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

                                                         S. Hrg. 112-498



                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                      ONE HUNDRED TWELTH CONGRESS

                             FIRST SESSION


                             FISCAL POLICY


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






                          DEPARTMENT OF ENERGY


                        RESPONSIBILTY AND REFORM



                                                        S. Hrg. 112-498




                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                      ONE HUNDRED TWELTH CONGRESS

                             FIRST SESSION


                             FISCAL POLICY
               February 1, 2011-THE U.S. ECONOMIC OUTLOOK
                          DEPARTMENT OF ENERGY
                        RESPONSIBILTY AND REFORM



68-184pdf                 WASHINGTON : 2011
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           Printed for the use of the Committee on the Budget

                        COMMITTEE ON THE BUDGET



                Mary Ann Naylor, Majority Staff Director

                Marcus Peacock, Minority Staff Director


                            C O N T E N T S



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


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


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


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

                        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.


    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 
    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 
    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 

    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.


    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 
    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 
    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 
    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.


    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    So it is a tough set of problems, and they are very much 
    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 
    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 
    Senator Cornyn. Mr. Chairman, I cannot clear my throat in 
30 seconds.
    Chairman Conrad. Seriously, we are doing eight-minute 
    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 
    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 
    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 
    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 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, 
    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 
    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 
    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 
    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 
    Senator Sessions. I would be glad to, although I am not 
going to lose any sleep over that prospect.
    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 
    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.
    Senator Merkley. I am disappointed to hear that, because 
there are two Senators from Oregon here and only one from 
Alabama, so--
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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.]



                       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.


    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 
    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 

    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 
    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.


    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 
    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 
    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.

                         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 
    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.
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    Senator Crapo. You are at 3.8 for this year, right? That is 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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.


    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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, 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    Senator Begich. Right.
    Mr. Elmendorf. So it is a combination of both domestic and 
    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, 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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, 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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.


    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 
    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 
    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 
    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.


    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 
    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.


    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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.

                    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 
    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 
    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.


    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 
    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 
    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 
    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 
    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 
    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 
    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 
    Chairman Conrad. That is what Tom Friedman called ``the 
electronic herd.''
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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. 
    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 
    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 
    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 
    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 
    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 
    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. 



                      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.


    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 
    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 

    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 
    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.


    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 
    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 
    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 
    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.


    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 
    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 
    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 
    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.

                        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 
    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 
    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.


    Ms. Altshuler. Thank you. It is an honor to appear today to 
discuss the need for and the benefits of fundamental tax 
    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 
    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 
    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 
    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 
    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 
    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.


    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    Ms. Altshuler. Absolutely.
    Chairman Conrad [continuing]. you can keep the Child Care 
    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 
    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. 
    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 
    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 
    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.
    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 
    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 
    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 
    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 
    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 
    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 
    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? 
    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 
    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 
    Senator Coons. Right.
    Mr. Steuerle [continuing]. moving debt abroad. But it is 
not just corporations that can do it. We individuals can do it, 
    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 
    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 
    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, 
    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 
    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. 
    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, 
    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 
    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 
    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 
    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.
    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. 
    Ms. Altshuler. I am not an expert on health--on health 
    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 
    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 
    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 
    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 
    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.]



                       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.


    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 
    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.


    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 
    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 
    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 
    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 
    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 
    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?


    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.


    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 
    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.
    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 
    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 
    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.

                     GOVERNORS ASSOCIATION

    Mr. Scheppach. Thank you, Mr. Chairman and Senator 
Sessions. I am pleased to be here on behalf of the nation's 
    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 
    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 
    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.
    Mr. Scheppach. I did not want to say that.
    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 
    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 
    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.
    Chairman Conrad. Chris Edwards, Directors of Tax Policies 
at the Cato Institute. Welcome back.

                         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 
    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 
    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 
    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 
    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 
    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 
    Senator Whitehouse. That is all I needed to hear. I 
appreciate it very, very much.
    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 
    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 
    Chairman Conrad. This is how we started the conversation, 
    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 
    Senator Thune. And you say we can talk about what that 
means. What does that mean, in your view, path to fiscal 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    The committee is adjourned.
    [Whereupon, at 12:06 p.m., the committee was adjourned.]



                       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.


    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 
    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 

    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 

    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 


    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 
    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 
    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.

                     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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    Chairman Conrad. No, that means you are 32 seconds over.
    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 
    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 
    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 
    Senator Thune is actually next.
    Senator Thune. I see everybody is really happy about that.
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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, 
    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, 
    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 
    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 
    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 
    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 
    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 
    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 
    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-
    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.]



                      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.


    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 
    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 
    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 

    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.


    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.


    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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, 
    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 
    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 
    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 
    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 
    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 
    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 
    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 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 Conrad. I thank the Senator for respecting the 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    [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.]



                         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.


    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 

    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 
    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.


    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 

    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 
    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.


    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 
    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 min