do. We 
think, again, particularly in small communities, rural 
communities, when it is very difficult to deal with the Federal 
bureaucracy, the easier we can make that relationship, that 
makes a lot of sense. It will enable folks to spend their time 
working with students rather than dealing with us. So we 
consolidated a number of programs. We eliminate a number of 
programs that we do not think are as effective as they can be. 
But at the end of the day, I believe we have to invest in 
education, that when as a country we have gone from first to 
ninth in college graduates with a 25-percent dropout rate, our 
students and our country deserve better than what they are 
getting today.
    Senator Sessions. Well, we need to figure out what is 
happening out there. A recent report indicated that colleges 
are demanding less and students are learning less. We are 
sending more students, we are spending more money, and we are 
getting less for it. And I really am worried, as the Chairman 
expressed, that our global competitiveness is at stake. 
Education is important. Thank you for promoting some of the 
reforms you have been working on.
    Secretary Duncan. One final comment, if I could say that I 
think what is so important to both your questions is one of the 
big things we have tried to do is encourage States to raise 
standards. Part of the reason there is not homework, part of 
the reason students are less prepared for college is because 
standards have been dummied down in far too many places. We 
have 41 States that have raised standards, colleges have raised 
standards, and my goal is to get universities out of the 
remediation business. Those who do graduate from high school, 
often 30, 40, 50 percent have to take remedial classes in 
college. They are not ready. With States raising standards, I 
think that is a game changer. That is a huge step in the right 
direction.
    Chairman Conrad. Senator Coons.
    Senator Coons. Thank you, Mr. Chairman.
    Thank you, Secretary Duncan, for your presentation today. I 
am extremely pleased to see that this budget continues on the 
President's public commitment to invest in world-class 
education for all our students, and I look forward to working 
with you on the Elementary and Secondary Education Act 
reauthorization.
    I think there are some very tough choices in this budget, 
and I was pleased to see some reductions, some trimming, some 
realignment. In your opening statement, you reasserted that 
your goal, given that Federal spending is just 10 percent of 
all education spending, is to promote reform, reward success, 
and support innovation at the State and local levels.
    In my view, Race to the Top has succeeded significantly in 
doing that. There are 11 States and the District of Columbia 
that are directly benefiting from Race to the Top, but as you 
mentioned, dozens of other States that may not have been 
selected made significant changes.
    If Race to the Top has, in my view catalyzed education 
reforms in both those States that won and lost the competition, 
what do you think would be the impact if funds were not 
appropriated to continue Race to the Top in this year's budget?
    Secretary Duncan. Well, what you have seen around the 
country over the past 2 years I think is reform at a level of 
unprecedented speed. As you said, you have 41 States that 
adopted college and career standards, raised the bar for 
children, and for the first time in this country, a child in 
Massachusetts and a child in Mississippi will be held to the 
same standard.
    You have 44 States today working together on the next 
generation of assessments to be much more thoughtful in how we 
do that. We had almost three dozen States eliminate barriers to 
innovative schools and create more room for flexibility. You 
have seen every single State that had laws on the books that 
prohibited the linking of student performance, student 
achievement, and teacher evaluation, all those laws have been 
eliminated. And you now have almost 1,000 schools around the 
country, dropout factories were historically 50, 60, 70 percent 
of students were dropping out, finally were challenging the 
status quo.
    So there has been a huge amount of movement at the State 
level. That has to continue. That has to be sustained. In our 
budget request for a third round of Race to the Top, $900 
million, we want to see that same pace of change at the 
district level, and we also want to have particular focus with 
a set-side in rural communities.
    And so we have to play at the State level, at the district 
level, at the community level, Promise Neighborhoods, and, 
again, we have to get better faster than we ever have in this 
country. Race to the Top has been a huge catalyst for raising 
the bar.
    Senator Coons. How do you see the competition being 
different this year with a district-level focus? And how 
through the Effective Teachers and Leaders State Grants 
Program, as you begin to implement local teacher and principal 
evaluations systems, how do you see us working together to 
ensure that teacher collaboration is sustained in the 
development of these valuable systems?
    Secretary Duncan. I think it is so important in this work 
that all of us move outside our comfort zones. We had a 
wonderful conference 2 weeks ago in Denver where we had 150 
districts, and 100 districts who wanted to come but could not 
get in, where the superintendent, the board chair, and the 
union leader came together to figure out how we work 
differently and how we use collective bargaining to drive 
student achievement. We had a number of districts presenting 
how they have done this in extraordinarily creative ways. So 
our themes at the district level would echo those at the State 
level, but with a real focus for closing the achievement gaps, 
raising the bar, and all of us moving outside our comfort 
zones. And what we want to do is simply reward courage. There 
are so many folks around the country who are doing this hard 
work, who, you know, want to be creative, that have never been 
rewarded for success.
    One of my biggest problems with the current law, No Child 
Left Behind, is that there are about 50 ways to fail, and your 
only reward for success is you are not labeled a failure. And 
so we want to shine a huge spotlight through reauthorization, 
through Race to the Top, through the Investment Innovation 
Fund, through Promise Neighborhoods, on folks that are willing 
to challenge the status quo, raise the bar for all students, 
and close those insidious achievement gaps.
    Senator Coons. I do think you are making significant 
progress through all those different vectors in strengthening 
the focus, strengthening the reform.
    One area of the budget that did concern me was the change 
to a direct loan program, so the incentive to convert so-called 
split loans to direct lending. Are you concerned about the 
additional debt that the Department will be taking on? And are 
you confident that the budget scoring of these savings is real? 
Or do you think it may possibly reflect a lack of an accurate 
assessment of the risk associated with direct lending?
    Secretary Duncan. Well, the folk that do the budget scoring 
are a lot smarter than I am, so I can only assume and think 
they are doing good work. The goal here is to simply make 
things simpler for the borrowers and to have, you know, one 
servicer rather than multiple servicers. This is an optional 
program. It is not mandatory. But we think it is the right 
thing for the students who are dealing with multiple 
relationships, and that is difficult and complicated. At the 
end of the day, we think this could save us $2.1 billion.
    Senator Coons. I have some concerns about that and will 
followup with outcome on that in more detail. But if I could as 
a last question, as you know, we have both worked over many 
years on improving postsecondary outcomes, particularly for 
minority or low-income students who are the first in their 
family to attend college. And I am very interested in the First 
in the World Initiative, which strikes me as sort of a venture 
capital fund approach to trying to really deal with these 
critical problems and the college completion incentive grants.
    Please, if you would, as my last question, just talk for a 
minute about what is different about these. How are these going 
to make it different going forward? And how is this going to 
make it possible for us to close those critical gaps the 
Chairman spoke about at the outset in terms of college 
completion in the United States?
    Secretary Duncan. So first let me just quickly say how 
lucky we are to have you in the Senate and to have you on this 
Committee, and almost no one brings your deep passion and 
knowledge of what it takes to help children who have not had 
these opportunities and families and communities that have not 
had these opportunities for decades, to give them the chance to 
break through. And so your leadership and insight and expertise 
I think is going to be extraordinarily valuable to this 
Committee and to me personally, and I look forward to our 
continued work together.
    At the end of the day, it is interesting, universities are 
not too dissimilar to high schools, and you see some that have, 
you know, first-generation college goes and many EL students 
who do a wonderful job of building cultures around completion. 
You see others where completion rates are very, very low. And 
just at the high school level, you see some high schools that 
are 95 percent minority and 95 percent poverty, with 98 percent 
graduation rates and 95 percent going on to college. You see 
others with similar demographics with 60-percent dropout rates, 
wildly different outcomes.
    What we want to do is almost a mini Race to the Top at the 
higher education level to put significant resources behind 
those States and those universities that want to build a 
culture not just around access--and access is huge--but it has 
to be around attainment, around completion. And some places do 
an amazing job with that. Some do not. When I was the CEO of 
the Chicago Public Schools, we tracked this data very 
carefully, and, quite frankly, I started to steer my students 
toward certain universities and away from others because 
students with identical GPAs, identical ACT scores were getting 
radically different outcomes at different universities. And the 
more we can build cultures around completion, that is what our 
children need, that is what their communities and families 
need, but ultimately that is what our economy needs. That 50-
percent dropout rate from college has to go down.
    Senator Coons. Thank you.
    Chairman Conrad. Senator Cornyn.
    Senator Cornyn. Thank you, Mr. Secretary. It is good to 
have you here today, and I want to tell you at the outset that 
some of the things I have heard you say during your tenure as 
Secretary of Education give me some hope that we can work 
together on a bipartisan basis to improve public education in 
America, recognizing the Federal Government does have a 
relatively small role, 10 percent of spending, in K-12 
education. So I look forward to working with you on the 
reauthorization of No Child Left Behind. And I hope that we can 
do some good there.
    But part of the problem that States that do fund 90 percent 
of public education in the country are experiencing is that the 
Federal Government has basically commandeered State budgets in 
a number of ways. There is a recent report that just came out, 
today as a matter of fact, demonstrating the Medicaid expansion 
that was part of the health care bill has essentially crowded 
out the ability of States to spend money on K-12 and higher 
education. In my State alone, it is $27 billion of an unfunded 
mandate over the next 10 years, and we have to get that under 
control.
    I appreciate what the Ranking Member Senator Sessions, his 
questions relating to money equaling quality education. We know 
that is not true, and there are a lot of good examples of 
charter schools, for example, the KIPP program, featured 
prominently among other charter school programs in the 
documentary ``Waiting for `Superman,' '' where we know that 
there are a number of innovative and more cost-effective means 
of delivering education taking place across the country. And 
just pouring more money into the same broken system is not 
going to improve outcomes in my view.
    But I want to ask you specifically about a Texas issue that 
you are well acquainted with. Congress, of course, appropriated 
$10 billion for the Education Jobs Fund, and my understanding 
is that roughly $975 million remain unobligated. Is that your 
understanding?
    Secretary Duncan. Yes, sir.
    Senator Cornyn. Of course, my State had submitted an 
application, and my understanding is that its share of funds 
would be roughly $830 million if indeed that application had 
been accepted and granted. But because of a provision that was 
put into the bill by Congressman Doggett in the House basically 
requiring the Governor to do something that he is barred from 
doing under the Texas Constitution--that is, guaranteeing 
certain levels of education expenditures in future legislative 
sessions--Texas was in a Catch-22 and could not qualify for 
that funding.
    As you know, there are provisions in the law for 
alternative methods of allocating that money, and I would like 
to know what you intend to do to work with us to try to make 
sure that Texas is not discriminated against when it comes to 
the allocation of these education funds.
    Secretary Duncan. Let me try and address the first part of 
your statement first, and then I will come to that specific 
question.
    I share your concern about where the Federal Government has 
been inflexible or commandeered local budgets. I spoke before 
the NGA this weekend, talked a lot about us trying to provide 
much greater flexibility at the State level, trying to help 
them become more productive in very tough budgetary times, and, 
again, I put some pretty non-traditional ideas out there for 
what folks can do in tough times, and actually this week we 
will be sending documents to every Governor of our best ideas 
about how we can be more flexible, challenging States to take 
advantage of that flexibility, which they often do not do, and 
really trying to be a much better partner.
    I just want to assure you that I have no interest in 
pouring more money into the status quo. We have a very 
different vision of where we are going. We are trying to push a 
very strong reform agenda, and I would agree with you: If we 
perpetuate the status quo with more money, that does not get 
our country where we need to go.
    I do think we need to invest but in a very different vision 
of what education can be and should be and to continue to work 
in a bipartisan way through ESEA. A big goal there for me, 
frankly, is to provide much more flexibility than exists today 
under the current law. The current law----
    Senator Cornyn. Well, I look forward to working with you on 
that, but obviously we only have 7-minutes rounds and----
    Secretary Duncan. Sorry.
    Senator Cornyn. What I am really interested in is how you 
intend to work with me and the Texas congressional delegation 
and Congress to make sure that the State of Texas is not 
penalized to the tune of $830 million for a requirement in the 
law that under the Texas Constitution the Governor does not 
have the power to do.
    Secretary Duncan. I am intimately familiar with the 
details. We obviously have to follow the law and congressional 
intent. I was having, I thought, good, productive conversations 
both with the Governor and the State superintendent, and then, 
frankly, they decided to sue the Department of Education in 
this matter.
    Senator Cornyn. So all discussions have ended?
    Secretary Duncan. Well, it is in litigation now, so----
    Senator Cornyn. So all discussions have ended?
    Secretary Duncan. I do not know if all discussions have 
ended, but it makes it more difficult now that we are being 
sued to----
    Senator Cornyn. Well, what is a State with 25 million 
people supposed to do when the Federal Government discriminates 
against it in the distribution of tax dollars to help public 
education? Your Department would not accept the application. 
What is the State official supposed to do other than to go to 
court to try to force you to do it because of the 
unconstitutional requirement? Now you are telling me because 
they have resorted to litigation that you are not going to 
continue negotiations with them to try to resolve this impasse.
    Secretary Duncan. No, I did not say either one of those. 
And to be clear, we did not reject their application, and so 
there is ongoing----
    Senator Cornyn. Well, you said it was not in acceptable 
form because it----
    Secretary Duncan. No, I----
    Senator Cornyn [continuing]. Because it did not meet the 
requirements of the Doggett amendment, which required an 
unconstitutional condition for State officials.
    Secretary Duncan. So we are not going to solve it this 
morning. What I will say is the children of Texas desperately 
need these resources, and our intent from day one was to make 
sure children around the country had access to it. Texas 
schools in many places are having huge budget cuts. We have 
seen skyrocketing class sizes. The dropout rate in Texas is 
pretty staggering. And if you have thoughts or creative ways 
that this could be resolved, I am all ears. But at this point, 
because they chose to sue, it makes it a little bit tougher 
to----
    Senator Cornyn. Well, Mr. Secretary, I am deadly serious 
about this issue, and it is not going to go away, and we are 
going to have to work it out. And I would invite you to engage 
with me and other Texas representatives to try to find a 
solution, because this is unacceptable--unacceptable--for a 
State, one of the largest States in the country with 25 million 
people, with the kinds of needs that you just described, that 
you and I both understand, for the Federal Government to 
basically thumb its nose at my State. It is just unacceptable, 
and we are going to have continuing problems unless you and I 
can work out some solution.
    Secretary Duncan. We have until September to do that, and 
48 States have received their money and put it to great use and 
saved a couple 100,000 educator jobs around the country and 
driven reform, and I would love to see the children of Texas 
get their fair share.
    Chairman Conrad. Senator Whitehouse.
    Senator Whitehouse. Thank you, Mr. Chairman. Thank you, 
Secretary Duncan.
    One of the areas that I have taken an interest in over the 
years, I come at this from a point of view of somebody who was 
a prosecutor. And when I moved from being the United States 
Attorney for Rhode Island to be Attorney General for Rhode 
Island, I began to oversee the prosecution of hundreds and 
hundreds and hundreds of children. And as I inquired as to what 
the best way to prevent this would be, over and over again I 
was steered toward middle school. Over and over again I was 
steered not only toward middle school but toward attendance and 
truancy and performance in middle school, particular emphasis 
on truancy.
    Over and over again I was shown cases where kids had become 
truant, completely fallen off the radar screen, engaged in the 
kind of really unhealthy behaviors that historically people 
never associated with middle school--gang membership, 
pregnancy, drug addiction--and that we really needed to bear 
down on our middle schools, and that it was an area, kind of a 
fulcrum period between the younger years where, as long as 
people are getting, you know, sort of basic needs met and 
getting their literacy needs met, both reading and mathematics, 
they are in pretty good shape; and then in high school they get 
to be much tougher kids, and it gets to be much more 
challenging to pull them back into the mainstream if they have 
fallen out of it. And it is usually just a 3-year program.
    The President supported it energetically, his success in 
the middle bill I was a cosponsor of when he was a Senator 
here. My senior Senator, Jack Reed, has picked that bill up, 
and yet I do not see much in the way of focus here on middle 
schools.
    Based on that experience, I adopted a middle school and 
started to work with the middle school in Providence. And as I 
have talked to teachers, this has been a continuing issue, and 
nobody has ever pushed back, ever. Teachers, law enforcement, 
administrators, no matter where you go, everybody says, oh, 
yeah, we get it, middle school is really a fulcrum period and 
investment there can make a particularly big difference because 
if you turn a kid around to a high-performing student in middle 
school, you are in a far better position than having to chase 
them through high school trying to pick them up if they are 
failing that.
    So I would love to hear from you where your focus is on 
middle school in this area, what specific programs you propose 
to help in that area, and then I would like to ask briefly 
about after-school as well.
    Secretary Duncan. So a couple thoughts. I think your sense 
of the challenge, and you have lived it, is real and painful 
and is too often the norm rather than the exception. Both 
Senator Coons and I got our start in education, starting with 
middle school students and trying to work with them for 6 years 
through college, and so I have lived this.
    Senator Whitehouse. A special breed.
    Secretary Duncan. So this one is very personal. A couple 
thoughts there.
    One of the biggest things that matters for children who are 
struggling is getting an adult in their lives who can be with 
them through thick and thin, so through the middle school 
years, a teacher, a social worker, a counselor, through high 
school, some adult that when things go wrong at home or it is 
tough in the community helps them to persevere. So school 
districts, some are doing some really innovative things, but I 
honestly think school districts cannot do this alone. 
Nonprofits, social service agencies, the faith-based community 
are stepping up. We know what----
    Senator Whitehouse. I get the big picture. My narrow focus 
is what is the Department of Education doing in this area.
    Secretary Duncan. So a couple different things. One is a 
huge focus on the STEM area, STEM fields to try and keep great 
math and science teachers in there when often those teachers do 
not have the content knowledge they need. It ties to your 
question for after-school. We are asking for additional after-
school money. I think when students are engaged in 
extracurriculars--art, dance, drama, music, band--that helps 
them stay engaged in very different ways. We are supporting 
programs like----
    Senator Whitehouse. Those are all general programs, so they 
do not relate to middle schools specifically. They may apply to 
a middle school, but they are----
    Secretary Duncan. They are part of an overall spectrum, but 
gear up----
    Senator Whitehouse. Let me roll, in the time that I have 
left, to the after-school question because one of the things 
that we hear from the education community enormously, 
regularly, is how important it is for a school to have 
community support; that the more the school is engaged in the 
larger community and the more the larger community is engaged 
in the school, the better off everybody is, the better off the 
kids perform and so forth.
    So in Providence, Rhode Island, in particular, we have a 
really exceptional after-school program. That has involved the 
community for a long time. It has been in many ways sort of the 
incubator for a lot of the education reform activity that has 
taken place in Rhode Island. And I worry that your emphasis in 
after-school in giving priority to more expensive extended 
school day, extended learning time programs over these 
community-supported and community-developed after-school 
programs risks crowding them out. It risks crowding them out 
because of the priority. It risks crowding them out because it 
is more expensive to extend the learning day than to work 
through the community. And I think it fails to take into 
account the added value that comes when the community is that 
engaged.
    So I hope that as you go forward with your program you will 
take into account concerns like mine that in some places--it is 
not the solution for everybody, but where it is a proven 
solution, you should be protecting and defending and growing 
and helping these very, very successful after-school programs 
rather than putting them at a competitive disadvantage with 
extended learning programs. I am not quite sure how this 
prioritization is going to work out in practice, but it really 
worries me that one of the best things going on in education in 
Rhode Island is going to be on the losing end of this priority 
shift of yours.
    Secretary Duncan. I would love to continue the 
conversation. It is a very fair, you know, concern and 
critique. What I ultimately believe is we just have to do more 
in this after-school space. It is not an either/or. It is a 
both/and. We are asking for about $100 million----
    Senator Whitehouse. It is not both/and in the way you have 
designed it. There is a priority that--you put a thumb down on 
the side of the extended day and against the after-school 
program, so it is not quite both/and. It is both/and with a 
bias, and it is the bias that concerns me.
    Secretary Duncan. And additional resources. But your point 
is well taken. I do think school days are too short, school 
weeks are too short, school years are too short. But the idea 
of schools being open 12, 13, 14 hours a day, wrap-around 
services--it is one of the things I was proudest of in Chicago. 
I had 150 schools that were open very extended hours. What 
happens in Providence I think is fantastic. We do not want to 
hurt that. We will actually look at that----
    Senator Whitehouse. My time just expired, so I will leave 
on that, because that is a great note to leave on, and we will 
continue the discussion.
    Secretary Duncan. To be continued.
    Chairman Conrad. Senator Johnson.
    Senator Johnson. Thank you, Mr. Chairman, and, Mr. 
Secretary, I want to start off thanking you for your service. I 
try to make that same comment to school board members when I 
meet them. I realize this is not exactly a thank-filled 
position, so I want to thank you at least.
    Seeing as this is the Budget Committee, I would like to 
kind of zero in a little bit on costs. I did here a recent 
interview with Joel Klein, the chancellor of New York City's--
former chancellor of their Department of Education, where he 
commented that our spending in real terms has doubled since 
1983, and we have not seen the results, but in particular I 
would like to hone in on college tuition.
    I have seen a number of studies--and what I will quote is 
from the Heritage Foundation--that States' college tuition 
since 1982 has increased 439 percent. To put that relative to 
things like health care and general inflation, health care has 
risen 250 percent; just general inflation has gone up about 105 
percent. So let us talk dollars.
    Just general prices, something that cost $10,000, today 
would cost a little over $20,000. College tuition, though, has 
gone from about $10,000 to over $50,000.
    I would kind of like to hear your comment on what has 
caused that.
    Secretary Duncan. It is a huge concern of mine, and I do 
not have a good answer as to what has caused it. We see college 
costs, college tuition escalating far ahead of the rate of 
inflation in many places, and so it is a real challenge. As I 
have said repeatedly, you know, going to college now is 
desperately, desperately important for all of our young people, 
and when tuition makes it untenable or too difficult, that is 
not good for families or the country.
    So I think colleges historically, frankly, have not always 
been as efficient as they need to be, have not made some of the 
tough cuts that families are having to make every single day, 
and tough priorities, and that we are trying to make in our 
budget, that you guys are trying to do in your work. So it is a 
real challenge.
    We have had very tough, candid conversations internally. 
You know, is there a legislative play? Is there anything to do 
there? I will tell you what my current thinking is, but I am 
not satisfied with it. I think our system of higher education 
is the best in the world. I think we have a couple thousand 
great options around the country. Parents today, they are 
smart, they are savvy. Students, they have more choices, more 
options than ever before. They want a great education, but they 
want value for their money. And so when colleges are 
escalating, you know, expenses way ahead of where they need to 
be, I think folks are going to start voting with their feet and 
going other places.
    Senator Johnson. Do you think Federal infusion of dollars 
has played anything--into that? Why else would we see such a 
dramatic difference in general prices versus the cost of 
college tuition?
    Secretary Duncan. I mean, I guess that is a possibility. 
That is not my first thought because--well, what I was going to 
say is you see actually huge variation. You are actually seeing 
movement the other direction. You have a university 2 weeks ago 
that reduced tuition 10 percent. You have other universities 
going to 3-year programs. You have other universities going to 
no-frills campuses. And what you are seeing is the marketplace 
starting to play, and parents are starting to vote with their 
feet, and they are starting to go to places to get a good 
education for less money.
    So I think, again, by transparency and good information, 
the bad actors will not get rewarded and the good actors will 
get a greater market share, and that is a good thing for the 
country.
    Senator Johnson. I will agree. Information is powerful as 
the free market enterprise system is pretty powerful as well.
    You may have noticed a few news reports within my State, 
the State of Wisconsin, that there are a few issues there.
    Secretary Duncan. I have.
    Senator Johnson. And I guess I would like to just ask you, 
What role--or how helpful have public sector unions been to 
education? And what would be the evidence of that?
    Secretary Duncan. So just in the midst of the Wisconsin 
situation--I have a good relationship with the Governor, talked 
to him several times, worked well with him, have a good 
relationship with the union, talked well--you know, talked with 
them.
    In the midst of the Wisconsin situation--this was 
coincidence, it was not planning--we had a conference in Denver 
with 150 districts from around the country and a waiting list 
of 100 on this very issue. And we talked about how historically 
in too many places collective bargaining had not worked for 
anybody, had not worked for the adults, had not worked for the 
children, had not driven student achievement, that we needed a 
third way, we needed to do things very, very differently. And, 
again, this is not just unions, to be clear. This is 
management. Often management has not been strong here. School 
boards have not been as effective as they need to be. So it is 
not about pointing fingers, about all of us doing things 
differently. But what we had is we had over a dozen districts 
present to the 150--we did not lead the conference. They did--
present how they had used the vehicle of collective bargaining 
to drive student achievement and to close achievement gaps.
    The goal there was to say if this works, why not make this 
the norm? And can we go from 15 creative, innovative districts, 
doing some radically different things through collective 
bargaining to drive much better student outcomes? Can we go 
from 15 to 150 to 1,500 to 15,000?
    So in many places, collective bargaining has not led to 
better student achievement, has not led to more satisfied 
workers, has not helped move the country where we need to go. 
But we have a number of places that are starting to break 
through, and we need to replicate those successes.
    Senator Johnson. Earlier in your testimony, you said that 
we need 4 million more college graduates. A lot of my volunteer 
work over the last 10 years has been in education in Oshkosh, 
primarily the K-12 level. What we were seeing as employers is 
just a mismatch, you know, whether it is colleges, whether it 
is our schools simply not providing the types of degrees, the 
types of educational opportunities to match the employment 
opportunities, as opposed to just cranking our more college 
graduates. Can you speak to that?
    Secretary Duncan. You are seeing reality, and I hear that 
complaint from CEOs all around the country. And one of the 
things we are doing actually in partnership with the Department 
of Labor is trying to put resources out there to community 
colleges and communities in the private sector where they come 
together to provide real training that leads to real jobs. A 
and where you have these mismatches, you know, students come 
out with greater debt, they are not employable. The employer 
ultimately moves overseas if they can get more workers there. 
There is no upside there. So there is an absolute mismatch at 
lots of different levels, and we want to put resources behind 
places--there are also some fantastic public-private 
partnerships that are leading to real jobs every single day. I 
visited one yesterday in Philadelphia around the health care 
industry where workers--some were just coming to the country to 
learn English, and then ultimately, because of great 
partnerships, are getting real jobs in the health care field 
around there. We have to do a lot more of that. So that is a 
real concern.
    Senator Johnson. One final question. I am a manufacturer, 
so I generally try and look at the root cause of a problem. To 
me a lot of what we talked about in terms of the problems of 
education really relates back to just the social pathologies, 
the fact that our out-of-wedlock birth rates have gone from 7.5 
percent to 40 percent from the 1960s. Can you just comment on 
that a little bit?
    Secretary Duncan. So I think our children are coming to 
school today with probably more challenges than ever before, 
and whether it is, you know, families that are not intact or 
whether it is the video games and all the distractions we talk 
about, the lack of time spent on homework. So those are 
absolutely real challenges. I think we are asking more of our 
teachers and administrators than we ever have.
    Having said that, in these very tough times with high 
poverty and high crime and, you know, single-parent families, 
we have never had more high-performing schools who are beating 
the odds every single day. We are trying to turn around these 
chronically underperforming schools, and so those challenges 
are real. They take long hours. They take after school. They 
take mentoring. But we have never, I do not, ever had so many 
high-performing, high-poverty schools in some of our 
neighborhoods--some of our country's most distressed 
communities, and we have to learn from those successes and take 
them to scale.
    Chairman Conrad. Senator Begich.
    Senator Begich. Thank you, Mr. Chairman. And thank you, Mr. 
Secretary, for being here, and thank you for your visit to 
Alaska, to Hooper Bay. And I know----
    Secretary Duncan. I will never forget it.
    Senator Begich. I know you will not. We had a great 
conversation on the way back on the plane as we sat there and 
talked about education. There is a clearly a much different 
view in rural Alaska than it is in Chicago. You have to, I 
guess, admit that.
    Secretary Duncan. Absolutely.
    Senator Begich. Let me also, again, just so you know, I 
come from a family of educators. My parents were educators. My 
two sisters are educators. My sister-in-law is an educator. I 
chaired the Student Loan Corporation for 7 years, the 
Postsecondary Education Commission for 7 years. But saying all 
that, when I campaigned for this office, I actually ran an ad 
because I think in Alaska, especially in Alaska, No Child Left 
Behind was a disaster. It had no understanding of really rural 
America, and when I say rural America, rural Alaska. And it had 
basically a system that penalized communities that were trying, 
as you saw firsthand out there, and it really worked in the 
wrong direction. So I want to followup to some degree on a 
couple comments I heard you say.
    First, on Race to the Top, can you describe what you meant 
when--I heard you say rural set-asides, so it caught my 
attention, because every time I have heard rural set---- aside, 
usually it means it is a Washington, D.C., description of rural 
set-aside, which is nothing--nothing--like Alaska. So define 
what you see as rural set-aside, and it would be great if you 
started with Hooper Bay as an example.
    [Laughter.]
    Secretary Duncan. So if I start on Hooper Bay, this is a 
conversation obviously to continue with you and with the 
Chairman, but let me be very, very clear. We have seen 
significant change in Race to the Top, in the Investment 
Innovation Fund. We want to make sure we are having an impact 
everywhere around the country. We think we can do more and do a 
better job in rural communities. I would be happy to work 
through the technical definition with you guys and get your 
thoughts there.
    But let me be very clear. In both a third round of Race to 
the Top and a second round of the Investment Innovation Fund--
and you have been so supportive of that effort. I appreciate 
it. In both of those we want to make sure that we are playing 
in a significant way in the rural community. So we are learning 
there, and the technical definition you guys can probably shed 
some light on it for me.
    Senator Begich. I have a feeling the Chairman and I will be 
happy to assist you in that effort, because I think in a lot of 
ways--and I mean it in respect to my colleagues here in the 
lower 48--that rural here is so much different. You can drive 
everywhere. You can drive down the street. Maybe the street is 
50 miles away to the grocery store. In Alaska you cannot. If 
you are in Adak, it is 1,200 to the hub by air. There is no 
road. And so we have a different ability to deliver education, 
and our competition is not--I mean, if we are competing against 
the L.A.s and the Chicagos and the Seattles, we will not win 
that battle for dollars, because you will look at it from a 
cost per pupil, and you will see that you can hit Chicago with 
so many thousands of students that will hit. And yet in a 
village of maybe 50 kids, this is their lifeline to the future.
    Secretary Duncan. Yes. So to me it is not--we were trying 
to make very significant strides and improvements in, you know, 
Race to the Top and Investment Innovation Fund, but you hit it 
earlier. I think so much of No Child Left Behind was broken for 
the country, but particularly broken in rural and remote 
communities, and I think we can fix the law this sessions. We 
want to fix it before we go back to school this fall. We could 
fix it in a bipartisan way, and a huge part of our goal is, 
frankly, to shrink the Federal footprint, to give much more 
flexibility, hold folks accountable for results, but to give 
them room to move.
    One of the biggest complaints I've heard in rural America 
is that you have a teacher teaching multiple subjects.
    Senator Begich. That is right.
    Secretary Duncan. And they are basically labeled not highly 
qualified, and they are often extraordinary.
    Senator Begich. Which is amazing, because in Alaska these 
teachers are doing amazing things in multiple disciplines, and 
yet because of the technical language, they are not highly 
qualified. And we would consider them the best of the highly 
qualified.
    Secretary Duncan. It makes no sense, and we are desperately 
trying to keep great teachers in underserved communities, be 
they rural, remote, or inner city. And so we have to remove 
that, moving from a paper-based definition of qualifications to 
effectiveness as the way to go. And so there are a number of 
common-sense fixes that we can put in place that will remove 
the perverse incentives and put in place the right incentives.
    Senator Begich. And, again, on Race to the Top as well as--
and I heard you say, and I want to make sure we are clear--on 
I3 also, programming to figure out how we do a rural set-aside 
that clearly recognizes the value and how we educate within 
those communities.
    Secretary Duncan. Absolutely.
    Senator Begich. OK. The other piece in rural communities--
and especially, again, I will use Alaska, obviously, as an 
example--some of the requirements require matches by local 
communities. In some of these communities, they have no 
property tax base. We are in some cases subsistence hunters, 
and their food and their belongings are caught off the land.
    Will you be flexible to help us address those kind of 
communities that just do not have--it is hard to believe in 
this country that there are cashless in some cases or limited 
cash communities, and they are basically in Alaska.
    Secretary Duncan. We will absolutely be flexible. So the 
short answer is yes. But I would also say one of the things we 
found as we got into this work--and you guys know this 
intimately--is we did not have enough foundations playing in 
the rural community. And so, frankly, one thing I am really 
proud of is we have encouraged a number of foundations to step 
up and be much more generous and targeted in rural areas. So we 
are helping to drive that market and increase investment in 
rural communities. We are going to continue to drive it. But 
will we be flexible and thoughtful on how we do this? Yes.
    Senator Begich. OK.
    Secretary Duncan. My fallback is just not to do nothing. My 
primary focus is to get many more of these foundations to play 
and create and reward great work in rural communities.
    Senator Begich. Right, we would love it. We do not have a 
Microsoft in Hooper Bay, but we would love an opportunity----
    Secretary Duncan. We can talk about it. We have a number of 
foundations that have increased their commitments, thanks, 
frankly, to us working with them.
    Senator Begich. Let me go to one other quick one here, and 
that is the $350 million to the Early Learning Challenge Fund. 
You and I actually had a conversation on the plane--you may 
remember this--about Head Start and how that plays a 
significant role in rural Alaska. It is truly--an educator in 
rural Alaska can point out a kid who has had Head Start in the 
third grade and say they had it. They do not even have to have 
their paperwork to show it. They can tell.
    So how will you ensure that the Head Start program that is 
in Health and Human Services and your Early Learning Challenge 
Fund will not create a conflict and run very seamlessly, 
especially, again, in rural communities that are critical for 
Head Start programs to be successful?
    Secretary Duncan. So hold us absolutely accountable for 
that, but, frankly, I am absolutely confident we can do that. 
Kathleen Sebelius has been an amazing partner. We have done a 
lot of work together on a lot of issues. We want to do two 
things. HHS is, you know, the big player here. We think we need 
to be an investor. We think we do not need another study, that 
if we can get our babies off to a great start in live, lots of 
these problems we talk about disappear. And----
    Senator Begich. Very good. My time is up. If I can just ask 
a yes or no question. When you say college, do you mean 
college/career education, voc. ed. technical schools?
    Secretary Duncan. Yes.
    Senator Begich. Yes. I just want to make sure.
    Secretary Duncan. And community colleges.
    Senator Begich. Community colleges. The broad array of 
higher education.
    Secretary Duncan. I always say 4-year, 2-year, trade, 
technical, vocational.
    Senator Begich. OK. Thank you.
    Chairman Conrad. Senator Thune.
    Senator Thune. Thank you, Mr. Chairman.
    Mr. Secretary, thank you for being with us today, and I, 
too, appreciate your service. It is a tough job, and most of 
us, there are lots of things where I do not agree with the 
current administration and some of the things that you are 
doing, and education is actually one of the areas that I do 
support some of the things that are being done.
    I do want to raise a concern that I have about some of the 
things that are happening with regard to the budget, and one 
has to do with this move toward competitive grant programs, 
which I know are probably good for urban areas, but formula 
funding is something that traditionally has benefited the more 
rural areas of the country. And it seems to me at least--and I 
am somebody who comes from an education family as well. My dad 
was the school teacher, he was the athletic director, he was 
the coach, and he was the bus driver. And so most cases I know 
that these are not people who have a lot of time to write grant 
proposals and grant requests. And that is a concern I hear 
repeatedly from school districts in rural places like South 
Dakota, that this process of distribution of funds, which 
traditionally was done through formulas, is now shifting more 
toward competitive grants. And these smallest school districts 
just cannot do that. They do not have the resources to write 
grant requests and proposals and that sort of thing.
    So I am wondering how you suggest that we deal with the 
issue of making sure that rural school districts do not get 
left out of this.
    Secretary Duncan. That is a great question. It is one we 
have spent a lot of time wrestling and debating, so let me just 
give you the facts: 84 percent of our proposed budget continues 
to be formula-based, so there is a perception out there that we 
are moving everything to competitive. It is actually 16 percent 
tops. So 84 percent, again, we are asking for increased formula 
funding, IDEA, Title I. We are maintaining the REAP funding, 
which is really important. So a couple other things. So that is 
just the facts. There is not some massive shift there. We do 
think it is important to reward excellence in the competitions 
that we talked about. We are going to do a rural set-aside to 
make sure those districts can play.
    A couple other areas. We think by consolidating 38 programs 
into 11 we make it much easier for rural communities to focus 
on their children and not focus on us here in Washington and 
trying to make, you know, ourselves a much better partner, much 
more flexibility.
    The Pell grant increases that we are asking for, about 38 
percent of our young people go to community colleges from rural 
areas. North Dakota specifically, recipients are up 58 percent, 
so we are really trying to create access in communities that 
have not had that historically. We think it is very important.
    Turning Around Schools, it is interesting, people think 
Turning Around Schools is an urban issue. About half are urban, 
about 20 percent are suburban, about 30 percent of these 
dropout factories are rural. So we are trying to invest in some 
very different ways in the rural community. We are trying to 
create more access through the competitions. Please be assured 
that the vast majority of our money always has been and always 
will continue to be formula-based. But where we have 
competitions, we are now putting a rural set-aside, a carveout. 
And so we think folks can play. And we are not looking for the 
fancy PowerPoint presentation. We are looking for folks for a 
vision of how we drive student achievement and get better, and 
that is what we want to reward.
    Senator Thune. The other question I have--and this pertains 
not just to rural school districts, but obviously federally 
impacted lands, which we have a lot of as well. Since 1950, the 
Federal Government has provided financial assistance to school 
districts that are impacted by Federal land or federally 
connected students within their district. And my State has 38 
such districts that rely heavily upon impact aid payments.
    In the past few years, there has been an increased number 
of impact aid school districts that have contacted me for 
assistance in reaching out to the Department of Education to 
ask for the Department to finalize payments for the previous 
fiscal years. For example, in May of 2010, a school district 
still had not received any payments from the Department of 
Education going back to June of 2008. So I am wondering what 
you can do to help ensure that the Department provides payments 
to school districts in a more timely way. There ought to be a 
better audit process.
    Secretary Duncan. No question. And it is one that our 
staff, frankly, has worked very hard on. Just to give you--it 
goes back even further. Six months ago, there were 4,000 
outstanding final payments for fiscal years 2006, 2007, and 
2008--sorry. Six months there were 4,000 outstanding final 
payments; all of those have been made, every single one. And so 
we are working very hard to fix the backlog from the previous 
administration and expedite these things. But that is 4,000 off 
the books in the past 6 months.
    Senator Thune. All right. As you know, much of Indian 
country is faced with unacceptable levels of suicide and, 
unfortunately, tribal youth are especially affected, making up 
64 percent of those suicides. So I guess my question has to do 
with the Native American students attend primarily BIE, and BIE 
and tribally run schools, and 93 percent of all Native American 
youth nationwide do attend public schools. So I am wondering 
what steps, if any, the Department is taking to work with the 
IHS and/or the BIE to help coordinate an effective response to 
what is really a terrible crisis, and particularly in Indian 
country.
    Secretary Duncan. It is staggering. In a couple days, you 
know, you visit lots of places. The day in Hooper Bay is one I 
will never forget, and in Montana, Northern Cheyenne country. 
You know, I thought I knew poverty in the south and west sides 
of Chicago, and in that community there is a 70-percent 
unemployment rate. The high school I went to had had one child 
in 6 years go to college. So it was a level of challenges that 
I had never seen before in my life. And it was a pretty 
profound experience.
    So we are working very, very closely with the BIE. There is 
a new leader there who we have a lot of confidence in. Our team 
has done--we have all been, you know, affected personally, 
quite frankly, by this. We have had many of our team members, 
including our general counsel, spend a lot of time on tribal 
consultations and trying to get out in the community and listen 
and hear and figure out how we can be a better partner.
    One of our winners in the Promise Neighborhoods Initiative, 
which is rallying around entire communities, was a Native 
American community, and as you know much better than I, there 
are no easy answers here. But please know we are trying to be 
the best partner we can. We are trying to invest. We are trying 
to travel the country and get out there and do everything we 
can to get much better outcomes for children who desperately 
need those opportunities.
    Senator Thune. One final quick question. My time is running 
out here. The Department had a series of proposed changes with 
regard to the way that Christian colleges--you probably heard 
this, a concern about some regulations that were moving forward 
that might affect the accreditation process, and particularly 
impacting Christian religious universities. And I am wondering 
if that is something that you are continuing to move forward 
with or what accommodation you are making for some of those 
institutions.
    Secretary Duncan. I do not know the details on that one, so 
I will have to get back to you on that.
    Senator Thune. Good. I would be interested in following up 
with you on that, because we had some correspondence with your 
Department on that.
    Secretary Duncan. Yes, sir.
    Senator Thune. Thanks.
    [The information referred to follows:]



    
    Chairman Conrad. Senator Sanders.
    Senator Sanders. Thank you very much, Mr. Chairman, and 
thank you, Mr. Secretary, for being with us.
    Let me begin, Mr. Secretary, picking up on a point that 
Senator Johnson raised, because I was not quite sure about your 
answer. As I understand it, the Governor of Wisconsin now is 
trying to end collective bargaining for State employees in that 
State, including teachers. Do you believe unequivocally that 
teachers have a right to engage in collective bargaining?
    Secretary Duncan. Not only do I believe it, I believe that 
collective bargaining can be a tool for improving student 
achievement and is a tool for improving achievement in a number 
of districts.
    Senator Sanders. And I agree with you, but I want to just 
be very clear, because I was not sure about your answer to the 
Senator. You would disagree, then, with what the Governor of 
Wisconsin is trying to do?
    Secretary Duncan. I have been very clear on that. I have 
had great conversations with him, and I have been very public 
on it, so yes.
    Senator Sanders. Could you be public with it right now? You 
disagree with what the Governor of Wisconsin is trying to do.
    Secretary Duncan. Yes.
    Senator Sanders. Yes?
    Secretary Duncan. Yes. Let me just take a moment, if you 
want to, on it.
    Senator Sanders. Are you going to be very clear by being 
unclear?
    Secretary Duncan. No, sir. What he asked from the teachers 
union was to have them help on the pension costs and the health 
care costs.
    Senator Sanders. Yes. Collective bargaining is the issue I 
want to focus on.
    Secretary Duncan. They agreed to that, and I thought he had 
his chance to fix the budget hole there. So there is a 
different agenda there.
    Senator Sanders. So you believe that teachers and public 
employees have the right to engage in collective bargaining.
    Secretary Duncan. Absolutely.
    Senator Sanders. OK. Let me ask you this: We support the 
protection in the President's budget to protect the maximum 
Pell grant award at $5,500. However, I am deeply concerned that 
the proposed budget eliminates the availability of a second 
Pell grant in the same award year.
    Now, you know and I know, because I get letters to this 
effect every week, that there are millions of students today 
who are graduating college or graduate school very deeply in 
debt, and they are working at low-wage jobs because of the 
nature of the economy, trying to pay off their debt, and they 
are falling further and further behind.
    Why did you propose the elimination of that second Pell 
grant when it would do so much harm to so many students?
    Secretary Duncan. So I really appreciate your concern, and 
these are very tough and hard and painful cuts. We did that. We 
had a $20 billion Pell shortfall to fill. We had to make some 
hard decisions. Our highest priority was maintaining the $5,550 
a year for every single student, and to close that $20 billion 
hole, by eliminating the second Pell that saves about $7.5 
billion. So that is not something we do easily or lightly or 
enjoy doing, but given the magnitude of the Pell shortfall, we 
felt we----
    Senator Sanders. Well, let me ask you this question. I know 
this is a little bit beyond your pay grade, but do you think it 
makes more sense to give tax breaks to billionaires or to make 
sure that our young people can afford to go to college?
    Secretary Duncan. Well, I am not the economist in the room 
here, but I will say that the most important investment we can 
make in this country is to make sure children have a great pre-
K-12 education so they can graduate from college and be 
competitive in a globally based economy. The most important 
investment our country can make.
    Senator Sanders. Earlier on, I think both Senator Conrad 
and Senator Sessions and you yourself raised some interesting 
questions making the point that in a sense education goes 
beyond education. These are cultural issues. It is more than 
what takes place in the classroom.
    One of the concerns that I have had for a long time is that 
the United States has by far the highest rate of childhood 
poverty in the industrialized world. Many countries in Europe 
and Scandinavia have 3, 4, 5 percent. We have 20 percent. So 
when you appropriately talk about so many young people dropping 
out of high school and ending up with nowhere to go, do you 
think that that relates to the fact that so many of our 
children start off in poverty, A; and, B, comment, if you would 
like, about how our early childhood education system, our child 
care system, compares with other countries. Do you think that 
if a kid starts off in poverty, if there is no decent quality 
child care available, how does that impact the likelihood of 
that kid to drop out?
    Third, our Republican friends are proposing massive 
cutbacks in Head Start. How do you think that will impact 
dropout rates?
    Secretary Duncan. So I do not think we need another study 
to tell us how critically important early childhood programs 
are for closing achievement gaps, leveling the playing field, 
and giving children from poverty, children from disadvantaged 
communities, a chance to be successful academically. We do not 
need another study. We just had another one, though, from 
Vanderbilt University in the past week where the data was 
absolutely compelling on the huge impact that high-quality 
early childhood programs have.
    When children enter kindergarten, some of whom are reading 
fluently, some of whom do not know the front of a book from the 
back of a book, some of whom do not know their names, they have 
been called a nickname all their life. That is an 
extraordinarily challenging task for the best of kindergarten 
teachers in the world to teach that wide disparity. So----
    Senator Sanders. Would you agree--again, and there are a 
dozen studies to make the point.
    Secretary Duncan. Hundreds.
    Senator Sanders. I am asking a question that I am sure that 
you agree with, that if kids enter the school system 
unprepared, their likelihood of dropping out is going to be 
much, much greater?
    Secretary Duncan. Unquestionably. When I met with the NGA 
this weekend, we are all facing tough budget decisions, and I 
challenged every single Governor in tough budget times not to 
scale back on early childhood education.
    Senator Sanders. But yet as a Nation--I am sorry that 
Senator Cornyn is not here. But I read things. My understanding 
is that in the State of Texas, for example, which generally has 
scores not among the highest in the country, they are looking 
at laying off something like 100,000 educators. And that is 
just one State. In my State there has been pressure as well.
    You have described that our system is in a crisis. I think 
that is the word that you used. What do you think will happen 
if all over this country, in order to balance budgets while, 
again, we are providing huge tax breaks to billionaires, while 
we lose $100 billion every single year because corporations and 
the wealthy stash their money in tax havens in the Cayman 
Islands and in Bermuda, an issue that the Chairman of this 
Committee has talked about on many occasions, and yet we find 
ourselves in a difficult budget situation so that States 
collectively will be laying off hundreds and hundreds of 
thousands of teachers.
    Now, you just said--and everybody seems to agree--we have 
an educational crisis. Do you think the laying off of hundreds 
of thousands of educators is going to help us address the 
educational crisis?
    Secretary Duncan. Of course not.
    Senator Sanders. Is it adding to the crisis?
    Secretary Duncan. Anytime we do not--again, I am not saying 
investment status quo. Anytime we cut back investments in this 
new vision of education, that hurts our country. I would just 
go right to the chart that the chairman began with. The cost of 
the dropout crisis, the cost of the achievement gap, is the 
economic cost of a permanent economic recession on this 
country. That is the cost that if we had the will and the 
courage, we could solve and put our country in a much, much 
better spot than we are today.
    Senator Sanders. I am running out of time. Let me ask you 
my last question. In Burlington, Vermont, where I live, we have 
a school which has a whole lot of immigrant kids. It is in the 
lowest-income neighborhood in the city. The teacher, because of 
rules, as you well know, related to No Child Left Behind, was 
fired because the kids did not perform particularly well on 
some of the tests. And yet most of the people in that community 
see this as an outstanding school where the teachers and 
principal did an extraordinary job.
    Do you think it makes sense to judge kids who are from 
immigrant families, some of whose families do not even speak 
English, the same way as you would judge an upper-middle-class 
family who were obviously fluent in English? Does that make 
sense to you?
    Secretary Duncan. No, and whether it is a child who does 
not speak English or a child with severe special needs who 
cannot comprehend a test, to have them take the same 
evaluation, the same, you know, rules as a child who has been 
in the country all their life and--no, it does not make sense.
    Senator Sanders. But why do we do it?
    Secretary Duncan. Well, we want to fix the No Child Left 
Behind law and do it together this year.
    Senator Sanders. All right. Well, I just want you to know 
that in a school in Burlington, Vermont, which many people see 
as an outstanding success because of the work of the principal, 
that principal was fired.
    Senator Sanders. Thank you, Mr. Chairman.
    Secretary Duncan. A big problem is the lack of focus on 
growth and gain. We need to be looking at improvements for 
every single child, every child.
    Chairman Conrad. Let me just say, there was a screw-up on 
the clock, so I gave you some additional time to make up for 
the screw-up on the clock, for other colleagues who are 
wondering. We want to be fair when we make a mistake and that 
it is not coming out of your time.
    Senator Merkley.
    Senator Merkley. Thank you, Mr. Chairman, and thank you, 
Mr. Secretary, for your testimony.
    I wanted to echo Senator Thune's concerns about the 
increase in competitive grants. I can tell you, we have 200 
school districts in Oregon. Most of them are very small. They 
do not have grant writers. There is a systemic disadvantage to 
small rural school districts that I do not think the 
administration has taken fully into account. I just want to 
share with you that, as I do my every county townhalls, it 
comes up time and time again that these school districts, they 
cannot even track the opportunities available let alone apply 
for them. And so we have to consider that in the formulation of 
fairness to school children all over this country.
    Secretary Duncan. Yes, sir.
    Senator Merkley. Second, I wanted to have you talk a little 
bit more about Pell grants. I thought college was 
extraordinarily expensive when I went off to college in 1974. 
Now as a parent with a freshman in high school and an eighth-
grader, and I am looking at the cost of college as it compares 
to the average income of working Americans, what has 
essentially happened since 1974 is that, inflation adjusted, 
the wages of working Americans have stayed flat for 35 years. 
Inflation adjusted, the cost of college has not stayed flat for 
5 years. This is a huge, huge challenge, and the result of that 
challenge is that we are becoming the first generation of 
parents whose children are getting less education than we got. 
Extraordinary community failure as a Nation, especially as you 
noted in a world economy, a world education-based economy, 
knowledge economy. Even the Pell grants we have in this budget 
I do not think quite level out the playing field when one 
compares where we were two decades ago or three decades ago. 
Just your thoughts about that growing gap and the ability of 
working families to afford college.
    Secretary Duncan. So it is real. Again, that is why I am 
proud that we have had the greatest increase in Pell grants or, 
you know, college funding and grants since the BI bill. But is 
there more unmet need out there? Yes. There are studies that 
show that of those who drop out of college, 52 percent, the 
majority drop out due to financial reasons. Again, if we think 
we have to educate our way to a better economy, we have to 
continue to invest there. And I think we have to continue to 
find those universities that are holding down costs and being 
thoughtful about how they provide value for the cost, for the 
expense, and shine a spotlight there, and continue to use the 
marketplace to drive students and families to those places who 
get this and get the stress that families are under today.
    Senator Merkley. When I look at the modest amount we are 
investing in our domestic infrastructure, physical 
infrastructure, and then I look at the failure to keep college 
affordable, do we have a major challenge as a Nation in which 
we are spending too much money on foreign wars and foreign 
bases rather than on domestic infrastructure and domestic 
education?
    Secretary Duncan. Well, obviously, again, I just think we 
have to educate our way to a better economy. We have to 
continue to invest in education. And whether it is the Pell 
grants, whether it is investments in community colleges--which 
have been, I think, an unpolished gem along the education 
continuum. We are trying to put a huge amount of resources 
there. The only way our country is going to have a strong and 
vibrant economy long term is if we have many more folks 
successful postsecondary.
    And to Senator Begich's point, that does not mean just 4--
it is 4 years, but it is 2 years, it is trade, technical, 
vocational training. That has to be the goal for every single 
young person in our country.
    Senator Merkley. All points that I agree with, but it does 
not answer the question. We all keep talking about these same 
goals, the importance of education, yet we seem to be slipping 
further behind. Are we as a Nation spending too much on foreign 
wars and foreign bases rather than on education and 
infrastructure?
    Secretary Duncan. Well, again, I am not the Secretary of 
State, but would I love to see us continue to invest more in 
education going forward? I think as a country we have to, and 
the President passionately believes it.
    Senator Merkley. OK. I will just note that I think until we 
are ready to have a serious conversation, we are all just 
repeating the same things, which is education matters, but we 
are not really getting to the heart of the problem. One example 
of that would be the President's proposed investment in 
training STEM teachers, 100,000 over the next 10 years. Do you 
have any concept of how many math, engineering, technology 
science teachers are being let go in the current State 
shortfalls across this Nation over the next 2 years?
    Secretary Duncan. I do not know the breakdown for math and 
science teachers specifically. I do not know that number.
    Senator Merkley. I would be very interested in that because 
it is very frustrating right now. We have a $3 billion 
shortfall in Oregon. It is not unlike many other States. We are 
in better shape than some and in worse shape than others. But 
while we are talking as a Nation about the importance of 
education, the reality on the ground is that there are going to 
be massive cuts in our public education system. It so happens 
my children are in the same school district that I went to from 
third grade through twelfth, and, therefore, it is a 40-year 
gap in between, but it gives me a chance to kind of compare 
apples to apples over the duration. The classrooms are much 
larger. The fees for kids to participate in extracurricular 
activities that keep them in the school are much higher. The 
range and diversity of activities smaller. In other words, we 
are not providing the same education to our children that our 
parents provided to us.
    And so it is fabulous to note that we need a lot more 
teachers in education--a lot more teachers in science and 
technology and engineering and mathematics. But if we do not 
provide enough resources to actually be funding K-12 schools 
across this country, then we are failing, and that is my 
concern. And I think right now we are losing the teachers. We 
are not gaining teachers. We are increasing classroom size, not 
shrinking it. We are losing school days. It is becoming routine 
for school districts to think about doing a 4-day week than a 
5-day week. Isn't that kind of a sign of something massively 
wrong in our national education system?
    Secretary Duncan. No question. So obviously these are 
horrendously tough budget times, but, you know, reducing 
instructional time might be the worst choice you could make in 
tough budget times. And so, you know, how Governors and school 
boards and superintendents make these tough choices in tough 
budget times says a lot about leadership, and where folks are 
eliminating time or eliminating days of the week, I cannot 
think of a worse decision to make in that tough budget time.
    Senator Merkley. My time is up, so I will followup on 
Perkins grants. Thank you.
    Chairman Conrad. Thank you, Senator.
    I want to go back to something Senator Johnson mentioned 
because as I evaluate what is happening, one of the things that 
really jumps out at you is this matter of college tuition, and 
I have not seen the exact number that Senator Johnson used. I 
think we are talking about a 400-percent increase in college 
tuition. Maybe, Senator Johnson, you would want to repeat what 
that number was.
    Senator Johnson. This is a Heritage Foundation study, and 
since 1982, college tuition has increased 439 percent.
    Chairman Conrad. And then you had some comparables for 
health care, which was 250 percent or----
    Senator Johnson. Right. I will give you the study. It is 
250 percent for health care and 105 percent for just general 
inflation.
    Chairman Conrad. You know, I tell you, my grandson is about 
to go to college, so he has been going to schools around the 
country, and it is stunning. My daughter went to an outstanding 
university. I did. I look at what has happened to college 
tuition, and I am not certain how it all works, because the 
stated college tuition is very high, and then they have 
financial aid packages, and people get dramatic reductions 
based on the package that they might qualify for.
    Now, obviously, a high-income family is not going to 
qualify for anything, and that is fine. I do not argue with 
that.
    Has the Department done an analysis of college tuition over 
this last 20 years? This study is from 1982, as I understand 
it, so that--so it is comparing--so it is going back to the 
1980s. I am just interested, has the Department done an 
analysis of college tuition? And what are the real increases 
when financial aid packages are taken into account? What are 
the real increases that we are seeing? Has the Department done 
that kind of analysis?
    Secretary Duncan. I am sure we have. If we have not, it 
would not be hard to do. So you are looking for the net number. 
I do not know that off the top of my head.
    Chairman Conrad. Yes, because one thing I have seen as we 
go through this with our grandson is the stated tuition number, 
and then you have these financial packages, I would be 
interested in piercing the veil here and trying to understand 
what has really happened.
    Secretary Duncan. I think the Senator's basic premise that 
these costs have gone up far faster than inflation, I think he 
is absolutely correct.
    Chairman Conrad. I agree with that as well. That is what my 
observation would be. But I really want to understand the full 
effect, not just the stated tuition, but when you take into 
account the financial packages, what has happened? And then 
why? Why has this--you know, it is not unusual now to see 
tuition $40,000, $50,000 a year.
    Secretary Duncan. We can do some work on that for you and 
get you what we do----
    Chairman Conrad. I think it would be very helpful to the 
Committee if the Department were able to do that.
    Chairman Conrad. Now I want to turn just very quickly-
because I have to be out of here a few minutes before noon, and 
I want to give Senator Sessions another chance as well. I want 
to go back to this question which I did not raise in my time, 
but you and I have had an exchange. I have written you an 
extensive letter that I went over in great detail the education 
community back home: dissatisfaction with No Child Left Behind, 
which in my State is intense; a very strong feeling that No 
Child Left Behind_this is not your responsibility. This came in 
a previous administration, a previous Congress. But what do we 
do going forward to correct it? Because the education community 
in my State--and I mean on every level; I am talking teachers, 
administrators, school board members--tell me the thing just 
does not relate to rural areas like the one I represent.
    Secretary Duncan. Rural, urban, suburban--I have heard that 
everywhere I go. We want to fix the law. Again, we want to fix 
it before the August recess so we go back in the school year 
with a better law. We can only fix and only want to work in a 
bipartisan way to do that. We want a law that is fair, that is 
flexible and much more focused.
    Let me just tell you quickly a couple things I think are 
wrong with the current law that with a common-sense approach we 
can fix.
    As I said earlier, the current law is far too punitive. 
There are many, many ways to fail. The only reward for success 
is you are not labeled a failure.
    It is very prescriptive, very top-down from Washington. I 
always tell the story that I almost had to sue our Department 
of Education when I ran the Chicago Public Schools for the 
right to tutor my children after school. I had tens of 
thousands of disadvantaged children who wanted to work harder, 
wanted to go to school, and we got in a pitch battle. I won. 
But why did I have to go to war with the Federal Government to 
tutor my children after school?
    It led--I think this is unintentional, but it absolutely 
led to a dumbing down of standards, which has huge 
ramifications, and it led to a narrowing of the curriculum.
    So how do we fix all those things? We have to reward 
success, reward excellence, great teachers, great principals, 
great schools, districts, States, beating the odds. I went to 
school in your State, George Hall in Mobile, Alabama, 
historically struggling school. Amazing job. It shows what is 
possible. Where we see excellence, we have to shine a 
spotlight, learn from it, encourage it, incentivize it, let 
folks know what is possible out there.
    We have to look at growth and gain rather than absolute 
test scores. How much are we improving? How much are we getting 
better? We need every child, you know, students with 
disabilities, English language learners, held to the same high 
standards. We want to know how much are they growing each year.
    Chairman Conrad. Let me stop you on that point because it 
is one of the things that has been the most--to me it is 
utterly bizarre. I do not understand why a measure of success 
is comparing one third grade to another third grade. I always 
say my brother's third grade was not nearly as bright as mine, 
so how you can compare the two--that is not quite true. The 
reverse is true.
    But let me just say this: I can understand if we are 
measuring a student's progress, if we are measuring the 
progress of an individual class. That makes sense to me. But 
comparing one third grade against another third grade to judge 
whether or not the school is performing to me is bizarre.
    Secretary Duncan. I have not met a teacher or a principal--
and I have been to hundreds and hundreds of schools--who are 
afraid of accountability. They just want it to be fair. They 
want a level playing field. If we are measuring growth and 
gain, how much a student is improving each year, you know, 
holding teachers, schools, districts, States accountable, look 
at who is raising the bar and who is not, universal support. 
Raising standards, 41 States are leading the charge, so this is 
a game changer. I cannot tell you how important this is to have 
college and career standards for every single child. Huge 
movement there. And then, finally--this is so important to me--
a well-rounded education.
    So, yes, reading and math are important, are fundamental, 
foundational. Science, social studies, dance, drama, art, 
music, foreign languages, physical education----
    Chairman Conrad. Physical education.
    Secretary Duncan. Hugely important. I was one of those 
young boys, I had to run around. I could not still all day. And 
so we can fix these things in a common-sense approach, fix it 
together, and I think help lead the country where we need to 
go. But if we do not, shame on us this year.
    Chairman Conrad. Thank you. Senator Sessions.
    Senator Sessions. Thank you.
    I was on the Education Committee when No Child Left Behind 
came up. I guess I was one of the last to agree to support it. 
I had some doubts about it, but I remember reporting at one of 
the Committee hearings that in Mobile, where George Hall is--it 
is probably one of those schools that the reporting 
requirements made them report that some of their schools were 
remarkably behind others. Some of the inner-city schools were 
just really not performing well.
    They met, they assigned new principals and new teachers, 
and those schools showed dramatic improvement. I told that 
story; Senator Kennedy just beamed because that was what he 
believed and that is what President Bush meant when he said 
there is a soft bigotry of low expectations. So I do not know 
what the answer is. It is a tough question to deal with.
    I talked to a very fine college president recently, and 
this is what he expressed to me, and I would ask you to think 
about this as you develop Pell grant policy. He said, you know, 
I think it is a mistake to eliminate summer school. He said, I 
think the problem is we have too many students taking 12 hours 
and taking 5 and 6 years to graduate. They are running up debt. 
They are running up burdens on their families when they could 
graduate in 4 years, and they should be graduating in 4 years. 
And if they need to do a summer school to get out sooner, they 
are out working, making money, and costing their family and 
themselves less debt. He said, So I would limit Pell grants to 
students who take 16 to 18 hours minimum and allow them to take 
summer school if that works.
    Have you thought about that? And would that be something 
you would consider?
    Secretary Duncan. It is a great question. This goes back to 
your basic premise of we just cannot keep spending. I would 
have loved to have kept the second Pell grant. That goes, 
again, from $5,500 a year to $11,000 for each student. With the 
second Pell grant, we honestly did not see a big jump in the 
number of students participating in summer school. It was like 
a 1-percent increase. So in an ideal world, Senator, I would 
loved to have maintained that. We just----
    Senator Sessions. Well, let us think about--that is 
probably correct. I do not want to focus on the summer school. 
I guess what I would focus on is, Should we emphasize getting 
students to finish their career in 4 years? Wouldn't it save 
the Government a lot of money and save them debt? And wouldn't 
it be better for America?
    Secretary Duncan. It is a really thoughtful question, and 
we need to work on that. So in an ideal world, absolutely we 
would have students graduating in 3 and 4 years. The reality, 
as you know, Senator, is that we have many folks who are not 18 
years old going to college but 28, 29, and they are working a 
full-time job and they are supporting a family. As much as I 
would desperately love them to finish in 4 years, 6 or 7 years 
might be more realistic.
    And so we want to speed up completion rates. We want to 
encourage that. I think your basic point, how do we encourage 
completion, is one we are focused on and we want to do more on. 
But the average age for a college student has gone up pretty 
significantly, and they are dealing with challenges going to 
college that--you know, I just had to go to school. I did not 
have children. I was 18. You have, you know, single moms, 28, 
working 40, 50 hours a week and taking classes at night. And we 
need----
    Senator Sessions. Well, that is certainly a mix of 
students. Could I ask you one more thing?
    Secretary Duncan. Yes, sir.
    Senator Sessions. My time is up. Do you agree with the 
recent report that indicates that our graduates who are 
graduating with 4-year degrees are less educated and proficient 
than they were I think 20 years ago, they said; that we are 
spending the money, and they are going through and getting 
their degrees, but they have not really accomplished as much 
learning, and is that a concern?
    Secretary Duncan. Yes. I have not seen that report, but 
that is an issue or a concern that has absolutely been raised 
to me. So I am not informed enough to know that.
    If I could add one final thing, Mr. Chairman, this question 
about college tuition. One thing we are coming out soon with--
and just stay tuned and we will get it to you--is a watchlist, 
and we will be reporting net tuition and ranking schools by 
sector. So, again, we are trying to use the bully pulpit to 
drive transparency, and we will get that to you shortly.
    Chairman Conrad. I would be very interested in that because 
there is something going on here. It is very evident to me that 
they have these tuitions, but then they have these financial 
packages, and so really, I would just like to know what is 
real.
    Senator Sessions. Could I offer one real explanation for 
that? I was on the board of trustees in my little liberal arts 
college. We had an outside speaker who said one of the factors 
in a college or university being rated by the evaluating is how 
much the tuition is. I was stunned at that. But it apparently 
is a very real fact.
    Chairman Conrad. We thank the Secretary. We thank all the 
colleagues who have participated today.
    The Committee will stand in adjournment. We have another 
hearing tomorrow with another Cabinet Secretary. I thank this 
Secretary for your first appearance here.
    Secretary Duncan. Thanks for the thoughtful questions.
    [Whereupon, at 12 p.m., the Committee was adjourned.]





 THE PRESIDENT'S FISCAL YEAR 2012 BUDGET REQUEST FOR THE DEPARTMENT OF 
                                 ENERGY

                              ----------                              


                        WEDNESDAY, MARCH 2, 2011

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Nelson, Stabenow, Cardin, 
Whitehouse, Merkley, Begich, Sessions, Enzi, Cornyn, Thune, 
Portman, and Johnson.
    Staff present: Mary Ann Naylor, Majority Staff Director; 
and Marcus Peacock, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The Committee will come to order.
    I would like to welcome everyone to the Senate Budget 
Committee this morning. Our witness today is Secretary of 
Energy Steven Chu, and our focus will be on the energy budget.
    Secretary Chu has done, in my judgment, an excellent job 
leading the Energy Department. We are very lucky to have 
someone of his capability and character leading that agency at 
this time, and we are pleased that he could join us and look 
forward to his testimony.
    I believe the two biggest challenges facing the country 
right now are the rising Federal debt and our dependence on 
foreign sources of energy. We simply will not be able to remain 
globally competitive if we fail to address both of these 
challenges. Our competitors in Asia and Europe are moving 
quickly to develop and adopt alternative and clean energy 
technologies. These technologies will be among the biggest 
industries in the world in the years ahead. We cannot afford to 
fall behind. The United States should be a leader, not a 
follower on energy issues.
    So even as we look to cut spending to bring down the 
deficit, something that we must do, we also need to ensure that 
energy remains a priority. We need to focus resources on energy 
programs that promote clean energy and energy efficiency and 
that encourage private sector innovation and the adoption of 
new technologies. And we need to ensure that every dollar we 
spend on energy is spent wisely.




    The fact is we are dangerously dependent on foreign oil. In 
1985, we imported only 27 percent of our petroleum. We now 
import over 60 percent. As a result, we are increasingly 
vulnerable to oil supply disruptions and instability in other 
parts of the world.
    The events of recent weeks have demonstrated just how much 
this dependence can impact our economy as turmoil in North 
Africa and the Middle East has led to a spike in gas prices and 
fluctuations in other markets.
    This addiction to foreign oil is also a threat to our 
national security. Many of the countries from which we import 
petroleum are unstable or in unfriendly regions, and many are 
becoming more unstable by the day or risk being affected by 
unrest in neighboring countries.




    Here is a list of the top ten countries exporting petroleum 
to the United States in 2010 and the number of barrels we 
import from those countries in a single day. You can see that 
we have large quantities of oil from countries like Saudi 
Arabia, Nigeria, Venezuela, Algeria, Iraq, Angola, and 
Colombia.




    At the same time we are losing ground in the race to 
develop the clean energy resources of the future. We are being 
left behind by countries like China and India. Here is a New 
York Times article from earlier this year about how the third 
largest manufacturer of solar panels in the United States has 
packed up, moved its operations, and hundreds of skilled jobs 
to China. According to the article, the company moved because 
China provided ``much higher government support.'' That is 
troubling. We need to keep those jobs here in America.




    This next chart helps put our energy funding in some 
perspective. It shows that funding for the Department of Energy 
represents a small fraction of Federal spending, only 2.4 
percent of the discretionary budget. Let me repeat that: 2.4 
percent. And roughly two-thirds of that is dedicated to nuclear 
weapons-related activities. So funding to promote and support 
new energy technologies represents a tiny fraction of the 
Federal budget.




    But we also spend between $8 and $10 billion a year on 
energy through the Tax Code by providing certain energy tax 
incentives and credits. The largest of these include oil and 
gas tax incentives, coal tax incentives, a renewable energy 
production tax credit, and an energy-efficient home 
improvements tax credit. Those are the four big expenditure 
items in the Tax Code.




    This is what the Obama administration has proposed in its 
budget for energy. Overall, the budget requests $29.5 billion 
in discretionary funding for the Department of Energy for 2012. 
This represents a $2.5 billion increase over the 2011 
continuing resolution level. Among other things, the 
President's budget would increase support for clean energy 
alternatives, such as solar, biomass, wind, and geothermal, 
advance development of low-carbon coal technologies, invest in 
the Nation's transmission infrastructure to improve energy 
efficiency and reliability--something that we clearly need--and 
increase support for basic research and science.




    The President's budget supports many of the same 
initiatives that I would like to see in the next energy bill. I 
believe the next energy bill needs to invest in clean sources 
of electricity, boost energy efficiency in homes and buildings, 
help reduce our dependence on foreign oil by develop advanced 
vehicles and promoting alternative fuels, and by increasing 
domestic oil and gas production.
    I believe we have to have a balanced plan. I was part of 
the group of ten--five Democrats, five Republicans--that 
proposed a far-reaching, balanced plan to reduce our dependence 
on foreign energy, including increasing domestic production of 
oil and gas, clean coal technology, advanced battery 
technology, a move to use natural gas in our bus and truck 
fleets, incentives for nuclear plants. We already have over a 
hundred nuclear plants in this country. We are going to have to 
have more if we are going to dramatically reduce our dependence 
on foreign energy. At least that is my belief.
    I look forward to working with my colleagues on both sides 
of the aisle on energy legislation this year. I believe it is 
absolutely a critical priority. It cannot be allowed to slip 
another year.
    With that, I will turn to Senator Sessions for his opening 
remarks, and then we look forward to hearing from Secretary 
Chu.

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. Thank you, Mr. Chairman, for your 
leadership and for this series of hearings. I think it has been 
very helpful to us.
    Secretary Chu, thank you for appearing as we continue to 
discuss the President's budget, and that is the fundamental 
question here. We all have views on energy policy, and I share 
many of your views and have supported a number of energy bills 
that Senator Conrad has referred to.
    You are a man of great accomplishment, and I have 
appreciated getting to know you. But you now hold the job of 
Secretary of Energy, and energy at an affordable price is 
essential to our economic future. It is not a theoretical or 
academic matter.
    Right now we are in the midst of a growing fiscal crisis, 
and it is crucially important that we have an honest 
conversation about the challenges we face. The President and 
his Budget Director tell us their budget plan does not add to 
the debt, that we are living within our means. But the plain 
fact is the budget doubles our gross national debt, never once 
produces an annual deficit of less than $600 billion in its 10 
years.
    The President's Education Secretary told us that the 
administration was making tough cuts and difficult choices to 
make our programs leaner and more productive, but the budget 
called for another 11-percent spike in education funding 
following a 68-percent increase over the last 3 years.
    Perhaps the most consistent spin is the repeated claim that 
every cent of new Government spending is an investment in our 
future. Just because you call something an investment does not 
make it so, certainly not a good investment. If the 
administration's argument held true, then even our Nation would 
be thoroughly enriched by this year's spending spree and the 
$1.65 trillion deficit.
    In reality, the most obvious result of what we have done is 
this massive surge in Federal spending is a crushing debt 
burden that has grown the Government at the expense of the 
private sector.
    So while your energy budget increases spending 
substantially, I reject the idea that you have made an 
investment necessarily in a better future. To the contrary, 
instead of wisely investing the taxpayers' money, the plan 
often would waste it. We have magnificent energy resources in 
this country from which we can create thousands of jobs without 
adding to the deficit. And yet these resources remain under 
lock and key. The American people expect fact- based budgeting 
that produces more energy, not locking it up. The simple fact 
is that the nearly 10 percent spending increase you have 
requested in your budget is not being used to produce larger 
sources of energy that would actually impact the American 
economy and reduce costs to the American taxpayer, but to chase 
after the vision of higher-cost sources of energy in the hopes 
that somehow we can bring those down, which has not been 
successful to date.
    As we contend with a sluggish economy and high 
unemployment, the plain truth is the actions of this 
administration are making things worse. The gas prices are 
rising rapidly, some say to that dangerous level of $4 a 
gallon. Yet the Interior Secretary issued only one single 
deepwater drilling permit this year, and only after being found 
in contempt of court for keeping the moratorium on.
    High gas prices exact a painful toll on American families 
and have historically done significant damage to the economy. 
The refusal to drill domestically has cost tens of thousands of 
high-paying jobs and billions of dollars in lost revenue to the 
Government, to the U.S. Treasury. Offshore drilling rigs are 
leaving for foreign shores and taking jobs with them. This 
administration has in the past 2 years revoked oil and gas 
leases in Utah, Colorado, and Wyoming, and shuttered the Gulf 
of Mexico. One of the major producers there just declared 
bankruptcy because they could not get permits to drill in the 
shallow waters where we have never had a serious problem.
    Permits to mine for coal in West Virginia have been 
withdrawn, and permitting delays have occurred elsewhere with 
little or no explanation.
    The failure of your Department to advance clean, reasonably 
priced nuclear power has hurt our Nation. We have talked about 
it. I believe we could have done more. We have to do more.
    An estimated 40 percent of our Nation's uranium deposits in 
Arizona were unilaterally locked up just 2 years ago, leaving 
us to import 90 percent of the uranium we use.
    And the Green Jobs Program, subsidized by the overburdened 
taxpayers, has never lived up to those promises that have been 
made about it. Indeed, the much ballyhooed state-subsidized 
solar panel plan in Massachusetts, I believe the one you 
referred to, failed in January, costing 800 jobs. It got $58 
million from the State.
    The experience in Spain cannot be ignored, and the 
Solyndra, the $535 million loan that the U.S. Government made, 
seems to be failing already.
    A recent study by Bjorn Lomborg's Copenhagen Consensus 
Center demonstrates that the higher prices and job losses that 
are the result of green energy policies significantly outweigh 
the jobs created. The reason is that costs of renewable energy 
are higher than standard forms of energy so that when they are 
mandated on the economy, it means more economic inefficiency, 
higher manufacturing costs, and less disposable income for the 
American citizens.
    So, in summary, Dr. Chu, the President's plan I think 
worsens a desperate fiscal circumstance and fails to invest by 
any honest measure in our Nation's real energy future, the 
challenges we have. America's vast proven energy reserves that 
we have are not being unlocked, and they are not being acted on 
apparently in the pursuit of a failed green jobs stimulus plan 
that has produced neither energy nor jobs. Instead, the 
President's plan will produce increased spending, increased 
taxes, increased regulation, increased reliance on foreign oil, 
and increased debt.
    So this plan is a non-starter, and the budget is a non- 
starter. We do not have the money. So we need to replace it 
with a plan that actually does invest in our future by 
producing more low-cost energy that makes it easier on American 
families, unlocking the vast energy sources that belong to the 
American people and keeping dollars and jobs in America, making 
us stronger and not weaker.
    So I look forward to working with you on this. I know you 
are a good man. I know you want to achieve some of these 
things, and maybe we will have some breakthroughs. I would 
support some research and development, but I do not support 
mandated energy programs that drive up the costs that are not 
yet competitive economically. We have gone too far in that 
direction.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you.
    Again, Mr. Secretary, welcome to the Budget Committee. We 
look forward to your testimony. Please proceed.

 STATEMENT OF THE HONORABLE STEVEN CHU, PH.D., SECRETARY, U.S. 
                       DEPARTMENT ENERGY

    Secretary Chu. Thank you, Chairman Conrad, Ranking Member 
Sessions, and members of the Committee. Thank you for the 
opportunity to appear before you today to discuss the 
President's fiscal year 2012 budget request for the Department 
of Energy.
    Before I begin my remarks, I want to take a moment to thank 
Chairman Conrad for his decades of public service and for his 
tireless efforts to address the big challenges facing our 
Nation, especially fiscal and energy issues.
    Chairman Conrad, I look forward to working with you over 
the next 2 years and wish you the best as you start a new 
chapter in your career.
    President Obama has laid out a plan for the United States 
to win the future by outinnovating, outeducating, outbuilding 
the rest of the world, while at the same addressing the 
deficit. Many countries are moving aggressively to lead in 
clean energy, and we must rev up the great American innovation 
machine to create jobs, win the clean energy race, and secure 
our future prosperity.
    To that end, President Obama has called for increased 
investments in clean energy research, development, and 
deployment. In addition, he has proposed a bold but achievable 
goal of generating 80 percent of America's electricity from 
clean sources by 2035.
    A clean energy standard will provide a clear, long-term 
signal to industry to bring capital off the sidelines. It will 
grow the domestic market for clean energy, creating jobs, 
driving innovation, and enhancing national security. The most 
competitive clean energy sources will win in the marketplace. 
The Government does not need to pick favorites.
    The Department of Energy's fiscal year 2012 budget request 
of $29.5 billion supports the President's goals and strengthens 
the Nation's economy and security. Through programs to make 
homes and buildings more energy efficient, we will save money 
for families and businesses by saving energy. In addition, the 
budget supports the research, development, and deployment of 
renewable sources of energy; the modernization of the electric 
grid and the advancement of carbon capture and sequestration 
technologies; and it helps reduce our dependence on oil by 
developing the next generation of biofuels and accelerating 
electric vehicle research and deployment.
    We are also requesting a new credit subsidy which will 
support approximately $1 billion to $2 billion in loan 
guarantees for renewable energy and energy efficiency 
technologies, And we are requesting a credit subsidy for a 
Better Buildings Pilot Loan Guarantee Initiative.
    To jump-start the nuclear industry, the budget requests up 
to $36 billion in loan guarantee authority, while also 
investing in advanced nuclear technologies, including small 
modular reactors. To spur innovation, the President's budget 
invests in basic and applied research and keeps us on a path to 
doubling funding for key scientific agencies, including the 
Department's Office of Science.
    The budget invests $550 million in the Advanced Research 
Projects Agency for Energy, known as ARPA-E. The administration 
also seeks an additional $100 million for ARPA-E as part of the 
President's Wireless Innovation and Infrastructure Initiative. 
This investment will allow ARPA-E to continue promising early 
stage research projects that aim to deliver game-changing clean 
energy technologies. ARPA-E's projects are generating 
excitement both in the Department and in the private sector.
    For example, through a combined total of $24 million from 
ARPA-E, six companies in their first year have been able to 
advance their research efforts and go back to the private 
sector and show the potential viability of their cutting-edge 
research. This extremely valuable early support enabled these 
companies to achieve R&D milestones that in turn have attracted 
more than $100 million in private sector funds to the projects. 
This is precisely the innovation leverage that is needed to win 
the future.
    Another key piece of our research effort is the energy 
innovation hubs. Through the hubs, we are bringing together our 
Nation's top scientists and engineers to achieve similar game-
changing energy goals, but where a concentrated effort over a 
longer time horizon is needed to establish innovation 
leadership. The budget requests $146 million to support the 
three existing hubs and to establish three new hubs in areas of 
batteries, energy storage, smart grid technologies, systems, 
and critical materials. The energy innovation hubs were modeled 
after the Department's Bioenergy Institutes which have 
established an outstanding 3-year track record.
    Finally, the budget continues to support the Energy 
Frontier Research Centers, which are mostly university-led 
teams working to solve specific scientific problems that are 
blocking clean energy deployment and development. When you 
think of the EFRCs, think about a collaborative team of 
scientists, such as Watson and Crick unlocking the secrets of 
DNA. When you think of ARPA-E, think of the visionary risk 
takers launching new technologies and startup companies out of 
their garages. When you think of the hubs, think of large 
mission-oriented research efforts, such as the Manhattan 
Project, the development of radar at MIT's radiational 
laboratory during World War II, and the research in America's 
great industrial laboratories in their heyday.
    To reach our energy goals, we must take a portfolio 
approach to R&D, pursuing several research strategies that have 
proven to be successful in the past. But I want to be clear. 
This is not a kitchen-sink approach. This work is being 
coordinated and prioritized with a 360-degree view of how the 
pieces fit together. Taken together, these initiatives will 
help America lead in innovation.
    In addition to strengthening our economy, the budget 
request also strengthens our security by providing $11.8 
billion for the Department's National Nuclear Security 
Administration. The request of $7.6 billion for weapons 
activities provides a strong basis for transition to a smaller 
yet still safe, secure, and effective nuclear stockpile without 
additional nuclear testing. It also provides much needed 
resources to strengthen science, technology, and engineering 
capabilities, and to modernize the physical infrastructure of 
our nuclear security enterprise.
    To support the President's goal of securing all vulnerable 
nuclear materials around the world in 4 years, the budget 
invests $2.5 billion in the defense nuclear nonproliferation 
program. Through our investments we are laying the groundwork 
for the Nation's future prosperity and security. At the same 
time we are mindful of our responsibilities to the taxpayer.
    We are cutting back in multiple areas, including 
eliminating unnecessary fossil fuel subsidies. We are 
streamlining operations. We are making some tough choices, 
including freezing salaries and bonuses for hard-working 
national laboratory site and facilities management contractor 
employees.
    The United States faces a tough choice today. Will we lead 
in innovation and outcompete the rest of the world? Or will we 
fall behind? To lead the world in clean energy, we must act 
now. We cannot afford not to.
    Thank you, and I am now pleased to answer any questions you 
might have.
    [The prepared statement of Secretary Chu follows:]



    
    Chairman Conrad. Thank you for that testimony, Dr. Chu, and 
thank you for your taking on this assignment. You are a 
distinguished scientist with a remarkable record of 
accomplishment of your own.
    I would be most interested in what your vision is of what 
is most exciting on the technological front. As you look across 
the broad array of initiatives that are underway, both in your 
agency and in the private sector, what are the emerging 
technologies that you are most excited about in terms of an 
opportunity to dramatically reduce our dependence on foreign 
energy?
    Secretary Chu. Well, regarding foreign energy, I would say 
that in the recent 5 years especially, and even in the recent 2 
years, I have seen a quality of ideas and a passion for 
developing electric vehicles. We are beginning to market the 
first electric vehicles in the United States that have a 100-
mile range, but I see on the very close horizon, perhaps as 
short as 4 years from today, the testing of automobile 
batteries where people can drive perhaps 300 or 400 miles on a 
single charge, where the cost of those batteries can be reduced 
by as much as 70 percent, 60 percent. And the companies and 
countries that achieve those type of batteries--and this is 
close enough that you can really feel. It is not a pie-in-the-
sky dream of the future. Those companies and countries that can 
achieve those type of batteries will have a multi-multi-
billion-dollar market. And we really want the United States to 
be that country.
    We have invested in advanced battery manufacturing to 
deliver by 2014 half a million batteries. This is the first 
tangible thing that we can do to get us off our dependency on 
foreign oil.
    Chairman Conrad. And who is our toughest competition?
    Secretary Chu. I would say it is the Japanese, the Koreans, 
and soon the Chinese. This is actually a worldwide race to 
develop these batteries because it is not like it was 20 years 
ago where we would say, well, maybe we can do this. You know, 
as I said, the ideas that we are now investing in in the 
research labs and in agencies like ARPA-E and in the Department 
of Energy renewable energy and energy efficiency, they are 
really where we can bank on 50- percent improvement, a factor 
of two improvement in the next couple years. But to get to the 
next steps where it just becomes ubiquitous is very exciting to 
me. That is one of the things. I think that is going to come to 
pass very quickly.
    I think another thing that is not directly related to our 
dependence on foreign oil but is also very exciting is we see 
very rapid developments now in photovoltaics. For a long 
photovoltaics have been making good progress, but there is 
still--the energy created by photovoltaics is still too 
expensive, and there is no doubt about it.
    The industry game plan says certainly within the decade 
they think they can reduce those costs, the full costs, not 
only of the module but the insulation and everything, by 50 
percent.
    We started to engage in industry and said, OK, that is 
good, but if you reduce the costs by 75 percent, then you do 
not even think anymore. You put it up everywhere. And, again, 
you have, you know, a tens of billions of dollars world market, 
because at that point it becomes competitive with the lowest-
cost fossil fuel generation today.
    So if we can pull this off in 10 years, that would be 
amazing, and that would be something that would help the United 
States lead for decades and create prosperity at both home and 
abroad.
    So this is not energy for the sake of clean energy that 
would last forever on subsidy. We see a pathway now in some of 
these areas where within a short period of time it could be 
competitive without any subsidy, and that is very exciting.
    Chairman Conrad. Let me ask you, we have had a major effort 
underway by Boone Pickens to encourage the country to move 
toward the use of natural gas for bus and truck fleets, and I 
think that his advocacy has had a significant impact here in 
Congress.
    What is your assessment of the opportunity to encourage the 
use of natural gas in our large fleets?
    Secretary Chu. I think it is very promising, and we are 
looking--in fact, we are indeed supporting some of the pilot 
demonstrations of that. Boone Pickens was thinking that for 
long-haul trucks that would be very good.
    There is an infrastructure issue. We are looking into that. 
But on the near term, the short term, the medium term, we think 
that delivery vans in a centralized location where there is a 
centralized refueling is a no-brainer, and we have supported 
those demonstrations. UPS is looking very much at that as a way 
of fueling its delivery trucks. But, again, while UPS looks at 
natural gas delivery vans, which is, you know, very clean, and 
natural gas, because of the fracking technologies which, I 
might add, were first invested in at the Department of Energy 
in the early 1980s. As soon as industry picked it up by 1992, 
we got out of the game because Schlumberger picked it up by 
1991, and we handed it off to the private sector. That is 
exactly what we wanted to do. You do the initial research. You 
prove it. It gets commercial interest, and then you step back 
and let industry take over.
    So that is a very good story. We do not know whether it is 
going to be electric vehicles. FedEx is going to electric 
delivery vehicles. They are going to electric delivery vehicles 
because--it was a hard business decision. I had lunch with Fred 
Smith, the CEO of FedEx, and he said if you look just a few 
years into the future, we see only electric vehicles, a total 
life cycle cost of electric vehicles less than the cost of a 
diesel.
    So, again, nobody was saying that 5 or 10 years ago, and 
all of a sudden we are in this tipping point. Those are the 
things that really excite me. So we can really decrease our 
dependence on imported oil.
    Chairman Conrad. Let me ask you two other quick questions. 
First of all, clean coal technology. Look, coal is the basis 
for 50 percent of the electricity in the United States, or 
thereabouts. What do you see as encouraging developments on 
clean coal technology?
    Secretary Chu. Well, first, one of the most amazing 
encouraging developments is that countries all around the world 
have recognized this, most recently China. And although it is 
not widely known, two major utility companies in the United 
States, AEP and Duke, are now in agreements with two Chinese 
companies, Huaneng and ENN in China, to develop clean coal 
technologies. And, amazingly those pilot projects, co-supported 
by those four companies, are being done in China.
    Now, right now I would say that the clean coal technologies 
we now have are too expensive for large-scale deployment. And 
so we have put together a game plan. We co-chaired a clean coal 
commission that said that it is reasonable to expect by 2020, 
in 10 years' time, now 9 years' time, that one can begin to get 
the costs down so you can begin to have significant deployment. 
But to be fair, it now costs too much money.
    Now, we have looked very hard at all the research areas, 
both in proving in multiple sites that you can sequester safely 
and economically, but also the technologies for capturing the 
clean coal, lots of ideas that we think have great promise, but 
they have to be tested. This is research and development, and 
it is not ready for prime time where the American public could 
say, OK, we can deploy this.
    There is significant hope, I might say, that now we see 
countries all around the world realizing that this is a 
technological hurdle that you have to solve, and then also 
realizing the country or companies that first solve these 
technological things can sell worldwide. And I think that is, 
you know, why China is doing this.
    Chairman Conrad. OK. I have another question, but my time 
has expired. But I would really like to talk about nuclear 
power as well before we conclude this hearing.
    Senator Sessions.
    Senator Sessions. Thank you. Thank you.
    Secretary Chu, Admiral Mullen says our debt is the greatest 
threat to our national security. Do you agree with that?
    Secretary Chu. Whether it is the greatest or not, it is 
certainly up there. I think the debt, the national debt is 
something that we have to work hard to bring down.
    Senator Sessions. Well, you are asking for an additional 9 
percent increase for the Department of Energy, and this is the 
Budget Committee. Do you think that energy should be exempt 
from the tough choices that everyone says, including the 
President, that this nation must face on spending?
    Secretary Chu. I think the President has made some tough 
choices. As you know, this budget has put a freeze on non-
security discretionary spending and made a commitment to do 
this for the next 5 years. This stopping the increase is the 
beginning, and I think--but having done that, the President has 
said that if you look at what is going to drive, what is going 
to really be the engine of not only the far term, but the near-
term future prosperity in the United States and get Americans 
back to work and really guarantee that we will be as prosperous 
in the 21st century as we were in the 20th century, energy was 
seen as central to that.
    Senator Sessions. Well, Education was in yesterday with an 
11 percent increase. They think they are central. We will have 
Transportation in tomorrow and they are asking for a bigger 
increase than you are getting. The State Department has a huge 
increase. So at some point, we have to ask how we can keep this 
country on a sound fiscal path, and I believe we are going to 
have to ask you to do more with less, at least not the kind of 
increases that are being asked for.
    You know, this past week, I was in Winfield, Jemison, 
Sulligent, Parrish, Haleyville, Glen Allen, and Cullman. I 
would talk about the budget and great issues of war and peace 
and the question would go up almost every place, gas prices. 
This impacts people. It is real to people. I know you have 
great hopes about these alternative sources. I called you about 
ethanol, an idea in Alabama I thought was going to work, and 
now it collapsed. I see this one in Boston, the Solyndra plant, 
are not successful. We have to understand, I think, that just 
promising, promising does not mean it is going to necessarily 
happen.
    I know a lot of the focus on solar and wind is for 
electricity, but I do believe the biggest threat to our economy 
is the liquid fuel we are using to power our cars, 61 percent 
of which we are importing. I am willing to support and have 
supported spending on batteries and research, but I begin to 
wonder how much we can demand of the economy through forcing 
technologies that are not yet available, are not yet proven or 
effective. You have noticed that coal sequestration or carbon 
sequestration is just not feasible.
    What we know is that we are going to be importing a 
substantial amount of oil for some period of time. I know, 
Senator Conrad, in North Dakota, I think they have the lowest 
unemployment in the nation. They are producing a lot of oil and 
gas. He told me they needed more workers in the oil and gas 
field. Yet we have laid off people along the Gulf Coast. We are 
not producing in other areas. We are importing this oil now. 
People are even discussing selling off some of our Strategic 
Reserve because of the surge in prices.
    Do you not think, as a matter of national energy policy, we 
need to take more immediate actions to actually produce the oil 
and gas that we have?
    Secretary Chu. I agree with you that we, as part of a 
national plan to get off of foreign oil dependency, developing 
further sources of oil and gas in the United States as part of 
a plan, but it will take five, perhaps even 10 years from now 
to actually be producing this amount. But it is part of a 
coherent plan. And I agree with you that the $300 to $400 
billion we spend, where money is offshored to bring in oil, is 
a huge, a huge burden on the American people.
    Senator Sessions. Well, Reuters just had this article, 
``Deepwater Rigs Moved Out of the Gulf of Mexico.'' Diamond 
would move to Egypt. They would also move another rig to the 
Republic of Congo. Transocean was moving one to Nigeria. 
Another, Transocean said, is leaving for Egypt. INSCO said it 
would work off French Guyana. Pride International was removed 
to the Mediterranean Sea. Noble Corporation said that the Clyde 
Boudreaux rig would move to Brazil.
    Presumably, we are importing from Nigeria, Saudi Arabia, 
Brazil, Venezuela. We will be, instead of producing this in our 
own country, receiving royalties of billions of dollars from 
the production of that oil that goes to the Treasury, we will 
be importing that oil. Do you not feel like, that as Energy 
Secretary, you need to maybe call Secretary Salazar, our 
friend, and say, watch out what you are doing. We are not ready 
to produce batteries yet that are going to take over America.
    Secretary Chu. Well, at least you have the right Secretary. 
I think Secretary Salazar----
    Senator Sessions. You have his phone number, I am sure.
    Secretary Chu. Yes. I think Secretary Salazar wants to 
resume Gulf drilling and deep Gulf drilling. He feels compelled 
he needs to do it safely, and I, as during the oil spill, I 
will certainly avail myself and the Department in any way we 
can.
    But going back to the fundamental question, I think today's 
spike in oil prices is causing great concern, great hardship. 
The American people, we have a very delicate recovery going on 
and an increase in prices will make that vulnerable. And so we 
need both short-term and long-term plans going forward. And as 
I said, right now, advanced biofuels, I will tell you, is not 
quite ready for prime time, but I also----
    Senator Sessions. I had hoped that we would be further 
along----
    Secretary Chu. Yes.
    Senator Sessions [continuing]. And I shared that with you, 
but it just has not happened.
    Secretary Chu. That is true, but again, what is different 
in--you know, if you look back in the early 1980s versus now, 
it is a transformative difference in what is going on. In the 
last couple of years, again, the proof is going to be in the 
pudding, but already, people are beginning to pilot advanced 
biofuels where they think they can sell, for example, diesel at 
$4 a gallon. Now, that is still higher, but sell at a profit at 
$4 a gallon. You want to sell at a profit at $3 a gallon. But 
again, it is a little bit further off, perhaps, in batteries, 
but it is within grasp. Increased fuel economy, 
electrification, gas vehicles, gas-powered vehicles, all those 
things are part of the thing. A single--one single technology 
will not solve the problem, but also bearing in mind that we do 
have gas and oil reserves that we can simultaneously develop. 
All these things are needed.
    Senator Sessions. Well, we just need more energy at a 
reasonable cost, and I am afraid our policies seem to be 
focusing more on higher-cost energy and locking up the energy 
we have. We have to get away from that direction.
    Chairman Conrad. I thank the Senator.
    Senator Stabenow is next.
    Senator Stabenow. Thank you, Mr. Chairman and Secretary. 
Thank you very much for your leadership and vision about the 
future.
    Mr. Chairman, I think this is such an important debate and 
discussion, frankly, that we need to be having, I think, in a 
more extended way about what our energy policy is and how we 
get there.
    At the risk of plugging somebody's book, which I am going 
to do, Andrew Liveris, who wrote Make It In America, I would 
strongly encourage everyone to read this, my colleagues. He is 
the CEO of Dow Chemical Company and has many things I know 
colleagues on both sides of the aisle would agree with. What I 
think is most powerful about what he talks about, though, is 
the fact that energy drives the world, and in this, from his 
vantage point as someone who is in every country around the 
world, watching what Germany is doing--not exactly a low-wage 
country or low-tax country--and China and other places talked 
about, he is extremely concerned about the lack of focus in 
this country from an innovation and manufacturing standpoint.
    One of the things he says--I would just quote one thing he 
says--``It is ironic, energy independence is closer at hand 
than it could ever be in the age of oil, but America's policy 
inertia suggests that it seems willing to trade one form of 
dependency for another, to let other countries build the clean 
energy technologies that we will then buy. It is still within 
America's means to be a world leader in clean energy, but only 
if we wake up to what the rest of the world is doing and to 
what we must do.''
    I raise that because in the book, he really is talking 
about, and in conversations, many conversations I have had with 
him, about how we partner with American businesses like every 
other country is doing. Right now, our companies are competing 
with countries. When Germany or China or Japan or someone else 
says, come here, we will build the plant for you or provide you 
financing or pay for your R&D, we are at a significant 
disadvantage.
    And so I am reminded of what Japan did to help Toyota get a 
jump on us on batteries, by funding most of the R&D. We are now 
in a situation where by putting $2 billion into advanced 
battery innovation and manufacturing--$2 billion in this 
country--we have unleashed billions of dollars. Over 12 
companies in my State now, including Dow, are doing advanced 
batteries, and we are going--as I understand it, last year, the 
number was we manufactured 2 billion--or, excuse me, 2 percent 
of the world's batteries, and within 4 years, it is going to be 
40 percent.
    And so to our distinguished Ranking Member, I would say 
part of the way we get off of these high costs and so on in 
terms of oil going up is to really create some competition with 
other alternatives that are not pie in the sky. They are really 
happening now. We have the Chevy Volt and close to, what, 300 
miles on a gallon of gas because of extended range, and the 
Ford Focus, and, of course, Toyota has been there with the 
Prius, and we could go on and on. I mean, these are not 
technologies that are fringe anymore. They are technologies 
that are here.
    And Mr. Chairman, when you said that--we put up your chart 
about oil and gas subsidies, you know, we started oil and gas 
subsidies in 1916 and it made sense, industrial revolution, 
investing in energy policy. But that is 19th century tax policy 
and energy policy at a time when we need to focus on the 21st.
    So my question would be this. First of all, I want to thank 
you for your support and the President's support of an idea I 
put out last year to take up to $7,500 tax credit for consumers 
to buy these new vehicles, which is already paid for, and 
front-loading that at the time of sale so more people can 
purchase them and get the marketplace going.
    But one of the other areas that we have been very involved 
with is doing what other countries are doing in terms of 
financing, low-cost loans. You and I have talked many times 
about Section 136, which Senator Bingaman and I authored in the 
Recovery Act, and I am wondering, as we go forward, we are 
looking at about 35,000 jobs nationally, thousands in my State 
that have come from partnering. We actually have Ford bringing 
back jobs from Mexico to Michigan because of the loan that they 
received to retool a plant.
    But I am concerned continually, Mr. Secretary, about the 
process taking too long. That is what I hear from the companies 
and I wonder if you could speak about the process, the hurdles 
in receiving this financing, which has been so critical to many 
companies to actually be rebuilding, retooling, and keeping 
manufacturing here in America.
    Secretary Chu. Thank you, Senator. First, I concur. I have 
read that book, also, and I agree with much of what it says. 
Its fundamental tenet is that America should not be willing to 
cede manufacturing to the world. Manufacturing jobs are 
particularly highly leveraged jobs because they institute 
supply chains and all the support services for the 
manufacturing, and finally the services for the workers who are 
in manufacturing jobs.
    Senator Stabenow. Right.
    Secretary Chu. So it is an extremely highly leveraged job 
and we should not even think of ceding manufacturing. We 
should--you know, I think our slogan should be, invented in 
America and made in America.
    Senator Stabenow. That is right.
    Secretary Chu. Now, regarding the foreign competition, I, 
too, agree with you. If you look at what China and other 
countries are doing, and the subsidies, tax holidays, very 
inexpensive money for loans, that they are luring American 
industries abroad to manufacture in their country. They are 
also developing a whole market for those products.
    China thinks it is mandated by 2020 to be 15 percent 
renewables and will probably get to 18, perhaps even 20 percent 
renewables. They are growing their nuclear industry. The reason 
they are doing this is, in part, because they want to go to a 
greener economy, but also in part because they see a world 
market for all these products, whether it is wind or solar or 
nuclear, you name it, or high-voltage transmission lines. So in 
that sense, the loan guarantee program is a very important part 
of how we can help industry get going.
    Now, if you consider the history of the loan guarantee 
program, it was authorized in 2005. I think the first 
appropriations were at the end of 2006, beginning of 2007. And 
when this administration came into office, not a single loan--
--
    Senator Stabenow. Right.
    Secretary Chu [continuing]. Had been given. And if you 
consider right now, we have now closed or given conditional 
commitments to 23 companies, but we are still working to up 
that rate. We want to more than double it. The OMB and we are 
working very hard, and Treasury are working very hard to make 
it smoother. I will be honest, it can be done faster, better. 
It is an important part of what we need to do.
    And this is why we are asking in the 2012 budget for more 
authorization, particularly in the nuclear industry, in which I 
think it is very important we start the nuclear industry again, 
something where we were the leader. But in all the other, the 
clean, renewable energy sources and fossil energy, all those 
things could help with that, and we are working very hard with 
the other agencies.
    Chairman Conrad. Thanks, Senator.
    Senator Cornyn.
    Senator Cornyn. Thank you, Mr. Chairman.
    Mr. Secretary, thank you for being here and thank you for 
your service. You have had a distinguished career--continue to 
have a distinguished career. But I want to ask you about the 
transition to this green energy future that you have described, 
which all of us, I believe, support from the standpoint of 
alternative sources of energy and reducing our dependence on 
imported energy and, hopefully, increasing our dependence on 
cleaner energy.
    How is it--well, let me just ask this question. Currently, 
the U.S. energy supply is about 83 percent fossil fuels, and 
the figure I have is that about 51 percent of the oil and gas 
that we consume in America, we are importing from foreign 
sources. How long will it take us to get from a situation where 
83 percent of our energy supply is fossil fuels to a situation 
where, let us just say, half of our energy supply will come 
from fossil fuels, whether domestic or imported? Are we talking 
about a 1-year, 5-year, 10-year, 20-year, what time table are 
we looking at?
    Secretary Chu. Well, it is not going to be 1 year. I do 
not----
    Senator Cornyn. It is not going to be 5 years, either.
    Secretary Chu. It is probably not going to be 5 years. But 
then beyond that, I think a lot of things will kick in. I think 
in four or 5 years, I think there is a reasonably good shot a 
million cars, electric vehicles, but that is just scratching 
the surface because there are about eight million vehicles 
being sold now in the United States a year. It would really 
depend on what happens in battery development, and as mentioned 
before, for the first time in my career--I have been looking at 
this for a while, and when I was at Lawrence Berkeley Lab, I 
was on the scientific board of a new, innovative battery 
company, so I know a little bit about this--but the first time 
in the last 3 years, I am seeing things that are saying, you 
know, this is going to happen.
    Senator Cornyn. I hope you are right, but, of course, a lot 
of our electricity is generated by----
    Secretary Chu. Right.
    Senator Cornyn [continuing]. Fossil fuels, either coal or 
natural gas, and we have to--so we cannot say that--we cannot 
imagine a fantasy world where all of a sudden, we are all going 
to be driving plug-in cars and we will not need fossil fuels 
from some source, correct?
    Secretary Chu. I absolutely agree with you. For the coming 
decades, fossil fuel has to be a very important part of--for 
the next half-century and perhaps beyond, it is going to have 
to be a very important part of what we do.
    Senator Cornyn. So here is my question. How is it, 
recognizing that we will continue to be dependent on fossil 
fuels for the near term and mid-term, how does it reduce our 
dependency on imported energy to raise taxes to the tune of $46 
billion on our domestic energy producers, which the President's 
budget proposes, which this budget proposes?
    Secretary Chu. Well, I think the President was calling for 
an ending of certain tax subsidies on fossil fuels that had its 
origination in the beginning part of the 20th century and----
    Senator Cornyn. But you agree with me, however you want to 
characterize it, it will increase costs of production for 
domestic producers, correct?
    Secretary Chu. It will be, I believe, a very small part of 
the total cost of producing oil in the United States.
    Senator Cornyn. Well, I think in conjunction with the 
policies of the administration with regard to the Gulf of 
Mexico, which has been a job-killer in our part of the world, 
in Texas and Alabama, the Gulf of Mexico, and reduced revenue 
to the Federal Government, the royalties from that production, 
and has made us more dependent on imported energy from abroad.
    I worry that, along with the additional tax burden, that an 
industry which employs 9.2 million people in America right now, 
by adding $46 billion in additional taxes over the next 10 
years by the permitorium we have seen in the Gulf of Mexico--
now the moratorium has gone away, but the difficulty of getting 
permits--and this vision of a green energy future that may 
occur ten, 20 years out, but it will not occur next year, what 
does that do to the average consumer that is now paying $3.38 
for a gallon of gasoline, and with the geopolitical unrest that 
we are seeing in the Middle East and elsewhere, if the Suez 
Canal is blockaded, if the imports from the countries the 
Chairman mentioned were to occur because of disruption there? 
Is there not a very real danger of gasoline prices skyrocketing 
for the average consumer, and what would that do to our fragile 
economic recovery?
    Secretary Chu. Well, we are certainly very concerned about 
what will be happening to the gasoline prices in the near term, 
but we also have to keep in perspective the fact that, 
currently, the United States consumes about 25 percent of the 
oil produced in the world and we have about two or 3 percent of 
the known reserves in the world. And if you further consider 
the fact that within our territories we have scoured that much 
more than the rest of the world, you know, going to the future, 
those newer reserves, that fraction will be less.
    So while I do support an integrated plan which includes 
production of oil and gas, we cannot simply say, we can end our 
dependency on foreign oil by simply drilling our way out of the 
problem, given those numbers, 25 percent and 3 percent.
    Senator Cornyn. Well, and nobody is suggesting that we 
drill our way out of the problem. I think we all agree we need 
a plan----
    Secretary Chu. Right.
    Senator Cornyn [continuing]. Really, what I would love to 
see is a plan that deals with every element of our energy 
sources here, and particularly domestic. But you have expressed 
great hope and optimism about research and development in 
electric batteries and other alternative sources of clean 
energy and I share that hope and I really do hope that we 
develop alternative sources because I think it is going to take 
all of the above to get us there.
    But you also would acknowledge that we have seen a 
tremendous 14fold increase in the amount of natural gas 
reserves here in the United States because of the development 
of new drilling technology and the fracking techniques that you 
alluded to earlier. So is that not an area that we also ought 
to continue research and development to see if there are ways 
we can gain access to domestic energy sources rather than just 
ignore that altogether and put all of our hope, all our eggs in 
the basket of something being deployed ten or 20 years in the 
future?
    Secretary Chu. No, we are certainly not ignoring that, and 
it is a wonderful thing that the development of the 
technologies that allow us to frac the shale rock to release 
natural gas. I am certainly looking at what the projected 
increase in reserves are. I hear estimates all over the map. 
The EI estimate is much less than that. But that is neither 
here nor there. I think as we go forward in time, as the 
extraction methods get better and safer and all those things, I 
think those estimates will grow. I am not sure it is going to 
be 14 times.
    But it is a good thing that is happening because this is 
energy produced in our borders and it is a cleaner form of 
energy and gas will be a transition fuel that we will need in 
the coming decades, and----
    Senator Cornyn. Mr. Chairman, thank you for your 
indulgence. I would just add that this is jobs here in America, 
too, right?
    Secretary Chu. Right. Absolutely. And that is one of the 
reasons--all of the electrification, actually, is using energy 
produced in America to power our vehicles.
    Chairman Conrad. Let me say this to my colleagues. The vote 
is scheduled for 11. Senator Whitehouse is next on our side, 
then it comes over to Senator Portman. My intention is to leave 
now, have Senator Whitehouse proceed, and I think, Senator 
Portman, if you would leave now, there would be a prospect that 
you could be back after this vote and have your chance, and 
then we will just keep going back and forth.
    So if, for whatever reason, we are getting on the second 
seven-and-a-half minutes, Senator Whitehouse, and you are done 
with your questioning and nobody is here on the other side to 
proceed with their questioning, you just put the committee in 
adjournment so that you do not miss the vote, OK?
    Senator Whitehouse. Very good.
    Chairman Conrad. Senator Whitehouse.
    Senator Whitehouse [presiding]. Thank you, Chairman, and 
thank you, Secretary Chu, for being here.
    There is an image that I recall of a lineman who has 
climbed up a telephone pole and he is installing on the top of 
the telephone pole an array of solar cells. It is a picture 
that I recall because it was taken the year that I was born, 
back in 1955, and it is a reminder that America invented solar 
cell technology.
    And yet as you look around, as a country, we are fifth in 
solar component manufacture now. Only one of the top ten 
companies in the world that is engaged in solar component 
manufacturing is an American company. And we seem to have 
slipped in terms of our competitive advantage in this market--
and it is not just in this market, it is true, as well, in wind 
turbines.
    I am from Rhode Island. We have the potential of a very 
significant wind turbine farm going in offshore. It has 
considerable prospects for our energy portfolio, for clean 
energy, for ultimately lower costs, but mostly for the assembly 
and installation and construction jobs in Rhode Island, which 
we now desperately need.
    So in that context, I would love to get you to talk a 
little bit more about when it makes sense for the government to 
take a role in encouraging investment, and in particular, I 
think you have already described in your testimony that this 
new clean energy market is a rapidly emerging market and it is 
also a potentially enormous market. I do not know if you heard 
John Doerr's testimony. He was one of the most successful 
investors in the entire tech revolution and he now observes 
that the energy revolution is going to be six times bigger than 
the tech revolution in terms of the money at stake.
    Is there a particular role where it makes sense for a 
government to encourage early investment at the beginning 
stages of what can foreseeably be described as a rapidly 
emerging technology to protect against foreign competition or 
protect against being overwhelmed, really, by foreign 
competition in those markets?
    Secretary Chu. Yes, there is a government role, but before 
I answer that, I might also add, at the institution I used to 
work at for 9 years, Bell Laboratories, invented that silicon 
photo cell. To have the leadership slip and the production 
exports slip from the United States is--even in the mid-1990s, 
we were the leader in the world----
    Senator Whitehouse. Yes.
    Secretary Chu [continuing]. And now it is clearly over in 
Asia and China is clearly--really wants to dominate this market 
today.
    Senator Whitehouse. And how does that work? Is there an 
economic theory by which the bare investment is justified to 
try to capture an early emerging market and take a 
technological lead?
    Secretary Chu. Yes. What they and--but it not only China, 
it is Japan, it is Korea, the EU countries. What they are 
saying is, OK, we have certain mature technologies, but there 
are some rapidly growing technologies and their crystal ball 
says it is highly likely that these technologies will become a 
dominant growth industry in this next decade, from now until 
2020. And they think that this is going to be the place of 
major economic growth, and they made no bones about it.
    And for that reason, you have these, you know, no corporate 
taxes in Asia type of policies. You have inexpensive money in 
Asia type of policies. And you have a bevy of engineers being 
trained in those countries that can work on these things and to 
drive the processes down. The myth of cheap labor is simply a 
myth. Most of the cost of these things is in the capital 
expenditures and in the engineering to drive the quality up, 
the production costs down. So these are highly roboticized 
factories.
    Senator Whitehouse. So if you had to make a choice, if you 
were a government and you had to make a choice between 
subsidizing a mature extractive industry and an emerging clean 
energy industry, which is more or less the facts that we have 
before us, justify for me the investment in the clean energy 
rather than the mature extractive industry.
    Secretary Chu. Well, the United States has a history of 
having government support in emerging industries which it 
thinks is going to be important.
    Senator Whitehouse. Has it worked in the past?
    Secretary Chu. It has worked in the past. As mentioned, 
actually, the oil industry was subsidized in the early 20th 
century until today.
    The airplane industry, even though we invented the 
airplane, the leadership went very quickly to Europe, and by 
the end of World War I, it was noticed that we could not 
compare in the technology and the United States, beginning with 
Woodrow Wilson, started an Aeronautics Board and said, we need 
to support this industry. How can you support this? You get 
airmail delivery, that the government would sponsor airmail 
delivery so there was a market to encourage people to build 
better planes that would solve that need. The military played a 
huge role in that.
    So we rebuilt an air industry that was important for our 
national defense, important for commercial things. It did not 
spring out of the private sector alone. There was help from the 
government. And so----
    Senator Whitehouse. So investing in emerging new 
technologies has a long and successful American pedigree----
    Secretary Chu. Right.
    Senator Whitehouse [continuing]. Across Republican and 
Democratic administrations alike.
    Secretary Chu. Right. The semiconductor industry, the 
transistor was invented at Bell Labs. It was a monopoly. It had 
the wherewithal to invest in this long-term research. It took 
more than 10 years to develop that technology. But the first 
transistors were not competitive with tube technology, and for 
the first two decades, guess what was the first buyer of all 
the semiconductor material. It was the U.S. military, because 
they knew full well that they had to nurse this along and 
nurture it and it became a dominant force in wealth creation in 
the United States.
    So again and again and again, the government said, these 
are the things--and it was fundamentally a nonpartisan issue, 
Republican Presidents, Democratic Presidents, Republican 
Congresses, Democratic Congresses, said that this is what you 
do in order to nurture a beginning industry which we think will 
be a dominant force of wealth creation in the future.
    The United States did it. Other countries have taken from 
our playbook and are now doing it. And for us to say, well, we 
do not want to do this anymore, simply does not make that much 
sense to me.
    Senator Whitehouse. If you compare extractive industries in 
which demand competes for a diminishing supply with 
technological industries in which technological advancements 
and increased demand have a history of lowering cost--I have my 
BlackBerry right here. I see behind you, you have a staff 
person with his iPad up. I can remember the days when a simple 
calculator was a very expensive thing to buy. Now they are so 
cheap, people give them away. The price of technology, I 
believe, tends to have a downward curve, whereas the price of 
extractive industries tends to have an upward curve, inevitable 
from supply and demand in that case. Is that an additional 
argument for getting on the side of technology and not just 
extraction?
    Secretary Chu. Yes, I would say that technologies in all 
areas, including actually oil and gas, actually improved. But 
with an extractive technology there is something else you are 
fighting. As the technology improves, as we see ourselves--the 
multinationals have to go harder-to-access oil, deeper 
offshore, Arctic regions, much more expensive. A deep offshore 
rig now costs $2 to $4 billion for a major platform.
    So even though their technology is getting better, they are 
fighting this other thing, that you have to go to more 
inaccessible oil, and it gets more expensive. And you can 
compare that to looking around and saying, well, you know, one-
hundredth of 1 percent of the energy hitting the sun for a day 
can power the world for a year, so can we figure out a way to 
capture a small fraction of that energy, store it when needed? 
Because if we do, and if we can do this in a decade or two, 
then we would not be.
    Senator Whitehouse. Another potential win big seems to me 
to be turning what is presently nuclear waste into nuclear 
power. And I know that there are a few emerging technologies 
that promise or suggest an ability to take what is now an 
expensive-to-dispose-of, poisonous, dangerous, potentially 
proliferation and, you know, dirty bomb, national security-
related problem, and through the use of that technology be able 
to turn that into clean nuclear power. How are you investing in 
that? Do you see those technologies as credible? And is there 
an added value to investing in them because it helps solve the 
problem of the nuclear waste that is now scattered at various 
power sites around the country?
    Secretary Chu. Sure. First, as you know, I am a big 
supporter of the nuclear industry getting restarted. I think it 
should be and has to be part of our energy diversity in this 
century.
    What you speak of, the fact that in our standard nuclear 
power plants we put in the fuel, lightly enriched uranium, and 
we have right now a once-through cycling, about 1 percent of 
the energy content of that material is used.
    After that, you have a used fuel rod, and just imagine_now, 
we will naturally evolve, and we are doing short-term research 
to help the industry double that, which doubling is great, but 
it is only 2 percent. And so if you can say let us not go from 
1 percent to 2 percent, but what do we need to do in order to 
go from 1 percent to 20, 30, 40, 50 percent? That means for the 
same amount of nuclear material you get 20, 30, 50 times more 
electricity.
    Senator Whitehouse. Yes.
    Secretary Chu. Which means for the same amount, that much 
less waste. And so we think that it is very important_but this 
is a tough long-term thing in order to invest in that 
technology.
    I can tell you that right now today we do not have the 
technologies that we think are cost effective and cost 
competitive, but there is time to figure it out.
    Senator Whitehouse. When you say cost competitive, are you 
taking into consideration the proliferation hazard that these 
rods lying around with no purpose and the disposal problems, if 
they are left with no other use other than to be poisonous, 
hazardous waste?
    Secretary Chu. Yes, but there is also--with today's 
technology that is being used by France and Japan, notably, the 
recycling technology they are using, which was invented in the 
United States, actually presents a proliferation problem, and 
it is not cost effective either. You know, Japan unfortunately 
has discovered this because their costs of their current 
recycling have more than tripled.
    Senator Whitehouse. Let me hold a moment because I am 
getting a different instruction than I had before about the 
management of this hearing and the vote.
    Senator Thune is here. He is waiting to ask questions. Has 
the Senator been over and voted?
    Senator Thune. No.
    Senator Whitehouse. No. Well, the two choices we have here 
are either to go to you, and you are going to have a very close 
run at making the vote, or to wait a few moments longer for 
somebody to return, and then we can both go vote.
    Senator Thune. I am fine with proceeding. I am happy to 
make the run to the vote.
    Senator Whitehouse. So you would care to proceed now?
    Senator Thune. Yes.
    Senator Whitehouse. We will do so, and you can make your 
dash.
    Senator Thune. Thank you, Mr. Chairman.
    Mr. Secretary, thank you so much for being here and, again, 
for your service and for the work that you do in what is one of 
the most important areas that we deal with in this country, and 
that is our energy sector. It has enormous potential to create 
jobs to grow the economy and reduce the Federal deficit. 
Unfortunately, if you do not have the right policies in place, 
you can get the exact opposite outcome, and I fear that 
sometimes our energy and environmental policies act to destroy 
jobs and economic growth and are not a good service to our 
taxpayers at the same time.
    I know as we look at your budget for this year, there is a 
significant proposal in there for an increase, and some of that 
I know is attributable to the additional demands on account of 
the new START treaty, but we obviously have to, at a time when 
everybody else in this country is tightening their belts and 
trying to do with less spending, make sure that our budgets are 
following that basically same approach.
    But I wanted to raise a couple of issues with you, if I 
could, and one has to do with--and I know this is not directly 
under your jurisdiction, but they say that there is as much as 
$2 trillion in capital sitting on the sidelines right now 
because of the economic uncertainty that exists today, some of 
which is being driven by policies coming out of Washington. 
Much of that is--at least folks that I deal with, small 
businesses and others, suggest that a lot of that has to do 
with policies coming out of EPA.
    I guess my question has to do with whether or not you 
believe that the Clean Air Act is the best approach to limiting 
greenhouse gas emissions.
    Secretary Chu. Let me respond by saying that I think the 
President has--I think in terms of going forward and 
transitioning to a clean energy economy, which will actually 
put us on the forefront of being able to export abroad those 
technologies we develop at home, one would much prefer to have 
it through the legislative process.
    One of the things that has been proposed--I am a very big 
fan of this--is a clean energy standard that includes, you 
know, half credit for gas if it is combined cycle gas, again, a 
very efficient generation of electricity by gas, but it also 
includes nuclear, it includes wind, solar, new hydro.
    If you do that and you give it a long enough leash--and the 
President proposed 2035--that clean energy standard will allow 
the development of technologies so that you can be sure that 
you can build nuclear reactors in a cost-effective way, on 
budget, on time; that you can further develop the technologies 
for clean coal and other carbon capture sequestration methods; 
that just simply saying that this is going to be the goal of 
what we need, we have seen this in States. When States do this 
it provides market certainty to that $2 trillion, because then 
all of a sudden a company says, OK, if I build it--and the 
Federal Government is not going to pick winners. They could 
say, you know, if you can do it by wind or if you can do it by 
solar or if you can do it by nuclear or combined cycle gas, you 
do this and you get credit for it, that means that the 
financial institutions can say, OK, we will loan you the money 
because if you do this, you will have a market.
    So the investors will have that certainty. I think the 
long-term planning--and we have seen this in States that have 
done this, that all of a sudden there is a much longer-term 
planning, the electricity transmission and distribution lines, 
it creates market certainty. And you say if you do the right 
thing and it is cost competitive, you will have a market.
    So we think that that will relieve a lot of the uncertainty 
that is now--and I agree with you. There is--I do not know 
whether it is $1 trillion or $2 trillion--a tremendous amount 
of capital sitting on the sidelines, which means not driving 
the engine of the United States and jobs.
    It is a very light touch. We established this goal; 
industry, you figure out what is the best solution. And each 
State and each region can figure out what is the best solution.
    Senator Thune. But the way to accomplish that--I have come 
back to my original point, and you suggested this--would be 
some direction from Congress. What EPA is doing today I think 
is making it very, very difficult for businesses out there to 
create jobs, and it strikes me at least that if you are 
concerned about private investment, getting that capital off 
the sidelines, getting jobs created, and growing the economy, 
the approach that they are taking right now is completely 
contrary to that.
    You mentioned a clean energy standard. How would you treat 
gas, clean coal technologies? You mentioned increased hydro. We 
have a lot of hydro in my State, as does the Chairman. How 
would those be treated under a clean energy standard in your 
estimation?
    Secretary Chu. Sure. Hydro is clean energy. I think gas, if 
you look at combined cycle gas, it is more efficient than the 
most efficient coal plants. It is 55, going to 60 percent 
efficient in terms of the amount of energy you get out, and it 
has, by its very nature, less carbon emissions. So as you take 
the combined cycle gas plant and compare it to a new high-
efficiency coal plant, roughly speaking you get twice as much 
electricity for carbon emission, so we count that as half.
    Now, if you come along and develop a technology that grabs 
80 percent of the carbon from coal or 90 percent, you just pro 
rate it that way.
    So what that means is if--that is another incentive for the 
utility companies to begin to invest in pilot demonstrations of 
clean coal technologies, because they can say, OK, there is 
going to be a market, and if you are a coal State and there is 
a lot of abundant coal, you can say we can develop those 
technologies. Now, the development of those technologies, I 
firmly feel that the Federal Government has to do a lot of the 
research to help the companies to develop those technologies. 
But having said that, if you have those technologies, again, 
2035 is a long enough lead time where we are pretty confident 
they will be developed by then or even--because they have to be 
actually developed 10 years before then in order to get a 
business plan going. And so 2025 we think is a long enough lead 
time where we can dramatically bring down the costs so it looks 
like a good business investment.
    Senator Thune. Well, and I hope that you consult with 
Administrator Jackson about that approach and having Congress 
come to some solution as opposed to having these regulations 
coming out of EPA, because I talk to groups all the time, and I 
hear that over and over and over, that what they are doing over 
there is making it incredibly difficult.
    I have to go vote, and thank you, Mr. Chairman.
    Chairman Conrad. Thank you, Senator.
    Senator Merkley.
    Senator Merkley. Thank you, Mr. Chair, and thank you, Mr. 
Secretary, for your testimony and your leadership.
    Senator Cornyn was talking about the importance of a plan 
to end our dependence on imported oil, and indeed certainly 
that echoes a sentiment of mine. We have so many technologies 
that we are talking about at this point, including electric 
vehicles, plug-in hybrids, the use of more natural gas for 
trucks, many technologies that increase the fuel efficiency of 
trucks, the shift of trucking to rail, et cetera, et cetera, et 
cetera.
    What has been missing, in my thinking, is for the 
Department of Energy to lay out a plan for how we are going to 
over a period of some time--because it does take time to, say, 
shift fleets--end our dependence on foreign oil? Is there any 
prospect we might see a plan like that from the Department in 
the course of the coming year?
    Secretary Chu. Well, we are beginning--I am so glad you 
asked that question because this is something where I think in 
the past we would say, OK, this looks good, we will fund this; 
that looks good, we will fund that. But we are now going about 
it in a slightly different way. It is a very hard look. Without 
Department of Energy help, where is business going? And what is 
its timeline? What can we do in the Department of Energy to 
accelerate it? And what price point can we get to at any given 
time? And it is those price points--because energy, you know, 
fundamentally the investments in energy and how it is, it is 
about money, and you have to bring prices down in the new 
technologies. And what is the timeline you say? You know, can 
it be done in 5 years, 10 years? Or is this so far--you know, 
20 years means, well, we are not really sure.
    And so we are developing this. We are looking at this in 
every sector, and it now cuts across all of the Department. For 
example, in photovoltaics, we are able to attract a very 
talented individual--who happens to be a personal friend of 
mine, Arun Majumdar, a professor at Berkeley--to say, OK, we 
have had our Sputnik moment on energy; the equivalent of the 
moon shot is not a sun shot. What do we need to do in order to 
bring the price of electricity generation down to--the full 
cost, what is called the levelized cost down to be competitive 
with gas or coal? And how far will that be?
    And so now all of a sudden this program is going to cut 
across all the lines within the Department to say what is it we 
can do. And so we are doing this for every technology--
biofuels, coal, transmission and distribution, battery storage, 
battery storage for vehicles, but also for utility scale. And 
so we will be developing this plan.
    In addition to that, we are working--there was a PCAS 
report, Presidential Science Commission, that suggested--in 
fact, it was spurred by requests I made of them, to say what 
can we do in the Department of Energy to help the country's 
goals in energy. They made a recommendation that said, Why 
don't you develop a longer-term plan, what they call a 
Quadrennial Review, which has been done in the Department of 
Defense and now in State, and they made that recommendation to 
the President and we are enthusiastic about it and intend to go 
forward with that. We are now working with OMB and then soon 
with relevant agencies within Congress going forward. And we 
would like to actually do in a very short time scale the first 
version of that. It is a technology review to address precisely 
what you want to do.
    Senator Merkley. Well, thank you. I am very glad to hear 
that, and it is certainly appropriate to incorporate the vision 
for how costs will play into this.
    Quite frankly, most of our estimates about cost are always 
a bit of because the world changes in ways we do not 
anticipate. Certainly the drop in natural gas and the increase 
in the supply are a good example of that. But, crudely, the 
projections are that 20 years from now we will be importing 
between 8 and 9 million barrels per day without our changes in 
technology.
    Four Senators have put out a plan as a bill that lays out a 
pathway to reducing our consumption of oil by over 8 million 
barrels per day, which more than exceeds our non-North American 
imports 20 years out. This is without the sophistication that 
the expertise of your Department can bring to bear. But I think 
when you complete this vision of wrestling with the cost lines, 
I think you will have all the data to do a much more 
sophisticated version of a 20-year plan or less to end our 
dependence on foreign oil.
    Now, clearly, that does not end our dependence upon or our 
concern about price shocks because it is a global oil market.
    Secretary Chu. Right.
    Senator Merkley. But it does play a lot into our 
understanding of our national security challenges from being 
dependent on overseas oil. So I would really encourage you with 
considerable enthusiasm to translate all that data into a road 
map, recognizing the road map will change, because the world 
will change and we cannot envision accurately all the ups and 
downs. But I think it would give us a pathway to seize hold of.
    We have proposed, the Senators who have put this forward 
have proposed having a Department of Energy Security that is an 
ongoing--not a full department but actually a council like the 
National Security Council--to keep pushing so that between 
administrations or the transition of administrations we can 
fulfill a 20-year plan. That, too, I think is part of a plan I 
would love to see the administration come forward with. Lay out 
a 20-year vision but then a structure for how we make that 
vision happen, knowing that we will have to adjust the changing 
dynamics over time. I just think that sort of understanding--it 
is like a business positioning itself in a smart way 
strategically. And we need to position ourselves as a Nation 
not to be dependent on overseas oil. And in the process it 
creates a lot of jobs at home and does a lot of good for the 
environment. So obviously I am spending a lot of time on this 
just to try to root for it as much as possible.
    Secretary Chu. I could not agree with you more. And, in 
fact, when you said do it like a business, that is exactly the 
way we are trying to do it. If we think more as, you know, 
green eyeshades, what are we going to do, you know, it is a 
competitive world out there. There is going to be a race as to 
who is going to develop these technologies first, and we want 
to get them and we want to win this race. So treat it like a 
business.
    So that is why we are saying, OK, the traditional boundary 
and traditional way of thinking cannot go forward, and it has 
to be a business plan that looks out into the future, knowing 
that a technological breakthrough can be totally upended, and 
that is what we really want. But you also make plans. You know, 
you do not want to make--sail on on what we are doing hoping 
out of the blue some miracle might happen. You know, you do not 
make plans hoping for a miracle. But you make miracles much 
more likely with a better plan.
    Senator Merkley. Great. Thank you. My time is up. On your 
way out, I will give you the copy of the plan that the four 
Senators put forward, ``America Over a Barrel: Solving Our Oil 
Vulnerability,'' and I will look forward to when you can hand 
me back a plan from the administration of a more sophisticated 
strategy. Thank you.
    Chairman Conrad. Thank you, Senator.
    Senator Portman. Thank you, Mr. Chairman.
    Dr. Chu, good to see you again and have you before the 
Committee. I am going to followup on Senator Merkley's comments 
about a plan and also focus, I hope, on two issues: one is 
nuclear and natural gas. You just said we are living in a more 
competitive world, and you are right. Senator Sessions has also 
reminded us that we are living in a time period of not just 
more competition but more budget constraints. And to me this 
means that we need to determine ways to unleash the American 
potential to create sources of energy right here. And I would 
associate myself with some of the comments earlier of some of 
the members on both sides on clean coal and other technologies, 
but let me focus on nuclear, if I could, because I think that 
may be one we have not gotten into as deeply.
    As you know, I am very concerned about the slow pace on the 
loan guarantees. I think it is fair to say that nuclear is the 
only baseload emissions-free option that we have. It is U.S. 
based. It will create a lot of jobs, and it is critical in 
terms of our dependency on foreign sources, but also in terms 
of having cleaner energy. And the infrastructure is aging, as 
you know. Plants are getting older. They are less efficient. We 
should certainly be encouraging upgrading our energy 
infrastructure generally. As you know, I have been specifically 
involved in the front end of that on the enrichment side. And 
when you look at the track record since the beginning of this 
administration, I think there has only been two loan guarantees 
on the nuclear side. The last one was about a year ago, one of 
which is conditional. And that, of course, goes to a French-
owned company on the front end, which is nuclear, but it is 
really uranium enrichment.
    So I guess my question to you would be--you said earlier 
your goal was to double renewable loan guarantees. What is your 
goal on nuclear? And what can we do here in the Congress to get 
these loan guarantees moving? And then I want to followup with 
some specific questions about enrichment.
    Secretary Chu. Sure. First, in the President's fiscal year 
2012 budget, we are asking for an additional $36 billion in 
loan guarantees. We have made one conditional commitment to the 
Vogtle plant for two new reactors. We have another three 
projects before us, and then after that, another four. And so 
we are actively working on the first three.
    I think it requires additional loan guarantees, and it 
requires other things. A great stimulant to nuclear energy 
would be a clean energy standard, quite frankly, because that 
says if you build a nuclear power plant, you get credit for 
this. And many regions in the United States say this is part of 
it. So it is a market draw. The loan guarantees will help 
industry get started, provide the assurance that you can build 
these reactors on budget, on time.
    Then in addition to that, we are helping--we think there is 
a great opportunity in the United States for the development of 
small modular reactors, and so instead of reactors that are 
1,000, 1,500 megawatts of power, these would be more of the 
scale of 100 megawatts of power, maybe 200 megawatts, maybe 50 
megawatts.
    The advantage of that is--well, first, the reason we built 
these very large reactors is you get an economy of scale. There 
was a very long licensing period, approval period, things like 
that, so you built one big one. The only trouble is when you 
build one humongous one that the full costs could be $8 billion 
plus, this is a huge asset and so, you know, this is a large 
fraction of the cap ex of a utility company. So if you build a 
small or large reactor that can be built in a single factory, 
the economy of numbers can then compensate for the economy of a 
single one.
    The electricity infrastructure in many parts of the United 
States could not even accommodate a 1.5 gigawatt reactor. And 
it is something where we think we can begin to retake back the 
lead in nuclear technology. We made the first nuclear reactor 
in the world in the United States. But that lead has gone to 
France, it has gone to Japan, it has gone to Korea, and now 
China want to take that lead. So we are no longer major 
players. GE and Westinghouse are majority owned by Japanese 
companies. But to be sure, these companies, GE and 
Westinghouse, many U.S. engineers are still part of this.
    So we want to restart the nuclear industry. We also want to 
start----
    Senator Portman. Let us not forget Babcock and Wilcox.
    Secretary Chu. Oh, Babcock and Wilcox.
    Senator Portman. Modular units like mPower.
    Secretary Chu. Right.
    Senator Portman. But let me just back up for a second, if I 
could. It is fine that you are asking for more money for loan 
guarantees. The question is: You have loan guarantee money in 
the pipeline; how do we get it out?
    I agree with you on modular. It seems to me--you are the 
expert, literally the scientist on this, but it seems to me it 
makes sense for a lot of reasons, including commercial reasons. 
But there has to be a demand for it, and there has to be a 
clear pathway through the regulatory process. So what can we do 
to get utilities to move forward and get you to get these loan 
guarantees out so we can actually begin this nuclear 
renaissance?
    Secretary Chu. Well, I think if you look at the dynamic of 
what is happening, there is uncertainty. For example, there 
will not be a price on carbon in the next couple years. The cap 
and trade is not going to be revived for the next couple of 
years. And so that is why the clean energy standard is a market 
draw that allows that to go.
    The low price of natural gas also has an influence on 
economic decisions of investment, and so--but when you build a 
nuclear reactor, this is a 70-year horizon, and we do not 
really know what is going to happen to the price of natural gas 
in 70 years. We know in the next 10 or 20 years it is probably 
going to be a lot lower than it has been in the past. But it is 
still a very volatile commodity.
    And so that is why we need to diversify our energy supply, 
and that is why I think nuclear is very important in that. But 
there are all these other factors, and to the extent that the 
Federal Government can say, OK, there is a market for clean 
energy and nuclear counts full, whereas natural gas might count 
half, we think that that would be a stimulant. But as these 
companies go through this, we still see a lot of interest in 
trying to get it going, and we are looking at those companies.
    Senator Portman. I would love, if it is all right, to do 
some followup with you on this, maybe just look on paper at 
what is exactly your goal on the nuclear side. You mentioned 
doubling on the renewable loan guarantees. How would you 
measure your success or failure to get there over the next 
couple years? And what do we need to do specifically to get 
some of these loans going?
    On enrichment just for a second, do you think we need a 
U.S. source of enriched uranium?
    Secretary Chu. Yes.
    Senator Portman. Do you think we need a U.S. sort of 
tritium, which is so critical to your nuclear arsenal?
    Secretary Chu. Yes.
    Senator Portman. And any update on the loan guarantee for 
the Piketon plant? We are, as you know, very concerned about 
that and particularly concerned that this may be a pivotal time 
over the next few months in order to keep the project going?
    Secretary Chu. Right. I think, you know, we are--specific 
loan guarantees, as you know, I really cannot talk to you about 
that, but I do believe that we do need a domestic enrichment 
technology. It is important for our national security, let 
alone our energy security, which are now so intertwined I do 
not really draw a distinction between our national security and 
our energy security. And so I do believe it is important that 
we develop technology, a leading technology in the United 
States.
    Senator Portman. Thank you, Dr. Chu.
    Chairman Conrad. Thank you, Senator.
    Senator Begich. Thank you, Mr. Chairman.
    Thank you, Secretary Chu, and thank you for coming up to 
Alaska and especially to rural Alaska, and Hooper Bay was one 
of the locations you went to, and I thank you for that.
    I have a couple questions, and just by circumstances and 
timing, I just finished meeting with Mayor Hopkins of Fairbanks 
North Slope Borough, and in Alaska, as you saw, the cost of 
energy is high. In some cases, you can be as low as $4--and I 
say ``low``--for heating fuel to as much as $11 or $12 a gallon 
for heating fuel. So the economics for some of the projects are 
important.
    I am going to give you a little frustration, but it is 
really an ask to have you review, and that is, Fairbanks, which 
is a cold climate area--today I think they are 20 below. The 
last 60 days they have failed their PM2 air quality 50 times, 
so EPA, of course, is going to tell them, you know, shame on 
you, we are going to take highway money away and everything 
else.
    But one of the things they are doing is starting to truck 
in gas, truck it in, because there is no pipeline access there. 
In order to do that, they have to have an LNG plant, they have 
to have storage and so forth. So they are going to be meeting 
with your folks tomorrow to try to see if there are 
opportunities for loan guarantees in doing that project.
    This is the frustrating part. On the one hand, EPA says 
clean up your air. So they say, OK, let us use clean-burning 
gas, but there is no one to help in figuring out this problem. 
But it is a Federal rule that is telling them they have to do 
it. So I am hoping that there is some coordination between 
these kind of activities. They are going to be in your office 
or with your folks tomorrow. I am just putting the bug in your 
ear now because it is very frustrating to me when the climate 
conditions themselves are--we cannot change 30 below. It is 
what it is. But can we move down the path? Yes, we can with 
some gas issues, which is a better fuel than some of the stuff 
they use now. So I would hope at least you would consider that 
when there is a Federal agency putting the requirement on.
    The second part of this is we have strategic military bases 
there; 4,500 Striker Brigade members are leaving in the next 2 
months to go to Afghanistan to fight the war there. But they 
are stationed right there in Fairbanks. And one of the big 
issues the military keeps bringing up is air quality. And yet 
we have a solution, but we cannot get DOD, EPA, Energy 
Department, who all have--it is all the same pot of money--to 
figure this out in order to protect our energy resources up 
there, make it economical to clean the air and make sure we 
have a very strategic air base and army base continuing to 
operate.
    So this is just kind of a statement. It is a little 
frustration, I got to tell you, after hearing what I just heard 
about an hour ago in this meeting. So I would hope you would at 
least have your folks look at that.
    The second piece is--and you talk about gas, and I 
appreciate it, and this is one I am just going to ask you if 
you could come back. In the 2012 budget, there is an amount of 
money, $17 million, that goes into the North Slope. It is a 
partnership that the Department of Energy has had for many 
years in developing gas resources and understanding the 
research, and it is called the Barrow Gas Field. It has been 
very successful in having that whole community on gas, for 
example, but also looking at new technologies. But it has been 
totally eliminated out of your budget, and this is how it 
reads: ``The detailed justification''--that is what it is 
listed under. It ``reads: `Consistent with the administration 
policy to phaseout inefficient fossil fuel subsidies.' '' That 
is it. That is the detailed justification.
    I would say that gas, which you have mentioned more than 
once here, as well as others, Secretary of Interior, EPA, the 
President, is a very important part of the equation in dealing 
with our long-term energy policy. So if I could get a little 
more justification, because honestly this is an incredible 
project that has brought great technology to the field when it 
comes to gas, oil and gas exploration. It is why in a lot of 
places--and the Chairman's State is very successful, it is 
because some of the gas exploration technology, fracking as 
well other things, were developed in Alaska.
    So just help me understand it and why you have cut that 
from your budget totally, not even lowered it but totally 
eliminated it.
    Secretary Chu. Well, I am not sure which one. I know of one 
item of gas in Alaska that was shifted from fossil energy to 
the Office of Science. This is a--it is a cooperative research 
with, I think, Conoco----
    Senator Begich. It is Conoco.
    Secretary Chu. Yes, OK. So that is the one. So that one is 
one that is looking at research into whether one can extract 
gas from methane hydrate formations under the ground. I 
actually support that, and it has been transferred over into 
the Office of Science, but we hope to continue--and it is a 
research thing. It is not a subsidy of oil and gas, and----
    Senator Begich. Well, I agree with you. The justification 
seemed----
    Secretary Chu. Right. And so--but it has not been killed. 
That program has been moved over to the Office of Science and 
what we want to do is we want to do research. Again, if you 
look back in the fracking, long before, the major oil and gas 
companies were not interested in that.
    Senator Begich. That is right.
    Secretary Chu. They did not think it would----
    Senator Begich. Would produce anything.
    Secretary Chu. Right. And so in terms of research, we think 
that there--you know, it is difficult. Methane hydrates, as you 
may know, they were found because they plugged up oil and gas 
lines----
    Senator Begich. That is right.
    Secretary Chu [continuing]. Because as you release the 
pressure, it freezes----
    Senator Begich. Right.
    Secretary Chu [continuing]. As we saw, actually, in the 
Gulf of Mexico, in the deep Gulf. And so--but there is a 
tremendous amount of natural gas in methane hydrates, both 
underground and off the continental shelf. If you think that 
fracking of natural gas can perhaps double our natural gas 
supplies, if you can safely, environmentally, responsibly extra 
methane hydrates----
    Senator Begich. It is huge.
    Secretary Chu [continuing]. It is much bigger.
    Senator Begich. That is right.
    Secretary Chu. And then you can really think of doing 
things like reforming natural gas to hydrogen and sequestered 
carbon. There are many opportunities. But it is still research, 
and----
    Senator Begich. Good. So I am going to hold you to that, 
because I have only got about 30 seconds left.
    Secretary Chu. OK.
    Senator Begich. But let me just say that what I hear you 
saying is it is transferred. It is still happening on some 
level of research. And the language that was utilized in 
justification may not have been the most accurate in 
description of what happened to that.
    Secretary Chu. Yes. I have personally known about that 
program for a couple of years----
    Senator Begich. Right.
    Secretary Chu [continuing]. And I am very positively 
disposed to it because it is research. It is not--again, it is 
not underwriting of commercial interests, because right now, 
the gas companies are staying away from it, quite frankly, the 
oil and gas companies, because----
    Senator Begich. But in this case, we have a partner, which 
is----
    Secretary Chu. Well, it is not only a partner. We need this 
partner because they actually have the equipment that we could 
not--so they are actually, in a certain sense, loaning us--they 
are using--ConocoPhillips-BP is loaning us this equipment, if 
you will, working with us. The program is dictated by the 
Department of Energy research scientists-----
    Senator Begich. Right.
    Secretary Chu. And they are willing to say, OK, we will 
partner with you. You can--because we could not afford----
    Senator Begich. I hear you. Let me end there and just ask 
one question. Does the President have an energy team that is 
developing an energy policy for this country, and who are they? 
And I will leave it at that.
    Secretary Chu. Yes, and this was actually in an earlier 
question, asked before. We have not in the past had a 
coherent--I would start with, more modestly, first, where we 
are in energy technology and where the most probable outcomes 
will be in the coming years and what the cost will be. And so 
we are embarking--I talked yesterday to the OMB about this and 
it is set in plans, and my next step would be to Senator 
Bingaman and Murkowski's committee to talk to them about it, 
but to be able to start a review of the technologies that would 
then form a basis for the energy policies. You need sort of a 
knowledge of the technologies, where they are going, and how 
might they be accelerated, and then from that you formulate 
policies, and that is our intent.
    Chairman Conrad. Senator Cardin.
    Senator Cardin. Thank you, Mr. Chairman. Secretary Chu, it 
is always a pleasure to have you before our committee.
    Just following up a little bit on Senator Begich's point, 
it seems to me, though, that to have an energy policy that is 
going to be right for America, that three goals must be met, 
and that is one of energy independence so that we are not held 
hostage to countries who disagree with our way of life or 
circumstances that happen globally that disrupt our economy and 
our security.
    And second, we have to do it in a way that is smart for job 
growth. Clean energy is a way that we can create more jobs here 
and keep more jobs in America.
    And then, of course, third is the environment. This is a 
serious risk we have on the environment. In your exchange with 
Senator Portman, you sort of gave up, and I think it is right, 
that we will not be able to pass a comprehensive bill. We tried 
that. I think that is regrettable because I think until we have 
a proper price for pollution, it is going to be very difficult 
to put in place an energy policy that is right for America.
    So I do not want to give up on the pricing of carbon. I do 
not want to give up on the way of energizing our economy to 
solve these problems. But I do think we have to look at steps 
now that are politically realistic, and I think the way that 
you have presented it is what we will need to do. But do not 
ever give up where we need to be as a nation, not only for 
America's security, but for international leadership on a lot 
of these issues.
    I want to ask a specific question, following up on Senator 
Portman's comments about nuclear energy. As you can tell by my 
previous comments, I am a strong believer that to solve our 
energy problems in America, we have to use less energy, we have 
to develop alternative and renewable energy sources, we have to 
continue with technology growth, all of the above.
    But part of it is obviously, to me, is nuclear power, that 
we need to move forward with nuclear power, which leads me to 
the concern that we now have the appetite and need for more 
loan guarantees than the budget will allow us to move forward 
with at the current time. Part of it is the fact that we do not 
have enough money up for loan, enough capacity for loan 
guarantees, and the second is the manner in which OMB scores 
these loan guarantees, which at times discriminates against a 
State based upon its regulatory structure.
    I represent Maryland. Maryland is prepared to move forward 
with a nuclear power plant at Calvert Cliffs and we are in the 
process, and it is not really aimed at that specific 
application, because I think that process is moving forward and 
we thank you for your help in that regard. But if we are going 
to accomplish the need for nuclear power in America, then we 
have to sort of get a handle on the realistic cost of this. It 
is my understanding that the risk factor of these loan 
guarantees are very minimal, so it actually will be beneficial 
to our budget and our economy. So it is going to be a plus, not 
a negative.
    So I just urge you as we go through this process of trying 
to move forward with loan guarantees for nuclear power plant 
expansions or construction, that we work together as a team 
here and figure out the problems that OMB might have so that we 
can get more action for the dollars that are available.
    Secretary Chu. Yes, Senator. So what you are--for others in 
the room, I know you will understand this, but what you are 
referring to is what is called the credit subsidy in a loan 
guarantee, that the $36 billion we are asking for is scored by 
CBO as 1 percent cost, even though we have to prove to OMB that 
it is zero cost to the taxpayer.
    So the credit subsidy is, loosely speaking, what we would 
call a loan, mortgage insurance, should the project be delayed, 
something of that nature, and the payment of the loan be 
delayed, that the government could still recover its 
investment. And so it is essentially insurance that is then 
paid to Treasury. And in that amount of money, that comes from 
the company. It does not come from the Federal Government. And 
if that amount is too high, then it is prohibitively costly. 
If, let us say, you want to mortgage, but the mortgage 
insurance is half the cost of the mortgage, that is pretty high 
and the mortgage might not be so desirable.
    So we are working with OMB. Now, by statute, OMB has the 
final authority ruling on what that credit subsidy should be. 
They make a determination of the likelihood that the loan might 
default and the U.S. Government cannot get its resources back. 
Therefore, that company has to pay that insurance to the 
Treasury. It is that probability that that will happen.
    And so we certainly are willing to work with OMB to try to 
figure out what is the best way of assessing the most accurate 
probability that these loans will not be paid back. I think the 
nuclear industry--the highest risk is that there would be delay 
in construction. It is not as though this thing will not work. 
That, we know. We have done 107 nuclear commercial reactors in 
the United States. We know they will work. And so the risk is a 
delay, and then to what extent. So we are working with OMB to 
try to see if we can have a good assessment of what that risk 
is.
    Senator Cardin. I appreciate that, and let me just 
underscore the point. You have to set it at a rate where it 
will not cost the taxpayers any money, and yet it still gets 
scored as an issue because of the OMB formula.
    Secretary Chu. It is actually a little more--for these type 
of loans, the nuclear loans, we have to convince the OMB, and 
it has to be scored as no cost, and then it is a probability of 
default, so you will not get paid back, or at least the pay-
back would be a long period of time. So we have to convince OMB 
that it costs the taxpayers zero, but then the CBO says, no 
matter what you do, we will still charge you 1 percent, and 
that is just the way it is.
    Senator Cardin. Well, I----
    Secretary Chu. And so that is beyond my comprehension as a 
physicist----
    [Laughter.]
    Senator Cardin. You know, it is beyond our comprehension, 
also. But I think what we need to do is to work closely 
together between Congress, OMB, and DOE, because I think there 
is a real commitment here to make sure the capacity is there to 
move forward on approved nuclear reactors, where it has gone 
through the process and where it is reasonable to expect that 
the loan guarantee is part of the overall equation.
    So I think there is a number that we all should be able to 
come together with and I very much appreciate the way that you 
explained it, not only to those who were unfamiliar with this 
issue, but even those of us who are familiar, because I think 
you laid it out in the best way. Thank you very much.
    Chairman Conrad. I want to thank the Secretary for your 
appearance before the Budget Committee today. I also want to 
thank you for your service. It is so important to the country 
that people of your quality and your character are willing to 
serve in these positions, and we very much appreciate it. And 
we appreciate the time that you have spent with the committee 
this morning. I think it has been very valuable for the 
members. It has certainly been valuable for me.
    The committee will stand adjourned.
    Secretary Chu. Thank you.
    [Whereupon, at 11:51 a.m., the committee was adjourned.]





THE PRESIDENT'S FISCAL YEAR 2012 BUDGET REQUEST FOR THE U.S. DEPARTMENT 
                           OF TRANSPORTATION

                              ----------                              


                        THURSDAY, MARCH 3, 2011

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Wyden, Nelson, Cardin, Sanders, 
Whitehouse, Warner, Merkley, Coons, Sessions, and Thune.
    Staff present: Mary Ann Naylor, Majority Staff Director; 
and Marcus Peacock, Minority Staff Director.
    Chairman Conrad. The hearing will come to order.
    First of all, I want to welcome everyone to the Senate 
Budget Committee. I especially want to welcome the Secretary 
and say right at the top that I personally think you are doing 
an outstanding job. I have had this responsibility for more 
than 24 years now, and you have done the best job I have ever 
seen of communicating with members, and that is to your credit.
    Before I give my full opening statement, I want to 
recognize Senator Nelson because he has another commitment and 
would like a few moments. Then I will give my opening 
statement, Senator Sessions will give his, then we will go to 
you, Mr. Secretary, for your statement.
    I will recognize a very valuable member of this Committee, 
my very good friend Senator Nelson.
    Senator Nelson. Mr. Chairman, thank you for this courtesy. 
Mr. Ranking Member, my favorite Republican from Alabama, thank 
you for your courtesy. Do not tell Senator Shelby that, please.
    [Laughter.]
    Senator Nelson. I just wanted to say publicly, Mr. 
Chairman, that I have seen the Secretary on a daily basis 
perform his duties in the last several weeks as we have been 
going through the turmoil of, after an awful lot of hard work 
by a lot of people, including the Secretary, one of the best 
high-speed rail projects in the country because it is ready to 
go--the environmental studies, it is the right of way right 
down the middle of Interstate 4 from Tampa to Orlando, 
eventually to Miami. The recognition that Interstate 4 and 
Interstate 95 in 20 to 30 years you can imagine what it is 
going to be like in that period of time. And here we have an 
opportunity of an alternate form of transportation where the 
United States is 30 years behind Europe, and now high-speed 
rail is all over Asia.
    I just want to sing the praises of the Secretary. He has 
worked with the State of Florida, despite the Governor of 
Florida trying to reject the funds, and over and over has 
worked with us in order to give us time to try to work it out, 
to show the Governor that his conditions are met, that the 
State of Florida will have no financial responsibility, that it 
will all be a privatized matter. And if it were not for the 
Secretary, this thing would have long been passed. And we now 
are at the 11th hour with a petition filed by a Republican 
State senator and a Democratic State senator to the Florida 
Supreme Court asking for a writ of mandamus to compel the 
Governor to follow the law of the State of Florida. Oral 
arguments are this afternoon, and we are expecting--because the 
Supreme Court took this quickly yesterday, we are expecting an 
imminent decision. And I just want to thank the Secretary again 
for his being willing to work with us, to extend the deadline, 
to try everything possible that we can to make this happen. And 
so, too, depending on what the decision is of the court, we may 
come back to him and ask him again for another extension, 
depending on what the Supreme Court says.
    So I wanted to put that on the record to corroborate your 
kind comments about Secretary LaHood.
    Chairman Conrad. Thank you, Senator Nelson. Let me----
    Secretary LaHood. Mr. Chairman, can I just offer my thanks 
to Senator Nelson?
    Chairman Conrad. Certainly.
    Secretary LaHood. And to you for your very kind comments. 
Thank you.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. Let me say that the hearing today will 
focus on the President's transportation budget request. Our 
witness is the Secretary of Transportation. This is Secretary 
LaHood's second appearance before the Budget Committee. He 
reminds me the last time he was here I was the only one here, 
and I had my little dog, Dakota, with me because, as I recall, 
we were in the middle of a blizzard, I think. No one else could 
make it. So it was a very good hearing. I know I got all of my 
questions answered.
    [Laughter.]
    Chairman Conrad. Probably for the first time ever.
    So we are pleased that he could be back and look forward to 
his testimony. I believe personally that the strength of the 
Nation's transportation infrastructure is one of the most 
important factors that will determine our future economic 
success.
    Transportation infrastructure is really the foundation for 
our economic growth, and I recognize absolutely jobs are 
created in the private sector, but I also recognize that 
transportation infrastructure is absolutely critical for the 
economic competitive position of the United States. So even as 
we look to cut spending to bring down the deficit, which we 
absolutely must do, we need to ensure that transportation 
funding remains a priority.
    Yes, we have to cut spending, but we have to be smart about 
where we cut. We cannot afford to cut areas that are critical 
to future growth. That would be counterproductive.
    Investment in transportation can play a critical role in 
strengthening the economy in the near term because it is clear 
that transportation funding in the 2009 Recovery Act did help 
to create jobs and created jobs here in America and jobs that 
helped strengthen the Nation's economic recovery.
    It is also clear that there is a tremendous need for 
further infrastructure investment. According to the World 
Economic Forum's Global Competitiveness Report, the United 
States ranks 23rd in the world in the quality of its overall 
infrastructure. We even rank behind countries like Barbados and 
Oman. 




    The American Society of Civil Engineers has created a 
report card on America's infrastructure. They give our 
infrastructure an overall grade of D. Aviation they give a D; 
bridges they give a C; rail, a C-minus; roads, a D-minus; 
transit, a D. An overall grade of a D from the American Society 
of Civil Engineers.




    The next graph, which was made with data from the 
President's budget, shows that our combined investment in 
infrastructure, research and development, and education has 
fallen as a share of GDP from 6.1 percent in 1962 to 3.6 
percent in 2012. So as a share of the economy we are spending a 
smaller amount on infrastructure and these other critical areas 
than we did in the 1960s.




    There is widespread agreement on the need for further 
infrastructure investment. I think it is notable that just last 
month Thomas Donohue, the head of the U.S. Chamber of Commerce, 
which represents many of the country's largest businesses, 
joined Richard Trumka, the head of the AFL-CIO, America's 
largest union, in testifying before the Senate Environment and 
Public Works Committee on the need for more infrastructure 
funding.
    Here is what Mr. Donohue said: ``If we don't change course, 
over the next 5 years the economy could forgo as much as $336 
billion in lost economic growth as transportation networks 
continue to deteriorate. I am well aware of the fiscal 
constraints facing this Congress and the Nation,'' he went on 
to say, ``but we must avoid cutting off our nose to spite our 
face. Without proper investment and attention to our 
infrastructure, the United States' economic stability, 
potential for job growth, global competitiveness, and quality 
of life are all at risk.''
    I think Mr. Donohue has it about right.



    
    Here is what the Obama Administration has proposed in its 
budget for transportation. It proposes $556 billion in a 6-year 
surface transportation reauthorization. This includes $468 
billion to rebuild roads, bridges, and transit systems and 
improve safety, which represents a 60-percent increase over the 
previous 6-year authorization bill. It also increases funding 
for high-speed rail and incorporates rail funding in the 
Highway Trust Fund, and it creates a National Infrastructure 
Bank within the trust fund to leverage Federal funds for 
transportation projects.
    The budget proposes front-loading $50 billion in 
transportation funding in 2012 to help boost economic growth. 
It reclassifies transportation spending as mandatory spending, 
subjecting it to PAYGO rules. And it includes a place holder 
for a bipartisan financing solution to be developed between the 
President and Congress. I will be interested in hearing more 
from Secretary LaHood on the Administration's ideas in that 
regard.




    The reality is that even before we factor in the 
Administration's new transportation request, we already have a 
very serious shortfall at existing funding levels.
    Let me repeat that. At existing funding levels we have a 
very significant shortfall.
    This chart shows that Highway Trust Fund receipts are 
projected to be far lower than Highway Trust Fund outlays in 
the years ahead, and under the Administration's request, the 
funding gap would be far larger.
    Now, let me just point out here: The red line is the 
outlays, the expenditures. The green line is the anticipated 
Highway Trust Fund receipts. And you can see the gap by the 
time we get to 2021 is over $18 billion a year. Now, that is at 
the existing levels.




    We have a very big problem here to deal with, and we know 
that the reality of the trust fund financing is based on the 
gasoline tax. The gasoline tax is more and more disconnected 
from the reality of modern transportation. With electric cars, 
with hybrids, with renewable fuels, with all the rest that is 
happening to change the way we transit, we have a big problem 
here between the need and the funding mechanism.
    With that, I will turn to Senator Sessions for his opening 
remarks. I want to thank Senator Sessions for the cooperation 
of him and his staff as we have scheduled these hearings. We 
have had a lot of hearings.
    Senator Sessions. Yes, we have.
    Chairman Conrad. And we have more to go. I just want to 
thank him for his courtesy and the professionalism of his 
staff.

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. Thank you. I appreciate your tough 
leadership. We have a lot to do. I agree with you. We have to 
contain spending in this country. We are heading off a cliff 
with 40 cents out of every dollar being borrowed and our debt 
surging, on pace under the President's budget to double from 
$13 trillion to $26 trillion in 10 years, and we know we have a 
difficulty with transportation.
    Secretary LaHood, I share my colleague's comments that you 
are accessible, and I appreciate you coming by and visiting in 
my office. That does not often happen, and I think that is very 
helpful.
    I do believe that transportation is a major issue for us. 
We have to be sure that we maintain the required infrastructure 
this Nation has to maintain its productivity. But we have 
problems. We know that our gas tax revenue has been falling 
below our projected budget for a number of years now. I think 
we were at 36 billion income and 43 billion spending last year. 
So that money is filled with Treasury money, and Treasury money 
is borrowed money.
    And so we know we are in this difficult time, and I was 
looking with great interest on what kind of budget projections 
we would see. We have seen a Department of Education request on 
Tuesday for an 11-percent increase. We had the Department of 
Energy yesterday with a 9.5-percent increase. But I have to say 
I was flabbergasted to see that the Department of 
Transportation is asking for a 62-percent increase in 
spending--at a time when all of us know we have to contain 
spending and do something about the surging debt we have.
    And why is this? Well, because we have crumbling 
infrastructure. But I remember very well, because I made a 
number of speeches on the floor about it, that I was 
disappointed deeply that the stimulus package, which was 
projected repeatedly as a plan to increase spending for our 
crumbling infrastructure, only had about 3 percent of the 
budget for roads and bridges, maybe 5 percent for 
transportation total out of the $800 billion or so. That was a 
tragedy. That was an opportunity lost of monumental 
proportions. We did not do enough to fix the crumbling 
infrastructure we have, so now we are reduced--having not 
produced many jobs out of this stimulus package, every penny of 
that money being borrowed, now we are reduced, I suppose, to 
coming up with a new plan. And this plan says that we are going 
to have a tax that is not a gas tax, ``a not-gas-tax tax,'' I 
guess we will call it. And it is going to raise $435 billion. 
Well, we have a $300 billion plus hole in our Medicare 
physician payment that we cannot find the money to fill in that 
critical area. We have a 200 or so plus hole on the alternative 
minimum tax that we cannot fill. But now the Administration 
proposes some tax that we are supposed to assume will arrive in 
a bipartisan fashion to produce $435 billion so that we can 
have a massive increase in highway spending. And I just have to 
say that is unrealistic, Mr. Secretary. I am sure that when you 
were in the room--I have no idea directly, but I am confident 
over the stimulus bill that you were advocating for as much for 
highway infrastructure as you could get. But the final decision 
was not enough, and we are placing this country at risk. In all 
honesty, I do not think--if you cannot tell us what kind of tax 
you think would fund this and prepare to defend it, I think 
there is zero chance of us passing such a tax as this. And so 
we are dealing with the question, will we just borrow it again 
or not have enough? Or what will we do?
    Mr. Chairman, I think that is a fairly honest statement of 
where we are from my perspective, and it leaves us in an 
unhappy place with regard to transportation infrastructure. I 
look forward to questions as we go forward.
    Chairman Conrad. Thank you, Senator Sessions.
    We will turn now to the Secretary for his opening statement 
testimony, and then we will go to colleagues for questions.

    STATEMENT OF THE HONORABLE RAY LAHOOD, SECRETARY, U.S. 
                  DEPARTMENT OF TRANSPORTATION

    Secretary LaHood. Thank you, Mr. Chairman. Chairman Conrad, 
Ranking Member Sessions, Senator Wyden, I appreciate the 
opportunity to discuss President Obama's fiscal year 2012 
budget request for the U.S. Department of Transportation. 
Joining me today is our Chief Financial Officer Chris Bertram, 
who is an alum of this side of the Capitol.
    Just a few weeks ago, President Obama delivered a powerful 
message in his State of the Union address. He said that for 
America to win the future, our citizens and companies need the 
safest, fastest, most reliable ways to move goods and 
information. He reminded us that if we build it, they will 
come. If we want businesses to open shop and hire our family 
and friends and neighbors, we have to invest in our roadways, 
railways, and runways. We have to invest in 21st century buses, 
street cars, and transit systems, and we have to invest in 
next-generation technology for our skies and sidewalks and bike 
paths that make our streets more livable. And all of this is 
included in the President's $129 billion 2012 budget for the 
U.S. Department of Transportation. Designed as the first 
installment of a bold 6-year, $556 billion reauthorization 
proposal.
    Now, to make room for these essential investments, 
President Obama's 2012 budget proposes the lowest relative 
level of domestic spending since President Eisenhower was in 
office six decades ago. That was ten administrations ago, if 
you are counting. The simple fact is that we have to cut and 
consolidate things that are not growing the economy, creating 
jobs, or making it easier to do business in order to pay for 
the things that are.
    So at the Department of Transportation, President Obama's 
budget slashes red tape. It consolidates more than 50 programs, 
and it includes reforms that will accelerate project delivery 
and empower local communities.
    Of course, our major objective is to make investments in 
tomorrow that expand economic opportunity today, to dream big 
and to build big. And to illustrate that, if you look at the 
cover of our budget, you see a picture of a bridge over the 
Hoover Dam, which several months ago some of us had the 
privilege of cutting the ribbon on and dedicating. This is 
thinking big. This is a bold vision. This is a vision that the 
people who came before us had about transportation. This put 
thousands of people to work building this bridge. And it is a 
21st century opportunity for infrastructure to connect two 
States and a magnificent structure, and I think it really 
reflects the big, bold vision that the President has.
    Our major objective is to make investments in tomorrow that 
expand economic opportunity for today, to dream big and build 
big. That is why the budget keeps us on track toward a national 
high-speed rail system with an $8 billion investment in 2012 
and a $53 billion investment during the next 6 years. It 
increases resources for highway and bridge improvements by 48 
percent and increases funding for affordable, efficient, and 
sustainable bus, street car, and transit systems by 126 
percent. It includes a $50 billion up-front boost to keep our 
economy moving in the short term and a $30 billion annual 
infrastructure bank that will finance major projects of 
national and regional significance over the long run. It also 
unleashes innovation and competition with a new $32 billion 
grant program called the Transportation Leadership Awards.
    At the same time, safety is and always will be our No. 1 
priority. President Obama's budget renews our commitment to 
prevent traffic crashes with resources for ongoing campaigns 
against distracted driving, drunk driving, and to promote seat 
belt use. The President's proposal requests new authority for 
the Federal Transit Administration to ensure the safety of rail 
transit riders across America, and it gives the Federal Motor 
Carrier Safety Administration stronger capacity to keep 
commercial traffic safe.
    Finally, we are dedicated to doing all of this without 
passing on another dime of debt to our children or 
grandchildren. For the first time, transportation spending will 
be subject to PAYGO provisions that ensure that the dollars we 
give out do not exceed the dollars coming in.
    So these are just a few components of the President's plan. 
They reflect a much larger point. America's transportation 
system is at a crossroad. Our choice is not between policies on 
the left or policies on the right. Our choice is whether our 
economic recovery rolls forward or falls backward. It is up to 
us whether we lay a new foundation for economic growth, 
competitiveness, and opportunity, or whether we settle for a 
status quo that leaves America's next generation of 
entrepreneurs, our children and grandchildren, with clogged 
arteries of commerce.
    It is up to us whether we do big things or we do nothing. 
And if we choose wisely, our legacy can be an economy on the 
move and a future that America is prepared to win.
    With that, Mr. Chairman, I will be happy to answer your 
questions. Thank you very much.
    [The prepared statement of Secretary LaHood follows:]



    Chairman Conrad. Thank you, Mr. Secretary.
    Let me begin where I ended, and that is with this chart. 
Matt, if you can put that up?
    This is kind of the harsh reality that we all confront. It 
is not anybody's fault. It is because of a changing of 
transportation financing in this country.
    The green line is the revenue of the trust fund, and 
basically it goes from $36 billion a year to $40 billion a 
year, basically flat for the entire 6 years. And we have a gap 
before we ever enter this 6-year period, as can be seen in 2011 
where the expenditures were $43 billion, which Senator Sessions 
mentioned, and the income was $36 billion. So we start with a 
gap of $7 billion, and that gap grows dramatically as we go 
toward 2021, 10 years out. So a $7 billion gap per year turns 
into a gap of $18 billion. That is under the baseline. That 
just takes the current program and extends it. That does not 
capture what the President is proposing, which is an actual 
increase.
    So the question that we have before us is: What are the 
options for closing this gap? And what is your assessment of 
how realistic those various options are? That is really my 
first question to you. What do you see as the options for 
closing this gap? And what is your assessment of how realistic 
those various options are?
    Secretary LaHood. Well, look, the Highway Trust Fund is 
deficient. There is no question about it. People are driving 
less. They are driving more fuel-efficient automobiles. We know 
that. And as things continue to stay stirred up in the Middle 
East and countries that produce crude oil, we know that 
gasoline prices are going to continue to go up, and probably as 
a result people will be driving maybe even less frequently than 
they are today. It is probably not going to help us in our 
collection of the gas tax.
    The Highway Trust Fund helped us build a state-of-the-art 
interstate system. There is no debate about that. We have one 
of the best interstate systems anywhere in the world, and we 
want to work with Congress on our way forward.
    I think the one thing that people ought to recognize is 
that our budget is a budget that will put people to work. For 
the $48 billion that we received in the economic recovery plan, 
we created 15,000 projects and 65,000 jobs. Our money actually 
helped people build roads in your States.
    We know that the work that we do and that our budget will 
reflect will increase jobs, increase opportunities to get 
economies going in the States. And, Mr. Chairman, we want to 
work with Congress on the way forward. There can be no dispute 
about the fact this is a big, bold plan. This is a big vision, 
thanks to the President, because the President recognizes this 
is a jobs bill. When you all pass a transportation bill or pass 
our budget, you are going to create jobs. That is the one thing 
that everybody recognizes. There is no debate about that.
    So we want to work with you on trying to find the resources 
that we know will put our friends and neighbors to work 
building our infrastructure and creating a 21st century 
transportation system that really reflects the values for the 
next generation the way that, you know, others did for our 
generation.
    Chairman Conrad. Well, I agree with your basic statement 
here. I mean, there is no question in my mind that these 
highway funding initiatives, bridge funding initiatives, 
transit funding initiatives create jobs, create jobs in the 
United States, and they are also critically important to our 
competitive position.
    Do we have an assessment of what the lost productivity is 
because of a deficient infrastructure system in terms of 
transportation?
    Secretary LaHood. You know, I do not have that figure, but 
we will see if some of our smart people can get that for you. I 
have never really heard that articulated in the Department, but 
I am sure we can find it.
    Chairman Conrad. You know, I would be very interested. I 
ask the question because any day after 4 o'clock, if you leave 
here and you go out on the major arteries--395, 295, 95--often 
as not they are stopped dead. And I see trucks delivering goods 
across the country. They are idle. They are stopped dead in 
their tracks. There has to be an economic cost to that. And I 
believe the economic cost must be substantial because on the 
east coast and the west coast, these arteries are clogged.
    Let me go back to the first question I asked because you 
answered about the importance of doing what has been proposed. 
The question we have on this Committee is: how do we pay for 
it? And, of course, we cannot direct the funding committees on 
how to raise the money. We can tell them how much money to 
raise. We cannot tell them how to do it. But we have to give 
them--to be credible, we have to give them some options. Do we 
do a gas tax? Do we move to some kind of an assessment that is 
based on how many miles vehicles go so that we capture revenue 
from those who are going to be using the roads who are not 
going to be paying any gas tax or very little with hybrids and 
electric cars? Do we go to more tolling? I have just had, as I 
told you, the head of my transportation department back home, 
Francis Ziegler, in to see me yesterday. He said, ``Kent, in 
North Dakota, tolling does not work at all.'' It does not make 
any sense in a big, wide open State like ours, sparsely 
populated.
    What options do you see--are there options that I have not 
listed there that we should be thinking about?
    Secretary LaHood. Mr. Chairman, tolling is an option--not 
in every State. I just met with the two Governors of Oregon and 
Washington. They are proposing to build a bridge across the 
Columbia River. It is a great project. It is about as 
multimodal as you can get. And there is going to be a transit 
system that runs across that bridge. There is going to be 
availability if somebody wants to ride their bike across the 
bridge, and there is going to be availability for people to 
drive across that bridge. And they are going to pay for part of 
it with tolling. They are going to pay for part of it with 
State resources. They are going to pay for part of it with 
Federal resources. But tolling is a good way for those two 
States to, you know, think big and dream big for this Columbia 
River crossing.
    Chairman Conrad. But you would acknowledge that in some 
States tolling is really not a very viable option.
    Secretary LaHood. I do not think it probably works in your 
State, Mr. Chairman, but there are a lot of States where it 
does work. And you know what? A lot of States are thinking 
about adding capacity, taking an interstate that was built with 
taxpayer money, putting a couple additional lanes on it, and 
tolling that. They have done that in Miami where they call it a 
``hot lane.'' They built a lane, and they toll it. And you can 
raise a lot of money and actually pay for a project like that.
    We support that kind of opportunity where you can add 
capacity and use tolling to help pay for it. And then, you 
know, leverage that with maybe some money from our Department, 
leverage it against maybe some private dollars.
    Look, our idea is this. The Highway Trust Fund is going to 
be around. It is deficient. We know that. Tolling, couple it 
with tolling. We have a TIFIA loan program that people--the 
President has talked about in his budget the Infrastructure 
Bank with significant, billions of dollars. You leverage all 
those together, you can begin to do big things in America. 
People can then think about dreaming big again.
    Does that get us to everything we want or everything that 
we think is necessary? No. That is why we need your help on 
this.
    Look, I agree with what Senator Sessions said. If some of 
us had been writing the stimulus bill, there would have been 
more than $40 billion. We spent every one of those dollars the 
way that you all directed us. No boondoggles, no earmarks, no 
sweetheart deals. You have not seen any bad stories written 
about the $48 billion. And what it did, it created 15,000 
projects that put 65,000 people to work over 2 years that would 
not have had a job if you all had not given us that authority 
and given us that money. The stimulus worked.
    Chairman Conrad. I can say--and then we will turn to 
Senator Sessions because my time is over--I remember very well 
the battle. A group of us proposed a $200 billion 
transportation package as part of the overall stimulus plan, 
and we lost that fight. But we did not lose it because you 
opposed it. You did not oppose it. You were an ally. So I think 
that should be stated publicly. There were others who did 
oppose it, and I remember them well.
    Senator Sessions. Well, we lost. The President and the 
leadership kept the highway transportation money at a minimum 
and it was a tragic, tragic thing, because one thing about a 
road, as you know, Mr. Secretary, once it is built, it can be 
used for generations. It is an asset that continues to help us 
be more productive and happier as a society and I think that is 
important.
    So I know you are passionate about roads, but we have a 
problem now. We had our opportunity and it lost, passed, and 
now we have a budget that says how we are going to fix this 
with a $435 billion new phantom tax, the ``not gas tax'' tax, 
and I do not believe that is going to be successful and we have 
to wrestle with how we are going to proceed there.
    Another thing I think is important for us to acknowledge, 
Mr. Chairman, since we are a Budget Committee and we received a 
budget as required by law from the White House, that this is 
another huge gimmick in the budget. Since it does not suggest 
how and where this tax is going to come from, CBO is not going 
to score it as income as the Administration scores income. They 
are proposing a spending plan for roads and they are proposing 
to pay for it with a tax increase they will not even explain 
what is, and the money is not going to come in. It is just kind 
of Washington budgeting, this kind of Washington logic that has 
put us in this financial crisis we are in, and we cannot 
continue it.
    We cannot go forward on the bald assumption that, somehow, 
we can appropriate and authorize spending based on a tax that 
is not going to be collected, probably. We have a lot of things 
in this country we have to raise money for, and I will tell 
you, the doctors so they take care of our Medicare patients is 
one of them, and there is a lot of money there.
    Well, you have said, Mr. Secretary, that the budget would 
collect more revenue. It is definitely not a gas tax. So where 
will the money come from?
    Secretary LaHood. Well, Senator, as I said earlier, we want 
to work with Congress on that, and we are happy to work with 
you. We are happy to be a part of the debate and happy to work 
with you. I think the President has made it clear that he is 
not in favor of raising the gas tax when we have 9 percent 
unemployment in this country and a lousy economy in many places 
in the country, but look, we are----
    Senator Sessions. Well, do you have any suggestions?
    Secretary LaHood. You know, Senator, I think what we need 
to do is to sit down together and figure this out and we are 
willing to do that.
    Senator Sessions. Well, sitting and figuring out is a 
little late when you have a budget that assumes it is going to 
be done when it is not going to be done. We just are not going 
to be able to raise that much tax to meet this need when we 
have a lot of other departments that have needs, too, 
particularly when you are talking about a 62 percent increase 
in spending next year--62 percent, on top of the $48 billion 
total that went to roads and transportation--$27 billion only 
actually went to roads, about 3 percent of that total stimulus 
package. And so I do not think we are going to get there and I 
think we are fooling ourselves and I think we are putting 
ourselves, from a budget perspective, do you not, on a 
dangerous course that could lead to increased spending without 
any revenue to pay for it.
    Secretary LaHood. Look, Senator, here is what I think. I 
think this. I think that what we do in transportation will put 
our friends and neighbors to work. This is a jobs bill. This is 
a jobs budget. That is what this will do. And we have--in 
America, what we have never done is been dissuaded by the fact 
that we do not have--we are not smart enough to figure out how 
we get there. If we really want to get the economy going, if we 
want to build roads and bridges, if we want to really improve 
infrastructure, there are a lot of smart people previously, 
other leaders, that have done it. And we can do it, too, and we 
are willing to do it. We are willing to sit at the table----
    Senator Sessions. Well, Mr. Secretary, we have been----
    Secretary LaHood [continuing]. With you and figure it out.
    Senator Sessions. We have tried this and we have had, I 
have no doubt, some jobs created with the stimulus package. It 
is impossible to spend that much money and not create some 
jobs. I think, percentage-wise, we probably did more jobs per 
dollar on the highway side than we did on all the other 95 
percent that was spent. I am totally confident of that.
    But we do not have the money. We are borrowing 40 cents out 
of every dollar we spend. We do not have the money to go a 
massive new program. So if we do not have a tax increase, do 
you propose borrowing the money?
    Secretary LaHood. Here is what I propose. What I propose is 
that a budget is a reflection of the Congress's values, and 
this President's budget on transportation is a realization that 
if you pass a very strong transportation program, you recognize 
that it will put people to work. It will get our economy going. 
It will set priorities. The President has a pretty big view 
about this.
    Senator Sessions. Well, we have some priorities and views 
and one of them is to get the country's fiscal house in order 
before we go bankrupt and have a debt crisis----
    Secretary LaHood. Well, look at----
    Senator Sessions. --Geithner sitting right there a few days 
ago indicated that not only is this debt that we are increasing 
dramatically reducing economic growth, and he agreed with the 
studies that show that, he said it places us at risk of a debt 
crisis, another fallback, perhaps, to another recession, and 
this would be a tragic thing for us. So we just--obviously, we 
cannot unlimitedly borrow money.
    Now, the proposal is to double spending on highways over 
the 10-year period, basically. In this time of financial 
crisis, are you asserting that education gets a 10-percent a 
year, I suppose, energy gets an increase, and you all get to 
double the transportation budget?
    Secretary LaHood. I think this is a reflection of the 
President's values. That is what I think. This is a--our budget 
is a reflection of the idea that if you put people to work, 
what are they going to do? They are going to pay taxes. Some of 
those taxes are going to come to the United States. What is 
that going to do? That is going to improve our fiscal situation 
here.
    Look, you can pay down some debt and the President wants to 
do that. You can also have transportation priorities that puts 
Americans to work building American roads and bridges. You can 
do both, Senator.
    Senator Sessions. We are not going to pay down a dime of 
debt. I cannot believe that the President continues to insist 
that we are going to be paying down debt on this budget. The 
lowest annual deficit is $600 billion added to the debt. All of 
this borrowed. This money is going to be borrowed if it is 
spent because we are not going to have this kind of tax 
increase, so we have a problem.
    I really respect your passion and interest, but I do 
believe that this Congress has a high priority to have fiscal 
sanity in this Congress in spending and we have to work at it 
and it is not going to be easy.
    Chairman Conrad. Senator Whitehouse.
    Senator Whitehouse. Mr. Secretary, thanks for being with 
us.
    Secretary LaHood. Good morning.
    Senator Whitehouse. Good morning. You have been to Rhode 
Island to visit Senator Reed and myself and you are aware of 
our circumstances, how difficult the State budget is there, how 
difficult our unemployment situation is there. We are still at 
11.5 percent unemployment and it has been that way a long time. 
We have the so-called 99-ers who have run out their 2 years, 99 
weeks of unemployment and are stranded now. It is a tough 
situation.
    We have a couple of potential bright spots on the horizon. 
I want to make sure that they do not get snuffed out. One of 
them is our TIGER II grant that goes to the Port of Providence 
to buy new cranes because our cranes are so decrepit, and that 
will, it has been estimated, add 550 jobs just in Rhode Island, 
another nearly 1,000 jobs around the country because of the 
activity that having those cranes in place as infrastructure 
will generate.
    Our predicament is that that is being held up right now, as 
I understand it, while we get a ``Made in America'' waiver for 
the cranes, and my worry is with all the sweeps that are being 
threatened here, I do not want to be in a situation in which 
this account gets swept while this money is unobligated because 
we have not sorted through the waiver when it should be an easy 
call. We got the waiver already on the TIGER I grant, which was 
also for a crane down at Quonset, and the reason we got the 
waiver is because no matter how you slice and dice the 
information, nobody makes a crane in America any longer. It 
just cannot be done. That should be a 2-minute discussion, 
already decided on TIGER I. There ain't no crane out there to 
buy. Please, if you can do anything you can to expedite this so 
we can move it through, obligate it, and make sure that we do 
not lose that funding.
    Secretary LaHood. Senator, I told our Deputy Secretary to 
sign the waiver today. It is already--it was signed this 
morning.
    Senator Whitehouse. I am delighted.
    Secretary LaHood. I knew you were going to bring this up, 
and I am sorry that we have delayed and caused so much 
heartburn about this, but it is signed.
    Senator Whitehouse. Perfect. Perfect.
    The second thing up there is high-speed rail. We have 
common cause here on high-speed rail. I think we all recognize 
that when, in the Eisenhower administration, we took a national 
move to high-speed road and built a national highway system, it 
was one of the best things ever done for our economy. It 
exploded growth in shipping, lowered costs, created enormous 
industry that uses that infrastructure to this day.
    So now that we had our high-speed road moment, it would be 
great to have also a high-speed rail moment, and there is no 
place that is more important than in the Northeast where that 
rail corridor gets used so much, creates so much value, is such 
an important core, spine of transportation infrastructure. What 
can you tell us about where you are on Northeast corridor high-
speed rail?
    Secretary LaHood. Well, we believe that the Northeast 
corridor is--not only exists currently as a very viable rail 
connection for many, many people and takes a lot of cars off 
the road in the Northeast corridor, we like the plans that take 
us well beyond, all the way to the Canadian border and further 
south through the Carolinas, all the way to Florida. That is 
our dream. That is our vision. If you look at the President's 
budget, 50----
    Senator Whitehouse. We particularly like that Boston to New 
York corridor.
    Secretary LaHood. I have it. We like Boston to New York, 
also. But if you look at the President's--look, nobody has a 
bigger, bolder vision of this than President Obama does. We 
would not be where we are at. We have invested $11 billion 
already. That is more than has ever been invested in high-speed 
rail, ever in the history of the country, thanks to the 
President and the Vice President.
    Senator Whitehouse. I appreciate it. I think it is a great 
thing.
    Secretary LaHood. And there is $50 billion in the 
President's budget over the next 6 years for high-speed rail. 
That is more than has ever been invested. We are with you. We 
are on the track with you on this.
    Senator Whitehouse. Good. And as we have seen some of the 
newly elected Governors decide that they do not want money from 
the Federal Government on this, even though it has been 
allocated to them, when Governors turn back this money, I hope 
that you will quickly reallocate it to places like the 
Northeast corridor that do want it and it will have----
    Secretary LaHood. What we intend to do, Senator, is when 
States decide they do not want the money, we are going to make 
it available throughout the country so everybody has a fair 
shot at it. We think that is the only fair way to do it.
    Senator Whitehouse. Good. I appreciate it. And obviously, 
the quicker that can be turned around and the quicker other 
States can get access to that, the better, and I am confident 
that in the Northeast, we will be able to make a compelling 
presentation as to why----
    Secretary LaHood. I have no doubt of it.
    Senator Whitehouse [continuing]. The Northeast corridor is 
critical. Thank you very much.
    Secretary LaHood. Thank you.
    Senator Whitehouse. Thank you, Mr. Chairman.
    Chairman Conrad. Senator Thune.
    Senator Thune. Thank you, Mr. Chairman. Mr. Secretary, 
great to have you with us.
    Secretary LaHood. Thank you.
    Senator Thune. Thank you for your service and your spirited 
answers to these questions today.
    I want to--and I do not want to beat a dead horse, because 
I know it has been talked about already at some length, but I, 
like my colleagues who have spoken before, am concerned and 
somewhat mystified at why we did not do more in the area of 
infrastructure out of the amount of money that the stimulus 
provided. I mean, you look at just over 5 percent was spent on 
transportation and what could have been done in terms of 
addressing these shortfalls that we have and this year over 
year shortfall that we are now experiencing in the Highway 
Trust Fund, which is a problem. We are transferring now out of 
the general fund to the Highway Trust Fund.
    And the budget, as I understand it, suggests that 
significant increases in spending and a highway reauthorization 
bill, which I hope we can get to this year, but increases 2012 
spending on surface transportation by 86 percent over 2010 
levels. It also includes a $50 billion front-loaded 
transportation infrastructure plan for 2012, which, I think, as 
again is mentioned, sounds more like another stimulus program.
    But I guess the question I come back to is the issue that 
has already been raised. There has not been any--there is not 
anything in this proposal, and you have said several times your 
proposal does not include any more revenue raised from the gas 
tax and that that is not an option the Administration is open 
to, so where does the increased revenue come from? How do you 
pay for all this stuff? If you do not tax gasoline, how do we 
do it?
    Secretary LaHood. Well, we have to think creatively and we 
have to figure out ways to pay for this. We think that it can 
be done the way that things are done around here, when people 
sit around a table together and put creative ideas on the 
table, and I think that will be done when the Congress gets 
around to writing a transportation bill. We hope we are in the 
room and we hope we can be part of finding the revenue to do 
it. We think that is the way we get there.
    Senator Thune. Do you have any more specific ideas? Does 
the Administration have any suggestions that they would like to 
offer up, because historically, this has always been a--this is 
a gas tax issue. It is a user fee, basically. And obviously it 
is not keeping up with the demands. You saw what the Chairman 
put up in his chart and how big that thing gets to at the end 
of the decade. It is a $28 billion shortfall. Clearly, that is 
going to take a significant amount of revenue, and although we 
all appreciate, I think, the budget and its recognition of the 
needs that are out there, not having a way of funding it seems 
like many of the aspects that we have seen in this budget, and 
that is these proposals just do not have funding sources.
    I mean, it seems to me, at least, that the Administration 
has kicked the can down the road on a lot of the big issues 
that we are facing. This is one of many. But do you have any 
ideas? Has there been any discussion on your end of this about 
how we might--what kind of a funding mechanism or source we 
might come up with?
    Secretary LaHood. Well, we have had lots of discussions 
privately with Members of Congress about this, particularly 
members who believe that the investments the President is 
proposing are absolutely critical to continuing the progress. 
And as the Congress gets serious and really begins to sit down 
and write a bill, you know, we want to be there. We want to be 
a part of the discussions and we want to be a part of finding 
ways to continue to make these investments, to put friends and 
neighbors around the country to work building roads and 
building bridges.
    Senator Thune. Let me ask you, and I appreciate the answer, 
although there is a complete lack of specificity or any hard 
solutions, in my view, about how we deal with this. The 
suggestion that we have to be creative is great, but----
    Secretary LaHood. We like your Build America Bonds program, 
Senator. I know you and Senator Wyden have promoted that. It 
has been a good program. It has worked very well. Lots of 
States have taken advantage of it. I mean, look, that is one 
way to get some additional money. I talked about tolling. I 
talked about the fact the President has put the Infrastructure 
Bank on the table. And so it is not as if you all have not come 
up--you and Senator Wyden have come up with this very creative 
way of--and it has worked, and we think the Infrastructure Bank 
is also another creative way of thinking about funding some of 
these things. The specific pay-for, we are willing to be in the 
room and have these discussions and debates.
    Senator Thune. I am not a big fan of the Infrastructure 
Bank, as you might expect. I think that we are going to see 
that probably is going to benefit primarily largely 
metropolitan areas.
    But the other thing I wanted to express a concern about is 
the $53 billion plan on passenger rail investment over the next 
6 years. As someone who represents a rural State, the budget 
proposal is concerning when you look at the much faster growth 
in proposed spending for transit and passenger rail investment. 
I, frankly, do not think that if you get west of Boston or east 
of San Francisco that you are going to see much transit 
investment, and at the same time, the transit programs within 
the DOT do not contribute to the Highway Trust Fund when it 
comes to user fees. And as I understand your proposal, it 
allows transit systems to use funding for O&M. That, to me, is 
very concerning, given the fact that transit does not 
contribute to the Highway Trust Fund.
    Secretary LaHood. Well----
    Senator Thune. In rural areas of the country, we are not 
anticipating we are going to see any high-speed rail anytime 
soon.
    Secretary LaHood. Well, I hope you also looked at the idea 
that we increased the spending on highways by 48 percent. In 
over 6 years, it is $330 billion. We get it. Look, at DOT, we 
know how to work with our partners in the States to build roads 
and bridges and the President has asked--requested huge 
investments and a huge increase to build roads and bridges for 
States like yours, Senator. We get it. We know that there is 
crumbling infrastructure. We want to be helpful on that. We 
have great partners in the States. We worked with those great 
partners on spending $48 billion, of which $28 billion was for 
roads and bridges, and we did it the right way because of our 
friends in the State that have partnered with us on these 
things. We believe in roads and bridges, and if you look at the 
increase, it is significant.
    Senator Thune. OK. Well, thank you, and my time is 
expiring, but again, I just come back to the proposed increases 
are great, but at some point, the Administration is going to 
have to lead in figuring out how we pay for this stuff. Thank 
you.
    Chairman Conrad. I thank the Senator for respecting the 
time.
    Let me just indicate, Senator Wyden is next, then Senator 
Cardin, Senator Coons, Senator Sanders, Senator Warner.
    Senator Wyden. Thank you, Mr. Chairman, and welcome, Mr. 
Secretary. I just want to followup on that last point with 
respect to Build America Bonds, because as you know, they just 
went out the door like hotcakes. We estimated that, given the 
fact that we never tried anything like this in our history--
Senator Conrad will remember this--in the Finance Committee, I 
was asked to give an estimate of what we might do in the Build 
America Bonds area, and I said, oh, maybe $8 or $10 billion, 
and as you know, it was $181 billion, I mean, something like 18 
percent--exceeding an 18-fold increase in terms of 
expectations.
    Now, the question is, where do we go from here, and Senator 
Thune asked the right question and that is where are we going 
to look to try to get additional funds. And I think it would be 
possible to again build a bipartisan coalition for Build 
America Bonds if we get them to focus only on transportation. 
And I have talked with a number of my colleagues on both sides 
of the aisle about this. We are looking at the numbers that 
have come in so far and it looks like Build America Bonds just 
for transportation purposes over this experimental period of 
time exceeded the amount that went out under the Recovery Act. 
So the Recovery Act was $48 billion and we think--the numbers 
are still coming in--that it was well over $50 billion just for 
transportation alone, Build America Bonds.
    And for colleagues that are interested in this, in our 
State, where they really kept track of the numbers, they 
estimated there was a 10-percent savings associated with this 
compared to the traditional level of bonds. So a chance to do 
more work, A, get additional revenue, and save money at the 
same time.
    My question to you, Mr. Secretary, because Senator Thune 
has been a wonderful partner in it, and, as you know, many 
Republicans have been involved in this going back to Senator 
Talent and Senator Dole and Senator Vitter, we have had a whole 
lot of Republicans involved in this, and I think we could get 
this again to be a bipartisan program if the Administration 
would say, look, it has been wildly successful as it related to 
transportation. New money, savings. We will, for purposes of 
bringing the Congress together, put it solely to 
transportation, and I have mentioned to Senator Thune, perhaps 
we could rebrand this. We could call them TRIPS bonds, 
Transportation and Regional Infrastructure bonds, so that 
everybody would walk away and see that we are trying to get a 
good concept which has been successful confined to 
transportation and have a chance to answer the question asked 
by Senator Sessions, asked by Senator Thune, where we have had 
bipartisan support. What is your take on that in terms of 
trying to bring folks together once again as we were able to do 
over the years?
    Secretary LaHood. Well, as I said, Senator, I congratulate 
both you and Senator Thune for your leadership on this. I know 
there are other Senators involved in this. This is a very good 
stream of funding and we will work with you in any way we 
possibly can because we think this is one of the options that 
needs to be out there to pay for all the things we want to do.
    Senator Wyden. What is going to be our challenge in the 
Administration? Part of it--I discussed this with some of my 
colleagues on the other side of the aisle--this was so 
attractive to the private sector that people automatically 
said, well, let us see if we can look at it for other kinds of 
approaches, and that is when some of the bipartisan support 
seemed to drift away, is people just saw it being used in a 
variety of other kinds of areas. Do you think within the 
Administration you can get people to say that the 
transportation need is so great, No. 1, and getting this back 
to having bipartisan support is just as important, that you can 
get the Administration to help us as we build a bipartisan 
coalition, say we will go just with transportation given the 
fact that the need is so acute?
    Secretary LaHood. Well, I will commit to say this, Senator. 
I will work very hard within the Administration to make the 
strongest case that I possibly can that this ought to be 
dedicated to transportation. Now, whether I can get there or 
not, I do not know, but I know this. There is a shortfall. The 
President has a big vision. We need to find the resources to 
pay for it. Your Buy America Bonds have been wildly popular, as 
you knew they would be and Senator Thune knew they would be, 
and they have provided a great resource to get some significant 
things done.
    Senator Wyden. I appreciate your willingness to do this 
because I think Senator Thune and a number of Republicans are 
very interested in working in a bipartisan way on this issue. 
We worked through some of the kinks early on. There were 
questions about fees early on. Now we have seen no one raise 
concerns about that. The one concern has been, is this going to 
be used as an open-ended approach to fund all kinds of other 
services in government, and I hope we can get back to what 
essentially Senator Talent and a big group of Democrats and 
Republicans started dreaming about six, 7 years ago.
    I think it is clear it has worked, No. 1. I think the other 
approaches are going to be a huge lift in terms of getting 
bipartisan support. Colleagues are asking for details about 
Infrastructure Banks and the like. This is something we know 
works. We know there are not a lot of rallies outside our 
offices to raise the gas tax in this kind of economy. We know 
that to have big league economic growth, you have to do 
something about little league transportation systems. And my 
hope is that as you go forward, you can convince the cabinet 
and the Administration to say that this is the area that will 
produce the most jobs most quickly.
    You have been to Oregon. You can go around our State and 
see all kinds of folks across the political spectrum, some of 
our most conservative business leaders working with labor 
leaders around Build America Bonds because, they say, this is 
something that has actually made a difference. And if we can 
get it back to its original focus, I think we will have an 
answer to Jeff Sessions's questions, the point that Senator 
Thune was making. I think they were raising logical concerns 
and we can come together in a bipartisan way and I am grateful 
for what you have said today.
    Secretary LaHood. Thank you for your leadership, and to 
Senator Thune, also.
    Senator Wyden. Mr. Chairman, thank you.
    Chairman Conrad. Senator Cardin.
    Senator Cardin. Well, thank you, Mr. Chairman. Secretary 
LaHood, it is nice to have you before the Committee.
    Secretary LaHood. Good morning.
    Senator Cardin. I am going to give you a little different 
view than Senator Thune on the transit issues, but first let me 
say that I support the budget, the more robust budget that you 
come in with for transportation infrastructure. I think that it 
is critically important for our Nation to be as competitive as 
we need to be. It is about jobs. It is about outbuilding our 
competitors. And I think that we need to find a way to make 
sure we can finance that.
    I also want to applaud you on the multimodal approach that 
you have. Look, we cannot do it by roads alone. We cannot do it 
by transit alone. We need to invest in smart transportation 
that allows us to recognize the different needs in rural 
America and in urban America.
    But I just really want to urge you to continue aggressively 
on the transit funding, and I really want to respond to Senator 
Thune's point.
    You know, it is interesting. In the prospectus that GSA 
puts out for Government space in this area, a high priority is 
given to locate a space on a transit line because the Federal 
Government understands that we do not have the resources to 
build all the parking lots that we would need in order to take 
care of people using the highways. If we had all of our Federal 
workers on the highways, they would never get there because we 
do not have enough roads.
    If you take a look at the dollars--and maybe you should do 
this for us--as to how much more you would have to spend in 
highway maintenance if we did not have a transit system to deal 
with people getting to and from work. You know, we are building 
a new road in Maryland, the ICC. That is going to cost close to 
$3 billion. So transit saves us highways and highway 
maintenance dollars and allows us to have a way that we can 
bring our communities together.
    I would last point out on this argument of rural versus 
urban, in our State, on the eastern shore and in western 
Maryland, transit is critically important. They understand 
that. Now, maybe we could be more effective in rural 
communities on transit, and we should look at that. But it is 
important in Salisbury, it is important in Cumberland, 
Maryland, to have transit to get people to and from work.
    So I just want to urge you to keep focused on it, and I 
have not even gotten to the other issues of our national 
security, of using less energy and a cleaner environment. So 
this is an important issue for our Nation, and I just want the 
Chairman to understand that this Senator is going to continue 
to fight for adequate infrastructure financing for all the 
modes of transportation because I think we need--it includes 
also our bill we just passed for the airports, the port 
modernization, and rail.
    In rail, we need to get to the next generation. Thank you 
for what you are doing on high-speed rail--I think that is 
important--for inner city rail. All of the above we are going 
to need if we are going to be able to have a sensible transit 
project.
    With Senator Warner here, we live in the second most 
congested area in the country, and we all, I think, have a 
responsibility because the Federal Government is mainly 
responsible for the transportation challenges we have in this 
community. And it is important that the Federal Government 
maintain its responsible share in dealing with the transit 
costs. We are going to be talking about that because the House-
passed budget did not. And we are going to fight for the 
Federal Government doing what it is responsible for. We do not 
want to see newly created unfunded mandates to local 
governments as a result of what is coming out of the House of 
Representatives.
    Now, I had one question which was dealing with groundwater, 
storm runoff. I have asked you about this before. I have the 
honor of chairing the Water and Wildlife Subcommittee on the 
Environment and Public Works Committee, and we need partner 
wherever we can. And high construction--and I really do applaud 
you because we are using the best practices. It can make a 
major difference on the amount of storm water that runs off in 
a very inefficient way, or in an efficient way, and the way we 
do our highways can be critically important.
    So I just really want to get your reply as to how you see 
the priorities in your agency helping us deal with the proper 
management of storm water.
    Mr. LaHood. Well, as you know, Senator, we stole away from 
your State your Secretary of Transportation, John Porcari, and 
he is our Deputy Secretary now, and he knows these issues 
intimately, having worked on a number of road projects in your 
State. We are committed to work with the EPA and work through 
the environmental impact statements to make sure that whatever 
responsibilities we have to take in terms of providing the 
resources to make sure that when the construction takes place 
there is the right, you know, avenues for water and runoff and 
all of those things.
    You know, our commitment is to work with the other agencies 
to make sure that it is done correctly and properly and that we 
provide the resources to do that.
    Senator Cardin. I thank you, because the private sector 
really looks to what we do in Government, and if we do not set 
the example--we have done that on our energy standards. We need 
to do it on our environmental commitments on storm water. It 
can make a huge difference in getting the type of cooperation 
we need from the private sector as they develop their buildings 
and construction to also do the right thing.
    Secretary LaHood. Right.
    Senator Cardin. We have rules, but if the Federal 
Government does not set the example, it makes it difficult to 
get the type of compliance----
    Secretary LaHood. Right. We are committed to that.
    Senator Cardin. Thank you.
    Thank you, Mr. Chairman.
    Secretary LaHood. Mr. Chairman, could I just respond to 
Senator Cardin about transit?
    Chairman Conrad. Oh, please do. Certainly.
    Secretary LaHood. He and Senator Warner have the privilege 
of representing what I believe is, if not the best, one of the 
best transit systems in America. And I will tell you why I say 
that. I was struck when I was on the platform at President 
Obama's inauguration and saw a couple million people out on The 
Mall. Almost every one of those persons was delivered there by 
the Metro system in Washington. It is a magnificent system. It 
was well designed. It is not without its problems, but it is a 
great system. And if you think of all the people that it 
delivers here to Capitol Hill every day and around this region 
every day, it really is a good system, and we support their 
efforts to improve. We are going to provide $150 million to, 
you know, do the fix-up on the infrastructure and help them buy 
new cars, help them buy safer cars. But this is America's Metro 
system, and it is a model for the rest of the country. And we 
have worked closely with your Metro system because we think it 
is one of the best, and we want to keep it that way, and we 
want to make sure it is the safest.
    And that is why, if I can put a plug in, Mr. Chairman, last 
year last year the Banking Committee passed by unanimous 
consent a transit safety bill that gives to the Department of 
Transportation some responsibility that we are currently 
prohibited from doing now, which is looking after safety in 
transit systems around America. And I hope there will be some 
Senators this year that will reintroduce that bill, give us 
that responsibility, because there is nobody in the Government 
looking after transit safety, and we need that. We need that 
responsibility. We need the Congress to give us that 
responsibility. And those of you who represent one of the 
greatest transit systems in America, I hope you will consider 
doing that.
    Senator Cardin. Let me just very quickly, Mr. Chairman, 
agree completely, and that bill, of course, was strongly 
supported by our delegation here, and we want to see you have 
that authority. We have had difficulties with safety issues in 
regards to the Washington Metro system.
    Let me also just underscore the point that the $150 million 
that you have put in the budget, there was a 10-year commitment 
of $1.5 billion. You have carried out that commitment. Now it 
is our responsibility to make sure that stays in the budget. It 
was not in the House-passed budget. We are going to do 
everything we can to make sure it stays in the budget.
    And the last point, I also got to the inaugural through 
rail coming in from Baltimore, so rail is very important to get 
into the city.
    Thank you.
    Chairman Conrad. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman, and, Mr. 
Secretary, it is great to see you.
    Secretary LaHood. Good morning.
    Senator Warner. There are so many places to hit in 6 
minutes and 54 seconds. Let me, first of all, thank you for all 
of your work, but let me start with associating, affiliating, 
and whatever other terms we use my comments and questions with 
my good friend Senator Cardin's. And as a member of that 
Banking Committee that passed that bill out unanimously, I look 
forward to working with your office to make sure it gets 
reintroduced and gets again that kind of support from the 
Banking Committee.
    Secretary LaHood. Thank you.
    Senator Warner. Because it is terribly important. The 
Washington Metro is a great system, but it has had its issues, 
particularly around safety. As a former Governor, this notion 
of where the ball lands in terms of safety was something we had 
never really fully thought through.
    But let emphasize again what Senator Cardin has said, is 
that it has taken--it took a long time for all of the State 
partners to pony up their share, but we got there. And as we 
build out some of these extensions and upgrade the facilities 
on Metro, it is, I think, both for the region irresponsible but 
from plain business planning purposes to kind of have the rug 
pulled out the way the House budget proposes is something that 
we should not allow to happen. And I look forward to working 
with Senator Cardin and I hope a united bipartisan Senate on 
that issue.
    Secretary LaHood. Senator, let me just say, you are very 
modest about this, but when you were Governor, you were one of 
the leaders that made this system what it is today, and you 
should be congratulated for all of your leadership on making 
Metro what it is today.
    Senator Warner. Well, thank you. When we first tried to 
convince our folks in Northern Virginia how we would help pay 
for that share, I got my tail whipped. I wish you had been 
Secretary then to give that support.
    Let me also echo my good friend the Senator from Rhode 
Island's comments with one slight amendment.
    Senator Whitehouse. Is that the southward amendment?
    [Laughter.]
    Senator Warner. One slight amendment. As we have discussed, 
we were concerned in Virginia--I think it is great that we are 
moving forward on high-speed rail, but building out pieces in 
Florida or elsewhere, or to my good friends in North Carolina, 
building out these segments without a connection, without a 
connection to the Northeast corridor that starts from 
Washington up through Boston, to me, you know, did not make 
necessarily all that much sense. And when we think about a 
corridor where we do not have the amount of congestion and 
other issues and more of a straight shot, our Nation's capital, 
down the 95 corridor through Richmond, connecting with Hampton 
Roads and down into North Carolina, I cannot think of a better 
place with higher potential usage and a more willing bipartisan 
support at this point than the Commonwealth of Virginia.
    I know you were able to move very quickly on some of those 
others dollars that came back from the Midwest, but if those 
Florida dollars--and I say this with trepidation and Senator 
Nelson is not here. If those Florida dollars get back in the 
pot--I love my friends in the Northeast, but if we wanted a 
great demonstration example of how to do high-speed rail, we 
look forward to Virginia's application being perhaps more 
competitive than it was in the first round.
    Now let me come to, in my 3 minutes left, something that 
Senator Sessions and I have talked a lot about, and Senator 
Whitehouse as well. We have to figure out how we are going to 
fund transportation, but we have also got to make sure that, 
within our limited dollars of how we fund, we have better 
performance metrics. And I want to commend you and your 
Department for recognizing, I think for the first time in a 
long time, that we have to have performance metrics in our 
allocations; that some of the current formulas and some of the 
current approaches just do not get it.
    I am glad that your proposal includes the establishment of 
performance measures for highway investments and repair 
investments at the FHA. I do think we need more. As you know, I 
have been working with the Bipartisan Policy Center about how 
we make sure that these metrics and data are out there so we do 
not just have these kinds of arguments back and forth, but we 
have actually some ability to evaluate.
    One of the things I think we have to do, though, is make 
sure that these metrics go outside of highway but that they are 
kind of mode neutral. And I would like for you to comment for a 
moment about the whole sense of metrics, how we make sure that 
we have some mode neutrality in this, that we really look at 
moving people and goods as the goal, not simply highway miles 
traveled, vehicle miles traveled, that we look at----
    Secretary LaHood. Well, on both of your points, the reason 
that Virginia is going to be significant in high-speed rail is 
because of your leadership, meetings that you have called that 
we have attended. You are really persuading us that there is a 
lot of leadership in Virginia thanks to you and other members 
of your delegation.
    Senator Warner. Bipartisan support. Let us make sure we get 
that on the record again.
    Secretary LaHood. Absolutely. But, again, you are being a 
little modest here.
    Senator Warner. That is not something I have often been 
accused of, Mr. Secretary.
    Secretary LaHood. I think you have pressed on this, and the 
reason we have really gone to these performance standards is 
because of what you have said to us over the last couple of 
years. We get it. We think it is important. We think it is a 
way to show the Congress and the country that we are just not 
spending their money willy nilly, that we are just not spending 
money because the Congress gave it, but there are performance 
standards, and it will be multimodal and it will be an 
opportunity for us to really measure and judge using good 
metrics to make sure that taxpayer money is being spent in a 
way that reflects the values of the Congress. And we took our 
cues from you on that.
    Senator Warner. You are more generous with your comments 
than the actual record is, but I will take them.
    Let me on the last comment just say I am very intrigued 
with the infrastructure investment bank that you have talked 
about. I do have some of the concerns that Senator Thune has, 
that, you know, we have to make the financing work the right 
way. It is not free money. But some of the existing programs, 
the TIFIA program and others, they do have a tendency to bias 
toward highway. How do we make sure we get that mode neutral 
right in the infrastructure investment bank? My time has 
expired.
    Secretary LaHood. We want to work with Congress on this 
infrastructure bank and make sure we do get it right. And we 
want to make sure that it is money that can be leveraged with 
TIFIA, with tolling, with other opportunities from the private 
sector that want to make investments.
    It would not be the sole source of funding. What it would 
leverage is tolling, TIFIA, private sector money, maybe some 
State money, maybe some additional Federal money out of 
highways or something. So it really is--we think it is an 
opportunity to leverage some additional money and really get 
some other players involved. And that is the way we see it.
    Senator Warner. My time is up, but do you see this bank 
being transportation only, or do you see it ultimately 
migrating to include smart grid and other kinds of 
infrastructure-related projects?
    Secretary LaHood. Well, we see it in our proposal for 
transportation.
    Senator Warner. Thank you, Mr. Chairman.
    Chairman Conrad. Senator Sanders.
    Senator Sanders. Thank you, Mr. Chairman.
    Mr. Secretary, thank you very much for the very important 
work you are doing. Sometimes what gets lost in the shuffle is 
the disastrous condition of America's infrastructure, the fact 
that we are falling further and further behind many other 
countries, and the point that you have made, and made 
repeatedly, is that if we are serious about pulling ourselves 
out of this recession and creating decent-paying jobs, 
investing in the infrastructure--our roads, our bridges, public 
transportation--is perhaps the fastest way we can do that. So 
count me in as somebody who supports the thrust of your 
argument. I think it is exactly right. And to my mind, 
investing in infrastructure, creating decent-paying jobs 
frankly is a lot more important than giving tax breaks to 
millionaires and billionaires for the future of this country. 
So when our friends ask where the money is coming from, I think 
some of us know where the money could come from.
    Let me just get to a question. In Vermont, we are 
concerned. We have a new Governor, and I would like the 
opportunity to chat with you, maybe bring the Governor into 
that, to talk about transportation needs in Vermont. Is that 
something that we could do?
    Secretary LaHood. Absolutely, and I met your Governor at 
the White House when he was here for the Governors' meeting, 
and I think he is going to be very progressive on 
transportation issues.
    Senator Sanders. I think he will, and the problem in our 
State, as in many rural States, is that people often have no 
option other than the automobile to get to work. So how we can 
address some of those needs is important.
    Second of all, you received and responded to a letter that 
the Vermont delegation sent to you requesting that you extend 
the designation of the Northern New England High-Speed Rail 
Corridor to include a 120-mile segment between Springfield, 
Massachusetts, and White River Junction, Vermont. I know it is 
an issue you are looking at.
    Secretary LaHood. Yes.
    Senator Sanders. It is an issue we would like your support 
on, and let us continue talking about that as well.
    So I will just end with that and to say that as a Nation, 
Mr. Chairman, we should be deeply concerned that in China they 
are building high-speed rail all over the place, and that we--
Mr. Secretary, you correct me if I am wrong. Are we the only 
major nation on Earth that is lacking in real high-speed rail 
at this point?
    Secretary LaHood. Well, we are one of a few, that is for 
sure.
    Senator Sanders. And would you agree with me that if we 
want to take cars off the road, if we want to lessen the heavy 
traffic at our airports, high-speed rail is one way to go?
    Secretary LaHood. High-speed rail will provide thousands of 
jobs. It will help the economy. It will provide lots of green 
jobs, and it will provide alternative transportation that does 
not exist in America today. And this is what Americans want. It 
is not just President Obama or Vice President Biden or Ray 
LaHood. This is what Americans want. You have people all over 
the country that have worked on high-speed rail for over two 
decades, and 33 States and the District of Columbia have 
accepted the $11 billion that we have put out so far because 
they want to connect America with high-speed rail.
    Senator Sanders. And I think others have raised this point. 
If there are States that choose not to take the Federal money, 
please put Vermont at the top of the list.
    Secretary LaHood. Yes, sir. Your Governor made that very 
clear.
    Senator Sanders. We will take that money. If other States 
do not want it, that is fine.
    Go back to a point you made earlier. In terms of job 
creation, if we are investing in roads, bridges, tunnels, how 
many jobs do you see being created in that type of investment?
    Secretary LaHood. Well, I would just say this. The $48 
billion that was in the stimulus program created 15,000 
projects and 65,000 jobs. We did that in 24 months, and we did 
it by the way Congress said to do it. You have not seen any bad 
stories written about our stimulus--none--because we did it the 
right way. We did it the way you all told us to do it, and we 
put 65,000 people to work in 2 years with 15,000 projects.
    Senator Sanders. But you would not deny--and, by the way, I 
happen to believe that the stimulus package did pretty much 
what it was supposed to do. It created 2 or 3 million jobs. I 
agree with those people who say we should have put more money 
into infrastructure. But let us not ignore the other very good 
things, and my State opened up a whole lot of other areas. But 
I will tell you that the stimulus package in Vermont put more 
money into our roads and bridges than we have ever seen in the 
history of the State. But you would agree, I think, that that 
is just the tip of the iceberg.
    Secretary LaHood. Tip of the iceberg, absolutely.
    Senator Sanders. Give me an idea, give us an idea--and I 
understand the funding issue. We cannot create money out of our 
ears here. But if you had your druthers, what would we be 
investing in infrastructure in America?
    Secretary LaHood. Over the next 6 years, the President put 
out a plan for $550 billion. That is as bold as any President--
no other President has been that bold. No other President has 
stepped up with that kind of a plan, $50 billion for high-speed 
rail. Never that kind of investment. We have increased funding 
for roads and bridges. It is now over--it will be over $300.
    Senator Sanders. All right. Let me ask you again a question 
whose answer is obvious, and I speak as a former mayor. If we 
have a crumbling infrastructure, which I think many people 
recognize that we do, and you do not invest in that 
infrastructure, if States all over this country are facing 
enormously serious fiscal problems and are unable to do that, 
if you do not invest in infrastructure, does the 
infrastructure, our roads and bridges, magically get better?
    Secretary LaHood. They actually become unsafe, Senator.
    Senator Sanders. Not only do they become unsafe, will it 
cost more money to improve them as they deteriorate----
    Secretary LaHood. Costs go up every year for 
infrastructure.
    Senator Sanders. So we are in a situation where, if you do 
not invest now, you are simply going to have to invest more 
later. We are in a situation now where we have a horrendously 
high unemployment rate. Now is the time to invest to create the 
jobs. The Federal Government has that responsibility. Where do 
we get the money? Well, I would say to my good friend from 
Alabama that investing in infrastructure is a lot more 
important than giving tax breaks to billionaires. He may 
disagree with that. That is my view.
    Mr. Chairman, thanks very much.
    Chairman Conrad. Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair, and thank 
you, Mr. Secretary.
    Secretary LaHood. Good morning.
    Senator Merkley. Good morning, and I know that you will be 
out in Oregon soon to visit Oregon----
    Secretary LaHood. Yes, sir.
    Senator Merkley. --Iron Works and attend a gathering of the 
Bicycle Transportation Alliance. I am sorry I will not be able 
to be there with you, but I know you will get a firsthand view 
of the street cars under construction at Oregon Iron Works and 
some other good projects. And thank you so much for your 
support of smart transportation modes.
    Secretary LaHood. Thank you.
    Senator Merkley. In the budget from the Department, it 
notes that the Administration will bolster metropolitan 
planning, award funds to high-performing communities, and 
empower most capable communities and planning organizations to 
determine which projects deserve funding.
    When I read those words, they sounded a little bit akin to 
a concept I have been promoting, and I am not sure they are the 
same, but I will use this as a chance to ask you if they are. 
But essentially I have been working on legislation that would 
encourage communities and States to use performance-based 
planning where the local community would set goals for how they 
want to grow on a range of factors from economic development to 
congestion reduction to a reduction in oil dependence. They 
would then develop several scenarios to weigh or to compare how 
they perform against those standards, and this sort of 
scenario-based planning captures the interaction of different 
modes of transportation. So that concept, is that akin to what 
you are talking about in your planning document?
    Secretary LaHood. One of the things that we learned during 
the six town meetings or listening sessions, or whatever we 
were calling them--transportation authorization listening 
sessions that we held around the country--is that there needed 
to be some change to incorporate more ideas. And as I said to 
Senator Warner, we believe these performance standards are 
critical so that taxpayers know and that you can go back to 
taxpayers and say, hey, they are using metrics to make sure 
this money is being spent correctly, and they are basing it on 
some performance standards.
    So I think what you have said is where we are at and what 
we would like to incorporate in a transportation bill so that 
we can say to taxpayers this money is being spent according to 
these metrics and really have some good performance standards.
    Senator Merkley. Well, thank you. I appreciate that a lot.
    Another concept that we have been talking about is 
practical project design that would empower local communities 
to plan projects that are more tailored to their local needs, 
most cost effective. We hear from a number of communities that 
they get frustrated that the State Departments of 
Transportation have very rigid design guidelines that increase 
the project costs, maybe the same large lanes or the same large 
ramps, regardless of the community context. Is this concept of 
additional flexibility in design something that fits in with 
the way you are approaching the transportation----
    Secretary LaHood. Well, look, we have great partners at the 
State level. We work with them day in and day out. And we will 
continue to work with them. We know that sometimes it can be 
frustrating for local folks to get their projects through the 
State. We know that the TIGER program was very successful 
because people with creative ideas brought them forward, and we 
looked at them and we thought they could be creative and do 
some creative things. We awarded the money to them, and 
certainly your State benefited from that program.
    We are going to continue to work with our State partners to 
make sure they understand that we want to get projects done, we 
want performance standards, and we want to make sure that all 
the stakeholders are involved in the process.
    Senator Merkley. Great. Thank you.
    One of the other changes that is in your budget is 
consolidating 55 highway programs into five streamlined ones. 
How do you see that in terms of the application process for the 
communities that are seeking funds, any--let me put it this 
way. A lot of our smaller communities do not have a lot of 
grant writers, and when I saw this, I thought this is going to 
make it a little easier for them to track opportunities to 
apply and find the funds that match their community and easier 
for us as a congressional office to help them find funds that 
they can apply for.
    Is that part of the thinking that went into this or----
    Secretary LaHood. Part of the thinking is that we want to 
follow the President's lead on trying to reform agencies and 
make sure that the Department of Transportation comes into the 
21st century, continue to work with our partners, but really 
squeeze a lot of programs together. Almost everything now is 
multimodal. It might involve--you know, the bridge that they 
are going to build across the Columbia River is certainly 
multimodal. It involves transit, it involves cars. It involves, 
you know, the ability of people to bike and walk across the 
bridge. It involves tolling, and it involves a number of 
things. And so we want to make sure that we have an 
organization that is lean but also takes the best talent we 
have so that we can give people access so they do not have to 
go through 50 layers of bureaucracy to get done what they want 
to get done. And we know a lot of things are going to be 
multimodal, and we have really tried to take the best and the 
brightest, put it together, and make it certainly more 
accessible to States around the country.
    Senator Merkley. Well, I want to applaud the work you are 
doing on that because I do think that it is exactly the right 
direction for the reasons that many things are multimodal, and 
also that in terms of communities being able to understand how 
and where to apply, it greatly simplifies it.
    You mentioned the Columbia River Crossing, and that is a 
huge regional challenge, including the extension of light rail 
across the river, pedestrian and bike paths, but having an 
effective passenger and freight corridor as well. It is just 
such a huge choke point. I appreciate that you are familiar 
with it, and we are doing all we can to get all of the 
community leaders to come together behind a common design, and 
I will certainly be working with you all on that project.
    We have others--the extension of our light rail into the 
Milwaukie area--and your Department has been extremely helpful 
in that. And I just in general want to applaud your--you have 
been a breath of fresh air since you came in in terms of 
thinking about transportation and making it cost effective and 
functional. I guess I echo Senator Warner's comments about it 
is not about how many miles you pave or how many miles you 
build, but how do you make the transportation system overall 
work better, and that has been a concept that Oregon has been 
pursuing for a long time and that I think you have really come 
to take forward to the benefit of transportation across this 
country.
    Secretary LaHood. Well, thank you, Senator. You have some 
great leadership in your State. I just met with the Governor of 
your State, and also Washington, and we talked about the 
multimodal nature of the bridge, the Columbia River Bridge 
Crossing, and the multiple ways that we are going to fund it. 
It is very creative. It is going to happen. It is needed, and 
you have some great leadership in your State.
    Senator Merkley. Thank you. I look forward to continuing to 
work with you.
    Secretary LaHood. Thank you.
    Chairman Conrad. Thank you, Senator.
    Mr. Secretary, I would like to now just take a few more 
minutes and Senator Sessions will take a few more minutes.
    Secretary LaHood. Sure.
    Chairman Conrad. If Senator Coons has returned by the time 
we are done, we will have him have time. If not, we will shut 
it down.
    I want to raise the issue that you are very well aware of, 
Devils Lake, North Dakota. Devils Lake is a lake that has risen 
more than 30 feet in the last 15 or 16 years. Devils Lake is 
now three times the size of the District of Columbia. Devils 
Lake is now forecast--we just have in the last week a most 
recent forecast from the National Weather Service that the lake 
is going to go up another three feet this year. That puts it 
perilously close to an uncontrolled release of water out of the 
east end of the lake, where the water quality is many times 
worse than the water quality in the west end of the lake.
    As you know, the entire transportation system is 
compromised in that part of our State. We have already spent 
$850 million--that is Federal money alone--$850 million dealing 
with the flood threat in the Devils Lake basin. We have had 
hundreds of thousands of acres that have been flooded and 
inundated. People have lost access to their land. We have spent 
hundreds of millions of dollars raising the road network and 
building a massive dike--it has been raised three times--
protecting the city of Devils Lake. We have a town that is 
about to be flooded on the west end of the lake, the little 
town of Minnewaukan. The school is directly threatened. We have 
$6 million than has just been secured to move that school. We 
need to move much of that community.
    The road and bridge network in the area, as you know, has 
been raised repeatedly and we require additional work or parts 
of the road network are going to go under this year, and maybe 
you could give us an idea of what the plans are in the 
Department of Transportation to continue to help us with this 
crisis.
    Secretary LaHood. Well, Senator, thanks to your leadership 
and others in your delegation, we will be committed to working 
with you and others in the State to do whatever is necessary to 
make sure that the roads and bridges are not compromised, that 
communities are not compromised. We are committed to doing 
whatever we can to make sure that we take care of continuing to 
fix the problem.
    Whoever named this Devils Lake named it aptly. I think that 
this--the devil is responsible for this. I mean, I do not know 
how else to explain it. It is something that belies belief or 
belies nature. So I do not know who else to blame but the 
devil, so that is why his name is on it, I guess. Somebody was 
prophetic in putting that name on it. This is a natural 
disaster and we are committed to working with you to do 
whatever it takes to make sure that roads and bridges and 
communities are not compromised.
    Chairman Conrad. I appreciate that, and you have been 
great. You know, I think so many people in the Federal 
bureaucracy have hoped that this lake was going to just stop 
going up. We know in 4,000 years of history, this lake has gone 
through this cycle before, and it is now on its fourth time. 
And when it has gone through this cycle, it has led to an 
uncontrolled release of water out of the east end. If it 
happens this time, now that that part of our State is 
populated--in the previous times it has happened, there was 
very little population--this will be a disaster of staggering 
proportions, absolutely staggering proportions.
    And so I wanted to again alert you to this latest forecast 
that predicts that the lake is going to rise much more than the 
previous forecast, and so we have an ongoing crisis. And I 
thank you for the help you have already given and I thank you 
for the attention that you, I am sure, will give to it in the 
weeks ahead.
    Secretary LaHood. Yes, sir.
    Chairman Conrad. Senator Sessions.
    Senator Sessions. Mr. Secretary, just to push back a little 
bit on this high-speed rail, the President wants it available 
to 80 percent of the population. You talk about $53 billion, 
but there is going to be hundreds of billions if anything like 
that were to occur. And I would just note that in Tampa, to 
Florida, the Governor there has rejected that after careful 
review. I do not think he did that because he wanted to. I 
think he did it because he felt it was not a defensible matter 
economically.
    Governor Kasich has rejected $385 million for a passenger 
rail line, Cleveland to Cincinnati through Columbus, Dayton. I 
am sure they have given great thought to that. It is their 
State. I am sure there are people there that want to see the 
free money from Washington.
    You have Wisconsin, Governor Walker rejecting an $810 
million connection. You have California with a high-speed rail 
line to nowhere out in the desert, some $5.5 billion on that 
project. In Minnesota, that plan has controversy, cost 
concerns, and without the Wisconsin connection, it is probably 
indefensible.
    So I just want to say, what I am hearing about and what I 
think most of us are hearing about is how to get across the 
14th Street Bridge. I mean, there are traffic intersections and 
problems and headaches all over cities and I just think we have 
to be realistic. And we will have a tough debate about it, and 
where it can be defended, I will acknowledge that. In some 
areas of the Northeast, I think it probably can be. In some 
other areas, it cannot be.
    No. 2, would you look at a situation that I think is 
systemic dealing with a two-lane intersection improvement in 
Alabama. Two roads cross, two-lane roads, and they want to fix 
the intersection and are told they have to have a NEPA review, 
environmental review, for 30 miles on either side of that 
intersection. And apparently, this is a systemic problem and I 
was advised of it by my people yesterday and they asked me if 
we could seek relief and I will followup in writing with you.
    Secretary LaHood. Yes, sir. We will look at that.
    Mr. Chairman, could I just respond to the high-speed rail?
    Chairman Conrad. Sure.
    Secretary LaHood. What we are pleased about, Senator 
Sessions, is that 33 States and the District of Columbia have 
accepted more than $11 billion because they believe in high-
speed inner-city rail. They believe in the President's vision. 
I have talked to Governor Brown twice about high-speed rail, 
Governor Jerry Brown of California. They are going to move 
ahead with their project. Eventually, there will be a 
connection to the so-called rail line that you claim is going 
to dead-end somewhere.
    I met with Governor Dayton of Minnesota when he was here 
for the Governors' meeting. He came to my office. I spent an 
hour with him. He is a very strong advocate of high-speed rail. 
He asked for our cooperation and we are going to work with him 
on that.
    There are some Governors who, for whatever reasons, believe 
that, at least in Ohio and Wisconsin, and we are going to hear 
from the Governor of Florida tomorrow who is going to give us a 
final decision on high-speed rail, but you are correct about 
Ohio and Wisconsin. They have decided to go a different 
direction. But that will not dissuade the other 33 States and 
the District of Columbia from moving ahead with the investments 
that we have provided and matched with a lot of local 
resources. High-speed inner-city rail is coming to America 
because that is what the people want.
    Senator Sessions. Well, it may show in polling data, but 
when the numbers become reality, the support is not so strong. 
And I just would say we are going to have to look at that 
closely and I have doubts, as these Governors have indicated. 
It is hard to turn down free money from Washington, though. A 
lot of States may find themselves lured into projects that end 
up costing far more than they expected and doing far less than 
they expected, so it is a matter of good debate. Thank you, 
sir.
    Secretary LaHood. Thank you.
    Chairman Conrad. I thank the Senator.
    Senator Coons.
    Senator Coons. Thank you, Mr. Chairman, and thank you, Mr. 
Secretary, for your passionate defense today of the important 
infrastructure investments that are projected in this year's 
budget. I think you have been a vital part of the 
Administration. I think your vision for modernizing and 
streamlining and investing in infrastructure around 
transportation is critical.
    I just want to ratify some comments that were made earlier. 
My previous role was as a county executive. We made great use 
of the Build America Bonds. They were well received by our 
private sector community. We were able to create jobs with 
them. I have already spoken with Senator Wyden and hope to 
speak with Senator Thune. I will join them in whatever way they 
can to try and move them forward. I think we need creative 
financing mechanisms like an Infrastructure Bank. Some would 
say that Delaware is the case study for tolling. We toll 
everything. We probably collect more per mile of highway tolls 
than any State in America.
    On to high-speed rail, if I might. As our Vice President 
did for so many years, as my senior Senator Carper does every 
day, I commute almost every day by rail from my home in 
Wilmington to Washington and am sold, and have been for years, 
on the value of inner-city passenger rail, and in particular 
the promise of high-speed rail. I think it will put people to 
work. I think it will make us more competitive. I will join 
Senator Whitehouse in saying, should the Governor of Florida be 
so foolish as to turn back funds, please reprogram it as 
swiftly as possible, and it is our hope that the Northeast 
corridor will be highly competitive in that.
    I understand that the FRA is leading a region-wide 
Environmental Impact Study, and that EIS, the Environmental 
Impact Statement, for high-speed rail in the Northeast corridor 
has hit some snags, some delays, there are some challenges, and 
that that may be part of why we are not seeing as much coming 
to our region and to the Northeast corridor in funding as could 
be.
    Can you help me understand what I might be able to do, what 
barriers you see in terms of moving that forward? What do we 
need to do to get more investment in high-speed rail in the one 
part of the country where there is already a corridor that 
benefits from it daily?
    Secretary LaHood. I think more than anything else, one of 
the things that we are going to do is include Amtrak as a 
potential applicant for high-speed rail money. I think we were 
not able to do that earlier on and we think we can. I think 
once that happens, I think there will be a lot more 
opportunities on the Northeast corridor, frankly.
    You know, one of the criticisms was that Amtrak was not 
able to utilize this money and we feel there is a way now for 
us to include them and we are going to do that, and I think 
that will enhance the Northeast corridor's ability to really 
step up and do some of the things that you and others have 
provided leadership on. So I see that happening in the near 
term.
    Senator Coons. Thank you. If there is anything I can do to 
be supportive of that move----
    Secretary LaHood. Thank you.
    Senator Coons [continuing]. I would welcome a chance to do 
so.
    I am also very concerned about the potential impact that 
the House-passed Continuing Resolution would have on Amtrak 
employment in my home State. I have been to the Bear and the 
Wilmington shops repeatedly. They have high-quality employees. 
I think they are critical to the mission of sustaining the 
train sets that you have in service in Amtrak today and could 
play a key role in high-speed rail in the future. My 
understanding is the House-passed CR would cut 215 jobs in 
Delaware. What is your sense of the impact on transportation 
were we to, on the Senate side, pass the same level of cuts 
that the House side has already----
    Secretary LaHood. Well, I would recommend that the Senate 
not do what the House did. I would say that. Amtrak is doing as 
well as it has ever done in the history of Amtrak. They made 
money last year.
    Senator Coons. Yes.
    Secretary LaHood. People like their service. They are 
providing on-time service. They are providing good food. They 
are providing a great form of transportation for people that 
people can afford to use, and ridership on Amtrak is through 
the roof. I know I am telling you everything you already know, 
but--so this idea that you should cut something that is 
successful is just, to me, not realistic.
    This is one form of transportation that takes cars off the 
road, provides clean, green transportation along a corridor 
that is one of the most congested corridors in the country, and 
to a company that now is making money, providing a good 
service, and should be rewarded by having as many passengers as 
they possibly can. Cutting their funding will not be helpful. 
It will be hurtful.
    Senator Coons. Can you tell me anything, Mr. Secretary, 
about the status of Amtrak's application? They applied for an 
RIF loan for their electric locomotives that would also help 
them expand their fleet.
    Secretary LaHood. Mm-hmm.
    Senator Coons. What is the status of that?
    Secretary LaHood. Well, we are working on that and we are 
reviewing it and, you know, it is sort of in process.
    Senator Coons. What I would like to do is work with you as 
much as I could to make sure that Amtrak achieves the level of 
service that I think they are capable of delivering, both with 
the current train sets and with the next generation.
    Secretary LaHood. Yes, sir. We will do that.
    Senator Coons. Also, there are some substantial State of 
Good Repair needs in the Northeast corridor, as you are well 
aware. Some of them could fall under the System Preservation 
account, some under Network Development. How do you see the 
Northeast corridor fitting into this budget proposal and what 
sorts of benefits or investments might there be in the----
    Secretary LaHood. I am going to ask Chris Bertram, our 
Budget Director, to give you the figures, but look, this 
Department of Transportation is very high on Amtrak. We think 
they have good management. We think they have a board that is 
paying attention. We think they are providing a valuable 
service. We think that the fact that ridership is up, that they 
made money last year, is an indication, if you will pardon the 
pun, they are on the right track.
    Senator Coons. They are. They are. I am grateful to hear 
that from you, Mr. Secretary.
    Secretary LaHood. Could we just have Chris respond?
    Senator Coons. Please. Absolutely.
    Mr. Bertram. On the Northeast corridor for the State of 
Good Repair projects, most of those would probably be eligible 
under the new proposed System Preservation account, and then if 
there were sort of capacity additions or extensions that Amtrak 
would be interested in doing, they would be available under the 
Network Development account.
    Senator Coons. And do you think this budget provides 
adequate capital financing for those sorts of improvements in 
the corridor?
    Mr. Bertram. Yes. There will be almost $4 billion available 
for State of Good Repair, System Preservation type. Most of 
those probably would be for Amtrak, which would be quite a bit 
of an increase over 2010.
    Senator Coons. One last concern I have. There is a 
critical, oh, I think it is an eight-mile gap between Delaware 
and Maryland where there are two rails rather than three and 
there is a capital investment project that has already been 
design engineered, applied for, and there is funding, but it is 
not yet under construction. One of my concerns is that should 
there be some agreement that leads to recisions of financing or 
funding for projects like that, that there be particular 
attention given to that.
    The rail line congestion that exists between sort of 
Baltimore and Philadelphia could be critically advanced by 
finishing that rail that would allow then SEPTA and MARC to 
connect. It would make a significant advancement in the sort of 
variety of passenger rail systems that are accessible to our 
general community so that Amtrak can do what it does best, be a 
regional rail carrier, and then MARC and SEPTA can connect 
right at the Newark train station.
    I just want to say how grateful I am----
    Secretary LaHood. Thank you.
    Senator Coons [continuing]. For the energy, the focus, the 
vigor you bring to this. It is difficult in other parts of the 
country, I think, for folks to assess effectively just how much 
high-speed rail can bring to them. I think we have a great work 
force working for Amtrak, and literally every day, I can tell 
you, you are right. They have better food, better service, more 
on-time delivery of a great resource for America. So anything I 
can do to work with you on rail, I would be grateful for a 
chance to do so.
    And Mr. Chairman, thank you for keeping the hearing open to 
accommodate my floor speech on patent reform.
    Secretary LaHood. Thank you for your leadership on this, 
Senator. We appreciate it and we will work with you.
    Senator Coons. Great. Thank you very much, Mr. Secretary.
    Chairman Conrad. Thank you, and thanks, Senator Coons, for 
coming back quickly so that we could not have a break in the 
hearing.
    Let me just conclude, if I could, on some of what I heard 
from the committee on high-speed rail, because I hope 
colleagues will think very carefully about the appropriate test 
for whether or not high-speed rail should be supported in our 
country.
    If the test is, is it going to be in my State, I do not 
think that is the right test. High-speed rail is probably not 
going to be in my State. But I support high-speed rail because 
I believe it is good for America. Look, I have things in my 
State that are not in other States that get Federal support. I 
have two of the largest Air Force bases in the country in my 
State. They are not in other States. But my colleagues know 
that those bases have value for America and so they support 
them.
    High-speed rail, it is very clear to me, has value for 
America, and we are all part of Team America. When I look at 
what Team Japan is doing, they have high-speed rail. I have 
ridden on it. I think it goes nearly 200 miles an hour. I have 
been on high-speed rail in Russia, a train that went almost 200 
miles an hour. We see what is happening all across Europe with 
high-speed rail. If America is not to fall behind, if we are 
going to be competitive, we are going to have to have high-
speed rail, and I believe it is one of those investments that 
actually will pay dividends in terms of the competitiveness of 
our country, in terms of attracting tourists to America.
    And by the way, I have thousands of people from my State, 
my little State of North Dakota, who come and ride the rail 
that is outside of my State. I have people who ride the Metro 
system here in Washington. Thousands of people from North 
Dakota have come here every year and ride Metro and ride the 
Northeast corridor rail.
    So we are not the individual States of America. We are the 
United States of America, and if we are going to be strong, I 
do not think the best can be, it has to be in my State or I am 
not going to support its funding. I think the test has to be, 
is it good for the country. I think we have to apply the 
additional test now, is it being paid for, because we cannot 
just add to the charge card when we are borrowing 40 cents of 
every dollar we spend.
    And the hard reality is when we look at the spending of the 
country today as a share of the GDP, it is the highest it has 
been in 60 years. The revenue as a share of GDP is the lowest 
it has been in 60 years. So both sides of that equation are 
going to have to be worked, but we cannot forget the 
fundamentals of economic strength and growth. And if we are not 
investing in infrastructure in America, we are making a big, 
big mistake.
    Mr. Secretary, I want to end as I began. I think you are 
exceptional.
    Secretary LaHood. Thank you.
    Chairman Conrad. I have rarely seen a witness who is better 
prepared or does a better job of defending his position than 
you do, and I just want to thank you for the leadership you 
have provided.
    Secretary LaHood. Thank you, sir. Thank you for your 
leadership.
    Chairman Conrad. We will stand adjourned.
    [Whereupon, at 11:52 a.m., the committee was adjourned.]





  THE REPORT OF THE NATIONAL COMMISSION ON FISCAL RESPONSIBILITY AND 
                                 REFORM

                              ----------                              


                         TUESDAY, MARCH 8, 2011

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:03 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Wyden, Nelson, Cardin, Sanders, 
Whitehouse, Warner, Merkley, Coons, Sessions, Enzi, Crapo, 
Graham, Thune, Portman, Toomey, and Johnson.
    Staff present: Mary Ann Naylor, Majority Staff Director; 
and Marcus Peacock, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    I want to welcome everyone to the Senate Budget Committee 
today. I particularly want to welcome our two distinguished 
witnesses today: Erskine Bowles and Senator Alan Simpson, the 
Co-Chairs of the President's National Commission on Fiscal 
Responsibility and Reform. Our hearing today will focus on the 
Commission's plan and how it would address the Nation's long-
term debt crisis.
    I want to begin by thanking Erskine and Alan for the really 
outstanding job they did leading the Fiscal Commission. We 
never would have accomplished as much if it would not have been 
for their extraordinarily gifted and determined efforts. They 
made a significant personal sacrifice to come back to 
Washington to lead this Commission, and we owe them deep 
gratitude. I believe when the history of this period is 
written, their names will ring out as being leaders at getting 
the country back on track.
    I also want to thank them for starting the Moment of Truth 
Project, which they are launching today to continue pushing for 
a bipartisan solution to the debt threat that we confront. The 
Fiscal Commission succeeded in putting this issue in the 
national spotlight. There is now a growing consensus on the 
need to act, and the Commission provided a bipartisan road map 
for moving forward.
    Now, I believe we need to seize this opportunity. I believe 
we need to act this year. And that is why I have been part of a 
bipartisan group of Senators who are trying to turn the essence 
of the Fiscal Commission's plan into legislation. If we can 
reach some kind of bipartisan agreement in the Senate, we hope 
it will provide more momentum to move toward a broad agreement 
this year.
    Here is what Admiral Mullen, the Chairman of the Joint 
Chiefs, said about the debt threat: ``Our national debt is our 
biggest national security threat.'' That is coming from the 
Chairman of the Joint Chiefs of Staff.




    Make no mistake. We are at a critical juncture. We are 
borrowing about 40 cents of every dollar that we spend. 
Spending as a share of our national income is the highest it 
has been in 60 years. The revenue as a share of our national 
income is the lowest it has been in 60 years. No wonder we have 
record deficits.




    If we look at the gross debt as a share of the economy, we 
see that it will reach 100 percent this year, well above the 
90-percent threshold that many economists regard as the danger 
zone. Two of our Nation's leading economists, Carmen Reinhart 
and Kenneth Rogoff, studied the impact of debt on economies. 
They looked over a 200-year span at 44 countries, and this is 
their conclusion: ``We examined the experience of 44 countries 
spanning up to two centuries of data on central government 
debt, inflation, and growth. Our main finding is that across 
both advanced countries and emerging markets, high debt/GDP 
levels''--above 90 percent gross debt to GDP--those levels 
``are associated with notably lower growth outcomes.'' So if 
people wonder what this is about, this is about our economic 
future. This is about opportunity, this is about jobs, this is 
about the economic strength of the Nation.



    This is not just about numbers on a page. This is not just 
about bar charts showing deficits and debt. This is about the 
economic future of America. And the conclusion of the Reinhart-
Rogoff study is that when you get a gross debt above 90 percent 
of GDP, your future economic prospects are compromised, are 
reduced, and reduced substantially. That is why this matters.
    I believe the only way we are going to solve the Nation's 
long-term fiscal imbalance is by enacting a comprehensive debt 
reduction plan. We need a plan of the size and scope of what 
was proposed by the President's Fiscal Commission. The proposal 
would reduce the debt by $4 trillion over the next decade. It 
would put us on a course to get the debt stabilized and then 
brought down as a share of GDP so that we would be in a 
position to handle future shocks that none of us can 
anticipate.




    I believe a plan like the Commission plan must include 
spending cuts, entitlement changes, and fundamental tax reform 
that simplifies the Tax Code, lowers rates, and raises more 
revenue. The Commission plan provided such a balanced approach. 
Its savings come roughly equally from non-defense 
discretionary, defense discretionary, mandatory spending, and 
revenue. It is worth emphasizing that savings from Social 
Security reforms in the Commission plan are used only--and I 
emphasize ``only''--to extend the program's solvency, not for 
debt reduction.
    If there is one message I would like to get out there as 
clearly as I can, the savings in Social Security were 
redirected to Social Security to extend its solvency, not for 
debt reduction.




    This chart highlights the key elements of the tax reform 
included in the plan. The plan eliminates or scales back tax 
expenditures and lowers tax rates. And, by the way, tax 
expenditures are now running over $1.1 trillion a year. Tax 
expenditures are as big as all of regular--that is, non-war 
related--discretionary spending. And it makes the Tax Code more 
progressive. It promotes economic growth and improve America's 
global competitiveness. If we are going to reform the Tax Code, 
one thing we have to have in mind is the competitive position 
of the United States. We are no longer so dominant that we do 
not have to worry about the effect of our Tax Code on the 
competitive position of the United States.




    Notably, the Commission's report included an illustrative 
tax reform plan that demonstrates how eliminating or scaling 
back tax expenditures can actually lower rates and produce more 
revenue. Instead of six tax brackets for individuals, the 
illustrative plan included just three brackets of 12, 22, and 
28 percent. The corporate rate would be reduced from 35 to 28. 
Capital gains and dividends would be taxed as ordinary income. 
The mortgage interest and charitable deductions would be 
reformed, better targeting their benefits. The child tax credit 
and earned income tax credit would be retained to help working 
families. And the alternative minimum tax would be repealed.
    The Commission's plan also increases revenue to 21 percent 
of GDP by 2022 and over time actually balances the budget. That 
is the kind of tax reform we will need to adopt. That along 
with the spending reductions and the entitlement reforms are 
what is required to actually succeed.
    Let me just conclude by showing the different paths forward 
of the various plans. You can see the course that we are on is 
going to take us to a debt-to-GDP--and this is publicly held 
debt now, not gross debt; publicly held debt of 233 percent of 
GDP on the current course. The Ryan road map takes us to a 
place I do not think we want to go because that is over 90 
percent of GDP for publicly held debt. On a gross debt basis, 
that would be higher.
    The plan by the Commission takes us to publicly held debt 
of 30 percent of GDP. On a gross debt basis, that would be even 
higher. That is to me a responsible target, one which would 
allow us to handle any future shocks that we might experience 
as a Nation.




    So that is why we went a little further than just 
stabilizing the debt. We actually brought it down markedly as a 
share of the economy so that we could handle future shocks.
    With that, I am going to turn to my excellent colleague 
Senator Sessions for any opening statement that he wants to 
make, and then we will go to the witnesses.

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. Thank you, Mr. Chairman, for those wise 
remarks and our challenge to us all.
    Senator Simpson and Mr. Bowles, thank you for appearing 
before us and for your very successful report that in a mature, 
wise, and indisputable fashion affirmed the growing consensus 
that our Nation is on an unsustainable path of surging debt.
    We live in an ordered universe, and the laws of finance are 
as immutable as the laws of gravity. Nothing comes from 
nothing. Government debts have the same kind of consequences 
that individual family debt does. Deficits do matter. They 
always have and always will. Too much debt has always brought 
destruction, and it always will.
    But some of our great minds have thought they knew better. 
They mock the green eyeshade folks who worry about debt until, 
of course, the wolf is at the door, and then they say, well, we 
did not mean that much debt. Now our financial masters say it 
is all Congress' fault, and it is a lot of Congress' fault; but 
you have to clean it up, Congress. And we do. But do not be too 
quick, be careful, do not go too far, do it just right. For 
sure do not take any action that might affect my investments or 
my program or my interests that are there. It is the other 
programs that are wasteful, not mine.
    Your Commission rose above that. For the most part, it was 
not without compromise. Your recommendations I think should 
have gone even further. But it was a bipartisan effort, and it 
left no doubt that our debt problem is not imaginary but very 
real, even immediate.
    When former Chairman of the Federal Reserve Alan Greenspan 
told the Wall Street Journal a few weeks ago that our Nation 
has a little better than a 50/50 chance to avoid a debt crisis 
in 2 to 3 years, surely we can take the hint that something 
serious must be done. And Moody's said in December that--
warning us that they could downgrade our debt in less than 2 
years if we do not take action. So the Nation and much of the 
world is in a serious financial fix.
    If you read the comments of Wall Street, the fear there is 
real. Anger is real among the Wall Street people. Their words 
combine concern for our Nation's future and short-term self-
interest. But our best path I think calls on us to--some of our 
best people, I would say, are producing contradictory ideas for 
action, and it is causing some confusion. You have helped us 
cut through that confusion, in my view.
    So the House proposes meaningful spending reductions. 
Meanwhile, the President continues to advance his investment 
agenda, declaring against plain fact that his budget calls for 
us to live within our means and to begin paying down our debt. 
What world are they living in? Are we now through the looking 
glass, a post-modern world where words have lost all meaning? 
If so, our beloved Nation is in greater danger than many think. 
But I do not think so.
    The American people get it. We can do this. This is not 
impossible. Leadership at this time is most precious and in 
short supply. It seems to me that when confusion, uncertainty, 
hard times, even fear abound that good leadership like your 
report should call us to return to the tried and true--first 
principles, the old verities. We are vigorous, healthy people. 
We can accept the truth and get on with fixing problems. The 
people know, if not the intelligentsia, the bubblized folks in 
Washington, that the right road will be difficult for a while, 
but that it will lead to prosperity and progress and preserve 
our great heritage of freedom and limited Government. The 
current road just leads to debt and decline.
    The first old verity is to start telling the truth, and the 
truth is this budget we have been presented does not live 
within our means, but instead doubles the entire gross debt of 
the United States from $13 trillion to $26 trillion by the end 
of the decade. It assumes no recession, low interest rates, and 
no new war or military conflict. It cannot stand. It will not 
stand.
    For the time and effort you have given this cause, we are 
much obliged. You have worked hard, given us clear picture of 
the danger we face and the methods available to overcome that 
danger. Your Nation is once again grateful for your service.
    Thank you.
    Chairman Conrad. Thank you so much, Senator Sessions.
    We will now turn to our witnesses: Erskine Bowles, Alan 
Simpson, two people of real courage and character. And I would 
say to other members, including Senator Crapo who served on the 
Commission, as did I. The leadership of these two was really 
textbook. It could not have been done better. And at the end of 
the day 11 of the 18 members endorsed the findings--five 
Democrats, five Republicans, and one Independent. That is about 
as bipartisan as it can be. And so welcome to the Budget 
Committee. Thank you for your leadership. I do not know who 
wants to go first.
    Senator Simpson, welcome.

  STATEMENT OF THE HONORABLE ALAN SIMPSON, CO-CHAIR, NATIONAL 
         COMMISSION ON FISCAL RESPONSIBILITY AND REFORM

    Mr. Simpson. Thank you very much, old friend, and Senator 
Conrad and Senator Sessions. Thank you for your remarks. Thank 
you for, again, explaining it through those wonderful charts 
that we have been watching for many months. You have been very 
helpful, and you are very informative. And it is a great honor 
and privilege to be here, to be in this chamber, in these 
offices, this Capitol, and not be always inspired by the 
democratic experience. If that feeling ever leaves any of you, 
you want to leave. And it is a great forum.
    Erskine and I have left our witness protection program. We 
make sporadic appearances in various locations, as is today, 
and the people are waiting for us to go back into sequester 
when we leave.
    Let me just say this: It is a treat to look around this 
room and see friends of both parties that I thoroughly enjoyed 
when I was here. And over there is Mike Enzi. He replaced me, 
and people said, ``Thank God'' that he did that.
    [Laughter.]
    Mr. Simpson. It was a selfless effort. And he is an old and 
dear friend, and he and Diana are very dear friends. And this 
cat over here, Portman, was a staffer when I was on the Select 
Commission on Immigration and Refugee Policy. Now look at him: 
suave, a piece of work. Rob Portman, as I say, Ron over there, 
Bill, I worked with all of them.
    But on with the business. I know that it is 5 minutes or 
something like that.
    This forum is where the most frustrating and irritating and 
cumbersome and sometimes sloppy work of legislating is 
performed. As an old cowboy said, ``It ain't pretty.'' But as 
another Western rustic said, ``If you hire on to be a cowboy 
and you draw a bucking bronco, you cannot complain.'' And 
Erskine and I drew that critter. And he is a splendid man. He 
is a remarkable man, a creative and positive fellow with great 
integrity and an absolute joy to work with. And we have 
thoroughly enjoyed our time together, and work is what we do. 
We do work together.
    Folks say to us, ``Why are you doing this?'' And we say, 
``We have 14 reasons.'' He has eight grandchildren and I have 
six. It cannot be simplified any more than that. That is where 
this is. It is about my grandchildren and yours. It is not 
about us.
    It all started for me when I got this cheerful call from 
Joe Biden in January. He said, ``Al, I got a real deal for 
you.'' I said, ``Thank you, Joe. Let me get Ann on the phone so 
she can laugh along with me so that we can get out of this.'' 
He said, ``No, no. Listen.'' Joe and I worked together on many, 
many things when we were here together.
    And so I said, ``Well, who is the Co-Chair?'' And they 
said, ``Erskine Bowles.'' The first call I get is from 
Elizabeth Dole and Bob, my Leader. I was the Assistant Majority 
and Minority Leader. You need to serve in both of those 
capacities. It is very helpful in legislating if you are in the 
minority for a while and you are in the majority for a while. 
It kind of sobers you up.
    Anyway, the Doles called and said, ``This is one of the 
finest men we have ever worked with.'' And so it is, and so it 
came to pass. But let me tell you, it took us 3 months on this 
Commission to establish trust. Just plain trust. Trust used to 
be the coin of the realm around here. Let me tell you, the coin 
of trust is severely tarnished in this place, which is very 
sad. I worked with so many on the other side of the aisle, 
Kennedy and Pryor and Bradley and Bumpers, and Levin, who is 
still here. Dear Carl and I came here together. And we trusted 
each other, and I hope that that can come back. It came back in 
our Commission, and once we got through the initial hammering, 
which was who was the biggest spending President in the history 
of the world: George W. Bush, 6-12 years, never vetoed a single 
spending bill. Then this other side would say, yes, but your 
guy has outdone him 3:1. Finally, Erskine and I said, ``Look, 
we will just do a two-man report. It will just be the two of 
us, and it will not be mush.'' Too much stuff comes out of here 
which is much.
    So off we went, and as they came around, a remarkable group 
of five Democrats, five Republicans, one Independent--Mike 
there was on it and, of course, the Chairman. But 60 percent of 
the Commission bought this. That is pretty good; 60 percent is 
kind of the big number around this place. It fits well with the 
filibuster activities, the magic number.
    When we go around the country, we just tell people--I do 
not use charts. This is the numbers guy. You are going to hear 
from him. And if you have any numbers or percentages that you 
wish to probe, this is your man. I do the color, he does the 
numbers. And it works so far. We still do things together if we 
can.
    Now, I have one more minute. I yield to myself one other, 
whatever we did there.
    What I tell people is very simple, and people in America 
are way ahead of all of you. They know what is going on because 
when you say, ``Why don't you go back and think what people are 
doing at their kitchen table?'' I will tell you what they are 
doing at their kitchen table. They know that if you spend more 
than you earn, you lose your butt, and they know that if you 
spend a buck and borrow 40 cents of it, you must be stupid. And 
they have it figured out that this Government is stupid, to 
borrow 40 cents for every buck you spend. Forget the charts, 
forget the GDP and all the rest of it. That is where we are.
    The tipping point--I do not know where the tipping point 
is. Erskine and I would take questions on that. But Durbin kept 
asking. Give Senator Durbin the Medal of Honor. He stepped 
right in here, and at the end of his vote, he said his son 
called him and said, ``Thanks, Pop,'' because that is what this 
is about.
    So, anyway, the tipping point, I do not know where it is, 
but at some point it comes when those people that hold our 
paper say, ``We thought these guys had the guts to attack 
Medicare, Medicaid, the solvency of Social Security.'' Do not 
swallow this business that we are balancing the budget on the 
backs of poor old Social Security people. That is a fake. It is 
a phony. It is wrong. It is untrue. We are doing it so it will 
have its own solvency, and your chart showed it.
    So I just want to give you a couple of quotes--and let me 
just say about Social Security. Do not throw anything. There 
are people out here. I get that. I have a lot of e-mails that 
are choice and that I will hope never get into the public 
venue. Social Security is not a retirement. It was never 
intended as a retirement. It was an income supplement after the 
Depression. The average age of life was 63, and that is why 
they set the retirement age at 65--the beginning of the 
greatest Ponzi of all time.
    Now the life expectancy is 77. There were 16 people paying 
into this system when I was at the University of Wyoming and 
one taking out. Then there were 10 paying in. Today there are 
three people paying in and one taking out. And in 10 years, 
there will be two people paying in and one taking out. How long 
do you think that kind of thing can be sustained? And the money 
has not been stolen by you greedy people. It is all choice 
stuff, highly--lots of frills and prints on the side, paper. It 
is paper. They were not going to leave that kind of cash, nor 
did President Roosevelt want it. That is why the statute said 
you could get in there and give full faith and credit to take 
it out.
    So, anyway, if you have to go through the myth and the 
anguish, just remember everything in this place, it was my 
experience, sadly, that you have to use facts, because you are 
going to have to beat back emotion, fear, guilt, and racism. 
Everything I touched was filled with emotion, fear, guilt, or 
racism, used a death blend either way to get it done or kill 
it.
    Two quotes, and then I will turn it over to the numbers 
guy.
    Cicero--boy, here is a crazy guy--said in 55 B.C.: ``The 
budget should be balanced, the treasury should be refilled, 
public debt should be reduced, the arrogance of officialdom 
should be tempered and controlled, and assistance to foreign 
lands should be curtailed lest Rome become bankrupt.''
    Here is what Abe Lincoln said as a young man: ``At what 
point then is the approach of danger to be expected? I answer, 
if it ever reach us, it must spring up amongst us....If 
destruction be our lot, we must ourselves be its author and 
finisher. As a nation of freemen, we must live through all 
time, or die by suicide.''
    And, finally, I do not know where this little baby came up, 
so I do not want any copyright infringement on it. ``Gold is 
the money of kings; silver is the money of gentlemen; barter is 
the money of peasants; but debt is the money of slaves.'' Go 
look at Alexander Hamilton. Go look at his statue. Look at what 
it says on there. Everything this country has meant had to do 
with getting rid of its debt. And, boy, here is your handful.
    So God bless you.
    [The prepared statement of Mr. Simpson and Erskine Bowles 
follows:]



    Chairman Conrad. Thank you, Senator Simpson.
    Erskine Bowles, good to have you here.

 STATEMENT OF THE HONORABLE ERSKINE BOWLES, CO-CHAIR, NATIONAL 
         COMMISSION ON FISCAL RESPONSIBILITY AND REFORM

    Mr. Bowles. Thank you, sir. I spent a long time trying to 
get here. I sometimes thank God for unanswered prayers.
    [Laughter.]
    Mr. Bowles. I want to thank Senator Conrad, and he is not 
here but Senator Gregg. Without their leadership none of us 
would be here today to talk about this, so I thank you for 
having the courage, you and the group that stood up some years 
ago and said we are not going forward unless we have some 
Commission to deal with this. It simply would not have happened 
without you.
    Senator Sessions, thank you for meeting with us this 
morning and thank you for your kind words.
    I also want to thank Senator Crapo, Senator Coburn, and 
Senator Durbin for having the courage to support what is a 
politically very, very difficult plan to support. And I want to 
thank Senators Warner and Chambliss for your yeoman's work in 
trying to turn what is a 67-page plan in plain English into 
legislative language and bring together a bipartisan group to 
make this happen.
    I am not going to use any notes today. I am just going to 
talk to you. And I am really concerned. I think we face the 
most predictable economic crisis in history. A lot of us 
sitting in this room did not see this last crisis as it came 
upon us, but this one is really easy to see. The fiscal path we 
are on today is simply not sustainable. This debt and these 
deficits that we are incurring on an annual basis are like a 
cancer, and they are truly going to destroy this country from 
within unless we have the common sense to do something about 
it.
    I was with former Senator Kerrey, Bob Kerrey, about a year 
ago exactly, and he said, ``Erskine, look at the Nation's 
current income statement, and let me tell you what you will 
see. You will see that 100 percent of the revenues that this 
Nation produces today are being consumed by our mandatory 
spending and the interest on the debt.'' That means that every 
single dollar that we spend today on these two wars, on our 
military, on national security, on homeland security, on 
education, on infrastructure, on high-value-added research is 
borrowed, and half of that is borrowed from foreign countries. 
That is a formula for failure. And if we do nothing, if we just 
take the ostrich theory in this room, then we will be spending 
$1 trillion a year in interest costs alone by the year 2020.
    Think about that. That is $1 trillion that will not educate 
our children. It is $1 trillion that will not build a highway 
or will not bring broadband infrastructure to rural South 
Carolina. That is $1 trillion that will not create the next new 
thing in this country. It is $1 trillion that is going to 
create the next new thing somewhere over there from the people 
we are borrowing money from. It is crazy.
    And this is not a problem we can grow our way out of. You 
could have double-digit growth for the next two decades and not 
solve this problem. So do not think we can grow our way out of 
it.
    And this is not a problem we can tax our way out of. 
Raising taxes does not do a darn thing to slow the rate of 
growth of health care or to change the demographics of the 
country. And, in fact, if you want to try to solve this with 
just taxes, you will have to raise the highest marginal rate to 
around 70 percent, the corporate rate to 80 percent, the 
capital gains and dividends rate to 50 percent. And what kind 
of country will we have? You are not going to have any 
businesses started or businesses growing with that kind of tax 
structure. So we cannot simply tax our way out.
    And we cannot simply cut our way out of this problem. You 
know, when I see people go on the Sunday shows and they say, 
``Oh, look, we are going to cut our way out of this problem, 
but we are not going to touch Medicare and we are not going to 
deal with Medicaid and we are not going to mess with Social 
Security, and for sure we have to stay safe and secure so we 
are not taking a dollar out of difference, and, oh, by the way, 
we have to pay the interest on the debt--well, you know, if we 
exclude all those things, you have to cut everything else by 65 
to 75 percent. That is not going to happen. That is not a 
realistic world.
    So what Al and I tried to do was to present a realistic 
plan, a balanced plan, a plan that turned out to be a 
bipartisan plan. And it is based on six basic principles.
    The first is we did not want to do anything that would 
disrupt a very fragile economic recovery, and the economy is in 
a recovery. This growth is real today. But, boy, we can lose it 
and lose it quickly.
    So when we looked at cutting spending, as Senator Crapo 
knows, most of our spending cuts come in 2013. That is where we 
get back to 2008 levels in real terms to the pre-crisis level, 
which I believe we can do.
    Now, I expect that the Republicans will be for getting back 
to 2008 levels in 2012. We simply were afraid to do that 
because we did not want to disrupt what is a very fragile 
economic recovery. We have real cuts in 2012, but we get back 
to 2008 levels in real terms in 2013.
    Second principle, we did not want to do anything that would 
harm the truly disadvantaged, and that is why if you look at 
the cuts we made in mandatory spending, we did not touch things 
like food stamps or unemployment or SSI. We left that off the 
table, the income supplement plans. And when you look at 
Medicare, we did a couple of things that made our job more 
difficult. We increased the minimum payment up to 125 percent 
of poverty to protect the truly disadvantaged, and we gave that 
1-percent bump-up a year to what is called the ``older old,'' 
people between 81 and 86. Both of those cost money, and in our 
plan we paid for that. But we wanted to do the right thing. And 
when we, yes, raised the retirement age, we did put in a 
hardship provision to protect those people that had those back- 
breaking jobs, those manual labor jobs, that really cannot work 
as long as we raised the retirement age. So we really did--our 
second principle, we tried to protect the truly disadvantaged.
    Third, we do want to keep this country safe and secure. 
Now, I am not personally one that believes we can afford to be 
the world's policeman. But I will put it in more basic terms. I 
do not think this country can afford to spend more on national 
defense than the next 14 largest countries combined--and have 
enough money to invest in education, infrastructure, and high-
value research, which we have to do in order to be competitive 
in a knowledge-based global economy that we all compete in 
today.
    Fourthly, I do think we have to make these investments in 
education, infrastructure, and high-value-added research. It 
does not mean we have to spend money willy nilly. I just 
finished 5 years as president of the University of North 
Carolina. It is a 17-university system, and so I saw where some 
of your research dollars go. Today we have 375,000 research 
projects that you all are funding on 3,000 separate university 
campuses. Now, all of that is not great research. Some of it 
keeps us from going down a lane and, you know, it ends up 
dying, but it is good research because it keeps you from making 
a bad decision. And some of it actually ends up in something 
that is great. But some of it is not high-value research. In a 
time of limited resources, we have to spend our money more 
wisely.
    Fifth, for God's sake, let us reform the Tax Code. The Tax 
Code is archaic. It was created when America dominated the 
world. We live in a global economy today. You saw it every day 
when you were at USTR. It is a fact. What we proposed was 
broadening the base, simplifying the Code, eliminating or 
greatly reducing these tax expenditures, bringing down rates, 
and using some money to reduce the deficit.
    We went to what is called a ``zero-based plan,'' and if you 
eliminate all of these $1.1 trillion worth of tax 
expenditures--I call them ``tax earmarks.'' You all have been 
so bold to get rid of the $16 billion of earmarks in the 
spending part of the budget. But we have $1.1 trillion that we 
are spending in the Tax Code, and it is just spending by 
another name. But if you eliminate those, you could actually 
take rates to 8 percent up to $70,000, 14 percent up to 
$210,000, and a maximum rate of 23 percent, you could take the 
corporate rate to 26 percent, and you could go to a territorial 
system which will bring all of those trillions of dollars or 
billions of dollars back to the country that are captured 
overseas and create jobs over here. So I hope we will reform 
the Tax Code.
    Last, we, too, have to cut spending, and we have to cut 
spending wherever we find it. We cannot just deal with domestic 
discretionary spending. You know, the Democrats, as near as I 
can tell from reading the paper or talking about cuts of $10.5 
billion in discretionary spending and the Republicans are 
basically talking about $61 billion worth of cuts. Well, let me 
tell you something. Sixty-one billion dollars out of a $3.7 
trillion budget is 1.6 percent. I can cut my budget 1.6 percent 
tonight, by tomorrow morning. I took $625 million out of a $3 
billion budget at the University of North Carolina. The 1.6 
percent is nothing. The problem is that you all are focusing on 
taking 1.6 percent out of a very narrow part of a budget, out 
of 12 percent of a budget, so some of the cuts are having a 
disproportionately adverse effect on certain groups of people. 
But if you are talking about the gross amount of $61 billion, 
hey, it is nothing. You know, we take $1.7 trillion out of 
discretionary spending, we take $430 billion out of health care 
spending, we take $215 billion out of other mandatory spending, 
and we get Social Security solvent for 75 years. Our plan 
reduces the deficit by $4 trillion. It takes the debt-to-GDP 
ratio to 65 percent by 2020 and to 60 percent by 2023. It cuts 
the deficit in half by 2015 to 2.3 percent of GDP. The 
President asked us to get to 3 percent of GDP. And it takes us 
to 1.2 percent of GDP by 2020 and eventually to balance.
    I came here today simply to ask you to act. I know these 
cuts are politically difficult, but this is not a decision we 
can postpone. We have to act and we have to act now. And if we 
do, the future of this country has never been brighter. We can 
compete with anybody. But we have to get our fiscal house in 
order.
    Thank you, Mr. Chairman, for allowing me to come.
    Chairman Conrad. Thank you. I think you have made the case 
about as clearly and persuasively as it can be made. And I want 
to thank you both for, again, the leadership that you have 
provided.
    Let me ask you this: What happens if this does not get 
done? In other words, Erskine--and I did not give all the bona 
fides of Erskine Bowles when I introduced him, but this is a 
man who was Chief of Staff to the President of the United 
States, headed the Small Business Administration, has been the 
administrator for the college system, the university system in 
the State of North Carolina. A pretty good set of bona fides. 
And at every place he has served, he has produced results.
    Let me ask it again. So what happens in your judgment to 
the United States if we fail to get an agreement in the range 
of what the Commission concluded was necessary?
    Mr. Bowles. Hearing what he said about me reminds me of 
when my Uncle Sam died in North Carolina, and the obituary 
editor of the Greensboro Daily News called up to ask about him. 
And my aunt kind of went on and on about all the things he had 
done, and finally he said, ``Now, Mrs. Bowles, you do know we 
now charge $5 a word for every word we put in the paper.'' She 
said, ``Oh, no, no. I did not know that.'' She said, ``In that 
case just put in there `Sam died.' ''
    [Laughter.]
    Mr. Simpson. I thought you were going to say the one about 
look in the casket and see if that really is your old man.
    [Laughter.]
    Mr. Bowles. You know, Al said and I used to say that I got 
into this thing for my grandchildren. I have eight 
grandchildren under 5 years old. I will have one more in a 
week. And my life is wonderful and it is wild. But this problem 
is going to happen long before my grandchildren grow up. This 
problem is going to happen like the former Chairman of the Fed 
said or Moody's said, this is a problem we are going to have to 
face up to. It may be 2 years, you know, it may be a little 
less, it may be a little more. But if our bankers over there in 
Asia begin to believe that we are not going to be solid on our 
debt, that we are not going to be able to meet our obligations, 
just stop and think for a minute what happens if they just stop 
buying our debt. What happens to interest rates? And what 
happens to the U.S. economy?
    The markets will absolutely devastate us if we do not step 
up to this problem. The problem is real, the solutions are 
painful, and we have to act.
    Chairman Conrad. Alan, do you want to add to that?
    Mr. Simpson. I would just say--and I know it is 
repetitive--if you can understand here what the people of 
America--as we travel around and we do stuff, we go to the 
business councils, we go to the conservative group in Dallas, 
the policy institutes, the Panetta Institute, the Economic Club 
of New York, and wherever we go people get it. And then we tell 
them that if they just draw, pick, go to the Internet and go 
www.fiscalcommission.gov, it is 67 pages. If we leave that out, 
they will never read it, you see, because they will say, oh, my 
God, they worked for a year, must be as high as this box. It is 
not. And it was not written for pedants or politicians or 
panderers. It was written for the American people, and I uses 
terms like ``going broke'' and ``shared sacrifice.''
    Let me tell you what was stunning for us. There has never 
been any sacrifice required of the American people since World 
War II--except for our military, God bless them, and that is 
the sacrifice. And they chose to do it. They are volunteers.
    And so when someone says, well, you cannot use that word, 
well, the American people are using that word. It is called 
``shared sacrifice.'' And it is a puzzling thing. It is the 
right and the left. They are not involved in social issues 
deeply. Now this has risen to No. 1: jobs, very important, and 
this No. 1 or No. 2 is the debt. They understand debt, because 
in their own home they have been wiped out by debt.
    The first thing that anyone did during this crash that had 
any brains at all was to gather their loved ones around and 
say, ``We have to get out of debt.'' That is first. And you 
know my wife, Ann, and Lucy has saved you many times. She said, 
``Pay it off, Al. You guys from Cody are on credit cards. In 
Grable, we paid cash.'' So I said, ``OK, it is a deal.''
    I think it will come before 2 years. I think that when the 
people that hold this paper look around and all you have done 
is cut waste, fraud, and abuse, foreign aid, Air Force One, 
Pelosi's aircraft, and all this and Congress pay, that they 
know that you did not get anywhere. You got to 5 or 6 percent 
of the whole, and they are going to say, ``You did not do it.'' 
And then, of course, when the debt limit extension comes up, 
you have about 85 guys over there saying, ``Hey, I am never 
voting for that under any circumstances.'' And they say, ``Wait 
a minute,'' and then you will hear the cracking of knuckles and 
elbows as they say, ``If you do not do this, you are going to 
impair the full faith and credit of the U.S. and might even 
have to shut the Government.'' And some of them are going to 
say, ``That is why I came here.'' And at that point, there will 
be a sound of bone against flesh. But at that point, too, if 
they--I cannot imagine shutting the Government. Our party tried 
that once. It was just about the biggest disaster that I have 
ever seen.
    So I am just saying that at some point, I think within a 
year, at the end of the year if they just thought we were 
playing with fluff, 5, 6, 7 percent of this whole, they are 
going to say, ``I want some money for my paper.'' And if there 
is anything money guys love, it is money. And the money guys, 
when they start losing money, panic. And let me tell you, they 
will and it will not matter what the Government does. They will 
say, ``I want my money. I have a better place for it.'' Who 
knows? Stabilize the euro, do this, do that, whatever. I am 
just saying, to me it will not be a year.
    Mr. Bowles. You know, I do not see how we cannot face up to 
it. You showed a chart, Senator Conrad, from Admiral Mullen. 
Admiral Mullen says it is our greatest national security 
problem. Think about that. You know, if you believe in 
investing in education and infrastructure and high-value 
research to be competitive in today's global marketplace, if 
you do not want those people creating that next new thing over 
there but creating it over here, there is not going to be any 
money for it. And if you are a business guy like me, you know, 
small businesses cannot grow and cannot create jobs without 
money. And, you know, they will be starved for capital if this 
budget continues to grow as it is today.
    Chairman Conrad. Thank you. My time has expired.
    Let me just say we are going to go to 5-minute rounds, make 
an exception for Senator Sessions, but 5-minute rounds because 
of the number of people we have.
    Senator Sessions. Well, the remarks you have just made are 
very sobering. It goes beyond the academic or theoretical to a 
warning of an immediate and dangerous threat that is before us. 
The language you used in your written statement, I noticed that 
it was pretty stark, and you used it, Mr. Bowles: ``We believe 
that if we do not take decisive action, our Nation faces the 
most predictable crisis in history.''
    And I really, I cannot dispute that. The more I read about 
it, the more I believe that is true, and, therefore, I believe 
we need to take action.
    Let me ask you to just share with us your thoughts about 
the President's budget, if you have had a chance to see it and 
if you think that is sufficiently decisive to alter the 
trajectory we are on.
    Mr. Bowles. I guess you want me to do that.
    Mr. Simpson. I do, I do.
    Mr. Bowles. The president's budget, I think, on the 
domestic discretionary spending does a pretty good job if you 
look at it over an 8-year period. It has some gaps in it, like 
they talk about investing in transportation, but they do not 
tell you how they are going to pay for it. We said you have 
even got to cut transportation spending back to the level of 
income coming in, or if you are going to spend to the level you 
are today, then we proposed a 15-cent gas tax to pay for it. 
Your choice.
    The total deficit reduction in the President's plan is 
somewhere between $1 and $2 billion. It is hard to tell. We 
propose $4 billion worth of cuts, so it was much less than what 
we proposed.
    Chairman Conrad. Trillion.
    Mr. Bowles. Trillion, excuse me. And I think that is about 
the minimum amount that should be done.
    If you look at health care, we cut health care spending by 
$430 billion. His budget cuts it by $310 billion, but only $50 
billion of that is specifics; the other is $250 billion worth 
of unnamed cuts. But I do not know where it is coming from. We 
did say how we would pay for all $430 billion of our cuts.
    On other mandatory spending, we had about a $215 billion 
cut or 11.2 percent over that time period. In his cuts, he has 
about $60 billion for waste, fraud, and abuse, and we could not 
find anybody who could support more than $20 billion for that. 
So I do not know where that other $40 billion is going to come 
from.
    On Social Security, we have a real plan that leads to 75-
year solvency, and they talk about us doing something for 
solvency and also making sure that we up the minimum payment 
and we protect the basic payment and we get it solvent in the 
long run. And, of course, our plan does exactly that.
    And on revenue, they, too, eliminate some tax expenditures, 
but they spend the money that they create by eliminating those 
tax expenditures. We take those tax expenditures, and the vast 
majority of it we use to reduce rates and to lower the deficit. 
So the overall effect of the President's plan I think falls 
short of what the country needs to do right now.
    Now, I think the President has done a lot of good things. I 
think appointing this Commission was a bold step. I think in 
the State of the Union he showed us a little leg of some of the 
things he would cut. I think in the budget he went a little bit 
further. My hope is that he will show strong support to what 
Senators Chambliss and Warner are now trying to do. But we have 
to do more, and it is going to take the leadership of both 
Houses of Congress; it is going to take it from both parties; 
and it is going to take it from the President.
    Senator Sessions. Well, the way we calculate it, it is not 
a $4 trillion reduction as you propose, but one basically as 
the President declares, and then we think that is incorrect 
scoring, and CBO will probably score the budget as not having 
reduced spending at all. So I really think it is insignificant 
there.
    With regard to discretionary, I just want to push back a 
little bit. The $61 billion, we have calculated this out over--
reducing the baseline $61 billion over 10 years plus the 
interest saved, assuming some steady growth or no growth or 
however you calculate it, but taking that baseline down 60 
would result in a save of $850 billion, pushing $1 trillion. 
You proposed $1.7 trillion. I notice you shared with me the 
rather significant reductions you had to undertake at the 
University of North Carolina, 30 percent or some figure such as 
that. The $61 billion would amount to, as you noticed, 1.6 
percent of the overall budget. And if you take it only on 
discretionary, it is about 6 percent. So I do not think that is 
harsh or extreme, especially in light of the fact that the 
administration has achieved a 23-percent increase in 
discretionary spending baseline in the last 2 years.
    So I believe you are on the right track. I believe you are 
sharing with us the fundamental truth of the financial 
condition we are in. I do believe that the American people who 
benefit from Social Security and Medicare want to see us bring 
the wasteful Washington spending under control, too, that it 
should not be off the table. It should be on the table, and it 
results in real trillions of dollars in savings if we work at 
it. And if you combine that with the entitlement reforms that 
could take place, we would do pretty well, I think, in altering 
the trajectory.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you,
    Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman.
    Mr. Bowles, you correctly say that you cannot do serious 
deficit reduction just by cutting, and you cannot do serious 
deficit reduction just by taxing. What I want to do is make 
sure that as part of this debate we see that to really drive 
the deficit down, you have to do some serious growing. And to 
me, that is what the tax reform debate is all about.
    In the 2 years after the 1986 tax reform bill was passed, 
we created 6.3 million non-farm jobs, twice as many as were 
created between 2001 and 2008. So we are clear--and you all 
have done an excellent job--isn't the heart of your interest in 
tax reform, that it will help us create more good-paying jobs 
and it is key to growth?
    Mr. Bowles. Unequivocally, yes. As you know, our plan has 
been called ``Reagan on steroids.'' It was modeled after the 
Wyden-Gregg bill. And I believe that if we take such steps and 
we get rid of some of the inefficiencies in the Tax Code and 
bring down rates and reduce the corporate rate and get rid of 
this--get to a territorial system, then I think we have a 
chance to really create a lot of jobs in this country.
    Senator Wyden. Let me ask the two of you a technical 
question, and I am very appreciative of all the work that you 
have done with Senator Gregg and myself. You all propose an 
important budget enforcement mechanism--this is something I 
have talked about with the Chairman and colleagues in the 
past--but you did not include a mechanism that would keep us 
from backsliding on tax reform. And what concerns me is when 
you go back and look at the history of 1986, practically as 
soon as the ink was dry, as soon as Democrats and Ronald Reagan 
came to this historic kind of compromise, what you saw is the 
lobbyists went back to work and they kept packing in break 
after break after break, and pretty soon it added up to 15,000 
new breaks added to the Tax Code between 1986 and 2005.
    Do the two of you agree that this time as part of tax 
reform it is going to be important to have a mechanism in place 
to no longer have this easy backsliding so that a few years 
after you have put in place major historic tax reform you are 
not back in the same boat? I will let either one of you take a 
crack at that.
    Mr. Simpson. Well, I agree with that totally, Senator 
Wyden. It has been so interesting to talk to people about the 
Tax Code, and we have people who--one person came and testified 
that Ronald Reagan was his hero, and I said, ``Well, that is 
good because he is kind of my hero, too.'' And I knew him very 
well. This man was Grover Norquist. He has a job to do, and he 
does it beautifully.
    I said, ``Well, Ronald Reagan raised taxes 11 times in his 
8 years.'' He said, ``I did not like that at all.'' I said, 
``It is not whether you liked it or not. Why do you think he 
did it?'' ``Well, I do not know, but I am very disappointed.'' 
I said, ``He did it to make the country run.''
    Now, we have to put triggers in there. We have to do 
things. But let me tell you what happened. People were talking 
about a VAT tax. I cannot understand how distorted things can 
get as if we were going to put a VAT tax on top of the present 
Tax Code, and that is the word. That was the word, the Bible 
said. They are talking about a VAT tax on top of this atrocity. 
If you did a VAT tax, you have to scrub everything off the 
board.
    It was very difficult to deal with a VAT tax when the U.S. 
Senate, by a vote of 84-15 or something, said there will never 
be a VAT tax in the history of the world. The Rivlin-Domenici 
group talked about a VAT tax, and they probably get hammered a 
lot on that. But at some point these--we found that only 2 
percent of the American people, the wealthiest in America, the 
connected, are using these 180 tax expenditures. That is who is 
using them. The little guy does not even know what they are. If 
he does a standard deduction, he has no concept of--well, I 
will mention this. I mean, bombs will fall: oil depletion 
allowance, mine land reclamation. I am from Wyoming. You know, 
if we were a country, we would be the largest coal-producing 
country in the world.
    So we all took a terrible bite out of our ankles, and we 
are here. But unless you do something, these things are like 
the zombies that rise from the graves because this city is 
lined with people who make big bucks to go get it back. But 
this time they will not be bringing home the bacon. The pig is 
dead.
    Senator Wyden. Thank you.
    Mr. Bowles, a mechanism to make sure that we have 
essentially tax enforcement from backsliding like we are going 
to do on budgets.
    Mr. Bowles. Absolutely. If you do not, you will end up 
right back where we are today. The top 400 taxpayers in the 
country pay a marginal rate of 16 percent. You know, Warren 
Buffett talks about he pays a lower rate than his secretary 
does. That is what will happen. The people that benefit from 
these tax expenditures are, by and large, people in the upper-
income brackets.
    Senator Wyden. Thank you, Mr. Chairman.
    Chairman Conrad. Thank you.
    Senator Enzi. Thank you, Mr. Chairman. It was about 37 
years ago that Senator Simpson told me that I needed to put my 
money where my mouth was on this leadership stuff and get into 
politics, and I ran for mayor as a result of that. And God has 
winked a number of times, and I wind up here. He has been a 
tremendous mentor to me over the years, and I appreciate that 
both he and Mr. Bowles were willing to take on this task. And I 
appreciate the results that they haveten and the way that they 
have promoted it across the country. It needed to be done.
    I was one of the cosponsors of the Conrad-Gregg bill and 
thought that that was essential and was disappointed when that 
did not pass and was elated when the President decided to do it 
anyway, and I thought that was a good step.
    I have to say I was a little disappointed when the 
President missed the opportunity in the State of the Union 
speech to say exactly what you have been saying here today, to 
inform the people of this country of just how desperate the 
situation is so that we could take some positive action on it. 
And I was disappointed when the budget proposal came out 
because I think that was another opportunity for him to show 
exactly what you have been saying and to put some of those 
things into effect. And the biggest thing he did in there was 
take the tax expenditures and use them for new programs instead 
of reducing the corporate debt.
    The American people have figured it out with your help, and 
they are getting it clearer and clearer every day. We have to 
get Congress to catch up. But, yes, there is a question in 
there somewhere.
    [Laughter.]
    Senator Enzi. My question is: You broke your 
recommendations into six areas: discretionary, taxation, health 
care, mandatory spending, process reforms, and Social Security. 
Now, I know that your task was to have a single vote on all of 
that, but given the fact that Congress has trouble doing 
comprehensive legislation, well, would it make sense for us to 
break that into six areas separately? Or do you think we have 
to do it in one big piece of legislation?
    Mr. Bowles. Alan can probably speak to that better than I 
can. What I can tell you is based on what our experience was. 
Before I do that, I want to address one of the things you said, 
that we had shown how desperate the situation is. It is only 
desperate if we do not act. If we do act, the future of this 
country is so bright, I cannot believe it. So if we just have 
the guts and the courage to stand up and do something that is 
real today in all six of those areas, then the future could not 
be brighter.
    We originally started out thinking that one of the easiest 
things to do, since it was part of the President's request, was 
Social Security because you can kind of figure out how to get 
it to 75-year solvency and make it safe over the next 75 years. 
And we thought that was morally important.
    Second, we thought we could do some of the discretionary 
stuff and thought we could make some progress there.
    But as we went on through this process, we found that the 
bipartisan group really did coalesce around doing something 
that was comprehensive, and we got more support rather than 
less support when we were bolder and did something more 
comprehensive rather than trying to break it up into individual 
pieces.
    Mr. Simpson. I think that we also felt that--you know, it 
is tough to keep anything together here. I remember that so 
well. But if we could just stabilize the situation, just 
stabilize things so that they know that it is just not on 
automatic pilot, that alone would be worth everything. I know 
that is--you would not challenge that, would you? No, I do not 
think. Of course you would not. You would try. But you would 
not.
    Let me just say this: If you cannot get Social Security 
solvent for 75 years and this Congress cannot do that, you can 
forget everything. You will never get to Medicare, Medicaid, 
and defense. You will have failed what we see is the easiest 
thing to do, which is to restore solvency of Social Security 
for 75 years. Very clear what we do. We do not privatize it. We 
are not stealing from the old people. We are not putting 
people--throwing bedpans out of hospitals. That is not what we 
are doing. And people who use that are involved in massive 
fakery, at worst. And I do not use those words. I have many, 
many other words. Just as salty as Bernie can be. I have always 
respected him. I hope he comes back and asks some questions. We 
want to answer his questions about Social Security. But if you 
cannot solve that, you are gone. Forget the rest of it. It will 
not work. It just will not work. It will not touch it with a 
stick.
    Senator Enzi. I did appreciate your comments in the report 
about when we were doing the tax reform to have transition 
rules in there. I think that will make it possible to get it 
done. I am anxious to work on all of the ideas that you put 
forward and see a way to get them done.
    Mr. Bowles. But if we only do Social Security, we have not 
come close to solving the problem. It is just like if we only 
do domestic discretionary spending, you can get rid of all 
domestic discretionary spending, and you have still got a $1 
trillion deficit this year. You really do have to do a 
comprehensive look at it. And I think you have to look at both 
revenue and spending in order to really solve the problem we 
face.
    Senator Enzi. I think we do have to do all of them, but I 
still think we will have to do them kind of one at a time with 
agreement to do all of them so that we can get the trust of the 
American people. They do not think we are going to do anything.
    My time has expired.
    Mr. Simpson. But, Mike, with your skills at bipartisan 
work--and I saw how you worked with Ted Kennedy. You two did 
about 35 or 40 pieces of legislation. Nobody realized that. You 
always worked with the other side. Your gifts will be heavily 
called upon.
    Senator Enzi. Thank you.
    Chairman Conrad. I thank the Senator. I first thank Senator 
Enzi because he has been a key ally in trying to advance a 
Commission approach. So, too, has Senator Nelson. In fact, 
after Judd and I lost the vote on our proposal--we got 53 
votes, but we needed 60, and I was called to the Vice 
President's residence to negotiate the Executive Order 
Commission. Bill, Senator Nelson, volunteered to go with me, 
and I readily accepted. And I just want to say we would not 
haveten the Executive Order Commission without Bill Nelson's 
hanging in there and being tough. Also, I will forever be 
grateful for his assistance in negotiating the Executive Order 
Commission because that was a pretty tough negotiation as well.
    Senator Nelson.
    Senator Nelson. Well, thank you, Mr. Chairman.
    Senator Enzi, the problem is that if we try to do these 
things one at a time, we will not get it done. You have to take 
that comprehensive approach. And I do not know how bad it has 
to get before we can get everybody to the point of being all 
willing to pull up and hitch up their belts to do a 
comprehensive approach.
    Now, let me give you an example. You mentioned the six 
things, the six major components. Well, you know, one of them 
was health care cost containment. Well, you know, why should 
Medicare be paying the premium price for drugs instead of the 
discounts that the U.S. Government gets in the drugs for 
Medicaid? Well, we know why.
    Why are there royalty payments that are not being paid for 
the extraction of oil from the Gulf of Mexico? That is a tax 
expenditure. Well, we know why.
    So if you try to take individually items on, you are not 
going to be able to get--you are going to get beat because the 
powerful interests are there that can always beat you on an 
individual basis.
    Now I want to ask a question. You all have put Social 
Security as part of this overall reform, and I agree that it 
has to be. But you also are quick to point out that nothing in 
the way of Social Security savings here goes to help the 
deficit. So other than the symbolic value of tackling Social 
Security for the long term, which is a notable goal--and which, 
by the way, was one of the finest achievements of the U.S. 
Government back in 1983 when Social Security was down to about 
6 months before going into cardiac arrest. Everybody came 
together in a bipartisan way, and two old Irishmen, one named 
Reagan and one named O'Neill, got it done.
    My question is: Other than Social Security, why does that 
have to be so much a part of it since it is not actually 
helping the deficit--which is what we are trying to get to 
right here--other than the symbolic value?
    Mr. Bowles. I think it is a lot more than symbolic. First 
of all, we had no choice. If you look at the President's two-
part mandate, the second part of that mandate required us to 
look at the long-term entitlements and the effects they have on 
the country.
    In addition, we really felt like we had a moral obligation 
to face up to Social Security. You know, we are not making this 
up. Social Security really does--the trust fund is exhausted--
all of the interest earned on the trust fund for the funds that 
are lent to the general fund are exhausted in 2037--probably 
before that now because of what we did at the end of last year. 
And benefits will have to be cut by 22 percent. That is under 
current law. That is not something that we made up. It happens.
    In addition, it is a fact that--I think I will just leave 
it at that. You know, we have made promises as a country that 
we cannot meet, and what we tried to do was to restore the 
solvency of Social Security for 75 years while protecting the 
most disadvantaged and, in fact, giving them a higher benefit 
so they could have some kind of quality of life.
    Mr. Simpson. I think, too, that we have seen--at least I 
saw in my 18 years here--sometimes for budgetary purposes or, 
you know, gimmick figures, they will use the $2.5 trillion of 
Social Security as not counting it against the budget. And then 
sometimes they will count it. And when you have a figure of 
$2.5 trillion in surplus and people are saying that you stole 
it and all the drama that goes with that, it just seemed to us 
to let people know that if you do nothing and the howling and 
shrieking by these interest groups--and do not think we did not 
believe we would be savaged--savaged--in this country by what 
we propose by groups, and I will name only one. I was not the 
only living person that ever had a hearing on the AARP. They 
are still looking for me. But you cannot play games with it 
unless you just want to go up to all these toughies on the 
other side who are saying, ``You rotten finks, you are going to 
touch my precious Social Security.'' Great, pal. Waddle up to 
the window. Your relatives in the year 2037 get 22 percent less 
and downhill the rest of the way. And there is no way to avoid 
that--you can appeal, you can pull out the Constitution--
because it pays only payable benefits. It will not pay 
scheduled benefits. And if everybody can wake up and figure 
that the thing they get from the Social Security, when you are 
65, here is your scheduled benefit, it will not be there 
because you did nothing.
    Chairman Conrad. I thank the Senator.
    Senator Graham.
    Senator Graham. Thank you both. I really do appreciate what 
you have done for the country, and if we are wise, we will take 
some parts of what you have done, add it with some of our 
wisdom, if we can muster any, and do something. And if we are 
politicians who are not wise, we will all get beat. I think 
America really, really wants us to do something.
    Can you imagine a budget being generated by a Republican or 
Democrat that does not have meaningful entitlement reform and 
that would be a serious effort to solve our financial 
difficulties?
    Mr. Bowles. No.
    Senator Graham. Can you imagine any scenario where we can 
save Social Security from impending massive cuts, 30 percent in 
2037 or maybe more, or any entitlement program without 
adjusting the age for eligibility? Is there any sensible way to 
do it without adjusting the age?
    Mr. Bowles. You can do it without adjusting the age 
mathematically, so yes. But we thought you should adjust the 
age.
    As you know, you are not eligible for Social Security at 65 
today. You are eligible at 66. And under current law it goes to 
67 in 2027.
    Senator Graham. Senator Simpson, can you imagine any 
scenario of saving Social Security and Medicare or getting our 
debt situation in better standing without adjusting the age of 
eligibility?
    Mr. Simpson. Well, I think it is impossible. The average 
age is 77. It is going to go to 80. As I say, 63 was the life 
expectancy and 65 was the retirement. Now you can retire at--
you used to be able to retire on Social Security and you might 
live 3 or 4 years. Now you retire on Social Security and you 
may live 20. So how is that supposed to be when there were 16 
people paying in and now there are only two people paying in, 
in 10 years.
    I tell people, read the trustees' report on Social 
Security. It has been done by Democrats and Republicans for 
years.
    Senator Graham. Now let us build on this. Can you imagine a 
scenario of saving Social Security from bankruptcy or major 
cuts without some forms of means-testing of benefits?
    Mr. Bowles. Again, arithmetically, you can do it, but it is 
not what we would recommend.
    Senator Graham. Now, both of you talk about sacrifice. The 
one thing we like around here is patting ourselves on the back, 
how brave we all are. I would argue that nobody in this room, 
including both of you all, is doing anything near like going to 
Afghanistan. So let us put this in perspective.
    All we are asking people to do is to do things that make 
sense. The sooner you do it, the better off we all are, because 
if you do it sooner, that means the solutions are not as 
draconian. So let us talk about means-testing and sacrifice.
    If you took an idea that said that if you make $50,000 or 
less in income, including Social Security, you would not have 
your benefits adjusted, what would that mean for the people 
that make over $50,000? You would have to have your benefits 
reduce somewhat. Is that correct, Mr. Bowles?
    Mr. Bowles. You would probably have to slow the rate of 
growth win the benefit.
    Senator Graham. Right. For a guy like me----
    Mr. Bowles. You really would not have to have the benefits 
reduced.
    Senator Graham. You know, when I was 21 my mom died, when I 
was 22 my dad died. My sister was 13. Social Security Survivor 
benefits came to my sister. It made the world of difference. I 
am 55. I do not have any kids. I am making 170,000 bucks a 
year. I am going to have a military retirement, hopefully a 
congressional retirement. What would it mean for someone in my 
income level in actual--the difference between what is being 
promised and what would be paid? Do you have any idea how much 
it would affect my benefits if we did a means test for people 
in my income level?
    Mr. Bowles. I do not know exactly.
    Senator Graham. Would it be $100 a month, $200 a month?
    Mr. Bowles. I cannot tell you exactly.
    Senator Graham. Could you get me that number?
    Mr. Bowles. Sure.
    Senator Graham. Because I believe it is going to be very 
small.
    Mr. Bowles. And one of the things I can tell you is that 
your benefit actually would not be cut. The rate of growth in 
your benefit would be at a slower rate.
    Senator Graham. So means-testing is not cutting anything. 
It is paying people what you actually can afford.
    Mr. Bowles. Yes. What it does, it grows it at the rate of 
inflation rather than at a higher rate.
    Senator Graham. So you have a progressive price indexing.
    Mr. Bowles. Yes.
    Senator Graham. Senator Simpson, do you think that is a 
smart idea for us to embrace?
    Mr. Simpson. Well, I think anything--what I tell people is 
this: I am 79, and so I see these people in the room, you know, 
with their signs and all sorts of activity. I say, ``Wait a 
minute, pal.'' I put $5 bucks in it when I was 15 and worked at 
the Cody Bakery. I was in the army, and you did put it in when 
you were in the army. Not now. And for the most productive 
years of my life practicing law in Cody, I never put in over 
874 bucks a year and neither did any other guy in the United 
States. This is fakery. Then I got stuck for $1,200, $1,400, 
$2,000, $4,000, $5,000, finally on up. But let me tell you, you 
are going to get it all back. In 1983, we found that the guy 
who got out got everything back plus 6 percent interest in 3-1/
2 years.
    Senator Graham. Would both of you urge the Congress to take 
up Social Security reform as part of this effort to bring about 
fiscal sanity?
    Mr. Simpson. Without question.
    Mr. Bowles. Absolutely, unequivocally, yes.
    Mr. Simpson. Got to.
    Senator Graham. Thank you.
    Chairman Conrad. I thank the Senator. I thank him for 
respecting the time as well. I appreciate that very much.
    Senator Cardin.
    Senator Cardin. Well, thank you, Mr. Chairman, and let me 
thank both of you for your work.
    I think you have the right formula, and each element will 
be controversial. We understand that. So let me deal, in the 
limited time that I have, with the one dealing with the 
revenues. And I know that you have already had some discussion 
in regards to consumption taxes, but I want to carry it to--
make a point here.
    We get around to tax reform, if we are lucky, about every 
25 years, so it is important we get this right and that we have 
a goal in your report to have revenues equal to about 21 
percent of our economy. That is a revenue goal that could be 
achieved through the reforms in the income tax that you have 
outlined, or it could be by using some consumption taxes as 
well as using our income tax. But the revenues would be the 
same.
    Now, I mention that because since we passed the last major 
tax reform in 1986, our Chairman frequently points out that 
there are now 140 provisions in the Tax Code that have been 
added, that have been added temporarily and need to be reviewed 
for extensions on a regular basis.
    My concern is that if we were to pass the recommendations 
of the Commission, it is unlikely that that would stand for 
very long before Congress would once again, for reasons of 
political expediency, us the Tax Code rather than the revenue 
code in order to carry out some policy. I think we are safer if 
we use less income tax revenues and we have more consumption 
revenues to equal the dollars that we want to bring in.
    And I also point out the realities of competitiveness and 
the fact that during the best of times this Nation did not save 
enough, and our policies need to reward savings. Senator 
Portman and I worked together in the House to try to encourage 
more savings for Americans, and our Tax Code certainly has not 
been terribly helpful in rewarding savings.
    And, last, we know that the income taxes, the corporate 
income taxes are not border-adjusted, whereas the consumption 
taxes are border-adjusted in international trade, which puts 
American manufacturers and producers at a disadvantage.
    The argument I hear the most against consumption taxes is 
progressivity, but we can make a consumption tax progressive, 
and we have ways of doing it. One of my goals is to make sure 
that at the end of the day we bring in revenues in a more 
progressive way, not a less progressive way, than we currently 
bring in the revenues of this Nation.
    So having said all that and knowing full well that you all 
really did your best to put forward the policy objectives that 
this Nation needs, we are certainly realistic to know that your 
proposals are going to be politically controversial wherever 
you went.
    Could you just share with me why we should not be 
considering as a matter of policy less reliance on income and 
more on consumption, knowing full well the history of Congress 
in changing the Tax Code?
    Mr. Bowles. I will be glad to do that. Let me tell you why 
it is not in our plan. It is pretty simple. About a week before 
we started, the U.S. Senate voted I think 85-14 and it did not 
look to me like the odds were too great we were going to have a 
consumption tax.
    Second----
    Senator Cardin. Well, you know, I am going to stop you on 
that because a lot of us were tempted to put in similar 
resolutions on Social Security, similar resolutions on every 
one of your proposals, and I daresay we could haveten 85 votes 
on the floor of the Senate on each one of those individual 
recommendations. I think it was terribly irresponsible for the 
Senate to take up that resolution.
    Mr. Bowles. I am just telling you why we did not do it.
    Senator Cardin. I understand.
    Mr. Bowles. There was no opposition on the Commission, as 
near as I could tell, to a VAT tax or a consumption tax in 
theory. In theory. Most people believe that it is much better 
to tax consumption if you can do it on a progressive basis than 
it is to tax wages or investments or savings. You have to make 
it progressive, but there was not a lot of opposition in theory 
on either side of the aisle.
    Where there was enormous concern was that we would end up 
with two engines of revenue. We would end up with an income tax 
that would be escalated, and we would end up with a consumption 
tax, and you would have two engines out there fueling revenue 
and fueling the tax rate. And that is why there was not support 
for it in our Commission. It was not the theory that it is 
better to take consumption.
    Senator Cardin. Well, I feel better getting that 
explanation because--and I would just conclude on this point. 
We want the best policy objectives. Future Congresses are going 
to act regardless of what we do in this Congress on these 
recommendations. I just think we are safer having a Tax Code 
that is less likely to be changed in the future for social 
reasons than we currently do under the income tax.
    Mr. Simpson. I think take a good look at the Domenici-
Rivlin report because they had the courage to put that out 
there. And we talked together, we visited with them, but we 
felt because of that resolution in the Senate we were just 
ramming our heads into the wall.
    Chairman Conrad. Let me just say on this point, exercise 
the privilege of the Chair for a minute. I argued strenuously 
for a VAT tax or a consumption tax in whatever form to be part 
of the package. And I do so in part based on the 
recommendations the Commission received. We brought in the best 
tax experts in the country, Republicans and Democrats, 
progressives and conservatives. Their recommendation to us was 
to go to a hybrid system--part income tax, part consumption 
tax--not layer one on top of the other in the sense of adding 
additional revenue as a result, but displacing part of the 
income tax system so that we could lower rates, especially 
corporate rates, to help America be more competitive. And we 
had the proposal from Mr. Graetz to adopt a hybrid system with 
part of it being consumption tax and to take 100 million 
Americans off of income tax rolls completely. A hundred million 
people no longer would have to file income tax returns at all, 
and you would achieve the same amount of revenue that is in the 
Commission plan, but you would do it with a hybrid system.
    So, look, we understand the politics of it, but I did want 
to take this moment to explain the position that at least I 
took.
    Senator Portman.
    Senator Portman. Thank you, Mr. Chairman, and I want to 
thank both of you for your service on behalf of the people I 
represent in Ohio and on behalf of our country. You know, most 
Commission reports end up collecting dust on a shelf somewhere, 
and there is an opportunity here for this to be a seminal 
report, to really change the direction of our country. It 
depends on what Congress does. And you have given us the 
opportunity to make these necessary changes.
    To Alan Simpson, he mentioned that I worked for him at one 
point. He inspired me to take a shot at elected office, which 
means you are going to be blamed for even something additional 
now.
    Mr. Simpson. Both of you now.
    Senator Portman. That witness protection program will have 
to be even better. And, Erskine, thank you for your service. 
When you were Chief of Staff at the White House, we worked 
closely together. Ben Cardin and I did some work on increasing 
savings and helping in retirement, and I do not think it ever 
would have been enacted into law without your intervention. I 
recall that and your willingness to step out of the 
partisanship and into solutions. And that is what you have done 
in this report, so thank you.
    Because you always spent so much time on this, I have three 
quick questions for you, just to get your thinking on it. Two 
we have already discussed briefly--tax reform and Social 
Security--but just on tax reform quickly, do you think from all 
the testimony you heard that the proposals that you have will 
not just have the impact that CBO and the Joint Committee on 
Taxation would indicate from the scoring but also will make our 
economy competitive?
    Mr. Bowles. Yes, no question.
    Senator Portman. So that is an intangible that is really 
not represented in the numbers that you are providing which can 
help to grow the economy and, therefore, to grow revenues.
    On Social Security, we will hear later today, I am sure, 
and we have heard all along that Social Security is not adding 
a dime to the deficit and it is in good financial condition. Do 
you agree with that?
    Mr. Bowles. Well, it is $45 billion cash negative today, 
and it is expected to stay cash negative for the foreseeable 
future.
    Senator Portman. That is based on the Congressional Budget 
Office report recently?
    Mr. Bowles. Yes, sir. What people sometimes forget is that 
when somebody my age goes to collect on their Social Security, 
I want money, cash. And I go to present that obligation to the 
Social Security Trust Fund, and it does not have cash. What it 
has is the Government IOUs there, which are as good as gold. 
But the Government has to go out into the marketplace and 
borrow the money.
    Senator Portman. Borrow the money.
    Mr. Bowles. And so it increases the national debt. So, in 
essence, what we are doing, since half the money is borrowed 
from foreign countries, at least half the money I am getting is 
coming from some foreign country to pay my Social Security.
    Senator Portman. That is a very good way to put it. I think 
that is the reality. I am glad you addressed the issue in the 
report and also talked about it today because it is adding to 
our debt.
    The final one is the toughest one of all, which is: What is 
the economic impact of all this? There are some folks out 
there, as you know, who study this who have said recently that 
if we reduce discretionary spending it will result in job loss. 
It is called a Keynesian model where Government spending being 
reduced equals a certain amount of less economic activity, 
therefore job losses. These are the same folks, you will 
recall, who looked at the stimulus package and said that 
roughly $800 billion--over $1 trillion when you add interest on 
the debt that had to be paid for because we had to borrow money 
for it. But those folks said that our unemployment would be 8 
percent last year and would be 7 percent this year. Now, that 
has not happened, but now they are saying that if we reduce 
spending by the 1.6 percent that you mentioned earlier, 
Erskine, there would be a great loss of jobs.
    You have looked at this carefully, and earlier you talked 
about the potential of financial crisis. You talked about small 
businesses being starved for capital if we do not do something. 
What do you think the economic impact would be of reducing 
spending along the lines that you have recommended?
    Mr. Bowles. I am not an economist and do not want to 
pretend that I am. What I am is a pretty decent business guy, 
and what I can tell you from a career as a business person and 
from heading the Small Business Administration, small 
businesses cannot grow and cannot create jobs without money. 
And if we do not tackle this fiscal mess that we have today, 
then small businesses will be crowded out of the marketplace, 
and there will be fewer jobs, not more jobs.
    If you are really concerned about jobs, then we have to 
tackle this fiscal problem at home.
    Mr. Simpson. And we did realize throughout the fragile 
nature of an emerging economy which seems to be happening, 
except, of course, the jobs do not meet the expectations. But 
people, I do not think, when you are all through with what we 
have done, will say that this was a failed Commission like all 
Commissions, because you, Senator Portman, were involved deeply 
with the Select Commission on Immigration and Refugee Policy, 
and we did two major pieces of legislation--legal immigration 
and illegal immigration--and with that bill brought 2.9 million 
people out of the dark to obtain legal status in America.
    I was on the Iraq Study Group. That was not a failure. This 
last administration did not accept maybe four or five but 50-
some of those 79 recommendations have been adopted. These are 
not feckless things. And this one ain't going away. This is a 
stink bomb in the garden party.
    Senator Portman. Thanks for your good work.
    Chairman Conrad. Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair, and thank 
you all for your work on the Commission.
    I wanted to ask some questions about an area I do not think 
anyone has touched on. If they have, I apologize. But 
addressing really the health care provisions and the steady 
elimination of the deductibility for businesses of the costs 
they spend on health care. I believe the way you have laid it 
out is that the deductibility be limited to the 75th percentile 
in 2014, stay steady for 4 years, and then be phased out over 
the following 20 years.
    The first concern I have is that I can imagine immediate 
response in which employers say, Well, we are going to reduce 
the size of our package down to the area that is tax 
deductible, and to do that we are going to have employees pick 
up a lot higher co-pays, a lot higher share of their insurance 
and so forth, which sounds an awful lot like an immediate, very 
regressive tax on working Americans. And so I just wondered if 
you all could touch on that for a moment.
    Mr. Bowles. I do not think that is the case. What I think 
you will see is, first of all, every business in the world, 
whether it is a small or large business, has raised the 
deductible, raised the co-pay, reduce the benefits in order to 
offset the increased costs. And that is a fact of life that we 
have all had to live with during the last--you know, at least 
as long as I have been in the business world. And I do not know 
any business that has wanted to do it but it has been forced to 
do it. So I think if we do nothing and we take the ostrich 
theory, then I think you will see that continue into the 
future.
    Health care is the biggest single problem that we face from 
a fiscal viewpoint. If you just look at Medicare and Medicaid 
and the CHIP program, it is about 6 percent of GDP today, and 
it is going to go to 10 percent before you know it. And that 
does not even count the $276 billion it takes to do the doc fix 
or the $76 billion to fix the CLASS Act.
    We think we are going to have to stand up to that, and we 
have proposed some pretty aggressive proposals as it relates to 
Medicare, Medicaid, to the tax deductibility, as you mentioned, 
that we felt were responsible in order to meet the fiscal 
challenges that the Nation faces. The problem is we have made 
promises we just cannot deliver on.
    Senator Merkley. Well, I am not sure you have really made 
me feel any better about this, because I think what I have 
described is kind of the reaction of a normal business. If you 
increase the cost of providing that particular benefit to their 
workers, they are likely to decrease it. And the way that they 
have done that is to increase the co-pays and the share that is 
being picked up by the employees.
    But the other reason I am very concerned about this is 
that, in the context of health care reform, there was a premise 
of companies continuing to provide health care. And if indeed 
you set up a situation where employers say, hey, without the 
tax deductibility of these benefits, we are simply going to 
shut that down; we will provide benefits to our employees in 
other ways, that results in a huge cost shift from the private 
sector to the public sector, actually increasing the size of 
the deficit.
    So I am wondering if you have modeled this out into the 
future, because it sure looks like something that is going to 
increase public deficits and public debt into the future rather 
than reducing them.
    Mr. Simpson. Senator, let me wade in. This was a monster, 
and we could not even wrap our arms around it. That is where 
health care is. All you have to do is think of things in your 
own family or in the family down the street where, in the last 
10 years of life, there is air flight, there is hospice, and 
maybe in 2 weeks you can run up a bill for $400,000. That is 
just Cody, Wyoming.
    There is a way to do this. You cut providers and you reduce 
physicians' fees, you increase co-pays for patients, and you 
begin to affluence test those. And you get one set of books in 
a hospital instead of tow, and you do tort reform by the use of 
health courts. And we have recommended all those things. Now, 
is that tough. You will not want any of that. But let me tell 
you, leave it like it is and it will eat a hole through 
everything you love in the discretionary budget.
    Senator Merkley. My time is up, but I will just mention 
that there are a number of concepts, including the House-passed 
bill, to get rid of the exemption from antitrust that health 
care currently employs. There was a lot of discussion of a 
public option. A public option in Oregon in workers' comp 
decreased the costs by half, and my colleague from Rhode Island 
said that when they adopted it in Rhode Island it had the same 
impact. The ability to negotiate the prices of drugs in 
Medicare on the same rhythm that we do in veterans would save 
$60 billion over 10 years. So there are many, many approaches 
other than a short-term transfer onto the working Americans of 
health care costs.
    Thanks.
    Chairman Conrad. I thank the Senator.
    Senator Thune.
    Senator Thune. Thank you, Mr. Chairman, and I want to thank 
you, Mr. Bowles, and, Senator Simpson, welcome back. You did a 
terrific service with your work, and although I did not agree 
with every piece of it, the body of work I think was 
exceptional, and I think you gave us, if we want to follow it, 
at least a pathway to start to get this fiscal situation under 
control. And because you were attacked by both the right and 
the left, I assume you were trying to find the spot right there 
in the middle that might be able to attract a level of support 
that would be necessary to actually enact something around 
here.
    I do want to ask a couple of questions--and I think it has 
been talked about a little bit already, but maybe get you to 
elaborate a little bit on it. If we were to adopt--the 
President's budget this year did not address what many of us 
thought it should have, and that is, some of these issues of 
entitlement reform. If we were to adopt the President's budget, 
how does that address the long-term structural issues and 
problems that you have identified in your work and seem to be--
some of the recommendations that were included in your work 
seem to be absent from the President's proposals?
    Mr. Bowles. I can answer that pretty straightforwardly. 
First of all, I do not think anybody on our Commission agreed 
with every part of the Commission report. I sure did not; Al 
did not. I know that the Chairman did not. So we all kind of 
held our nose and swallowed some of the things that are in the 
Commission report for the good of the country.
    The President's budget, again, as I said earlier, I think 
does a relatively good job of dealing with the domestic 
discretionary spending cuts, but it does not step up to, nearly 
to the extent I believe it should, the defense cuts that are 
necessary or the cuts that are needed in health care or 
reforming Social Security so it is solvent for the next 75 
years.
    Mr. Simpson. I think, Senator Thune, it is much like the 
Republican response, which both of them are just light budget 
efforts.
    Senator Thune. I do not know if this has been mentioned, 
but former Fed Reserve Chairman Greenspan recently said the 
U.S. could face a bond market crisis if politicians do not act 
soon to start cutting the Nation's debt. And he remarked that 
the probability of that happening in the U.S. in the next 2 to 
3 years is 50 percent. Do you agree with that assessment?
    Mr. Bowles. I do not know what the percent is, but let me 
just tell you how crazy our situation is today. We have this 
treaty where we are supposed to--if China were to attack 
Taiwan, we are supposed to support Taiwan. The only problem is 
we would have to borrow the money from China in order to do it.
    You know, this is a real mess we are in today, and we can 
either take the ostrich theory and put our heads in the sand, 
or we can decide we are going to step up and do something 
about. But I can tell you, bankers are not going to continue to 
finance something that they are not sure they are going to get 
paid back. And the less sure they are, the more they are going 
to charge you at first, and then they are going to cut you off. 
And we are borrowing half of our money from foreign countries.
    Senator Thune. How do we translate that--and a lot of times 
when we talk about these things here, we talk about it sort of 
in the abstract. How do we translate that, the American people 
personalize it so that they in their personal lives or family 
lives understand what the implications and impacts of our not 
acting are? Because I think in many cases they respond to the 
attacks that are made that this program is going to be cut or 
this program is going to be cut, and it is hard, once you focus 
on the specifics, to get the kind of support that you might get 
when you are talking in the general term about the need to 
reduce spending and debt.
    How do we translate this into terms? What does this mean to 
the average American family if we do not take steps to fix this 
mess?
    Mr. Simpson. Senator Thune, they have already got it, 
because here on this level we or you or I used to talk and say, 
How are the people handling this at the kitchen table. Well, I 
will tell you how they are handling it. They do not need any 
charts, nothing. They just say if you spend more than you earn, 
you lose your butt; and if you spend a buck and borrow 40 cents 
of it, you must be stupid. And that is what they know, and that 
is why they are with us.
    When we travel this country, they understand this because 
that is all you have to say. You are borrowing 40 cents for 
every buck you spend. And they know that if they did that in 
their own home, they are out, you know, in the bow wows. It is 
over. I do not know. They get it.
    Senator Thune. All right. My time has expired, Mr. 
Chairman. Thank you.
    Chairman Conrad. Thank you, Senator Thune, and thanks for 
respecting the time.
    Senator Whitehouse.
    Senator Whitehouse. Thank you, Chairman. Thank you, 
gentlemen.
    Back to health care for a minute, health care consumes 
about 18 percent of America's GDP right now, and the closest 
country is at about 12 percent, the worst. So we are half again 
as bad as the worst country in terms of the efficiency with 
which we deliver health care. We do not get better outcomes for 
it. The rate of increase is--it is not just going up. The rate 
is accelerating. So it strikes me that we have a real problem 
on our hands in health care, and it is not just an entitlement 
problem. It is a health care system problem, because the cost 
increases in our health care system are clobbering the private 
sector just as strenuously as they are clobbering the public 
programs.
    And so I do not think we can entirely fix the health care 
system just by trying to cut benefits in the health care 
programs that Government supports. There is an underlying cost 
problem in our health care system that I think has a lot to do 
with our sort of Rube Goldberg design of the health care 
system, although it is worse because Rube Goldberg's was kind 
of accidental. In this Rube Goldberg diagram, every party has a 
motive.
    So I think there is a lot of work being done to try to 
correct and reform the system as it goes. The areas that are 
obvious are the quality improvement movement that is out there. 
We spend $2.5 billion a year treating what should be completely 
avoidable hospital-acquired infections. You could zero that out 
if you could get rid of those. If we could figure out which 
prevention methods actually save money, we could invest in 
those and that would save costs overall. A really robust 
information technology platform can make a huge difference and, 
frankly, generate new private industries. We can start paying 
doctors better for results instead of just for amassing as many 
procedures as possible. And the overhead can be driven down a 
lot. There is a great deal of overhead that goes into the 
totally unproductive warfare between insurers and doctors over 
getting paid. They now have armies of consultants and staffers 
who fight with each other over getting paid. That is all on the 
health care system, and it does not provide a nickel's worth of 
health care value.
    You stack all of those up, there is quite a lot going on. 
And there are some very big outfits that are pursuing this 
stuff and have a lot of confidence in it--Kaiser, Geisinger, 
Intermountain, Gundersen Lutheran, Mayo--and they are seeing 
real cost reductions, and they are seeing real quality 
improvements.
    If you look at the President's Council on Economic Advisers 
report, they have calculated that the savings available from 
this is about $700 billion a year. New England Health Care 
Institute puts it at $850 billion a year. Secretary O'Neill, 
working with the Lewin Group, has calculated it at $1 trillion 
a year. Do we know the exact number? But it looks like it is a 
really, really big number.
    So if you agree with that, I would urge you, as you are 
discussing this issue, to really focus on this question of 
delivery system reform and the win-win that is possible from 
improved care, improved efficiency, and improved experience of 
care, all lowering costs. It has one big flaw, and that is that 
CBO and OMB cannot predict it because it is a process of 
learning and experimentation, as Dr. Gawande has said. We know 
there is good stuff to be done out there. We can have 
confidence in our ability to get there, but we cannot predict 
the dollars.
    So when you get down to a budget discussion, my fear is 
that this incredibly significant opportunity gets shoved off 
the table because nobody says, ah, I can put this dollar figure 
at it, and you all in generating your reports need to be able 
to put a dollar figure on it.
    So I guess my appeal is do not give up on that just because 
it is not cost-able. It is probably the biggest and the best 
thing that we can do for our worst and most severe long-term 
budget problem, which is the health care piece of the system. 
And, unfortunately, I do not see as much as I would like to 
about that in your report. Even if you put it in as a footnote 
saying, look, we cannot measure this, we understand why we 
cannot measure this, but it has a huge potential, and we should 
focus on that potential, because it worries me we are not 
getting that.
    Probably one of the best people in the world on this is act 
Don Berwick, and yet he is under constant attack right now 
because he did not come here and get confirmed properly. Well, 
fine, but we have a national emergency in this area. We have 
the chance for a huge win-win by reducing the costs in these 
big numbers. Let us not throw that baby out with the bath water 
just because we do not have a number. And the more you ignore 
it, the more things like attacking Don Berwick begin to seem 
like an OK idea instead of a really suicidal step. So I urge 
you to consider that as you go forward.
    I am sorry to speechify during the question time, but I 
just think it is so important and so frequently overlooked, and 
it is a constant frustration, and I hope, if you agree, you 
will give it a little bit more air time.
    Mr. Bowles. I actually do agree, and I have actually done 
it.
    Mr. Simpson. I do, too.
    Mr. Bowles. I was vice chairman of Carolinas Medical 
Center, the seventh largest publicly held hospital company in 
the country. After that, I headed the University of North 
Carolina's public health care system, the largest provider. 
What you are saying is exactly right. It is not, unfortunately, 
scorable, and that is why it is not in our report.
    Senator Whitehouse. Thank you.
    Mr. Simpson. And when I was here, Senator, we had a 
bipartisan group of John Chafee and John Breaux and Nancy 
Kassebaum and Dave Pryor, and we worked for months, and the 
problem was--and it is a terrible thing to say, but nobody ever 
understood it. And that is why it is like this. You go to the 
floor, and you do an amendment, and it is something good. 
Somebody sticks it on and nobody understands the impact. But I 
agree with what you are saying. You have gone to the core of 
it. I think those figures are correct, 4800 billion. But, wow, 
we--there are people who use terms hoping that you will feel 
inferior enough not to ask any questions.
    Chairman Conrad. Senator Johnson.
    Senator Johnson. Thank you, Mr. Chairman, and I would like 
to thank both of you for putting forward a serious proposal. I 
think it is absolutely essential that we mobilize the American 
public so they understand how urgent the problem is. And I 
think one of the ways we do that is--and we hear this term 
``debt crisis'' all the time. Can you describe in layman's 
terms what a debt crisis is going to feel like? How is it going 
to affect a family, an individual? Not just in theory but in 
layman's terms, what is that going to do to a family?
    Mr. Bowles. Their interest costs in every single thing they 
have are going to rise and rise relatively rapidly. The quality 
of education that they can provide their schools is going to 
erode. Their university systems are going to--the research they 
do is going to evaporate, and, therefore, the likelihood of 
that creativity creating the next new thing here rather than 
somewhere overseas is less, so, therefore, less likelihood that 
there will be a new job, even if you are trained for that new 
job down the road, less likelihood that the training funds will 
be there to train them. Their roads, their bridges, their 
highways will be less. There will be fewer cops on the street. 
It will affect them in every way possible.
    Senator Johnson. It is not going to be pretty.
    Mr. Simpson. And, excuse me, Senator, the guy who gets hurt 
the worst will be the little guy that everybody always talks 
about. That is who is going to get hammered when that happens.
    Senator Johnson. I do not think we can make that point 
loudly enough.
    You touched on one question I wanted to ask in terms of how 
do we redeem these Social Security bonds. I mean, we talk about 
the system is solvent to 2037, but that is by redeeming these 
bonds. In your fix, did you fix that on a cash-flow basis? Or 
how is the $2.5 trillion that we are either going to have to 
tax the American people again for or borrow from China, how is 
that accounted for?
    Mr. Bowles. We did a couple of things. On the revenue side, 
we raised the minimum payment that somebody would be taxed 
upon. Today it is capped at $106,800. Naturally it will grow to 
$168,000 by 2020. We took it to $190,000 by 2020. So you would 
pay that tax on the differential, on $22,000. And we reduced 
the rate of growth in benefits being paid to people at the 
higher levels because we changed what is called the BIN rate, 
and we changed the eligibility age, and we also changed the 
rate of inflation to what is called chained CPI, which is a 
slightly lower rate of inflation than the regular CPI.
    Senator Johnson. So, again, you did account for the fact 
that $2.5 trillion needs to be raised in some way, shape, or 
form, and you have accounted for that dollar amount?
    Mr. Bowles. Yes. It has to be.
    Senator Johnson. OK. You know, you are projecting or you 
are proposing that we increase revenue to 21 percent of GDP. In 
the President's 2012 budget, we have only--we have never hit 21 
percent of GDP in terms of revenue. We have hit it close three 
times: in 1944, in 1945, and I think the year 2000. I kind of 
subscribe to Hauser's Law that says no matter what the tax 
rates are, we are going to get about 18.8 percent of GDP in 
terms of revenue. How do you overcome that? Again, I am kind of 
a reality-based guy. You know, I am one who looks at real 
factors and figure.
    Mr. Bowles. Me, too. I looked at the forecast. I saw that 
revenue was forecast in 2020, I think, to be approximately 19 
percent of GDP. Spending was about 25 percent of GDP. That was 
6-percent gap. I have had to figure out how in the world are we 
going to close this gap. I wanted to close the vast majority of 
it on the spending side, so we took somewhere between two-
thirds and three quarters out of spending. Therefore, we had 
to--I wanted to get to a balanced budget. I had to do some on 
the revenue side. Historically, we have balanced the budget 
always, you know, as you said, at a level below 21 percent of 
GDP. And so I thought that was the maximum level we could get 
to, and I also thought it was probably one of the lowest levels 
we could get spending down to.
    Senator Johnson. But no matter what the rates we have taxed 
people at, we have never raised on average more than about--
well, never raised 21 percent.
    Mr. Bowles. Right. That is why we said that ought to be the 
maximum level, I think is what our report says.
    Senator Johnson. OK. I guess one final question. I do not 
subscribe to the theory that it has to be comprehensive reform. 
I mean, I think the American people want single-issue bills. 
They want to be able to understand what we are trying to do 
here. So with that in mind, did you make any attempt to 
prioritize the components of this in terms--you know, obviously 
Social Security is No. 1, I think, in your book. But did you 
prioritize the other recommendations if we did this in a 
piecemeal fashion?
    Mr. Bowles. We did Social Security separately because we 
thought we were doing that not for deficit reduction but for 
75-year solvency to save Social Security. We did not prioritize 
the others. We looked at it in a comprehensive basis, because I 
believe you have to do all of it, you know, not just one little 
bit of it, if, in fact, you are going to deal with this $1.6 
trillion deficit in a fiscally responsible manner.
    Senator Johnson. Thank you.
    Chairman Conrad. Thank you. Senator Coons.
    Senator Coons. Thank you, Mr. Chairman, and I just want to 
start, as has every other member of this panel, by thanking you 
for your service to the country in previous administrations and 
in the Senate and for your willingness to take on this 
thankless task, but one that, as you said at the outset, you 
took on for your grandchildren, for your communities, for our 
country. I think all of us agree that we are in a debt and 
deficit crisis and one that I would welcome your elucidating a 
little bit further just what the consequences would be for, as 
you put it, Senator, the little guy, because I am convinced 
that if we do not tackle this in the next 2 years, the 
consequences for the American economy, for our competitiveness, 
and for our long-term future are drastic.
    I want to commend you for tackling six different 
significant areas and for your core principles, with which I 
agree. And Tax Code reform is the piece that I am going to 
focus on and that I am interested in. It is my hope that part 
of your assumption is that if we made this significant changes, 
the zero-based budgeting approach to sort of scraping clean all 
the tax expenditures, lower the rates, that there would be 
greater growth and some possibility of higher receipts than the 
18.8 percent referenced by Senator Johnson.
    Please tell me, if you would, three things. First, give us 
a picture in a little more detail about how it might unfold if 
we fail to take these steps. How would it unwind that rates 
would go through the roof and the consequences for the average 
folks of America would be felt? And how do we stay on top of a 
sense of when that is going to happen? Because my sense is it 
may happen very suddenly and without a great deal of warning. 
First.
    Second, we talked earlier about the need for a long-term 
mechanism to restrict not just growth in spending but to also 
prevent the re-emergence of a lot of tax expenditures, doing 
all the hard work of fixing the Tax Code, some mechanism that 
would prevent it from then being undone. Any suggestions in 
that field would be welcome.
    And then if we have a minute or two left, something about 
the health reform ideas. You have a significant amount of cuts 
here, more than $430 billion, that have not been touched on in 
the two previous senators who have asked specifically about the 
health portion of it, if you would.
    Mr. Simpson. Well, Senator, let me just address the tipping 
point, because your colleague, our colleague--I think it was a 
colleague, he was of ours--in the Commission, Senator Durbin--
kept asking, Where is the tipping point? And we kept saying, We 
do not know. But some say 2 years, some say three.
    I happen to say it all depends on how far the Congress goes 
in getting to the meat of reducing a $14 trillion, which will 
be $300 billion, $14 trillion $300 billion debt, and the 
deficit of $1.6 trillion or $1.7 trillion. It depends on that, 
because the people who hold our paper are not going to be 
patient and they are going to say, You did not have the guts to 
do anything, you romanced the stone again, you did not do what 
you are supposed to do, and we want some money for our paper.
    It is my experience that big guys take care of themselves 
and they will take care of themselves. That is how we got in 
this huge slosh of a recession. The fat cats took care of 
themselves, and the little guy will get stung. That is all I 
know and that is what I keep talking about. It does not make 
any sense to anybody when you talk about getting the paper for 
the money, but that is what it is, and the bondholders are not 
just gentle people.
    Senator Coons. And what kind----
    Mr. Simpson. And he can handle the tough question.
    Senator Coons. What kind of mechanism might we put in place 
to keep tax expenditures from ballooning once again?
    Mr. Bowles. We did a couple things. We put a fail-safe in 
there on the tax side that said if Congress does not act by 
2012, then you have an automatic, across-the-board reduction in 
tax expenditures. I think that would get you to move.
    We also had another fail-safe in there that if the deficit 
to GDP was greater than what is called primary balance, which 
is 3 percent, that the President had to submit a proposal to 
get it to 3 percent. This was by 2015. That was his date he 
picked, so that is why we went with that. Or if the debt became 
unstabilized, after that it began to grow again, then the 
President would have to act.
    On health care cuts, we have, in our plan--we did not just 
willy nilly say that there ought to be cuts in health care. We 
have every single cut absolutely spelled out for and paid for. 
Again, I had to gore my own opportunities to do this. I did cut 
the funds that go to hospital for medical education, but again, 
I thought it was one of the areas we could.
    We took away some of the trickery and gaming that goes on 
in Medicaid. One of the things you can see that some of the 
states do is they will raise the cost of a tax that they have 
on providers, and then the providers will then be allowed by 
the state to raise their fees.
    So it is kind of a wash for the provider. But, oh, by the 
way, when the providers can raise their fees, then the feds 
have to match it, the taxpayers, two to one. It ends up costing 
us, over that same time period, about $44 billion. We cut out 
that kind of gaming.
    Senator Coons. I see I am over my time. I just want to 
close by thanking you again for your very hard work, and I am 
hopeful, with the leadership of the Chairman and Ranking 
Minority Member, that this Committee will step up to the task. 
Thank you.
    Chairman Conrad. Senator Sanders.
    Senator Sanders. Thank you very much, Mr. Chairman, and 
thank you, Senator Simpson and Mr. Bowles for being with us. 
Five minutes is not a whole lot of time, so I just want to make 
a few points and then maybe ask a few questions.
    I think one of the problems that we have when we just focus 
on deficit reduction, as significant an issue as it is, we lose 
the broad context of what is happening in this country, which 
is not just deficit reduction. The other reality that is 
happening in this country is that for many years the middle 
class has been collapsing. Poverty has been increasing.
    We now have, by far, the most unequal distribution of 
wealth and income of any major country. So while the middle 
class shrinks and poverty increases, the wealthiest people for 
many years have become much wealthier. So that you now have a 
situation, if you can believe it, where the top 400 families in 
America own more wealth than half of the families in America. 
Where you have the top 1 percent earning more income than the 
bottom 50 percent.
    So when you talk about moving toward deficit reduction, 
which we all appreciate is an important issue, the question is, 
well, on whom should that burden fall? Should we really, as our 
Republican friends have recently suggested, throw 200,000 
children off of Headstart? Should we cut back on the Social 
Security Administration? Should we cut back on Pell grants with 
middle class families finding it harder and harder to be able 
to afford college? How do you deal with that?
    So to my mind, the first question that I would ask, and I 
am going to have to request very brief answers because I want 
to get to Social Security, I want to get to health care as 
well. At a time when we have such a grotesquely unequal 
distribution of income and wealth, where over a recent 25-year 
period, 80 percent of all income in this country went to the 
top 1 percent, why, in your proposal, did you suggest that 
three-quarters of the movement toward deficit reduction come 
from spending cuts, only 25 percent from revenue?
    Why didn't you ask the wealthiest people in this country to 
start paying--I know you did some of it--but in a much more 
significant way their fair share of taxes?
    Mr. Bowles. First of all, I think we have a significant 
spending problem in this country. Second, I think we did 
exactly what you said. In every single case, we tried to 
protect the truly disadvantaged. If you look at all of our cuts 
in the other mandatory category, which is about 20 percent of 
the other mandatory category, we did not touch a single one of 
those.
    Senator Sanders. I would respectfully disagree with that.
    Mr. Bowles. It is a fact we did not touch food stamps, we 
did not touch unemployment, we did not touch SSI. We left them 
all alone. If you look at----
    Senator Sanders. But answer my question. Answer my 
question. If you are earning----
    Mr. Bowles. I am answering your question and I will 
continue to.
    Senator Sanders. We do not have a lot of time.
    Mr. Bowles. Well----
    Senator Sanders. How 400 people in this----
    Mr. Simpson. We will take some more time.
    Mr. Bowles. That is because the tax expenditures actually 
go to those people. Those are the people who benefit from this. 
The top 400 people pay an average tax of about 16 percent.
    Senator Sanders. That is correct.
    Mr. Bowles. Why do they do that? Because they have all 
these tax expenditures. We got rid of tax expenditures. That is 
why of a rate of increase the taxes of the top 1 percent or the 
top 1/10th of 1 percent is about 155 times what it is for 
somebody at the bottom. That is the right thing to do.
    Senator Sanders. But Mr. Chairman, at the end of the day, 
in your movement toward deficit reduction, three- quarters of 
your plan talks about cutting spending. And I ticked off, how 
do you feel about throwing 200,000 kids off of Headstart? That 
is a cut in spending. Good idea?
    Mr. Bowles. I do not think we recommended that, sir, so I 
do not believe----
    Senator Sanders. I know, but this is the result. When you 
talk about cuts in spending, Pell grants and so on--all right. 
Let me go on. We do not have a whole lot of time and I 
apologize.
    Mr. Simpson. What about your President offering to cover 
LIHEAP at 50 percent?
    Senator Sanders. Terrible idea.
    Mr. Simpson. I did not do that.
    Senator Sanders. And it was a terrible idea, no question 
about it. But let me go to Social Security. Social Security, to 
my mind, has been an enormously successful program for the past 
75 years, taken a whole lot of elderly people out of poverty, 
people with disabilities, widows and orphans, paid out every 
nickle owed to every eligible American.
    Now, I found it interesting. You just made a point, which I 
think is right, Mr. Bowles. You said, When we dealt with Social 
Security, we did not do it from a deficit reduction 
perspective. We did it to try to strengthen Social Security.
    President Obama, during his campaign, also had an idea. His 
idea was to raise the taxable income level at $250,000. 
Remember that? People earning more than $250,000, that cap 
would be removed. I thought that was a pretty sensible idea. 
What do you think about it?
    Mr. Bowles. I am on the record. I have said many, many 
times that I did not think that people in my income bracket 
needed a tax cut.
    Mr. Simpson. I was part of a group of Dave Pryor and Jack 
Danforth that met years ago with Paul Simon and agreed to take 
that lid completely off. That is me--
    Senator Sanders. Is that your view today?
    Mr. Simpson. You can do anything you want. I am not----
    Senator Sanders. No, not what I could do, but do your 
recommend to the Congress that we----
    Mr. Simpson. I do not know. You are the guy----
    Senator Sanders. Well, I agree with President Obama, that 
at $250,000 or more that cap be removed. Do you agree with that 
proposal from the President? Any comments? You guys just did a 
long report.
    Mr. Bowles. I have already said, you know, I did not 
believe that the top 2 percent of taxpayers need a tax cut.
    Senator Sanders. I asked a fairly simple question. Do you 
agree with President Obama, that above $250,000 we should 
remove the cap? Yes or no?
    Mr. Bowles. Should remove what cap?
    Senator Sanders. The cap on taxable income for Social 
Security.
    Mr. Bowles. Well, actually----
    Senator Sanders. Right now it is at $106,000.
    Mr. Bowles. $106,800. We actually did raise that.
    Senator Sanders. I know you did, I know you did. But the 
President went a lot further than you did.
    Mr. Bowles. No. I believe what we recommended, we took it 
to 90 percent, which was what it originally was.
    Senator Sanders. But you are not----
    Mr. Bowles. Which means when, in 2020, instead of going to 
$168,000, it goes to $190,000.
    Senator Sanders. The President said----
    Mr. Bowles. Or you will pay taxes on an additional 22 
percent.
    Senator Sanders. But the President said we should start 
very shortly by removing the cap for people over $250,000. I am 
not hearing your opinion on that.
    Mr. Bowles. No, no, I am happy to give you my opinion. My 
opinion is what we would recommend.
    Senator Sanders. So you do not agree with the President?
    Mr. Bowles. I do not.
    Senator Sanders. OK, that is fine, that is fine. In terms 
of health care----
    Mr. Simpson. I do not think you would ever agree with us 
either, so it does not make much difference.
    Senator Sanders. In terms of health care, at the end of the 
day, the United States spends almost twice as much per capita 
on health care as any other nation. We are the only nation in 
the industrialized world that allows private insurance 
companies to play a significant role in health care. Other 
countries have national health care programs without private 
insurance companies. Would you suggest that one way to get 
below the cost of health care is to----
    Chairman Conrad. Senator, Senator, in fairness to 
colleagues, you have now gone over----
    Senator Sanders. You are right.
    Chairman Conrad [continuing]. Well over, so I think we have 
to end it there, in fairness to colleagues.
    Senator Sanders. All right.
    Chairman Conrad. When there is a flow of a conversation, I 
have permitted both sides to go up to a minute over, but now we 
are at 2 minutes. So honestly, I do not think it is fair.
    Let me go to a point that Senator Johnson raised, because I 
think it is a critically important point and we discussed this 
in the Commission. If we just use the historical average for 
revenues, at no time in the last 40 years would we have 
balanced the budget, not one time.
    So I do not think that is going to work. If we look at the 
five times the budget has been in surplus, what has been the 
revenue? And there you can see, every time we have actually 
balanced the budget, revenue has been nearly 20 percent of GDP. 
In 1969, 19.7. 1998, 19.9. 1999, 19.8. 2000, 20.6. 2001, 19.5.
    And we have a different circumstance we are dealing with 
and the different circumstance we are dealing with is the baby 
boom generation, which is going to double the number of people 
that are eligible for these programs.
    So when we looked at that, and we are at 25 percent of GDP 
on spending now, we decided, and I wish Senator Sanders was 
still here, that we had to do more on the spending cuts side of 
the ledger, substantially more, but that we also had to do 
something on the revenue side if we are going to bell this cat 
in some kind of fair way, because we are borrowing 40 cents of 
every dollar we spend.
    If we did that all on the spending side, we would have to 
cut every single thing. The Federal Government spends 40 
percent across the board. Social Security, 40 percent. 
Medicare, 40 percent. Defense, 40 percent. I do not think that 
is reasonable. There has to be some revenue in this equation.
    Now, some will say, Well, revenue is going to return to the 
norm. Right now revenue is about 15 percent of GDP, the lowest 
it has been in 60 years. In fact, very close to being the 
lowest it has been in 80 years. Now, as the economy recovers, 
we will get back to close to the average, because we know that 
in economics, there is a return to the mean. We see it in the 
markets all the time, a return to the mean.
    We can expect that here, too. But the reality is, a return 
to the mean is not going to balance this budget. It is not 
going to balance this budget. And so, we concluded we have to 
have some revenue, although much more of it has to be done on 
the spending side of the equation.
    I want to just end my questioning without a question, to 
again say thank you. I know that, Alan, you could have been out 
there with Ann in Wyoming, and for those that do not know, Alan 
married up. His wife is spectacular. Of course, she is tough on 
him, too. She does not cut him a wide swath. You took on a 
tough assignment and we appreciate it.
    Erskine, I will tell you, there are very few people I have 
more confidence in to deal with something like this than I have 
confidence in you. And, boy, you proved it in spades, the two 
of you working together on this Commission, because I think the 
result--look, there are all kinds of things in here I dislike 
intensely. If I were going to do this, I would do this very 
differently.
    Dick Durbin called me the night before the vote. He said, 
Kent, what are you going to do? I said, I am voting yes. He 
said, Well, why? I said, The only thing worse than being for 
this is being against it, because the country is in deep, deep 
trouble. I do not know what could be more clear. This thing is 
headed for the cliff.
    And we say, Well, we do not know when we are going to hit 
the cliff. That is true. There is not a single person that can 
honestly tell you they know with certainty when we are going to 
hit the cliff. The one thing we know for sure is we are 
hurdling toward it. That is one thing we know with certainty.
    So I would say to colleagues, please, whatever your 
ideology, whatever your philosophy--I will tell you, I put mine 
on the back burner because I deeply believe we have to do 
something like this, and the only plan out there I see that has 
bipartisan support is this one, as much as I dislike it, and I 
do dislike it. I would do this very differently.
    But hey, what matters to the country is getting a result, 
because failure is not an option. Senator Sessions.
    Senator Sessions. Thank you. We appreciate your work and we 
will continue to pursue bringing this Government to fiscal 
sanity. I have no doubt that we need to start cutting this 
year. I do not think $61 billion out of $3.7 billion is going 
to put us in an economic slowdown. I know politically the 
Administration is opposing any of those kind of cuts, but I 
think that they can be done and can be done wisely and will add 
up to over $800 billion if we were to execute it.
    So I am saying, let's get busy now. And I do not shut the 
door on entitlement reform because obviously they are 
unsustainable. There are on an actuarially unsound basis and 
when you have that, you have just got to face up to it. It goes 
without saying, I think the world financial markets and our own 
economy would respond if we put ourselves on a sound course 
rather than an unsound course.
    You have given us good suggestions. Many of them, I think, 
are within the realm of achievability and let's see if we can't 
make some progress, Mr. Chairman. I look forward to working 
with you and thank you for your leadership.
    Chairman Conrad. Thank you. I thank all of the colleagues 
who participated here today, and special thanks to the 
witnesses. Thanks for your contribution. You have done 
something very important. I hope the country is paying close 
attention. I especially hope my colleagues are.
    Mr. Simpson. Mr. Chairman, let me just say thank you for 
your consistency. You came here when I was here, you stuck 
right with your guns on the budget all the way. I thank Mike 
Enzi and Senator Sessions, and if we can just remember one 
thing, one thing. We are Americans first, not Republicans or 
Democrats, and if we cannot get out of that rut, we will never 
get out of the rut.
    Chairman Conrad. Amen. Thank you both.
    [Whereupon, the committee was adjourned at 12:20 p.m.]





        DISTRIBUTION AND EFFICIENCY OF SPENDING IN THE TAX CODE

                              ----------                              


                        WEDNESDAY, MARCH 9, 2011

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:01 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Wyden, Sanders, Whitehouse, 
Begich, Sessions, Thune, Portman and Johnson.
    Staff present: Mary Ann Naylor, Majority Staff Director; 
and Marcus Peacock, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    I want to welcome everyone to the Senate Budget Committee 
today. Today we are going to focus on spending in the Tax Code, 
or tax expenditures, as they are known. These are the countless 
credits, deductions, and exclusions that riddle and complicate 
the Tax Code. Specifically, we will examine the distribution of 
benefits and the efficiency of tax expenditures.
    Our distinguished witnesses today are: Robert Greenstein, 
the president of the Center on Budget and Policy Priorities; 
Robert McIntyre, the director of Citizens for Tax Justice; and 
Scott Hodge, the president of the Tax Foundation. Thank you all 
for being here. We look forward to your testimony.
    Our Nation is at a critical juncture. We are borrowing 
about 40 cents of every dollar that we spend. Spending is at 
the highest level as a share of our economy in more than 60 
years. Revenue is the lowest it has been in 60 years as a share 
of the economy. Both sides of the ledger are part of the 
problem, I believe, and both have to be part of the solution.




    Looking at revenues in isolation has led some to argue that 
revenues should be held to the historical level over the past 
40 years, about 18 percent of GDP. But revenues at that level 
would not have produced a single balanced budget in 40 years. 
In fact, on the five occasions when the budget has been 
balanced or in surplus since 1969, revenues have ranged between 
19.5 percent and 20.6 percent of GDP. It is this higher level 
of revenue that provides, I believe, a more useful guidepost 
for what is needed if we hope to dig ourselves out of this 
fiscal hole and set the budget on a sustainable path.




    Unlike in previous years, the country now faces an 
unprecedented demographic challenge which will put a tremendous 
added strain on the budget going forward. I believe that tax 
reform has to be part of the solution to addressing our fiscal 
problems coupled with spending cuts. The current state of the 
Tax Code is simply indefensible. Our Tax Code is out of date 
and hurting U.S. competitiveness. It is hemorrhaging revenue to 
offshore tax havens and abusive tax shelters. The Tax Code is 
riddled with expiring provisions. This creates enormous 
uncertainty for citizens and businesses alike, making it very 
difficult for them to plan ahead.




    If we took steps to simplify and reform the Tax Code, we 
could reduce tax rates below where they are today, and tax 
reform would also allow us to raise more revenue to help 
address the very serious debt threat hanging over America.
    Eliminating or scaling back tax expenditures should be at 
the heart of any tax reform we consider. This year, we will 
spend $1.1 trillion on tax expenditure. That is as much as all 
of domestic spending, including defense. That is roughly 
equivalent to the size of our deficit. The deficit this year is 
going to be $1.5 trillion; the tax expenditures are $1.1 
trillion. It is a staggering sum by any measure, and these tax 
expenditures receive far too little scrutiny. I am a member of 
the Finance Committee, and I can tell you, as a member of that 
Committee, the tax expenditures have not received the attention 
that they deserve.




    Here is how well-known conservative economist Martin 
Feldstein described tax expenditures in a recent op-ed in the 
Wall Street Journal. He said, and I quote: ``Cutting tax 
expenditures is really the best way to reduce government 
spending.''
    Let me repeat that: ``Cutting tax expenditures,'' according 
to Martin Feldstein, ``is really the best way to reduce 
government spending. Eliminating tax expenditures does not 
increase marginal tax rates or reduce the reward for saving, 
investment, or risk taking. It would also increase overall 
economic efficiency by removing incentives that distort private 
investing and spending decisions. And eliminating or 
consolidating the large number of overlapping tax-based 
subsidies would also greatly simplify tax filing. In short, 
cutting tax expenditures is not at all like other ways of 
raising revenue.'' That is from an economic perspective and 
from a conservative economist.




    As we consider ways to reform the Tax Code, it is important 
to keep in mind who is benefiting from the status quo. In 
recent years, the effective tax rate for the wealthiest in this 
country, the rate actually paid after factoring in exclusions, 
deductions, credits, and other preferential treatment, has 
fallen dramatically. In fact, the effective tax rate for the 
400 wealthiest taxpayers fell from almost 30 percent in 1995 to 
16.6 percent in 2007.




    This trend was highlighted in a recent article in Tax Notes 
by tax expert Martin Sullivan. The article uses IRS data to 
compare the average effective tax rates for the residents of 
one Park Avenue building in New York City where the average 
income is more than $1.1 million. They compared that to the 
average effective tax rate for a typical New York City janitor, 
someone who might work in that very building, with an average 
income of $33,000. The data show that the average effective tax 
rate for the building residents was 14.7 percent--those are the 
people with an average income of $1.1 million--while the rate 
for the janitor was 24.9 percent; his income, $33,000.
    I do not know how anybody can defend or justify that kind 
of tax burden. It is not right.
    The reason for this disparity, of course, is that almost 
all of the janitor's income comes from wages, which are taxed 
at the regular income and payroll tax rates. The Park Avenue 
building residents, however, receive almost two-thirds of their 
income from investments, which are taxed at lower capital gains 
and dividends rates. In addition, the Park Avenue building 
residents receive a greater benefit from tax breaks because 
they itemize their deductions.




    Tax expenditures are clearly worsening the disparity 
between how the wealthy are taxed compared to everyone else. If 
we look at the increase in after-tax income from tax 
expenditures, we can see the top 1 percent received more than 
$142,000 from tax expenditures in 2009. The middle quintile 
received less than $2,800.




    The President's Fiscal Commission included the kind of tax 
reform I believe will be needed. It demonstrated that by 
eliminating or scaling back tax expenditures, we can simplify 
the Tax Code, actually lower rates, and still raise more 
revenue. Here are the key elements of tax reform that were 
included in the Commission's plan:
    One, it eliminates or scales back tax expenditures and 
lowers tax rates. It promotes economic growth and improves 
America's competitive position. It makes the Tax Code more 
progressive. Under the Commission's illustrative tax reform 
plan, instead of six tax brackets there are three: 12 percent, 
22 percent, and 28 percent. The corporate rate would be reduced 
from 35 to 28. Capital gains and dividends would be taxed as 
ordinary income. That would raise the effective tax rate of 
those people in the Park Avenue building because they are 
paying an effective tax rate of 16 percent. They would go up to 
28 percent.
    The mortgage interest and charitable deductions would be 
reformed, better targeting their benefits. The child tax credit 
and the EITC would be preserved to help working families. And 
the alternative minimum tax would be repealed. The Commission's 
plan also increases revenue to 21 percent of GDP by 2022.
    We simply will not be able to solve our Nation's long-term 
fiscal and economic problems without fundamental tax reform--
tax reform that improves our economic efficiency while also 
bringing in more revenue. And addressing tax expenditures has 
to be the heart of that tax reform.
    With that, we will turn to Senator Sessions, my able 
colleague, for his opening comments, and then we will turn to 
our excellent panel, really outstanding panel, for their 
comments. And then we will open it to questions from our 
colleagues.
    Senator Sessions.

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. Mr. Chairman, I do think the Commission's 
report on tax reform is very valuable, and it has a lot of 
suggestions that are critical that we could make and take and 
make our economy more productive and make the tax system more 
effective in producing a fair source of revenue. I would note 
that one reason, I assume, that the top 400 taxpayers have seen 
a major drop in their income, one reason is--in their taxes 
that they pay is because they are making less money. We have 
skewed the tax rate to very high income taxpayers whose incomes 
are volatile. They are not certain. And when you depend on that 
for your income, that is how, I think, we are down to 14.9 
percent of GDP in income, is because the profits are not there, 
and if you do not make profits, you do not pay taxes. If you 
sell your stock or your real estate properties for a loss, you 
take losses instead of show incomes. And I do think that is a 
factor in the problem we have with having a steady source of 
income.
    Mr. McIntyre thinks that is funny. Maybe I am wrong on 
that. Maybe upper-income people are making as much in the last 
2 years as they were during the boom period. I do not think so.
    I will just note this with regard to the actual share of 
wealth being paid in taxes: The top 20 percent pay 70 percent 
of the taxes in America, all taxes--payroll, excise, corporate, 
income taxes. According to CBO, between 1979 and 2007, the 
average tax rate for Federal taxes combined declined for all 
interest groups. The average rate declined for all. The average 
income tax rate also declined over those years. The largest 
decrease occurred for the fifth of the population with the 
lowest income. They got the biggest reduction. Those taxpayers 
in the top income quintile, the top 20 percent, in 2007 paid an 
average tax rate of 25 percent, a rate 6 times higher than 
those in the bottom quintile. The top 1 percent earned 19 
percent of the Nation's income but paid nearly 30 percent of 
the Nation's Federal taxes.
    According to CBO, in 2007 households in the highest 
quintile earned 55 percent before-tax income--they earned 55 
percent, the top 20 percent, before-tax income and paid almost 
70 percent of the Federal taxes. For all other quintiles, the 
share of Federal taxes was less than their share of the 
national income.
    In comparison to the tax rates in effect under President 
Clinton, low-income earners pay a smaller share under the 
current income tax structure while higher-income earners pay a 
larger share. In President Clinton's last year in office, those 
in the bottom income quintile paid a negative 1.6 percent share 
of all income tax--a negative share results from their 
receiving tax credits--while those at the top paid 81 percent. 
In 2007, the last year available, the share of income taxes 
paid by the bottom 20 percent became even more negative, while 
the share paid by the top 10 percent increased to 86 percent.
    The Tax Code is already highly progressive. An effort to 
eliminate credits, deductions, and exclusions without 
corresponding reductions in marginal rates will sacrifice 
economic growth. An average wealthy person, let us say, making 
$400,000 a year, they would pay under President Obama's plan to 
increase taxes 39.6 percent. The health care bill added an 
almost 1.9 percent payroll tax increase to them. We have added 
another 3.8 percent for our investment income. Alabama has a 5-
percent income tax, State tax. Other States have lower and many 
have higher. So you are around 50 percent of a person's upper-
income people subject to tax, a marginal rate. I mean, how much 
more do you do without damaging the economy? I think it is a 
dangerous trend to think we can just continue to drive up the 
tax rates and there will be no consequences. There will be 
consequences for it, and it is not all good.
    With regard to tax expenditures, the way I understand that, 
your charitable deductions count as tax expenditures. Every 
deduction virtually is scored as a tax expenditure. I am not 
sure every deduction is bad. I am not sure every deduction 
should be scored in that fashion. If you gave a $10,000 
contribution to some charitable enterprise and you only pay 
taxes on--you get to deduct that and you do not pay taxes on 
it. It saves you some of that money. But most of it is the 
contribution that went to the charitable enterprise; 40 percent 
or whatever for the upper-income people would be saved, but 60 
percent is out of their pocket of the charitable contribution.
    So I think we just need to simplify the Tax Code. I look 
forward to hearing these witnesses discuss it. You are exactly 
right, Mr. Chairman. You and the Commission raised this 
question of taxes. Are they serving our national interest? I do 
not think so. I do not know how to fix it. We need to get our 
arms around it, and if we--because we have to work with the 
Finance Committee and all. I know they are looking at this. But 
more than the deficit, getting your arms around the tax policy 
in America is exceedingly hard. I know there are a lot of 
suggestions, and I am open to them, and I am open to reform, 
that is for sure.
    Thank you.
    Chairman Conrad. Thank you, Senator Sessions, and I agree 
entirely with your last comment. Look, tax reform is essential. 
We do have a circumstance in which if you--what I was referring 
to in terms of the effective top rate dropping for the 
wealthiest 400 referred to actual income received. Clearly, 
many of those people have had a reduction. Some have not. Some 
have had huge increases even though there was an economic 
downturn. But the effective tax rate I was referencing was 
based on what they pay on their actual income, and that 
effective tax rate has dropped, and it has dropped because we 
have changed the tax law. We have made capital gains and 
dividends preferentially treated in a way that Warren Buffett 
says he pays an effective tax rate of 16 percent. The woman who 
is his executive assistant pays a much higher effective tax 
rate. And that is really the disparity that I was referencing, 
that the difference between the people who live in that Park 
Avenue building that we know exactly what their tax 
responsibility is because IRS reports it--we do not know who 
the individuals are; we now what their effective income is; we 
know what their effective tax rate it. They are paying a tax 
rate of 16 percent, and yet the janitor who may work in that 
same building, a much lower income, is paying a much higher 
effective tax rate.
    So the message from the Commission on tax expenditures was 
much as what Martin Feldstein said, a conservative economist, 
that the tax expenditures are really in many of the elements--
not all. I would say to the Senator charitable contributions, 
that is something we have to think very carefully about. But 
what we have done in Congress--and I am on the Finance 
Committee, so, you know, I am part of the process. I have a 
responsibility here, too. You know, it is becoming----
    Senator Sessions. You are a real master of the universe.
    [Laughter.]
    Chairman Conrad. It has become a back-door way of spending 
money, of spending Federal money.
    Senator Sessions. Mr. Feldstein made that point in the 
article, and he was critical of some of the Democratic 
criticisms that ignore the fact that one way to spend money is 
to do it through the Tax Code, on certain lower-income groups 
also through the earned income tax credit, which is one of our 
largest expenditures. But you are correct. Let us look at this. 
We have a good panel, and I look forward to hearing their 
comments.
    Chairman Conrad. I appreciate that.
    We will start with Mr. Greenstein, who has testified before 
this Committee on many occasions, has as high level of 
credibility here as president of the Center on Budget and 
Policy Priorities. Welcome. Please proceed with your testimony.

 STATEMENT OF ROBERT GREENSTEIN, EXECUTIVE DIRECTOR, CENTER ON 
                  BUDGET AND POLICY PRIORITIES

    Mr. Greenstein. Thank you, Mr. Chairman. As you know, 
bipartisan majorities on all of the major deficit reduction 
panels have agreed that to reduce the deficit, we need a 
balanced approach that consists of both program and tax 
reforms, both contributing to deficit reduction. Both taxes and 
programs are implicated in the fiscal problems we face, and 
both need to be part of the solution.
    Tax expenditures offer a particular target of opportunity. 
I still recall the moment in 1994 when Alan Greenspan was 
testifying before the Kerrey-Danforth Deficit Commission, on 
which I had the honor of serving, and Greenspan told us that we 
needed to look at what he called--these were his words--``tax 
entitlements.'' And indeed a number of tax expenditures are 
essentially spending entitlements delivered through the Tax 
Code.
    Take child care as an example. If you are a low- or 
moderate-income person, you may get a subsidy to help cover 
your child care costs through a spending program. But if you 
are higher on the income scale, you still get a Government 
subsidy that reduces your child care costs, but it is delivered 
through the Tax Code via a credit. Moreover, if you are a low- 
or moderate-income parent with child care costs, you might miss 
out because the spending programs that provide child care 
subsidies are not open-ended. They are capped, and when you 
reach the cap, people have to go on waiting lists. But if you 
are a higher-income household, your child care subsidy is 
guaranteed because the tax subsidy operates as an open-ended 
entitlement.
    As the Chairman noted, tax expenditures now total nearly 
$1.1 trillion a year. This substantially exceeds the cost of 
Medicare and Medicaid combined (a little over $700 billion), 
Social Security (about $70 billion), and non-security 
discretionary programs, (less than $600 billion).
    Both the Bowles-Simpson and Rivlin-Domenici Commissions 
contained a focus on tax expenditures, and as you noted, Martin 
Feldstein--I have a different quote from the same article. He 
said, ``If Congress is serious about cutting government 
spending, it has to go after many of these tax expenditures.''
    You might also note that in the GAO report that just came 
out on overlap and duplication, there is a whole section in 
that report on tax expenditures where the GAO says improving 
tax expenditure performance could reduce revenue loss 
potentially by billions of dollars.
    Now, a particular issue here is that tax expenditures are 
not just costly; they are often--not always, but often--
economically inefficient. Many tax expenditures are incentives 
designed to subsidized and encourage certain desired 
activities, but they often do so in inefficient ways. They do 
so often by distorting investment or other economic decisions, 
as Feldstein has noted, and adding to the inefficiency is the 
fact that many tax expenditures--principally those that are 
deductions, exemptions, and exclusions--tie the tax subsidies, 
the tax incentives they provide to the marginal tax rate of the 
beneficiary so that the amount of the tax subsidy increases 
with income and the wealthiest households get the largest 
subsidies.
    Now, from an economic perspective, such a structure does 
make sense if but only if higher-income people need a 
substantially greater monetary incentive to take the desired 
action and would not take it in the absence of the tax 
incentive. But the reality is often the reverse. High-income 
households would generally send their children to college, make 
sure they have enough assets for retirement, and buy a home 
with or without the current costly tax incentives, and that is 
why a number of liberal, conservative, and centrist experts 
alike have characterized key parts of our tax incentive 
structure as being upside down. We spend money providing the 
largest incentives to people in the top brackets despite the 
fact that the incentives generally have a smaller effect on 
whether they will send their children to college, become 
homebuyers, and put aside money for retirement than those 
incentives have for people lower down on the income scale.
    In fact, in that regard, tax credits differ significantly 
from deductions and exclusions. They reduce the price of the 
desired activity by an equal percentage for most households. 
Reformers view them in many of these areas as increasing 
economic efficiency, and both Bowles-Simpson and Rivlin-
Domenici propose to convert some of the tax deductions into 
credits.
    Now, my point here is that the economic efficiency 
weaknesses in the structure of various tax incentives offer you 
an opportunity. By converting various deductions into flat-
percentage tax credits, policymakers can improve economic 
efficiency by increasing the effectiveness of the tax 
incentives in boosting things like national saving, college 
attendance, and the like, even as you achieve deficit reduction 
and improve the progressivity of the Tax Code.
    Let me talk for a moment about progressivity. There was a 
fascinating recent article by economist Kenneth Rogoff. In this 
article, Rogoff warned of the consequences of widening a 
historic levels and historic levels of inequality in income, 
wealth, and opportunity throughout a number of countries. He 
cautioned that the ability of countries to address inequality 
could be the key factor that, and I am quoting Rogoff, ``could 
separate the winners and losers in the next round of 
globalization'' and could emerge as, his words ``the big 
wildcard in the next decade of global growth.''
    And the Bowles-Simpson report sets forth a basic principle 
here. It states, and I am quoting, ``Though reducing the 
deficit will require shared sacrifice, those of us who are best 
off will need to contribute the most. Tax reform must continue 
to protect those who are most vulnerable and eliminate tax 
loopholes favoring those who need help least.''
    Which brings me to my final point. Bowles and Simpson, as 
you noted, Mr. Chairman, on one of your slides, called for 
deficit reduction that protects low-income families and 
indicated it should protect the earned income credit and the 
child tax credit. These credits are vital to the standard of 
living of low-income working families, to ``making work pay,'' 
and to promoting work over welfare.
    Furthermore, those credits lower marginal tax rates for 
many low-income workers who otherwise face some of the highest 
marginal tax rates of any group of Americans, because they 
receive other means-tested benefits that phase down as their 
income rises. This is why, in calling for various tax 
expenditures to be curbed, Martin Feldstein wrote that he was 
not including the EITC in this list, which, Feldstein explained 
and I am quoting from Feldstein, ``acts largely as a tax rate 
reduction.'' And numerous academic studies have shown that the 
EITC has a powerful effect in increasing work, reducing welfare 
use, particularly among single parents with children.
    There has been a longstanding bipartisan principle in this 
town that people, parents who work full time should not have to 
raise their children in poverty. The only reason we comply with 
that principle and policy today is because of the earned income 
credit and the child tax credit.
    Finally, all past deficit reduction measures of recent 
decades--1990, 1993, 1997, the Gramm-Rudman-Hollings Act in 
1985--all reflected a commitment to protecting low-income 
households in general and the EITC in particular.
    Thank you.
    [The prepared statement of Mr. Greenstein follows:]



    
    Chairman Conrad. Thank you.
    Next we will hear from Mr. McIntyre. Robert McIntyre is the 
director of the Citizens for Tax Justice and has also testified 
on many occasions before this Committee. Welcome back.

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

    Mr. McIntyre. Thank you, Mr. Chairman. Well, today is the 
first day of Lent. It is an opportunity to take a resolution 
and maybe give up, not just until Easter but maybe even longer, 
what has become a great deal of enthusiasm in the Congress 
among both parties for providing subsidies to American 
businesses, and foreign businesses sometimes, in programs that 
are administered by Congress's favorite agency, loved beyond 
any other, the Internal Revenue Service. I do not know why you 
like it so much, but you do.
    You know, a quarter of a century ago, President Reagan took 
on these business subsidies that had grown into the tax code--
some of them he actually had put in there--but he took them on 
in 1986 and he passed a big tax reform bill that, among other 
things, raised corporate tax payments by more than a third, and 
the money was used to help fund individual tax reductions. But 
President Reagan was not afraid to do that, to raise taxes on 
corporations in the sense of taking away subsidies that they 
did not deserve. He did not think there was anything wrong with 
that at all. That may not be the current thinking here, but I 
am going to try to talk you out of the current thinking.
    In our view, as you know, the lobbyists have been back. 
They have worked their magic and the corporate and personal 
business side of the tax code is a mess again. We have three 
complaints. One is about what the current system does to hurt 
us. These subsidies, $365 billion in this fiscal year alone for 
business income, tax subsidies for business income, both 
corporate and personal, they cost that much money. It would 
make a huge step toward deficit reduction if we could recover 
some or all of that, and we strongly disagree with President 
Obama on his idea that corporate tax reform should be revenue 
neutral. That would defeat one of the main points of reform, 
and that point is that we need to deal with our deficit over 
the long term.
    And, you know, if there is one thing the public likes in 
terms of deficit reduction, it is asking American corporations 
to pay their taxes again. They do not like Social Security 
cuts. They do not like Medicare cuts. They do not like cuts in 
any program they have actually ever heard of. But they do like 
making American companies pay at least as much taxes as they 
are, which is not true now.
    Now, you get bonuses out of corporate tax reform done right 
because the current subsidies, as any economist will tell you, 
are designed to make companies do things that do not make any 
sense economically. That is the program. We want them to not 
invest in what is the highest rate of return or what the 
customers want to buy. We want them to do things that you very, 
very smart Senators and the smart people over in the House of 
Representatives think are better, sort of Soviet-style 
socialism, you could call it if you were a mean person. Not me.
    Well, if you tell companies to do things that are 
uneconomical, mostly, they will not because that is not where 
the money is. In fact, that is not what they lobby for. I mean, 
think about this for a minute. I am a steel company. I come in. 
Senator Conrad, I would like a tax break to make aluminum. No. 
I am asking for a tax break to make steel, because that is what 
I do. That is what I will do. But if you want to pay me to do 
it, so much the better.
    So that is the good news about the tax breaks, is most of 
them are a complete and utter useless waste. But sometimes they 
make a difference. We have a system where the aerospace 
industry pays 1 percent in taxes and the retail industry pays 
27 percent, and in between the rates are all over the place, 
too. I mean, that has to have some effect in getting investors 
to move to one place or another and that distorts behavior. 
Some effect.
    I will tell you where the real effect is, though, the real 
worst effect, and that is our international system, which right 
now we pay our companies to either artificially shift their 
profits offshore or, in some cases, move things offshore and 
really do business offshore instead of here in the United 
States. We have tilted the playing field with tax breaks so 
that you can make more money after tax in China than you can in 
the United States, even if before tax you make the same thing, 
and that seems to me to be nuts. So very economically harmful.
    The third point that I worry about is that, as you have 
pointed out, Senator Conrad, the disparity between taxes on 
capital income and taxes on wages has grown larger and larger. 
And if you look at what we could do about that, well, yes, 
capital gains and dividends breaks are part of it. But most 
capital gains are not over-taxed and neither are most 
dividends.
    The one place we could do something about this inequality 
in taxes and lack of progressivity compared to the olden days 
in the tax system is on the corporate side, where the income is 
earned. If we can get some taxes out of the capital income at 
the source, which is what the corporate income tax is supposed 
to do, because we all know most dividends are not taxed, most 
capital gains are not, then we would have a more progressive 
and a fairer tax system and that would be a good thing, I 
think. Now, we can argue about whether it is good, but I think 
it is good.
    So in conclusion, you on this committee are going to play a 
major role in trying to design a plan to reduce the long-term 
budget deficits and you do not want to do it in a way that 
endangers our very fragile economy, so you are going to do it 
gradually, I hope, and you are going to do it well and you are 
going to make great choices.
    We urge you to make reduction or elimination of business 
tax subsidies your highest priority here, because doing so, you 
can not just cut the deficit and therefore retain some 
important programs. You can make the economy more efficient. 
You can add jobs. And you can make America a better society.
    Thank you.
    [The prepared statement of Mr. McIntyre follows:]



    
    Chairman Conrad. Thank you, Mr. McIntyre.
    Next, we will hear from Mr. Hodge, the President of the Tax 
Foundation. Welcome. Good to have you before the committee. 
Please proceed with your testimony.

      STATEMENT OF SCOTT HODGE, PRESIDENT, TAX FOUNDATION

    Mr. Hodge. Thank you, Mr. Chairman and members of the 
committee. The immutable principles of economically sound tax 
policy tell us that taxes should be neutral to economic 
decisionmaking, they should be simple, transparent, stable, and 
they should promote economic growth. In other words, an ideal 
tax system should only do one thing and do it well, and that is 
just raise a sufficient amount of money for the government 
activities while doing the least amount of harm to the economy, 
and I think everyone on this committee will agree that the U.S. 
tax system is far from that ideal.
    Over the past two decades, we have asked the tax code to 
direct all manner of social and economic behavior, such as 
buying hybrid vehicles, turning corn into gasoline, encouraging 
people to save more for retirement, purchase health care, buy a 
home, replace the windows in that home, adopt children, put 
them in day care, take care of grandma, buy bonds, spend more 
on research, purchase school supplies, go to college, invest in 
historic buildings, and on and on and on. In too many respects, 
the IRS has become a substitute for every other cabinet agency, 
from Energy to Education to HHS and HUD.
    And thanks to the generosity of the credits and deductions 
in the tax code, a record 52 million taxpayers, or 36 percent 
of all filers, pay no income taxes at all and are now off the 
tax rolls. In other words, they have no skin in the game. And 
indeed, many of these people now look to the IRS as a source of 
income, thanks to more than $100 billion worth of refundable 
tax credits paid out to people who have no income tax liability 
at all.
    You know, the OECD reports that the U.S. has the most 
progressive income tax system of any industrialized country. 
Indeed, the top 1 percent of U.S. taxpayers now pays a greater 
share of the income tax burden than the bottom 90 percent 
combined.
    But the entire Federal fiscal system is progressive, not 
just the tax code. Tax Foundation economists have estimated 
that the majority of American families now receive more in 
government spending benefits than they pay in taxes. And 
overall, the Federal fiscal system, between taxes and spending, 
combine to redistribute more than $824 billion from the top 40 
percent of families to the bottom 60 percent.
    Unfortunately, many companies and industries, as Bob has 
mentioned, are now looking to the IRS as a source of income, 
too. In fact, a recent case, one-third of the profits of a 
major appliance company came from the Energy Production 
Credits, and I doubt that when Members of Congress enacted that 
program that they thought that it would be to this appliance 
company what the EITC is to poor people, an income subsidy.
    And today, the biggest crises facing working families and 
the economy are health care, housing, and local government 
finances. And ironically, these are the areas in which the 
government and the tax code are most involved. So the cure to 
what ails these industries is that we wean them off the tax 
code, not give them more subsidies.
    The tax preference for employer-provided health insurance 
has undermined in health care the market forces that deliver 
quality goods and services to everything from bread to 
computers. Housing suffers a similar problem because of the 
plethora of tax and spending subsidies intended to promote home 
ownership. One study determined that the MID is an ineffective 
policy to promote home ownership and to improve social welfare. 
And it should be noted----
    Chairman Conrad. Can I just stop you on that?
    Mr. Hodge. Yes.
    Chairman Conrad. You were referencing there the Mortgage 
Interest Deduction?
    Mr. Hodge. I apologize for using the acronym.
    Chairman Conrad. Yes. You know, any time, because we have 
people watching this----
    Mr. Hodge. Geek-speak.
    Chairman Conrad. Yes. So I know in the Washington community 
and Congress, everybody knows what that is, but if you will use 
the words so that people listening know what it means, as well.
    Mr. Hodge. My apologies. It should be no surprise that 
State and local debt has soared from $1.5 trillion in 2000 to 
$2.4 trillion today because local governments can pass off some 
of that cost to Uncle Sam through State and local tax 
deductions and subsidized municipal bonds.
    And we have, because, I think, in part, the rising local 
taxes, more and more Americans are finding themselves trapped 
by the AMT.
    But Washington can actually do more for the American people 
by doing less. The solution lies in fundamental tax reform, 
which means lowering tax rates while eliminating many of the 
preferences in the tax code. And a good starting point could be 
the Zero Plan by Erskine Bowles and Alan Simpson. And it is 
certainly not a perfect plan, but it does demonstrate that 
Americans could enjoy lower tax rates and the government could 
raise as much money if some, if not all, of the tax 
expenditures were eliminated.
    That said, with $1.5 trillion deficits, it is tempting to 
look at closing loopholes as a honey pot for deficit reduction, 
but I believe that would be a mistake. The primary goal of 
fundamental tax reform should not be raising more money for the 
government. It should be to improve the nation's long-term 
economic growth and lift the living standards of every 
American.
    Economists at the OECD in Paris, the Organization for 
Economic Cooperation and Development, have determined that high 
corporate and high personal income tax rates are the most 
harmful taxes for long-term economic growth. Unfortunately, of 
course, as many of you know, the U.S. has one of the highest 
corporate tax rates in the industrialized world, and as I 
mentioned, we have one of the most progressive personal income 
tax systems in the industrialized world.
    Fundamental tax reform can restore the nation's 
competitiveness and put us on a growth path for the future. And 
not only will this improve the living standards of all 
Americans, but it will improve the nation's fiscal health, as 
well, and that is a win-win for everyone.
    Thank you very much, Mr. Chairman. I welcome any questions 
that you may have.
    [The prepared statement of Mr. Hodge follows:]



    Chairman Conrad. Yes. Very good testimony, all three. Thank 
you very much. You made a real contribution to the committee. I 
appreciate your taking the time to be here and share your 
thoughts with the committee.
    I would like to go to something that has been a pet peeve 
of mine for many years. I used to be a tax administrator. I 
used to be Chairman of the Multi-State Tax Commission. And one 
of the things that jumped out at me in those years was the rise 
of offshore tax havens and the, what I think is the 
extraordinary rip-off that is occurring to average taxpayers 
and, frankly, to other businesses that do not avail themselves 
of the opportunity to use these offshore tax havens.
    Many times, I have shown the picture of Ugland House down 
in the Cayman Islands that claims to be the home to 18,000 
companies, a little five-story building, and all of them claim 
to be doing business out of little Ugland House down in the 
Cayman Islands. I would say it is the most efficient building 
in the world to be the home of 18,000 companies. Of course, 
there is no business being conducted out of there. The only 
thing that is being conducted is monkey business, because what 
they are doing is they are avoiding taxes in the United States 
and other jurisdictions.
    The estimate by the Subcommittee on Investigations is we 
are losing $100 billion a year to offshore tax havens. If 
anybody doubts that this is a big problem, I would invite you 
to go Google ``offshore tax havens.'' See what you get. I think 
you will be amazed at what you get. I certainly was.
    No. 2, abusive tax shelters. We now have the spectacle in 
this country of some companies buying European sewer systems 
and writing them off on their U.S. books to reduce their tax 
obligation here, not because they are in the sewer business. It 
would be legitimate if they are in the sewer business. But 
these are companies that are simply looking for a tax cover and 
buying European sewer systems, deducting them on their books 
for U.S. tax purposes, leasing them back to the European cities 
that built them in the first place.
    And it does not only apply to European sewer systems. They 
are doing the same thing with European transit systems. They 
have even gone so far as to buy European city halls and then 
deduct them on their books for U.S. tax purposes, lease them 
back to the European cities that built them in the first place. 
I mean, really, how can anybody justify this? That, the 
Subcommittee on Investigations, say is costing us $50 billion a 
year.
    Mr. Greenstein, have you looked into the abuses of offshore 
tax havens, abuse of tax shelters, and if so, what have you 
found?
    Mr. Greenstein. I think this is probably more an issue for 
Bob McIntyre. We have not looked at offshore tax havens 
ourselves, but I think he has probably done a lot of that.
    Chairman Conrad. Mr. McIntyre?
    Mr. McIntyre. Well, I think you put your finger on probably 
the most serious problem in our tax code today and our subsidy 
system today, on the corporate side in particular, because 
there are individual issues of hiding income and there are 
corporate issues of artificially shifting profits, and I think 
the second is your major focus there.
    The reason that happens, that we let it happen, is two. 
First, we have this extraordinarily complicated system of how 
companies allocate their expenses and their revenues. They have 
to pretend when they are dealing with their wholly owned 
subsidiaries offshore that they are dealing with an unrelated 
third party and they just make stuff up and the IRS cannot 
police it.
    Chairman Conrad. Let me just----
    Mr. McIntyre. But that problem, by the way, would be 
trivial, absolutely trivial. This arm's length of pretending 
you are negotiating with yourself would be a trivial and almost 
nonexistent problem were it not for the fact that if they can 
shift that profit to the Cayman Islands or wherever, then the 
tax that ought to be paid on the income is indefinitely 
deferred. If we got rid of that deferral, then it would not do 
them any good to move it to the Cayman Islands and the problem 
would be solved.
    Now, there are some people in the Congress, I know many 
business lobbyists, I am sure, who are calling for Congress to 
make this problem worse by saying that not only can you defer 
what you shift to the Cayman Islands, you can be exempt forever 
on it. It is called the territorial system, or as one of my 
assistants called it, a territorialism system, because it would 
make--it is like a terroristic attack on the Internal Revenue 
Code.
    So as you go on on this, and it will come up for you in the 
Finance Committee, there is going to be a lot of talk. What 
should we do with our current system? Should we try to do what 
John Kennedy wanted to do back in the early 1960s and get rid 
of deferral, or should we go to what the Europeans have done, 
which is go to this territorial system which has turned out to 
be a disaster for them and would be a disaster for us and would 
make your building down in the Cayman Islands have to add a 
very large annex.
    Chairman Conrad. Let me ask you this question. Have you 
done any analysis on how big the revenue hemorrhage is from 
offshore tax havens?
    Mr. McIntyre. Well, on the corporate side, the Treasury 
Department has been doing a somewhat better job of putting a 
number out. A lot of the estimates have been bootstrapped. You 
know, some reporter will ask me how much, and I say, I do not 
know, $70 billion. Then somebody reads that and says, well, I 
am going to raise you.
    But Treasury has made a serious effort. They peg it right 
now at about $50 billion, but I think they are leaving 
something out. So the numbers you gave, could it be 75, could 
it be 100 a year, I think it could. But they are at least 
getting it up there, because--and if you look in their latest 
tax expenditure book, you will see it, and that is a big piece 
of that $365 billion in corporate subsidies.
    Chairman Conrad. Let me just say, when I was a tax 
commissioner, I one time found a company that was doing 
business in the United States and I found out through 
involvement with the IRS, this company just kept--they had a 
series of transactions within the United States between wholly 
owned subsidiaries here showing no profits at any point in the 
United States. They got to the Cayman Islands. They showed $20 
million in profit with one employee working half-time. I always 
said that was the most efficient guy in the world, to produce 
$20 million in profit half-time. And, you know, the Cayman 
Islands gave them the opportunity to defer it indefinitely.
    So, you know, this is the kind of thing that is really 
going on in the real world and it is, I think, patently unfair 
to people who have all of their income exposed to taxation at 
whatever level of income, to have some who are avoiding 
everything that they owe through these kinds of tax dodges.
    My time has expired. Senator Sessions.
    Senator Sessions. Well, it is very complex. I am aware of a 
businessman who sold a profitable asset in another country and 
his comment to me was, well, I will tell you, the United States 
Treasury is going to receive a lot less money because this is a 
foreign company and they probably will not even incorporate in 
their country. They will probably incorporate in the Islands 
and not going to have any income. But the income tax he was 
paying was a significant factor in his decision to cease to 
sell the business.
    I guess, Mr. Hodge, we have had a good bit of talk about 
the corporate tax rate, simplification, and the rest of the 
world is going to the territorial system. None of them are 
going back from it, I do not think, Mr. McIntyre. They must be 
reasonably happy with it. And we are ending up with the highest 
rate in the world. When Japan reduces theirs, I believe we will 
be the highest developed corporate tax rate in the world. And 
within that structure, as the Commission said and the Chairman 
has noted, we have great disparities between health care--
industry is paying 5 percent, the trucking company is paying 30 
percent, and it is a hodgepodge--no pun intended--of a tax 
situation.
    Is there any way we could--what are the principles here 
that we ought to consider as we seek to do something about the 
difficult challenge of corporate tax rates that is making the 
United States less competitive, costing jobs in America. There 
is no doubt about that.
    Mr. Hodge. Well, Senator, I think we first have to 
understand that the United States has a Neiman Marcus corporate 
income tax system where the rest of the world is moving toward 
Walmart tax prices. We have everyday high taxes every day while 
the rest of the world has everyday low taxes every day. Every 
other country on earth looks like a tax haven compared to the 
United States. As you mentioned, the United States has a 
combined corporate tax rate of nearly 40 percent. Only Japan 
has a higher rate. And in 3 weeks, they are about to lower 
their rate to below 35 percent, which will make the U.S. the 
highest in the nation.
    But we cannot also forget that Canada has already cut their 
corporate tax rate again as of January 1, from 18 percent to 
16.5 percent at the Federal level, and they are on their way to 
reduce their rate to 15 percent in a few years. The U.K. in 3 
weeks, as of April 1, will reduce their corporate rate from 28 
percent to 27 percent on a long-term path to reduce their 
overall corporate rate to 24 percent. And they, along with 
Japan, were the two most recent countries to move to a 
territorial system and for very different reasons.
    Japan did it because Japanese companies were not 
repatriating profits from largely U.S. income back to Japan 
because their tax rate was so high and they had a worldwide 
system. So they had to move to more of an exemption-based 
system to encourage those companies to repatriate those profits 
back to Japan, which has been in about a 20-year recession.
    Great Britain moved toward a territorial system because it 
was losing companies to other countries who were redomiciling 
in Ireland or Switzerland or the Netherlands, and so they had 
to move toward a territorial system in order to prevent those 
companies or discourage companies from leaving the country. And 
so they have had to make corrective actions to make themselves 
more competitive in a global environment.
    Let us not forget, when we talk about companies that are--
--
    Senator Sessions. I would just say, in this time when jobs 
are just a critical factor for us, what would you say to a 
working individual in the country who thinks that corporations 
ought to pay more, that they are having a hard time getting by. 
They read about corporate assets, their wealth they are sitting 
on and not spending. How do you explain in simple language your 
view that tax increases can be damaging?
    Mr. Hodge. Well, first of all, understand that every 
multinational company in the United States has IRS agents 
permanently staffed in their offices auditing their books. 
Imagine if you had to give up your guest bedroom to an IRS 
agent and they were constantly looking over your shoulder----
    Senator Sessions. One company said, I had to provide free 
coffee. I am still irritable about that.
    [Laughter.]
    Mr. Hodge. But to get to your point, what the economic 
research is telling us is that the real economic burden of the 
corporate tax is now falling more and more on workers and 
labor, and that is because in a global environment where 
capital is very mobile but workers are not, the real economic 
burden of the corporate tax falls on workers through lower 
wages and productivity. And so if we want to encourage higher 
wage growth, higher productivity, we need to cut that corporate 
income tax and those benefits will eventually fall onto workers 
or benefit workers.
    And I think that if we really care about the long-term 
living standards of Americans and workers, we need to cut our 
corporate tax to be more competitive and to reduce the 
incentives for other countries----
    Senator Sessions. And that will create jobs----
    Mr. Hodge. It will create jobs----
    Senator Sessions [continuing]. Make the companies healthier 
and be able to probably drive up wage rates----
    Mr. Hodge. Exactly.
    Senator Sessions [continuing]. Which I would like to see 
happen. Well, so on the Canadian border, and a company is 
deciding where to locate a plant, would this corporate tax rate 
induce them--I am sure that is Canada's goal, to induce 
corporations to expand in Canada rather than expand in the 
United States. Is that realistic?
    Mr. Hodge. The Canadian government has an explicit policy, 
and it is on their website if you go there, that they want to 
become--they want to have the lowest corporate tax of all of 
the G-7 nations, the major G-7 nations, and to make themselves 
as competitive as possible and as attractive as possible, not 
only to U.S. companies, but to all inbound investment.
    So I think that there--we often look at Ireland as being 
sort of the model for low corporate taxes, but we ought to be 
most concerned about Canada. As they are driving to be more and 
more competitive, it is going to become a much more attractive 
place for U.S. businesses to grow and expand and we risk 
falling behind the longer we delay doing something about our 
high corporate tax.
    Senator Sessions. And the haven problem is exacerbated by 
higher rates, would you agree?
    Mr. Hodge. Absolutely. I think, and as the Chairman 
understands, being former Revenue Director, when you have 
States such as South Dakota and Wyoming or Nevada that do not 
have personal and corporate income taxes, those look like 
pretty attractive places for high net worth individuals or 
businesses to expand and grow. So tax competition is real, not 
only in the States, but also globally, and the more we 
understand that we need to bring down our tax rates to be more 
competitive, the shorter time we will risk falling behind.
    Senator Sessions. Well, we face a lot of challenges. We do 
have a revenue shortfall and we cannot tax ourselves out of 
competitive world markets.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you.
    Senator Whitehouse.
    Senator Whitehouse. Thank you, Chairman. I appreciate you 
having this hearing.
    As I think both the Chairman and the Ranking Member are 
aware, it has been calculated that we spend, as Americans, 
about six billion hours every year in tax compliance. So 
clearly----
    Senator Sessions. Does that include looking for lost 
documents?
    Senator Whitehouse. Six billion hours. Think what you could 
build and design and invent and create with six billion hours 
of human economic activity.
    Anyway, one of the things that interests me is to sort of 
look back and try to put some historical perspective on where 
we are right now. And if you go back to 1935, there was 
essentially parity between what individuals in America 
contributed in the revenues of the country and what 
corporations contributed in the revenues of the country. It was 
one-to-one.
    And then in 1948, we broke through to two-to-one, with 
individuals contributing two dollars to the revenue of the 
country for every one dollar that corporations contributed. In 
1971, we broke through three-to-one, three individual dollars 
to our national revenues for every one dollar that corporations 
contributed. In 1981, we broke through four-to-one. And in 
2009, we hit close to a high-water mark at six-to-one, six 
dollars out of America's individual pockets into our revenues 
for every one dollar that corporations contributed to our 
national revenues.
    I understand the competitive advantage from lower corporate 
tax rates, but are we condemned to a race to the bottom in 
which corporations end up paying essentially no share of our 
national revenues and the entire burden is on individuals? That 
is a big change from a history during which America was a 
pretty strong power and that has lasted 75 years.
    Mr. McIntyre?
    Mr. McIntyre. Well, you are absolutely right that the race 
to the bottom is what is going on in the world today, and if it 
is going to be stopped, it is going to take some leadership 
from the United States.
    The other countries are not happy about it either. They are 
losing revenues that they could use to pay for the public 
programs that they are cutting instead that would help their 
economies a lot more. But we have been the instigator of this 
for a long time. They blame us for the race. And if we were to 
lower our corporate rate, they will just lower theirs more. It 
is one of those things that we have to get together, just like 
the States need to do, get together to stop profits moving into 
the low-tax States. And you worked on that for years, Senator 
Conrad.
    But, yet, it is absolutely a critical problem, and the 
answer is not to give up, which I think is Scott's advice, but 
rather to take the steps that we need to do to get with our 
trading partners and work out a way that we can all collect 
some money from the owners of capital.
    Senator Whitehouse. Mr. Greenstein, I was struck by the 
Chairman's remarks about the top 400. I have seen that as well, 
and I did a comparison between the rate that the top 400 paid, 
on an average $344 million each in annual income, with what 
that would connect to in Rhode Island. And the Bureau of Labor 
Statistics says that a hospital orderly on average makes about 
$29,100, and at that point they are paying about 16.7 percent. 
That is about where the crossover is as you climb the ordinary 
income wage scale if you a single person.
    So you have this sort of peculiar effect of the hospital 
orderly, you know, pushing his cart down the halls of a Rhode 
Island hospital at 2 in the morning paying the same share in 
total Federal tax, combining the income with payroll taxes, as 
the person who is making more than a third of a billion dollars 
a year, and that just does not seem right. The Chairman's Park 
Avenue example, you know, similar effect.
    If you take a look at H.R. 1, clearly there are going to be 
substantial burdens for people, and we often hear how we all 
have to share in this. For the hypothetical person making more 
than a third of a billion dollars in income and paying that 
16.7 percent tax rate, how does H.R. 1 affect their lives 
compared to, say, a family that needs Head Start to take care 
of the kids because both parents are working in the morning or 
a family that has kids in public school? What is in there that 
would change anything for that person?
    Mr. Greenstein. Well, I think there are fundamental things 
the Government does that benefit people at all income levels 
from making sure that the food supply is safe or funding 
research into diseases that affect you wherever you are on the 
income scale.
    Senator Whitehouse. But those would apply equally to all 
people, in theory.
    Mr. Greenstein. Yes.
    Senator Whitehouse. Those are common goods.
    Mr. Greenstein. Those are common goods.
    Senator Whitehouse. Is there anything that does not qualify 
as a common good that would apply to the person making $344 
million in a year?
    Mr. Greenstein. Well, as a general rule, if we are looking 
at various sorts of services, spending, subsidies, for lower-
income people they primarily come--not exclusively--on the 
spending side of the ledger, and for higher-income people they 
primarily come through tax expenditures on the tax side of the 
ledger. And the example I gave----
    Senator Whitehouse. H.R. 1 does not do anything in that 
regard, does it?
    Mr. Greenstein. Well, H.R. 1 by virtue of just focusing on 
non-security discretionary programs necessarily has a larger 
adverse impact on people lower on the income scale.
    Senator Whitehouse. The last quick question as my time runs 
out. Mr. Hodge, I just want to clarify one thing. I doubt you 
meant to suggest that there was a defense for tax dodges in the 
Cayman Islands that allow people to defer all taxation on their 
income indefinitely if they have been able to hide it there 
successfully by justifying the rate--justifying that by virtue 
of the corporate tax rate we have here. If we cut the corporate 
tax rate in half, you still cannot beat deferring taxes 
indefinitely by hiding them down in the Cayman Islands, can 
you? I mean, that is a real race to the bottom if we have to 
compete with the Cayman Islands and the tax dodge itself as our 
corporate tax baseline.
    Mr. Hodge. Well, the basic point is that--I am not going to 
defend tax dodges, obviously. But the fact is that the United 
States' high corporate tax rate is anticompetitive, and the 
rest of the world looks extremely competitive by comparison. It 
looks like a tax haven, because the average OECD rate is around 
26 percent while the U.S. rate is nearly 40 percent. And so 
that----
    Senator Whitehouse. Nominal rate.
    Mr. Hodge. Nominal rate and the effective rates. There are 
also great disparities between the U.S. effective rate and the 
effective rates of the rest of the world as well.
    Chairman Conrad. I thank the Senator.
    Senator Thune.
    Senator Thune. Thank you, Mr. Chairman.
    Mr. Hodge, you rightly pointed out that the goal of our Tax 
Code is not to raise ever-increasing amounts of revenue but 
instead to spur economic growth. With that in mind, what do you 
think is the most important pro-growth tax reform that we could 
undertake here?
    Mr. Hodge. Well, following the guide and the research of 
economists as the OECD who have looked at the relationship 
between different types of taxes----
    Senator Sessions. OECD, would you explain that?
    Mr. Hodge. Excuse me, sir. The Organization for Economic 
Cooperation and Development, and their job is to look at how 
Government policies affect long-term economic growth, and when 
they look at the relationship between different types of taxes 
and growth, as I mentioned, they find that the corporate income 
tax is the most harmful tax for long-term economic growth 
followed by high personal income taxes, and then consumption 
and property taxes are found to be least harmful.
    So I would address first our high corporate and personal 
income tax systems and try to bring down the rates, and while 
doing so we can certainly broaden the base by eliminating many 
of the provisions that are currently in the Code. But by doing 
so we will not only make ourselves more competitive, but I 
think that we will super charge the economy, get us back going 
again, and that will be good for everyone in terms of higher 
wages and living standards, which ought to be the primary 
objective of any tax reform.
    Senator Thune. You had mentioned that a typical family of 
four earning $50,000 now does not pay any taxes. Historically, 
what has been that break-even point? Do you know what that sort 
of historical average would be?
    Mr. Hodge. It has been climbing over time. There was a time 
where perhaps it was around, you know, $20,000, $25,000 a year, 
and over time, as we have included such things as the earned 
income tax credit, the child credit, and then making those 
refundable--meaning even if you did not have an income tax 
liability you would still get a refund check--the income 
threshold for those not paying income taxes has grown, as you 
mentioned, now to around $50,000 a year.
    Senator Thune. You had mentioned in your testimony, I 
think, that 36 percent of the people in the country now do not 
pay taxes. There was some reporting here awhile back that it 
was like 47 percent. Are you including payroll and income?
    Mr. Hodge. No. The 36 percent refers only to people who 
file an income tax return, and then there is a great group of 
Americans who earn some income but not enough to break the 
threshold of actually filing a tax return.
    When you add those two groups together, that comes out to 
close to 47 percent of all American households are essentially 
outside the income tax system.
    Senator Thune. What would be the distributional impact of a 
VAT tax, in your opinion?
    Mr. Hodge. By and large, economists believe that the value-
added tax is regressive, much like sales taxes. It tends to 
disproportionately harm low-income people over high-income 
people.
    Senator Thune. Could you discuss further the exclusion of 
the employer-provided health insurance and its effect on labor 
markets and health care costs? Because that is something that 
was debated during health care. There was a limitation, 
although a small, modest one, placed on so-called Cadillac 
plans. Do you believe that changes made in the health care bill 
are going to be effective in addressing these problems of 
distortions in the labor market and health care costs, 
increased health care costs?
    Mr. Hodge. The tax exemption for employer-provided health 
care really creates what we call a third-party payer problem, 
and that is, the real consumer or patient is disconnected from 
the real transaction. The real people paying the bills, the 
real ones that doctors pay attention to, are the employers and 
the insurance companies, not the patient. But the patient wants 
as much health care as possible because they are not paying the 
bills. So it breaks up the market system and creates an 
imbalance there. And so the closer we can get to really putting 
consumers and patients in the driver's seat, I think the better 
off we will be. Moving toward things like health savings 
accounts is an important step. I do not think that the health 
care reform bill that recently passed is going to solve this 
problem. In fact, it could exacerbate it by creating a larger 
third-party payer problem, and people will just simply demand 
more and more health care because they are simply not paying 
enough of the cost.
    Senator Thune. In his opening statement, the Chairman 
pointed out the discrepancy between the top 400 and someone at 
the lower-income level might be paying as a percentage less of 
their income. And one of the suggestions or explanations for 
that was that they had unearned income that was taxable at 
lower rates, capital gains and dividend rates. I am just 
curious, though, what your thoughts are on the impact of 
raising those rates. One of the reasons, I think, that the 
rates have been lower is that we have tried to encourage 
investment that is considered to be a pro- growth type policy 
to not tax investment, cap gains, and dividends at the ordinary 
income rates.
    So what would that do just in terms of economic growth, in 
your opinion?
    Mr. Hodge. Well, first of all, a lot of these individuals 
get some of their income through tax-free municipal bonds, and 
so essentially the Federal Government is subsidizing that to 
some degree, and so I think we ought to be concerned about 
that.
    But to get to your point, we do tend to forget that capital 
gains and dividends are really a second layer of taxation on 
corporate income. And when the OECD looks at the rates on 
dividend income, the U.S. has one of the highest combined rates 
on dividend income among industrialized nations. I think we are 
fourth of the 30 major industrialized countries in terms of our 
combined corporate and personal tax rates on dividend income.
    So I think that the more we can reduce that second layer of 
tax or reduce those dividend rates, I think that we will have 
more economic growth and we will have a better economy overall.
    Senator Thune. All right. Thank you.
    Mr. Chairman, just, as a final closing point, I would like 
to see the rates on everybody come down and broaden the base. 
You talked a lot about tax expenditures, which I happen to 
agree. I think we have way too many preferences in the Tax Code 
today and lots of distortions as a result of that. But rather 
than raising rates to the higher level, I would like to see the 
rate that, you know, the lower-income person is paying come 
down. Let us get everybody down to where we are lowering rates 
and hopefully broadening the base. So thank you. Thank you, Mr. 
Chairman.
    Chairman Conrad. That was really the approach of the Fiscal 
Commission: broaden the base, bring down rates.
    Senator Sanders.
    Senator Sanders. Mr. Chairman, thank you very much for 
assembling this excellent panel. You know, sometimes we wish we 
could have 2 days just to go over this stuff. This is very, 
very important stuff. It is a little bit complicated, and we 
have some different perspectives--not only perspectives but 
different facts coming out.
    For example, I would say to Mr. Hodge, my understanding is 
that a 2007 study by the Bush Treasury Department concluded 
that the effective--not nominal--U.S. corporate tax rate is 
lower than the average corporate effective tax rate imposed by 
our major competitors.
    But, Mr. Chairman, I think most of us understand that we 
have a serious deficit problem, that we also have major 
problems in our economy, that we want a fair tax system, and we 
want a tax system that enables us to improve the standard of 
living of ordinary Americans.
    Mr. McIntyre made the point that I would reiterate, that 
each and every year large and profitable corporations all over 
this country are able to avoid paying billions of dollars in 
Federal income taxes through loopholes in the Tax Code and 
generous tax breaks. In my view, this is simply unacceptable 
when we have a $14 trillion national debt.
    According to an August 2008 GAO report, two out of every 
three corporations in the United States paid no Federal income 
taxes between 1998 and 2005. Amazingly, these corporations had 
a combined $2.5 trillion in sales but paid no income taxes to 
the IRS. That is according to the GAO.
    Further, as Mr. McIntyre mentioned in his statement, a 
report from Citizens for Tax Justice on corporate tax abuses, 
what I found astonishing, is that 82 Fortune 500 companies in 
America paid ``zero or less in Federal income taxes in at least 
1 year from 2001 to 2003.'' And when you have record-breaking 
deficits and a huge national debt, I find that just 
inexplicable.
    Mr. Chairman, let me also mention that--and you made the 
points--I am sorry. Mr. Sessions made the point that the top 20 
percent pay 70 percent of all Federal taxes. That is what Mr. 
Sessions said. But that has to be put within the context of the 
fact that the top 20 percent earned 52 percent of all income 
more than the bottom 80 percent.
    So one of the realities when you talk about who is paying 
taxes, you have to also remember that median family income has 
gone down. Most of the new jobs that are being created are, 
unfortunately, low-wage jobs, and you cannot get blood from a 
stone.
    So I think all of our panelists have talked about the fact 
that millions of Americans are paying nothing in income taxes. 
That is true. You know why? Because they do not have any money 
to pay. If you are making $25,000 a year and you have a few 
kids and you have a house and you have a car, you have to get 
some health insurance, you maybe have some child care, there is 
no money to pay income taxes.
    Now, Mr. Hodge mentioned the OECD, the Organization for 
Economic Cooperation and Development. I will get to you, Mr. 
Hodge. I do not want to leave you out. But, Mr. Greenstein or 
Mr. McIntyre, of all of the countries in the OECD, is there any 
that does not provide health care to all of their people as a 
right of citizenship?
    Mr. McIntyre. They all do.
    Senator Sanders. They all do.
    Mr. McIntyre. And they give it to them for free.
    Senator Sanders. Oh, my word.
    Mr. McIntyre. And yet those people, despite the fact that 
they could spend every day of their lives in the doctor's 
office should they so choose do not.
    Senator Sanders. I do not want to get into health care 
right now, but the point is when we talk about OECD nations, 
let us look at the whole picture. The United States has 50 
million people without any health insurance. We are the only 
country in the industrialized world that does not provide 
health care to all people.
    To send a kid to Harvard University today costs what, would 
you guess? Fifty, sixty thousand a year? How much does it cost 
to send to the best universities in Europe? Mr. Greenstein, Mr. 
McIntyre, Mr. Hodge, do you have any guess on that? Not much. 
In fact, I think in Germany tuition there is probably free. Not 
a magical thing. That government there believes it is important 
to invest in education for the well-being of their country. We 
charge very high prices, and a lot of our kids cannot afford to 
go to college or they come out deeply in debt. When we talk 
about OECD countries, how do we compare, Mr. Greenstein and Mr. 
McIntyre, in terms of child care? I have a daughter in 
Burlington having a hard time paying for child care. What do 
you think? Do the governments in Europe do a little bit better 
job? Of course they do.
    Mr. Greenstein. Yes.
    Senator Sanders. All right, et cetera, et cetera. So, Mr. 
Chairman, my first point is you have to look at the entire 
picture.
    In terms of income inequality, Mr. Hodge, which major 
country on Earth has the most unequal distribution of income 
and wealth?
    Mr. Hodge. According to the latest OECD countries, the 
United States was, I think, fourth on the list.
    Senator Sanders. Compared to what? What countries were 
ahead of us? Major countries.
    Mr. Hodge. On the list, I think it was Portugal, Turkey, 
and Italy or something.
    Senator Sanders. Mexico, I suspect.
    Mr. Hodge. Mexico.
    Senator Sanders. Turkey. Well, there it is. We have a more 
progressive distribution of income than Turkey does. But of any 
major countries on Earth, what would be the answer? Major 
economy.
    Mr. Hodge. Well, I think I just answered that----
    Senator Sanders. The United States of America, right.
    Mr. Hodge. We also have the highest overall average per 
capita income, ironically.
    Senator Sanders. Average.
    Mr. Hodge. Yes.
    Senator Sanders. Meaning that if you have somebody who is 
making a billion dollars and somebody who is broke, average 
income is half a billion a year. We understand that. But you 
are also--I do not want to get into the average. We have dealt 
with the average issue here a whole lot. It does not mean a 
whole lot when the median family income of the average American 
has gone down by $2,500 in the last 10 years.
    My point, Mr. Chairman, is this is a fascinating 
discussion, and we need a lot more of this. Clearly we want tax 
policies which generate good-paying jobs. We want to deal with 
the huge trade deficit of some $500 billion a year where 
company after company is shutting down here and going to China. 
I would argue that taxes are not the only factor. I think 
wages, the incentives offered by the Chinese Government are 
also important.
    But my main point is that when we talk about who is paying 
taxes in this country, we also have to talk about the kinds of 
incomes that our people are experiencing. And the sad reality 
is that for millions and millions of Americans, their real 
incomes are going down. So it should not be shocking that they 
pay less in taxes.
    I would also add, when Senator Sessions talked about the 
top 20 percent pay 70 percent of all Federal taxes, while that 
is true, if you add to that, Senator Sessions, State taxes and 
you add local taxes, which are, by and large, regressive--
right? A billionaire and a working person fill up a gallon--
fill up their gas tank in a car, right? So if you are making 
$25,000 a year, that is a heavier burden on you than if you 
have a whole lot of money. Property taxes, by and large, are 
regressive. So when you add the Federal income tax and State 
taxes and local taxes, you probably end up with a situation 
where, for millions of people, working people, their effective 
total tax rate is a hell of a lot higher than it is for some of 
the richest people in this country.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, Senator.
    Senator Johnson.
    Senator Johnson. Thank you, Chairman. Thank you for 
appearing.
    I would like to start out with Mr. McIntyre. I really like 
looking at the reality of the situation. Who in effect pays the 
corporate income tax? When corporations view the tax as a cost, 
just like in my business I view resin prices as a cost, who in 
effect pays that corporate tax?
    Mr. McIntyre. The shareholders, in my view.
    Senator Johnson. You do not think it is the consumers of 
the product?
    Mr. McIntyre. Absolutely not.
    Senator Johnson. Mr. Hodge, what would you say----
    Mr. McIntyre. I can prove that to you, if you want. There 
are many, many companies in this country that argue for 
replacing the corporate income tax with a tax on consumers. It 
would seem to me a waste of time if it was already a tax on 
consumers. So why wouldn't--I cannot understand why they would 
make the effort.
    Senator Johnson. Mr. Hodge, I would like your thoughts on 
that.
    Mr. Hodge. Economists are pretty well agreed that there are 
three parties that pay the corporate income tax. It is either 
consumers through higher prices, shareholders through lower 
share returns and lower share prices, and workers through lower 
wages. But what we are finding in a global economy is that 
workers are paying the lion's share of the corporate income tax 
through lower wages and productivity. And so we need to really 
understand this in a global context where capital is extremely 
mobile but workers are not, that it is workers that are bearing 
that lion's share of the corporate tax.
    Senator Johnson. You know, oftentimes when I listen to 
these discussions, it is like we have an option not to compete. 
The U.S. as a country has to compete for global capital, 
correct? We do not have that option. We have to compete. So how 
do we compete when the CEO from Intel says in his 
decisionmaking factor, in order to produce--or build a 
semiconductor plant, it costs $4 billion in Asia and $5 billion 
in the U.S., and he largely attributes that to the tax regimen. 
I am sure regulations play a part in that.
    If you are a corporation manager, let us say, from a 
different country, if you are looking at investment decisions, 
why would you spend an extra billion to invest in the U.S.?
    Mr. McIntyre. Well, there is no doubt that some companies 
have advantages in low wages or that they provide other 
benefits that make it cheaper to do things abroad, and there is 
not too much we can do about that.
    My point is that we probably should not be paying our 
companies to go there. So if there is a tax advantage in 
China--I will take your word for it--we could solve that 
problem by getting rid of deferral so that the Chinese profits 
would be taxed at the same rate as if those profits were earned 
in the United States. So, yes, if that is a problem, my 
solution solves it.
    Senator Johnson. Mr. Hodge?
    Mr. Hodge. The corporate tax rate in China is 25 percent, 
which is just slightly below the average of the major 
industrialized countries. It is 15 percentage points lower than 
the Federal corporate tax rate. So, by definition, it is a much 
more competitive place, a cheaper, at least from a tax 
perspective, place to do business. And by ending deferral, as 
Bob has suggested, you would instantly make U.S. companies less 
competitive while doing business there and give a distinct 
advantage to German firms, Swiss firms, French firms, all the 
other firms that are doing business there. We want U.S. 
companies to do business in China. We want them to succeed in 
the global marketplace. And by hamstringing them by eliminating 
deferral or keeping the U.S. tax rate where it is, we are 
making the U.S. less competitive, we are making U.S. companies 
less competitive, and ultimately we are making U.S. workers 
less competitive. And that is a recipe for slow economic 
growth.
    Senator Johnson. Isn't it also true that when a U.S. 
company invests overseas, that also provides an awful lot of 
jobs in the U.S. supplying and servicing those overseas 
operations?
    Mr. Hodge. Yes, the research of Matt Slaughter from 
Dartmouth University has shown that it is what they call in the 
military the ``tooth-to-tail ratio,'' and that is, you need a 
certain number of people back home to service those people who 
are on the front lines. And it is that way in corporate 
America, too. So if we are doing business in China, we need 
researchers and designers and computer experts and financial 
people and all these people back here who do a lot of the brain 
work to support that work that is going on overseas. And so as 
we are growing abroad, U.S. companies are also growing 
domestically, and Mr. Slaughter has shown that pretty 
convincingly in his economic research.
    Senator Johnson. Overall, the U.S. economy has never really 
generated much more than about 18.8 percent of GDP in terms of 
revenue. Professor Hauser calls that ``Hauser's Law.'' I would 
like you to speak to that basic fact. As much as we would like 
to believe we could raise 21 percent of GDP in revenue by a 
different tax regimen, how realistic is that to actually occur?
    Mr. McIntyre. Well, we have done it before. In fact, the 
only time we have ever balanced the budget in the last 50 years 
is when we did it.
    Senator Johnson. In the 2012 budget, President Obama's 
budget, there are only 3 years where we actually collect 
revenue greater than 20 percent of GDP.
    Mr. McIntyre. Right. I am saying the last time we balanced 
the budget was in the Clinton administration when revenues went 
up to almost 21 percent of the GDP. Back in the 1960s, we 
balanced the budget briefly when it was about 20 percent of the 
GDP. All the other years in between those balanced budgets in 
Clinton and Johnson--a different Johnson--were places where we 
had lower revenues and unbalanced budgets.
    Senator Johnson. But don't you acknowledge the fact that 
taxpayers simply cannot reorganize their affairs quickly enough 
when you increase tax rates? It just takes a little while. You 
are able to snare a higher percentage of GDP when you increase 
taxes, but eventually that benefit falls off.
    Mr. McIntyre. No, I do not think that is true. I think what 
happened--and it is very clear what happened to the corporate 
income tax--is that Members of Congress are either cajoled or 
threatened by the corporate lobbyists to give them back their 
loopholes, and then every once in a while, we have to clean up 
the Tax Code again. It used to be on a 15-year cycle. We missed 
out on the 2001 one due to a difficult election decision, but 
we are overdue to clean it up again. Yes, it is kind of like 
the Medicare rules with the doctors. If you do not change them 
often enough, they will understand them.
    Senator Johnson. Well, first, I am totally supportive of 
slim-lining this Tax Code. It is absurd, 70,000 pages----
    Mr. McIntyre. Yes, and I am not talking about raising tax 
rates, you know. I am talking about probably cutting tax rates 
a bit to make it more palatable. But all these subsidies we 
have in the Code, don't we believe in free markets at all 
anymore? And, gee willikers, the companies come in with the 
same story, and you guys fall for it every time. The 2004 
American Jobs Creation Act, they came in and said look what is 
going to happen when you give us this thing. General Electric 
said give us all this stuff--they wrote half the bill--and we 
will create jobs in the United States. What did they do? Since 
then, 32,000 fewer jobs at GE in America, and jobs are up 
overseas.
    So, yes, I mean, you can fall for it or not, but----
    Senator Johnson. You have no argument with me on the 
special tax rates.
    Mr. McIntyre. Good. I appreciate that, Senator. We are 
friends now.
    Chairman Conrad. I would like to go back to one thing I 
heard, that 47 percent of the people in this country pay no 
taxes. I do not think that is an accurate statement. They may 
not pay income taxes, but they pay payroll taxes. In fact, I 
think two-thirds of the people in this country pay more in 
payroll taxes than they pay in income taxes. But I would just 
like the panel to respond to that.
    Mr. Greenstein. Well, actually the 47-percent figure is 
incorrect for the percentage of people that do not pay income 
taxes as well. It was a correct figure for 2009 and 2010 for 
two reasons. We were in a deep recession, and a lot of people 
lost their jobs and did not have income. And Congress passed a 
temporary making-work-pay tax credit that took more people off 
of the income tax roll. So, for starters, we want to look at 
the underlying figure without the make-work-pay tax credit and 
without 9 or 10 percent unemployment.
    So the figure before the recession was 37 percent. However, 
that is just income tax. When you take into account payroll tax 
and to a minor degree excise tax, the best estimates are that 
about 10 percent of families do not pay any Federal tax; about 
90 percent do. But that is a 1-year figure. Income is very 
volatile. People lose their jobs, they gain their jobs.
    If you said over a 5- or a 10-year period what percentage 
of people do not pay any tax year after year after year, any 
Federal tax, it would be very, very tiny.
    The other thing that--you know, we have a figure from CBO 
that if we take the bottom quintile, the whole bottom 20 
percent of Americans, for 2007--the last year we have--yes, 
their income tax was negative because of things like the earned 
income credit, but their total average Federal tax rates was 4 
percent. They paid 4 percent of their total income in Federal 
taxes of one sort or another, even though the income alone was 
negative.
    I guess the last point I would make on this is that you 
made a conscious and I think the right decision here in 
Congress on a bipartisan basis over the years that if you 
wanted to make sure that parents working full time did not 
raise their children in poverty, you could have not had an 
earned income credit or had a much smaller credit and had a 
dramatically higher minimum wage. Now, business would have 
complained mightily about the job and employment effects of 
having a much higher minimum wage. So you ended up doing 
somewhat less on the minimum wage and putting place a robust 
earned income credit, and my recollection--I remember in 1989 
or 1990 there was a debate over how much to raise the minimum 
wage, and the single biggest EITC expansion bill introduced 
that year was by Mr. Armey, now active with the Tea Party, 
because he felt it would be bad for business to raise the 
minimum wage a lot and that the alternative was to do a very 
large increase in the earned income credit.
    So we really need to take all these factors into account. 
But the idea that nearly half of Americans have no skin in the 
game is really not borne out by the facts.
    Chairman Conrad. Isn't it true that the vast majority of 
people in the country pay more in payroll tax than they pay in 
income tax?
    Mr. Greenstein. Yes, they do, and also nearly everyone pays 
State and local taxes because a very large share of State 
taxation is the sales tax. And regardless of how low your 
income is, you pay that. So most people at the bottom, Federal 
and State together, they pay tax liability, often a fairly 
significant amount, because in many States--and Bob McIntyre's 
group has done the key work on this--in many States the 
percentage of income you pay in tax at the State and local 
level is higher for people in the bottom quintile than people 
in the top quintile because of the regressivity of sales taxes.
    Chairman Conrad. Mr. Hodge, were you seeking recognition?
    Mr. Hodge. Yes, Mr. Chairman. In my written testimony, I 
point out a Joint Committee on Taxation report looking at 
refundable credits against--and how that not only eliminates 
people's income tax burden but also how much it erases of their 
payroll tax burden. And for 2009, these refundable credits 
exceeded the employee's share of payroll taxes for 23 million 
tax filers and exceeded the employer's share of payroll taxes 
for 15.5 million filers.
    So in addition to erasing their personal income tax burden, 
these refundable credits have become so generous they are now 
erasing their payroll tax burden as well. But we often forget 
we are just looking at the tax side of things, and we have to 
look into what also is being given to these people in various 
Government benefits. And when we look at both sides of the 
equation, we find that low-income people get as much as $10 in 
Government benefits overall for every dollar that they pay in 
taxes. And so we have to look at both sides of the equation, 
not just the tax side.
    Chairman Conrad. OK. I want to just in my remaining time go 
off the subject of this hearing because Mr. Greenstein is here. 
We had Mr. Bowles and Mr. Simpson here yesterday. I wanted to 
just have a moment to talk about Social Security with you, Mr. 
Greenstein. In the Bowles-Simpson Commission, as we looked at 
Social Security, we saw that in 2037 Social Security faces a 
22-percent cut, or thereabouts. It depends on a lot of factors. 
But in 2037, there is an across-the-board cut because Social 
Security cannot make all the payments that are scheduled.
    And so the question is: What does one do about that? The 
Commission concluded that it is important to address that 
sooner rather than later, made a series of changes, and one of 
the things that was done was to try to have a set-aside for 
people who need to retire early because they are in hard 
physical labor positions.
    On restring solvency, there were a series of other steps 
taken, going to chained CPI, which economists tell us is a more 
accurate measure of inflation; changing the bend points; and 
also raising the income level which Social Security taxes apply 
to because the traditional 90 percent of income being subjected 
to Social Security has fallen away.
    There is a technical problem with what the Commission 
reported, which I have been repeatedly assured will be fixed--
it has not yet been fixed--so that the lowest quintile would be 
protected. As it turns out, because of a technical flaw in what 
the Commission did, the lowest quintile have not been fully 
protected, but it is clearly the intention that they be.
    What would be your assessment of the Social Security 
provisions?
    Mr. Greenstein. I do think there are some serious problems 
with the Social Security provisions in the Bowles-Simpson plan. 
I fully agree with sooner rather than later and the chained CPI 
applied to everything, tax code, other benefit programs.
    Chairman Conrad. Which the Commission did.
    Mr. Greenstein. But the problem, for starters, the problem 
at the bottom really is not just a technical problem. So the 
Commission did--it intended, no question, fully intended to 
protect people in the bottom quintile through a hardship 
exemption. But now that the actuaries have looked at it more 
closely, only 20 percent of people with very low lifetime 
earnings would qualify for the hardship exemption.
    There is not an easy technical fix. If you redesign the 
hardship exemption to make sure you get all or nearly all of 
the bottom quintile, it is hard to do it without sweeping in 
large numbers of people in higher quintiles, as well, and 
costing a lot of money.
    I am also concerned about the next----
    Chairman Conrad. Can I stop you just on that? So is it your 
view that there is not a way to protect that lower quintile?
    Mr. Greenstein. There is a--here is where I am heading. I 
see two problems, and they sound like they are in conflict. 
They did not do an adequate job for the bottom or the next-to-
the-bottom, you know, elderly widows at $15,000 a year. Under 
the plan, they both have higher Medicare copays and lower 
Social Security benefits.
    The second problem is while I fully agree that we should be 
hitting people at the top more than the bottom, I worry about 
how far Bowles-Simpson went. Today, the higher earner pays 5.6 
times as much in payroll tax over a career, gets 2.5 times as 
large a benefit. Under Bowles-Simpson, ultimately, you pay 
eight times as much in payroll tax and maybe get less than 
twice as much benefit.
    To me, the bottom line is it is very hard to solve all 
these problems if you have two-thirds of the solvency coming on 
the benefits side. I think Rivlin-Domenici, which is about 50-
50, really--you know, you can quibble with it, but it largely 
addresses these problems. Changes could be made to ease the 
problem on the bottom quintile. It is going to be very hard to 
fully solve it unless there are some larger changes in the mix.
    Chairman Conrad. Can I just ask, outside of this, for your 
recommendations on what we would do----
    Mr. Greenstein. Yes.
    Chairman Conrad [continuing]. In your view, to fix, that at 
least is partially a technical issue, not intended effect, and 
in a larger view, what you think needs to be done.
    Mr. Greenstein. I would be happy to do it, and without 
going into details now, I would note that I think in order to 
do this in a cost efficient way, one needs to bring the SSI 
program, which is highly targeted on the bottom, into the mix. 
There is more one can do in a cost effective way if we look at 
Social Security and SSI----
    Chairman Conrad. Well, I would very much--you know, we are 
at a critical moment here, and as soon as you could provide 
recommendations--I should have called you before this, but I 
think as we haveten into it, we have understood better, and 
frankly, the thought piece that you put out, I think it was 
last week----
    Mr. Greenstein. Yes.
    Chairman Conrad [continuing]. That I saw, helped us 
understand better that there are problems here and we certainly 
want to address them.
    Senator Portman.
    Senator Portman. Thank you, Mr. Chairman, and I really 
appreciate the panel being here. I have so many questions and 
so little time, but I just have to touch on a couple of things 
quickly.
    One is on the issue of tax reform and as it relates to the 
EITC. I came in when you were discussing some of the history of 
this and the fact that some people view this as an alternative 
to minimum wage. My point on the EITC is really a very simple 
one, which is there are better ways to do it. If you look at 
what the IRS is asked to do today, it is really kind of the 
opposite of what the IRS is good at. I mean, they are asked to 
find out how much income we all have and question whether we 
are showing all of our income, and then for EITC, it is the 
opposite.
    And it is also, frankly, not their expertise to be able to 
deal with these kinds of issues, which are better sometimes 
dealt with by social service agencies, and the IRS is not the 
most gentle organization sometimes. So I think it is tough for 
them to do it and that is why you see 23 to 28 percent improper 
payments, according to the IRS Inspector General. You know, 
that is $11 to $13 billion a year in improper payments.
    One way to deal with it, obviously, is to use the payroll 
tax system. Offset payroll taxes. Now, as Mr. Hodge has said, 
because our system is increasingly progressive, it is difficult 
to cover everybody with payroll tax, but most people would be 
covered and then you would not have the IRS asking people, 
again, to do something that the IRS is not good at and you 
would not have the IRS in a position, again, more like social 
service agencies would be, looking at people's incomes at that 
level.
    So I think it is a call for reform, and part of the tax 
reform ought to include looking at EITC. These kinds of 
improper payments in the context of our budget crisis just 
cannot continue, just as we have talked about today.
    I would say, Bob, to your point on Social Security, it is a 
whole different environment on that, too. I mean, I understand 
what you are saying on looking at the benefit side versus more 
taxes, but we are looking at a very different scenario than we 
were in 1983 and certainly than we were even 5 years ago.
    On tax reform generally, I would love to get the views of 
the panelists. I know there are some differences of opinion 
that I heard expressed earlier. But let me quote Bob Greenstein 
before the Fiscal Commission. ``With sensible base broadening, 
we can reduce the inequities and inefficiencies in the 
corporate income tax, lower the top corporate rate, boost 
competitiveness, and raise somewhat more revenue.''
    Mr. McIntyre today says, ``We want corporations to do 
things that are not economical in the tax code. It distorts 
markets.'' I agree with him. I agree with you.
    Mr. Hodge, of course, has talked about the fact that our 
corporate rate is not competitive, and we may wish that the 
world were different, but the world is increasingly competitive 
and other countries have lowered their rates precisely because 
they want jobs in their economies and it is working.
    So I guess I would just throw out to the group, do we at 
least have a consensus here, although differences in terms of 
how to do it, that we do need, at a minimum, to lower the rate, 
reduce the number of preferences, and therefore have a more 
competitive tax system on the individual and the corporate 
side? I throw it out. Bob?
    Mr. McIntyre. Well, I think we should reduce the rate a 
little just so we can get some political support from the high-
tax companies to pass it. But if we get back into the race to 
the bottom with Europe rather than moving to a system where we 
protect jobs in the United States by getting rid of deferral, 
this will not stop. It started a number of years ago and it is 
a problem for everyone in the world and we need to stand up and 
say to the other countries, let us talk about this. It is not 
working for us. Get a system where we can get some tax on 
income from capital, and we are not getting it now and that is 
bad for the fairness of our society.
    Senator Portman. Well, it would surprise a lot of folks to 
hear we are not getting any. It is not a race just with Europe, 
as you know. It is a race with Asia, certainly Canada, as Mr. 
Hodge has pointed out. They are all very aggressive on this 
notion of taxing capital or capital taxes. There is pretty much 
a consensus among economists, most of that cost is borne by 
labor and a lot of it is passed along to us as consumers, 
obviously. So it is a different sort of tax.
    But, Bob, go ahead. Sorry.
    Mr. Greenstein. The concept of broadening the base and 
lowering rates has very broad support, but I think there are a 
couple of key things that have to go with it. No. 1, given our 
fiscal situation, unlike 1986, it cannot be revenue neutral----
    Mr. McIntyre. It was not revenue neutral in 1986, Bob. It 
raised corporate taxes by one-third.
    Mr. Greenstein. No, no, I am talking about----
    Senator Portman. Overall.
    Mr. Greenstein [continuing]. Corporate and individual 
combined, overall. It cannot be revenue neutral.
    Second, on the individual as opposed to the corporate side, 
1986 lowered rates, but it eliminated lower rates for capital 
gains and dividends. I think one should not be talking about 
lowering top rates in the income tax unless one is going to tax 
capital gains and dividends as ordinary income.
    Last key point, I just want to say quickly on the Earned 
Income Credit, the research literature is now overwhelming on 
the degree to which the credit has been successful in promoting 
work, reducing welfare. It has very low administrative costs. I 
do not think doing it through the social service side would be 
anywhere near as----
    Senator Portman. Well, remember, I talked about offsetting 
payroll taxes, because most of these people have payroll tax 
liability----
    Mr. Greenstein. If you offset it through payroll tax----
    Senator Portman [continuing]. And you would avoid a lot of 
the improper payments through that.
    Mr. Greenstein. Let me suggest an alternative route. If you 
try to offset it through the payroll tax and you want to do as 
much to promote work and reduce poverty at the bottom, you will 
have to spend a lot more money, because in the payroll tax, you 
do not know families' total income. You do not know who is a 
one-earner family or a two-earner family.
    I think the alternative route is, No. 1, to simplify the 
EITC, which has more pages of instructions than the Alternative 
Minimum Tax. And No. 2, gets to the question of IRS 
enforcement. We are now getting to the point where we have more 
data bases that could be used to, both in the EITC and the 
general code, find more questionable claims and followup on 
them. The problem is that we have not invested enough money in 
either updating IRS computer systems or, frankly, in enough IRS 
staff. So when the IRS looks, they can do more EITC 
examinations and save, I forget, four dollars for every dollar 
they spend. But if they use that money on small business or 
corporate noncompliance, the ROI is higher.
    Senator Portman. Yes. Listen, I----
    Mr. Greenstein. They just do not have enough resources to 
do it.
    Senator Portman. I agree with you on the data base, of 
course, and simplification, you are absolutely right on the 
EITC. But my point is, this is all about reform, and Mr. Hodge, 
do you have any comments on reform quickly? I have just got 1 
second left, literally.
    Mr. Hodge. Well, very quickly, the National Taxpayer 
Advocate says that while 63 percent of Americans pay someone 
else to do their taxes, for EITC recipients, it is around 75 
percent. I think it is a shame that poor people have to pay an 
expert in order to be able to get the EITC benefit.
    But more broadly, I think we need fundamental tax reform 
across the board to remain competitive and to--it sort of 
sounds like shouting into wind to say that, well, we can only 
lower our rates a little bit, but we are not going to go as far 
as the Europeans or the Asians. The world is changing and we 
have to change with it, and if we do not, we are going to 
continue to fall further and further behind in this very, very 
competitive global economy.
    Senator Portman. Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, Senator.
    Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman. I want to thank all 
three of your organizations. We have worked with you on these 
issues for quite some time.
    And I want to start by talking to you a little bit about 
the urgency of all of this. My concern is that if a fire is not 
put together for significant bipartisan comprehensive tax 
reform, in all probability, the lame duck session of Congress 
in 2012 will look much like the lame duck session of Congress 
in 2010. There will be a debate once again about how damaging 
it would be to raise taxes on middle-class folks, something I 
happen to agree with and I think all of you do. And once again, 
people will go into this kind of automatic kind of pilot 
routine where you say, let us just extend this extraordinarily 
broken system for a while longer, something that is not 
creating jobs, is just riddled with all of these loopholes and 
exemptions and the Swiss cheese nature of the system. And, of 
course, by that time, we will probably have a bunch more 
loopholes.
    So I would like to get a sense from all of you about your 
judgment, whether you agree with me that it is urgent that 
Congress move. I think it is urgent just from the jobs 
standpoint. As all of you know, I just saw a debate between Bob 
McIntyre and Bob Greenstein, two Bobs I admire very much. The 
one thing that is not in dispute about 1986 is in the 2-years 
after that bill was signed, our country created 6.3 million 
non-farm jobs, according to the Bureau of Labor Statistics. 
That is enormous in its implications, and boy, it sure looks 
good compared to 2001 and 2008, when we created three million 
new jobs. In 2 years after tax reform was enacted, we created 
6.3 million new jobs.
    So your judgment, before I get into some of the details, 
that this is really urgent, both from the standpoint of job 
creation, most important, and second, so we are not staring 
down the road here in the lame duck session of 2012 at 
repeating exactly what I think all three of your organizations 
are against. So this is just a question about whether this is 
urgent. Mr. Greenstein?
    Mr. Greenstein. Let me first say, Bob McIntyre are in 
agreement, not disagreement. He was saying 1986 raised revenue 
on the corporate side and I was saying it was neutral overall. 
I think we are----
    Mr. McIntyre. Right. It was just a dangling antecedent, not 
a disagreement.
    Mr. Greenstein. So do I think this is urgent? Yes, but. 
What I think would be a step, unfortunately would not be the 
wise thing to do, and you and I may have a disagreement on 
this, I worry that if we do tax reform, comprehensive tax 
reform in a way that is deficit neutral, that that will be a 
long-term negative because it will make it almost impossible to 
get a comprehensive deficit reduction agreement. The low-
hanging fruit on the tax expenditure side will be gone, and in 
the absence of having revenues on the table, we will not get a 
big agreement.
    Senator Wyden. Fair, fair----
    Mr. Greenstein. However, I do think it would be urgent to 
do comprehensive changes that give us long-term deficit 
reduction, do not take effect on the deficit reduction side 
until the economy is back, and include as part of them tax 
reform that both makes the system more competitive and raises 
significant revenue at the same time.
    Senator Wyden. Well, fair enough. As you know, Mr. 
Greenstein, there are definitions about revenue neutrality. The 
legislation I had with Senator Gregg, the Joint Tax Commission 
said it was more than revenue neutral and all the analyses that 
were done said it would produce revenue because of the extra 
benefits from job creation.
    I just think, having read a lot of the excellent work you 
have done, you share my view that not repeating in the lame 
duck session of 2012 what we had in 2010----
    Mr. Greenstein. That is correct.
    Senator Wyden. Thank you.
    Mr. McIntyre, same point, not repeating the lame duck drill 
of 2010.
    Mr. McIntyre. Oh, well I hate lame ducks, but you asked the 
question whether it is urgent to do tax reform as soon as 
possible. I would worry about that, because I cannot imagine a 
bill that could pass the House of Representatives that you and 
I would not hate. If you can persuade me that you can persuade 
them, then my urgency level goes way up. But right now, it is 
not there.
    Senator Wyden. Fair enough. Chairman Tiberi, who has done 
some very good work on this, put out a statement with me early 
on that could have been written by you because it talked about 
the benefits of 1986. So I tell you, I think there are a lot of 
Democrats and Republicans, who if we can just coalesce here 
fairly quickly and not write this thing off for another couple 
of years, which is what concerns me, I think a lot of what 
thoughtful people like our witnesses have been doing is still 
quite, quite doable, and take a look at Chairman Tiberi's 
statement about 1986. And he, of course, is the Chairman of a 
Ways and Means subcommittee who is very involved with the House 
leadership, and that was an extremely encouraging statement.
    Let us ask for your colleague from the Tax Foundation, Mr. 
Hodge, who we have worked with, too, how important it is to 
move on this.
    Mr. Hodge. It is critically important, Senator, to move as 
quickly as possible. Uncertainty in the tax code is one of the 
enemies of economic growth, and we have great uncertainty in 
the tax code through all of these temporary measures, short-
term, 2-year or 1-year, or in some cases with certain things, 
like the R&D tax credit, companies never know whether they can 
use it up until December 31. That is an enemy of economic 
growth, and the quicker we can move to fundamental long-term 
tax reform that broadens the base and brings down rates and 
adds certainty to the tax system, I think the better off we are 
going to be, and more importantly, the better off the economy 
will be over the long term.
    We are losing ground globally, as I have mentioned 
repeatedly, and I worry that the longer we wait to solve this 
problem and be more competitive, the more we are going to lose 
basically jobs and growth to other, more competitive countries.
    Senator Wyden. Mr. Chairman, I had one other area, 
deferral, that I wanted to get into, but it takes a little 
time.
    Chairman Conrad. No, take some extra time, because I think 
it is very important we do get into it. You and Senator Gregg 
had, I think, a very, very important proposal and dealt with 
that issue and I think we should take the time, because we are 
not going to have another opportunity.
    Senator Wyden. Thank you, Mr. Chairman.
    Let me start with you, Mr. McIntyre, and kind of walk it 
through in terms of how somebody in a supermarket sees it. If 
you go and see somebody in a supermarket and talk about what 
you are doing on the Senate Finance Committee on which I serve, 
the first thing they say is, take away those tax breaks for 
those guys shipping the jobs overseas. That is outrageous. I 
want red, white, and blue jobs.
    And then, of course, you go to the companies and the 
companies say, yes, you know, we want jobs in the United 
States, too, but our tax rates are higher than just about 
anybody in the Western industrialized world. You have heard 
their position, as well. And they will make the case that they 
have to have tax deferral in order to have jobs in the United 
States because of the relationship between jobs offshore and 
jobs here.
    So what I have said is, let us see if we can find our way 
out of this and say that we are going to roll back in a 
substantial way some of these breaks that are going overseas--
there is deferral and there are foreign credits--by 
dramatically lowering the rate for people who manufacture and 
do business in the United States. I call them red, white, and 
blue jobs, and when I bring it up with American businesses and 
I bring it up with labor folks, who, as we know, have not 
exactly seen eye to eye on it, conceptually, they think that 
this is something that they can proceed with.
    What is your take in terms of how we work our way through 
this question that starts in the supermarket or the coffee shop 
when our citizens are understandably furious about tax laws 
rewarding doing business overseas, and at the same time being 
competitive in a tough global market? What is your sense about 
how we might--because it was a lot of your creativity that 
brought people together in 1986--what might unlock an agreement 
in the future on this issue, starting with the person in the 
supermarket all the way to American business that has been 
concerned about competitiveness and how you might bring a new 
consensus together.
    Mr. McIntyre. Well, I mean, what is important to understand 
is that your proposal to get rid of deferral and tax worldwide 
income of corporations addresses the problem of subsidizing 
foreign investment, because wherever you move your money, 
whether you artificially shift it to the Cayman Islands or you 
really build a factory in China, you will still be subject to 
U.S. tax, and if you pay taxes to a foreign country, of course, 
we will not tax you twice. That addresses that problem.
    The companies' retort is that, well, yes, but you want us 
to go to China. Now, I do not understand why we want them to go 
to China very well. They have this argument that for every 
10,000 jobs they create in China, 300 are created in the United 
States to manage the business in China. But I would much prefer 
to have the whole 10,000 here, personally. And so their idea 
that they have to be competitive with the Germany company in 
China, eh, trivial at most, although that is what they make as 
the argument.
    So if we are talking to the person in the supermarket who 
wants to know why we are paying companies to go offshore, I 
would say, well, yes, Ron Wyden is going to solve that. Now, he 
has another thing he wants to do, too. He thinks that we should 
have a lower rate if you do business here in the United States, 
and he and I have an argument about that, because I think it is 
more important for American business to get the benefit of the 
public services that they need, the roads and the schools and 
everything else. That will make them more competitive with the 
rest of the world by doing business here in the United States 
and giving them a few points off their corporate rate.
    And you say, well, Mr. McIntyre, why do you not just tax 
the poor people to pay for these things for the businesses and 
give the businesses lower taxes? And I say, well, that makes 
things unfair, plus, I do not think the public would tolerate 
it. So this is the discussion you and I have had a lot.
    But the No. 1 thing that I admire so much about your plan 
is you take away the incentive to move things offshore, which 
just automatically says, now you have more of an incentive to 
do it here. And so if you want to provide a little bit bigger 
one on top of that, OK, but remember, that comes at a price.
    Senator Wyden. I want to hear from Mr. Greenstein and Mr. 
Hodge, and again, just before I leave you, colleagues, when you 
look back at the history of how it came together in 1986, Bob 
McIntyre did as much as anybody to, in effect, thread that 
needle, and we are going to be calling on you often. And this 
is, as I have talked about with both colleagues, this is an 
inexact science.
    Mr. Greenstein, you wanted to add something. We are talking 
about how we can find a way in a bipartisan fashion- -I mean, 
part of what the companies have said with respect to deferral, 
I think, is just understandable, because, oh, somebody is 
talking about making an abrupt change in a major economic 
policy that relates to competitiveness and I have said I am 
interested in working in a bipartisan way with good people like 
here and Chairman Tiberi and others so we can have transition 
rules, which Mr. McIntyre knows a lot about and would allow us 
to start making our way to a new system. But in terms of the 
principles of how we would wrestle with the corporate rate and 
deferral and going forward in a bipartisan way, your thoughts, 
Mr. Greenstein.
    Mr. Greenstein. I have not studied your specific proposal 
here to the degree that Bob McIntyre has. His comments make a 
lot of sense to me.
    The point I wanted to add was to contrast your proposal 
with something that I think would be very unwise and might soon 
come before you, which is the idea to, in the absence of 
reform, simply allow a big repatriation at a 5-percent rate. 
You know, we tried that in 2004. It did not create the number 
of jobs it was supposed to. But the more important point is 
that when it was done in 2004, it was said, this is one time 
only. And if we do it again now, it will create a sense, I 
think, among companies that they should actually shift more 
investment and jobs overseas because all they have to do is 
wait until the next recession or whatever and they will get 
another holiday where they can bring everything back at only a 
5-percent rate.
    So I think, unlike what you are trying to do, I think if 
you simply do a repatriation, in the long run, you are actually 
going to lose jobs. You are going to have exactly the opposite 
incentive to what you are trying to have.
    Senator Wyden. One of the opportunities, again, for common 
ground for this table to ponder is that I think that there may 
be an opportunity to look at repatriation if it was part of tax 
reform. In other words, if it was part of a tax reform proposal 
that adhered--and I saw the little skirmish we had on 1986, but 
1986 was progressive. It got rid of preferences and it held 
rates down, something I think all three of you have in common, 
and I think if repatriation is discussed, as I have heard 
Senators and House members talk about it in the context of tax 
reform, we may be able to get some more common ground.
    Mr. Hodge, and I am just very appreciative of you, Chairman 
Conrad. I just think this is a big issue that does not get 
talked about much. Mr. Hodge, your way out of this conundrum 
involving international tax policy and the person who is our 
constituent in the supermarket.
    Mr. Hodge. Well, Senator, I agree with your plan to lower 
the rate. I think reducing the rate to at least 24 percent is 
the absolute way to go. Preferably, I would like to see the 
Federal rate be around 20 percent so that when you add back the 
average of State rates, we are at about 25 percent overall, 
which would equal us to China and roughly the OECD average.
    But I disagree with remaining with the worldwide system and 
I would prefer to move toward a territorial-type system. That 
is the trend among our major competitors. The United Kingdom 
and Japan were the two latest countries to move toward more or 
less of a territorial-type system. And to remain with a 
worldwide system would simply hamstring American companies as 
they are trying to compete in an incredibly competitive global 
marketplace.
    I do not think that we want to concede China or Asia or 
Europe or any of these other emerging markets to our foreign 
competitors, and I think to remain with this worldwide system 
would absolutely do that. I think if somebody is going to make 
tractors in China, I want it to be Caterpillar. I want it to be 
John Deere. I do not want it to be a Germany company or a Swiss 
company or someone else. I want U.S. companies to be as 
competitive as possible in this global economy.
    And the benefit principle of taxation says that taxes 
should at least be linked to the benefits, and U.S. companies 
are paying taxes on those profits earned abroad. They are 
paying them to the host country where those profits were 
earned. And I think it is unfortunate the U.S. system penalizes 
U.S. companies for trying to bring those profits back and 
reinvest in the United States. And that is why I would like to 
see a permanent territorial system so there is no penalty for 
reinvesting, not one of these one-off. I agree that that was 
bad tax policy. And any of these holidays tend to produce 
unintended results. Permanence is the way to go.
    Senator Wyden. My Chairman has his gavel in his hand. Let 
me just kind of close with what our challenge is, and I would 
welcome your ideas, the three of you.
    Senator Gregg and I spent an enormous amount of time 
debating just this, and I will keep my public posture as being 
open to this and a variety of other things you will hear. Mr. 
McIntyre made very good intellectual arguments against it. What 
I have to tell you is we are going to need some proposals 
quickly on how people at this table might come together behind 
it, because issues like transfer pricing, which are sure to be 
compounded by anything in this area, have to be addressed in 
order to go forward.
    So I am open. A lot of Senators on both sides are 
interested in this. The Commission was interested in it. But we 
are going to have to have, quickly, some very creative kind of 
work done by people like the three of you in order to give this 
a pulse and I am going to stay open.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you so much. It was very important 
we have this discussion because we really are at critical 
moments of decisionmaking.
    With that in mind, I would ask both Mr. McIntyre and Mr. 
Hodge if you could provide to me and this committee a summary 
of the arguments that you believe are most important to keep in 
mind on the question of territorial versus worldwide. It would 
be very important that we get that because we are at a critical 
moment in discussions and it would be very helpful to have the 
information that you have and the knowledge that you have 
brought to bear as this decision is made. So could you do that?
    Mr. Hodge. Sure, absolutely.
    Chairman Conrad. All right. Senator Portman would like an 
additional moment, as well.
    Senator Portman. Well, just to follow on with the 
Chairman's request, this is a critical time because I think 
when you look at the economic growth possibilities as part of 
looking at our fiscal situation, tax reform is high on the list 
and it happens to be bipartisan. It is something the President 
is talking about, we are talking about on our side of the 
aisle, and we need to move and move quickly, in my view. We 
cannot wait another 18 months or 2 years, and because the 
election is coming up, it needs to move particularly quickly.
    I have a very different point of view, Mr. McIntyre, on 
what we ought to be encouraging U.S. companies to do, so our 
policy proposals may not be that different, because I am 
strongly supportive of what my colleague is talking about in 
terms of lowering the corporate rate, and Ron Wyden has done 
terrific work on this, because it solves a lot of those 
problems.
    But let me just give you a quick example, because we did 
this analysis in Ohio. There is a study recently done by an 
economist at Kenyon showing 17,000 jobs would be lost in Ohio 
just by extrapolating from some of the national data on 
deferral. So if you would eliminate deferral, you would lose 
jobs in Ohio.
    In the case of my hometown of Cincinnati, Proctor and 
Gamble Company, as you know, is a global company. They do a lot 
of business overseas. They do not export Tide, they make Tide 
elsewhere. You cannot export it and be competitive. Forty 
percent of the jobs in Cincinnati, and they are the largest 
private sector employer in our area, so over 5,000 jobs are 
there because of their international sales. So it is not just a 
couple hundred jobs for a couple thousand because they do all 
their research in Mason, Ohio, and they do their back office 
accounting and legal and marketing and so on. It is a U.S. 
company. We want them to stay in the United States.
    Their incentive right now, not speaking for them but 
speaking for international companies generally, if you are to 
keep the relatively high corporate rate relative to other 
countries and keep this notion in place that we should not 
allow them to defer prior to them bringing their profits back, 
would make it advantageous for them either not to be a U.S. 
company, first, and we have seen some companies make that 
decision.
    I remember when Daimler Chrysler testified before the Ways 
and Means Committee and told us why it was Daimler Chrysler and 
not Chrysler Daimler, but also, it obviously incentivizes them 
to sell their foreign subsidiaries and to allow those companies 
to be purchased by companies from other countries that have 
better tax advantages. They can pay a premium, the Italians, 
the Germans, the Japanese, the Chinese. That is what is going 
on in the real world right now.
    So I would say we need to be very careful. Ninety-five 
percent of the consumers live outside of our borders. We want 
to access those consumers. We want to create jobs here in 
America by accessing those consumers. If we do not, our 
standard of living will go down in this country. We will lose 
employment. And if we keep the corporate rate relatively high, 
and even 25 percent is relatively high if these other 
countries, as Japan, continue to lower their rates, and if we 
are the only country of our major competitors that has a 
territorial, or a worldwide tax system rather than a 
territorial system.
    So we, I think, are right on the edge here. If the rate is 
low enough, some of this can be looked at. But if it is not low 
enough, then we will continue to lose jobs here in this 
country. So I wanted to get that on the record and again 
appreciate all three of you today. I have enjoyed working with 
you in the past and look forward to your help on trying to come 
up with a bipartisan approach to tax reform that does create 
jobs and opportunity. Thank you.
    Chairman Conrad. Thank you, and I would like to turn to one 
other matter just quickly, because this really is a critical 
time, and that is the question of consumption tax as an 
increased part of the tax base of the United States.
    Virtually every expert from every philosophical background 
who came before the Commission, the tax group of the 
Commission--Congressman Camp and I were given the 
responsibility to lead the discussion in that area--told us we 
should have more of a hybrid system, that consumption should be 
more of a part of the tax base of the United States, that it 
should be done progressively, which is challenging, but there 
are ideas for how you do that. Professor Graetz, as many of you 
know, has a proposal to take 100 million people off the income 
tax rolls and have a consumption tax. The man has some ideas 
for how it be made progressive. Others who came before the 
Commission from a more progressive viewpoint had other ideas 
for how it could be made progressive.
    What are your thoughts with respect to having a system that 
has a consumption tax component as part of the base?
    Mr. McIntyre. Well, we already have one, of course. The 
States have sales taxes, which these days run around almost 7 
percent. So we have consumption tax as part of our mix. It is, 
in some ways, unfortunate because those taxes are so 
regressive, and every plan I have ever seen to try to deal with 
that regressivity is a failure because it is so hard to do.
    Mike Graetz's plan--he does not take 100 million people off 
the tax rolls. He just has 100 million people filing for tax 
rebates against their consumption tax. But they have to file 
their same income tax return they do now, pretty much.
    But anyway, no, I think people say, well, you know--I do 
not understand. Let us suppose that we are talking about a 
value-added tax, and some people say that would be a great 
idea, and I say, I look at them and I say, why? If you want to 
make the income tax less progressive, you could do it if that 
is your goal, to have a more regressive tax system. But why 
would you set up a new bureaucracy that estimates say would 
have to double the size of the IRS to collect this tax just to 
get a more regressive system?
    Now, they may have other arguments besides the fact that 
they may want more regressivity, but the ones I have heard do 
not hold water. So I am strongly and probably irrevocably 
opposed to adding a Federal consumption tax.
    Chairman Conrad. All right.
    Mr. Greenstein. Well, on this one, it may be the only thing 
we have discussed today I am in a different place than Bob 
McIntyre. I think over the coming decades, we are going to have 
no alternative but to get revenue to a somewhat higher share of 
GDP, given the aging of the population, increases in health 
care costs, and whatever other international challenges we may 
face. And whether it would be my preference or not, I do not 
see politically that happening on the income tax side alone.
    I think we will need a supplementary consumption tax. Were 
we able to do it, my first choice would not be a VAT but a 
carbon tax because of the growing concerns of the impact not 
only on well-being, but on the world economy of global warming. 
But I am not sure that a carbon tax is not even politically 
more difficult than a value-added tax. Interestingly, the last 
conversation I had on this with Michael Graetz, I think Michael 
privately probably would prefer a carbon tax, as well.
    Now, having said that, particularly for a VAT, there are 
two huge challenges. One you noted, progressivity/regressivity, 
easier on paper to make it progressive than in the real world. 
You can offset the adverse effect on the bottom. As you may 
know, we helped design a provision that would have done that in 
the cap and trade bill that passed the House, and we were 
working with Senators Kerry, Graham, and Lieberman when they 
were moving forward on an energy-type bill before it collapsed. 
But the farther you want to go up the income scale into the 
middle class with the kind of mechanism we developed, it gets 
harder.
    The other big challenge, particularly for a VAT, is--and it 
is really complicated--is figuring out how to design it so it 
does not interfere with State and local tax collection, and the 
local is actually harder, because a lot of localities have 
sales taxes than the State.
    One last point. I am not sure, you will have to ask 
Michael, but I think in my last conversation with him on this, 
he had me actually do a session for this VAT group that he has 
on how to offset the impacts on the bottom in December. I 
thought by the end of it, he was kind of convinced that his 
idea of taking 100,000 people off and having no income tax, 
that he was moving away from that, and there were two problems 
with that.
    Michael fully agrees that we need to make people whole with 
regard to the Earned Income Credit and the Child Credit and the 
like, but neither he nor anybody else has really figured out a 
good way to do that that works in the real world in the absence 
of any income tax at all.
    The second is health care. Whether you favor the Affordable 
Care Act, as I do, or you favor the kinds of approaches that 
Republicans offered when George Bush was President, in both 
cases, they rely on marketplaces where people get subsidies--
people who are low and modest income get subsidies to make 
coverage affordable and the subsidies are delivered as tax 
credits through the tax system. And the people that get the 
subsidies are all in the income group that under the Graetz 
plan no longer files a tax return. And when I mentioned this to 
Michael, he said, oh, that is a really good point. I designed 
my plan before we went in that direction in health care.
    Chairman Conrad. All right. Mr. Hodge, any comment?
    Mr. Hodge. Very quickly, Mr. Chairman. I once had a very 
senior British tax official tell me that if you want a perfect 
tool for funding big government, the value-added tax is the 
perfect tool. It is hidden from view and you can always dial up 
the rate if you want more revenues, and that is exactly what 
the British government has done recently to solve their 
problems.
    I do not believe that we need an imperfect tax on top of a 
tax system that we already have. The value-added tax has many 
of the same problems in Europe and elsewhere that we see with 
sales taxes here in the United States. They have various carve-
outs for groceries and medicines and children's clothing and 
other things and that creates as many problems as you have seen 
at the State level.
    I do believe we can move toward more of a consumption base 
by moving toward what you might call the traditional flat tax, 
as advocated by Professors Hall and Rabushka at Stanford or 
Steve Forbes or even a plan like what Congressman Paul Ryan has 
put forward, where you have a flat tax for individuals, a flat 
tax for corporations, you do not tax savings on the individual 
side, you allow full expensing at the corporate side, and you 
essentially have more of a consumption base, but you do it 
within kind of an existing system as we have, rather than 
adding something on top of what we already have. I would prefer 
that.
    Chairman Conrad. Let me just say, my reaction to that is 
what you do is you would either raise a lot less revenue- -
every flat tax proposal I have seen does--or you would 
dramatically make more regressive the tax system, because our 
system now is progressive. If you have a flat tax that 
generates the same amount of revenue, it is a mathematical 
certainty that people at the top pay less and people at the 
bottom are going to pay more.
    Let me just thank you. We have really gone well past what 
we intended and what we had asked you to prepare for. I deeply 
appreciate the contributions you have made. This is a very 
timely hearing and important to the work of the committee and 
the work of other groups who are having discussions right now. 
I thank you all.
    The committee will be adjourned.
    [Whereupon, at 12:18 p.m., the committee was adjourned.]




  THE PRESIDENT'S FISCAL YEAR 2012 DEFENSE AND INTERNATIONAL AFFAIRS 
                                 BUDGET

                              ----------                              


                        THURSDAY, MARCH 10, 2011

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:01 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, 
Chairman of the Committee, presiding.
    Present: Senators Conrad, Wyden, Cardin, Warner, Begich, 
Sessions, and Thune.
    Staff present: Mary Ann Naylor, Majority Staff Director; 
and Marcus Peacock, Minority Staff Director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    I want to welcome everyone to the Senate Budget Committee 
today. Today's hearing will examine the President's budget 
request for defense and international affairs. Our witnesses 
today are the Deputy Secretary of Defense Bill Lynn and Deputy 
Secretary of State Tom Nides. We appreciate them being here and 
look forward to their testimony.
    For a number of years, many people have stressed that our 
national security relies not just on the Defense Department but 
also on the State Department through its diplomatic missions. 
So I am glad this hearing will provide a chance to look at our 
national security with both agencies represented.
    Our country is at a critical juncture. We are borrowing 
about 40 cents of every dollar that we spend. Deficits have 
exceed $1 trillion for 3 years in a row. Federal debt is 
soaring. The long-term outlook is even more sobering. We are 
clearly on an unsustainable course.
    Our budget situation is not just a fiscal and economic 
threat. It is also a threat to our national security. We simply 
will not be able to remain a global superpower if we fail to 
stop the explosion of Federal debt. And I would note the story 
this morning that the PIMCO Total Return Fund has indicated 
they have dumped all U.S. debt.
    Now, let me repeat that. The PIMCO Total Return Fund has 
made public today they have dumped all U.S. debt.
    Here is what Admiral Mullen said about the debt threat: 
``Our national debt is our biggest national security threat.'' 
That is coming from the Chairman of the Joint Chiefs of Staff.




    This year, for the first time since World War II, gross 
Federal debt will exceed 100 percent of GDP, well above the 90-
percent threshold that many economists regard as the danger 
zone. That has to be a wake-up call for all of us.




    I have always been a strong supporter of defense spending 
because I believe providing for the national defense is the 
Government's single most important responsibility. And make no 
mistake, Congress will continue to provide our troops what they 
need for their mission and to keep them safe. But given the 
fiscal crisis, every area of the budget is going to have to 
come under scrutiny, is going to have to find savings, 
including defense. That was the conclusion of every bipartisan 
Commission that has examined the long-term fiscal imbalances, 
including the President's own Fiscal Commission and the 
Domenici-Rivlin group that we will hear from next week.
    The examples of inefficiencies in the Defense Department 
that have come to light are particularly troubling. We need to 
root out wasteful spending everywhere we find it, including 
defense. The reality is that defense spending has grown 
dramatically in recent years and has contributed to the climb 
in deficits. In 1997, we spent $258 billion on the Department 
of Defense. This year, when we include war costs, we will spend 
about $685 billion on the Department. To put that in a 
historical perspective, this will be the fifth year in a row we 
will be spending more on defense than we did at the height of 
the Korean War in real terms.




    The President's budget proposes to continue to increase the 
defense budget. In 2012, the administration requests $553 
billion for the regular defense budget, representing a $27 
billion increase over the 2011 continuing resolution level. The 
administration has said its defense request would save $78 
billion over 5 years by implementing savings proposed by the 
Secretary of Defense, Mr. Gates. While I welcome those savings 
proposals, that estimate compares the President's current 
budget request with the President's request last year, which 
was never implemented or agreed to. Compared to CBO's baseline 
for defense spending, the administration's current request 
actually represents a $128 billion increase over the 5 years. 
That is over the baseline, $128 billion.




    This chart shows a similar rise in our international 
affairs funding, although on a considerably smaller scale. In 
2001, we spent $24 billion on international affairs; in 2004, 
we saw a notable spike in war-related international affairs 
funding from Iraq reconstruction. This year, we are spending a 
total of $58 billion on international affairs when war-related 
funding is factored in.




    For 2012, the administration proposes to keep the base 
international affairs budget at $53 billion, the same level as 
in the 2011 continuing resolution. However, when war-related 
international affairs funding is added in, the administration 
is requesting a total of $61 billion for international affairs, 
representing a $3 billion increase over the total for 2011. I 
would be the first to acknowledge that is modest.
    The requested increase in international affairs war-related 
funding is explained in part by the transition in Iraq where 
the State Department is scheduled to take over responsibility 
for U.S. operations there.




    For overall war funding, including both defense and 
international affairs, the administration is requesting $127 
billion in 2012. That is $40 billion less than the average war 
funding provided from 2007 through 2011. In those previous 
years, this administration and the previous administration made 
two or three war funding requests each year. Although I give 
this administration substantial credit for being much more 
accurate and realistic with its initial request each year, I do 
hope our witnesses will be able to comment on whether this $127 
billion war funding request will be it for the year or whether 
we should anticipate another request later on.




    Again, I want to emphasize we will provide our troops with 
whatever they need to complete their missions and to be safe. 
But the days of an open checkbook here are ending for everyone. 
I want to make that very clear. This Committee--I think I can 
speak for both sides--recognizes the debt threat hanging over 
this country. It must be addressed. There is not an option. 
And, again, I would go back to the story this morning--the 
PIMCO Total Return Fund advising us they have dumped all U.S. 
Government debt. If that is not a wake-up call for where we are 
headed, I do not know what would be.
    With that, we will turn to Senator Sessions for his opening 
remarks. Senator Sessions.

             OPENING STATEMENT OF SENATOR SESSIONS

    Senator Sessions. Thank you, Mr. Chairman, and I want to 
welcome our guests. They represent two of the great historic 
Departments of the U.S. Government, and we value your insight 
and your testimony.
    The Chairman of the Joint Chiefs of Staff, Admiral Mullen, 
spoke the plain truth when he declared that our national debt 
was our greatest long-term national security threat. I believe 
that Secretary Clinton has said the same thing, that it 
represents the greatest threat to American security.
    The DOD's annual budget compared to the projected growth of 
the Nation's interest payment on our surging debt turns out to 
be in the years to come less spent on defense than we spend on 
interest on our debt. Right now we are spending about 3 times 
as much on defense as we spend on interest. It just shows, I 
think, the perspective that we are facing.
    Mr. Chairman, I share with you the urgency that we have 
with regard to spending. I do not believe there is an 
opportunity for us to delay any longer. Moody's told the 
Government in December that if things do not change, they could 
downgrade our debt in less than 2 years. Alan Greenspan said in 
January that, in his view, there is a 50-50 chance, a little 
better than 50-50 chance, but not much better, that we would 
have a debt crisis in 2 to 3 years. This is the former Federal 
Reserve Chairman. And Mr. Geithner told this Committee last 
week that he agreed with the Rogoff study showing that debt at 
the levels we are now, 90-plus percent of GDP, pulls down 
economic growth and puts us in danger of a crisis. He 
volunteered that. And he agreed with the Rogoff studies.
    Then we have Mr. Simpson, Alan Simpson, and Mr. Bowles, who 
chaired the Debt Commission, appointed by President Obama, and 
they said to us the day before yesterday that a debt crisis 
could actually happen. In fact, Mr. Bowles suggested 2 years. 
He said it could be a little sooner, it could be a little 
later. And Mr. Simpson said in his view it would be a year or 
less.
    So I suggest that the message is clear. We need to do some 
things now, and the Defense Department cannot be absolved from 
those challenges.
    I so much admire and love the men and women who serve our 
country. We have the finest military, Mr. Lynn, the world has 
ever known, the finest I believe this Nation has ever fielded 
in terms of being trained, being disciplined, being courageous, 
willing to go into combat, and also being equipped and trained 
on how to use their equipment, and the coordination among the 
branches and services is at a level never before achieved, and 
it is critical, Mr. Chairman, as we ask the Defense Department 
to constrain spending, that we do so in a way that does not 
damage what we have been blessed to have created over the last 
number of years.
    When the cold war ended, we had too much reduction in 
forces. Army divisions were cut from 18 to 10. The 600-ship 
navy went to 300. The Air Force fighter wing equivalent fell by 
half. We ended up with a high proportion of muscle and fat, I 
am afraid, during that situation. So we will have to watch it. 
We have to be careful.
    I am concerned about some of the surging increases 
requested by the State Department. We are going to have to look 
at that carefully. I also, frankly, am concerned that the role 
we are calling on the State Department to fill in Iraq may be 
beyond the capabilities of any State Department to fulfill, and 
I worry about that both as to cost and to the capability of 
achieving that mission.
    So, Mr. Chairman, thank you for the hearing. This 
represents a huge, substantial portion of the discretionary 
budget. We have to ask our Defense Department to do more with 
less. But at the same time, we want to do it in a way that does 
not call for bad decisionmaking. Driving up the cost of 
procurement per item, that would be unnecessary. We need to do 
it in the right way.
    Thank you for your leadership.
    Chairman Conrad. Thank you, and thank you for your 
partnership, Senator. I think we have had a series of hearings 
here that have been very important. My staff tells me we have 
now done more hearings on this budget cycle than have been done 
in previous budget cycles for a very long time. And I think we 
have done a pretty good job of outlining for those who are 
paying attention the dimensions of the problem, the challenge 
that we confront, the need to take action now. And we have had 
a chance to hear from the President's Fiscal Commission. Next 
week we will hear from the other bipartisan Commission, the 
Domenici-Rivlin Commission. And then we will go to work on the 
budget resolution, and I hope to be able to work closely with 
you on that because, frankly, I do not think there is time to 
waste.
    Reading this story about PIMCO making the decision to dump 
all of their U.S. Government debt, this is a long article from 
Bloomberg this morning, five pages, six pages. Anybody that 
reads this, pretty sobering stuff in here about people--Jim 
Rogers of Rogers Holdings deciding to short U.S. Government 
debt because of the debt overhang in this country. You know, it 
is what we have been talking about for a number of years on 
this Committee, that no one can predict when this day comes. 
The one thing we can say with certainty is we are moving very 
rapidly toward the fiscal cliff. We do not know when we will 
get there, if we get there this year or next year or the year 
thereafter. What we know with certainty is when we are adding 
$1 trillion of debt every year, gross debt every year, we are 
putting this country in an extremely vulnerable position. It 
cannot continue.
    With that, Mr. Lynn, Mr. Nides, thank you for being here. 
Who would like to go first? Tom, if you would like to go first.
    Let me just say that Mr. Nides, of course, helped run 
Morgan Stanley before being convinced to come into the 
Government. We very much appreciate the sacrifice that you have 
made, the personal sacrifice that you have made and that your 
family has made to serve the Nation at this difficult time. 
Welcome to the Budget Committee.

STATEMENT OF THE HONORABLE THOMAS R. NIDES, DEPUTY SECRETARY OF 
  STATE FOR MANAGEMENT AND RESOURCES, U.S. DEPARTMENT OF STATE

    Mr. Nides. Thank you very much, Chairman Conrad and Ranking 
Member Sessions. I began my career on Capitol Hill as Assistant 
to Majority Whip Tony Coelho and then to Speaker Tom Foley, so 
I very much appreciate the pressure you all are under to 
justify every dollar that is spent.
    Today I want to explain how with just 1 percent of the 
Federal budget, the State Department and USAID prevents 
conflicts abroad, promotes prosperity at home, and, most 
importantly, protects the American people. From countering 
extremism in Yemen to serving alongside our troops in Iraq and 
Afghanistan, to train Mexico's police force to help ensure our 
southern border, we do every day--what we do is for our 
national security.
    I appreciate you inviting me to speak alongside Deputy 
Secretary of Defense Bill Lynn. The fact that we are presenting 
our budgets together is a very important first. It speaks to 
the sense of shared mission that begins with the President, the 
Secretary of Defense, and the Secretary of State, and extends 
all the way to the civilians and troops working shoulder to 
shoulder in Iraq, Afghanistan, and Pakistan. Cooperation 
between State and the Department of Defense has never been 
better.
    Today I want to walk you through the investments that allow 
us to combine diplomacy, development, and defense to advance 
our national security.
    This year, for the first time, our request is divided into 
two parts. The first part is our core budget, our foreign 
assistance and operations in just about every Nation in the 
world. Our 2012 request is $47 billion, essentially flat from 
the 2010 levels.
    The second part is our extraordinary temporary war costs in 
Iraq, Afghanistan, and Pakistan. This year, for the first time, 
the President's budget presents our war funding in the same way 
it funds the Pentagon's--in a separate account called the 
Overseas Contingency Operation Account, or OCO for short. This 
more transparent approach distinguishes between the temporary 
war costs and our enduring budget and reflects a shared effort 
on the ground. The State Department and USAID's share of the 
President's OCO account of $126 billion in 2012 is $8.7 
billion, which I will come back to in a moment.
    Let me start with our core 2012 budget request of $47 
billion. It represents a 1-percent increase over the comparable 
levels in 2010, less than the rate of inflation. And make no 
mistake, even without the extraordinary war costs, the core 
budget should be considered part of the U.S. Government's 
national security budget. It stabilizes conflict zones and 
reduces the threat of nuclear weapons; it restores old 
alliances; it supports democratic transitions; it counters 
extremism; it opens global markets; and it protects American 
citizens abroad. And where we are not actively working with the 
military today, State and USAID are deploying diplomats and 
development specialists so that the Department of Defense does 
not have to deploy our troops tomorrow.
    We are investing in four principal areas:
    First, we devote $11 billion of our $47 billion core budget 
to prevent conflict and support fragile states. For example, 
this budget supports humanitarian and security assistance for 
the likes of Yemen, crisis diplomacy in Sudan, and rebuilding 
Haiti.
    Second, we invest $7.4 billion of our $47 billion core 
budget to support key allies and partners. This includes over 
$3 billion for Israel and strong support for our partners on 
every continent. It also includes military-to-military 
partnerships in 130 countries across the world, administered by 
State and implemented by DOD.
    Third, we invest $14.6 billion of our core budget to 
advance human security. We have targeted drivers of future 
conflict: disease, hunger, and climate change. Our largest 
single investment is $8.7 billion in global health programs, 
including the continued support for PEPFAR, the program to 
treat and prevent HIV and AIDS started under George W. Bush.
    We are also investing $1 billion in food security, $650 
million to address climate change, and over $4 billion in 
emergency humanitarian assistance for victims of war, survivors 
of natural disasters, and refugees, like the hundreds of 
thousands who have fled Libya in the last few weeks.
    Fourth, we invest $14 billion to strengthen and sustain our 
presence across the world. This is an investment of a 
remarkable group of public servants, and it delivers 
significant returns to the American people. Our political 
officers build relationships and promote democracy. Our 
economic officers fight every day for American companies and 
jobs. Our development officers spread opportunity and stabilize 
societies, while our public diplomacy officers tell our story 
across the world. And our consular officers help average 
Americans every day.
    Finally, we have our temporary extraordinary war costs in 
the front-line states. I am glad to have Deputy Secretary Lynn 
here with me because when you consider our two OCO requests 
together, you come away with a much clearer picture. The 
Pentagon is saving $45 billion this year on its overall OCO 
request from the 2010 levels, largely due to the transition 
from military to civilian leadership in Iraq.
    Chairman Conrad. Tom, if I can just stop you on that point, 
because we have people listening and sometimes we use terms 
here that are not familiar to the viewing audience. If you 
would describe what OCO stands for, because it is going to be 
continually referenced during this hearing, I think it would 
help who might be listening. If you could describe what OCO 
stands for.
    Mr. Nides. Certainly, sir. OCO is basically an ability for 
us to be able to show the costs of our war funding, which is 
defined as temporary and extraordinary. As you know certainly 
from the State Department and somewhat from DOD, much of our 
war funding in Afghanistan, Iraq, and Pakistan has been funded 
by supplementals. And so this year in 2012, we want to have a 
fuller picture of what we believe we need to fund the front-
line states. So we are separating our core budget from our war 
costs budget for you all to be able to understand exactly what 
we define as temporary and extraordinary.
    Chairman Conrad. And OCO stands for Overseas Contingency 
Operations.
    Mr. Nides. Yes, sir.
    Chairman Conrad. So when people hear this reference, OCO, 
that stands for Overseas Contingency Operations. It relates to 
war funding and conflict funding globally.
    Mr. Nides. Yes, sir. So as I was saying, as the Pentagon is 
saving $45 billion this year on its overall OCO request for 
2010, largely due to the transition from military to civilian 
leadership in Iraq, ours--that being the State Department--is 
increasing by $4 billion. And as Secretary Clinton likes to 
say, every business owner she knows would gladly invest $4 to 
save $41.
    In Afghanistan and Pakistan, alongside our military 
offensive, we are engaged in a major civilian effort to 
strengthen our partners, undercut the Taliban, and take on al 
Qaeda. We are also working to deepen our partnership with the 
Pakistani people and empower the governments who act on our 
shared interest in taking on violent extremists. Our OCO 
request for Afghanistan and Pakistan is $3.5 billion.
    A few weeks ago I visited Iraq, and as soldiers pass on the 
responsibility to civilians, the State Department is ready to 
lead. But we need the support and the resources to do the job. 
We have lost too many lives and spent too much money not to see 
this through. The Iraq portion of our OCO request for State and 
USAID totals $5.2 billion.
    Finally, sir, I would like to address our funding for the 
rest of 2011. The 16-percent cut for State and USAID that 
passed the House last month would put our missions severely at 
risk. In the front-line states, our efforts would be hollowed 
out. In the Middle East, we would be forced to scale back 
exactly at the wrong moment. And, finally, we would turn our 
backs on millions of HIV/AIDS patients, mothers, and children.
    The American people are right to be concerned about our 
national debt, and so are we. But they still expect us to make 
smart investments in the future. And when a crisis erupts--and 
they always do--they expect us to be ready. This is a moment 
when America needs to lean forward and not pull back. I look 
forward to working with you to do what is necessary to keep 
America safe, strong, and competitive in a changing and 
dangerous world.
    Thank you.
    [The prepared statement of Mr. Nides follows:]



    
    Chairman Conrad. Thank you, Mr. Nides.
    Now we will go to Deputy Secretary Lynn. Let me just 
indicate that Secretary Lynn enjoys credibility on both sides 
of the aisle here because he has a reputation as a very strong 
manager and somebody who has been dedicated to public service 
for a long time and somebody that we respect.
    Welcome, and please proceed with your testimony. And before 
you do that, I should also indicate this hearing, which is for 
the first time a joint appearance by Defense Department and 
State Department, was actually requested of us by the Secretary 
of Defense, Mr. Gates, and the Secretary of State, Ms. Clinton. 
They made this request of us, and we have accommodated that 
request because they felt it was important given how their 
operations are closely linked.
    Secretary Lynn.

    STATEMENT OF THE HONORABLE WILLIAM J. LYNN, III, DEPUTY 
        SECRETARY OF DEFENSE, U.S. DEPARTMENT OF DEFENSE

    Mr. Lynn. Thank you. Thank you very much, Mr. Chairman. If 
it pleases the Committee, I would like to have my full written 
statement included in the record, and what I would like to do 
is just summarize the main points for you.
    Chairman Conrad. That will be done.
    Mr. Lynn. As you indicated and as Secretary Nides 
indicated, this is, I think, the first time or at least the 
first time in recent memory that the two Departments have been 
before this Committee together, and it does represent, as you 
said, the desire of Secretary Gates and Secretary Clinton to 
represent the strong partnership that they have established and 
the two Departments have established to jointly address our 
national security challenges. It is really two sides of the 
same coin. We at the Department of Defense strongly believe 
that a full and robust funding of our foreign policy operations 
is a very effective means of meeting our national security and 
that, indeed, if we promote stability and responsible 
governance as crises are brewing, we will be able to avoid 
later in the crisis deployment of armed forces, of U.S. 
military forces. And so we fully want to support that 
partnership. We believe that the mix of competencies between 
the State Department, the Department of Defense, as well as 
USAID is what is needed to address the kinds of security 
crises, the kinds of instabilities, the kinds of regional 
conflicts that spark up around the world and to do those at the 
earliest possible point.
    We think that the budgets that we are putting forward 
today, both the State Department and Defense Department budgets 
for fiscal year 2012, well represents that partnership. In 
Afghanistan, State, DOD, and USAID are working together on 
counternarcotics programs, on the training of Afghanistan law 
enforcement. We have proposed with congressional concurrence an 
Afghan infrastructure program that will meld the DOD 
responsibilities for counterinsurgency and the AID and State 
responsibilities for development in a way that is, I think, 
more integrated than in the past, integrated with both the 
long-term development plans in Afghanistan as well as the more 
immediate needs of the military campaign plans.
    At the same time, we are working together with the State 
Department to ensure the joint delivery of security assistance 
wherever U.S. interests are at stake. We have developed over 
the past several years some joint authorities, some dual key 
cooperative authorities, such as the Pakistan Counterinsurgency 
Capability Fund, the Section 1206 authority to train and equip 
partner nations in the counterterrorism fight. Similarly, this 
year we are requesting funding for an Office of Security 
Cooperation in Iraq. This would be a remaining DOD presence as 
we transition to a State Department lead in Iraq. We think 
there is still some need for a DOD presence in terms of 
security assistance. We think that is yet another key joint 
mission.
    In Mexico, we have jointly addressed surveillance, 
interdiction, air and maritime operations and planning through 
a variety of initiatives.
    We continue to work together to train partner militaries in 
over 100 countries through programs such as the International 
Military Education and Training program, as well as the newly 
proposed Global Peace Operations Initiative.
    For fiscal year 2012, we are also requesting a new and I 
think path-breaking program which would involve pooled funding 
where State and DOD would both contribute to a fund in which we 
would seek to anticipate security issues, whether they are in 
Africa or Latin America or Asia, and to jointly target 
assistance for development funding, for economic assistance, 
and for security assistance in an integrated way in an effort 
to anticipate brewing crises and reduce them before they get 
started.
    I also want to endorse what you and Secretary Nides were 
talking about that the State Department is proposing, that its 
funding for the conflicts that we are in, particularly 
Afghanistan and Pakistan, be funded through the Overseas 
Contingency Operations fund, to identify those funds which are 
essentially the marginal costs above the base budget of 
addressing those contingencies, that that is appropriately done 
in a separate fund that Congress can consider fully and 
transparently in that manner.
    As the partnership between State and DOD indicates, 
concepts of security assistance are changing. We at DOD view 
the security assistance activity as a vital instrument that can 
prevent or attenuate instabilities that might otherwise draw 
the United States into armed conflicts. If properly applied in 
a timely manner, security assistance is likely to be more 
decisive and less costly than direct military intervention 
after a problem has become a crisis.
    Our cooperation with the State Department is, therefore, an 
important component of our national defense, and so I would 
urge, as Secretary Gates has, that you fully fund the State 
Department request.
    With regard to our request for fiscal year 2012, we are 
seeking a total of $671 billion. That is divided between a base 
budget of approximately $553 billion and an OCO, or Overseas 
Contingency Operations, budget of nearly $118 billion. In our 
judgment, this budget is both reasonable in that it meets our 
national security needs and prudent in that it supports the 
administration's plan to hold down the deficit. The proposed 
budget will take care of our people. It will continue to 
rebalance the U.S. defense posture. It will provide deployed 
forces with what they need to carry out their very important 
missions, and it continues the reform agenda that Secretary 
Gates has been embarked on for the past 2 years in terms of 
streamlining our business operations.
    As we built this budget, the military departments found 
approximately $100 billion in savings from business operations 
and lower-priority programs. They reinvested that $100 billion 
into higher-priority programs: intelligence surveillance and 
reconnaissance, unmanned aerial vehicles, cyber defense, and 
other programs.
    At the same time, outside the military departments, the 
Secretary and his staff were able to identify an additional $78 
billion in defense-wide efficiencies. That money was reduced 
from the Department's top line over 5 years to support the 
administration's efforts to reduce the deficit.
    Finally, Mr. Chairman, I would close my opening remarks by 
mentioning the unfinished business that confronts both the 
executive and the legislative branch. We are still operating 5 
months into the fiscal year under a continuing resolution. If 
Congress is unable to enact an appropriations bill for DOD, DOD 
would presumably have to continue to operate under a CR, 
continuing resolution, for the entire year. This would have 
three very negative effects on the Department's operations.
    First, it would not provide in our view enough money to 
meet all of our national security needs. It would represent a 
$23 billion reduction from the request the President made for 
fiscal year 2011.
    Second, a year-long CR would leave the dollars that we do 
have in the wrong places. For example, it would not provide 
enough funding in the personnel accounts to support the 
military pay raises that have been approved, and it would not 
provide enough funding in the operations accounts, in the 
medical accounts to meet medical inflation.
    Third, a year-long CR would not provide us with sufficient 
management flexibility to address the needs of the Department. 
We would not be able to start new weapons, we would not be able 
to increase production of existing weapons systems, and we 
would be unable to start new military construction projects. We 
are already dealing with those problems 5 months now into the 
year. If the CR continues for the full year, those problems 
will get far more severe.
    So, Mr. Chairman, it is our hope that working with the 
Committee and the Congress we will be able to find a way to get 
approved and signed a full year appropriations bill for the 
Department of Defense.
    Mr. Chairman, that concludes my prepared remarks, and 
Secretary Nides and I, I am sure, would be happy to take your 
questions.
    [The prepared statement of Mr. Lynn follows:]



    Mr. Lynn. Mr. Chairman, that concludes my prepared remarks 
and Secretary Nides and I, I am sure, will be happy to take 
your questions.
    Chairman Conrad. We appreciate that. Thank you both for 
your testimony. Let me start by saying, I have supported, in my 
24 years on this Committee, every penny that has been requested 
by every President for our national defense and our national 
security. For 24 years, I have supported every penny requested.
    But I have to say to you, we are going to have to change 
course. It is as clear as anything can be to me. We have the 
Chairman of the Joint Chiefs saying, as I indicated in my 
opening statement, the biggest threat to our national security 
is our national debt. I believe that to be the case.
    I served on the President's Fiscal Commission, 18 of us 
did. Eleven of the 18 agreed to a plan that would reduce both 
defense and non-defense discretionary spending over the next 
decade by $1.7 trillion. We did so not because it was 
attractive to do or politically popular to do, but because we 
saw a fundamental threat to the economic and national security 
interests of the United States if we failed to act.
    We also called for an additional trillion dollars of 
revenue over that period by reforming the Tax Code, broadening 
the base, actually reducing tax rates to help America be more 
competitive so we could generate more jobs. And those savings 
on spending, and we also save money, some $600 billion in so-
called mandatory accounts over that period, and because of 
those savings through spending cuts and additional revenue, we 
saved hundreds of billions of dollars in interest, for a total 
package of some $4 trillion.
    And defense was not exempt. Defense was asked to shoulder 
its fair share of savings. I was delighted to see Secretary 
Gates propose a package of reductions of some $78 billion in 
the defense budget, but he took those savings and put them 
elsewhere in the defense budget. So that is not a change in 
overall spending.
    I just want to share with you things I heard during the 
Commission considerations of the defense budget going forward. 
Testimony before the Commission by some of the top defense 
analysts in the country were that 51 percent of all Federal 
employees are at the Department of Defense. 51 percent of all 
Federal employees are at the Department of Defense. And that 
does not count contractors.
    When we asked the contractors--we asked the analysts, How 
many contractors does the department have, they said, We cannot 
tell you. I pressed the analysts and asked them, Well, can you 
give us a range? Yes, we can give you a range, 1 to 9 million. 
That was the range provided the Commission, 1 to 9 million 
contractors. That is a pretty big range.
    When we asked the General Accounting Office for an 
auditable record of the Department of Defense, they told us the 
books are not auditable. You know, we have a big problem here 
and I have concluded, we simply cannot stay this course. And it 
is not just the Defense Department, it is every part of 
government operations.
    We are going to run a deficit this year of $1.5 trillion. I 
mean, that is a number so stunning, if 5 years ago anybody 
would have told me we were going to ever run a deficit in this 
country of $1.5 trillion in 1 year, I would have thought, it is 
not possible. But it is not just this year. We are going to add 
to the gross debt of this country every year for the next 10 
years over a trillion dollars.
    We have a gross debt now of 100 percent of our gross 
domestic product. At the end of this year, we are going to have 
a gross debt of 100 percent of our GDP. We have just had a 
study that was done by Carmen Reinhart at the University of 
Maryland, Ken Rogoff at Harvard, studied 200 years of fiscal 
crises in 44 countries. Their conclusion: When you have a gross 
debt of more than 90 percent of GDP, your future economic 
growth is sharply reduced. That was the testimony before the 
Commission.
    When gross debt is 90 percent of your gross domestic 
product, your future economic growth is sharply reduced. Our 
gross debt, at the end of this year, will not be 90 percent. It 
will be 100 percent.
    So I just say to you, and my question would be, Secretary 
Lynn, can't the Defense Department come up with savings that 
are net savings? Not just savings that are redirected so that 
the overall spending remains the same? Aren't there savings 
that you can find there?
    Mr. Lynn. Yes, and I think we have. Let me first say, I 
agree with you and your citation of Admiral Mullen that we 
should indeed treat the deficit problem, the national debt, as 
a national security problem and we need to address it with that 
type of urgency.
    I think, though, as we look at defense reductions, as every 
department, you need to approach it in a balanced way. We need 
to ensure that we retain what Senator Sessions talked about, is 
that we have the best trained, best equipped, best led military 
that the world has ever seen and we do not want to lose that by 
taking precipitous or unwise cuts.
    In that context, I think we can learn from prior draw 
downs, ones that may not have gone as well as we would have 
hoped. When we take reductions, we need to take them in a 
balanced way. We need to take them not just in one account, but 
we need to take them across all accounts. We need to reduce 
force structure, investment and operations in a seamless way so 
as not to unbalance and hollow out the force.
    We need to take tough decisions early. We have tried to do 
that with some of the weapons' decisions in the past couple of 
budgets, not always popular, but I think important decisions 
that we need to take. And we need to be sure that we do not 
over-reach, that we do not cut into the true bone of that high 
quality military that we have.
    Now, with that as a preamble, let me go to your specific 
numbers question, Mr. Chairman. The savings that we were able 
to identify as we built this budget were actually $178 billion. 
You are correct, we reinvested $100 billion of that $178 
billion. $78 billion was removed from the top line, and it was 
done in a way, I think, that reflects the lessons that I just 
said.
    It was done in a balanced way in that there are force 
reductions, but we tried to do it in a prudent way in that 
those force reductions do not occur until 2015 and 2016 when we 
hope we will have completed the draw-down in Iraq and that we 
will have been able to transfer the bulk of the security 
function in Afghanistan to indigenous forces.
    That will then allow us to get to the kind of reductions 
that you are talking about. But I think we have to step through 
this in the process that I have just described.
    Chairman Conrad. Let me just say, I think I have great 
respect for you, Mr. Lynn. I do not know if we have ever met 
except in passing, but I have read about you and I know the 
kind of record you have brought to this position. So I want to 
say, I have great respect for you.
    But, you know, words, I think, that we use in this town can 
be very misleading. When we talk about there being $78 billion 
in savings here on a net basis, you know, it is from an 
inflated baseline that comes off of years where the budget was 
just going straight up.
    So, if one looks at the year over year spending levels in 
this budget, every year the spending goes up. It goes up. It 
goes up. It goes up. And honestly, as the Chairman of this 
Committee, I am talking to colleagues and there are so many 
people who are giving the speeches they gave 20 years ago. The 
world has changed.
    I salute the Secretary for saying, Hey, we have to take 
money out of the baseline plan. I am just saying to you, Then 
to take a big chunk of it and put it right back in, it is not 
going to work. It might work this year. It might work next 
year. These budgets, all of them in all of the Federal 
Government, this is not going to work.
    Our spending, as a share of the national income, is the 
highest it has been in 60 years. Our income, as a share of the 
national economy, is the lowest it has been in 60 years. So the 
reality is going to come crushing in on us here. It is going to 
come crushing in on us. Those who are financing this debt, half 
of it now abroad, much of it from the Chinese, if you read the 
reactions today of this announcement that Pimco has dumped U.S. 
debt, I just urge you, read what the Chinese are saying.
    Former Chinese Finance Minister saying, They have to re-
evaluate whether they are going to continue buying U.S. debt. I 
will tell you, we are on a crash--we are on a collision course 
for a financial crash. It is as clear as it can be. And doing 
things the way we have been doing them is not going to cut it.
    Senator Sessions.
    Senator Sessions. I think that is a bipartisan consensus, 
gentlemen, and it is very scary. The reality is upon us and it 
is critical that we take some steps to show that we get it and 
we are putting the country on the right path. I would just note 
that I have to be critical of this Administration, both of 
which you are a part.
    The Education Secretary was in here the week before last, 
last week, and testified in favor of an 11 percent increase 
next year in his budget. And the Energy Secretary was here, 
testified in favor of a 9.5 percent increase. And the 
Transportation Secretary was here and proposed a 62 percent 
increase. And the Defense Department, if we do real numbers 
based on what the CR is and where you want to go next to, is a 
5 percent increase. That puts you in better company, Mr. Lynn, 
a little bit.
    Mr. Lynn. It is pretty reasonable.
    Senator Sessions. Well, it may sound that way, but it is 
not in light of the debt we have and the crisis that is 
happening in the country. I think we are in a bubble in 
Washington. I think people are talking about investments. I 
think they are talking about business as usual. We are in 
denial about the reality of the threat. I am just saying, I 
agree with Senator Conrad, change is upon us and we are going 
to have to make it. I do not think our institutions have yet 
grasped that.
    Some in the Congress have not yet grasped it. The ones who 
just ran for election did. They talked to the American people 
who, I think, get it. The State Department is proposing a 10.5 
percent increase in the State Department total increase in 
spending.
    So these are not acceptable increases, I do not believe, 
and I do not think they are going to be approved, so we have to 
work on it. I agree with our Chairman, that language is 
important. I mean, I love the Defense Department. I know how 
big it is and how hard it is to move this monumental ship of 
defense, but DoD has portrayed the 2012 request that you made, 
not as an increase, but as a $13 billion cut from last year's 
projection of $566 billion.
    So one of the things we have to do in Washington is we have 
to get our language straight. We have to abandon this idea that 
somebody's projection increases are the fact and that a 
reduction of increase is a cut in spending. We have to talk 
about, what is our current level, the CR level, and how much up 
you plan to go from that.
    As I calculate it, Mr. Lynn, you are talking about going 
from this year a 5 percent increase over the CR level, which 
would be a real increase, but not--I think that would be an 
accurate way of saying it based on my articulation of an 
accurate way of saying it. Would you agree? Is that where you 
say you are, about 5 percent?
    Mr. Lynn. I think that would be an accurate reflection of 
the base budget. Of course, it does not include OCO budget 
which represents a $40 billion reduction.
    Senator Sessions. You are talking about $158 billion on the 
war funding to $118 billion, a saving of $40 billion, which is 
very significant.
    Mr. Lynn. And that will actually get you a net reduction. I 
cannot do the math in my head, but it would be a few percent 
net reduction.
    Senator Sessions. Well, but we are not going to go down 
that road either, because that is the military conflict and one 
of the things we hope to achieve by this rapid draw-down--I 
hope it is not too rapid--is a financial savings and that to be 
separate. We are looking at the base defense budget. So I know 
you have done some things.
    But let's talk about, when you focus on procurement and 
reductions there, you have stretched out, as I see it, the 
Joint Strike Fighter. You call that a restructuring, but 
basically it just moves the requirement from this 5-year window 
out further. Does that have an increased cost for a copy if our 
contractor now is making few planes in his assembly line, is 
less? Are there any kind of cost increases that occur from that 
in addition to the fact you d not get the planes as soon as you 
would like them?
    Mr. Lynn. There is a modest--I think it is in the 1 or 2 
percent range--increase in the unit cost from that move, but we 
thought it was prudent. As you are well-aware, Senator, we have 
had challenges with this program and we thought it was prudent 
to slow that production line down until we were further along 
in the development; that we thought that that was, frankly, the 
best use of the taxpayer dollars.
    You are correct. There is some modest unit costs, but they 
are, as I say, relatively modest like 1 or 2 percent.
    Senator Sessions. But in general, when you take a 
procurement plan and you stretch it out, it tends to drive up 
costs as well as delaying you obtaining the system.
    Mr. Lynn. It does do that. However, if you buy the planes 
too early and then the development is not complete and then you 
have to go back and retrofit the planes with the fixes that you 
develop later in the development process, that is actually even 
more expensive.
    Senator Sessions. I got you. I think that may well be 
justified in this case. I am just raising the point that as you 
make tough choices about trying to save money, sometimes your 
savings can actually drive up costs, and we need to be careful 
we do not unnecessarily do that.
    With regard to the State Department, Mr. Nides, over the 
last 10 years, the State Department has more than doubled. It 
has gone up about 7.7 percent annually. The rule of 7, your 
money doubles in 10 years. And the budget for the State 
Department from 1908 to 1910, I guess that period of time, is a 
33 percent increase.
    So what I want to say is, that is an unsustainable rate. 
That is over 10 percent, 11 percent rate, I guess it is on--
well, actually, those 2 years. 1909 and 1910 is a 33 percent 
increase, so that is about a 16 percent increase each year. So 
I have to tell you, we do not have--we cannot sustain that. My 
time is up and I will let you comment on it and we will just 
say one more thing.
    I am very worried that the State Department, by its nature, 
is going to be in a situation where it is asking its State 
Department personnel to go in dangerous areas of Iraq and 
Afghanistan that the military goes every day. They salute and 
they go and they take the risk, as they have sworn to do.
    But our State Department people have not taken the same 
kind of oath and do not see themselves as combat personnel. I 
am really worried as to whether or not we will be able to 
handle this massive challenge you seem to be undertaking in 
Iraq. But basically, on your budget, I will give you a chance 
to respond to my comments.
    Mr. Nides. Well, thank you, Senator, and I agree with 
Secretary Lynn. We all are quite concerned and certainly very 
much focused on making sure each dime we can justify, and 
certainly understand the focus that taxpayers have on how we 
are spending our money.
    I should say, in our 2012 request, as I think you noted, 
our base budget, which is base budget over 10, is basically 
flat from base to base. The growth in our 2012 budget is 
principally and solely in the OCO account, which is principally 
the transition, which I will get into in a minute--for 
military----
    Senator Sessions. It is a 3.6 percent increase on the 
regular budget, which is above the inflation rate.
    Mr. Nides. Yes, I----
    Senator Sessions. It is not flat, to my way of thinking.
    Mr. Nides. Well, our budget of--again, this is from where--
the State Department/USAID's perspective and the way we look at 
our budget, our budget is $47 billion for our base budget in 
the 2012 request, versus basically that same number was in 
2010. There is a $6.7 billion OCO request, which then adds to 
the total number of our request for the budget.
    So between our OCO request and our base budget, we felt 
that, at least from our base budget perspective, there was a 
substantial justification for the moneys that we were spending 
since, obviously, we were basically flat from the 2012 to 2010. 
Obviously, the OCO account, as I spoke about earlier, as you 
have seen the OCO account being reduced by DoD, ours has gone 
up $4 billion and theirs has come down $45 billion.
    But again, I think it is, from our perspective, we are 
trying to be, and I think Secretary Clinton has spoken not only 
to the appropriating committees, but to the public, a very 
clear understanding of how we are focused on every dollar that 
we are spending for this department.
    As it relates to Iraq, if you would like me to comment on 
that?
    Senator Sessions. According to the numbers I have, the 
regular budget is up 3.6. If you break it down to State 
operations, that is 2.9; foreign operations, 4.0; war is about 
a double increase. Total budget authority goes up 10.5 percent.
    Mr. Nides. Senator, I would be more than happy----
    Senator Sessions. It is not flat. I do not believe it is 
flat.
    Mr. Nides. The 150 account, which includes outside of the 
State and USAID, and that is the only account I am speaking to, 
the 150 account is up 3 percent, the 150 account. But state 
operations are base budget, and I would be more than happy to 
come back to your Committee and walk through the numbers. Our 
base budget of $47 billion for state and USAID, which we 
include a variety of items in that, the base of that is flat, 
but the increase--and you are right--the increase is our OCO 
account for 2012.
    Chairman Conrad. Let me just thank the Senator for his 
questions and we will go now to Senator Wyden.
    Senator Wyden. Thank you very much, Mr. Chairman. I want to 
thank two very dedicated and long-time public servants, 
Secretary Nides and Secretary Lynn, and we welcome you both.
    I want to start with Libya. And last week, Secretary Lynn, 
Secretary Gates said, and I am pretty much quoting directly 
here, ``We have to think frankly about the military in another 
country in the Middle East.'' That was Secretary Gates. Now, I 
am of the view that part of the frank thinking is considering 
the financial cost to American taxpayers, especially in light 
of the trillion dollars plus that has been spent in Iraq and 
Afghanistan.
    So my first question is, can you provide me with an 
estimate of the costs weekly, per day, to taxpayers of 
establishing a no-fly zone in Libya?
    Mr. Lynn. I cannot at this hearing. I could provide 
something for the record, but it would depend on what the 
dimensions of that no-fly zone were.
    Senator Wyden. Well, walk us through the various options 
that I know the Department would be looking at. For example, 
the Center for Strategic and Budget Assessments went through 
three scenarios that seemed to be getting a wide amount of 
debate. They called them the full and the limited and the 
standoff approach. So walk us through the analysis that you 
have done to date of the various options.
    Mr. Lynn. That, Senator, that analysis is still ongoing and 
I am not in a position to provide that yet to the Committee, 
but I would be happy to come back at an appropriate time and in 
an appropriate forum and do that.
    Senator Wyden. You feel you need to do it in a classified 
manner?
    Mr. Lynn. Yes. Yes, I do.
    Senator Wyden. Well, I am on the Intelligence Committee as 
well. When could you have that at the Committee to the Chair, 
Senator Feinstein, Ranking Minority Member, Senator Chambliss, 
and myself? When could I have that in the Intelligence 
Committee in a classified way?
    Mr. Lynn. I am going to have to come back to you because we 
are in the middle of the planning and I am not sure when the 
planning will be completed and when the President will want to 
share what--that planning with the Congress. But whenever that 
is ready, we would be prepared to do that.
    Senator Wyden. Would it be possible? I mean, as you know, 
there is a statute that says Intelligence Committee members 
have to be kept informed. Would it be possible to have, within 
the next 72 hours, what you have to date, at the Intelligence 
Committee?
    Mr. Lynn. Again, I have to defer and come back to you with 
a specific response on both timing and content.
    Senator Wyden. I will ask Secretary Gates this same 
question.
    Part of what I am concerned about is that we are looking at 
a double standard with respect to inefficiency. As Chairman 
Conrad correctly pointed out, the Department cannot get its 
arms around the number of contractors it has; and yet, we are 
cracking down on contractors in other parts of government.
    What I want to do is look at a number of the issues that 
concern me the most, and I want to start with what seems to be 
the continuation of a number of cold war-era programs and 
facilities that no longer deal with the most important threats.
    I mean, it is puzzling, for example, that the Pentagon 
needs five nuclear aircraft carriers to fight the Soviet Union, 
but it needs 11 to fight current threats, mostly insurgents and 
terrorists. And those 11 carriers cost more than $16 billion a 
year to operate. As the Chairman noted, there is also the 
question of bases. I am particularly concerned about bases in 
Europe that were built to deter an invasion by the Soviet 
Union. I think the Europeans ought to do more to defend 
themselves in the future.
    So my question here is, why has the Department rejected so 
many of the Commission's recommendations for defense cuts?
    Mr. Lynn. Well, let me come back to the two specific ones 
you raised, Senator. With regard to aircraft carriers, the 
analysis that you are looking at for war-fighting with the 
Soviet Union is a surge capability and a discreet engagement 
with the Soviet Union; and indeed, that, as you know, has 
disappeared.
    The requirement for 11 carriers is not based on that same 
kind of analysis. What it is based on is what kind of 
engagement around the world for crises such as Libya, what kind 
of carriers do you want to have on station and available? That 
requires a multiplier.
    In other words, to keep two or three carriers forward, you 
need 11 carriers. So the judgment there is that we do need 
those two or three carriers forward to deal with crises such as 
Libya, to deal with potential problems in the Gulf, in the 
Persian Gulf, in the Middle East, to deal with Asian 
challenges. So the analysis has to do with that rotational base 
as opposed to a war-fighting analysis, which I think you have 
correctly characterized, is not clearly part of today's world.
    With regard to bases in Europe, that happens to be timely. 
It is not just bases, but forces in Europe. Secretary Gates is 
meeting, as we speak, with his colleagues at NATO talking about 
what kinds of reductions in U.S. forces we might be able to 
take as a consequence of the changing environment.
    And it is not just reductions. We think that in terms of 
large ground units, we can take reductions in terms of some 
naval units, in terms of missile defense, in terms of some 
other units. There may indeed be enhanced capabilities that 
might be needed to meet the new challenges that the alliance 
faces, and we should have, coming out of his ministerial that 
the Secretary is at, some new plans that we would be happy to 
share with you.
    Senator Wyden. What is your response to my concern that 
there is going to be a double standard with respect to 
measuring inefficiency? I mean, to taxpayers, waste is waste 
wherever it takes place across the Government.
    The Chairman issued a very powerful statement in his 
opening statement, who has consistently supported defense, that 
when the Department cannot get its arms around the number of 
contractors, and we are trying to crack down on contractors 
elsewhere. I am trying to crack down on contractors in the 
intelligence sector. Why shouldn't we ask the Department of 
Defense to make a crackdown on contractors within its own 
agency?
    Mr. Lynn. You should. The--two things there.
    Senator Wyden. Well, wait. Well, you prepare--because my 
time is out. Will you prepare a specific response to what the 
Chairman has said with respect to why we shouldn't, in this 
Committee, cut the number of contractors? We are going to have 
a budget resolution pretty quickly, and I am going to propose 
that we make reductions in those kinds of areas, and I would 
much prefer to do it in concert working with you than trying to 
go forward myself. So can you get a plan to us with respect to 
cutting the number of contractors so we do not have this double 
standard?
    Mr. Lynn. We have indeed proposed such a plan, particularly 
for the contractors that I think you may be focused on, which 
are basically augmentees to headquarters' functions. We have a 
10 percent per year plan over the next 3 years that we will 
share with you. I know we are over time, but the underlying 
premise to your question is correct. Our data on contractors is 
inadequate and we need to remedy that and we are taking steps 
to do that.
    Senator Wyden. I would like to work with you on it. If I 
cannot work with you so we can come up with an agreed upon plan 
to cut the number of contractors, I am going to work with 
colleagues here on both sides of the aisle to do it. I would 
much prefer to do it with you. Thank you, Mr. Chairman.
    Chairman Conrad. I just want to followup and rivet this 
point. You know, everybody has to be in on the solution to this 
debt matter. Everybody has to be in. And if we do not do this, 
it is going to be imposed upon us.
    I was just sharing with Senator Sessions some of the 
reaction to PIMCO Total Return dumping all U.S. Government 
debt. And one of the reactions was in an interview with Mr. 
Gross, who says, ``We have not lost faith in the U.S. 
Government. America is still strong and the economy is growing, 
and we have, you know, perhaps $30 to $40 billion worth of U.S. 
Treasury bills, but those are shorter maturity obligations.'' 
The Treasuries from the Total Return Fund, they dumped them all 
as of the end of February.
    And in an interview, he was asked, ``Well, where should you 
invest?'' Here is what he said: ``You should probably go 
outside the United States. I mean, the emerging markets, the 
developing countries are improving credit. They have better 
balance sheets than the United States. You have Brazil, for 
instance, has half the debt relative to GDP that the United 
States does--as does Mexico.''
    You know, you think about this, I think Senator Thune, who 
grew up in South Dakota, I grew up in North Dakota. Had anybody 
said that Mexico when I was growing up was a safer place to 
invest because they have half the debt relative to GDP the 
United States has, it would have been such a stunning concept, 
nobody could haveten their head around it. Now here we are. It 
is the reality. Brazil and Mexico have half the debt to GDP 
that we do, and I will bet you we are giving them money. I will 
bet you if I asked my staff to go find for me what we are doing 
with Brazil and Mexico, I bet we are giving them money.
    Senator Thune.
    Senator Thune. Thank you, Mr. Chairman.
    Secretary Lynn, Secretary Nides, thanks for appearing 
before us today. As a follow-on to the Chairman's observations, 
you know, the Chairman of the Joint Chiefs, Admiral Mike 
Mullen, said a few months back that the greatest threat to 
America's national security is our national debt. And Secretary 
of State Hillary Clinton called the expected $1.3 trillion U.S. 
deficit, I quote, ``a message of weakness internationally,'' 
and went on to say that ``...it poses a national security 
threat in two ways: it undermines our capacity to act in our 
own interests, and it does constrain us where constraint may be 
undesirable.''
    I am just curious about your response to those observations 
and whether or not you share the view that--you know, when you 
talk about the threats that we face around the world today--and 
they are many: potentially nuclear Iran, instability in the 
Middle East, nuclear North Korea, China, lots of potential 
threats out there to pinpoint the national debt as being the 
biggest among those, if that is a view that you share and just 
sort of your general observations in response to what both the 
Chairman of the Joint Chiefs has said as well as what Secretary 
Clinton said.
    Mr. Lynn. Senator Thune, I certainly agree with both 
Admiral Mullen and Secretary Clinton that the national debt, 
the fiscal crisis we face is a true national security problem. 
And as we discussed a bit earlier with the Chairman, I think 
that DOD does need to be part of the solution to that fiscal 
crisis. And Secretary Gates has tried to take a strong step in 
that direction by developing $178 billion worth of savings: 
$100 billion of that was reinvested in capabilities; $78 
billion was removed from the defense top line and put toward 
that deficit reduction.
    We have tried, though, to do this in a responsible way. We 
need to take reductions in a balanced way, and that ultimately 
means if you are going to reduce the top line, you really need 
to reduce the underlying force structure. If you reduce the top 
line without reducing the force structure, what you will do is 
hollow out the forces by not giving them adequate training, 
adequate equipment. And we have seen that movie. We do not want 
to repeat that, so we want a balanced reduction.
    Our feeling was that given the fights that were in--Iraq as 
we are phasing down, Afghanistan we hope to phase down but not 
yet--we think it would be prudent to have those reductions 
starting in 2015 but not earlier. And so that is what we have 
laid in to the budget proposal that we have presented to the 
Committee and the Congress, so that the budget does go down. 
The reductions get us to a flat budget by 2015. They do that, 
though, with those force reductions in that timing, and that 
reflects the conditions we see internationally.
    Senator Thune. Anything to add to that, Secretary Nides.
    Mr. Nides. As someone who has spent a great deal of his 
career in the finance world, I certainly share both your and 
Senator Conrad's concern about this debt, and I certainly am 
very concerned about the issues as it relates to the bond 
market and the reaction to the debt, which is certainly an 
enormous problem for all of us.
    As we sit at the State Department--and I know you would be 
surprised for me to say this--we actually look at our budget as 
an ability to avoid conflict, to avoid the cost of my colleague 
on the left putting boots on the ground. There is a 
misperception that the State Department and foreign assistance 
is 10, 15, 25 percent of our national budget, our Federal 
budget. It is 1 percent of the Federal budget--1 percent of the 
Federal budget--and I think even within that 1 percent, 
Secretary Clinton has been very clear that every dollar that we 
are spending on conflict resolution and what we are spending in 
Afghanistan and Pakistan and Iraq or food security or health 
has to be justified. And that is why, as I spoke with Senator 
Sessions, we have attempted to be very conservative in our base 
budget, and the only increase that you are seeing in 2012 is 
those costs in what we refer to as ``the war costs'' or 
``extraordinary/temporary costs.'' But I, too, agree very much 
about the issues around the debt and the importance of 
resolving it, obviously at least reducing it as soon as humanly 
possible.
    Senator Thune. Let me touch on a current issue, and it 
bears on this discussion because, Secretary Lynn, as you know, 
many of our key European allies are seeking to substantially 
cut their military budgets. For example, the U.K. has de-
commissioned its aircraft carrier, retired its fixed-wing air 
component because, according to the U.K.'s Strategic Defense 
and Security Review, ``There are few circumstances we can 
envisage where the ability to deploy air power from the sea 
will be essential.''
    Now, ironically, the U.K. is telling the world that a no-
fly zone must be established above Libya and is working to 
draft a U.N. resolution to do so. Obviously, establishing a no-
fly zone for Libya will at least partly require the ability to 
deploy fixed-wing air power from the sea.
    It seems that our European friends are seeking to cut their 
military budgets while at the same time pushing us to intervene 
in world hot spots where only the United States has the ability 
to project power. And so my question is: What effect do these 
military cuts by our European allies have in placing even more 
of a burden on our defense budget?
    Mr. Lynn. We have been watching very closely what our 
allies, particularly NATO, have been doing with their defense 
budgets. Some of the reductions do concern us. We have worked 
particularly closely, though, with the British, and we have 
tried to work with them to ensure that as they adjust their 
budgets, it is done in the way that best protects our 
collective security.
    They are facing in many ways the same fiscal challenges 
that we are, and so we recognize what is driving this. It is 
driving us as well. But as I indicated to you earlier, I think 
we need to take reductions that are prudent and wise, although 
we do need to address the debt problems, as they do they.
    Senator Thune. Can I just followup on that? From what I 
have seen, the cost of establishing a no-fly zone over northern 
and southern Iraq during the 1990s was over $1 billion a year, 
and we flew about 34,000 sorties a year. Do you have any notion 
of how much it would cost to establish a no-fly zone over Libya 
on an annual basis?
    Mr. Lynn. I do not because we do not yet know what the 
dimensions of that no-fly zone would be and how it would 
compare to the Iraqi operations. It would be really premature 
for me to try and estimate the cost.
    Senator Thune. My time has expired, Mr. Chairman.
    Chairman Conrad. Thank you, Senator Thune. I thank you for 
really excellent questions.
    Mr. Secretary, both the Ranking Member and I have talked 
about the use of language here. And in your response to Senator 
Thune, you used language, again, that somebody listening that 
does not know how baselines work around here, how budgets are 
inflated over time, might conclude that somehow the spending is 
going down. And I would just like to ask you for the record, 
the base budget for 2011 for defense is $526 billion under the 
CR. Is that correct?
    Mr. Lynn. The fiscal year 2010 budget would be $526 billion 
if you do a nominal extension. That is correct.
    Chairman Conrad. OK. So for 2012, what is the request 
without war costs?
    Mr. Lynn. The request without war costs is $553 billion.
    Chairman Conrad. And for the next year?
    Mr. Lynn. I would have to look that up, but--$571 billion.
    Chairman Conrad. OK. And for the next year? 586 is the 
number I have, for the next year 598. And the 553--so the point 
I am making every year, people need to understand the spending 
is going up, and we are talking about somehow it is going down. 
And for fiscal year 2012, the $553 billion does not include the 
war costs. With the war costs what would the budget be?
    Mr. Lynn. About $671 billion, which I think is actually, 
just to continue your line, I think that is down about 3 
percent from fiscal year 2011. So when you do the net with the 
war costs coming down over $40 billion, the next of the base 
budget plus the war costs will come down from fiscal year 2011 
to fiscal year 2012.
    Chairman Conrad. Can you assure this Committee that there 
will not be an additional request for funds in 2012 for war 
costs?
    Mr. Lynn. I cannot do that. It is possible, but as you 
noted at the beginning, we have tried to be conservative with 
our estimates of what those war costs would be to prevent 
exactly that.
    Chairman Conrad. Well, I would just say the history that we 
have, not in this administration but previous administrations, 
is they were nowhere close in estimating. They would come to 
this Committee and tell us that they were going to be $50 
billion, and then it would be $120 billion. I understand that 
you have changed course here. You are trying to give us a more 
accurate reflection, which we appreciate. But the point I am 
making here is the language we use I think kind of misleads us. 
I am not accusing you of intentionally misleading anyone. You 
are using the language that is used with respect to a baseline. 
The actual dollars are going up every year.
    Senator Cardin.
    Senator Cardin. Thank you, Mr. Chairman. Let me thank both 
Secretary Nides and Secretary Lynn for your service to our 
country and for you being here.
    I agree with the Chairman that our current deficits are not 
sustainable, and they are huge national security issue that 
needs to be dealt with on a bipartisan basis by having a 
credible plan to deal with the deficit. We are not going to be 
able to do it on the discretionary budget side.
    We have already agreed that we are going to have at least a 
freeze on discretionary domestic spending, and we have also 
agreed that we are going to be reducing our defense spending.
    I might say on defense spending--and I am sorry, Chairman, 
we do not have charts, but if you look at America versus the 
rest of the industrial developed nations of the world and how 
much we devote toward national defense issues, we are 
shouldering a larger burden than our allies. And at one point 
we have to recognize that and do something about it because it 
is not fair to the American economy. And I am one who will 
always support the necessary budgets for the defense of the 
people of this Nation. But we are shouldering an unusual 
burden, and it is part of the problem that we have today trying 
to figure out a sustainable budget for our growth and for 
dealing with the deficit.
    Entitlement spending needs to be contained. I think we took 
a major step in that direction last year by the Affordable Care 
Act, by investing in technology and prevention and managing 
people's diseases and setting up clinics rather than the use of 
emergency rooms. I think we are going to bring down Medicare 
and Medicaid spending and health care spending in this country. 
We need to do more. There are more entitlement programs. And we 
have talked about revenues. We just had several hearings in the 
Finance Committee dealing with looking at tax reform so that we 
can equate our revenues with our necessary spending.
    Which brings me back to the issue at hand. We are not going 
to balance the budget on 12 percent of the budget, on 12 cents 
out of every dollar, and that is the discretionary domestic 
spending, which our international development assistance 
happens to fall under. I happen to think that less than 1 
percent of our budget being spent on international development 
assistance is a very modest amount of money. As you point out, 
both of you point out, these types of expenditures are 
critically important for U.S. objectives internationally and 
developing capacities in other countries to provide more stable 
regimes, putting less stress on the future needs of our 
military and developing the type of stability that is important 
to the United States, including markets that will buy U.S. 
products. All that I think is very true.
    And I must tell you, I find the share of the pie that is 
devoted toward international development assistance to be a 
little bit too modest, and I think we should be making greater 
strides. Having said that, we need to have accountability in 
every dollar that is spent.
    So I want to know what you are doing to make sure that the 
dollars that are being appropriated by Congress are spent for 
their intended purpose. And what are you doing to make sure 
that we are not financing corruption among different regimes? 
We are very concerned that dollars that we appropriate may very 
well be ending up in foreign bank accounts of deposed leaders. 
So what assurances can you give us that you are monitoring the 
moneys that are being spent so that we get value for the 
dollars that we are appropriating?
    Mr. Nides. Would you like me to take the question first? 
Thank you very much, Senator. I want to emphasize--and you 
pointed out the 1 percent of the Federal budget again. I want 
to emphasize that 1 percent is all of the costs for the State 
Department and USAID. That includes all of our embassies across 
the world, all of our foreign service officers, civil service 
officers, our locally engaged, all of our foreign aid, all of 
what we do to fight hunger, all we do to fight AIDS and HIV, 
and all the things that we are doing to help us in those 
individual crisis countries. So as the American people--and you 
and I have spoken about this. The American people hear about 
how much money is spent on foreign aid, and obviously the views 
of it is 15 or 20 percent. It is 1 percent, and it includes all 
of what we are doing around the world.
    No. 2, to answer your question specifically, the Secretary 
announced for the first time the QDDR. Actually we borrowed the 
idea from DOD. The QDDR was our attempt to do exactly what you 
are looking at. How do we look at ourselves faster, better, 
smarter? How do we find the efficiencies? How do we look at 
every dollar that we are spending, be it on global health, be 
it on how we organize, how our staff is paid, how we as an 
organization operate? And in our attempt to try to very much 
focus on what you are getting at, as it relates to our issues 
around how dollars are sent, we have a very strong IG within 
the State Department. We work very closely with them all over 
the world, particularly in areas we are spending a lot of 
development dollars. So we are as an organization inherently 
committed because we know the focus that you have on the money 
spent and we know how rare those dollars are.
    Senator Cardin. In order to have successful efforts for 
increasing capacity of other countries, there needs to be a 
priority on gender equality. There is a direct relationship 
between how women are treated in countries as to their economic 
growth and potential. The Millennium Challenge Corporation has 
integrated gender equality into their basic core missions.
    What are you doing in the State Department or Defense to 
make sure that in our efforts to help other countries on their 
development assistance, priority is placed on gender equity, 
equality?
    Mr. Nides. I will quickly answer the question, and then I 
will turn to my colleague. As you probably know, there is 
probably not much more that the Secretary cares more about than 
this issue. You may have seen her on the cover of the recent 
news magazine talking specifically on this topic. It is 
inherent in everything we do, with the way we organize and how 
we focus, how we put programs together, beyond global health, 
what we are doing for women and girls and what we do across the 
world. But this is something that certainly is part of our 
core, and I assure you that Secretary Gates feels the same way, 
but it is a part of our foundation because we believe that 
conflicts end at the beginning of what we do on gender and what 
we do specifically about women and girls.
    Senator Cardin. Secretary Lynn?
    Mr. Lynn. Secretary Nides is correct. Secretary Gates 
shares the importance and the attention that is needed for 
gender equality. It goes to the more general question that we 
started the hearing with, that we are trying to create a much 
strong partnership between State and Defense so that we are 
working together with State and Defense on common goals like 
gender equality and that the overall impact for our national 
security is that we should be able to anticipate and respond to 
brewing crises, with development and security and diplomatic 
assistance, before we have any need for any kind of armed 
intervention. And we are trying to work a strong partnership 
toward those ends.
    Senator Cardin. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, Senator.
    Senator Begich.
    Senator Begich. Thank you very much, Mr. Chairman.
    Secretary Lynn, let me followup on what Senator Cardin just 
started with this conversation in regards to where we have to 
balance the budget and deal with the costs of the Federal 
Government.
    Do you agree with his statement that it has to be spread 
among all agencies and discretionary cannot take the load that 
it is taking? Do you agree with that statement?
    Mr. Lynn. Absolutely.
    Senator Begich. OK. I know Senator Wyden asked this 
question, and I want to expand on it--he was here earlier--in 
regards to the overseas stationing and the bases and the 
construction budgets. I have only been here 2 years, but one of 
the things we put in the defense authorization bill--and I know 
it is in process. You have indicated, I think, that it is 
Secretary Gates' hands or a start process of reviewing our 
stations overseas, and there will be a report coming soon. Can 
you define--and this is what I have learned in my hearings. 
What does ``soon'' mean? Define ``soon'' when that report will 
come, that we will see some report that tells us our overseas 
base operations, what we need to do to create more efficiency, 
scale back, or reassign.
    Mr. Lynn. I am not sure which report you are referring to, 
Senator, but in the earlier discussion what I was referring to 
is that there are ongoing consultations with our NATO allies 
about what the future force structure in Europe ought to look 
like, and we will have the results of that later this spring.
    Senator Begich. OK. In expansion of that, I am pretty 
sure--and I will confirm this with my staff and maybe your 
staff--that is, I think an authorization bill, we also wanted 
the Defense Department to look at the overall overseas 
operations; in other words, not just Europe but where we have 
bases. And, you know, is it the right model for the wars that 
we are engaged in today and the security that we are engaged in 
today? And how can we examine that and see if there are 
opportunities for savings there? We will pull that language. We 
will share it with you. It makes me nervous because it is 2-
year-old language, but I will work with your office, because we 
have to look at the whole picture. As you are looking at NATO 
allies, we have operations worldwide, and we have to re-examine 
what is the right approach. And, honestly, we cannot afford 
what we are doing. It does not matter if it is in education or 
defense, or you pick the subject matter. Based the President's 
own conversations, we cannot afford to be on the track we are 
on financially for this country because at the end of the day 
we will hit a brick wall, and there will be nothing available 
for us to operate. So I will get your staff that language.
    Mr. Lynn. Terrific.
    Senator Begich. Let me ask you also, I know GAO has done a 
report that identified issues that are overlap or duplication. 
There are about 30-some of these issues. About 10 relate 
directly to DOD.
    One, have you started to review that report, those 
responses of that GAO report?
    Two, do you anticipate giving a response to this Committee 
and/or to Armed Services or what your actions will be? And I 
only say this based on history that I read in 2005 when this 
effort was approached in a more narrow focus. The military 
started, then they stopped. They did not do anything.
    Mr. Lynn. Started what? I am sorry.
    Senator Begich. It was a review of efficiencies. I think it 
was the medical command, if I remember right, unification of 
the medical command, and it just kind of--they started but they 
never went any further even though GAO had reported in 2005, I 
think it was, that there were some inefficiencies, 
opportunities. So what I am worried about--because now we have 
another report that talks about ten other areas that are 
potential. What is going to be--I should preface this with 
saying I think one of the things I have learned here after 2 
years, we do not do a good enough job in oversight, to be very 
frank with you. And so having this meeting, my intention would 
be your response to continue to badger you in this Committee 
and the Armed Services Committee to know what we are doing, 
because what I find is I keep reading report after report of 
stuff that has been done by GAO, and then kind of just brushed 
aside, and new administration, new Congress, new people, out of 
sight, out of mind. So my objective is to kind of keep my 
shopping list and keep pounding.
    So have you see that report, the latest one? And what are 
your intentions with it?
    Mr. Lynn. I have seen the report. Let me say two things, 
one broad, one a little narrower.
    First, the Secretary developed even before this GAO report 
his Efficiencies Initiative and developed, as we have discussed 
in the rating agencies, $178 billion worth of savings. These 
are business efficiencies, consolidation of headquarters, 
elimination of lower-priority programs, reduced use of 
contractors, reduced civilian hiring, a whole variety of 
measures.
    We plan to continue that effort. That was not a one-time 
deal to your point. We are looking for all inputs to the next 
phase of that effort. We are certainly going to look at that 
GAO report you mentioned, and in response to the specific 
question on the issue of how should we organize our medical 
operations, we are going to look at the issue of should we have 
a defense health agency, should we have a unified military 
command, should we continue and try and improve the process 
that we have now. We will look at all of those options.
    Senator Begich. What is your timetable for doing that?
    Mr. Lynn. We are looking at--we just started that review, 
so I do not have a precise timetable, but I think the next 
iteration of this broader efficiencies effort would be we would 
have something to submit with the fiscal year 2013 budget.
    Senator Begich. Which I appreciate because I know the GAO 
report had between $280 and $400 million, give or take. You 
know, in this world we live in, a few million here and a few 
million there. But it is significant. And so I appreciate your 
willingness to take a look at that.
    My time is almost up, but I want to followup on one that 
is--actually the conversation started in the Armed Services 
Committee when I was over there. I think it was earlier this 
week or last week. I have kind of lost track of time here a 
little bit. But it is on the MEADS air and missile defense 
system, and I just want you to help me understand the proof of 
concept and how this works, because for a guy who does not deal 
with those terms, I see we spend almost $1 billion, but then 
wisely the military says, you know, this is not working out, 
this program is running--you know, it is delayed. It is not 
cost-effective. The list goes on and on. You made a good 
decision to cancel it.
    The problem is we are going to have to pay $800 million, 
give or take a few there, in regards to the proof-of-concept 
requirement. How does that--I guess, you know, as a former 
mayor, when I had people doing software development for me, for 
our technology and so forth, the risk was on them. We gave them 
the idea. Their job was to give us a bid with cost ranges, and 
then if they could not fulfill that and I canceled the 
contract, I did not pay one dime. That was their risk.
    One, how do we do this? And do we do this in every 
contract? Or I should not say ``every.'' In other contracts?
    Mr. Lynn. Well, it depends on the program. We have a 
variety of different contracting mechanisms. With this program, 
the MEADS program, this is complicated not only by contracting 
mechanisms, but it is an international program. We have two 
major international partners, the Germans and the Italians. So 
we cannot take unilateral decisions. This has to be a joint 
decision.
    We have, as you correctly cited, decided that we are not 
going to pursue production of this program. Partly it is a 
narrow need. It can be met by other programs. Partly, as you 
said, the costs have grown and the schedule has slipped.
    We have to make that decision, though, in consultation and 
collaboration with our allies, and what we have decided to do 
is to finish the development phase, which takes over the next 2 
years, and then if they choose--they may choose to go forward 
with production. That is their decision. We will be pulling out 
at that point.
    You might say, Why not pull out now?
    Senator Begich. Right.
    Mr. Lynn. Which I think was the thrust of your question. 
The nature of the way the contract was signed many, many years 
ago is that if one of the three nations pulls out, they pay all 
of the termination costs. If we pay all of the termination--you 
can question that, but that is the way it is.
    Senator Begich. Right.
    Mr. Lynn. Decided long ago. If we pay all of the 
termination costs, we will pay essentially the same amount and 
get nothing. That did not seem to be the wise choice. We 
decided we will pay that amount and get the technology that is 
developed, which can be used in other systems. But that is the 
central reason for that.
    Senator Begich. Thank you very much.
    Mr. Chairman, I know my time is out. I just have one 
question for the record, if I could, and that is, in general--
--
    Chairman Conrad. Senator, we are doing well, so if you want 
to take a little additional time, you can do it.
    Senator Begich. OK. Thank you very much, Mr. Chairman.
    I guess on this one, can you prepare--and I know you 
probably cannot do it right now, obviously, but what other--
because I would consider that a financial risk to the Federal 
Treasury when we have contracts that have these out clauses 
that cost us money to get out of a development. Are there other 
contracts like this that if that can be estimated, what kind of 
these risk costs could be for us if we get out of contracts? I 
mean, at this point I know the Defense Department operates 
uniquely in their own way, but, honestly, I got to tell you, I 
am always surprised--you know, the F-35 was another example. I 
think when I first came here 2 years ago, it was, I do not 
know, $60 million a copy or whatever it was. I forget what it 
is now, 120, 130, whatever. But it almost seems like when we 
work with these defense contractors--who actually, we were 
shown yesterday, paid 1.6 percent taxes, the lowest of all 
corporate entities in this country, but put that aside for a 
second. We are their biggest customer. How is it that, you 
know, we lay out the parameters, but I see on and on again we 
always have these costs that we have to pay the contractor to 
get out of the contracts that we have, and the reality is, 
without our contracts, they would not be in business? I mean, 
we are their platinum customers. When they take this technology 
and we allow them to sell it to other countries, our allies--I 
mean, I am struggling with this. I know there is some long 
explanation for the military infrastructure, but I just do not 
get it because--you know, I can talk about the personnel system 
when you are trying to change the system on payroll, you spend 
half a billion dollars. Cancel the contract because it did not 
work like you had anticipated? I mean, if I was in the city as 
a mayor, we would sue the contractor and get our money back 
because they had sold us a bill of goods, because they came in 
and gave us a razzmatazz in the RFP process and it did not 
really work. I mean, I do not--I do not understand. Or the 
satellite system where we spent, I do not know, $4 or $5 
billion and it really did not work out as well as we expected.
    How do we get a handle on these contractors that know they 
win either way? Because they do come back and contract with us 
later, because there is such a limited group. So they know they 
have us because there are only so many we do business with. If 
they fail to perform, we pay them anyway--not all of it, 
obviously, but they build it into the margins. They are smart 
business people. That is why they are very profitable and they 
pay very little in taxes to the United States. How do we get at 
that? I mean, it is billions. I am shocked, just in the 2 years 
that I am here, how many contracts we have canceled and we are 
just, like, what is half a billion here, what is 5 billion 
here, and now today it is another $800 million.
    Mr. Lynn. Well, there are a couple of things there, 
Senator. One is whenever you take the tough decisions to 
eliminate a system--and I think we have taken quite a number--
you are losing your sunk costs. And the judgment there is that 
even though you are losing that sunk cost, the marginal cost 
going forward is not worth the value or benefit to the 
Government of paying even the additional marginal costs. And we 
have made that--but you have to acknowledge there is going to 
be some cost to that prior decision probably not recapturable.
    To your broader question of can we do something about how 
we contract, we are trying. In particular, we have focused on 
using fixed-price contracts, which I think is more what you are 
expecting as mayor and whatever. But we have tried that in the 
past, and it has been worked poorly at times, and you have to 
be careful about where you used fixed price.
    Senator Begich. Sure, I agree.
    Mr. Lynn. If you are using fixed-price contracts where you 
a developing cutting-edge technology, that is probably not 
going to work.
    Senator Begich. I agree.
    Mr. Lynn. Where you have mature technology, where you have 
an established contract, where you have an established 
production base, we think you can pursue a fixed-price 
development contract. Now, frankly, the Government is probably 
going to pay a little bit additional on that contract up front 
because you are asking the contractor now to take more risk. 
The benefit to the Government is that is the limit of the 
Government's risk. At this point now the risk migrates to the 
contractor, and they have every incentive to deliver the 
contract on that amount of money.
    So we have tried--the large example that has been in the 
papers recently that you will know about this is the tanker 
contract.
    Senator Begich. Right.
    Mr. Lynn. In the prior iterations, the development contract 
was cost-plus. We felt that that met exactly the criteria I 
just laid out. It is well-understood technology. Our 
requirements are stable, and we had two companies that, 
frankly, had very mature production bases. We were able in that 
case, therefore, to go to a fixed-price contract as well as not 
to exceed contracts for the production. We ended up with a 
very, very strong competition, and the result of that is, 
frankly, versus the 2008 competition, the American taxpayers 
saved billions.
    Senator Begich. Thank you, Mr. Chairman, for allowing me. 
Can I get for the record--because I know I used a number, but I 
do not know if it--you know, it is what I keep hearing is the 
amount that our buyout is or our termination costs in the MEADS 
contract. Can you put that----
    Mr. Lynn. We will get that to you for the record.
    Senator Begich. And do all contracts that we negotiate have 
subject to appropriation?
    Mr. Lynn. Yes, I believe so.
    Senator Begich. OK. Honestly, I would just say we are not 
going to appropriate to MEADS, so what happens?
    Mr. Lynn. Well, there is already--I will get it for the 
record. I believe we have already had enough appropriations. 
The way we would work is there has already been enough money 
appropriated to cover the termination liability. Otherwise----
    Senator Begich. Right, but I guess for the legal department 
here is the question: If we clawed back and said you do not get 
that money, we are not appropriating that money for the purpose 
that you have described, the contract then terminates. I am not 
a lawyer, but I would be curious what the law department thinks 
within your ag.
    Mr. Lynn. We will get that.
    Senator Begich. It is just a different way to skin the cat.
    Senator Begich. I will leave it at that. Thank you, Mr. 
Chairman.
    Chairman Conrad. I thank the Senator.
    I thank both the witnesses. I appreciate very much your 
appearance here today, Secretary Nides, Secretary Lynn. I would 
ask you to take the message back--and I think you have probably 
heard it loud and clear here. There are more cuts coming. I 
mean, you can write it down. It is going to happen.
    No. 2, those cuts will be more draconian if there is not a 
comprehensive long-term deal that involves tax reform and the 
entitlement programs. That is as clear to me as it can be. And 
I visit with colleagues on these issues every day. The votes 
are not there to sustain spending at these levels. There are 
more cuts coming--the cuts will be much more draconian--to all 
of discretionary spending if there is not a comprehensive long-
term deal that involves tax reform and the entitlements. And it 
does not matter whether I am here as Chairman or not. As you 
know, I have announced I am not running again. But it is going 
to happen. It is just as sure as we all sit here. And it may 
happen much sooner than anyone anticipates if we get more news 
like the news today that PIMCO dumps all their U.S. Government 
debt.
    I have been here 24 years. I do not know of anything that 
is more clear to me than the cuts that will be imposed on your 
agencies could be draconian and could come much quicker than 
anybody anticipates if there is not a more comprehensive long-
term deal that involves tax reform and the entitlements. I know 
that with certainty, so I would ask you to share it.
    Thank you very much, and we stand adjourned.
    Mr. Lynn. Thank you very much, Mr. Chairman.
    Mr. Nides. Thank you.
    [Whereupon, at 11:47 a.m., the Committee was adjourned.]




    Questions for the Record from Senator Bill Nelson for Dr. 
Till von Wachter
    ``Challenges for the U.S. Economic Recovery,'' Senate 
Budget Committee
    Thursday, February 3, 2011

    Questions:
    Florida's economy largely relies on stability in the 
housing market. The Treasury Department and the Department of 
Housing and Urban Development are expected to release a plan 
for reforming Fanne Mae and Freddie Mac sometime this month. Do 
you believe the housing sector would be significantly 
encumbered by a quick withdrawl of Gannie and Freddie from the 
secondary mortgage market? How would structure Fannie Mae and 
Freddie Mac given the past distortion of risk within the 
mortgage industry?

    Response:
    Senator, I do not have specific recommendations in response 
to your question, as they fall outside my area of expertise.

                                 
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