S. HRG. 109–649

CONCURRENT RESOLUTION ON THE 

BUDGET

FISCAL YEAR 2007

HEARINGS

BEFORE THE

COMMITTEE ON THE BUDGET 

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

February 2, 2006—THE CBO BUDGET AND ECONOMIC OUTLOOK

February 7, 2006—THE PRESIDENT’S FISCAL YEAR 2007 BUDGET 

PROPOSAL

February 15, 2006—UNDERSTANDING THE CAUSES OF AND 

SOLUTIONS TO ADDRESSING THE FEDERAL TAX GAP

February 16, 2006—THE PRESIDENT’S FISCAL YEAR 2007 BUDGET 

PROPOSAL (STATE DEPARTMENT)

March 1, 2006—THE PRESIDENT’S BUDGETARY PROPOSALS FOR THE 

DEPARTMENT OF HEALTH AND HUMAN SERVICES

March 2, 2006—THE PRESIDENT’S FISCAL YEAR 2007 BUDGET 

PROPOSAL FOR THE DEPARTMENT OF DEFENSE 

(

Printed for the use of the Committee on the Budget 

CONCURRENT RESOLUTION ON THE BUDGET FISCAL YEAR 2007

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26–726pdf 2006

S. HRG. 109–649

CONCURRENT RESOLUTION ON THE 

BUDGET

FOR FISCAL YEAR 2007

HEARINGS

BEFORE THE

COMMITTEE ON THE BUDGET 

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

February 2, 2006—THE CBO BUDGET AND ECONOMIC OUTLOOK

February 7, 2006—THE PRESIDENT’S FISCAL YEAR 2007 BUDGET 

PROPOSAL

February 15, 2006—UNDERSTANDING THE CAUSES OF AND 

SOLUTIONS TO ADDRESSING THE FEDERAL TAX GAP

February 16, 2006—THE PRESIDENT’S FISCAL YEAR 2007 BUDGET 

PROPOSAL (STATE DEPARTMENT)

March 1, 2006—THE PRESIDENT’S BUDGETARY PROPOSALS FOR THE 

DEPARTMENT OF HEALTH AND HUMAN SERVICES

March 2, 2006—THE PRESIDENT’S FISCAL YEAR 2007 BUDGET 

PROPOSAL FOR THE DEPARTMENT OF DEFENSE

(

ii

COMMITTEE ON THE BUDGET 

JUDD GREGG, New Hampshire, Chairman 

PETE V. DOMENICI, New Mexico 

CHARLES E. GRASSLEY, Iowa 

WAYNE ALLARD, Colorado 

MICHAEL ENZI, Wyoming 

JEFF SESSIONS, Alabama 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

JOHN ENSIGN, Nevada 

JOHN CORNYN, Texas 

LAMAR ALEXANDER, Tennessee 

LINDSEY O. GRAHAM, South Carolina 

KENT CONRAD, North Dakota 

PAUL S. SARBANES, Maryland 

PATTY MURRAY, Washington 

RON WYDEN, Oregon 

RUSSELL D. FEINGOLD, Wisconsin 

TIM JOHNSON, South Dakota 

ROBERT C. BYRD, West Virginia 

BILL NELSON, Florida 

DEBBIE STABENOW, Michigan 

JON S. CORIZINE, New Jersey 

SCOTT GUDES, Majority Staff Director 

MARY NAYLOR, Staff Director 

iii

C O N T E N T S 

HEARINGS 

Page 

February 2, 2006—The CBO Budget and Economic Outlook .............................. 1

February 7, 2006—The President’s Fiscal Year 2007 Budget Proposal .............. 73

February 15, 2006—Understanding the Causes of and Solutions to Addressing 

the Federal Tax Gap ............................................................................................ 165

February 16, 2006—The President’s Fiscal Year 2007 Budget Proposal (State 

Department) ......................................................................................................... 273

March 1, 2006—The President’s Budgetary Proposals for the Department 

of Health and Human Services ........................................................................... 385

March 2, 2006—The President’s Fiscal Year 2007 Budget Proposal for the 

Department of Defense ........................................................................................ 463

STATEMENTS BY COMMITTEE MEMBERS 

Chairman Gregg ........................................................................ 1, 73, 165, 273, 385, 463

Ranking Member Conrad.......................................................... 2, 75, 166, 274, 386, 464 

Senator Bunning .................................................................................................. 104, 406

Senator Enzi .......................................................................... 71, 129, 269, 315, 438, 519

Senator Feingold ...................................................................................................... 439

Senator Grassley ...................................................................................................... 230

Senator Johnson................................................................................................... 130, 441

WITNESSES 

Hon. Joshua Bolten, the Director of the Office of Management and Budget .......................................................................................................................... 88, 125

Gordon England, Deputy Secretary, US Department of Defense .................... 479, 482

Hon. Mark W. Everson, Commissioner, Interanal Revenue Service ............... 174, 177

Admiral Edmund P. Giambastiani, Jr., Vice Chairman, Joint Chiefs of Staff, 

US Department of Defense ...................................................................................... 487

Michael O. Leavitt, Hon., Secretary, Department of Health and Human Services ..................................................................................................................... 397, 427

Mr. Donald Marron, acting Director, Congressional Budget Office..................... 19, 64

Nina Olsen, National Taxpayer Advocate, Taxpayer Advocate Services......... 240, 243

Hon. Condoleeza Rice, Secretary, US Department of State ............................. 285, 288

Hon. David M. Walker, Comptroller General of the United States, US Government Accountability Office............................................................................... 189, 191

QUESTIONS AND ANSWERS

JOSH BOLTEN ................................................................................................ 138

DAVID M. WALKER ........................................................................................ 270

CONDOLEEZA RICE ....................................................................................... 317

MICHAEL O. LEAVITT ................................................................................... 444

(1)

THE CBO BUDGET AND ECONOMIC OUTLOOK 

THURSDAY, FEBRUARY 2, 2006

U.S. SENATE, COMMITTEE ON THE BUDGET, Washington, DC. 

The committee met, pursuant to notice, at 10:03 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Judd Gregg, chairman of the committee, presiding. 

Present: Senators Gregg, Allard, Crapo, Alexander, Conrad, 

Stabenow, and Menendez. 

Staff present: Scott B. Gudes, Majority Staff Director and Jim 

Hearn, director for federal programs and budget process. 

Mary Ann Naylor, Staff Director and John Righter, deputy staff 

director & commerce and housing credit. 

OPENING STATEMENT CHAIRMAN JUDD GREGG 

Chairman GREGG. Let me begin the hearing. 

We appreciate today having the opportunity to hear from Don 

Marron, who is the acting head of CBO. This is an opportunity to 

get CBO’s estimate relative to the baseline, which is important. It 

is a technical concept, the baseline, but it substantively drives everything that we do around here. So this hearing is important on 

where we are going as a Government and how we are going to be 

able to approach the budgeting process in this coming year, because what CBO says, it is the memo that controls the meeting, as 

Henry Kissinger was fond of saying. 

So we look forward to hearing from Mr. Marron, who is doing an 

exemplary job, an excellent job. We appreciate his being thrown 

into the breach here and taking over so well. 

On other topics or the general topic of what is happening relative 

to the budget, I want to congratulate the House of Representatives 

for passing the reconciliation bill last night. It was a close vote, as 

it was here in the Senate, a tie vote in the Senate with the Vice 

President casting the vote that caused it to go over the top. 

This bill is the first time in 8 years that we have begun undertaking the process of addressing entitlement spending. Anybody 

who looks at the Federal budget these days, if they are honest, has 

to admit that the issue is entitlement spending. As Willie Sutton 

said, when they asked him why he robbed banks, he said, ‘‘That 

is where the money is.’’ Well, the money in the Federal Government is in the entitlement accounts. They have grown to about 60 

percent of our spending, and the failure of the Congress to discipline those accounts and to put in place responsible policies in 

those areas has caused those accounts to continue to grow at a 

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rapid pace. But, more importantly, with the looming issues of the 

baby-boom generation retiring, the demand on the Federal Government and, therefore, on the taxpayers of this country, who will be 

the baby boomers children and grandchildren, will be extraordinary. 

We have talked about this a lot, but approximately in the year 

2035, three accounts—Social Security, Medicaid, and Medicare—

will essentially absorb all the revenues of the Federal Government, 

assuming that the Federal Government stays at the historical level 

of revenues. And the practical implications of that are that there 

isn’t going to be any money for anything else—national defense, 

education, environmental protection, or just general entitlement activity. 

So we have an obligation as a Government and as policymakers, 

but more importantly as baby boomers, to address this issue. We 

have no right as one generation to pass on to the next generation 

the problems which are going to confront it if we do not address 

the issue of entitlement reform, specifically in the areas of health 

care and pensions. 

And so I was also appreciative of the President raising the visibility on this issue by talking about it in terms of the baby-boomer 

responsibility in the State of the Union, and hopefully we can proceed from that point and actually get something constructive going 

here. It cannot be done unless it is done in a bipartisan manner. 

I know that the Senator from North Dakota is very interested in 

this issue, very concerned about this issue. We have different approaches, obviously, but that doesn’t mean we shouldn’t be able to 

sit down and try to work something out. And that is what I hope 

we can do, or at least begin the process of doing, and at least the 

reconciliation bill did show that we can put our toe in this water—

and it was just our toe in the area of Medicaid—and try to do 

something constructive. 

So we look forward to hearing from you and getting your 

thoughts on what the baseline looks like. I have many questions 

about how we structure this baseline, but I do not want to absorb 

all the discussion here. And I will yield to the Senator from North 

Dakota for his thoughts, and then we would like to hear from you, 

Mr. Marron. 

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD 

Senator CONRAD. Thank you, Mr. Chairman. Thank you again for 

your courtesy in discussing the agenda of the committee for the 

year and the many courtesies extended by you and your staff to me 

and my staff. We continue to appreciate the extraordinary professionalism that you bring to this task and that your staff does as 

well. 

Chairman GREGG. Thank you, and the feeling is mutual obviously. 

Senator CONRAD. And welcome to Mr. Marron. I think this is the 

first time you have had an opportunity to present before the committee, and we welcome you and look forward to a good working 

relationship with you as well. We had a very good meeting the 

other day in my office talking about some of these same concerns 

that the chairman has raised. 

3

Obviously, we do have a different perspective. My great concern 

is the explosion of deficits and debt. That is a combination of 

spending and revenue, and I believe we are going to have to work 

on both sides of the equation in order to achieve a result. And 

hopefully somewhere there is a principled compromise on which 

both sides could agree to avert this explosion of debt. 

Let me just go through——

Chairman GREGG. Would you just yield for a second? 

Senator CONRAD. Yes, I would be happy to. 

Chairman GREGG. I failed to recognize Senator Menendez, who 

has joined us and is part of the committee now, and we very much 

appreciate his choosing the Budget Committee to serve on. It is a 

place where you get a lot of arrows and very few kudos, and we 

thank you for being willing to take some arrows. 

[Laughter.] 

Senator CONRAD. If I could, Mr. Chairman, extend my welcome 

as well. I was going to wait until we introduced Mr. Menendez to 

the committee, but this is an appropriate time to welcome him to 

the Senate Budget Committee. He comes from a distinguished career in the House of Representatives. This is a challenging post, 

and Senator Menendez and I have already talked about the work 

that we will have this year and on into the future. 

Let me just try to outline what I see as the significant concerns 

we face. This is the history over the last 5 years of what has happened to the budget deficit, and these are the largest budget deficits in dollar terms we have ever experienced. Last year, there was 

a bit of improvement, but then the outlook for this year, especially 

when you add back omitted costs, looks like we are headed back 

in the wrong direction.

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Let’s go to the next slide, if we could. 

My greatest concern is that the growth of the debt is far greater 

than the deficits, and I find people are confused by this. I go 

around my State, and people assume—many people assume that 

the amount of the deficit is the amount by which the debt increases. And, of course, Mr. Marron, you know that is not the case. 

We are projecting now a deficit for 2006 of $364 billion, but we now 

estimate the debt will increase by $637 billion. Of course, the biggest difference between the two is Social Security money that is in 

surplus at the moment, but which will be all needed for the future, 

which is being used to pay for other things.

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Let’s go to the next slide. 

This is a slide that I wish we could just imprint on members of 

the committee and our colleagues in the Congress, because this 

goes back to 1980 and it shows the relationship between spending 

and revenue. The red line is the spending line. The green line is 

the revenue line. And you can see back in the 1980’s we were 

spending about 22 percent, some years even more than that, of 

gross domestic product in the Federal Government. During the 

1990’s, each and every year the spending came down as a share of 

gross domestic product. Now since the Bush administration came 

in, we have had a substantial move up. But I think it is important 

for people to know that roughly 90 percent of the increase in discretionary spending is defense, homeland security, and rebuilding 

New York—spending priorities we all agreed were necessary. 

But look what happened to the revenue side of the equation. Revenue, when the President came in, was at a record high. He was 

quite correct in pointing out at the time that revenue was at a 

record high in terms of a share of our national income. But look 

at what has happened since. The revenue side of the equation fell 

dramatically. 

Some of our friends will say, well, when you cut taxes, you get 

more revenue. We cut taxes in a major way three times, and revenue kept falling. Now we have had an uptick, but we are still well 

short of where we were in the 1980’s and 1990’s, and the difference 

between what CBO and OMB are projecting in terms of spending 

and what they are projecting in terms of spending and revenue is 

this gap. And it is a big gap. And it is a gap that is occurring in 

many ways at the worst possible time—before the baby boomers retire.

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Let’s go to the next slide. 

There have been so many assertions that if you cut taxes you get 

more revenue. Let’s just have a historical review here. The Federal 

Government in 2000 received $2 trillion in revenue, just a little 

over $2 trillion; 2001, right at $2 trillion. At that point we enacted 

substantial tax reductions. The next year, revenue fell to $1.85 trillion. We enacted more tax cuts. The next year revenue fell to $1.78 

trillion. In 2004, we had a bit of an uptick but still well short of 

where we were back in 2001. In 2005, a healthy increase, only now 

getting back to where we were in revenue way back in 2000.

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Let’s go to the next slide. 

As we look at the CBO numbers, it is very important for people 

listening to understand the Congressional Budget Office is only 

able to tell us what they project deficits to be absent policy 

changes. But we know that policy changes are being recommended. 

For example, the President is saying make the tax cuts permanent. 

That costs $2 trillion. Alternative minimum tax reform, the old millionaires’ tax—it is now becoming a middle-class tax trap—costs 

$864 billion to fix. These are all over 10 years. The President’s defense buildup costs about $300 billion; the funding for ongoing war 

costs, almost $400 billion. 

Then we adjust for things that are one-time that should be removed. For example, we have taken out the effect of supplementals 

because we hope—we hope—those are one-time events. That takes 

out $827 billion, and the reconciliation conference report just 

passed in the House and previously passed in the Senate, that 

should save over 10 years $105 billion. If you add the debt service 

that occurs as a result of these additions, you have $3 trillion of 

added debt.

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That is where we are headed with the policy changes that have 

been proposed. That gives us a very different long-term budget outlook than what the President is talking about. The President is 

talking about cutting the deficit in half, but he only gets there by 

leaving out things. When we add them back, here is what we see 

as the deficit outlook. And, of course, the President only has a 5-

year budget horizon. The cost of his tax cuts absolutely explodes 

right beyond the 5-year budget horizon.

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Let’s go to the next one. 

The President has said, back in 2001, ‘‘My budget pays down a 

record amount of debt. We will pay off $2 trillion. That will be the 

largest debt reduction of any country ever.’’

Then he made a statement that I strongly agree with: ‘‘Future 

generations shouldn’t be forced to pay back money that we have 

borrowed. We owe this kind of responsibility to our children and 

grandchildren.’’ That is what the President said.

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Here is what is happening. When he made that statement, the 

debt of the country was $3 trillion less than it is now. It was below 

the bottom of this chart. Just in these 5 years, the debt has gone 

up by $3 trillion to $8.5 trillion, and every year of this budget proposal that has just been heralded here by my colleague, the debt 

is going to increase by $600 or $700 billion each and every year. 

This is before the baby boomers retire.

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This to me is utterly unsustainable, and it does require our 

prompt action. I agree absolutely with the Senator: Entitlements 

on the spending side are the big enchilada. That is where the 

money is. But I think, in fairness and in truth, we are also going 

to have to deal with the revenue side of this equation. And lest 

somebody conclude that my first reaction is to increase taxes, let 

me assure my colleagues that is not my first reaction. My first reaction is to attack aggressively the tax gap, the difference between 

what is owed and what is being paid. That difference, the Revenue 

Service tells us, is over $300 billion a year. We have to do better 

than that. 

I thank the chairman for his patience, and I thank the witness 

for his presence. 

Chairman GREGG. Thank you, Senator. 

We would now like to hear from Mr. Marron. 

STATEMENT OF DONALD B. MARRON, ACTING DIRECTOR, 

CONGRESSIONAL BUDGET OFFICE 

Mr. MARRON. Outstanding. Thank you. Is this on? 

Chairman GREGG. If the red light is on, it is. 

Mr. MARRON. Excellent. Thank you, Chairman Gregg, Senator 

Conrad, members of the committee. It is a pleasure and exciting to 

be here today for my first appearance. 

Let me just say in my first month or so of being Acting Director, 

I haveten to work closely with your staffs and gotten to meet both 

of you and felt it has been very productive and look forward to continuing that. 

Both of you obviously are already familiar with our outlook, 

which we released last week, so I will try to keep my remarks short 

here. 

The key points that we have are: 

The deficit projection for 2006 increased a little bit from where 

we were last August. Most of that is due to Katrina, not a surprise. 

Some small improvements in the later years of our projection period, revenues slightly higher than we predicted previously, spending slightly lower. But I would characterize those changes as relatively small, and I would characterize the budget outlook as being 

roughly the same as what we reported last August. 

On the economic front, basically a solid economy for a variety of 

reasons. The economy has momentum and we expect solid growth 

this year, expect that to continue. 

And then a point that I want to emphasize and that reinforces 

some of the opening remarks of the members is that you can see 

in our projection the beginning of the challenges that are going to 

be posed by Social Security, Medicare, and Medicaid. And so it is 

in there. It is within the 10-year budget window that we are looking at. 

Turning to some details, as mentioned, our official budget projection of the deficit for 2006 in the Outlook is $337 billion. We are 

not in the business of projecting what legislation might pass, and 

so as a result, we did not include the reconciliation bill in that 

number. If you include the reconciliation bill, that projection would 

become something in the neighborhood of $332 billion. That is up 

slightly from last year, but basically in the same ballpark relative 

20

to the overall size of the economy, 2.5 percent of GDP this year 

versus 2.6 percent last year. 

Again, we are in the business of projecting assuming current law, 

current policies. We cannot make predictions about what happens 

in the future. There are a few spending pressures that we see that 

are already sort of built in to what is going to happen: some additional spending on operations in Iraq and Afghanistan, and some 

spending that is likely to be necessary very soon on flood insurance. If you take those and add them in, for 2006 we would be looking for a deficit that is somewhere in the $355 billion range. 

If you could put up the first chart, please? 

Looking out over the rest of our projection—and the members 

have these charts in front of them as well—it is basically a race 

between the red line and the blue line as you look at the right side 

of this chart. Let me start with the red line, which is spending. It 

has a variety of components—mandatory and discretionary primarily, along with interest—and the key thing to know is that, as 

CBO constructs its baseline, we are required to do so under certain 

rules.

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For mandatory programs, we basically take the mandatory programs as they are structured and assume that they continue regardless of whether or not they are scheduled to expire over this 

period. Over this period, the drivers of spending on mandatory include growth in the caseloads for those programs, particularly driven by the baby-boom generation, and for the health care-related 

ones, there is the increasing expectation that health care will continue to cost—the costs of health care will continue to rise more 

rapidly than the economy. Those two factors together cause mandatory spending to grow relative to GDP over our projection period. 

Now, you don’t see that in our red line because of the way that 

we are required to structure our projection of discretionary spending. For discretionary spending, in essence what we do is take the 

budget authority that has been approved for fiscal year 2006, and 

we project it out into the future using our economic forecast of inflation rates. As you all know, in recent years discretionary spending has tended to grow much more rapidly than inflation alone, but 

for purposes of constructing this baseline, those are the rules that 

we have to follow. And what you see with the red line, where 

spending relative to GDP appears to go down over the projection 

period, that is in essence the story of the construction that we are 

doing for discretionary spending more than offsetting the underlying growth in the mandatory spending that we see going on in 

parallel. 

On the revenue side, the key thing I would point out is that 

given our current tax system, the natural state of affairs is for revenues to grow slightly faster than the economy. That is because of 

the structure of the regular tax system, because of the structure of 

the AMT, and also because increasingly with the baby-boom generation coming upon us, we are going to see some withdrawals 

from 401(k)’s and tax-deferred accounts that are going to provide 

some boost to revenues. 

So the natural tendency of revenues is to grow faster than the 

economy, but the big enchilada, which you can see in our forecast 

when we get out to 2011, is that under the rules under which we 

construct our baseline, we assume that the various tax provisions 

expire, and as a result, revenues increase dramatically in 2011 and 

2012. And that essentially explains why the blue line of revenues 

rises up and gets slightly above the red line of outlays. 

Let me turn just to the economic outlook quickly. Again, we see 

a solid economy with momentum. There are reasons to believe that 

business investment needs to continue to be strong and will be 

strong this year and next year. Basically that is a story where the 

demand for products, the growth of demand for products in recent 

years has grown faster than the investment that businesses have 

been doing and that, therefore, in essence businesses have to do 

some additional extra investment to catch up. 

Rising wealth and rising incomes are helping to support spending by consumers, and there are some reasons to believe also that 

our situation on the trade front should improve somewhat. The dollar declined substantially from 2002 through 2004, went up a little 

bit last year, but there is still basically some pent-up decline in the 

dollar that needs to flow through and is expected to flow through 

into somewhat better performance on the international side. You 

23

take all those together and our expectation is for solid growth, 3.6 

percent real GDP growth this year, 3.4 percent next year. 

People worry a lot about housing. In our projection, we expect 

that the housing sector will indeed cool somewhat this year and 

next year. So we see housing investment lower this year than last, 

and we see it lower in 2007 than in 2006. So that degree of cooling 

is built into our projection. 

Then, again, in thinking about the longer-run challenges that we 

face on the budget front, it is important to recognize that another 

effect of the baby-boom generation aging is that the expected 

growth of the labor force, the pool of workers who produce things 

in our economy, that is expected to slow over time. And so that 

even as we see growth above 3 percent this year, next year, and 

for a few years after, in the later years of our forecasts we actually 

see economic growth slowing to about 2.6 percent. And so we are 

in a situation in which spending on mandatory programs is going 

to be rising faster and faster, and yet the size of the economy to 

support it is actually going to be growing slower and slower. 

Let me just emphasize quickly, as you all know, there are great 

uncertainties in the projections that we put together. It is extremely difficult to forecast all of the effects that will drive budget 

outcomes. If you take our projection in the spirit in which it is intended, which is as a projection, the key uncertainties are economic 

and technical factors. In the report, we have a very nice fan chart 

which tries to illustrate what the range of uncertainties are, and 

the basic story there is if you go out 5 years, say, to 2011, in that 

year we project a small deficit under the rules under which we construct our projection, but realistically it could be several percentage 

points of GDP either way. So there is a significant amount of uncertainty. We do our best to resolve that and eliminate it. But the 

reality is we live in an uncertain world. 

Then, second of all, our projection is not intended in any shape, 

way, manner, or form as a forecast, but it is sometimes interpreted 

that way. The key uncertainty for anyone who wishes to take our 

projection as a forecast, as was already pointed out, is policy uncertainty. Depending on what policies are adopted by the Congress 

and the administration, the outcomes could turn out quite different 

from what we project. 

Finally, if we could just go to the second of the two charts I had? 

There it is. 

I just want to emphasize a point I made earlier, which is you can 

now see within the window—the 10-year window that we are using 

for projecting the increasing pressures that are coming from the big 

three entitlement programs. So you can see that Social Security, 

Medicare, and Medicaid combined are going to place increasing 

pressures on the budget. Over this time period, these three rise by 

about 2 percentage points of GDP, from about 8.7 percent of GDP 

this year to about 10.8 percent in 2016, the final year of our projection. Most of this at the moment is being driven by the expectation 

that health care costs are going to continue to rise much more rapidly than the economy. You can only begin to see the transition in 

demographics. As you get beyond this window, the pressures from 

those programs become increasingly larger, and as you go out several decades, again, under the projections we make both in this reVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00029 Fmt 6633 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
24

port and in our long-term budget report, these three programs look 

to grow to be, say, 15 percent of GDP, which seems relative to 

where we have been historically something that would be 

unsustainable.

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With that, I am happy to take your questions. 

Chairman GREGG. Thank you. We appreciate that. And we especially appreciate your explaining that your baseline really is—it 

takes into account things that probably are not going to happen. 

Mr. MARRON. Yes. 

Chairman GREGG. And you are forced to do that by law. For example, you have to continue Katrina spending as if we are going 

to do it forever. And you have to continue the war, the Iraq 

supplementals as if they were going to go on forever. And clearly 

those two events are not. They are both going to come down rather 

drastically here, as the chart that Senator Conrad held up made 

that point. 

But that is one of the things that bothers me, I guess, and the 

big area that we have this problem is in the area of how you are 

required to account for entitlements and revenues. You know, you 

have two different major rules on entitlements. If they sunset, you 

still have to consider them as going on. You have a different rule 

for discretionary, which you described. And then you have a different rule for revenues. 

Shouldn’t we have homogenization here so that we have one rule 

that basically applies to all four categories so that there is consistency? In other words, if we are going to sunset revenues and we 

are going to presumably go back to the old law, then shouldn’t we 

do the same for entitlements and actually have mechanisms to create that and make it happen so that we have a baseline that is consistent and treats these different accounts consistently? 

Mr. MARRON. Well, that is a challenging question. I think it is 

important to keep in mind that whatever rules we choose, the 

goal—I think the goal cannot be to create baseline projections that 

look like forecasts because there will be, obviously, policy changes 

in the future. 

Chairman GREGG. We want to create as much accuracy as we 

can. 

Mr. MARRON. We want to create—well, accuracy and, I guess, 

usefulness to you. I mean, in part I am afraid my answer is going 

to be to put the question back on you and your colleagues about 

what is the most constructive and useful way to present these data. 

And then I would distinguish the discretionary side where it is not 

entirely obvious to me what the rules are and what the alternative 

rules are one might use to project that out into the future. We went 

through various scenarios in our book of, you know, keeping it flat 

in nominal terms or growing it at the growth rate of GDP. At the 

moment, the rules are grow at inflation. I am not exactly sure of 

the best—if there is some specific way that would guide us to 

choose which of those makes the most sense. 

As for mandatory spending versus tax revenues, that raises a 

key issue, which you raised, which is if there is any symmetry. So 

we assume that tax things that expire truly expire; whereas, mandatory things that expire do not expire. That is clearly an asymmetry. It is clearly something to think about. I guess I would put 

back on you is that constructive for the process or is that not constructive. 

Chairman GREGG. Well, I appreciate that. I do not think it is 

constructive, and we will try to address it. 

27

But on another issue, today on the floor we have the reconciliation tax bill. The big battle, to the extent there is a big battle, has 

been waged around the issue of extending capital gains and dividend rates for 2 years. There appears to be support—I am not necessarily one of them—for doing an AMT patch, for doing State and 

local sales tax deductibility across the board, or across the aisle. 

I guess my question to you is, if you look at State and local deductibility, which essentially gives States which have a high tax 

burden a benefit, in other words, you are saying to a State that has 

a sales tax, you go ahead and raise it because your people are going 

to be able to deduct a percentage of it, so you can raise it to the 

extent the Federal income tax basically subsidizes it; whereas, 

States that do not have a sales tax, like mine—we do not have an 

income tax—end up, therefore, paying an unfair—getting treated 

unfairly in that exercise because they have nothing to deduct because their States are fiscally responsible and do not have those 

taxes. So you create an atmosphere where you are actually encouraging tax increases in States, and most of those are large States. 

Connecticut, Massachusetts, New Jersey, New York, Illinois, California all have major sales taxes. 

If you compare that tax from an effect on the economy to capital 

gains, where basically you are saying to people you go out and you 

invest and you reinvest and you realize your gains and then you 

reinvest and you create jobs, which one generates more economic 

activity, which in turn probably generates more revenue for the 

Federal Government: cap gains or sales tax deductibility—extending the cap gains rates or making sales tax deductible? Recognizing 

that both are essentially costing the same. 

Mr. MARRON. So purely from an economic efficiency point of view 

in terms of economic activity, leaving aside any distributional considerations, reducing taxes on investment returns and on the returns to saving generally tend to be among the most pro-growth 

tax reductions that you can have. They encourage capital formation. Capital formation leads to a larger economy, higher wages, 

and economic growth as we go over time; whereas, the deduction 

for State and local taxes has exactly the two effects that you emphasized. The first is that, in essence, it reduces the cost to individual States to raising their taxes and, therefore, on balance encourages higher taxes at the State level. And then, second, given 

the different approaches that States take in this country to how 

they structure taxation, it provides that incentive in a way that 

sort of is not equal across the States and, therefore, it creates 

some—I guess you would say economic activity as a result faces different taxes at the margin across different States, which is not 

something that encourages efficiency. 

Chairman GREGG. I appreciate that answer, and I appreciate the 

forthrightness of it, and I agree with it. Basically we should not extend the deductibility of State and local sales taxes, in my opinion, 

because it does have an adverse and disproportionate benefit to 

States that have high—an adverse impact on States with low tax 

burdens, or at least that don’t have sales tax burdens, and a disproportionately positive impact on States that have high tax burdens and have a sales tax. 

28

Another issue, and I am running out of time, but the Part D premium, the Part D drug benefit, the estimate is that it is now $45 

billion over the original estimate. Is that correct? Or do you have 

a number on that? That is the estimate we have. And shouldn’t we 

bring it back or have you assume that it is going to be brought 

back in line with the original estimate in order to properly budget 

for it? 

Mr. MARRON. In our outlook we have a box that discusses Medicare Part D and tries to put some of the numbers in context. I believe the number we have at the moment is $42 billion so that our 

current estimate—and I should emphasize what that is. Our current estimate of the spending from Medicare on prescription drugs 

is about $42 billion higher than we estimated in our original cost 

estimate. That increase reflects essentially three things: 

Some economic changes, basically inflation was higher over recent periods than we previously thought, and that flows through 

into some of the prices; 

Second of all, we have learned some more about how the program 

is going to operate. We learned something about how the rules are 

going to be implemented. A variety of those factors lead to the 

change; 

And that is what is built into our baseline, so we have no expectation of any possible future legislative change to the program. We 

have the program that is currently written. 

Chairman GREGG. But if we were to bring it back to its original 

proposals, we would reduce the rate of growth in that program by 

about $42 billion. 

Mr. MARRON. If we brought it back to the original estimates, yes. 

Chairman GREGG. Senator Conrad. 

Senator CONRAD. Thank you, Mr. Chairman. 

Let me just go to a couple of questions to you because I know 

it is confusing to people out there listening, and I think it is confusing, frankly, to our own colleagues when they see CBO issue 

these estimates, because I don’t think they have it firmly in mind 

what the chairman has said. That is, you are required by law to 

use existing policy, not what the policy proposals are that we are 

facing and that are likely to be adopted, but instead, existing policy. Isn’t that correct? 

Mr. MARRON. Absolutely. 

Senator CONRAD. And you are required by law to do it that way, 

aren’t you? 

Mr. MARRON. Yes. 

Senator CONRAD. So this is not any criticism—I want to make it 

clear—of the Congressional Budget Office. You are required to do 

it this way, and there is a good reason for that. But the problem 

is it is unlikely to match reality. 

Now, let’s talk a minute about the policy proposals that are out 

there. Let me just ask you, the President said in his State of the 

Union, ‘‘Make the tax cuts permanent.’’ We see the 10-year estimate of the cost of that proposal is $2 trillion of lost revenue. Do 

you agree with that? Is that roughly your understanding—

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Mr. MARRON. Yes. 

Senator CONRAD. An alternative minimum tax reform—and I 

know you say alternative minimum tax and right away people tune 

you out. But basically it is the old millionaires’ tax that, unfortunately, is rapidly becoming a middle-class tax trap. There are going 

to be 20 million people affected this year if we do not do something. 

The 10-year cost of fixing that is $864 billion. Do you agree with 

that rough estimate? 

Mr. MARRON. With the caveat that I think people may disagree 

on what constitutes a fix. 

Senator CONRAD. A fix. 

Mr. MARRON. And so we have a specific possibility, as we illustrated in our report, but obviously the actual fix, if one happens, 

may look different. 

Senator CONRAD. And this estimate of what has been widely regarded as a fix, that is, to freeze this so more people are not swept 

into it, rough cost $860 billion over 10 years? 

Mr. MARRON. Let me check my numbers. 

That sounds about right. 

Senator CONRAD. The third issue is the President’s ongoing defense buildup, and we have been given an estimated 10-year cost 

of roughly $300 billion. Do you believe that is roughly——

Mr. MARRON. I must admit that is not actually a calculation I 

have seen. I expect other people at CBO have. 

Senator CONRAD. Let me just say that we face a tremendous 

stress on the military budget. I have just been advised by my 

Guard leaders and other Army leaders that the equipment in Iraq, 

much of it will just have to be left there because it is junk, and 

it is becoming junk because of the extreme heat, the adverse conditions, and, of course, the stress of combat. And this is going to pose 

substantial additional costs. 

Funding for ongoing war costs, I believe this is actually a CBO 

estimate, 10-year cost $380 billion. Do you agree that that is in the 

ballpark? 

Mr. MARRON. Under a particular set of assumptions, yes. 

Senator CONRAD. Now, we have backed out the 2006 

supplementals for the reason that Senator Gregg gave, and I think 

he is exactly right. Many of these supplementals for Katrina, for 

the war in Iraq, you are required to include those in future year 

estimates, but we have backed them out because we assume they 

are one-time costs. And when we back those out, that is a savings 

of $827 billion. Would you agree that that is roughly correct? 

Mr. MARRON. Yes. 

Senator CONRAD. And then the reconciliation conference report 

passed in the House—I know it is referred to as $39 billion, but 

that is the 5-year effect; the 10-year effect, $105 billion. Do you 

agree with that? 

Mr. MARRON. That looks about right. 

Chairman GREGG. It passed the Senate, too. 

Senator CONRAD. And it passed the Senate. 

Chairman GREGG. I just want to make that point. 

Senator CONRAD. Yes, it passed the Senate. The debt service related to all this, $481 billion. So we see the debt going up by $3 

31

trillion over this next 10 years. Do you agree that that is roughly 

in the ballpark? 

Mr. MARRON. Ballpark, if all these things come to pass. 

Senator CONRAD. All of these elements. Well, that, I would say 

to my colleagues, is alarming to me because this is before the baby 

boomers fully retire. And if there is one place the chairman and I 

absolutely agree, it is this demographic change that is occurring is 

going to create a tsunami of debt, because the number of people eligible for Medicare and Social Security are going to double in very 

short order. 

Would you agree that the number of people eligible for Social Security and Medicare will double as the baby boomers retire? 

Mr. MARRON. Yes. 

Senator CONRAD. So if we are looking at the spending side of this 

equation, we have to focus there. Would you agree? 

Mr. MARRON. Yes. 

Senator CONRAD. And on the revenue side of the equation, the 

notion that tax cuts pay for themselves, my understanding is that 

CBO has found, using a wide variety of economic models, the tax 

cuts do not pay for themselves. Some of the models show positive 

effects on growth, but they are not large enough to offset the revenue loss. Is that an accurate characterization of what CBO has 

found? 

Mr. MARRON. Yes. Pro-growth tax cuts, reducing marginal rates, 

things that are focused on savings and investment do help the 

economy grow. And, therefore, you get back something from macroeconomic behavior that a purely static estimate would not account 

for. But the scenarios we have considered do not come close to actually paying for themselves. 

Senator CONRAD. Let me just say this by way of conclusion. I believe that we together have to take on this growth of the debt. I 

believe it is going to take a focus on the spending side, especially 

entitlements, and on the revenue side, and that the first place we 

ought to look for revenue is this massive tax gap. 

One final question, if I could on that. The tax gap—have you had 

a chance to look at the Internal Revenue Service estimates of the 

difference between what is owed and what is being paid per year? 

Mr. MARRON. I know they exist. They are somewhere between 

$300 and $400 billion a year. 

Senator CONRAD. The difference is $300 to $400 billion. That, my 

colleagues, I suggest, on the revenue side ought to be the first place 

we look. 

I thank the Chair. 

Chairman GREGG. I hope we can pursue that later, whether you 

have language which could accomplish that. 

Senator Crapo I guess was here first. 

Senator CRAPO. Thank you very much, Mr. Chairman. 

Mr. Marron, I wanted to pursue a little further the line of questioning that both the chairman and the ranking member have pursued with you, namely, the dynamic impact of tax cuts. 

As you have already indicated, certain types of tax cuts are progrowth, stimulate the economy, stimulate the development of capital and wealth and development of jobs, and have the ability, 

32

therefore, to create a stronger and more dynamic environment in 

which greater revenue can be accomplished. 

Now, you indicated on the models that you have looked at that 

they did not return as much as they cost. Do you build any of those 

models into your projections, or have you just looked at them? 

Mr. MARRON. For purposes of the baseline that we construct and 

that we have talked about here today, we do indeed account for dynamic effects. And so, for example, in our projections in 2011 and 

2012—in 2011, in particular, you see taxes rise significantly. And 

so as a result, in our projections we see that labor force participation goes down after that. And so there are some dynamic effects 

in the baseline. 

In the evaluation of legislation, which on the tax side I should 

emphasize is primarily done by the Joint Committee on Taxation, 

those effects are typically not accounted for. 

Senator CRAPO. Do you get specifically into—say that again, 

what you just said? What is not accounted for? 

Mr. MARRON. In evaluating legislative proposals on the tax side, 

which, again, is primarily done by our colleagues at JCT, they take 

into account some behavioral responses, so they are not purely 

static estimates, but they do not take into account possible macroeconomic effects of tax cuts. 

Senator CRAPO. As you are evaluating the impact of tax relief, 

do you focus on the specific taxes that are being—let’s take, for example—and I think you are aware of the recent information that 

has come out on the capital gains tax cuts over the last 2 or 3 years 

and the impact of those cuts on revenue. Do you take that into account specifically as to the specific taxes that have been cut? 

Mr. MARRON. There are really two related things there. In constructing our baseline, we definitely take account of the fact that 

if you change capital gains taxes, you change people’s realization 

behavior roughly as you would expect. If the capital gains tax is 

lower, people are more willing to realize gains, and they also affect 

their timing. So we build that into the baseline. And then we also 

build into the baseline some macroeconomic effects from that, although, they are not that large given all the other taxes that we 

have. 

Senator CRAPO. Well, what I am trying to get at—and I am using 

the capital gains tax information as the example here. I am trying 

to get at an understanding of just what it is that you are projecting 

and are not, because it appears that the projections of CBO, and 

others, when we passed the capital gains tax cut all were that 

there would be a net negative impact on the Treasury, on the budget in terms of revenue, and yet that the actual occurrence was dramatically different than that and that the net result was that there 

was a significant increase in revenue as a result of—and then the 

question is: Was it as a result of the tax relief, or was it as a result 

of something else? 

Mr. MARRON. Specifically with capital gains, my understanding 

is the estimates that are prepared by the Joint Committee on Taxation do take account of the fact that people change their realization behavior. And so, for example, we saw capital gains tax rates 

come down significantly, and that essentially unlocks some gains 

that people had not wanted to realize, and that may—depending on 

33

the relative size of the change in taxes can give you either a plus 

or a minus on revenues. 

Senator CRAPO. But our actual experience was that it was a dramatic increase in revenues, wasn’t it? 

Mr. MARRON. Yes, we have seen capital gains revenues on both 

the individual side and corporate side go up significantly. There is 

a confounding factor. There is something that happened at the 

same time which we are not able to fully yet measure, which is this 

dramatic increase in real estate prices. And so some of the recent 

increase in capital gains is clearly coming from that sector. 

Senator CRAPO. And wouldn’t some of that even have been a result of the increase in capital transactions generated by——

Mr. MARRON. Yes, and some of that may be the realization of 

capital gains on real estate that had been there for some time. 

Senator CRAPO. The bottom line, though, is that the charts we 

were all using 3 years ago were saying that it was a net loss, and 

the reality that we are seeing now is that it was a very significant 

net gain. Is that not correct? 

Mr. MARRON. It is true that the capital gains realizations have 

been very strong. Connecting that strength specifically to the tax 

reduction is a challenge because of the other things that have happened in the economy. And for that I would have to plead the need 

for more research. 

Senator CRAPO. Are you saying that we do not have the ability 

to make those kinds of estimates in terms of the dynamic impacts? 

Mr. MARRON. I think our colleagues at JCT, do their professional 

best to understand, given what happened in the past, to forecast 

capital gains realizations. We have a brief discussion in our outlook 

here about how forecasting capital gains is a particularly challenging part about constructing revenue projections. Just in the 

normal course of affairs, the actual realizations that occur could deviate wildly from what the best economic models predict. 

Senator CRAPO. But you do not at CBO try to conduct that type 

of dynamic analysis? 

Mr. MARRON. We do for purposes of constructing our baseline. 

This is one of the confusing nuances about how we do things. So 

in our baseline, which is our responsibility, we try to take into account exactly those effects. When it comes to score legislative 

changes, that is done by JCT. They take into account behavioral response, but they do not take into account macroeconomic effects. 

Senator CRAPO. All right. I just have about a minute left, and I 

want to shift topics entirely here for a minute and talk about the 

growth in Medicare. I noticed that growth is projected to be in 

this—I don’t know if these are your figures are not, but $339 billion 

in 2006 to $500 billion in 2011, and then over the next 10 years 

it grows to $744 billion. 

Do you know what percent of the growth in Medicare is attributable to the enactment of the prescription drug benefit? 

Mr. MARRON. For 2006 alone, the addition of the drug benefit is 

responsible for about 50 percent of the growth in Medicare. That 

obviously gets smaller as you go out over time. This is the first 

year. 

Senator CRAPO. And do you know what percent is attributable in 

these projections to the increased in the number of seniors retiring? 

34

Mr. MARRON. I don’t have particular numbers at hand for you, 

but I would say that the predominant driver is increased health 

care spending, so increased services and increased prices for those 

services. But there is also a portion of—because of the transition 

to the baby boom, significant growth in the population in the program. I could get you specific numbers, but qualitatively it is primarily the rise in health care costs and then also some significant 

change from the caseloads. 

Senator CRAPO. All right. One last question, and you may give 

the exact same answer to this, but do you have any idea what percent is attributable to the more intensive care that is being provided to seniors? 

Mr. MARRON. I would include that in with the rise in health care 

costs, which is being driven, as I said, in part by prices and in part 

by increased utilization of various services. 

Senator CRAPO. All right. Thank you. 

Chairman GREGG. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. I want to thank 

you and the ranking Democrat for the welcome to the committee 

and for reassuring me I made such a great choice in seeking the 

committee. But it is a privilege to be here, and I look forward to 

working with our colleagues in crafting a sensible, responsible 

budget, and I look at that as a very serious exercise since I believe 

that budgets are a reflection of values. We do that every day in our 

lives in terms of our personal budgets. What we earn and what we 

spend in terms of providing a home, educating our children, providing for health care, the money that we tithe to our faith, the 

charitable contributions we may make—those are all expressions of 

values within a budget. And I think the national budget collectively 

on behalf of the Nation is also an expression of values, and so how 

we choose to use the collective resources of the Nation is an expression of our collective values. And in some respects I haven’t agreed 

with the values that we have had over the last several years. 

I hope one of the values that we will be able to deal with today 

as we work on the Senate floor is rewarding work, those individuals who work very hard every day but find themselves in a set 

of circumstances where they are going to be subject to a tax even 

though their income may not have grown on the alternative minimum tax. That was never meant for 17 million middle-class families in our country, many from my home State of New Jersey. So 

I am looking forward to seeing that the Senate hopefully will act 

in a way that speaks to a value that rewards work. 

And I certainly share the concerns of Senator Conrad in this 

presentation. To me, one of the things that I thought we achieved 

several years ago is balancing budgets for the first time in a generation, creating record surpluses, low unemployment, low inflation, and moving to a Nation that was debt-free within 4 years. 

And now this mountain of debt that is being generated is just in 

my mind beyond the realm and comprehension of most Americans. 

When we talk about the type of figures that are being projected 

in the out-years, it certainly baffles them, as I think it might baffle 

any one of us. And that does not even deal with some of the concerns that I have that we have learned over the last year, that in 

addition to the rate of debt that we are accumulating, one of the 

35

things we learned, especially last year, is that sometimes the unexpected and the unthinkable will happen, and it certainly did last 

year. And that adds to our challenges and our readiness. So it is 

in that context that I look forward to the work of the committee. 

I would like to ask you, Director, about a couple of issues. One 

is the CBO acknowledges that the war costs may be understated 

in the next few years given that the baseline includes the $50 billion appropriated for 2006, a figure that is likely to be surpassed 

this year. Given the probability that we will be near the $90 billion 

range in 2006, and the possibility that we may be near these same 

funding levels at least for the next couple of years, could you provide a revised baseline and demonstrate the impact on the deficit 

if we were spending between $80 and $90 billion on the war effort 

through 2008? 

Mr. MARRON. Sir, we can clearly run scenarios based on different 

assumptions about what funding would be for Iraq and Afghanistan operations, absolutely. I wouldn’t be able to characterize them 

as a baseline. The baseline is what the baseline is, but as an alternative set of projections, that is certainly possible to do. 

Senator MENENDEZ. So if we asked you to do that, you could do 

that for us. 

Mr. MARRON. Certainly. 

Senator MENENDEZ. OK. We will ask you to do that, because I 

just find it very difficult to be including in supplementals, which 

in my understanding was supposed to be emergencies, that which 

you know that you are spending. We are obviously still engaged in 

Afghanistan and Iraq, and yet we continue to offer supplementals 

versus deal with the funding expectations that we need to provide 

for the engagement of our troops, their safety, and ultimately our 

mission. 

Let me ask you about the CBO projects that the budget reconciliation bill passed by the House yesterday results in about $5 billion 

in savings in 2006, $39 billion between 2006 and 2010 and $99 billion from 2006 through 2015. 

It also projects the costs of extending the 2001 and 2003 tax cuts 

would be about $346 billion if we extended it through 2011, and a 

whopping $2 trillion if we extended it through 2016. 

Given the arguments that the spending cuts will help reduce the 

deficit, can you compare the impact of each of these approaches 

that it has on the deficit? Isn’t $99 billion in savings over 9 years 

a drop in the bucket compared to $2 trillion in additional revenue 

loss? 

Mr. MARRON. That is an easy one, so yes, roughly $100 billion 

is about 1/20th of roughly $2 trillion. 

Senator MENENDEZ. Let me ask you, with reference to the President’s—I have been listening to the President’s State of the Union 

speeches now for 5 years. We have heard numerous times from the 

President his intention to cut the deficit in half by 2009. If I am 

correct, he first made that pledge in 2004. At that time the projected deficit for 2004 was $521 billion, and the projected deficit for 

2009 was $237 billion. So cutting the deficit in half was more of 

a projection than a promise. 

36

Is the President talking about actual dollar terms or is he talking 

about the deficit as a percentage of GDP? Which one is he talking 

about? 

Mr. MARRON. Sir, I have seen news coverage and discussions 

that characterize it both ways, either in dollar terms or as a share 

of GDP. 

Senator MENENDEZ. Well, it is hard to have it both ways, isn’t 

it? 

Mr. MARRON. They are both meaningful measures. You know, I 

have the luxury of being sort of a pointy-headed economist, and we 

like to divide through by GDP, so that tends to be the type—obviously, as you saw in my chart earlier, that tends to be the kind of 

numbers we focus on. But I would hesitate to characterize, you 

know, what the President’s specific target was. 

Senator MENENDEZ. I think most Americans would expect, when 

they hear that we are going to cut the deficit and the debt, they 

are talking about listening to actual dollar amounts. That is the reality in their lives. They don’t get to do it as a percentage of GDP. 

Thank you, Mr. Chairman. 

Chairman GREGG. Thank you very much, Senator. 

Senator ALLARD. Mr. Chairman, thank you. And at the risk of 

starting a war of charts, which I hope we can avoid, I just want 

to make a very brief point here because my good friend from North 

Dakota has tried to say that the growth package that was put forward by the President and passed by the Congress in 2003 was not 

good public policy. The fact is that the facts point out differently, 

and so I have just four charts I want to briefly run through here 

that point that out. 

The first chart that we see here reflects basically that jobs have 

rebounded and that unemployment is falling.

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On the second chart that we have here, we have a chart that just 

quickly reflects the fact that gross domestic product is on a path 

of sustained growth and continuing in that direction. And the green 

line that we see on the chart is actually the point where the jobs 

growth package, a main portion of which was capital gains and 

growth stimulus, where we reduced taxes to stimulate the economy.


26726.019
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Then on the third chart we have, look what has happened to 

Federal revenues rising. Despite projections that they would go 

down when the President’s growth package was implemented, we 

see that the chart shows a pretty dramatic growth upwards.


26726.020
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Then the fourth chart shows what is happening to household 

wealth, and it has reached record highs.


26726.022
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Now, while those in opposition to those tax cuts have tried to 

make the point that it is bad public policy, in reality what we have 

seen happen is that that policy has been good for the economy.It 

has been good for the Federal Government because revenues have 

increased to the Federal Government, and it has actually helped 

American families. And so I for one think it was very good public 

policy, and I hope we can sustain that effort with policy toward a 

permanent tax cut. And I would agree with the chairman that capital gains was a vital part of that. 

One of the problems with estimating capital gains taxes is they 

have always been dramatically off, and in general, when we talk 

about cutting taxes to benefit the economy, it seems like the estimates that we get from the CBO have been off considerably. 

Let me take a couple of examples just to make that point. In 

1992, President Clinton was elected into office, and around 1993, 

we had what was characterized by many of us as the largest tax 

increase in the history of America at that particular point in time. 

The CBO projection in 1992 for the year 1993 up to 1996 had estimated a certain level of revenue. And when we applied these tax—

when they applied the tax increases—and they were increases of 

up to 16 percent to 28 percent, depending upon—that was just on 

the top tax rates. And the revenue that was generated from that 

was less than 1 percent higher than the 1992 estimate. 

Now, when we get into the 2000 President’s tax growth package 

earlier, the CBO had estimated that it was going to cost revenues 

to the Federal Government $27 billion. In reality, what it did, it 

increased revenues by $26 billion. There was a miscalculation of 

somewhere around $53 billion there. 

And when we look at—before I ask my question, and my question 

is going to be how can we improve the accuracy of revenues when 

we are talking about cutting tax policy, policy we retain of cutting 

taxes, particular economic growth taxes. 

By the way, on the chart of my good friend from North Dakota 

where he showed the economy coming down dramatically, revenues 

are up, we hadn’t even applied the President’s tax growth yet. We 

were still working under the policy of the previous administration, 

the Clinton administration. And so then when we see the Bush administration policy comes, we see the growth and what all of these 

charts here reflected. 

So, again, my question is: What is it that we can do to improve 

the accuracy of a tax cut’s impact on the economy and revenues to 

the Federal Government? 

Mr. MARRON. Again, I want to emphasize what I understand to 

be—as the new guy I may get this slightly wrong, but I want to 

emphasize my understanding of the roles and responsibilities. CBO 

is responsible for the baseline projection of revenues and spending. 

Among those would be capital gains. Our colleagues and friends at 

the Joint Committee on Taxation are responsible for the scoring of 

bills. 

And so to the extent that any of these issues arise with their 

scoring of the bills, I cannot speak to it directly. 

Senator ALLARD. I am not trying to—but you understand how 

they score bills, don’t you? 

Mr. MARRON. Yes, I understand why they do it. 

42

Senator ALLARD. What can we do to improve that, so we get a 

more accurate reflection of what is going to happen when you do 

things like cut capital gains? 

Mr. MARRON. I have the standard economist answer, which is 

that one of the great challenges we face, particularly on capital 

gains, is how long is takes us to have data about what is happened 

recently. So if you think about it, capital gains often go to people 

with complicated tax returns. People with complicated tax returns 

often do not file until October of the year during which their taxes 

are due. It takes a while for the IRS to get the data together. And 

as a result, for people who are trying to study capital gains realizations and project them on behalf of the Congress we are actually 

operating—I forget the exact period. but we are operating with 

roughly a 2-year lag in which we are kind of guessing, to be honest. 

So it is hard to know exactly what is going on. 

I think unfortunately there is some irreducible uncertainty about 

capital gains realizations. They bounce around, for reasons that 

professional economists have not yet been able to fully ascertain. 

And then, perhaps to be more responsive to your question, I 

think it is always helpful and fruitful to revisit the techniques we 

use to forecast these things. And to the extent that there is room 

for improvement there—I cannot speak to it because I am not exactly sure how JCT does it, but to the extent that there is room 

for improvement——

Senator ALLARD. I appreciate the last part of your response. I do 

think we need to look at it, and hopefully we can do something to 

make this more accurate. 

That is the whole point of my question. I think that, as policymakers, it serves us all if we can improve the accuracy so it truly 

reflects. It is a chronic problem with capital gains. Every time it 

is come through this Congress, it is been—revenues from reduction 

of capital gains has been badly underestimated. And I do think we 

need to look seriously at that. 

With your indulgence, and perhaps maybe the minority members’ 

indulgence, I have another question on flood insurance. We are 

going to be increasing the debt limit on how much the National 

Flood Insurance Program can incur. I guess we do not know exactly 

where that number is going to be, but we are going to be increasing 

that up to $23 billion. In other words, they can incur these obligations on flood insurance up to that because of what is happened 

with Katrina. 

So you have this that is increasing. And then we have this other 

obligation of how we are going to pay for the current program, 

there is actually two aspects to it. And we have people that are exempted from having to pay flood insurance because they were there 

before the program was initiated. 

Do you have any ideas on how we can make this program more 

actuarially sound? And perhaps maybe you do not have any ideas 

but I think it would be helpful for those of us who happen to be 

on the Banking Committee to get some kind of written—me personally, I would be particularly interested in getting some kind of written response to that, what we can do to actuarially make our flood 

insurance program sustain itself without having to have a future 

obligation we are placing on it by increasing this debt limit, that 

43

we are looking at putting around probably somewhere around $23 

billion. 

Mr. MARRON. Sir, as you know, I had the opportunity to appear 

before the Banking Committee last week and talk a little bit about 

these issues. I would be happy to provide more detail on anything 

you have in mind. 

The key issue which you identify is there is a certain group of 

properties that are subsidized under the program. They pay premiums that are significantly less from what people believe would 

be actuarially fair, and particularly what FEMA estimates would 

be actuarially fair. 

To eliminate that by itself, the natural economist response would 

be to raise premiums, but that clearly raises issues about some of 

those people dropping their coverage and whether that is a desirable public policy outcome. Other ideas were brooded about at the 

hearing and we would be happy to followup with you. 

Senator ALLARD. I would appreciate taking a little time to discuss that with you. 

I thank the indulgence of the chairman and minority party. 

Chairman GREGG. Senator Stabenow. 

Senator STABENOW. Thank you, Mr. Chairman. Thank you and 

welcome, Mr. Marron. It is good to see you, as a member of the 

Banking Committee as well, seeing you in front of both committees. 

Mr. Chairman, I feel like Yogi Berra when he said it is deja vu 

all over again. It seems that every year that I have been on the 

committee since 2001 we have heard about growing deficits. We 

have heard about what is happening in terms of the budget. 

When we look at the fact that now the projection from CBO, understanding that you have to project out with current policies, is 

going to be $1 trillion over the next 10 years for our children and 

our grandchildren. It is astounding. 

And when we figure in what Senator Conrad was talking about, 

with the costs of the war and Katrina and all of the other issues, 

we are talking more like $4 trillion, which is stunning when we 

look at these numbers. 

Mr. Chairman, we have a lot of work to do on this, as I know 

you know. 

I wanted to speak to the question of wages. We are always, I 

think, in a classic debate about supply and demand and where that 

balance is. I think some of my colleagues feel it should all be about 

supply side tax cuts, focusing on that. Others of us believing that 

it is about wages, money in people’s pockets as well as being able 

to support investments and so on. 

And I certainly have to say that with my friend, Senator Allard, 

who just showed the charts on wealth, I assume that the only way 

we could get those kind of numbers would be to include equity in 

people’s homes. Because certainly people are not feeling that somehow they are wealthier, certainly in my State, and in many other 

States across the country. They may have a home with more equity 

in it but they cannot sell the house. They have to live in the house. 

It does not pay the heating bill. It does not pay the gas bill. It does 

not send the kids to college. 

So where the rubber meets the road in Michigan it is a very different picture. 

44

But I wanted to just raise an interesting section on 121 of your 

report, just an interesting comment that I think is important to 

this debate. You talk about two of the most important types of income for projecting Federal revenue are wages and salaries and 

corporate profits. And you say wages and salaries are the most 

highly taxed component of income—wages and salaries—being subject to income tax and Social Security and Medicare and so on. 

And then you say consequently, CBO estimates that an additional dollar of corporate profits produces less revenue than an additional dollar of wages and salaries. Thus, higher projections for 

wages and salaries and correspondingly lower projections for profits 

result in higher projected budget received. 

And you go on to talk about that relationship to lowering the 

debt. 

I say that to followup on Senator Menendez’s comment about valuing work. Valuing work. I mean, here we are talking about how 

the way that people are taxed the most in our country are through 

wages and salaries. Is the person working every day getting a paycheck? But then we go to this debate about capital gains possibly 

at the expense of the Alternative Minimum Tax hitting middle income people. And this seems to go certainly contrary to the picture 

of what is really happening if, in fact, the wages and salaries of 

Americans are the most highly taxed part of the revenue that is 

received for the Federal Government. 

And we are debating with the House of Representatives about 

whether 19 million people ought to get a tax increase right now because they bump up against the AMT ceiling versus giving another 

tax cut for people who earn their money off of investments. 

So I wonder if you might just speak for a moment about the importance of jobs or wages and salaries. I would argue that it is not 

only about revenue for the Federal Government, but that in my 

State, where we are losing jobs, we have lost one-third of our manufacturing jobs in the last 5 years, we are really fighting for our 

way of life in our country and it is about jobs. 

And we cannot just say this is about top down economics. It has 

to also be about somebody working, having wages, having money 

in their pocket to purchase things, to drive the economy as consumers. 

So I wonder if you might just speak—I guess I would not have 

a specific question for you other than to say that wages and salaries and people working are an important part of this equation; 

isn’t that correct? 

Mr. MARRON. Absolutely. Wages and salaries, clearly they are 

important for tax revenues. They are important for providing people with the money to live on and accomplish the things that they 

want to accomplish. 

I guess as an economist, the point I would emphasize is that the 

wages and salaries come from employers. And so you have to think 

about the balance of setting up an environment which makes employers as enthusiastic about hiring people as possible. 

From an individuals’ point of view, a key determinant of how 

much you get paid obviously are your skill levels and your education. From the employer’s point of view, the key determinant of 

how much they are willing to pay you is essentially how productive 

45

you can be for them. And over very long periods—not even very—

over long periods what economists have found is that a key determinant of that is productivity growth. And then a key driver of productivity growth is capital accumulation. 

So that one channel actually for raising wages and salaries in 

the long run is to make sure that our companies invest, buildup 

capital, and therefore in the future are willing to pay high wages 

and salaries to their workers. 

I just want to emphasize lowering taxes for capital does not necessarily mean you are not helping workers. 

Senator STABENOW. I understand that. But doing that at the expense, as a tradeoff to lowering taxes on wages or salaries or doing 

other things such as lowering health care costs, protecting somebody’s pension, lowering the cost to go to college, it all is a package. 

And we do not often enough, in my opinion, focus enough on that 

whole package. 

Let me just say, in conclusion, that in a global economy I think 

that debate changes from what you are saying. We have seen productivity go up and jobs go down and investments go overseas. The 

reality is in a global economy that our workers can and are more 

productive than they have ever been. But because of what is happening in the global economy, because we fund health care differently than any other country, because we do not enforce our 

trade laws on currency manipulation or counterfeit parts—and I 

will give you one example of $12 billion counterfeit auto parts coming into this country. Illegal. Illegal. We have beefed up our laws, 

and yet we are doing nothing about it. And it is cost 200,000 jobs. 

People stealing our patents. 

I would just suggest that if we only say that this is about on the 

supply side, we have no guarantee that that capital is going to be 

in the United States unless we address the other pieces that unfortunately, because of the deficit right now and the tradeoffs that are 

being made, we are not addressing. We are not addressing. We 

would be a lot better off for jobs, that wages and salaries component that you are talking about for revenue for us, if we were to 

invest those dollars on the high-end tax cuts back into paying for 

health care and helping manufacturers build to compete in the 

global economy to keep high wages here and invest in our people 

here at home. 

I would just say, Mr. Chairman, that I think part of all of this, 

as well, is when you talk about investing for the future and what 

employers want in a skilled work force, the $12 billion we just cut 

in student loans goes contrary to anything that we ought to be 

doing, in my mind, to compete in the global economy. 

Thank you. 

Chairman GREGG. Thank you, Senator. 

I would point out that there was no reduction in student loans. 

In fact, what we did was reduce the rate of return, which was a 

windfall of significant proportions to the lenders. And then we took 

some of that money and we actually put it into expanding the benefits to students, through expanding the Pell grants. We took some 

of that money and moved it toward deficit reduction. 

46

Senator STABENOW. Mr. Chairman, if I might just insert one thing, and that is over $12 billion was shifted onto people who get 

student loans. We are already seeing a change in Michigan. 

Chairman GREGG. No, that is not true, Senator. As a practical 

matter, that is a representation that has been made that is totally 

inaccurate. 

The HELP Committee produced a bill which reduced the subsidy 

to the lender community, which if we had not done, quite honesty, 

would have dramatically—would have created a dramatic windfall 

to the lender community. 

We did keep a fixed loan rate, which was a mistake. We did not 

go to a variable loan rate, which would have benefited students. 

But I would point out that that was at the request of the Democratic side of the aisle. That those of us who wanted a variable 

rate, which would have allowed students to get a better deal even, 

were not able to get that through the Committee because of the opposition of Senator Kennedy. 

This representation that student loans have been cut is a canard. 

Senator STABENOW. I look forward to debating the results of the 

policy we passed, as it becomes apparent. Thank you. 

Chairman GREGG. So do I, because I think the numbers are pretty clear—

Mr. Marron, the asbestos bill that is going to be coming to the 

floor, we have a reserve fund that this Committee put in place that 

is has some—that basically wants to keep this bill—is structured 

for the purpose of keeping the bill from costing the American taxpayer money. What is CBO’s view of whether or not this bill is 

going to cost us money? 

Mr. MARRON. The structure of the program, as I understand it, 

is to raise revenues in various ways and then to spin them out to 

beneficiaries who are stipulated under the bill language. The way 

that is going to be accounted for is that the money that comes into 

the fund are indeed treated as revenues to the Federal Government. And that, as a result, the money that goes out to pay claimants is treated as spending. 

So in an accounting sense, it is clearly going to be a spending 

and revenue program. 

If your question is how does—is your question how it operates 

over the long run and what its long-run prospects are? 

Chairman GREGG. My question is that if I am asked, as Chairman of the Budget Committee, whether or not the conditions of the 

reserve fund are met, which is that this will not be an obligation 

which falls onto the American taxpayer but will be paid for by the 

community which has agreed to absorb the responsibility, am I 

going to be able, as Chairman of this Committee, to say in good 

faith no, the American taxpayer will not have to pay the bill here. 

Mr. MARRON. I think that—as written—the bill is intended to 

have a structure in which the administrator of the fund is supposed to stop paying claims if they believe that the claims will exceed the revenues that come into the program. And so, in principle, 

it is supposed to stop and not spend more money than it is going 

to receive. 

Whether that actually executes as written, I think will depend on 

kind of the discussions that happen at that point. That would be 

47

a projection of what policy changes might be in the future, but 

clearly we would understand that there is the possibility that there 

would be pressure to have the Federal Government step in. 

I am giving you an on the one hand/on the other hand answer. 

Chairman GREGG. It appears that way, yes. Unfortunately, 

whether I make a point of order is not an on the one hand/on the 

other hand issue. 

Senator CONRAD. Can I make a point on this? 

Chairman GREGG. Yes, of course, jump in. 

Senator CONRAD. If I could say, Mr. Chairman, my people have 

done a report that is now on my desk that I will be sharing with 

you hopefully later today. I have not had a chance to read it. 

I have asked for the conclusion—and this is with respect to the 

issue that you are raising. And my people have no ax to grind here. 

And they have reported to me that they believe, in nominal terms 

over the life of the program that this proposal is $150 billion underwater. 

Chairman GREGG. On top of the $150 billion that is——

Senator CONRAD. Yes. That the shortfall over the 50 year life is 

$150 billion. That is the nominal shortfall. 

Chairman GREGG. Let me see if I understand that. CBO has estimated—the general estimate is that this program is going to cost 

$140 billion? 

Senator CONRAD. Correct. 

Chairman GREGG. So you are saying there is another $150 billion 

on top of it? 

Senator CONRAD. Correct. Over the life of the program, the net 

present value—net present value—shortfall is $50 billion. 

Mr. Marron, I think you have said on many occasions that the 

risks to this program all run toward the taxpayers—that they are 

heavily weighted in that direction. Is that not correct? CBO found 

that your estimates of the risks here run in the direction of taxpayers? 

Mr. MARRON. We have our official numbers, official estimate. 

And then there were a variety of things that we were not able to 

price out and cost. Most of those seem to point toward higher costs 

than the range we have. There is at least one study that would be 

done that could point the other way. So there is some possibility 

of being lower. 

But again, we are in the business of scoring legislation as it is 

written. And as we understand as it is written, it is supposed to 

stop at $140 billion. But I am sympathetic to where you gentlemen 

are coming from, which is it is not entirely obvious that that would 

actually be what reality looks like. 

But from where we sit, I cannot say too much on that. 

Senator CONRAD. I understand the strictures that you are under. 

I would just say to my colleague I asked this question of my 

staff, professional staff. They spent a lot of time analyzing this. 

They came back to me and they said they think this is way underwater. 

As I have looked at their work, and I have not read the whole 

analysis that they have just put on my desk I think yesterday or 

the day before, it really is striking. It really is striking. 

48

The assumption that the fund is ever going to stop, I think we 

have to do a reality check here. Is there any prospect, once this 

thing gets going, that it is going to be stopped? I think that is 

just—I know that you have to assume that it does stop. But the 

reality, all of us who are here, I think we all know what is going 

to happen. They are not going to stop. 

Chairman GREGG. Senator Stabenow, do you want to—I know 

this is an issue for your state. 

Senator STABENOW. It is. In an ideal world—yes, thank you. 

I am very concerned about the numbers, Mr. Chairman, as I 

mentioned to you. In an ideal world, this is an issue for us and our 

manufactures and I would like to see a trust fund that works. But 

there are a lot of issues that have been raised and the budget numbers are of concern to me. And so I am anxious to look at what 

Senator Conrad has been talking about before making a final decision myself. 

Chairman GREGG. We look forward to getting this information 

from you and your staff. 

On another question, to what extent are you factoring in oil 

costs? It appears we are in a world where $60 a barrel is, for the 

foreseeable future, the number, maybe even higher depending on 

demand coming out of Asia and what happens in places that are 

fairly unstable like Nigeria and Venezuela and, of course, the Arab 

nations such as Iraq and Iran. 

Mr. MARRON. Our economic projection is built off of substantially 

higher oil prices than we have ever had before in one of our projections. It starts off in the neighborhood of the high 50’s. I remember 

we locked down our economic forecast a bit over a month ago. Essentially it has prices at that level and then rising with inflation 

in the later years of the forecast. So we definitely have what traditionally has been viewed as high oil prices. 

In the intervening month, oil prices have gone up even further, 

and it is something clearly that we are keeping an eye on to see 

to what extent that may have some dampening effect on the economy. 

Chairman GREGG. As you know, one of the amazing things about 

the American economy and the American people are that we react 

and we are flexible. How do you factor this in to out-year productivity, which is clearly going to have an impact? Do you presume 

we will innovate out of this? Or do you presume that you just pick 

a static number and go forward? 

Mr. MARRON. This is not something that we factor in, in an incredibly detailed level, into the projections that we make. As you 

say, the economy has been very resilient and flexible in the past. 

It is absorbed various shocks in various areas. In terms of projecting longer run productivity growth, we essentially look at a 

snapshot of recent history and use that as our projection of what 

will happen in the future. 

Chairman GREGG. I do think this is a huge issue for us, because 

I do not think we have had this type of shock to our economy in 

a long time. I think we are just beginning to have the impact of 

it felt. Hopefully, we can innovate our way out, or at least through 

policy drive other sources of production. 

49

But in any event, it looks like this price for production, whether 

it comes from ethanol or whether it comes from some other nuclear—it still looks like the price is going to—we are going to have 

a new base on an economy that was built on $11 to $15 per barrel 

of oil, and it is got a base of $60 a barrel, and that changes a lot 

of things in an economy. And the changes will not be immediate 

maybe, but they will certainly have an impact over the long run, 

I would think, on productivity and on the development of wealth, 

the development of capital. 

I would be interested if you could have some of your thinkers 

take a look at that beyond the static approach and give us your reaction. If we are going to go out—and even if it is not oil—whatever 

it is. If we are going to pay for that unit of energy $60, what $60 

translates into, whether it comes from some other source or not, as 

versus what has historically been probably $15. What is that sort 

of a quadrupling of the cost of that unit of energy do to our economy over the long run? And how—well, you do not answer this, 

this is our job. But when we have that number, how should we try 

to address it? 

Mr. MARRON. I would be happy to. 

Chairman GREGG. Thank you. Senator Conrad. 

Senator CONRAD. Mr. Chairman, let me just go back. My colleague from Colorado made a number of characterizations of charts 

that I put up. He said that with respect to revenue and the drop 

in revenue compared to where we were, that that happened before 

President Bush’s policies took hold. That is just not the case. That 

is just factually not the case.

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In 2000 we had over $2 trillion of revenue. In 2001, the first year 

of the President’s administration, we had almost $2 trillion. In 

2002, after the big tax cuts of 2001, revenue was down. 

More tax cuts in 2002. In 2003 revenues are down more. 

Then we had an uptick in 2004 but still way below where we 

were back in 2000. Much less revenue. 

Only now, 5 years later, are we back—and this is in dollar terms. 

If you look at this with inflation taken out, we have still not recovered. 

Now we are in the fifth year of the presidency. To say that his 

policies have not taken hold, I do not think it is factually correct. 

The Senator from Colorado talked about how good the economy 

has been. Let us look at a number of measures here. This is what 

has happened to real median household income. It has declined for 

four straight years. We believe the 2005 numbers will show a further decline. This is inflation adjusted household income. It has 

gone down every year. That is not the sign of a good economy.

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Let us compare what has happened in this economic recovery to 

the other major recoveries that have occurred since World War II. 

There have been nine business cycles, major recessions, since 

World War II. The red dotted line is what has happened to GDP 

growth coming out of those recessions. The black line is what has 

happened in this recovery. It is 25 percent weaker than the average of all of the other recovery since World War II. That is GDP 

growth.

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Let us look at business investment. Business investment is even 

worse. Again, the dotted red line is what we have seen in each of 

the other recoveries since World War II, the average. The black 

line is what we are seeing in business investment in this recovery. 

It is 50 percent lower than the average of all other recoveries since 

World War II.

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Job loss recovery. Again, the red dotted line is the average of all 

the recoveries, the major recoveries, since World War II. The black 

line is what we are getting in this recovery. We are 6.9 million private sector jobs short of the typical recovery.

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Something is wrong here. Something is wrong here. Something 

has fundamentally changed. I would argue it is what is happening 

with international competition. 

The result is, what the Senator did not want to talk about, is 

what has happened to the debt. The debt has skyrocketed. And the 

external debt of the United States has more than doubled. It took 

224 years and 42 presidents to run up a trillion dollars of external 

debt. This president has doubled it in 5 years, more than doubled 

it.

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Let me just show, finally, the other thing he did not want to talk 

about is what has happened to the debt. In 1998 to 2001, we did 

not add any publicy-held debt in this country. Nor did we increase 

the debt limit. In fact, we were paying down debt.

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In 2002, we had to add $450 billion to the debt limit. In 2003, 

$984 billion was added to the debt limit. In 2004, $800 billion. Now 

in 2006 they want to add another almost $800 billion. 

So, unfortunately, an awful lot of what is going on here is being 

put on the charge card and increasingly it is a charge card that is 

owed to foreigners. 

I would just ask, Mr. Marron, do you believe it is sustainable—

sustainable to have this growth of debt held by foreign entities? We 

had 100 percent increase, more than 100 percent, in 5 years. 

Mr. MARRON. If I think about it in terms of the current account 

deficit and what would be sustainable on that front, which essentially translates into the debt as it builds, our analysis suggests 

that if the current account deficit were to hold at its current level 

in nominal dollar terms, and therefore decline over time as a share 

of the economy, that would probably return back to a sustainable 

level. But if it stays the same, relative to the size of the economy, 

over time that would be extremely difficult to sustain. 

Senator CONRAD. I deeply believe that the combination of our 

trade deficit and our budget deficits, especially in light of the demographic time bomb that is coming at us, this is utterly 

unsustainable. 

I would just ask you, on the question of budget policy, do you believe, Mr. Director, that there is an imperative for us to act on 

these long-term imbalances in our budget accounts? 

Mr. MARRON. Sir, the long-term situation would seem to be 

unsustainable, and I think I am well within the range of what CBO 

Directors and Acting Directors are allowed to do if I were to say 

that addressing those earlier rather than later is probably helpful 

for everyone involved. 

Senator CONRAD. I know the Chairman believes that. I certainly 

believe it. The quicker we get at this, the better. And I hope that 

is the conclusion that comes from this hearing. 

Chairman GREGG. Thank you. 

I also think that is the conclusion that comes from this hearing, 

so that is a good place to stop. 

We appreciate your testimony and we thank you for your time 

and for your professionalism and the professionalism of your organization. It is very important to us as a Congress to have a fair 

arbiter out there, and you are it. 

Thank you. 

Mr. MARRON. Thank you. 

[The prepared statement of Mr. Marron follows:]

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Senator CONRAD. You have done a very good job. 

Chairman GREGG. The hearing is adjourned. 

[Whereupon, at 11:33 a.m., the committee was adjourned.]

PREPARED STATEMENTS SUBMITTED


26726.032
(73)

THE PRESIDENT’S FISCAL YEAR 2007 BUDGET 

PROPOSAL 

TUESDAY, FEBRUARY 7, 2006

U.S. SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to notice, at 3:03 p.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Judd Gregg, chairman of the committee, presiding. 

Present: Senators Gregg, Domenici, Allard, Bunning, Cornyn, Alexander, Conrad, Murray, Wyden, Johnson, Byrd, Nelson, 

Stabenow, and Menendez. 

Staff present: Scott B. Gudes, Majority Staff Director and Dave 

Pappone, professional staff member. 

Mary Ann Naylor, Staff Director and John Righter, deputy staff 

director & commerce and housing credit. 

OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

Chairman GREGG. We will begin the hearing, and we certainly 

appreciate the Director of the Office of Management and Budget, 

Josh Bolten, being here today, someone whom I have great simpatico for because I think he is the only person in the city who upsets more people than I do just by showing up. Well, actually, Senator Bunning actually beats us both. 

[Laughter.] 

Chairman GREGG. Director Bolten has a very difficult job in a 

very complex and challenging time, which is putting together the 

budget of the United States. It is always hard to believe that a 

budget that spends $2.7 trillion is attacked for not spending 

enough. And yet that happens. And it is a complex budget in that 

it addresses today’s problems, but it also has to address next year’s 

problems and the year’s after that. 

I want to thank the Director, speaking on behalf of the President—not me, but the Director representing the President, for having put in play what I consider to be the biggest public policy issue 

which we have as a Nation beyond the question of fighting terrorism, and that is the issue of how we deal with the retirement 

of the baby-boom generation, which we know is going to cost us an 

extraordinary amount of money as a Nation because the size of the 

generation is so huge, and the effects of that generation’s demand 

on their children and their children’s children relative to services 

for their retirement in the area of pensions and health care is going 

to overwhelm us. 

74

The estimates from the Comptroller’s office, which is a fair arbiter on this issue, is that the unfunded liability of Medicare, Medicaid, and Social Security exceeds $47 trillion. That is over the actuarial life of those programs, 75 years. That is a hard number to 

comprehend, $47 trillion, but to try to put it in context, all the 

taxes raised in the United States since the beginning of our Government represent less than $47 trillion. The entire net worth of 

this country—everybody’s car, house, stock, assets—is only $43 trillion, I believe. So we actually have on the books a debt that exceeds our net worth as a Nation. And it is not going down. 

Last year, we put our toe in the water on this issue with a reconciliation bill which for the first time started to address mandated 

costs, which are health care and pensions. That passed, after a 

long, tortuous route, just a week or so ago, $40 billion over the next 

5 years, a reduction in the rate of growth of the Government. 

It had in it good policy, especially on the issue of Medicaid. This 

committee does not have any jurisdiction over Social Security by 

law. But we do have jurisdiction over the issues of health care, and 

so I respect and thank the administration for being willing to step 

forward on the issue of Medicare this year. Last year, there was 

some reticence to do that. This year, the budget addresses it, using 

what I think are fairly reasonable proposals, especially in the context of the overall Medicare spending. You are asking for, I think, 

$35 billion in a slowing of the rate of growth of Medicare. That 

means Medicare, instead of growing at 8.1 percent every year for 

the next 5 years, will grow at about 7.7 percent. And those reductions in the rate of growth are, as I understand it, a function of 

proposals that came forward from a bipartisan health care policy 

group, MedPAC, which is a highly respected organization and 

which should be listened to. 

So I respect the administration’s proposals there. I also respect 

the fact the administration understands that we are fighting a war 

and we have to do whatever is necessary to give our troops the support to accomplish that effort. 

So we have a budget before us that obviously none of us really 

like in concept, but, in fact, it is something that we have to go forward with. We would rather not have a deficit projection of over 

$400 billion, but we understand, in light of what happened in 

Katrina and in light of the war we are fighting for our own survival as a Nation, that there are expenses we have to incur. 

But we also have a budget that at least sets us on a policy road 

to try and address what I consider to be our biggest public policy 

issue, which is the question of how we deal with the responsibility 

of paying for the next generation that is about to retire, the babyboom generation. 

So I congratulate you for that, and I thank you for being willing 

to take the time to appear before this committee, and I will turn 

to the Senator from North Dakota for his thoughts, and an occasional chart, I am sure. 

[Laughter.] 

Chairman GREGG. Then we will hear from the Director. 

75

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD 

Senator CONRAD. First of all, thank you, Mr. Chairman. Thank 

you for calling this hearing. Thank you, Mr. Director, for being 

here. It is always good to see you, and I enjoyed our visit the other 

day as well. 

I think you know pretty much my criticism of the budget is that 

it is really not coping or facing up to the fiscal imbalances that we 

face as a Nation. In fact, I think the President is doing an enormous disservice to the country by not putting before the American 

people how serious these long-term challenges really are. 

Let me just point out that these are the things left out of the 

President’s budget. He does not have full 10-year numbers. He does 

not have Iraq war costs beyond 2007. He does not have the cost of 

fixing the alternative minimum tax. And he does not have spending 

policy details beyond fiscal year 2007, something that has typically 

been provided.

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Let’s go to the next slide, if we could. 

The long-term war costs are substantially underfunded. The 

President has $120 billion in 2006 and 2007. The Congressional 

Budget Office says the additional outlays that are necessary are almost $300 billion.

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Let’s go to the next. 

Probably the area that the President is, I think, doing the poorest job in alerting the American people as to the full costs of his 

proposal is in the area of extending his tax cuts and the other tax 

cut proposals that he has made. This dotted line is the 5 years of 

the budget. You can see the President’s tax cut proposals explode 

beyond the 5-year budget window, and this pattern is very consistent, whether it is war costs or the tax cut or—let’s go to the 

next slide—the alternative minimum—the cost of reforming the alternative minimum tax, the old millionaires’ tax, it is now rapidly 

becoming a middle-class tax trap. The President has no funding for 

AMT reform beyond fiscal year 2006. So he is not facing up to any 

of this cost. It is $1 trillion with debt service, 10-year cost. It is not 

in the President’s budget. That is not a real budget.

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Let’s go to the next. 

The President says, well, don’t worry, we are going to cut the deficit in half over the next 5 years. That is this projection. But when 

you add back the things he has left out—the full costs of the war, 

the need to fix the alternative minimum tax, the full cost of his tax 

cuts—this is the pattern that we see. And the deficit gets a little 

bit better between now and 5 years from now, but then it falls off 

the cliff.

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Let’s go to the next. 

This is what the President said in 2001: ‘‘My budget pays down 

a record amount of national debt. We will pay off $2 trillion over 

the next decade. That will be the largest debt reduction of any 

country ever.’’

Then he said something I agree with very strongly: ‘‘Future generations should not be forced to pay back money that we have borrowed. We owe this kind of responsibility to our children and 

grandchildren.’’ The words were good. The performance has not 

been good.

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This is my final point. This is what has happened since the 

President took office on the debt. There is no paydown of debt 

going on here. The debt is exploding. At the end of his first year 

in office, the debt was $5.8 trillion. That has gone up. At the end 

of this year it will be $8.6 trillion, and our projections now say in 

the next 5 years, if the President’s policies are followed, the debt 

will reach $12 trillion—a doubling of the national debt—a doubling—before the baby boomers retire. That to me is a course that 

just is not sustainable, and it should not be supported.

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I thank the Chair. 

Chairman GREGG. Thank you, Senator Conrad. 

We would like to hear from the Director now. Give us your 

thoughts, and then we will ask you some questions. 

STATEMENT OF HON. JOSHUA BOLTEN, DIRECTOR, OFFICE OF 

MANAGEMENT AND BUDGET 

Mr. BOLTEN. Mr. Chairman, Mr. Conrad, other distinguished 

members of the committee, the President’s 2007 budget, which I 

transmitted to the Congress on the President’s behalf on Monday, 

meets the priorities of the Nation and builds on the progress of the 

last 5 years. 

Before getting to the 2007 budget, I would like to take a moment 

to review the substantial accomplishments in spending restraint we 

were able to achieve together over the past year. We have put up 

on the screens for you, Mr. Chairman—and I thank you for the 

technology. 

Chairman GREGG. This is a very high-tech committee. 

Mr. BOLTEN. It is indeed, sir.

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Last year’s budget, the 2006 budget of the President’s, had four 

major objectives: 

First, the President proposed to hold growth in overall discretionary spending below the rate of inflation. 

Second, he proposed an actual cut in the non-security portion of 

discretionary spending, the first such proposal since the Reagan administration. 

Third, he proposed major reductions or eliminations in 154 Government programs that were not getting results or not fulfilling essential priorities. 

And, fourth, he proposed reforms in mandatory programs to 

produce $54 billion in savings over 5 years. 

The Congress substantially delivered on all four of these objectives, as the chart on your screen shows in the second column. I 

would like to thank you, Mr. Chairman, in particular, and the 

members of this committee for your leadership and dedication in 

helping achieve those goals that are reflected in the second column 

on the chart on the screen. 

When President Bush gave me guidance on what the 2007 budget should look like, he directed me to build on last year’s progress 

by focusing on national priorities and tightening our belt elsewhere. He told me to give our troops and those who defend our security what they need to fight and win the global war on terror. 

And he emphasized that the 2007 budget must support our progrowth economic agenda. 

In particular, he said we should maintain our economic strength 

by extending the tax relief that has fueled our economic expansion 

and by aggressively restraining spending. Yesterday, I presented 

on the President’s behalf a budget that does just that. 

In the past 5 years, our economy suffered a historic series of 

shocks, starting with the recession and the terror attacks of 2001 

and continuing through the hurricanes of last summer. Those 

events had profound impacts on job creation and on the fiscal outlook. 

Despite these challenges, thanks to the productivity and hard 

work of the American people, our economy, as the chart on the 

screen now shows, is expanding at a healthy pace. In 2005, the 

economy grew by an estimated 3.5 percent—the third consecutive 

year of healthy growth. And as you can see on the chart, we project 

ongoing economic strength for the next several years. Economic expansion has produced more than 4.7 million new jobs since May 

2003, reduced the unemployment rate to 4.7 percent, and raised 

homeownership to all-time highs.

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This economic growth would not have been possible without the 

tax relief that you in the Congress passed and the President 

signed. The tax cuts—which were fully implemented in May 2003—

have been critical to helping the economy recover from the recession and terrorist attacks of 2001—and then helping the economy 

to continue expanding despite the hurricanes and high energy 

prices of the past year. 

With the tax cuts fully implemented in 2003, the economy responded strongly and tax receipts rebounded. As you can see on 

this chart, receipts grew substantially in 2004. What that reflects 

is 5.5 percent growth between 2003 and 2004. In 2005, receipts 

jumped by a remarkable $274 billion, or 14.5 percent, the largest 

increase in 24 years. These recent gains in receipts confirm that a 

strong economy is the most important factor in reducing the deficit.

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The chart on the screen now shows our progress in bringing 

down the deficit. Since the President set a goal of cutting the deficit in half from its projected peak in 2004 of 4.5 percent of GDP, 

the deficit has come down markedly. The final 2004 deficit was 3.6 

percent of GDP, and fueled by the surge in receipts I just mentioned, the 2005 deficit fell further to 2.6 percent of GDP. 

Although revenues are projected to continue to rise in 2006, the 

deficit for the current fiscal year is now projected to come in at 3.2 

percent of GDP, or in nominal terms, $423 billion, which is more 

than previously expected. This is in significant part due to the unanticipated spending associated with the relief and recovery efforts 

from Hurricanes Katrina and Rita. While this increase in the deficit is unwelcome, at 3.2 percent of GDP that projected deficit 

would be well within the historical range and smaller than the deficit in 11 of the last 25 years. 

More importantly, we project that if the policies in the President’s budget are adopted, the deficit will return to its downward 

trajectory. We forecast a decline in the 2007 deficit to 2.6 percent 

of GDP. By 2009, the deficit is projected to be cut by more than 

half from its projected peak to just 1.4 percent of GDP, well below 

the 40-year historical average of 2.3 percent of GDP. 

In order to keep the deficit on this declining path, we must continue to do two things: first, keep the economy growing; and, second, restrain spending. 

First, the 2007 budget supports continued economic growth by 

proposing to make permanent the tax relief signed into law by the 

President in 2001 and 2003. Some have argued that we should let 

the tax relief expire. A tax increase is the wrong prescription, not 

only for the Nation’s economic health, but for the Treasury’s fiscal 

health as well. 

We are not an undertaxed society. By rejecting tax increases on 

families and small businesses, this budget will help keep the economy on a continuing course of job creation and strengthen the foundations for long-term growth. 

The second critical component of deficit reduction is a vigorous 

policy of spending restraint. Similar to last year, the 2007 budget 

again holds overall discretionary spending growth below the rate of 

inflation. That is reflected in the last column on the chart on the 

screen now. It again proposes a cut in non-security discretionary 

spending. It calls for major reductions in or total eliminations of 

141 Federal programs, saving nearly $15 billion. And it continues 

our efforts to slow the growth in spending on mandatory programs, 

by proposing $65 billion in savings over 5 years.

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These efforts to restrain the growth in mandatory spending are 

vital—not just for our near-term deficit reduction efforts, but especially for the long term. The chart on the screen now displays our 

long-term situation. Toward the end of the next decade, deficits 

stemming largely from entitlement programs such as Social Security and Medicare will begin to rise indefinitely. No plausible 

amount of spending cuts in discretionary programs or tax increases 

could possibly solve this problem.

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The President has shown a willingness to take on these future 

unfunded obligations and to propose long-term reforms. This year’s 

budget proposes $36 billion in savings from Medicare and includes 

proposals that pave the way for additional reforms in the future. 

As with Social Security and Medicaid, we do not need to cut Medicare, but we do need to slow its growth. And this budget beings to 

do just that. 

In addition, the 2007 budget contains proposals to significantly 

improve the budgetary process. The budget proposes discretionary 

spending caps as well as restraints on new mandatory spending. 

The administration is also pleased that the congressional leadership is focused on the need for reform of earmarks in the budget 

process. One way we can address the excessive use of earmarks together is by Congress giving the President the line-item veto. 

The 2007 budget, Mr. Chairman, also continues our efforts to improve performance and make sure the taxpayers get the most for 

their money. Using the President’s Management Agenda, OMB 

measures success not by good intentions or by dollars spent but, 

rather, by results achieved. 

As part of these efforts, OMB introduced just yesterday a new 

website called ExpectMore.gov. ExpectMore.gov allows taxpayers to 

review the OMB assessments of nearly 800 Federal programs. You 

can search the programs by rating, topic, or by a simple keyword. 

I urge you and your staffs to make use of this new resource. 

This management agenda, coupled with the restraint reflected in 

the President’s 2007 budget, will help ensure that taxpayer dollars 

continue to be spent wisely, or not at all. 

Mr. Chairman, I would be happy to take your questions. 

Chairman GREGG. Thank you. Could you leave that chart up, 

that last chart you had, present trends are not sustainable? 

Picking up on that point, if you look at this chart—and your 

black line is historic revenues, obviously. 

Mr. BOLTEN. Yes. Historic revenues are about 18.2 percent of 

GDP. 

Chairman GREGG. It is fairly obvious that at some point in the 

not too distant future—within all of our lifetimes in this room, 

theoretically—we are going to have a cost of Government as a result of mandatory spending that exceeds the historic revenues of 

tax revenues, correct? 

Mr. BOLTEN. Correct. At some point, and on this chart——

Chairman GREGG. About 2035. 

Mr. BOLTEN. About 2035, we would need to spend all of our revenues just to pay for the mandatory programs with money left for 

nothing else. 

Chairman GREGG. And that would mean we would have no 

money left for national defense, for building roads, for environmental protection, for education. 

Mr. BOLTEN. Correct. 

Chairman GREGG. Because those are mandatory programs. And 

so the way out of that is either, one, to raise the historic revenue 

obligation of people, which would mean dramatically increasing 

taxes on our children and grandchildren, right? 

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Mr. BOLTEN. I suppose, although I don’t think there is any precedent in history for tax rates at the level that would be necessary 

to actually close the gap. 

Chairman GREGG. So you essentially cannot tax your way out of 

this. 

Mr. BOLTEN. I do not believe so, and the damage to the economy 

would be enormous and would probably affect revenues in the long 

run. 

Chairman GREGG. So the way you need to address this is by reforming the programs that are going to basically drive this issue, 

which is the major entitlement programs of Social Security, Medicare, and Medicaid. 

Mr. BOLTEN. Absolutely, Mr. Chairman. 

Chairman GREGG. And your budget really does not do a whole 

lot in this area, but it does more than anybody else has attempted 

to do, so I congratulate you for that, which is $35 billion in the 

Medicare accounts. 

Can you explain to us what the policy is behind that proposal, 

where it came from and why you think it is reasonable to make 

that type of change and what the base is? In other words, that $35 

billion over 5 years compares to total Medicare spending of how 

much over 5 years? 

Mr. BOLTEN. I don’t recall the total Medicare spending. One of 

my colleagues may be able to give that to us. But on the 10-year 

window that we looked at, if the President’s Medicare proposals 

were adopted, the rate of annual growth in Medicare spending 

would decline over the next 10 years from about 7.8 percent per 

year to about 7.5 percent per year. So it is a relatively modest decrease in a very rapidly growing program. Most of the savings in the $36 billion that the administration has proposed—and that is a 5-year number, the $36 billion savings is. 

Chairman GREGG. So it works out to about $7 billion a year. 

Mr. BOLTEN. Roughly, over the 5 years, although it expands in 

the later years. 

Chairman GREGG. Right. 

Mr. BOLTEN. Most of the 5 year savings, that we would achieve 

in our proposals would come from a very modest reduction in the 

market basket by which the Medicare providers are given their annual update. The proposals that we carry in the reduction in the 

market basket were recommended by or build upon the themes of 

the independent MedPAC Commission, which, as you know, Mr. 

Chairman, is an independent Commission that is appointed by the 

Comptroller General of the United States and makes its own recommendations. The kinds of savings we are proposing——

Chairman GREGG. On MedPAC, I think it is important to understand who the MedPAC group is, because this is where the essence 

of your proposal comes from. They are health care professionals 

and policy professionals. They are not in any way partisan. Is that 

correct? 

Mr. BOLTEN. No, and they have no connection to the executive 

branch that I am aware of. 

There are several other proposals within the Medicare $36 billion 

that we have on the table. For example, we are proposing that clinical laboratory services be handed out on a competitive basis, which 

101

is not required to happen now. Most of those are relatively small 

in comparison to the market basket changes we are talking about. 

I should emphasize, in closing my response on this point, Mr. 

Chairman, that your initial point is just right. This is just a downpayment on the broader reform that needs to be undertaken in 

Medicare. This is a modest first step that I hope we can all agree 

on and then come together on more fundamental reform that is 

needed to really change the trajectory of that first chart you asked 

me to put back up. 

Chairman GREGG. Well, I think that is important to understand, 

and I think that chart there—for anybody who is involved in public 

policy and has an obligation to the next generation—and it is really 

our generation that has created the problem, the baby-boom generation. That chart there is a stunning statement of what we need 

to confront. And if we leave this job of public policy without having 

confronted that, we won’t have done our job but, more importantly, 

we will have given our kids a very difficult hand to deal with in 

their future. 

At this point I yield to the Senator from North Dakota. 

Senator CONRAD. Let me just that this is the point on which we 

agree. I agree with the chairman completely in terms of we are on 

a course that is not sustainable, and my deep regret is I think the 

President’s budget does nothing to get us on a more sustainable 

course. In fact, as I examine the President’s budget, I think he 

makes the situation a whole lot worse when you put in the things 

he has left out. 

Let me ask you this: What was the gross debt of the United 

States when the administration came into office? 

Mr. BOLTEN. I believe you had the figure on your chart, Mr. 

Conrad. 

Senator CONRAD. Would you agree with that figure? 

Mr. BOLTEN. I don’t have any basis to disagree with it. I always 

enjoy your charts. 

Senator CONRAD. The debt was $5.8 trillion at the end of his first 

year. I do not hold him responsible, obviously, for the first year because other policies were in place. But since that time, he said we 

were going to have maximum paydown of the debt, but here is 

what has actually happened. Year over year, the debt just goes up, 

up, and up. And at the end of this year, can you tell us what you 

think the debt will be at the end of this year? 

Mr. BOLTEN. I don’t have any reason to disagree with what is on 

your chart, Mr. Conrad. 

Senator CONRAD. $8.6 trillion. We are just under $8.2 trillion 

today and headed for $8.6 trillion at the end of this year. That is 

the projection. Maybe actually somewhat more than that. 

What is your projection for 2011? 

Mr. BOLTEN. $11.5 trillion is the projection we hold. 

Senator CONRAD. We actually see the debt somewhat more than 

you are projecting by 2011. We think it is going to be $12 trillion. 

But let’s take your projection. The debt of the country will more 

than have doubled during this administration. In other words, it 

took 224 years to run up over $5 trillion of debt, and in the next 

10 years—the 8 years of this administration included in that 10 

years—the debt will more than double. Isn’t that right? 

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Mr. BOLTEN. When you combine the debt held by Government accounts and publicly held debt, yes. 

Senator CONRAD. Well, to me that is——

Chairman GREGG. Are you giving us a couple extra years in this 

administration, to 2011? 

[Laughter.] 

Senator CONRAD. No, but, you know, this is their 5-year budget. 

It is not anybody else’s. It is theirs. They are putting us on a 

course to run up the debt in this way. 

To me, it is just a failing grade. It is a failing grade. This administration proposes more spending and more tax cuts when we cannot pay our bills already. And the result is the debt is jumping very 

dramatically. This is what the debt is doing. Let’s show that other 

chart. 

Increasingly, this debt is being bought by foreigners. When we 

hold a bond auction, increasingly the debt is being bought by these 

countries: Japan, now over $680 billion; China, over $250 billion. 

Have we got that other chart that shows how the debt is—yes, that 

one right there. 

This is debt held abroad. It took 224 years and 42 Presidents to run up $1 trillion of debt held by foreigners. This President has 

more than doubled it in 5 years. 

Mr. Director, in your judgment, is this a sustainable pattern? 

Mr. BOLTEN. No, absolutely not, Mr. Conrad, and I am glad you 

are focusing on debt, on the long-term debt situation, because that 

is where our problem is. But the problem is not one of discretionary 

spending accounts. It is not one of being undertaxed. The problem 

and the reason why we have this exploding debt situation going out 

indefinitely into the future is a problem of the entitlement programs that I have been just been addressing with the chairman. 

Now, the President has put on the table measures to address the 

fundamental problems in our entitlements. He put on the table last 

year fundamental Social Security reform. We didn’t get very far 

with it, but as the President said in his State of the Union, this 

problem is not going away, and the President is——

Senator CONRAD. Well, let me just ask you, on that proposal, did 

that increase the debt or reduce the debt? 

Mr. BOLTEN. Over the long term, that proposal would have put 

Social Security on an entirely sustainable basis. 

Senator CONRAD. Well, you are talking a long term in which everybody is dead. In the foreseeable future, what that proposal did 

was add another $800 or $900 billion to the debt because it 

doesn’t—you know, the President, he has a bad habit here. This administration has a bad habit. Every question, the answer is to borrow money. We are going to have tax cuts? We are borrowing the 

money from China and Japan to give tax cuts here. You need more 

money for defense? We borrow money from China and Japan. 

I tell you, that to me is not a way to strengthen the country. And 

when we talk about it is all on the spending side of the equation, 

that is not what the evidence reveals. This is going back to 1980. 

The red line is the spending line. The green line is the revenue 

line. The red line was coming down each and every year until this 

administration. Under this administration’s watch, spending has 

jumped. 

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On the revenue side of the equation, the revenue was going up 

until this administration, and the revenue side of the equation has 

collapsed. The result is massive deficits. This gap represents the 

difference between what we are spending and what we are raising. 

And under this administration, you keep spending more, but you 

are not raising the money to pay for the spending. 

Let me just conclude on this thought: instead of raising taxes as 

the first notion of how to get additional revenue, I wish we were 

more aggressively going after this tax gap, the difference between 

what is owed and what is being paid. 

Could you tell us, how big is that tax gap now a year in your 

estimate? 

Mr. BOLTEN. Mr. Conrad, you will be more familiar with the estimates than I because you follow them very closely. I know Commissioner Everson has presented some estimates that run into the 

hundreds of billions of dollars of money that we should be collecting in revenues and are not. We are making strenuous efforts 

to try to close that gap. We have put proposals into our budgets 

in the last several years to improve enforcement. A lot of it means, 

though, going after a fairly heavy dose of fraud that is going on in 

the Medicare and the Medicaid programs, in the earned income tax 

credit. We do need to dig in on all of those measures, and I am very 

encouraged by your interest in closing that gap because the administration shares that interest completely. 

Senator CONRAD. Let me just say that the proposal from the administration is to collect about one in every 1,000 of those dollars. 

We have to do better than that. 

I thank the chairman. 

Chairman GREGG. Thank you. 

Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. First of all, I 

would like to put a statement into the record. 

Chairman GREGG. Of course. 

[The prepared statement of Senator Bunning follows:]

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Senator BUNNING. Josh, as released yesterday, in the budget for 

international affairs, the West Bank and Gaza are slated to receive 

$150 million. Is this funding going to be reviewed by the administration in light of the Hamas win in the recent Palestinian legislative council elections? 

Mr. BOLTEN. Yes, Senator. The budget was put to print before 

the elections were held. We are going to put a pause on that 

money, review it. Bear in mind that what is in the budget is 2007 

money, so it would not——

Senator BUNNING. I understand. 

Mr. BOLTEN. So it would not be money that would be available 

for some time. So we do have time to make an assessment of the 

situation——

Senator BUNNING. We do, too, and that is why——

Mr. BOLTEN. By ‘‘we,’’ I meant the administration and the Congress, and I imagine that that will be a subject of intense review. 

Under present circumstances, I would expect that Secretary Rice 

would want that to be reconsidered. 

Senator BUNNING. Just reading and listening to what she has to 

say. 

Mr. BOLTEN. Yes. 

Senator BUNNING. Also, the National Flood Insurance Program 

was created to generate enough revenue through premium dollars 

to prevent taxpayers from paying for disaster-related assistance 

due to flooding during an average flood loss year. Claim payments 

for flood damage from Hurricane Katrina will surpass any previous 

payments from the program at an estimated $23 billion. Under the 

current structure, assuming no major floods, it would take the program decades to repay the United States Treasury the necessary 

funds to pay off these claims. 

What changes would you suggest to improve the soundness of 

this program? 

Mr. BOLTEN. Senator, you are raising a very important issue that 

I think has been underappreciated in the context of the Katrina debate. It is an unsound system as it now stands. The Congress 

adopted last year $18 billion in borrowing authority for that program to meet its immediate needs. We need to go forward now in 

the next couple of weeks, I understand, to provide additional funds 

so that the Flood Insurance Program can pay off the legitimate 

claims that are now being made on it. 

The administration has sent forward proposals for fundamental 

reform in that program, which I anticipate will have to involve a 

reassessment of how we are calculating the premiums that people 

need to pay——

Senator BUNNING. We had a hearing today in——

Mr. BOLTEN [continuing]. And what the Federal liabilities need 

to do. 

Senator BUNNING. —Banking, so I know it is very important, but 

we have to have a pay-as-you-go program, and we are not getting 

it done. 

In 2004, CBO estimated that capital gains liabilities for 2004–05 

would be $98 billion, a $27 billion decrease from earlier projections 

made for those 2 years. When we look at CBO’s most recent report, 

it shows payments from capital gains taxes for $151 billion for 

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2004 and 2005, significantly higher than CBO estimated this time 

last year. I understand that when Congress cut capital gains in 

1997, actual 1997–98 capital gains revenue were about 11 percent 

higher than the original CBO estimates. Can you make a comment 

about this, please? 

Mr. BOLTEN. I can, Senator. What those data points reflect is 

that lowering the capital gains rate has had a very strong stimulative effect, not just on economic activity but also, it turns out, in 

our Federal revenues. One of the reasons why we had that spectacular increase in revenues in 2005, almost at 15-percent increase in 

revenues, was because we had much stronger than expected capital 

gains receipts. That is good news for the economy and one way that 

the tax cuts that you and the President have put in place have 

done a good job not only in restoring economic health but fiscal 

health to our economy. 

Senator BUNNING. Thank you very much. I yield 5 seconds. 

Chairman GREGG. Thank you. That is extremely generous. 

Senator Wyden. 

Senator WYDEN. Thank you, Mr. Chairman. 

Mr. Bolten, welcome. Given the administration’s interest in holding down the costs of entitlement programs, are you all willing to 

reconsider your opposition to lifting the restriction in Medicare so 

that Medicare can bargain to hold down the costs of medicine? It 

seems to me a particularly appropriate time for you all to re-examine this. We got 51 votes in the Senate as of the last vote for this. 

As you know, there have been huge problems in rolling out this 

benefit in the first few months. Are you willing to work with us on 

a bipartisan basis to re-examine the administration’s position with 

respect to bargaining power in Medicare? 

Mr. BOLTEN. I am going to let Secretary Leavitt engage in the 

detailed discussions with you, but when last I spoke to him, my understanding was that our assessment was that it would not, in fact, 

save the Medicare system money to allow the Medicare program 

itself to come in and buy the drugs. 

We are finding that the——

Senator WYDEN. That is just factually wrong. There is a CBO letter that says on single-source drugs alone, there would be savings. 

Mr. BOLTEN. I do not believe the administration agrees with 

that, but I will let Secretary Leavitt take it up with you directly. 

But something we are finding is that the Medicare Part D program 

is costing less than originally anticipated, and part of it is because 

of the competition that is occurring in the private sector, with the 

private sectors providers now engaged in delivering those services 

to our seniors. So that aspect of the program seems to be working 

pretty well. 

Senator WYDEN. I am going to move on. Let’s see what the costs 

are when people who are not automatically signed up start making 

these——

Mr. BOLTEN. I should say the jury is still out on how well the 

costs are going to come down, but the initial signs are hopeful. 

Senator WYDEN. The Bush budget proposal requires Bonneville 

Power to make additional payments to the Treasury if the agency’s 

revenues from power sales exceed $500 million per year. Now, out 

in our region, folks really say this is sort of like Government loanVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00112 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
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sharking. It would be requiring somebody to pay more in loan fees 

just because they are making more money. 

Now, my question is: Because the President says if you do not 

extend his expiring tax cuts, that is a tax increase. Wouldn’t it be 

correct under that reasoning that the administration’s budget proposal for Bonneville is a rate increase because you are not extending a current policy that keeps Bonneville’s rates from going up in 

the future? 

Mr. BOLTEN. No, I don’t think so. What the policy does is say 

that if—and I am sure, Senator—you and I have had a chance to 

talk about this in the past some, but what the policy does is say 

that the Bonneville rates within the customer area are substantially below those in the neighboring districts, that when Bonneville sells power into those other districts at prices that are well 

above its costs—I think into California it is about twice its costs 

right now—the additional revenue that comes in to Bonneville from 

that can be used, as it has been, to lower the rates even further 

for Bonneville customers, which is a good thing. We like to see low 

energy rates for everybody in the country. But what we are asking 

is, that when those revenues exceed $500 million a year, that the 

extra money be used to pay down Bonneville’s Treasury debt, 

which we believe in the long run will enhance the soundness and 

stability of BPA and make it possible, with some ancillary proposals for BPA, to make investments in an infrastructure that in 

the long run will actually reduce the rates for Bonneville customers. 

I think this is a sound Government proposal that will not have 

any significant detrimental effects on Bonneville’s customers even 

in the short run. 

Senator WYDEN. You will find unanimous opposition in our region, Democrats and Republicans, to your views on that. 

One last question, if I might. Why are you all upending the most 

successful forestry law in decades? The Forest Service itself says 

that our county payments law, which is the law, of course, that replaces the money we used to get through Federal timber receipts, 

has brought together people who have never talked before—the 

timber industry, the environmentalists, local government. 

Your proposal would cut the revenue by more than 50 percent. 

We are very concerned about the prospect of an ideological fight 

through these land sales. I would just like you to set out for the 

record, Why do you all want to, as the kids say, ‘‘mess with success’’? 

Mr. BOLTEN. Senator, the original program was designed to be a 

transitional program to assist those communities that were hard 

hit by the sudden drop-off in timber receipts. It has been successful 

in that regard. 

The administration believes that we can carry through that success with our proposal, which is to reauthorize the law, which does 

expire. Going back to our conversation about expiring and not expiring, this program was intended to expire. It does expire. The administration is proposing that it be continued at a phasing out rate 

of subsidy to these communities. We believe that this can be done 

responsibly and that it can be done on a revenue neutral basis if 

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lated, unused, and so on. We think that this can all be done responsibly within a responsible budget, because all of the difficulties 

I have talked about with the chairman and Mr. Conrad and the 

other members suggests that we are in a constrained budget situation. We need to achieve savings where we can, and this is an area 

where we believe we can responsibly go forward with the program 

but do it on a revenue-neutral basis. 

Chairman GREGG. Senator Alexander. 

Senator ALEXANDER. Thank you, Mr. Chairman. 

Director Bolten, thank you for coming. Senator Conrad was talking about bad habits. I wanted to congratulate you for encouraging 

us toward some good habits last year with the suggestion that we 

slightly restrain the growth of Medicaid and the suggestion this 

year that we slightly restrain the growth of Medicare. And I would 

urge for your consideration as a part of the management part of 

your job S. 489, which is a bill sponsored by Democrats and Republicans that would give States and local governments more ability 

to terminate outdated Federal court consent decrees so that as we 

change our policy and our rules, they are able to respond and set 

their own priorities. 

But it was after these hearings last year that I sat down with 

Senator Domenici and Senator Bingaman, and we said to ourselves 

if all we do over the next 10 years is spend our money on war, welfare, Medicare, Medicaid, disasters, and debt, we are not going to 

have an economy strong enough to pay for all those urgent needs. 

And we asked the National Academy of Sciences exactly what 

should we do to keep our edge in science and technology so we can 

keep our jobs from going overseas and so we can have the kind of 

weaponry we need to win the war against terrorism and the technology to deal with health care. And I am very pleased that the 

President is off to a good start, and in the Senate we now have 60 

Senators—30 Democrats, 30 Republicans—in support of the recommendations of the National Academies. 

I wondered if you would want to comment on the rationale for 

the good financial start for that initiative in this tight budget and 

the level of the President’s ongoing commitment to this competitiveness issue. 

Mr. BOLTEN. Yes, Senator Alexander, thank you. And thank you 

for your and Senator Domenici’s commitment to the competitiveness of this country and to the initiative that the President included in his State of the Union address and that is prominent in 

our budget. The conversations that the two of you have had directly 

with the President I know were substantial contributors to the 

final result. 

The President’s proposal is recognizing that a critical part of 

maintaining our competitive edge in an increasingly competitive 

world is that we continue to lead in basic science, which is the underpinning of all of the major technological advances that have 

made this economy the envy of the world. 

To that end, the President’s proposal is that over the next 10 

years we double funding to those successful agencies that are at 

the core of Government’s basic science research—the National 

Science Foundation, the Department of Energy’s Science Program, 

and NIST at the Commerce Department. So the President’s budget 

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proposal reflects progressively over time, over the next 10 years, a 

doubling of spending in those areas. We believe that that is money 

very well spent, particularly because these science programs, if 

they can avoid earmarks, are done on a competitive basis. And they 

do a very good job, when they are left with a free hand, of handing 

out money to the most promising scientific projects. 

Second, the initiative involves a permanent extension of the research and experimentation tax credit, which has been so important to private industry. And, third, the initiative involves an education element that you and Senator Domenici and others, including Norm Augustine, the Chairman of the National Academy of 

Sciences panel that you helped get underway and bring prominence 

to. This country is falling behind in math—has fallen behind in 

math and science education for our children. The President’s budget includes a $380 million investment in improving math and 

science education in the United States and ensuring that those who 

have an interest in math and science have an opportunity to pursue those interests in higher education. 

Senator ALEXANDER. Thank you very much. I have one other 

short question. I believe I see in the budget that there is no funding to help States pay for the REAL ID legislation that we passed 

last year. This is a law to deal with border security that imposes 

a lot of responsibilities on States and State budgets. I think it tries 

to turn driver’s license examiners into CIA agents. And it is going 

to be very expensive. The National Conference of State Legislatures 

suggests it will cost $100 million a year. 

Now, I believe that if we impose a mandate on the States, we 

ought to pay the bill. And I am wondering why in a $30-billion-plus 

homeland security budget we do not include a sufficient amount of 

money, which is estimated at $100 million a year, to help the 

States pay to implement the REAL ID legislation. Senator Gregg 

got passed last year a 60-vote point of order for unfunded Federal 

mandates, and this violates the spirit of that. 

Mr. BOLTEN. Senator, I am not familiar with the details of the 

mandate on REAL ID that the legislation imposes or how we are 

proposing to fund that. I would like to come back to you for the 

record on it.

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The one thing I would say is that while the administration very 

much supports the notion that unfunded mandates ought not be 

imposed on the States when the Federal Government is not willing 

to put money behind them. There are already a lot of unfunded 

mandates in the law, and there is already in the law a lot of spending in the Federal budget that is a essential form of revenue sharing that goes out to the States. One of the things that the President directed me to look at, as we looked at the 2007 budget, is 

are we being sensible with all the dollars that are being sent out 

to the States, especially when State treasuries are in most cases in 

much better health now than they were a few years ago, largely 

a product of the improving economy the tax cuts you enacted 

helped trigger. The State treasuries are in the kind of situation 

where they ought to pick up more responsibility from the Federal 

Government. I don’t know whether this is a good case for that particular situation on the REAL ID or not, but I think it is fair to 

say that overall in the budget, when the Federal Government is 

dealing with Federal responsibilities like fighting the global war on 

terror and responding to Hurricane Katrina and so on, that it is 

fair to expect the States to pick up a larger share of the burden. 

Chairman GREGG. Senator Murray. 

Senator MURRAY. Thank you very much, Mr. Chairman. I appreciate the opportunity to hear from Director Bolten on the President’s 2007 budget request. 

I do have a number of concerns. I actually sent you a letter, January 31st, and I hope that I get a response on that, and a number 

of my questions. Let me just start by saying I would really have 

to concur with the remarks of our ranking member regarding this 

budget. This plan assumes the largest deficit in the history of the 

country, and yet it assumes over $1 trillion in new tax cuts. It does 

not show us the true costs of our commitments in Iraq, and really, 

from my point of view, really fails America’s children in the cutbacks in education, and our poor, the citizens who are most vulnerable who count on Medicaid funding, and really our seniors, with 

the proposed cuts in Medicare, I really see it as a budget that kind 

of forces a huge burden on those who can least afford it. 

And there is one thing I can say about this budget, it is not a 

shared sacrifice budget, so I have a lot of real concerns. I know this 

year, here we are back. It is February already. We are still dealing 

with last year’s budget and appropriations through the Budget 

Revenue Reconciliation and Debt Ceiling, we are being asked to 

still work on. I think we need to remember on this Budget Committee, that it starts with the budget process, and when we have 

an unrealistic budget, we end up 2 days before Christmas here unable to pass our appropriations bills. 

As ranking member on the Transportation, Treasury, Housing, 

Urban Development, Judiciary Branch—I think it is the one that 

oversees OMB as well, you know it well—we are going to be facing 

a very, very tough situation, and I will be working with Senator 

Bond, but I think it we do not invest in our transportation infrastructure, we are hurting our economy in the future, so I have 

more about that. 

But I did specifically want to ask you, Director Bolten, today 

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retary Nicholson, so we can prevent some of the budget shortfalls 

that we saw in 2005 and 2006. You may know that the GAO is 

doing an analysis on the VA’s medical services budget modeling, 

and one of the initial major findings has been—and I want to read 

it to you—‘‘VA’s internal process for formulating the medical program’s funding request was informed by but not driven by projected demand.’’ How do you justify a VA budget request that is not 

based on demand of services? How do we send that message to our 

men and women in uniform? 

Mr. BOLTEN. Well, the budget, I believe, is based on projections 

of what we expect the demand to be. There was an error made last 

year, that you, among many members——

Senator MURRAY. Has the budget modeling been revised then to 

reflect the——

Mr. BOLTEN. Yes. I believe that that is an ongoing process of improving the budget modeling, but I believe that the errors that 

were in the modeling process last year that caused those errors 

have been corrected. 

Senator MURRAY. I would like to specifically see that, because 

that is one of the things we were deeply concerned about is that 

the VA budget has to be based on real numbers and not just guessing. We know that the model was not correct, so I would appreciate——

Mr. BOLTEN. Sure. And my folks have worked hard with the folks 

at the VA to try to make sure that the modeling is better. You were 

among the many members that helped us put through a correction 

to an underestimate to how much demand there would be in the 

VA system. 

I should point out that this year’s budget for the VA in health 

care is about a 9 percent increase. 

Senator MURRAY. Right. I saw that and I appreciate that, and I 

have had a chance to talk to many of the VSOs out there who appreciate that, but one of their biggest concerns is that a lot of that 

increase is based on fees and copays that are again proposed by the 

administration. In fact, Secretary Nicholson and his staff have 

made it really clear that part of the purpose of that is to keep 1.1 

million vets from enrolling in the VA and prevent 200,000 vets 

from accessing care. That is part of their goal with those fees. Well, 

for one thing, none of our men and women who signed up to service 

were told that, ‘‘You will get health care services based on your income later in life.’’ It was, ‘‘You will serve our country and we will 

be there for you.’’

But there is another challenge here, and that is, having been 

around my State and holding a number of forums on the Medicare 

Prescription Drug, a lot of people who are calling about the Medicare program to Department of Health and Services are being 

asked, ‘‘Are you a veteran?’’ And if their answer is yes, they are 

saying, ‘‘Well, do not do this prescription drug thing. Go to the VA.’’ 

So it seems to me we kind of have two contradicting efforts here. 

We have Secretary Nicholson and his staff who are trying to lower 

the number of vets who are accessing VA through these copays and 

fees, and meanwhile over on the other side we have HHS who is 

telling everybody to go to the VA. How do you deal with that contradictory message? 

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Mr. BOLTEN. I am not sure about the contradiction. The purpose 

of the fees is not to drive people out of the system, but rather 

to——

Senator MURRAY. Actually, that has been made pretty clear from 

the VA, that one of the reasons that they are proposing these fees 

is to lower the access. 

Mr. BOLTEN. Well, if I can just back up for a second and say a 

word about the levels of VA medical care funding over the course 

of this administration. As the chart that has just been put up on 

the board shows, VA medical care funding has increased over the 

course of this administration.

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Senator MURRAY. Right. 

Mr. BOLTEN. In our current budget, what that will lead to is an 

almost 70 percent increase overall in the——

Senator MURRAY. No surprise. The cost of health care has gone 

up. The number of veterans who are returning home from Iraq and 

Afghanistan has increased. The number of men and women who do 

not have health care at their employer any more, vets who are 

turning to—the aging population of veterans from Vietnam who are 

accessing the system. That does not surprise me the all. What does 

surprise me is based on what happened last year and the fact that 

the VA said, ‘‘We looked at the wrong formula. We need to revise 

our formula.’’

I remain concerned that that formula has not been revised based 

on real demands, so that we are not faced with a situation 3 

months from now, 6 months from now, a year from now, with the 

same underestimates, and we are turning back to our VA centers 

across this country, and they are saying to me today that there are 

still long lines, that vets are not getting their access. They are coming home from Iraq and Afghanistan and are not getting access to 

PTSD care, and numerous other issues that I can describe for the 

committee here, but I think it is critical that we go back and make 

sure we have real numbers based on real facts, and I am yet to be 

convinced that that is occurring. so I appreciate the increased cost, 

but if we do not get a handle on what the reality is out there, it 

still is not going to work. 

Chairman GREGG. Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. 

Thank you, Mr. Bolten, for your presentation. I would just say 

that I do not have any constituents who have come to me and ever 

complained because their taxes were too low. In fact, the response 

I have seen from the President’s growth package is that the economy has grown, jobs have been created, revenues have gone up, 

and it is not unique just to this administration. The Kennedy administration put in place tax cuts so they could have more money 

for their programs, and the Reagan administration, and now we 

have seen it work in the Bush administration. These are all facts. 

You can go ahead and look at them, even reflected on Senator 

Conrad’s chart if he had gone past the first 2 years there when we 

were still living under the Clinton policy. 

So I hope that we can do something to make these taxes permanent. My question to you is, I think the response to the economy 

would have even been greater if we had made those permanent. 

Have you done a study as to how much revenue we would have lost 

to the Federal Government by failing to make them permanent, 

just putting them out for just 5 years, in some cases even shorter? 

What amount of revenue would we have lost in the Federal Government from the stimulation of the package when we compared it 

to permanent versus temporary? 

Mr. BOLTEN. We have not, Senator Allard. One of the problems 

we face in this area is that economists and actuaries have difficulty 

agreeing on how to calculate the feedback stimulative effect of a 

tax cut on the economy. But we—and the budget numbers, as they 

now exist, and that often get cited, do not take account of that feedback effect at all. 

116

One thing we do know is that the feedback effect exists, that 

when taxes are cut, the economy grows, and revenues into the 

treasury grow. It is has just been so far impossible to get agreement among the economists and actuaries as to how big that effect 

is. I believe the effect is large, and I believe the effect is magnified, 

when on top of a tax increase, we threaten uncertainty in the system because that is the one thing that really throws businesses off. 

On top of losing the opportunity to keep some of their well-earned 

gains, what really throws them off is not knowing what the tax 

rates are going to be. So, certainty, as well as a low-tax environment, are two key elements that I believe are critical to economic 

growth. 

Senator ALLARD. I would like to move on. I did not realize you 

just put ‘‘Expectmore.gov’’ up. I have already been on it. 

Mr. BOLTEN. Really? 

Senator ALLARD. Yes. You have 189 programs that you have listed there have either been ‘‘Ineffective’’ or ‘‘Results were not demonstrated.’’ The ineffective is pretty clear to me. I think many have 

set-ups and goals and objectives, and for one reason or another, 

they are not able to reach those goals and objectives. But the group 

that went into ‘‘results not demonstrated,’’ is this a group that just 

absolutely refused to put in the right management policies to get 

us so we can evaluate that program? You have described it here 

as ‘‘A rating of results not demonstrated indicates that a program 

has not been able to develop acceptable performance goals or collect 

data to determine whether it is performing.’’ Most of them fall into 

that category. Only 27 are ineffective. 

I wondered if you could clarify a little bit about how you come 

up with these two different types of ratings? 

I think it is important to us, by the way, when we look at where 

we can get more efficiency in our programs, get more performance 

out of them. I think it is a great approach. Go ahead. 

Mr. BOLTEN. Thank you, Senator, and thank you for logging on 

to ‘‘Expectmore.gov.’’ The ‘‘results not demonstrated’’ category can 

mean a variety of things. In most cases it is not resistance from 

the program, but it is an unfamiliarity with having to set a goal 

of what the program is intended to achieve. Under the President’s 

direction, my Deputy for Management, Clay Johnson, has been 

very aggressive in pushing all programs in Government to try to 

set some measure of accountability for what the money is being 

spent on, and then be able to make an assessment of, are you 

meeting that measure? 

And in a lot of cases it is understandably difficult to move to a 

system that actually measures accountability. That is what the 

‘‘Results not demonstrated’’ usually shows. In some cases I expect 

that when we are able to establish measures of accountability, 

those programs may score pretty well. My guess is a lot of them 

will score pretty badly, and one of the reasons why there has been 

resistance to establishing measures of accountability is that they 

cannot be met. 

Senator ALLARD. I think from a policy standpoint it gives us 

some guidance, and kind of begins to focus us on those programs 

that perhaps maybe can justify why they do it, and during times 

when we are struggling to balance our budget, I think this is a 

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helpful tool. So I want to commend your staff and you for working 

to put these out, because from a policy standpoint I think they are 

helpful. 

Thank you, Mr. Chairman. 

Chairman GREGG. Thank you, Senator. 

Senator STABENOW. 

Senator STABENOW. Thank you, Mr. Chairman. 

Welcome, Mr. Bolten. We appreciate your being with us. 

Just to start, for the record, as we look at historically the decisions that are made in the last 5 years, I think it is important to 

note that 2001, when I came in as the President did, and I came 

in on the Budget Committee, we had the largest surpluses in the 

history of the country recorded. At that time we had two proposals 

in front of us, one by our ranking member, Senator Conrad, who 

suggested we divide that into thirds, take a third of it for tax cuts 

to stimulate the economy, a third to invest in education, health 

care and science, research, all of the things that Senator Alexander 

has talked about eloquently, and a third to prefund the liability to 

Social Security. 

When you look back at that now and what you have talked about 

in terms of Social Security, I think that proposal looks pretty doggone good. Instead, unfortunately, it was top-down tax cut and 

massive debt, turning the largest surplus in the country into the 

largest deficit. I hate to think what is coming for our kids and our 

grandkids. 

Let me talk specifically about this budget. The budget really is 

a values document, I believe. It is a lot of numbers, but it translates into things that affect real people, and it really reflects, just 

like our own checkbooks do, what our values and priorities are. 

When I look at what is happening in Michigan right now and the 

job loss, what is happening to manufacturing, which has built the 

middle class in this country, it is deeply disturbing to see what is 

not in this budget, in fact, the cuts that are made in things like 

the Manufacturing Extension Partnership, and the Advanced Technology Program, things that are important for us in terms of jobs, 

and the other areas that are very important for us to grow in. 

And, again, Senator Alexander talked about math and science 

and education, all of which I support. I supported the words of the 

President in terms of talking about education and competitiveness. 

But when we look at the budget, it does not match the words, and 

that is deeply concerning. In fact, the budget cuts education funding by $2.1 billion. It would cut it below the current year, below 

2005, below 2004. In fact, it appears that it would be the biggest 

cut in the 26 years of the Department of Education since it was set 

up by President Carter. 

So you have small things, which I would support in focusing on 

math and science, but the big picture, when we talk about funding 

Leave No Child Behind, special education, the desire to eliminate 

vocational education, cut technology in schools and so on, I would 

just suggest the big picture on education does not reflect what you 

are talking about. 

Is it not true that in this budget you would cut $2.1 billion out 

of education? 

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Mr. BOLTEN. Senator, I am checking my book here. I believe that 

you are right, that there is a reduction in the spending in education from 2006 to 2007 of $2.1 billion. I would like to make a couple of points. 

First of all, the overall increase in education spending during the 

tenure of this President is about 30 percent, which I think over the 

course of any 6-year term is about as large as we have seen in the 

history of this country. So I do not think the President—if you 

want to judge the commitment to education by dollars spent, I do 

not think the President can actually be doubted on that count. 

Second, you mentioned that we need to put priority on those with 

the least economic means, the Title I kids, and the President has 

increased Title I funding as part of his No Child Left Behind proposals every year that he has been in office, very substantially over 

the first several years of NCLB. In this budget Title I funding increases by $200 million. You mentioned——

Senator STABENOW. Mr. Bolten, if I might just say that Michigan, if we were fully funding education, Leave No Child Behind at 

the level that we voted for, that I voted for in this bipartisan bill, 

Michigan would this year, counting the last 5 years, have $12.3 billion more. So the idea that there are small increases when there 

is a huge amount in standards and paperwork, and all that has 

been added to it, and the fact is, we passed something very different. 

I see my time is running out. Let me just raise one other issue, 

and that relates to health care, when you talk about health care 

cuts. Would you not agree that when hospital reimbursements are 

cut, they simply shift that over onto business? I mean we see right 

now that the biggest issue with our manufacturers, the biggest 

issue for our families, relates to health care. And when we see big 

cuts, or even small cuts as it relates to hospitals or doctors or home 

health and so on, would you not agree that this just means that 

we are going to see a shift over, and we are going to see private 

insurance rates go up? I mean that is how it works. The private 

sector picks it up when we are not funding the obligations from the 

public sector. 

Mr. BOLTEN. Are you referring to——

Chairman GREGG. Senator——

Mr. BOLTEN. I am sorry. 

Chairman GREGG. Why don’t you answer this question, and then 

we are going to have to move on. 

Senator STABENOW. Sure. 

Mr. BOLTEN. I am going to assume, Senator, you are referring to 

the President’s proposals on Medicare? 

Senator STABENOW. I am. 

Mr. BOLTEN. As I discussed with the Chairman at the outset, 

these are very moderate changes in projected growth in Medicare 

spending. If all of the President’s proposals are adopted, the rate 

of increase in Medicare spending will decline from 7.8 percent over 

the next 5 years to 7.5 percent. 

Second, will those costs—if there are higher than they were hoping for—or if there are lower than they were hoping for reimbursements going to hospitals and other providers, do those costs necessarily get passed on to the patient or to business? I do not think 

119

that is necessarily the case. One of the great accomplishments of 

this economy is the efficiencies that we have achieved in this economy in all sorts of areas. The one glaring exception that has been 

left behind is medical care, and in medical care we need to put in 

place the mechanisms that will ensure that we have an efficient 

medical system that can provide better service for the same 

amount of dollars as almost every business is required to do, and 

I think we can expect the same from providers in the Medicare system. 

Senator STABENOW. I agree, and I hope you are supporting Senator Snowe’s and my Health IT bill. But let me just say that does 

not address the big issue in term of jobs in this country and manufacturers, which is to move health care off of the back of our employers and families and change the way we fund health care. This 

does not do that. 

Chairman GREGG. Thank you, Senator. 

Senator DOMENICI. 

Senator DOMENICI. Thank you, Mr. Chairman. 

Director Bolten, Thank you very much for testifying. I want to 

ask two questions for the record, and then I will get on to some 

observations. 

Would you furnish the committee, in detail, two things, one, the 

list of the programs that you contemplate eliminating or dramatically reducing, just a list of them? 

Mr. BOLTEN. Yes, we will. 

Senator DOMENICI. The reason I need to know, I need to know 

how many of them we have tried again and tried again. Second, 

there is a list of receipts like the Bonneville Power and the like, 

where you expect revenues by changes in formulas or the like. I 

would like a list of all of those kinds of things, and an indication 

whether they have been tried before, or how many times have they 

been submitted up here and not done. Even if it is only once, we 

would like to see them. Can you do that? 

Mr. BOLTEN. Right. We can do that, Senator. There is a chart at 

the back of the main budget volume that lists all of our revenue 

proposals, and what we will do, we will check off the ones that are 

repeats. 

Senator DOMENICI. Would you do that? 

Mr. BOLTEN. Which I gather is your interest. 

Senator DOMENICI. Yes. My interest is just to see, as we put the 

budget together, what can we expect. I think that is a rather relevant thing. You would too if you were in my shoes. 

Mr. BOLTEN. Yes, that is a fair question. 

Senator DOMENICI. Now I want to make a point. Hidden in this 

budget, in the State of the Union speech, is a little paragraph that 

I would like to share with those who are listening, and with you, 

to be something passed over quickly that I think may be the salvation of this country. That is a little statement that the President 

is going to appoint a bipartisan commission. I hope he does it 

quick. What is it going to be about? It is going to be about the 

health care costs that the United States has now promised its citizens under Medicare and Medicaid, the expectations versus what 

we can afford, versus what is going to happen to our fiscal policy. 

120

I do not think there is any question we need not waste any more 

time. We cannot pay for what we promised unless we decided to 

impose taxes so high that the country economy cannot work. So we 

either wait around till everything falls apart—that is an option. I 

had begun to think about it, and for a while I figured that is when 

it will happen, when health care falls apart, we will do something 

about it. When the pension system breaks, we will do something 

about it. I hoped that there could be another answer, that we 

might do it in a bipartisan way because there is no other way. 

Democrats cannot do it. Republicans cannot do it. We can stand up 

here and preach and blame the other guy, as is happening today. 

You did too much on Medicare. If you do more, you are hurting 

people. If you do nothing, you were irresponsible. It just depends 

who is in office. But nothing happens. 

So that might be your one—whoever put that in there—nice idea. 

I hope they are good people, and then I hope he follows them. We 

have had one before. The President kept the string on too tight and 

we did not get the results. I have had a chance to talk to him about 

this, the President. He is not going to do that. When he appoints 

the commission, he is going to take their recommendations. I hope 

it happens. No other chance, in my opinion, to save Medicare and 

Medicaid for the American people. Sounds bad. 

Second, I am not so sure we are going to know when it falls 

apart. I mentioned that a little bit ago. I am not sure. It may be 

falling apart around the seams right now, health care. I am not 

sure, but maybe. 

Now, having said that, your budget does a terrific job of 

prioritizing. The problem is when we put it together, all the things 

you did not prioritize by cutting or reducing are going to run into 

your priorities, and that is the tough part, because the President 

has done a terrific job with competitiveness. The Alexander-Bingaman-Domenici-Mikulski PACE Act or the President’s so-called competitive initiative. You have funded it about 75 percent. That is terrific. Science, physics, R&D, research and development, all of those 

things we should have been doing, we are doing. Some terrific education programs to stimulate our ability to let our children develop 

their brains to the maximum. 

Then we will have American real brain power and free enterprise 

versus China, instead of America brain power depleted by our inability to teach our kids physics and math and science, competing 

with the Chinese. We will not make it that way. So those are great. 

But I am worried that when we are finished, because those are 

fit in your budget by reducing a lot of things that we will not have 

the courage to reduce, and we will not get the good things. 

So might I ask, will the President, in your opinion, stand firm 

on us getting these new initiatives in this appropriation process? 

Mr. BOLTEN. I believe he will, Senator, and I think the encouragement that you and Senator Alexander have given him on this 

issue has been critical. He shares your passion for achieving the requests that he has put into this budget. 

Senator DOMENICI. I am going to close by saying he mentioned 

some energy initiatives. I find them in the budget. I am very impressed. 

121

There is one area I am not so impressed with, and maybe Senator Byrd is going to speak of it, but in any event, I will just mention there is significant reductions in the fossil fuel research. Some 

of it is coal research. I think that I would like you, for the record, 

to explain in some detail what the justification was for the fossil 

fuel reductions, because you have some new initiatives in coal, but 

you got rid of some of the old ones, and I do not understand. You 

may be right, but I do not have an understanding. And I have to 

appropriate them now. Senator Byrd knows that. So I would like 

an explanation of that if you would, please. 

Mr. BOLTEN. I will provide that for the record. 

Senator DOMENICI. Thank you very much. 

Chairman GREGG. Thank you, Senator Domenici. 

Senator BYRD. 

Senator BYRD. Thank you, Director Bolten. Thank you for being 

our witness here today. 

The President’s budget includes a nominal 2.8 percent increase 

in coal health and safety enforcement. This barely covers inflation. 

Since 2001 there are 217 fewer mine safety inspectors and support staff. That President’s budget does not propose adding a single 

position to the Mine Safety and Health Administration. We have 

had this brought to our attention vividly in the last few weeks. In 

the wake of 19 coal miner deaths in just 37 days, where is the new 

money to hire additional mine safety inspectors and personnel? 

Mr. BOLTEN. Senator, the President’s budget does have a modest 

increase, as you referenced, for the Mine Safety Organization. 

There have been increases throughout the course of this presidency, so that we are funding that organization at levels that are 

equal to or above what it has always been funded at, I think even 

accounting for inflation. 

But you are right, the recent events have highlighted the need 

for a reexamination. That need for reexamination has been highlighted at a time after our budget went to press, and it is an issue 

that I know Secretary Chao and others will be glad to work with 

you and other relevant Members of the Congress on as we prepare 

the 2007 appropriations. I know that it will be a substantial discussion in her Appropriations Subcommittee. 

Senator BYRD. I hope so. According to the President’s budget request your proposed increase for MSHA is to cover the mandatory 

cost of living adjustment for current employees and increase in 

rent, but no new funding for new mine safety personnel. Will the 

President submit a supplemental request for additional personnel, 

core enforcement personnel? 

Mr. BOLTEN. I do not expect that, Senator. The request, I see in 

my notes here, is for $288 million, a 3.6 percent increase over the 

previous year. I do not expect a supplemental request to be submitted, but it is an issue that I think we can address in the overall 

budget situation without having to resort to a supplemental if the 

administration and the Congress agree that additional resources in 

the mine safety area are likely to be warranted, which I understand they well may. 

Senator BYRD. I think they are warranted. I think so. Don’t you? 

Mr. BOLTEN. Senator, I do not know enough to know whether the 

funding levels at the Mine Safety and Health Administration were 

122

related to the problems we have experienced so far. My understanding had been that the safety record during the course of this 

administration has been pretty good under this Mine Safety Administration. The recent events suggest that there is a problem 

there. Whether the problem is with the Mine Safety and Health 

Administration though, I do not know, and before I made any indication that we would want to substantially plus up funding there, 

I would want to see a good case made as to how that funding might 

improve the situation. 

Senator BYRD. I think it probably does in considerable detail affect the Mine Safety and Health Administration. 19 deaths in 37 

days. That is not a very good record. 

According to the General Accounting Office, the Defense Department’s accounting system is in disarray, costing taxpayers billions 

of dollars each year. The Pentagon’s budget, including 

supplementals, exceeds one-half trillion dollars annually, and yet 

the Defense Department cannot pass a simple audit. I have been 

talking about this for years. Secretary Rumsfeld, I think we first 

talked about it a half dozen years ago, and he said he was going 

to see if he could not do something about it. I think he has tried. 

It is so big, I do not know how we will ever get our arms around 

it. 

The Pentagon’s budget, as I say, is such that the Defense Department cannot pass a simple audit. When do you think the administration will make this a top priority issue? What is OMB doing to 

accelerate audit reforms at the Pentagon? 

Mr. BOLTEN. It is a priority, Senator. And I know that a number 

of our management experts have been working intensively over the 

last several years even, as you say, to try to improve the situation 

at DOD that does not create a sudden change in the way the Defense Department does business. The problem in their accounting 

structures has been present, I think, for probably almost as long 

as there has been a Defense Department. So it is an enormously 

complicated structure, an enormously complicated undertaking to 

try to bring them around to a situation in which they can pass an 

audit. It does remain a priority of this administration to move the 

Defense Department toward that goal. 

I mentioned earlier my Deputy Director for Management, Clay 

Johnson, is keenly focused on that, and is working with the folks 

at the Pentagon to try to make progress on that. We would welcome your assistance in making that come about, because it is certainly a goal that OMB would like to see achieved. 

Senator BYRD. Do you think w are making progress toward that 

end? 

Mr. BOLTEN. Yes, in certain sectors I believe we are making 

progress toward that end. There are much better measures of accountability that are now in place than were three or 4 years ago, 

but there is a long way to go. There is no sugar-coating the situation there, but I believe we are making progress, and I think everybody involved is committed to making progress more rapidly. 

Senator BYRD. How did we get so far behind? What happened? 

Mr. BOLTEN. Senator, I do not know. 

Chairman GREGG. Senator? 

Senator BYRD. Yes? 

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Chairman GREGG. Can we come back to you for a second round? 

Senator BYRD. Yes. 

Chairman GREGG. Thank you. 

Senator BYRD. Thank you. 

Chairman GREGG. Senator Nelson. 

Senator NELSON. Thank you, Mr. Chairman. 

Welcome. Mr. Bolten, I know you cannot know about everything 

in the budget, but I need to bring out one inconsistency with the 

administration here. The Department of Defense had approved the 

Navy request for $100 million for repairs from Hurricane Wilma relief funds for the critical infrastructure recovery at Key West Naval 

Air Station. The reason they had approved that is that it is now 

critical for the training of our pilots, because they will send a 

squadron down to Key West Naval Air Station, and then they have 

all that area out there over the Gulf of Mexico that is restricted 

space where they train. 

That request was refused by the OMB, so we have this conflict 

on the essential readiness of the carrier battle groups as they prepare to deploy. Key West was significantly damaged in Hurricane 

Wilma. These funds—and I can give you the breakdown. I have 

been down there, I have checked it out. Congress appropriated 

these recovery funds to ensure the readiness of our fleet, and we 

are going to have this insisting that that be allowed to be spent. 

So tell me about you want to deny it in the budget, and yet the 

funds are there in the relief bill. So how do we go about, in your 

opinion, getting this thing squared away? 

Mr. BOLTEN. Senator, I am not familiar with the details of it. I 

will commit to looking into it and come back to you. 

Senator NELSON. Well, the Navy is going to insist on this. OMB 

has thrown up the roadblock, in that it is not in the budget, and 

yet the funds were already appropriated in the Wilma hurricane 

relief funds. Let me just put it to you here, that I want to be notified as soon as the requested funds have been released to DOD. Is 

that a process that you would do? 

Mr. BOLTEN. That I personally would get involved in? No, not 

typically, Senator. 

Senator NELSON. But OMB? 

Mr. BOLTEN. Yes. OMB is the final stage before funds are released before anybody spends it, but my guess is that there is a 

story there that we will want to look into that may involve some 

details that I would want to inform you of before we reached any 

definite conclusions about whether what has happened so far is the 

right thing or not. 

Senator NELSON. OK. I will continue to converse with you on 

that. 

Mr. BOLTEN. Thank you, Senator. 

Senator NELSON. Thank you, Mr. Chairman. 

Chairman GREGG. Thank you, Senator. I am shocked to learn 

that OMB stood in the way of an agency doing something. 

Let me just check and see if Senator Conrad had any additional 

questions. Otherwise, we appreciate your attentiveness to this 

hearing. 

We thank you very much. We appreciate your answering all of 

the questions in such a forthright way, and we appreciate the work 

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you do. It is a very hard job you have, and we are fortunate to have 

public servants of your ability and talent in this Nation. I am sure 

all my colleagues feel that way, whether they agree with you or 

not. I happen to agree with you. 

Thank you. 

Mr. BOLTEN. Thank you, Mr. Chairman. 

[The prepared statement of Mr. Bolten follows:]

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[Whereupon, at 4:33 p.m., the committee was adjourned.]

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(165)

UNDERSTANDING THE CAUSES OF AND SOLUTIONS TO ADDRESSING THE FEDERAL TAX 

GAP 

WEDNESDAY, FEBRUARY 15, 2006

U.S. SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to notice, at 9:59 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Judd Gregg, chairman of the committee, presiding. 

Present: Senators Gregg, Grassley, Sessions, Conrad, and Wyden. 

Staff present: Scott B. Gudes, Majority Staff Director; and Cheri 

Reidy, director for revenues and budget review. 

Mary Ann Naylor, Staff Director and Steve Bailey, sr. analyst for 

revenues. 

OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

Chairman GREGG. Let’s get started a little early, which hopefully 

will set a precedent here, because our witnesses are here, and Senator Conrad is here. I know we will be joined by other people as 

we proceed forward. 

This hearing is to deal with the issue of what we call the Federal 

tax gap, the fact that there is a lot of taxes owed to the Federal 

Government which are not being collected. The IRS estimates a 

gap of $345 billion a year. That is a huge number, and the practical 

effect of not collecting those taxes is that other taxes end up being 

burdensome. The ability and flexibility of the Federal Government 

to do things that are necessary to improve the quality of life for 

Americans and to defend our Nation is limited. And we as a Nation 

need to make sure we are collecting what people owe simply to 

maintain the integrity of the Tax Code. 

We have always had a Tax Code which has been built on the concept of basically voluntary compliance. People recognize they owe 

a certain amount and they should pay it. Its success is unique to 

Western democracies. We have not had a history of avoidance, or 

fraud that has been systemic. It has occurred but has not been systemic. 

To the extent fraud occurrs, we should try to address it, improve 

on our collection capability, and make the Code more comprehensible so that we can effectively collect taxes which are owed so people can feel that the distribution of the tax burgen is just. 

But there is a lot we need to address to accomplish this goal. So 

we have an excellent panel today. 

166

The person who has been the greatest force here in the Congress 

in trying to address this issue has been my colleague, the Ranking 

Member on the Committee, Senator Conrad. This has been an issue 

that he has raised innumerable times, and I thank him for his vigilance on this and for raising the level of rhetoric. When someone 

becomes a champion for getting something done around here, that 

is the key of getting it done around here. And so, following his 

leadership, maybe we can get something done. 

So I yield to Senator Conrad on this issue that he has been so 

active and effective on. 

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD 

Senator CONRAD. First of all, I want to thank the chairman, especially thank him for his kind, generous remarks this morning, 

but thank him as well for holding this hearing. I very much appreciate it. 

I really do believe this is one of the big ideas that we have to 

pursue in order to make progress on the deficit.

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Let me just run through a couple of things quickly which put it 

in perspective. We have the President now suggesting the deficit 

this year will be $423 billion. My own calculations are that that is 

somewhat high. I see a deficit this year of about $360 billion. But, 

still, that would give us four of the largest deficits we have had in 

history in dollar terms the last 4 years. 

Let’s go to the next.

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When we look at revenue as a share of GDP, here is what we 

have seen going back to 1955. There have been a lot of jigs and 

jags, but really the revenue side of the equation fell out from 2001 

to 2004. We have had some recovery here. But here is the point I 

want to make. 

If the tax gap, the difference between what is owed and what is 

being paid, is $350 billion a year or thereabouts, that represents 

about 2.5 percent of GDP. If we were collecting that, we would 

have collections as a share of GDP about right here, with no tax 

increase. No tax increase. 

The point I am trying to make to my colleagues is we clearly 

need more revenue to float this boat. We also have to be tough on 

spending, without question. We also have to reform long-term entitlements. But we also need more revenue. And the first place to 

look, rather than any tax increase, is to collect the taxes that are 

actually now owed. If we were doing that, we would have a very 

different budget situation. 

Let’s go to the next chart.

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This is the rough estimate that we have received from IRS that 

the gross tax gap is approaching $350 billion a year. Hopefully we 

can get to a newer estimate because I think that is pretty conservative, based on my own judgment.

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Let me just put it in perspective. This is the projected deficit for the year, $423 billion. Here is the amount of the gross tax gap, 

$345 billion. Again, I think this deficit number is somewhat overstated. My own judgment is the deficit will be about $360 billion 

this year. If we are actually able to collect all this revenue that is 

owed, we would come close to eliminating the deficit. And I understand the difficulties with collecting it all. The question is: How can 

we make serious progress, not just through enforcement but 

through tax reform? Because I think we have to now seriously consider fundamental tax reform as part of the mission. 

The point I really want to make is that this is critically important to solving our budget problems. This is a component of what 

we could do to really close the gap, and we could do it without increasing taxes, but increasing the collection of taxes that are now 

due and owed. 

And with that I want to again thank the chairman very much 

for holding this hearing. 

Chairman GREGG. Thank you, and I appreciate your suggesting 

that we have this hearing. I think it is a critical issue. 

Of course, the Budget Committee only has the capacity to set a 

budget out which projects where we are going to and how we are 

going to get there. But it doesn’t have the authority to actually institute action in these areas. That lies with a different authorizing 

committee. In the area of tax policy, that is clearly the Finance 

Committee, and I notice we are joined by the chairman. Does 

Chairman Grassley have anything he wishes to add? 

Senator GRASSLEY. Not at this point, Mr. Chairman. I am just 

around to see what the Budget Committee thinks I ought to do a 

better job of doing. 

[Laughter.] 

Chairman GREGG. Well, the Budget Committee is always interested in having the chairman here. 

Mr. Everson, we would love to hear from you. We are joined 

today by two witnesses in the first panel: of course, the Commissioner of the Internal Revenue Service, Mr. Everson; and the 

Comptroller General, David Walker. 

Mr. Everson. 

STATEMENT OF HON. MARK W. EVERSON, COMMISSIONER, 

INTERNAL REVENUE SERVICE 

Mr. EVERSON. Thank you, Mr. Chairman, Senator Conrad, and I 

will say Chairman Grassley, because if I leave that out, it would 

probably be at my peril, given the frequency with which I am before Finance. 

I am pleased to be here today to discuss the tax gap. I understand it has been at least some years since an IRS Commissioner 

has come before the Budget Committee. Given the fact that the IRS 

is responsible for collecting substantially all of the over $2 trillion 

that comes into Government coffers each year, I commend you for 

putting tax compliance on your agenda. If we can improve tax compliance and reduce the tax gap, it will make all of our jobs easier 

and reduce the burden of debt being shifted to future generations. 

I also want to thank the committee for the important role you 

played last year in ensuring that the IRS received adequate reVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00180 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
175

sources for our enforcement activities. I am hopeful that you will 

do the same as pertains to the President’s 2007 budget request. 

Simply stated, the tax gap is the difference between the tax that 

taxpayers should pay and what is actually paid on a timely basis. 

Overall, our Nation enjoys a very high compliance rate, certainly 

among the best in the world. The vast majority of Americans pay 

their taxes honestly and accurately, and they have every right to 

expect that their neighbors and competitors do the same. Not only 

are the dollars at stake important, but so is the sense of fairness. 

As President Kennedy stated in 1961, ‘‘Large continued avoidance 

of tax on the part of some has a steadily demoralizing effect on the 

compliance of others.’’

Unfortunately, our research indicates that in tax year 2001, there was a gross tax gap of $345 billion and a noncompliance rate 

of about 16.5 percent. Noncompliance takes three forms: nonfiling, 

underreporting, and underpayment. As this chart indicates, the 

bulk of the tax gap, over 80 percent, relates to underreporting of 

income, not nonfiling or underpayment. The research which we 

have just completed for tax year 2001 further indicates that the 

largest piece of the underreporting component of the gap relates to 

individual income tax, almost $200 billion a year. And of this, over 

half is underreported business income. 

In attacking the tax gap, I would like to make four points. 

First, we are doing a great deal to restore the enforcement functions of the IRS. This chart shows the growth of enforcement revenues achieved over the last several years. Enforcement revenues 

are the direct moneys we bring in from our collection activities, audits, and document matching program. Enforcement revenues do 

not include the indirect behavioral impact of our enforcement activities. But enforcement revenues alone have increased from $33.8 

billion in fiscal year 2001 to over $47 billion last year. I believe the 

credibility of our enforcement activities has been restored. Still, we 

need to do more, and we will. 

As I indicated moments ago, I very much appreciate the support 

this committee has given for securing adequate funding for the 

IRS. Appropriate funding is essential to reducing the tax gap. 

Two, we are using the conclusions from our research to update 

our audit models. The tax gap research will help us do a better job 

of selecting cases for review. Our enforcement operations will be 

more efficient and more productive. 

Three, the President’s budget proposal contains several legislative proposals which will help close the tax gap. These are generally in the area of increased third-party reporting. This chart depicts the fact that noncompliance is greatest where there is little 

or no third-party reporting. 

Four, we continue to work to improve taxpayer service. Helping 

taxpayers understand their obligation and facilitating their participation in the system no doubt supports compliance. But I would 

emphasize that the most important thing we could do to better 

serve taxpayers would be to simplify the Tax Code. Complexity obscures understanding. 

The last point I would like to make is that while we are moving 

aggressively to reduce the tax gap and can close a significant portion of the gap over a period of years, I say here, ‘‘no one should 

176

think...’’—maybe I should revise that for Senator Conrad—that we 

can totally eliminate the gap. That would take draconian measures 

and make the Government too intrusive. We need to strike the 

right balance. 

Thank you. 

[The prepared statement of Mr. Everson follows:]

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Chairman GREGG. Thank you, Mr. Everson. 

Mr. Walker. 

STATEMENT OF HON. DAVID M. WALKER, COMPTROLLER GENERAL OF THE UNITED STATES, U.S. GOVERNMENT ACCOUNTABILITY OFFICE 

Mr. WALKER. Mr. Chairman, Senator Conrad, Chairman Grassley, thank you for being here to talk about the tax gap. I would respectfully request that my entire statement be included in the 

record. 

Chairman GREGG. Of course. 

Mr. WALKER. I will move to summarize the highlights. 

Let me note at the outset that I, too, would like to commend this 

committee for being concerned with this issue. I would also like to 

note for the record that the Senate Finance Committee held a hearing on this exact subject last year, at which both the Commissioner 

and I had the opportunity to testify. I hope and expect that the 

Senate Finance Committee will be taking action in a number of related areas in the future. 

With regard to the tax gap, let me make five major points, and 

I have some slides that have been made available to you that I will 

show so the audience can see. 

GAO’s long-term budget simulations show that over the long 

term we face large and growing structural deficits due primarily to 

known demographic trends, rising health care costs, and lower Federal revenues as a percentage of the economy. Figure 1 and Figure 

2, the first two slides that are on pages 4 and 5 of my testimony, 

exhibit this large and growing structural imbalance. I am happy to 

answer questions about the differences between 1 and 2 in the 

Q&A section if you so desire. 

Continuing on this imprudent and unsustainable fiscal path will 

gradually erode, if not suddenly damage, our economy, our standard of living, and ultimately our national security. Reducing the 

current tax gap would contribute to our fiscal sustainability while 

simultaneously improving fairness for those citizens who fully and 

timely meet their tax obligations. 

Second, underreporting of income by businesses and individuals 

accounted for most of the $345 billion tax gap for 2001, with individual income tax underreporting alone accounting for $197 billion. 

Corporate income tax and employment tax underreporting accounted for $84 billion, and that is noted on Table 1 on page 7, or 

the third slide that you have. 

Third, given the persistence and size of the tax gap, we need not 

only to consider options that have previously been proposed, but 

also explore new administrative and legislative approaches to reducing the tax gap. Even modest progress would yield significant 

revenue. Each 1-percent reduction would likely yield nearly $3 billion per year. Reducing the tax gap will be a challenging effort. 

Long-term progress will require attacking the gap on multiple 

fronts and involving multiple strategies over a sustained period of 

time. These strategies could include and in some cases should include such efforts as to regularly obtain data on the extent of and 

reasons for noncompliance; simplifying the Tax Code—I would 

agree that is No. 1; providing quality services to taxpayers, which 

190

I know the IRS has been focused on in recent years; enhancing enforcement of tax laws by utilizing such enforcement tools as tax 

withholding, additional information reporting, enhanced penalties 

where they have been eroded over time due to inflation, better 

leveraging technology, and maximizing resource allocation based 

upon the areas that are likely to generate the best value and, 

therefore, close most of the tax gap. 

With regard to tax expenditures, which are noted on Figures 3 

and 4 on pages 13 and 14 of my testimony, this notes the significant increase in the number of tax expenditures over the past two 

decades. We lose $700 to $800 billion a year in tax revenues due 

to tax expenditures. They represent in many cases back-door 

spending. 

It is important that we have appropriate visibility on these tax 

expenditures in order to make them part of the overall equation on 

assuring that we can ultimately pay our current bills and deliver 

on our future promises over time. 

And, last, Figure 5, which is on page 17 of my testimony, summarizes selected information with regard to individual tax underreporting as it relates to areas where information returns are not 

provided and withholding is not required. In this regard, some examples of additional information reporting or withholding actions 

which might make sense going forward would be: requiring tax 

withholding and more and better information return reporting on 

payments that are made to independent contractors; requiring information return reporting on certain payments made to corporations; and requiring more data on information returns dealing with 

capital gain income. 

In summary, our Nation’s fiscal imbalance and related challenges 

have created a situation where we are on an imprudent and 

unsustainable path that needs to be addressed. While our longterm imbalance cannot be corrected solely by addressing the tax 

gap, and while we should have zero tolerance for people who don’t 

pay their fair share, the tax gap will never be zero. Nonetheless, 

it could help tremendously in closing the gap over the longer term. 

We will, however, need to take other steps, and we stand ready to 

work with the Congress in trying to address this and other issues 

of mutual interest and concern. 

Thank you very much. 

[The prepared statement of Mr. Walker follows:]

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Chairman GREGG. Thank you, Mr. Walker, and thank you for the 

really excellent information and data that you have given the Congress, especially in the area of the out-year unsustainability of our 

present programmatic activity and the entitlement accounts. Anybody who looks at your numbers on entitlement accounts recognizes we have to do something, and it is our obligation as policymakers to do it sooner rather than later. So we thank you for that 

because you are viewed as a fair arbiter of those numbers. 

Commissioner Everson, last year the budget had in it basically 

what amounted to a reserve fund which was available to the Appropriations Committee to assist in funding further increases in enforcement for the IRS. I think it worked out to about $446 million 

when it was all done. 

The administration has asked for another $137 million for that 

type of a plussing up of your enforcement activity, again, as a special budgetary item within the budget. So it is a unique vehicle to 

use, quite honestly, to get to this enforcement. 

To what extent do those dollars assist you? And if we would put 

in more than $137 million, would we get a return of—you know, 

what is the return on those dollars? Is it 1:1 or 2:1 or 10:1? Hopefully 10,000:1. 

Mr. EVERSON. Let me first state, as I indicated a moment ago, 

I very much appreciate what you did last year. It was essential to 

our continued rebuilding of our enforcement activities. And I hope 

that you support every dollar requested in the budget, as well as 

the program integrity cap. 

I am taking the same approach I took last year. I am asking for 

every penny of the President’s budget request but not for a penny 

more. I don’t——

Chairman GREGG. Let’s stop there. What I want to know is: How 

much did we get for the money we put in last year? And if we exceeded the President’s request, would we get more back? I mean, 

I don’t mind putting more in——

Mr. EVERSON. I am going to answer that. I am going to answer 

that. So I am not asking for more than the President has requested. 

Chairman GREGG. I understand that. 

Mr. EVERSON. That is the first thing I am going to say and I am 

going to get that out of the way. 

Obviously, when we invest in enforcement moneys for the IRS, 

we get a return. If you take a look at our budget, our total budget 

is about $10.6 billion. So, roughly speaking—let’s go back to the enforcement revenues—the enforcement revenues alone last year 

were $47 billion. So use that as an order-of-magnitude comparison. 

That is the direct moneys you got back against the whole budget. 

The enforcement piece we are talking about is approaching $7 billion in terms of how we allocate within our budget what is enforcement. But the other moneys play an important role, too—modernizing our systems—the whole thing is important. 

Now, when you make a marginal investment, the return on that 

marginal investment depends. If you are doing document matching, 

it is very cheap. You might get a very high return—10:1, 15:1. If 

you are doing high-end complex audits, the return is lower, but it 

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is still a multiple of one after you have trained the people. So it 

is a good investment. 

Again, though, the big point here is that this is only the direct 

return that I am speaking about. I am not talking about some concept that I would consider dynamic—or you might consider dynamic scoring—which is to say when we audit Senator Conrad and 

whether or not we find more money——

Senator CONRAD. You wouldn’t get a dime. 

[Laughter.] 

Mr. EVERSON. You may think twice about something that you 

might do on your return. That is not in these concepts. And, clearly, there is an important behavioral impact. 

So, yes, you get a positive return. If you give us more money, yes, 

you will get a multiple of that. 

Chairman GREGG. Well, let’s say we were to take this number, 

137, the President has asked for and double it. Could we presume 

that our return on that would be 5 times, 10 times? I mean, how 

would we—in other words, if we were going to offset that with receipts that we would score in our baseline, what would be the number that we should be considering putting in as a result? And when 

do we get to a diminishing return event? 

Mr. EVERSON. I don’t think you will get to a diminishing return 

for some time. This gets to the basic question of how much can you 

reduce that tax gap. The way I view it is you can clearly reduce 

it by $50 or $100 billion without changing the way the Government 

interacts with its citizenry. And I don’t know precisely where that 

point is. But at some point, you will be more intrusive. You will 

get more allegations of strong-arm tactics and excess. But I believe 

you can make progress with investment and with the statutory reforms. I have seen in the press that some have pooh-poohed these, 

but I think that they are the most significant reforms that we have 

asked for in two decades, since the 1986 act when Congress said, 

‘‘Going forward, if you are going to get an exemption for somebody, 

you have to put down the Social Security number, not just the 

name.’’ Well, the next year, 5 million dependents vanished. 

What we are trying to do here is attack this also with statutory 

proposals, so I wouldn’t want you to lose sight of those. 

Chairman GREGG. Well, of course, this committee does not have 

jurisdiction over statutory proposals. That is Senator Grassley’s. 

But we do have the ability to set up this fund. 

Mr. EVERSON. Yes. 

Chairman GREGG. And give the money to the Appropriations 

Committee, which we did last year, which in turn generates additional revenues, which in turn allows us to score higher revenues, 

which in turn gives us a different budget scenario. So it is critical 

to us to know how those dynamics all work together, and I think 

you have answered that question for us. 

Mr. EVERSON. I would say one thing. My understanding is that 

part of the problem here is the revenue side does not score. That 

is my understanding. 

Chairman GREGG. Well, we understand that, too, but at some 

point we have to start being logical about this. If we put an extra 

$500 million into your enforcement mechanisms, we have to talk to 

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CBO about giving us some score for that, because, clearly, there is 

a return for that money. 

Senator Conrad. 

Senator CONRAD. Let me just pursue, if I could, with you, Mr. 

Everson and General Walker—first of all, I want to thank you 

both. I think your testimony has been excellent, I think it has been 

honest, and I think we begin to get a sense of how big this is, this 

$350 billion revenue gap here. 

I hear you saying, Commissioner Everson, in your judgment we could close that by $50 to $100 billion without affecting the interaction between the agency and taxpayers in some negative way. 

Let me first say I believe—and I have gone over in some detail 

how the estimates were made. I believe that it is likely the estimates are understated. And I understand how the estimates were 

made. I don’t fault you for how the estimates were made. You are 

in some sense locked into building off a base that is quite old because, as I understand it, this update to 2001 is based off a file 

that is substantially earlier than that. And so with what I have 

seen happen in the accounting community in terms of aggressive 

approaches to tax avoidance, I believe that there is a strong likelihood that the estimates are understated. 

Could you share, Commissioner Everson, your sense on that 

issue? 

Mr. EVERSON. Sure. Can we go to the tax gap map? 

If you look at the way we have color-coded this map, we have 

three colors. Now, this is not some sort of national security warning system, but maybe it is a fiscal warning system. 

Green represents actual amounts—that is to say the underpayment piece, which when I file my return and I indicate that I 

owe $7,000 but I don’t send the check in. That is a good, hard number. 

The blue numbers are the estimates that have been updated 

from this national research program that we did using the 46,000 

2001 audits so we think those numbers are very good. Also, the 

nonfiling piece is a very good estimate because we used census data 

and our own records to try and get our arms around what we think 

has not come in. 

Now, what is less reliable and gets to the issue that you just 

mentioned, are the pieces in yellow, and the biggest piece in yellow 

relates to corporate returns. 

The reason we didn’t update this piece is because we still have 

significant research to do here. We started with the individuals because that is where historically the biggest piece of the problem is. 

In terms of corporate audits, especially the larger corporate entities, we have a very high audit coverage. For businesses with assets of over $250 million, our audit rate is over 40 percent. So we 

are doing a lot in that area, anyway. 

I take your point, though, and I agree with it, but what I would 

say is, even if the tax gap for corporations is understated by half—

that is to say, it is $60 billion instead of $30 billion—it still doesn’t 

change the picture that dramatically. And I would not allocate our 

resources any differently because we already give, as Senator 

Grassley knows, a great deal of focus to corporations and high-income individuals. 

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Senator CONRAD. Let me just say that I have had the opportunity to talk to a number of big firms on Wall Street who have 

taken a look at this issue, and they have told me they have reviewed the analysis, had people with great expertise, and they 

think we may be understating this by $50, perhaps even $100 billion a year. Do you think that is out of the question? 

Mr. EVERSON. I would not venture a guess as to the amount. I 

would say, however, that one of my principal concerns is the issue 

of corporate compliance, particularly with increasing globalization. 

And what we have done is we have enhanced our contacts with 

other taxing jurisdictions. 

I was at a meeting—it took almost 2 years to set this up, believe 

it or not—where for the first time we have included the Chinese 

and the Indians in some of our discussions in anticipation of the 

reversal of capital flows. 

We are doing more here. We set up something called the Joint 

International Tax Shelter Information Center about a year and a 

half ago. It is a joint center involving the Brits, the Australians, 

and the Canadians, where we share information along with our exchange agreements, totally in accordance with treaties. We have 

found numerous instances of tax arbitragers who set up deals so 

that there is a tear line between our system and the U.K. system, 

and they don’t end up paying taxes either place. And that is 

not——

Senator CONRAD. May I just say——

Mr. EVERSON [continuing]. What was intended. 

Senator CONRAD. When I was a State tax commissioner, in one 

case alone I found a major company doing business in my State 

had an operation in the Cayman Islands. They showed no profits 

on very extensive operations in the United States. They showed 

hundreds of millions of dollars of profits in the Cayman Islands 

with one employee. And I always said that was the most efficient 

person in the world. That person was really productive. And that 

person didn’t even work full-time for the company. That individual 

was an agent for many companies. 

I showed on the floor of the Senate last week a five-story building in the Cayman Islands that is the home to 12,500 companies. 

It is amazing how much you can get done in a situation like that 

on avoiding taxes legitimately due here, and what they were doing 

is through the use of transfer pricing, showing their profits in the 

Cayman Islands where there are no taxes, avoiding their legitimate 

taxes here, and I collected a lot of money from companies playing 

this game when I was the State tax commissioner. 

Mr. EVERSON. I know David wants to say something, but let me 

just make one final point on this subject. The root cause of the 

problem here is the divergence between the incentives to increase 

book earnings on the one hand and to drive share prices and to 

minimize taxable earnings on the other. 

I would recommend to you a very interesting article in the Sunday Business Section of the New York Times from about 10 days 

ago that talks about this problem and the fact that all of this is 

obscured to the investor and public community. 

Mr. WALKER. As you know, among other things I am a certified 

public accountant, and I practiced in the private sector for a numVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00224 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
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ber of years. I believe that the world has changed dramatically, especially in the corporate sector, since the baseline for these estimates were created. 

We need to understand that corporations do not have duties of 

loyalty to countries. They have duties of loyalty to their shareholders. They will do everything that they can legally do to avoid 

and minimize taxes. In today’s world, through transfer pricing, 

through basing of corporate headquarters, there are lots of things 

that can be done in order to minimize tax burdens. Some of this 

deals with being able to make sure the IRS has enough people with 

the right kind of skills and knowledge to be able to effectively address these issues, because they are very sophisticated transactions. 

Part of it is the Congress looking at a substance over form doctrine to determine what does it take in order for somebody to legitimately say that they are headquartered in for example, the Cayman Islands, when, in fact, a vast majority of their operations and 

revenues occur in the United States. Their executives are based in 

the United States and many spend most of their time in the United 

States. 

And so, it will take both administrative actions as well as a potential legislative actions that the Senate Finance Committee will 

have to take a look at. 

Chairman GREGG. And we will turn to the Senate Finance Committee chairman. 

Senator GRASSLEY. To what extent are the numbers on here 

money that is going to come into the Federal Treasury once, if you 

have found that these people were cheating, or to what extent is 

that going to repeat from year to year? Like, for instance, if you 

close the gap on self-employment tax at $39 billion, would that $39 

billion come in this year, next year, and next year? 

Mr. EVERSON. The first point I would make about that, is that 

there is a reason there is an arrow in between those two. That 

amount is largely derivative of the underreported business income. 

In other words, you have obscured the income; therefore, that has 

just sort of an automatic effect on the self-employment tax that the 

Schedule C filer is not putting in there. 

These are annual figures. This is what is not coming in every 

year. If we go to the enforcement——

Senator GRASSLEY. Well, if you found a taxpayer cheating and 

they started paying their taxes, then these numbers would say this 

would come in year after year? 

Mr. EVERSON. That is right. What we have to do here is two 

things: we need to reduce that gross gap, which is to get better behavior up front, and we need to continue to make the IRS more efficient and effective in terms of what we actually bring in. That is 

how you get to the $290 billion number that is in there. It is the 

345 less an estimate back in 2001 of about 55 that we would bring 

in through enforcement revenue and late payments. 

Obviously that 55 number is now better because we have increased the enforcement revenue. So you want to attack it from 

both sides: bring down the overall gross gap and increase our recoveries. 

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Senator GRASSLEY. Now, questions that even if we did in these 

areas would be probably a small amount of revenue compared to 

the tax gap, but I want to ask your views on a couple things that 

my committee has been working on. One would be what I call the 

battle of appraisers, legitimate valuation disputes. We took some 

steps to deal with this a couple of years ago by giving more 

straightforward rules on car donations and intellectual property. In 

a bill that just passed the Senate, we have some additional steps 

regarding reforms of appraisal and who can appraise as well as trying to deal with other problems, such as clothing donations and facade easements, and valuation is part of this determination. 

Give me your view on this matter in general as to how big of a 

problem that is, and your thoughts are important. You might want 

to give some detail in writing. I recognize that, just as we have 

found, it may be many targeted reforms that are needed to deal 

with this overall problem. In other words, I wish there was one 

magic bullet about everything you have on here. But I think we are 

going to have to do like how do you eat 10,000 marshmallows one 

at a time. 

[Laughter.] 

Mr. EVERSON. First, let me say I think that you and I are in lockstep agreement that the tax-exempt sector is extremely important, 

not just for reasons of protecting the integrity of the sector itself, 

but beyond that, for protecting the revenue base of the country. If 

we allow individuals and businesses to masquerade as charities or 

tax-exempt entities, over time we will erode the revenue base. 

You are correct, though, Mr. Chairman, in saying that the costs 

of those abuses as indicated here our study are relatively small. 

But just as your committee has been aggressively looking at this 

issue, I think what we have to do is stop abuses in charities before 

they really get going and get larger. 

So I think you are on the right track here to make sure we address this. 

Senator GRASSLEY. OK. Then on another issue that may be 

small, but may be very big, too, because I don’t know that we know 

for sure, the Taxpayer Advocate recently came out with this proposal on reporting for stocks about what the basis is. How big of 

a problem do you see the issue of basis in the tax gap? In other 

words, how much would it help if we had a better basis reporting? 

And what are your thoughts on the Taxpayer Advocate’s proposal 

that has been put forth in this area? 

Mr. EVERSON. Certainly. If you look at this chart it sort of 

spreads those numbers in a different way in terms of what is in 

the underreporting piece. The capital gains understatement that 

we determined in the study was only about $11 billion. And I say 

‘‘only’’ because that was a surprise compared to what some academics and others had thought it might be. And so, as you can see 

here, the noncompliance rate to be about 12 percent. So I would 

caution to say that this, at least on the basis of our research, does 

not appear to be as big a problem as some had thought it to be. 

Now, of course, different years you would bring different results. 

In year 2001, stock prices were going down. You might haveten a 

different answer in earlier years in which the valuations were different. 

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But we have not included a proposal focusing on the tax basis 

issue in the President’s budget. We have included five proposals 

largely touching on increased reporting to get after these, but we 

have not targeted this particular issue at this time. 

Senator GRASSLEY. Before you go, General—but does what you 

just told me deal with the issue of how do you determine basis? 

Mr. EVERSON. Sure, because what they are doing, we are doing 

the audits here. We get good third-party reporting on the transaction in the sense that the sale is reported and the proceeds are 

reported to us. So it is only the basis that is at issue here. 

Senator GRASSLEY. OK. General Walker. 

Mr. WALKER. As you know, Mr. Chairman, this is something that 

we recommended at the hearing that you conducted on the tax gap 

last year. There were several specific areas where we felt that additional information reporting and potential additional withholding 

would be appropriate, and this was one. I would also respectfully 

suggest that $11 billion is a lot of money. 

Furthermore, if we look at what is happening with regard to investment patterns, it is not just stocks and bonds. There is a tremendous amount of investment going on in real estate. The capital 

gains aspects of real estate for investment properties has exploded 

within the last few years. And so I think if we are doing these estimates based upon conditions that existed in the 1980’s, I think it 

is a different ball game today than the 1980’s. 

Mr. EVERSON. The estimates are not based on the conditions of 

the 1980’s. The 1980’s issue really gets to Senator Conrad’s point 

about the corporations. That is where you get the $30 billion on the 

corporation side. The individual side is fresh research. Just to clarify this. 

Senator GRASSLEY. Thank you, Mr. Chairman. 

Chairman GREGG. Mr. Everson, just to clarify, these numbers 

don’t really include things like dishonest transactions, such as the 

drug industry and things like that? 

Mr. EVERSON. By ‘‘drug industry,’’ do you mean illegal drugs? 

Chairman GREGG. I am talking about illegal drugs, yes. 

[Laughter.] 

Mr. EVERSON. I think I know what you are saying, and that is 

correct. 

Chairman GREGG. And illegal gambling. 

Mr. EVERSON. Illegal sources. 

Chairman GREGG. This number, 340 or 420, whatever it is, does 

not even take into account that. This is just underreported or——

Mr. EVERSON. Legal source. 

Chairman GREGG [continuing]. Those taxable events that we 

should be able to find. 

Mr. EVERSON. That is right. 

Chairman GREGG. Senator Sessions. 

Senator SESSIONS. This is an excellent hearing. I am delighted 

to be with you, and I am one who believes that people should pay 

their taxes. They should be as low as we can possibly make them, 

but they ought to pay them. I try to pay mine. Most Americans try 

to pay theirs. And when somebody doesn’t pay their taxes, they are 

cheating all of us. If you are competing against a business who 

doesn’t pay their taxes, it is hard for you to compete when you are 

222

doing the right thing every day. So I think it is very, very important, and as a Federal prosecutor who worked with IRS agents a 

lot, Mr. Everson, I found that they were far more reasonable than 

most of the people they were investigating. 

[Laughter.] 

Senator SESSIONS. A lot of them were crooks. A lot of them used 

political pressure to get around paying taxes they owed and should 

have paid. But I do think we had this spasm before Senator Grassley took over to control the IRS, whatever they thought they were 

doing, and I am concerned we might have gone too far. We want 

this system to be a voluntary compliance system. People ought to 

pay their taxes, and if they are not, they ought to expect to be investigated at some point and possibly disciplined, if that is the appropriate thing. 

I saw the deal in Italy a number of years ago on ‘‘60 Minutes,’’ 

and they were raising the taxes to, I think, 95 percent because nobody was paying them. And so they just kept raising them up, and 

it becomes absurd, of course. Nobody is going to pay 95 percent of 

what they make. So everybody cheats. If we can keep it simple and 

low, I think that is the better approach. 

Perhaps you stated it, but I would ask both of you, out of this $345 billion estimate over a period of, say, 2 or 3 years, if we can 

commence a series of good reforms, how much of it could we recapture? 

Mr. EVERSON. What I indicated earlier, Senator, was that I think 

that over a period of time you can collect somewhere between $50 

and $100 billion without changing the dynamic between the IRS 

and the people. 

What we have said is that between now and 2009 we want to get 

the compliance rate from 83.5 percent to 85 percent, which gets you 

about $30 billion in improved compliance. That is a combination of 

things. It is increasing up those enforcement revenues further and 

driving down the noncompliance overall. 

Now, that is relatively modest, but I think what we need to do 

here is gain the experience of reinvigorating the IRS. We need to 

get that tax reform done; that will really help. And we need to 

build off of the legislative proposals for some increased reporting, 

because, again, where there is a third-party reporting there is 

greater compliance, and the idea here is not to be too burdensome. 

That is why we have asked credit card issuers to report to us gross 

receipts for a business and government entities to report to us the 

payments for goods and services. If we do things like that, I think 

we can make some real headway here. 

Senator SESSIONS. Mr. Walker, do you have any thoughts on how 

much we could reasonably expect if we took a series of appropriate 

steps, whatever they may be? 

Mr. WALKER. First, you should do what can you achieve through 

additional enforcement activities and additional communication activities to enhance voluntary compliance and you try to provide 

reasonable assurance that individuals are complying with the law 

and paying their fair share. When the Commissioner says $50 to $100 billion, I don’t know if that is incremental to the $55 billion. 

Mr. EVERSON. That is a net improvement from——

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Mr. WALKER. OK. 

Mr. EVERSON. From the 345, we figured we brought in 55. I am 

saying you can get another 50 to 100 on top of that 55. 

Mr. WALKER. That is helpful. 

Mr. EVERSON. Some of this is the result of increased collection 

and some is the result of behavioral change. 

Mr. WALKER. Right. I understand. He is in a better position to 

give you an estimate on that. I will tell you this, Senator: I do not 

believe that you are going to make dramatic progress on the 345 

billion unless you get tax simplification and unless you end up getting additional information returns in selected areas and additional 

withholding in selected areas. I am happy to be more specific if you 

want. 

Mr. SESSIONS. Well, my time is up. But, Mr. Chairman, as we do 

tax reform and, Senator Grassley, as we do tax reform, perhaps we 

need to ask the people who are collecting the taxes while we are 

doing it, if we wrote it in a simple, clear way, it would be easier 

to audit, it would be easier for people to—there wouldn’t be the 

gray areas they might justify not paying because it would be more 

clear, and we may get a better compliance rate. 

Chairman GREGG. Thank you, Senator. Obviously that is a bigger 

issue than this committee has a role in, although we can clearly 

be interested in it, as we are. But the things that we can impact 

are the issue of enforcement, because we can fund that through the 

appropriations process with specific language in the budget. 

Are there other things, Mr. Commissioner, that the budget could 

do in the way it was written which would assist you in collecting 

and addressing this tax gap? 

Mr. EVERSON. In terms of the jurisdiction of this committee, I 

think you have put your finger on the issues. There is a short-term 

issue of the President’s request, and then there is the overall issue 

of scoring, which goes back and forth and has taken different tacks 

at different times. So I think those are two. 

And I echo General Walker’s views here, that these are significant proposals on the reporting, and I hope that you as individual 

Senators will champion these proposals. They will be quite controversial in some communities, principally in small business, and 

some in the banking community will say that the credit card 

issuers may be reluctant to take these steps. So you can say this 

is important from an overall budgetary point of view. 

Chairman GREGG. Your one chart—and I appreciate your outlining where we can be most helpful, but that one chart on individual income tax underreporting gap, which shows the vast majority of the money is lack of transparency, is a startling chart. 

Mr. EVERSON. Yes. 

Chairman GREGG. Especially since we are not talking about illegal activity here. I mean, if we were talking about illegal activity, 

that would be an understandable number. But since it is not illegal 

activity, one presumes we ought to be able to get transparency on 

it some way. 

Mr. EVERSON. And if I could make just one point on this, because 

it is important. Most Americans are subject to this reporting already. There are about 235 million W–2s that are issued each year 

224

for about 150 million employees. There is not only reporting but, 

of course, as everybody is aware, withholding. 

What we are proposing here is relatively modest but I would say 

quite significant to get some information reporting, say, on gross 

receipts for businesses. 

Chairman GREGG. Mr. Walker, you made a comment that we also 

need to address tax expenditures. Can you define the type of tax 

expenditure you are talking about? Are these like targeted tax expenditures? Would these be the same things as an earmark? Is 

that what you are talking about? Or are you talking about something that is more broadly determined to be a tax expenditure such 

as the deductibility of mortgage interest? 

Mr. WALKER. Mr. Chairman, I will talk to you about this on an 

informational basis because all Senators would be interested, but 

it is not necessarily within the jurisdiction of this committee. 

What I am talking about is that ultimately what we have to do 

in order to get our fiscal house in order is that we need to do something about the tax gap to make sure that people are paying their 

fair share. We need to do something to constrain spending, including reforming entitlement programs. Ultimately we will also need 

to make sure that we have enough revenues to be able to pay our 

current bills and deliver on our future promises. 

In doing that, one of the things that is largely off the radar 

screen is the revenue side. We spend $700 to $800 billion in deductions, exclusions, exemptions, credits and other types of tax preference activities. Some have an economic policy impact. Some are 

for social policy reasons. But they are not part of the budget process. They are not part of the appropriations process. They are not 

adequately disclosed in the financial statements of the U.S. Government. And yet they are $700 to $800 billion a year and growing 

rapidly. The No. 1 item is the fact that no individuals in America—

pay income tax or payroll tax on the value of employer-provided 

and -paid health care, no matter how much money they make, no 

matter how wealthy they are, and no matter how generous their 

health care package might be. 

And so just as you talked before about if you end up investing 

more money in enforcement, that is likely to generate revenues, I 

think we need to think about how we can make sure that what is 

happening on the revenue side, whether it is a plus or a minus, 

comes on the radar screen. Right now it is largely off. 

Chairman GREGG. I appreciate that. You are getting into the 

broader concept of tax expenditure when you talk about that. I 

thought you might be talking about a more targeted event, which 

this committee might actually be drawn into that fight, because 

this committee is going to be drawn into the fight of earmarks by 

it being set up as a point of order, it appears. Although it won’t 

be going through this committee, it appears it is being done by a 

separate working group somewhere in some back room. But it is 

clearly going to be a point of order, which means this committee 

is going to be involved in that. 

What we are going to do here, since Senator Wyden just arrived, 

we are going to go to Senator Conrad for his second 5 minutes, 

then Senator Grassley, then to Senator Wyden. 

225

Senator CONRAD. First of all, let me say my own belief is that 

the tax gap is larger, perhaps significantly so, than the estimates. 

I say that not just based on some feeling, but based on our analysis 

of how this determination was made, and also what I have been 

told by very sophisticated financial firms on Wall Street who tell 

me they see the other side of these transactions. They think there 

is big leakage. They think there is significant underreporting on 

basis by both corporations and individuals that is very hard to detect. 

So, first of all, I believe that the tax gap is larger. A lot of this 

is behavioral change. Nobody knows this better than General 

Walker, who used to be in the accounting profession, and a very 

distinguished career there, I might add, with an outstanding company which at the time was the gold standard, I found in my transactions, absolutely superb people. And there has been a change, it 

is undeniable, in the corporate culture, because some of these 

firms, accounting firms, established very aggressive accounting 

practices after these base estimates were made, after the base periods. And so you have had—and I have people who I worked with 

very closely over many years telling me, Kent, there has just been 

a dramatic change in the ethic—in the ethic—and that because of 

competition, firms became much more aggressive, accounting firms, 

in helping people and companies avoid what they legitimately owe. 

I believe that is the case. 

Could I get a reaction from the two of you on that basic proposition? 

Mr. EVERSON. I think I have covered the point on the estimates, 

and we are going to use the estimates as well as we can. And I 

don’t think that changes really how I would do my job. There is 

real money on the table here. We know where the larger issues are. 

And so we are going to do the best we can, and we are going to 

continue to get better estimates, as the GAO and others have suggested, as best we can. 

Your point is exactly correct. Our system depends upon not being 

overly intrusive compared to other countries. It depends on the integrity of tax practitioners, and there is no doubt, I would suggest 

to you, that over the course of decades, the role of professionals has 

changed. 

I was also at that fine firm that you referenced for 6 years starting in 1976. And the role of the accountant in that era was to make 

sure that your client adhered to professional standards and followed the law. That role migrated to value creation and risk management, and this migration has compromised the image of both 

accountants and attorneys, whose roles have changed. And that is 

why in our 5-year strategic plan we made one of our four enforcement priorities to assure that attorneys, accountants, and other tax 

practitioners adhere to professional standards and follow the law. 

And we have done a lot in this respect. We have increased the size 

of our Office of Professional Responsibility and have a former prosecutor doing that work. As Chairman Grassley knows, there have 

been important criminal proceedings that have taken place in this 

area. And I think that the message that this hasten out of hand, 

hasten through. 

Senator CONRAD. General Walker. 

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Mr. WALKER. Senator, I practiced public accounting from 1973 to 

1979 and from 1989 to 1998 with some of the largest and bestknown firms in the world. It was a fundamental change in business 

and in the accounting profession between those two time periods. 

As I said before, corporations do not have duties of loyalty to 

countries. They have duties of loyalty to shareholders, and they 

will do everything that they can in order to maximize revenue and 

minimize expense legally. In addition to that, when attorneys and 

CPAs are representing clients in tax planning, they are not independent. They are there to try to help their client minimize their 

tax burden—legally, of course. 

There has been an explosion of products and techniques to try to 

legally avoid and minimize tax burdens. In today’s world, where 

more and more economic activity is crossing borders, part of that 

is the use of sophisticated transfer pricing techniques where specialized practices have been created, headed by Ph.D. economists 

and a variety of other individuals. 

You have the example that you gave where people will in form 

set up their headquarters in certain tax-advantaged locations, but 

in substance they are not really there. That didn’t really occur to 

a great extent in the 1970’s, but it occurs quite frequently today. 

Senator CONRAD. It has changed. It has changed dramatically. I 

have people that I dealt with in the accounting profession over 

many years. Your former firm is the absolute gold standard. I 

found deeply honorable people very, very troubled by what occurred. 

Let me go quickly to two other things. Obviously, more reporting, 

more withholding would make a significant difference. Let me go, 

because my time has really expired, to the question of tax reform, 

because my own conviction is, yes, we can make progress probably 

on the order of what, Mr. Commissioner, you are suggesting. But 

for us really to make dramatic progress would probably require tax 

reform that would involve simplification and also a system that is 

just more transparent by its nature. 

A final comment on that question? 

Mr. WALKER. I think Senator Sessions said it well. Ultimately if 

you want to minimize the tax gap, you are going to have to reform 

the overall tax system to make it as simple as possible and, therefore, broadening the base, having much fewer exemptions, deductions, and exclusions. You need to keep it as simple as possible, enhance the transparency associated with income of all different 

types from all different parties, and thereby try to minimize the tax 

rate that would apply to a much broader base and a much simplified tax structure. 

Over the long term, the Congress, in addition to streamlining 

and simplifying the income tax system, may also have to consider 

whether and to what extent it wants to have our tax structure 

more consumption based, because we are the only major industrialized country in the world that doesn’t derive a significant percentage of its revenue through a consumption type approach. After 

all the distribution of wealth and income in the United States is 

fundamentally different today than it was in the early 1900’s when 

we created the income tax. 

227

Mr. EVERSON. I would simply add that I think tax simplification 

is absolutely essential. As I indicated in the oral statement, complexity obscures understanding. And so it hurts the taxpayer who 

desires to be compliant, and it also is a tool of taxpayers who seek 

to obscure their true activities from us as tax administrators. 

Mr. WALKER. And if I can quickly say, Senator, I have for a number of years prepared my tax return by hand, and I am a CPA. It 

is mind-numbingly complex. Even for an individual who wants to 

pay every dime that they owe, it is tough to be sure that you have 

done it right. It is unbelievably——

Senator CONRAD. Can I just say, as a former tax commissioner, 

I would be happy to review your return and make sure you are 

paying——

[Laughter.] 

Mr. EVERSON. I will say this. If he has a problem and in any way 

we have mishandled it, David, just call me personally. 

Senator CONRAD. Can I just conclude by saying I would ask for 

both of you, if you could provide to us in writing your recommendations on what we could do to really make progress, whether they 

are on the tax reform side or the administrative side, your recommendations to us. 

Mr. EVERSON. The Administration proposed, in its Fiscal Year 

2007 Budget Request, five new legislative changes to reduce the 

tax gap and re-proposed four legislative changes to improve tax administration efficiency. In addition, the Administration noted that 

it would strudy the standards used to distinguish between employees and independent contractors for purposes of withholding and 

paying federal employment taxes. The nine legislative proposals 

are:

Closing the Tax Gap

1. Clarify the circumstances in which employee leasing companies and their clients can be held jointly liable for federal employment taxes. This proposal would facilitate the effective use of third 

party employee leasing companies by small businesses to pay employment taxes. In addition to clarifying joint liability, it would also 

provide standards for holding employee leasing companies solely 

liable for such taxes, if they meet specified requirements.

2. Increase information reporting on paypment card transactions. 

In order to improve compliance, annual reporting to the IRS would 

be required for aggregate payment card reimbursements made to 

certain businesses in a calendar year.

3. Expand information reporting to certain payments made by 

Federal, State, and local governments to procure property and services. This proposal would improve tax compliance of those taxpayers who do business with government agencies.

4. Amend Collection Due Process procedures for employment tax 

liabilities. For Collection Due Process purposes, this proposal would 

align the treatment of levies to collect employment taxes with the 

treatment of levies to collect Federal taxes from State tax refunds. 

The proposal would curtail delinquent employers’ ability to pyramid myltiple periods of unpaid employment tax liabilities. TaxVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00233 Fmt 6601 Sfmt 6633 C:\DOCS\26726.TXT SBUD1 PsN: TISH
228

payers would retain the ability to seek managerial appeal and to 

participate in the formal Collection Appeals Process.

5. Expand to non-income tax returns the requirement that paid 

return preparers identify themselves on such returns and expand 

the related penalty provision. This proposal would address the 

growing problem of return preparers who assist in the preparation 

and submission of improper excise, employment tax, and other nonincome tax returns and related documents.

Improving Tax Administration

1. Implement administrative reforms to improve the efficiency of 

IRS operations such as (a) adopt measures to reduce frivolous submissions made solely to delay or impede tax administration; (b) 

allow the IRS to terminate installment agreement if the taxpayer 

is not paying as agreed; and (c) streamline jurisdictionover collection due process cases in the Tax Court.

2. Initiate cost savings measures such as: (a) Reduce transaction 

costs by changing the way the Treasury Department’s Financial 

Management Services is reimbursed for offsetting collections, and 

(b) expand IRS’ authority to require electronic filing.

3. Authorize the IRS to access employment date in HHS’ National Directory of New Hires for tax administration purposes, including data matching, verification of taxpayer claims during return processing, preparation of substitute returns for non-compliant taxpayers, and identification of levy sources.

4. Extend IRS’ authority to fund undercover operations, which 

expires on December 31, 2006, to permit the IRS to fund certain 

necessary and reasonable expenses of undercover operations, including international and domestic money laundering and narcotics 

operations. 

These legislative proposals strategically target areas where (1) 

research reveals the existence of significant compliance problems, 

(2) the compliance benefit is properly balanced against the burden 

placed on taxpayers, and (3) the changes support the 

Administrations’s broader focus on identifying legislative and administrative changes to reduce the tax gap. The enactment of these 

proposals would position the IRS for improved service and enforcement effectiveness and productivity. 

The FY 2006 appropriation for the IRS earmarked $6,382 million 

(post rescission) specifically for tax enforcement and included an increase of $442 million (post rescission) for enchanced enforcement 

programs, for a total of $6,842 million. The Appropriators were 

able to accommodate this increase as part of a program intergrity 

cap adjustment proposed by the Administration in the FY 2006 

Budget, and adopted as part of the Budget Resolution. This enhancement is a critical component of our efforts to reduce the tax 

gap. 

In the FY 2007 request, the Administration is again proposing a 

program intergrity cap adjustment for IRS enforcement. The 

amount for FY 2007, $137 million, is the amount needed to pay 

cost increases associated with the FY 2006 enforcement base (the 

FY 2006 cap adjustment of $442 million is now part of the ‘‘base’’ 

and would be included within the capped amounts when the SubVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00234 Fmt 6601 Sfmt 6633 C:\DOCS\26726.TXT SBUD1 PsN: TISH
229

committees receive their 302(b) allocations.) The $137 million is 

necessary to perserve the intergrity of the program increase provided in the FY 2006 budget.

Mr. EVERSON. I don’t speak to tax policy, as Chairman Grassley 

knows, but we will certainly give you what we can in terms of pulling this all together. 

Chairman GREGG. Senator Grassley. 

Senator GRASSLEY. I have a statement I want to put in the 

record, an opening statement. 

[The prepared statement of Senator Grassley follows:]

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231


26726.108
232

Senator GRASSLEY. I want to bring up something that probably 

would amount to no more than a few hundred million dollars that 

you have on the tax gap there, but probably a few hundred million 

that you may not collect the way we are going now, and make a 

suggestion to you, Commissioner. And that is in regard to the 

interplay between the alternative minimum tax and the incentive 

stock options. 

You know, the idea of our tax law is to encourage people to hold 

their stock to get preferential tax treatment in a very legal way, 

but then we had the dotcom bubble burst of 2001 so people received 

a lot of stock options. They drop in value. They don’t have it. They 

have to pay the tax on, you know, what is not really income. So 

I believe that we have a lot of that in this tax gap. 

And I have had people in my State come to me about this, and 

probably for every one in my State, there are 50 people in California having a problem, maybe Massachusetts, too. But I believe 

the right solution here for the IRS would be to exercise its expansive authority that it was given in the 1998 IRS restructuring bill 

to provide offers in compromise for the purpose of effective tax administration. I think that these cases fit well within the type of 

people Congress is trying to assist, people who have honestly paid 

their taxes for years but because the law is working at cross purposes, they are between a rock and a hard place. And, unfortunately, the IRS and Treasury, I believe, have been overly narrow 

in construing the authority given them in this provision passed in 

1998. 

So I have been pushing for quite some time to get the IRS and 

the Treasury to move more open-mindedly on this matter and 

would like to note that I particularly appreciate the Taxpayer Advocate’s assistance in trying to help some of my constituents. 

So I am only asking—I am not asking you to explain right now, 

but if you would make this a priority, because I believe it is a way 

of bringing in some income, that maybe because you cannot get 

blood out of a turnip, you may get nothing. 

Mr. EVERSON. Certainly, Senator, we will take a look at it again. 

This is a complicated issue because if people exercise the options 

and then hold onto the stock and the stock value decreases, they 

may have a personal economic hardship, and then they can come 

in to us under the offer in compromise program if they don’t have 

the money. But sometimes they are asking for a blanket exemption, 

which we tend to feel might require a statutory review. 

So we will certainly take a look at it, of course. 

Senator GRASSLEY. OK. And then just for the benefit of the 

Budget Committee, I would say that Senator Baucus and I have 

made the tax gap a very major effort of ours over the last couple 

years, working very closely with the Commissioner trying to take 

care of some of these industries that are promoting tax shelters, a 

lot of them that leave the poor taxpayer owing the Government a 

lot of money and thought they were getting honest advice that just 

was not very good advice. 

But in addition, Senator Baucus and I asked the Joint Tax Committee to study, and they came out a year ago with a report. Some 

of it, as the General has suggested, just changing tax laws to bring 

in more revenue, not from people cheating on it necessarily, and 

233

some of these are very controversial: repeal of the mortgage interest deduction for home equity loans, subject State and local workers to Medicare tax, apply the payroll tax to most fringe benefits, 

allowing the offshore activities of U.S. companies to be exempt 

from U.S. taxes, examples of things that are very difficult to deal 

with and very popular with taxpayers. 

Then they had another part of it that dealt with the tax gap, in 

other words, people cheating, and we are trying to zero in on those 

efforts, and efforts that are not there, some things that our respective staffs are coming up with. 

And then, last, sometime last year we held a hearing on leakage 

of the payroll tax system, in other words, how it basically impacts 

upon solvency of Social Security. And, again, some of those are very 

controversial, probably would be real easy to handle in the context 

of overall Social Security reform because they deal with small business, maybe more difficult to deal with the case in isolation, although I am not saying that they shouldn’t be dealt with in isolation, but, you know—well, I guess I have said what I wanted to 

say. 

Thank you, Mr. Chairman. 

Mr. WALKER. Can I comment real quick, Mr. Chairman, on this? 

Senator Grassley, I realize that there are two dimensions, as you 

properly pointed out, with regard to this revenue issue, one of 

which is what can be done to try to reduce the tax gap—you will 

never eliminate it—and the other is what type of broader tax reforms might be necessary. And they are very different things. 

Candidly, based upon any reasonable set of assumptions given 

where we are at and where we are headed fiscally, in addition to 

minimizing the tax gap—and I think things can and should be 

done through additional information returns and withholding and 

targeted enforcement activities—there is no question that you are 

going to have to make some tough choices in order to generate 

enough revenues to be able to pay our current bills and deliver on 

our future promises. And it is going to require real tough choices 

that are not going to be popular. 

Frankly, one of the things that I am trying to do is to try to help 

pave the way for people to understand that, because realistically, 

elected officials cannot get too far ahead of their constituents, and 

their constituents need to understand where we are and where we 

are headed and what the consequences are for their kids and for 

our country if we don’t start dealing with some of these things. 

Senator GRASSLEY. The only think I would add to what you said 

is that the other side of the equation is the extent to which Congress over the last 4 years, maybe unrealistically, overpromised, 

and promises that cannot be kept as well, maybe not badly intentioned at the time, but how unrealistic they are right now, that you 

couldn’t close the gap just on the revenue side. 

Mr. WALKER. Absolutely. The current liabilities and unfunded 

commitments of the United States, which includes unfunded promises for Social Security and Medicare—just those two, not Medicaid—are $46 trillion in current dollar terms, up from $20 trillion 

5 years ago, and growing every second of every day. 

Chairman GREGG. A startling number. 

Senator Wyden. 

234

Senator WYDEN. Gentlemen, thank you, and thank you for your 

service, and both of you have been very helpful to me. 

I have introduced the Fair Flat Tax Act, S. 1927, and in the legislation—I am going to hold it up—is a one-page 1040 form. I filled 

it out myself. It took about half an hour, and that in and of itself 

is kind of a revolution for a member of the Senate Finance Committee to actually be able to do their own taxes. And a reporter 

called yesterday and said he did his in 15 minutes using my form. 

It is pretty straightforward. You take your income from all your 

sources, subtract your deductions, add your credits, and send it off 

to Mr. Everson and say to the IRS, ‘‘I’m done. Have a nice day.’’ 

The end. 

What I find so baffling is I have a one-page 1040 form, the President’s Commission that reported this fall, their proposal, colleagues, is maybe six, seven lines longer, but for purposes of Government work, they are pretty darn close. What are the problems 

in terms of actually getting this done? 

I pressed Secretary Snow on this a week ago. I just for the life 

of me can’t understand why an effort can’t be begun immediately 

to jump-start this tax reform. I have one approach. The President 

has another. A Democrat is saying that the Republicans have some 

good ideas. 

What is the problem here? Why can’t this be well underway? 

Mr. EVERSON. I, again, as you can appreciate, do not speak for 

the administration on tax policy. I have said consistently, including 

before the tax panel last March, that I believe reform is essential. 

As I indicated actually before you came in, Senator, simplification 

is one of the most important answers in terms of reducing the tax 

gap, which is the subject of today’s hearing. So I am a strong advocate of moving forward with reform. 

Senator WYDEN. But specifically on the idea of taking what I 

have and what the administration’s proposal has—and others, by 

the way, have good ideas as well—wouldn’t that make sense doing 

that now? 

Mr. EVERSON. I think that Treasury is looking at the reform 

panel ideas, and I am sure that as they do that, they are cognizant 

of what else is also out there, including your proposal. 

Senator WYDEN. You are being very diplomatic. When I tried to 

get them to put this on deadline or anything resembling some 

sense of urgency, it just wasn’t there. 

Mr. EVERSON. It is in my self-interest to be diplomatic. 

Senator WYDEN. Yes, it is. 

[Laughter.] 

Senator WYDEN. Mr. Walker, you are a good man. Any thoughts 

on this? 

Mr. WALKER. From a policy standpoint, it absolutely makes 

sense. From the standpoint of trying to close the tax gap, it absolutely makes sense. 

There are a lot of people, Senator, vested in the status quo. Not 

everybody is for transparency. Not everybody is for broadening the 

base because they have their special preferences and an interest in 

maintaining their special preferences. And my view is it is also a 

matter of what other priorities exist at any given point in time as 

235

to where decisionmakers are going to allocate their time and political capital. 

The sooner, the better, from the standpoint of streamlining and 

simplifying the Tax Code, not only from the standpoint of the tax 

gap, but in order to minimize tax burdens and enhance economic 

growth and efficiency. 

Senator WYDEN. There are plenty of interests that will oppose 

this, you are right. But unlike Social Security, there are not going 

to be any rallies outside a Member of Congress’ office saying, ‘‘I 

love the Internal Revenue Code.’’

I am going to do everything I can with colleagues on a bipartisan 

basis to see what I can do to goad both political parties into getting 

into this. 

Gentlemen, in your view, how much of the underreporting and 

underpayment of taxes is due to genuine confusion—genuine confusion—due to complexity, and how much is due to cheating? Give 

me just a ballpark figure because I know, Mr. Everson, there are 

a lot of issues with respect to how that is calculated. But give me 

a ballpark assessment of how much you think is confusion, how 

much you think is people trying to cut corners. 

Because willful noncompliance has to do with the motivation of 

the taxpayer at the time he or she filed his or her tax return, it 

is virtually impossible to know for certain how much of the tax gap 

is due to genuine confusion as opposed to cheating. While our auditors may be able to identify what appear to be obvious cases of willfulness or simple mistakes, in the vast majority of cases, the motivation of the taxpayer is not at all clear. Moreover, it is not realistic to rely on taxpayers themeselves to indicate whether they deliberately tried to understate their tax liability. Finally, many taxpayer mistakes arise from not doing something that should have 

done, which could be caused by anything from innocent carelessness to willful evasion. It is not difficult for an auditor to note what 

was not done, but it is often virtually impossible to be certain 

about why. 

That fact that reporting accuracy is much worse in the absence 

of third-party information reporting and withholding suggests that, 

with respect to income reporting, many taxpayers exploit their opportunities to be noncompliant. It also suggest that information reporting makes it easier for honest taxpayers to comply. More significantly, the growing complexity of the tax law is a primary driver of the tax gap, creating both genuine confusion and opportunities for those who wish to exploit the tax law. 

Mr. EVERSON. I would decline to do that, Senator. While we directionally are trying to work on that issue through our research, 

we don’t have precise conclusions at this point even to give a ballpark. What I would suggest to you, though, is that there is no 

doubt that confusion is a very real contributor here. 

Look at something like the EITC or look at some of the other 

credits that are out there. Complexity is quite significant and a 

great challenge to individuals as they try to navigate educational 

credits, of which there are a number. 

Senator WYDEN. I still think it is important for you all to give 

us a ballpark estimate of what this problem is all about. I understand it is difficult. But I would like to ask you, as one member 

236

of the Finance Committee and someone on this committee as well, 

to get back to us with even a ballpark figure, because to just say, 

well, we cannot give that. 

Mr. EVERSON. Well, I will talk to our research people to see 

whether they can do that. 

Senator WYDEN. Right. 

Mr. EVERSON. I must tell you that, they are pretty reticent to say 

something that they don’t feel is substantiated. 

Senator WYDEN. I understand, but I think we owe it to our constituents to get a general sense so that we know what it is we are 

tackling. 

One more question for you, Mr. Everson. What is it going to take 

to make those yellow boxes blue? My understanding is that the yellow boxes are the areas where we are not making the kind of 

progress we need in terms of the audits. 

Mr. EVERSON. Yes. 

Senator WYDEN. Can you give us a deadline when those yellow 

boxes will be blue so that people will see that there are modernized 

criteria with respect to how taxes are determined? 

Mr. EVERSON. We are looking now at the continuation of our research programs. One thing we have done this year is work on S 

corporations. S corporations have exploded over the last two decades in terms of being used as pass-through entities. They don’t 

even show up on that yellow piece there, if you will. But that is 

where we are looking now. 

As I indicated, I think before you came in, if you look at what 

we do in terms of the corporation side, which is the biggest piece 

of the yellow, our coverages there are significantly higher by a factor of 10fold or more than what they are on the individual side. 

That is why we have not gone forward to do research per se on that 

issue. 

I would say to you that as we look at this program, we will probably be more inclined to circle back and update the 2001 figures 

on the individual side and probably do more on the C corporations. 

Senator WYDEN. Now, the administration’s budget expands thirdparty reporting of income for additional transactions as part of its 

proposal to close the gap. They propose specifically expanding 

third-party reporting to include Government payments for goods 

and services as well as debit and credit card reimbursements paid 

to merchants. But the proposal for expanded third-party reporting 

does not include third-party reporting of investment income. 

I find it very troubling. What I did with my tax reform proposal 

was build on what Ronald Reagan said in 1986, that, marginal 

rates are a big deal, they send a powerful message with respect to 

growth and opportunity, but we ought to treat all income the same, 

which is, of course, what was done in 1986. 

And so I want to continue to try to build on the philosophy that 

Ronald Reagan laid out and would simply ask, Why aren’t you applying the same rules to investment income that apply to wage, interest, and other income? 

Mr. EVERSON. I guess my answer to that, Senator, is the five proposals we have made as well as the commitment we have made to 

look at the definition of employee versus independent contractor, 

which is really going to cause a firestorm. That definition has been 

237

locked in since 1978, and since then the employment model has 

really changed with many more independent contractors. I do consider them a very significant set of proposals. If we can work and 

get these done, then, of course, we ought to look at what other 

issues need to be included. 

What we have not done in our proposals, by the way, is send specific language over to Finance or Ways and Means. We have said 

we want to do this and then will work with you on the details. So 

we are open to discussing what needs to be done here, but I do 

view it as very important that we are again tackling this issue substantially for the first time in 20 years. 

Senator WYDEN. I share your view, and I think it is helpful that 

you are. I just am concerned that right out of the box again we are 

going to set up a double standard in this country. And colleagues 

have heard me talk about that we have two standards in America: 

one for people who work for wages and another for folks who make 

their money from investments. I am not interested in soaking anybody. I believe in markets. I believe in creating wealth. But when 

the cops on the street gets a raise, they pay 25 percent of their income to the Government in taxes, pay Social Security payroll taxes 

on top of it, and the person who makes their money on capital 

gains and investments pays 15 percent and no Social Security payroll tax, looks at this budget and says, Hah, down in Washington, 

D.C., they are talking about closing the tax gap, I hear all about 

that, but we got one set of rules that apply to me and we got another set of rules that apply to the investor. 

Mr. EVERSON. I would point out, as you know, there is very good 

reporting in the dividends and interest areas already, and that is 

why the noncompliance rate is very low there. 

Chairman GREGG. Senator Sessions. 

Senator SESSIONS. Quickly, I would ask Mr. Everson, if we had 

tax simplification, would that not help your auditors and reduce 

the time that they spend and help them be able to focus more on 

the abuses? 

Mr. EVERSON. Absolutely, sir. 

Senator SESSIONS. Could you suspend CPAs and attorneys, short 

of some criminal or ethical prosecution, for irresponsible advice or 

lack of professionalism? And would that be something you could accomplish with far less litigation than might otherwise be the case? 

Mr. EVERSON. We have strengthened professional accountability 

over the last several years through doubling the size of our Office 

of Professional Responsibility. There is something called Circular 

230, which is standards that govern the conduct of attorneys and 

accountants who practice before us. We have included for the first 

time a provision that says said if you get an opinion from an attorney that you are doing the right thing, then you get out of paying 

penalties if the Service audits you and says that transaction does 

not work. We have said now how those opinions have to be developed for shelter transactions. That is a very important step. 

We continue to monitor this area and look to do more, but, again, 

the leverage of making sure the practitioners are responsible is 

also essential and keeps us from having to, if you will, have more 

auditors. We have to have integrity in the attorneys and the accountants. 

238

Senator SESSIONS. Well, most accountants I think really do try 

to do the right thing, and when they sign their name on there, they 

expect you to know that they have done professional diligence. 

Would you not both agree on that? 

Mr. EVERSON. Yes, that is absolutely correct, and the steps we 

have taken, including the steps you have taken in the Congress—

for example, the JOBS Act, which provides tougher standards and 

penalties for people who go awry of the standards—are important. 

And the other thing we are asking with one of the five proposals, 

gets to preparer standards on the non-income tax type reporting. 

So that is in the mix. We are trying to do more there, and we are 

asking for you to pass some new law on that issue. 

Senator SESSIONS. Mr. Walker, would you like to comment as a 

CPA yourself? 

Mr. WALKER. I would agree that simplification would do a lot to 

take enforcement pressure off of the IRS and help them target 

much more. I also agree that a vast majority of CPAs, and I am 

sure attorneys as well, try to do their job to the best of their ability 

and in compliance with the laws and regulations as they understand them, although I think we have to keep in mind we live in 

a gray world. 

Mr. EVERSON. Let me make one final point. Practitioners come 

to me all the time and say, ‘‘We applaud what you are doing, going 

after the bad practitioners,’’ because it is a competitive disadvantage when somebody in your State is saying, ‘‘I can get you a better 

deal with the IRS’’ when they really are just, you know, smoking 

something. 

[Laughter.] 

Mr. EVERSON. That is the drug business we were talking about. 

Chairman GREGG. You are implying that to deal with the IRS 

you should be smoking something. 

[Laughter.] 

Senator SESSIONS. I dealt with a good lawyer when I was United 

States Attorney, and he came to me and he said, ‘‘Tell me what the 

law is. I am telling my client they have to pay taxes on this. The 

competitive businesses down the street are not paying taxes on it. 

They think I am costing them money. What is the law? What 

should we do?’’ It was a fair question, I thought. I am not sure that 

he ever got a clear answer. 

With regard to your allocation, Mr. Everson, of the resources you 

get in total, are you satisfied that you have the resources in the 

right areas? I do notice that your customer service seems to be 

working. Complaints are down, and audits are beginning to go back 

up. Those are good things. Are you confident as Congress mandates 

money in certain ones of these accounts, whether it is audits or 

compliance or those things, are we requiring expenditures and organizations of your office that make you less efficient than you 

would like to be? And can we help? 

Mr. EVERSON. Broadly speaking, let me say this. We have three 

strategic objectives for the IRS: one is to continue to improve service to taxpayers; the second is to significantly enhance enforcement 

of the law; and the third is to modernize the IRS. 

This only works if we support all three in a balanced manner, 

and that includes the funding. So it would be a bad cocktail to give 

239

us more money for enforcement but to cut services or the IT infrastructure, because they all have to work together. And it is important to leave, I believe, the latitude to the Government managers—

there are only two appointees in the whole agency—to take those 

funds and use them wisely. 

So I do worry that we are in a bad space. We are in the TTHUD 

Subcommittee on Appropriations. And if you look at the President’s 

request, HUD is down by 2 percent and Transportation by something like 9 percent. I looked at the Federal Page the day after the 

budget came out. If you look at the non-Homeland, non-DOD domestic discretionary budget, it is a tough corner of the budget to 

be in. 

So, yes, I ask you to do what the President asks and provide us 

the funds that we have requested and let us be free to spend them 

as wisely as we can. 

If I could make one final pitch: please do your job on time. We 

are a big operational agency, and when you give us moneys or 

write language into the appropriations process 2 or 3 months into 

the year saying don’t do this or do that, then it is very hard for 

us, particularly with the curb we have on our spending, to implement some of those provisions. 

Chairman GREGG. Thank you. Let me thank you very much for 

your time. You have given us a lot of time today. 

Senator CONRAD. Might I have a minute? 

Chairman GREGG. Yes. 

Senator CONRAD. Two quick things, and I would say this to the 

Commissioner. My own brother called me. My brother prepares returns for people. He used to be the head of the Office of Management and Budget in our State. And he said in the office in Bismarck, the IRS office, it is on the second floor of a building, of a 

bank building. Forms are not available on the first floor by some 

agreement with the bank. And when you call to see if forms are 

available, he was unable to get through repeatedly in Bismarck, 

North Dakota. And if you could check on that and if we could do 

something to——

We appreciate that your brother pointed out this issue. There is 

an IRS office on the third floor of the same building in which the 

bank is located. We did some checking with the bank and determined that it does not appear that the bank ever distributed tax 

forms in its lobby. We recently placed a new sign on the first floor 

of the building. This sign indicates the location and hours of available tax assistance and also indicates that Tax Forms are available 

in the IRS office. 

In addition, IRS forms and publications are available in downtown Bismarck at the Veteran Library on North 5th Street. Forms 

also can be downloaded for free from IRS.gov and they are available free by calling 1-800-TAX-Form. 

Mr. EVERSON. Certainly. 

Senator CONRAD. You know, when my brother calls—my brother 

in 19 years has never called me about any governmental matter. 

But he said, you know, ‘‘Kent, it just not good service to taxpayers 

in the capital city of our State.’’

Mr. EVERSON. Certainly. 

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Senator CONRAD. One final thing I would say. When I was tax 

commissioner, an accountant came to me one of the first days I was 

in office and brought me his list of clients with a recommendation 

that I audit them. 

[Laughter.] 

Senator CONRAD. I thought that was a rather curious thing. 

Chairman GREGG. It would be helpful, if you can do this—and 

maybe you can’t do this, but the administration asked for $137 million of additional funding, set up in this special mechanism that 

basically gets you additional funding on top of whatever TTHUD 

can do for you. If you can give us an estimate of what that would 

represent in broad terms, in additional receipts as a result of better 

enforcement, that would be very useful to us, to maybe even go beyond $137 million. 

The $137 million you mention represents funds that provide for 

the pay raise and non-pay inflation associated with maintaining 

the enforcement base and building from Fiscal Year 2006 hiring. 

As these funds are intended to maintain the enforcement base, we 

measure that not in terms of additional receipts but rather the potential for lost revenue without the increase. As I reported last 

year, our FY 2006 initiative will yield a $4 to $1 enforcement revenue return per year once fully implemented. In addition, the increased enforcement presence will have a deterrent effect on those 

who are tempted to abuse the tax law. To clairify, if Congress does 

not provide the additional $137 million to maintain its FY 2006 enforcement build, the Federal Government would lose approximately 

$4 for every $1 reduced and the deterrent effect of the unfunded 

enforcement activities. If Congress provided additonal funding for 

enforcement activities in which the additonal funds were invested. 

Mr. EVERSON. Yes, sir. 

Chairman GREGG. Thank you, and I appreciate very much your 

time, and I appreciate your service. Both of you do extraordinary 

work for our Nation, and we thank you for using your talents on 

behalf of the American people. 

Mr. EVERSON. Thank you. 

Mr. WALKER. Thank you. 

Chairman GREGG. Our next witness is going to be Nina Olson, 

who is the Tax Advocate. 

Ms. Olson, we appreciate you taking time to come today. We appreciate your job as Tax Advocate and we look forward to your 

thoughts. You have obviously listened to the Commissioner and the 

General. Give us your thoughts. 

STATEMENT OF NINA E. OLSON, NATIONAL TAXPAYER 

ADVOCATE, TAXPAYER ADVOCATE SERVICE 

Ms. OLSON. Mr. Chairman, Senator Conrad, and members of the 

Committee, thank you for inviting me here today to testify about 

the tax gap. 

The tax gap is a serious problem because it deprives our Government of much-needed revenue and imposes excessive burdens on 

compliant taxpayers. The average individual tax return is effectively assessed a surtax of more than $2,200 each year to subsidize 

noncompliance by others. That is simply unacceptable. 

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The starting point for addressing the tax gap is solid research 

about the causes of noncompliance. The IRS needs more information to determine the best allocation of its resources after taking 

into account both the direct and indirect effects of its activities on 

tax revenue. Not all forms of taxpayer service and not all enforcement measures have the same affect on compliance. 

For example, if the IRS is given additional funds to combat noncompliance, will the IRS get the biggest bang for its buck by spending the funds on strengthening enforcement or on improving taxpayer service? If the answer is enforcement, should IRS continue 

to target corporate tax shelters or should it move more aggressively 

against the cash economy? If the answer is that funds are better 

spent on taxpayer service, should the IRS expand existing taxpayer 

services or should it develop new services that take advantage of 

the latest improvements in technology? 

Unfortunately, the IRS has little reliable research to help guide 

its choices. Simply put, we need more extensive research to make 

optimal fully informed resource allocation decisions. We do not 

know the return on investment of taxpayer service moneys because 

the IRS does not measure it. 

I want to stress that not all the tax gap is attributable to deliberate cheating. The sheer complexity of our 1.5 million word Internal Revenue Code leads to significant inadvertent error, particularly on the part of small-business owners and low and middle income taxpayers who have limited resources yet are expected to 

comply with particularly complex requirements. 

As the IRS works to reduce the tax gap, its choices should reflect 

the central role that taxpayer service, particularly taxpayer assistance, outreach and education, plays in achieving long-term compliance. 

Congress also has an important role to play here. If you adopt 

fundamental tax reform that puts a premium on simplification, inadvertent errors will decline. In my 2005 annual report to Congress 

I outlined six common sense principles for tax reform. And if you 

are able to construct a tax system that reduces what I call opportunities for noncompliance that will go even further to reducing the 

tax gap. 

Data released yesterday show that the most significant source of 

the tax gap is economic transactions that go unreported to the IRS, 

what I call the cash economy. Consider this: where payments are 

subject to tax withholding, compliance is almost 100 percent. 

Where payments are subject to Form 1099 or other third-party information reporting to the IRS, compliance is about 96 percent. But 

where economic transactions are invisible to the IRS the compliance rate drops dramatically, perhaps to around 50 percent, although no one knows for sure. 

These data tell us what most people would intuitively expect. 

When a taxpayer believes IRS knows he has received a payment, 

the taxpayer will surely comply. When a taxpayer thinks the IRS 

has no clue he has received a payment, the likelihood he will comply plummets. 

If we are then to successfully address the tax gap I believe that 

Congress must examine ways to expand such reporting. In some 

cases the burden of requiring third-party information reporting will 

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outweigh the benefits. But the tax gap is composed of many different types of taxes, types of noncompliance, and types of taxpayers. There is no one silver bullet that will eradicate all components of the tax gap once and for all. So we should begin by identifying various categories of transactions that currently are not subject to information reporting and consider on a case-by-case basis 

whether the benefits of requiring reporting outweigh the burdens 

such a requirement would impose. 

In the meantime there are many steps Congress or the IRS can 

take right now that would chip away at the tax gap. In my 2005 

annual report to Congress I made a number of administrative and 

legislative recommendations that are summarized at the end of my 

written statement. For example, some self-employed taxpayers who 

really do want to comply fall behind on their tax payments and 

simply cannot save enough money during the year to make quarterly payments. Thus, the IRS should encourage self-employed taxpayers to sign up for automatic monthly payments of estimated tax 

from their bank accounts like they pay their car payments or their 

mortgages. We already have a system capable of receiving regular 

payments. We need to do more to promote it. 

Under current law an individual taxpayer can escape information 

reporting by incorporating. For Form 1099-Miscellaneous information reporting purposes there should be no distinction between taxpayers providing the same services for compensation merely because one taxpayer is incorporated and another has not. Therefore, 

we recommend that many corporate taxpayers be subject to 1099 

Miscellaneous reporting requirements to the same extent that unincorporated businesses are today. 

My report also contains recommendations to promote voluntary 

withholding agreements, to require backup withholding on payments to taxpayers with a demonstrated history of noncompliance, 

and to develop local compliance initiatives tailored to the unique 

economies of different regions of the country. 

We also recommend that Congress require brokers on a going forward basis report to taxpayers and the IRS the cost basis of publicly traded stocks and mutual funds when these shares are sold. 

In conclusion, I am pleased that the IRS is making the tax gap 

a priority. I am pleased to see strong Congressional interest in this 

issue, and I am hopeful that we will make strides to collect more 

of what is due, yet with minimal burden on the taxpayer. 

Thank you. 

[The prepared statement of Ms. Olson follows:]

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Chairman GREGG. Thank you very much. I appreciate that statement. 

A lot of what you talked about, of course, is not within the jurisdiction of this Committee but just pursuing some of it just for my 

own edification and because it is part of the process of resolving 

this, you are basically saying that we could do some minimal 

things in the area of reporting—well, not minimal but some things 

in the area of reporting which are doable—let us put it that way 

rather than minimal—such as requiring—I like this idea of basis 

being reported prospectively. 

The Commissioner talked about having credit cards reported. Is 

that included? 

Ms. OLSON. That is not in our report, although I do not particularly have any objections to that myself. 

Chairman GREGG. Would that accomplish some of the goals? 

Ms. OLSON. I think it would. I think that the $11 billion that 

shows up in this new tax gap estimate for capital gains is about 

double what the IRS originally estimated the last time they estimated it, and is more than the tax gap attributable to the Earned 

Income Tax Credit which we throw a lot of resources at. 

So I think that $11 billion dollars is really interesting in terms 

of where you might want to pay attention. 

I think the unreporting of—the not reporting payments to small 

corporations—our recommendation was corporations with 50 or 

fewer shareholders—goes to a trend I am seeing where Schedule C 

sole proprietor taxpayers are converting to the corporate format for 

legitimate non-tax reasons, limited liability, those sorts of concerns. 

And S Corporations and small corporations are the forum of choice. 

And they are really operating as independent contractors but in the 

corporate format. 

So we are losing a lot of information there that we could just 

very simply and inexpensively document match to see whether 

those payments are showing up on the S Corporation’s gross receipts. 

I think that is where is some real money is. And again, when 

people think we are going to get that information they report it. It 

makes them nervous. And as I have often said, I like a society of 

nervous taxpayers because that changes their behavior. 

Chairman GREGG. On that theme of making people nervous, if 

we were to take $137 million the Administration has asked for and 

doubled it as an available resource for the purposes of enforcement, 

do you think that would make enough people nervous so we would 

generate significantly more revenues? 

Ms. OLSON. The one concern I have about that is that the IRS 

has done a lot of hiring in the last couple of years because of 

Congress’s support for building the enforcement side. And when 

you have a lot of new trainees you have problems with the kind 

of audits that you are able to give them to work on. 

And so although you might not max out on the IRS’s ability if 

it had fully trained auditors, that many auditors or that many collection people, they will not be fully trained over a period of time. 

You might max out on what kind of work we can actually give 

them in a particular area. 

265

Chairman GREGG. But you have to start training them some 

time. You are never going to get to the point of being able to do 

a complex tax shelter deal unless you put people in the pipeline so 

that four or 5 years from now can do it. 

Ms. OLSON. I believe that what we need to have is over a period 

of years this hiring initiative so that each year we are bringing on 

more people and being adequately able to train them and having 

them at various levels. 

Chairman GREGG. Does the IRS need some sort of differential in 

pay, such as we did with the FBI, in order to get talented people 

into the technology area? 

Ms. OLSON. That is a very interesting comment. I think that is 

very true. I think that my biggest concern right now—it is not my 

biggest concern but a great concern I have is on the business systems modernization. I believe that we really do need to support 

that initiative. 

So many times in the cases that my office gets, and our cases are 

increasing. They increased 17 percent last year on and year-to-date 

they are increasing 11 percent, taxpayers that are having significant hardships in their dealings with the IRS. 

When we go out to the IRS and ask, can we fix this problem, so 

many times the answer is we cannot fix it systemically because of 

our systems. And so there is a real taxpayer service and problemgenerating aspect to our systems, that they are just so far behind 

where they need to be. They create work and they create problems 

for the IRS. And our employees are spending time on those problems that are being generated just by our systems and not by enforcement actions. 

Chairman GREGG. Senator Conrad. 

Senator CONRAD. Thank you, Mr. Chairman. And thank you for 

being here as a witness. It is important to the work of the Committee and the work of the Congress. 

Let me just say what we have heard there this morning is the 

gross tax gap is roughly $350 billion a year. I believe that that is 

probably a conservative estimate based on the analysis that we 

have done. 

And we have heard from the Commissioner that he believes he 

could collect an additional $50 billion to $100 billion a year if we 

took the appropriate steps. And he focused on reporting and withholding. 

You have indicated today that in your analysis of where there is 

under-reporting taxes to the Revenue Service that in those areas 

where there is withholding there is almost 100 percent compliance. 

In those areas where there is reporting there is almost 96 percent 

compliance. But where there is not reporting, where there is not 

transparency, compliance falls to perhaps 50 percent. 

Interestingly enough, I was talking to a major Wall Street firm 

with significant research capabilities. They had almost the identical estimate that they gave to me some months ago in a conversation I had. That where there is not reporting they believe, from observing the other side of transactions, that compliance is way off. 

So if we were to engage in more transparency—because after all 

the vast majority of people, as your testimony indicated, the vast 

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majority of people do have those requirements. Is not that the 

case? 

Ms. OLSON. Right. That is correct. 

Senator CONRAD. What percentage of the people have reporting 

requirements now? What percentage of taxpayers? Has your work 

revealed what that would look like? 

Ms. OLSON. Commissioner Everson said this morning that we get 

235 million W–2s and there are 150 million employees. We get 

about 130 million individual returns a year. I do not have the answer to your questions exactly but we can go back and ask IRS to 

comment. 

Senator CONRAD. Let me just say in business school we always 

talked about the 80/20 rule: 80 percent of your problem is with 20 

percent of your clientele. If that rule applies here, and there are 

many variants on it, maybe it is 85/15. But the point is a fraction 

of your clientele—or in this case taxpayers—is the bulk of your 

problem. 

Do you believe that is the case here? 

Ms. OLSON. I think that is. And then I think that within that 

fraction there are many different reasons why they are noncompliant. We have spent a lot of time over the past 3 years focusing on 

the cash economy and the problems of self-employed individuals. I 

prepared returns for a living for 27 years and was a tax lawyer 

representing taxpayers in controversies. So I did not do the planning side. I got them when they had problems already and tried 

to get them out. 

And so much of the time the non-reporting, the underreporting, 

was not because they did not want to be compliant. It was because 

they just could not save or because their neighbor was also cheating and they felt that they cannot compete, they have to get away 

with that kind of cheating. 

And that has really led me to thinking about how do you change 

norms of behavior? And that goes to long-term compliance. This is 

the issue Senator Grassley was concerned about, that you get one 

fix 1 year. How do you convert people from noncompliant people to 

compliant taxpayers? 

Senator CONRAD. Let me just tell you when I was Tax Commissioner I had a program that I declared a period in which people 

could come in who had been tax cheating and I would suspend penalties. I would charge them interest but I would suspend penalties. 

It was amazing what we got. 

I remember one man had not paid any income taxes to our State 

since the Korean War. I had one man come in who was a priest. 

He had not paid taxes in 22 years. He came in and he cried. He 

said you know, this has bothered me every year around filing time. 

He said I have been so anxious about getting caught. I have been 

so upset. And he said I did not do it for a few years and then it 

kind of got to be a habit. And then I was afraid if I would report 

what the penalties would be and it would swamp me financially. 

I know there is a real resistance to declaring that kind of thing. 

But I must say I told him I made a deal with our legislature. You 

give me $1 million—in North Dakota that’s a lot of money—and I 

will give you a 10-to-one return. We got substantially in excess of 

that. 

267

And we started it by indicating OK, we are going into a new regime here. This deal of paying your taxes every other year, which 

some people had in their heads, that is over. We are going to get 

you—you can come and, come clean, just pay the interest on what 

you owe and we will start fresh. But from now on there is not going 

to be any of this. 

And it was amazing the kind of response we had. 

And it was behavior changing. We had people who after that 

filed every year. It makes quite a difference when you have people 

who are not paying at all all of a sudden start to pay into the system like the vast majority of people do. 

Ms. OLSON. Congress has authorized a program called the Offer 

in Compromise Program. And how it is administered is that taxpayers can come in and say if they have a tax debt that they cannot afford to pay the full amount of the tax, the penalties, and the 

interest. And the penalties and interest are often more than the 

tax after a period of years. We have 10 years to collect. 

And we look at what, on the basis of their financial condition, 

they can afford to pay. We say you have to pay that. 

Part of the deal though, because it is a deal, is that they have 

to agree to be a complaint for 5 years with all tax laws. And if they 

violate that agreement then the debt in full is reinstated and we 

get to go forward with collection action. 

I have always thought that that was a very important program 

for people who just have things that go wrong or they make bad 

business decisions. You want to be careful in administering this 

program. But that promise to be compliant for 5 years means that 

if somebody really is compliant for 5 years, his behavior is really 

changed for the long-term. 

Now disturbingly, the number of offers that we haveten over the 

last few years has declined significently. I think that people are 

concerned about the way the IRS is administering this program. 

And I have tried to say to the IRS this is an important program. 

It turns people who are noncompliant into compliant. And it does 

not undermine your other enforcement initiatives. They are actually mutually strong messages. 

Senator CONRAD. That is a good point. 

I again want to very much thank the Chairman for holding this 

hearing. I want to thank the witnesses that we have had here 

today. 

I think there is a growing level of information that supports the 

notion. This really is an area that needs to be addressed, that we 

could make meaningful progress at closing the budget deficit by aggressive approach on the tax gap, the difference between what is 

owed and what is being paid. At $350 billion a year, that just cannot be left unattended. 

Chairman GREGG. I thank the Senator for bringing this matter 

forward and being aggressive on it. And I know he is going to remain aggressive on it, as I hope I can. And to the extent this Committee can do something about it, we intend to. 

We also appreciate your testimony, Ms. Olson. I think your approach is very common sense, which is good. I hope somebody at 

the IRS will listen to you and maybe you can track down Mr. 

Everson in the hallway here. 

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Ms. OLSON. He is my boss. 

Chairman GREGG. Because I do think the ideas you are putting 

forward make a lot of sense, which is to make sure that we put in 

place the mechanisms for getting more reporting and, as a result, 

getting more compliance. 

So thank you. We appreciate your testimony. 

The Committee is adjourned. 

[Whereupon, at 11:48 a.m., the Committee was adjourned.]

PREPARED STATEMENTS

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THE PRESIDENT’S FISCAL YEAR 2007 BUDGET 

PROPOSAL 

THURSDAY, FEBRUARY 16, 2006

U.S. SENATE, COMMITTEE ON THE BUDGET, Washington, DC. 

The committee met, pursuant to notice, at 9:57 a.m., in room SR–

325, Russell Senate Office Building, Hon. Judd Gregg, chairman of 

the committee, presiding. 

Present: Senators Gregg, Conrad, and Murray. 

Staff present: Scott B. Gudes, Majority Staff Director; and 

Maureen O’Neill, professional staff member. 

Mary Ann Naylor, Staff Director and Rock Cheung, jr. analyst 

for science and international affairs, webmaster. 

OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

Chairman GREGG. We will convene the hearing a little early, 

which is nice. We appreciate the Secretary being here early. We 

know she has a very busy schedule and we hope to accommodate 

that schedule. 

It is a pleasure to have the Secretary of State here. She is an 

exceptional representative for our Nation around the world. She 

has done an incredibly strong job of making America’s views known 

throughout the world and effectively advocating our policies, and 

we appreciate her taking the time to come address the Budget 

Committee. 

It is ironic that we are meeting in this room. The last time that 

I was to have a hearing in this room was on September 11, 2001 

and the First Lady, Mrs. Bush, was supposed to be here to talk 

about education with the HELP Committee, and of course we know 

what happened. That is a day which clearly no one will ever forget 

and we should not forget. Much of what the secretary and her team 

does is about that day and how we continue to respond to the 

threat, which remains regrettably very viable out there. 

We have heard from our enemies that they intend to continue to 

try to attack us and kill Americans and destroy our culture. And 

part of our response to that is to have a strong State Department 

which can carry our message around the world of freedom, democracy and market-oriented approaches to the economies of the world. 

So this Committee, which has the jurisdiction of setting the numbers, deems it a pleasure to have the Secretary here to talk about 

how the State Department—the type of resources the State Department needs and how we can be of assistance in making sure you 

get the resources you need. 

274

With that I will yield to Senator Conrad. 

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD 

Senator CONRAD. Thank you, Mr. Chairman, and again thank 

you for holding this important hearing. And welcome, Secretary 

Rice. It is good to see a fellow Stanford alum here. I had a much 

less distinguished career there than you did. 

Chairman GREGG. That is true of most of the schools. 

Senator CONRAD. That is true. 

Chairman GREGG. He and I went to the same high school. 

Senator CONRAD. So we very much appreciate your service to the 

country. We know this is an incredibly challenging time for our Nation and for many parts of the world. 

With that said, this Committee is responsible for budget decisions and allocating resources. This is going to be a difficult and 

challenging year. 

Let me just say, I have already heard more from my constituents 

about this budget than any budget in the 19 years I have been in 

the Senate and serving on this Committee. 

I am going to go through in a moment what I am hearing about. 

But let me just first put up a slide that talks about the overall priorities of the budget. What we see here is in international affairs, 

which you have preeminent responsibility for, is getting the biggest 

increase—9.4 percent over the baseline. Defense, 3.4 percent, 

Homeland Security a little less than 3 percent. Other domestic 

spending down almost 5 percent. Let’s go to the next slide, if we 

can, because these are the kinds of things I am hearing about and 

it is important for you to hear it as well. And I know you are not 

responsible for putting together budgets and you are not responsible for domestic priorities, but I think it is important for you to 

know the kinds of feedback that we are getting.

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Let me just say in my State, Byrne Justice Grants are for local 

law enforcement. The President’s budget eliminates those. He 

eliminates the money for Safe and Drug-Free Schools. These first 

two are especially sensitive in my State at this time because we are 

facing an epidemic of methamphetamines, is the worst illegal drug 

I have ever seen. It is absolutely destroying families in my State. 

He eliminates funding in the budget for vocational education, 

also something very much valued in my State. 

Rural health care is cut 83 percent in this budget. 

The COPS Program, which has put some 200 police officers on 

the street in my State, is cut 78 percent. 

The Essential Air Service, which is critically important to the 

transportation needs of my State, cut more than 50 percent. 

Amtrak cut 30 percent, which will endanger passenger rail service to my State. 

And the RUS electrification loans, which are almost religion in 

my State, cut 29 percent. 

You can see that these priorities create real conflict. And I can 

tell you this budget submission is unpopular in the constituency 

that I serve.

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Let us go to the next one. I have shown this to my colleagues 

many times. As we look ahead we see the deficits with some small 

improvement over the next few years, but then getting much worse 

if the President’s policies are adopted.

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And the debt of the country, and this is an area that I hope is 

of direct concern to you, the debt of the country growing very dramatically—$5.8 trillion at the end of the President’s first year. Now 

at the end of this year, $8.6 trillion. Our projections are that, in 

the next 5 years, it will reach $12 trillion. 

And more than that, increasingly, we are relying on foreigners to 

finance this debt. In 5 years we have doubled the amount of debt 

held by foreigners. Doubled.

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These are the countries that we now owe money. Japan we owe 

almost $700 billion. China, more than $250 billion, and on it goes. 

This is of increasing concern in terms of our vulnerability to others making decisions about our financing. If these people pulled 

away from financing our debt, most economists tell us interest 

rates would rise significantly in this country, which would create 

economic slowdown.

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The Comptroller General said this on February 15th in a hearing 

in this Committee ‘‘Continuing on this unsustainable fiscal path 

will gradually erode, if not suddenly damage, our economy, our 

standard of living, and ultimately our national security.’’

That is really the final point I want to make because it goes right 

to the heart of what makes a strong country. If we are not financially strong, we cannot be militarily strong. 

And so the question of how we arrange the priorities of the country in the work of this Committee is critically important and we 

welcome your insights. 

Chairman GREGG. Thank you, Senator Conrad. Madam Secretary, we would be happy to hear whatever you wish to tell us. 

STATEMENT OF HON. CONDOLEEZZA RICE, SECRETARY, U.S. 

DEPARTMENT OF STATE 

Secretary RICE. Thank you very much. Thank you, Senator 

Gregg. Thank you, Senator Conrad and members of the Committee. 

I have a longer statement which I would like to enter into the 

record but I will not subject us to a reading of that statement so 

that we can have full time for a discussion and for questions. 

I would like, in lieu of reading the statement, to make just a few 

points and then, of course, to take your questions. 

It has been a little over a year since I was confirmed as Secretary of State and it has been a very eventful year. It is a time 

of great and historic change. It is a time when the United States 

and its friends are meeting multiple challenges across the globe. 

If I could start where you began, Senator Gregg, September 11th 

really was a crack in time. It changed our security priorities. It 

changed our thinking about what makes a secure America when we 

were attacked in that brutal way on that September day. 

The challenge for the United States is, of course, to use all of our 

means of national power, our military power, our economic power, 

our diplomatic strength, our influence around the world, of course 

to defeat the terrorist threat that so brutally attacked us, but recognize that we are not going to be able to have a permanent peace 

to pass on to other generations. I think we recognize also that the 

degree to which we can leave a world that is more democratic, 

more free, more prosperous, where there are not failed states of the 

kind that Afghanistan became which led directly to terrorist training camps in which people trained to attack us from, the more that 

we recognize that the incapacity of states to govern, to control their 

borders, to fight terrorists themselves endangers us. 

The President’s budget is a budget that is in support of those national security goals. And I have said to my colleagues, to your colleagues on Senate Foreign Relations Committee yesterday, that I 

think we should think of our assistance programs as national security spending because without a robust effort by the Department of 

State, on the diplomatic side, on the foreign assistance side, and on 

bringing well-governed democratic states alongside us, we will not 

be able to protect ourselves in the long term. 

This budget therefore is a budget that is in support of the tremendous democratic transition that is going on in the world in 

places like Iraq, where clearly there is a struggle for the creation 

of a stable and democratic Iraq. But the struggle that they are emVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00291 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
286

barked on is far preferable to the false stability of the dictatorship 

of Saddam Hussein who threatened us all, threatened his neighbors and caused two wars in the region. 

Afghanistan, as I said before, was a failed state that directly produced Al Qaeda and its attacks. Of course, countries like Jordan 

and Pakistan that are in the front lines of the fight on terrorism 

are with us. And we have seen, in places like the Palestinian Territories, that democratic processes are always not very predictable. 

At some point I can speak to the issue of the election that 

brought Hamas to power. Obviously, this will have an effect on 

American assistance. We have made very clear that we cannot fund 

a Palestinian government unless that government is devoted to 

Israel’s right to exist, to denouncing terror and to indeed disarmament. 

This budget also recognizes that we have other major challenges. 

In the areas of proliferation of weapons of mass distraction and 

prevention of that. I announced yesterday that we will be asking, 

in a supplemental request, for an additional $75 million for democracy programs in Iran. Perhaps one of the biggest problems that we 

face is the policy of the Iranian regime, which is a policy of destabilization of the world’s most volatile and vulnerable region. It is 

not just Iran’s nuclear program but also their support for terrorism 

around the world. They are, in effect, the central banker for terrorism around the world. They are also, of course, going 180 degrees away from the way that this region should be going in terms 

of human rights and democracy for their own people. 

We have worked very hard to create a coalition of states that will 

confront Iran’s aggressive policies, particularly its nuclear program. 

We have had some success and we are now in the U.N. Security 

Council to address that problem. 

I think it is worth noting that we will not be able to address the 

Iranian nuclear program and problem in a vacuum. It is Iran’s regional policies that really are concerning as we watch them with 

their sidekick Syria destabilizing places like Lebanon and the Palestinian Territories and indeed, even in southern Iraq. 

So there is recognition of those matters in this budget. 

There is also recognition of America’s desire to continue to be a 

compassionate nation. We have led the world, of course, when there 

have been humanitarian disasters, when there has been a need to 

deal with the world’s most vulnerable populations through refugee 

assistance or food assistance. And that is represented in this budget. 

And finally, and this is to speak, in part, to Senator Conrad’s 

concern. We are, Senator, very aware of the pressures on this budget. And we are very aware of the pressures on the American people 

and the American taxpayers’ dollars to fund the significant program that we need to secure ourselves through diplomatic means. 

As a result, we have launched a number of reform initiatives to 

try and make certain that we are better stewards of the American 

people’s taxpayer dollars, that we are not engaging in duplicative 

activities, that we are engaging in activities that are effective. 

I would just cite two of those reforms, which we have put under 

the title of transformational diplomacy. On the one hand, I have 

asked for and received a plan for global repositioning of our diploVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00292 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
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matic presence. It seemed to me that almost 15 years after the end 

of the cold war are still rather heavy in parts of the world where 

we traditionally had large presences, in Europe for instance, and 

rather light in places that are really growing in influence: Brazil, 

China, India, other places in Latin America and indeed in Africa. 

We have to put our people increasingly in very difficult hardship 

posts where they cannot take family with them, so I want to make 

sure that our people are well treated. To meet these changes, we 

are moving our diplomats around. So far we have repositioned 100 

people and I have asked for further repositioning plans to do more 

of this. 

I am asking in this budget that we create 285 new positions, for 

transformational posts, very important security measures that we 

must take, and also for work that we need to do to improve our 

capabilities in critical language skills. We are just simply very 

short of people who can use Arabic or Farsi effectively in the places 

that we really are meeting the threats. 

The other aspect of transformational diplomacy is that we are 

working very hard for foreign assistance reform. We believe that 

we must realign better the somewhat 80 percent of the foreign assistance budget that resides in USAID and State so that we are 

certain that we are meeting the objectives, addressing the concerns 

and the needs of the world’s most vulnerable people. But we are 

also building State capacity to address those concerns. We do not 

want our foreign assistance program to be a kind of permanent dependency for countries. We really want them to be able to take on 

their own problems. If you fund countries that are corrupt, if you 

fund countries that are unreformed, then there are going to be permanently dependent because they cannot govern wisely. 

So through foreign assistance reform we hope to be able to use 

the precious dollars that we receive better, to make sure that we 

are not duplicating efforts, and to make sure that we are spending 

on the highest priority items. 

I have proposed creating a Director of Foreign Assistance reporting directly to me who would also be the USAID Administrator so 

that we can get synergies between our various programs. 

Finally we are requesting for the Millennium Challenge account 

$3 billion this year. I know that there have been questions about 

how rapidly the Millennium Challenge program hasten up and running. I can go through some of the numbers later. But let me say 

that I think this is really, in many ways, the President’s flagship 

program, to change the way that recipient countries think about 

their responsibilities as they receive our foreign assistance dollars. 

These countries are states that are governing wisely, that are investing in their people, that are fighting and rooting out corruption 

and that we think are the lead edge of responsible sovereign states 

that can not only do better for their people but be contributing 

states to a safer and more secure world. 

Thank you very much. 

[The prepared statement of Secretary Rice follows:]

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Chairman GREGG. Thank you, Madame Secretary. 

That was really an excellent summary for us of where the State 

Department is and what you are trying to do. And I especially congratulate you on this effort, this transformational effort, to try to 

move people to where the problems are, which is something when 

I was chairing the State Department appropriating committee I 

worked on. There was some progress. But obviously your commitment to this is great. And we want to be supportive of that. 

You are in an ironic situation in that you are one of the few secretaries who comes before this Committee who has had significant 

increases in your budget. I guess our question to you is are there 

efficiencies which we could look at? Are there things that we 

should be thinking about that would allow us to get more additional dollars, more additional activity for the dollars we are putting in? There is concern about the Millennium Challenge and the 

way that has been started up. 

Can you just sort of give us an overview of how you think the 

Department can most effectively use the dollars we are giving you 

and whether or not the dollars we are giving you are enough, considering the fact that you are getting a significant increase? 

Secretary RICE. Thank you, Senator Gregg. I really do not take 

for granted or take lightly the sacrifice that is being made on behalf of the programs that we run. I know that there is a lot of pressure on this budget. 

I would just first go back to one point before I address the question of what the Department can do. 

We are now in a phase of our diplomacy in which we have gone 

through two wars in Iraq and Afghanistan. We have gone through 

the largest terrorist attack on American soil. And we are literally, 

I think, in the midst of a big historic transformation to a world 

that, if we do our work correctly, will be more democratic, more 

free, and have states that will be allies in the war on terrorism, 

not states that will be fueling the war on terrorism. We are in the 

midst of trying to beat back concerns about the proliferation of 

weapons of mass destruction because heaven help us if weapons of 

mass distraction ever fall into the hands of terrorists, let alone into 

the hands of rogue states. 

We are trying to meet the challenges of helping front-line states 

that are taking enormous risk in the war on terrorism, like Jordan 

and like Pakistan. We are in the midst of trying to help the people 

of Iraq and Afghanistan rebuild on the ruins on these dictatorships 

that were supportive of terrorism. 

And around the world we are trying to use our diplomacy to further the cause of freedom and liberty and responsible states and 

to engage our long-term allies as real partners in doing that. 

I would note that we have been very fortunate, for instance, to 

have the whole world really united against Iran, not just the 

United States. That takes work and it takes diplomatic effort. 

The Millennium Challenge, as I said, gives us a particular kind 

of tool to encourage responsible behavior by states. I can tell you 

that countries want to participate. They want to make the case for 

why they ought to be a Millennium Challenge country. They will 

tell you what they are doing to fight corruption and what they are 

doing to invest in their people. I think these are all dollars well 

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spent so that we can leave a foundation for a more peaceful and 

secure world, much as our predecessors left the foundation for a 

Europe that became whole, free and at peace and a Europe where 

no one can any longer imagine a war between the great powers. 

That is the challenge that we have in a volatile region like the 

Middle East. 

We will do our part to make sure that the dollars are well spent. 

It is why I think that we have to continue with our global repositioning. It is not going to be enough to come to the Committee 

and ask for more positions, and heaven knows we need more positions around the world, in places like Baghdad, like Islamabad, in 

many of our Latin American posts and in our posts in China and 

India. If you just look at the importance of those countries and the 

growth in populations in some of those countries, we are not meeting the diplomatic needs that we need to meet. However, with some 

combination of new resources and reprogrammed resources, I think 

can help us meet those needs. 

I have also asked Henrietta Fore, who is the Management Under 

Secretary, to work harder on our rightsizing initiative and to work 

on questions of what we might be able to do to merge functions between various parts of the foreign policy community, to see if we 

can do with more regionalization of some of our efforts. Maybe 

every embassy does not have to have every thing. Maybe we can 

do things on a more regional basis. 

So I promise you, we are going to be looking to squeeze out every 

dollar that we can. But right now the demand outstrips the supply 

of even significant increases that we have had because I think we 

have recognized the challenges before us. 

Chairman GREGG. Thank you. 

Yesterday I listened to some of the questions you were asked at 

the Foreign Relations Committee yesterday. And I thought some of 

them may have more to do with campaigns for the presidency 

maybe than what your answers were. 

But independent of that, the bottom-line question was, I thought, 

what is going to happen in Iraq? And when are we going to get out 

of there And so let me ask you that question. 

Secretary RICE. Well, the Iraqis are now engaged in the final 

stages of their political journey to actually create a permanent government. It is very hard to realize that it has only been a year 

since they have had their national elections and they now are in 

the process of creating a permanent government and creating a 

constitution. It is very hard because this is a country that has always resolved its problems by repression of groups, even repressions of majorities like the Shia or by dictatorship of the kind that 

Saddam Hussein imposed. 

However now they have to do this by politics and by compromise. 

I think they are doing really rather well at it and I think you will 

see the formation of a national unity government. 

Our support for them has been twofold. The Congress was generous in reconstruction funding for Iraq, which has been subject to 

some problems due to security. But I think the reconstruction program has had a real effect. We have been able to modernize large 

portions of the Iraqi infrastructure. For instance, we are delivering 

water and sewage in much larger numbers to many more Iraqis 

306

than in the past. We are continuing to work on the oil and the electricity infrastructure. 

The Iraqi security forces are about 227,000 strong now. And to 

be fair, we made a mistake earlier on. We relied on numbers, not 

quality. These are, according to those who train them, quality 

forces that are now the Iraqi security forces. They are taking their 

own territory, holding their own territory, and now beginning to 

create the circumstances under which these provinces can really be 

rebuilt. 

That, Senator is the way that I think about the course ahead for 

Iraq. Now our part in that is to continue to support them and to 

continue to support them so that they can have a secure basis on 

which to become democratic and prosperous. 

But I do not believe that we ought to think that this is only a 

job for American military forces. As Iraqi security forces stand up 

in their security task, there is no doubt in my mind that American 

security forces will be less and less needed and less and less relevant to the task. 

Indeed, I think it is why General Casey recommended to the 

President that we go from 17 brigades to 15 brigades, one now in 

Kuwait as a rapid reaction force. I think you will see more of that 

because Iraqi forces are stepping up, because the political process 

is progressing, because Sunnis are now heavily engaged in the political process and insurgents have less reason to be in the insurgency and Sunnis have more reason to be in the political process. 

So I know that it sometimes looks like a complicated place but 

it is a place that is making progress along the political front and 

ultimately that is how you defeat an insurgency. If we leave early, 

if we do not remain committed, then we risk leaving an Iraq that 

is going to be a force of instability and terrorism in the region. If 

we do this job well, imagine the impact of an Iraq that is fighting 

terrorism, that is democratically governed, that is a friend of the 

United States and that can anchor a different kind of Middle East, 

a Middle East which desperately is in need of change because any 

region that produces an ideology of hatred so great that people fly 

airplanes into our buildings is in desperate need of change. 

I think that the future of a better Middle East is one where Iraq 

is an anchor. That is why the United States is so important to that 

cause. 

Chairman GREGG. Senator Conrad. 

Senator CONRAD. Madam Secretary, did I hear you right when 

you said that water and sewer has improved in Iraq? 

Secretary RICE. Yes, you did. We have increased the capacity for 

clean water for several million Iraqis and 4 million Iraqis have better sewage than before the war.

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Senator CONRAD. Let me just ask you—this is from the New 

York Times from February 9th, and this was testimony by the Special Inspector General for Iraq Reconstruction before the Foreign 

Relations Committee. In that story, the lead paragraph is, ‘‘Virtually every measure of the performance of Iraq’s oil, electricity, 

water and sewage sectors has fallen below preinvasion levels’’ even 

though we have spent $16 billion of American taxpayer money on 

Iraq reconstruction. Specifically on percentage of drinking water 

before the war, according to the Inspector General, 50 percent had 

it before the war. Now only 32 percent do. 

On percentage with sewage service, 24 percent before the war, 

only 20 percent now. 

So who are we to believe? 

Secretary RICE. Let me give you the numbers. I have worked 

with the Inspector General and I actually went over his briefing before he gave that briefing. He came and gave the same briefing to 

me. 

On potable water, millions of persons served prewar 5.5, 2005 average 8.6. We hope by the end state, that 12.5 will be the case. 

Sewage, in millions of persons served, prewar about 0.5 average, 

in 2005, five. So the numbers have been going up on water and 

sewage. 

The problems, you are absolutely right, Senator, have been on oil 

and electricity. 

Senator CONRAD. Wait, wait, wait. This is the Inspector General’s testimony before the Foreign Relations Committee. He says 

yes, oil is down. Daily crude oil production down from 2.6 million 

barrels to 2.1. Daily heating oil production down from 5,000 tons 

to 1,700. 

But he says specifically drinking water, 50 percent had it before 

the invasion. Now only 32 percent do. Percentage with sewage 

service, 24 percent had it before the war and now only 20 percent 

do. 

Secretary RICE. I think this may be an issue of whether we are 

talking about delivery or capacity. We have increased the capacity 

for clean water for several million Iraqis and for 4 million Iraqis 

in sewage. 

Senator CONRAD. Can I say to you though, what matters to people is getting it. And what the Inspector General said very clearly 

is that in virtually every measure the performance of Iraq’s oil, 

electricity, water and sewage sectors has fallen below preinvasion 

levels. We can improve capacity and that is great. But at the end 

of the day what matters to people is that they get it. 

Secretary RICE. That is true, Senator, but without improved capacity more Iraqis are not going to get it. 

You are right, we have concentrated on improving the capacity 

to deliver these services. The reason that we now have moved from 

rather large scale reconstruction projects, as I say reconstruction 

with a large R, to smaller scale more local reconstruction projects 

is to make certain that there is also better delivery for Iraqis. 

Senator CONRAD. Let me stop you there, if I can, because in this 

article it goes on to say in one sense focusing on the plummeting 

performance numbers misses the point. The real question is whethVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00314 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
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er the Iraqi security forces will ever be able to protect the infrastructure from insurgent attack. 

That leads me to this question. This is an article that appeared 

in the Washington Times on December 3rd saying that ‘‘Funds may 

be lacking for ample Iraqi army... The U.S. general in charge of 

shaping an Iraqi army raised the prospect yesterday that the new 

Baghdad government will not have sufficient money’’ to fund the 

army envisioned by our Administration.

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Let me ask you this because this is a budget committee. As much 

as we are interested in foreign relations here—and I think every 

Senator is—our primary responsibility to our colleagues is budget 

matters. These things raise two questions in my mind that are directly budget related. 

We have the Inspector General saying things are getting worse 

there across a broad metric of delivering services to people, even 

though we have provided a lot of money. In fact, I think we have 

approved downsizing of expectations. It says, in this story, it was 

striking given that $30 billion of American taxpayer money has already been dedicated to the task. 

So the American people have been very generous already. And 

they are saying in this article that, according to the Inspector General and other witnesses before the Committee, they need more 

than $56 billion for reconstruction. 

What of that amount do you think the American taxpayers will 

be asked to finance? 

Secretary RICE. Senator, let me say first that the taxpayers’ dollars that we have spent have modernized aspects of the Iraqi infrastructure. For instance, creating more capacity will allow us to deliver more. The first is to create more capacity. 

Then you can deliver services. What we are now really focusing 

on is how to make that delivery work, which is why I think you 

will see, both in our budget request and in what will be a supplemental request, that the focus is actually not on large funding for 

reconstruction projects. Rather, we are focusing on funding for provincial reconstruction efforts that will be more decentralized, but 

will allow us to work with local governments to deliver services. It 

will focus more on creating capacity in the Iraqi ministries so that 

they can also deliver services. In effect, we have given them a real 

boost in the infrastructure itself, in helping to modernize it, helping to create its capacity. 

We are now going to have to work with others, and there are 

pledges from other countries that have not yet been paid, not yet 

been actually handed over to the Iraqis for infrastructure, that I 

think we will use it to help them to continue the infrastructure 

modernization. 

You will not see large numbers in our budget requests for further 

infrastructure projects. What you will see is funding for maintenance. You will see that we want to spend down the remaining 

money in the Iraq Reconstruction Fund (IRF–2). We have committed that money. Finally, we want to have provincial reconstruction efforts that will allow us to help the Iraqis to deliver services. 

Senator CONRAD. Let me just say you need to mark me down as 

a skeptic. According to the Inspector General, he says by virtually 

every measure things are going in the wrong direction, not the 

right direction with respect to delivering services to people there. 

And they say the $56 billion is not going to be enough. This is the 

testimony before the Foreign Relations Committee. 

I tell you, I am very concerned that we are going to be asked for 

a boatload of additional funding. And as I have pointed out, things 

that are terribly important to my constituents, including essential 

air service being cut more than half, Rural Utility Service being cut 

312

30 percent. There is an enormous challenge in the Middle East. We 

also face big challenges in our own Midwest. 

And I would say to you that this trajectory does not look good 

to me. And this notion that there is going to be a tremendous need 

for additional money, including for the Iraqi army, and we seem to 

be the ones that keep ponying up. We have to find a way to share 

this burden because I can tell you, patience is wearing thin. 

Secretary RICE. Thank you, Senator. 

I agree that we need to find a way to share the burden. In fact, 

we do have a significant amount of money that has been pledged 

to Iraqis that has not yet been appropriated to them. We need to 

work to get people to pay those pledges. Some of that money is for 

exactly the kinds of projects and you are talking about. But I want to be very clear, the United States has about $2.9 billion remaining in the IRF. We intend to spend that, continue the 

spending on infrastructure of that money. We intend to use that 

money in smaller scale projects that will allow for more rapid delivery. 

Our focus in this supplemental and in this budget is on making 

the Iraqis more capable of delivering their own services by working 

at the local level with provincial teams and working at the national 

level with ministry teams to make better use of the infrastructure 

that we have helped to provide. 

However, there are still problems. 

Senator CONRAD. Could you say that again? Could you just educate us here? When you say in the IRF, is that a term of art? 

Secretary RICE. I am sorry. That was in the Iraqi Reconstruction 

Fund. Sorry. 

Senator CONRAD. It is referred to in that way? 

Secretary RICE. Yes, that is where the money was appropriated 

by the U.S. Congress. 

Senator CONRAD. The thing that is so striking to me, I have had 

my staff every 30 days provide me with an update about how 

things are going with these matters. And every month I get these 

reports and things are not getting better. That is what is so striking to me. 

And now we have the Inspector General coming up here and testifying that in almost every one of these areas things haveten 

worse since before the war, and that the estimates of the cost are 

going up, up and away. And now they say there may not be the 

funds for the Iraqi army that we want to turn the responsibility 

for security over to. 

What is your anticipation there? Are they going to have the 

funds necessary to stand up an army that can provide security? 

Secretary RICE. Senator, I think the Iraqis and the new Iraqi 

government recognizes that one of their first responsibilities is 

going to be to provide security themselves. Yes, theoretically, you 

could end up with not enough money for the Army. But that is 

what budgeting is about and that is what programming is about. 

The Iraqis are going to have to budget and program hopefully with 

some help from others in the international community, as well, to 

be able to meet their security needs. 

They have two problems right now that we are helping them 

work on. One is that while it is true that oil revenue has been 

313

down because even though oil production and export was at prewar 

levels in the summer, there have been insurgent attacks against 

the pipelines making much more difficult the export of oil, which 

is a huge source of revenue for the Iraqis. 

We are working to try and improve that situation so that oil production and oil export can go back up. 

The other piece of that is that the Iraqis are working to eliminate some of the subsidies that are a huge drag on their budget. 

They also have a number of debt relief pledges that when they 

have an IMF program, can be met. 

So there are sources of revenue for the Iraqi government. It is 

a matter of their budgeting and programming that they are going 

to have to meet to cover their security needs. 

I would expect that that is going to be a very important conversation with the new government. 

Senator CONRAD. My time has expired. I must say that I am increasingly skeptical when I look at the data that I am receiving 

about what is happening with the infrastructure of Iraq by virtually every measure. 

I was just handed another review—down, down, down. I will tell 

you, I think we have a huge problem on our hands here. If they 

do not have the funds to stand up the Army necessary to provide 

security to their people, it makes me extremely concerned about 

what will be asked of our people. I thank you. 

Chairman GREGG. Thank you. Senator Sessions, do you have a 

questions? We have about seven-and-a-half minutes left on this 

vote. 

Senator SESSIONS. I will try to be brief. 

First, I would like to compliment you, Madame Secretary, on 

your commitment to review and transform the State Department. 

As a member of the Armed Services committee, the Defense Department is intensely reviewing its investments and how it spends 

its money, what its priorities are, what the future will look like, 

and trying to configure that department to meet those challenges. 

The State Department does not have weapons systems and 

things of that nature. But likewise, I think it is healthy that you 

are challenging, asking people where you really need embassies, 

where you need to have people stationed. 

And you may get push back from Congress or from people who 

prefer to be stationed in Germany than some Third World country. 

But you have to make those decisions. And I hope that if you do 

that you ask for support from this Congress. I think you will get 

it. 

I am also pleased that you are requesting funds for democracy 

in Iran. It was not too long ago that I met an Iranian who fled Iran 

and he was so sincere. It just really brought tears to your eyes to 

talk about his love for his country and the difficulties that they 

have, his belief that so many of the people there want a better life, 

they want freedom. And I think that is a policy we should encourage. 

And I think the President, by saying this openly and appealing 

to the people of Iraq, we are not hostile to them but we want them 

to simply have a better life, a freer life, that it is the right thing. 

314

You have been asked about the Iraq war and the reconstruction 

effort. Fundamentally I guess—I would ask you this way. 

The State Department’s responsibilities now include the infrastructure and the political progress in Iraq in trying to work with 

the new government of Iraq and assist them and encourage them 

to do things that would be in the long-term best interest of that 

country. The military is challenged and oftentimes have to carry 

the load, but they are executing policies that are consistent with 

the State Department policies; is that correct? 

Secretary RICE. Yes, absolutely. 

Senator SESSIONS. In other words, this is a sovereign, Iraq, now. 

We relate to Iraq through the State Department, our Ambassador, 

not by a military force that operates on its own will throughout 

that country; is that correct? 

Secretary RICE. Absolutely, Senator. What happens is that, first 

of all, we have found in a number of parts of the world, and Iraq 

is one and Afghanistan is another, that the strong integration of 

our military and political efforts, our military and diplomatic personnel, has to really be achieved. So you will not see a closer working relationship than between Ambassador Khalilzad and General 

Casey. They are joined at the hip. You rarely see one without the 

other these days. 

That gives us the ability to deal with the Iraqi government in a 

way that unifies what we need to do to continue to defeat the insurgency, with what we are trying to do to build the new Iraqi 

state. 

You need to vote. I will stop there. 

Senator SESSIONS. Thank you. 

I would just say that Secretary Rumsfeld was complimentary of 

the relationship. But as Chairman John Warner mentioned in our 

last hearing with the Secretary, that we talk about jointness within 

the military. We need a jointness within State, Commerce, Defense 

and within DOD as we deal with these complex issues. And I hope 

that you will work toward that. 

Thank you, Mr. Chairman. 

Chairman GREGG. Thank you, Madame Secretary. 

We have a vote on. You have been very generous with your time. 

I do not think you should have to sit here and wait for Senators 

to arrive after the vote. So we are going to adjourn the hearing and 

we appreciate the input. 

More importantly, we appreciate the job you do for this country. 

You are an exceptionally good spokesperson and manager of the 

diplomatic affairs of our Nation and we are very fortunate to have 

you as a public servant. Thank you. 

Secretary RICE. Thank you very much, Senator. 

Chairman GREGG. The hearing is adjourned. 

[Whereupon, at 10:45 a.m., the hearing was concluded.]

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THE PRESIDENT’S BUDGETARY PROPOSALS 

FOR THE DEPARTMENT OF HEALTH AND 

HUMAN SERVICES 

WEDNESDAY, MARCH 1, 2006

U.S. SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to notice, at 10:22 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Judd Gregg, chairman of the committee, presiding. 

Present: Senators Gregg, Bunning, Ensign, Conrad, Murray, Nelson, and Stabenow. 

Staff present: Scott B. Gudes, Majority Staff Director; and Dave 

Fisher, health policy director.21Mary Ann Naylor, Staff Director 

and Sarah Kuehl, analyst for social security, transportation and 

medicare. 

OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

Chairman GREGG. We will convene the hearing. I apologize to the 

Secretary. The understanding was that we were going to have a 

vote at 10 and then we were not going to have a vote at 10, so we 

have been in the practice of running back and forth to the floor. 

The Secretary obviously has a huge portfolio relative to the responsibilities of the Federal Government, and some of it is the dayto-day activity of maintaining the health and welfare of the Nation, 

and some of it involves significant issues of how we protect ourselves from the threats of a biological attack or potential influenza 

outbreak or some other major disease event. And equally important 

to that is the portfolio of the senior citizens’ Medicare and Medicaid 

accounts, which we know are going to be under huge pressure as 

we move into the out-years. 

This committee has spent a lot of time focusing on that issue, 

trying to put in context what we are looking at in the out-years, 

and I respect and congratulate the administration for bringing forward a budget which attempts to address in a small way the Medicare issue. And last year, of course, we made some progress on the 

Medicaid issue as a result of the hard work of the Secretary. 

Whether we are going to make progress on the Medicare issue 

this year is very much an issue, and that is something I want to 

hear from the Secretary, how he thinks we can—what his road 

map is for accomplishing that. 

And so we look forward to your testimony. Obviously, most of 

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stricted, and the non-defense discretionary accounts under the 

President’s proposal essentially are flat funded, and those would almost all affect accounts within your jurisdiction. But, of course, the 

entitlement accounts, like Medicare, are not and they are exploding. And there is a genuine bipartisan effort here in the Congress 

in support of the President’s efforts to try to get us ready for the 

potential of a pandemic flu outbreak, and that obviously has been 

budgeted for. 

So we look forward to your testimony, and thank you for taking 

the time to come here, and now I will yield to the Senator from 

North Dakota. 

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD 

Senator CONRAD. Thank you, Mr. Chairman, and thank you for 

calling this hearing, and thank you, Mr. Secretary, for being here. 

I apologize as well for the unpredictability of the Senate. I have 

high regard for you both personally and professionally, as I have 

expressed to you, both publicly and privately. 

I do not have high regard for this budget, and let me just run 

through some of what I see are the serious deficiencies of this 

budget.

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We heard from the administration the deficit is going to be cut 

in half over the next 5 years, but they only get there by leaving 

out things: war costs, the costs of fixing the alternative minimum 

tax, and the full cost of the tax cuts beyond the next 5 years. When 

you put all those things back in, this is our projection of where the 

deficit heads, and we do not think that is a healthy direction. The 

growth of the debt is even more alarming. As you know, the debt 

is growing much more rapidly than the deficit. This year the President says the deficit is going to be in the $400 billion range, which 

I think somewhat overstates the deficit for this year. But the debt 

will go up, according to our calculation, $630 billion this year, and 

every year for the next 5 years under the President’s budget proposal we see the debt increasing $600 billion or more each and 

every year.

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You understand this challenge very well. As we look at the unfunded liabilities of the country, Medicare is by far the biggest. 

This is the 75-year shortfall in Medicare, $29.6 trillion. It is more 

than 7 times the projected shortfall in Social Security. And, by the 

way, I think the projected shortfall in Social Security is somewhat 

overstated for technical reasons I will not go into, but I do believe 

the shortfall in Medicare is very real. And it is the thing that is 

going to swamp the boat. 

Let’s go to the next chart.

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Then I look at the specifics of the President’s budget, and for 

2007 through 2016, he proposes $154 billion in savings from Medicare and Medicaid. But during that same period, he proposes tax 

cuts of $1.7 trillion, more than 10 times as much. Frankly, I do not 

think these proposed tax cuts are affordable given the fact we cannot pay our bills now and given the priorities of the American people. 

Let’s go to the next chart.


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This is a statement, Mr. Secretary, you made that I very much 

agree with: ‘‘We had to make hard choices—hard choices about 

very well intentioned programs.’’ I agree that these are hard 

choices. I do not agree with the choices that have been made because I do not see any justification for having 10 times as much 

tax cuts as we are having in terms of spending savings. 

Let’s go to the next slide if we could.

Then we get to an issue of priorities. In the President’s budget, he would cut rural health care programs $133 million. During this 

same year, tax cuts, the cost of the tax cuts going to those who 

earn over $1 million a year is over $41 billion. You know, I think 

we are going to have to go to the wealthiest among us and say, you 


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know, everybody has to sacrifice here. We are at war. We are piling 

up debt at a record rate. We have to get everybody here pulling the 

wagon. We cannot be saying to those who are the wealthiest among 

us, ‘‘You get a pass.’’

Let’s go to the next slide.


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This hospital administrator back home says, ‘‘We cannot absorb 

cuts of this magnitude without reducing access to needed services 

and negatively impacting the health of our communities.’’ This is 

from the head of Mercy Hospital in Valley City, North Dakota. Valley City is a town close to where we were when you were with me 

in Fargo, and this is the consistent message I am getting back from 

back home.

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Let me go to my last slide because this goes to the question of 

what do we do about all this. This to me is the most compelling 

statistic: 6 percent of Medicare beneficiaries account for roughly 51 

percent of program costs. I think collectively we have to focus like 

a laser on that fact—6 percent of Medicare beneficiaries are using 

over half of the Medicare budget. This to me is the major opportunity to both save money and get better health care outcomes, because I do not think we are doing a good job of coordinating the 

care. The result is these people are taking many, too many prescription drugs, many of which work against each other. They are 

being subjected to all kinds of duplicate testing. And these factors 

actually make their health worse and cost the taxpayers massive 

amounts of money. Of course, it costs the patients massive 

amounts of money, too. 

So I hope that in this hearing today we are able to have a conversation about what could we do that would be effective at saving 

money here and improving health care outcomes. And then, Mr. 

Secretary, I just want to say I am going to try to focus on avian 

flu and what the plans are there and what we need to do to get 

ready, because I am convinced the risk is enormous, and you and 

I have had a long conversation on this matter before to talk about 

the strategy for how we get ready to combat a pandemic, whether 

it was avian flu or caused by some other virus. 

I thank the Chair. I thank the Secretary. 

Chairman GREGG. Thank you, Senator, and we welcome you, Secretary. We also welcome Vince back, Vince Ventimiglia, who has 

been a friend and a tremendous asset to the Senate for many 

years, and now I know is the same for your office, and has written 

most of the major health legislation that has come out of the Senate over the last 6 years. 

So we would like to hear what you have to say. 

STATEMENT OF HON. MICHAEL O. LEAVITT, SECRETARY, U.S. 

DEPARTMENT OF HEALTH AND HUMAN SERVICES 

Secretary LEAVITT. Well, thank you, Mr. Chairman and Senators. 

Thank you very much for having me here. I am here to speak of 

a budget that is a large budget, $700 billion. You well know that 

it is broken into two general pieces. There is the entitlement budget and then there is the discretionary budget. The discretionary 

budget is about $75.5 billion of that nearly $700 billion. The balance of it is the entitlement budget. 

The discretionary budget that I will present to you today is roughly down $1.5 billion. This is a deficit reduction budget. As 

Senator Conrad pointed out, there are hard decisions that have to 

be made in this kind of a context, and today I am here to talk with 

you about how I went about making the decisions I made. There 

will be areas on which we have disagreement, where you would 

have made different choices than I did. My purpose is simply to tell 

you the basis on which I made my suggestions. 

But I do want to speak for a moment about the same subject that 

you have raised, both of you, and that is the entitlement budget. 

This is of grave concern to me. It is to the President. You have expressed it in trillions of dollars. A trillion is a startling number on 

its face. I have begun to focus on this in a different way, and that 

398

is, what is the percentage of the gross domestic product that these 

expenditures make up? 

As you are aware, we recently put out a report indicating that 

health care in total is now over 16 percent of the gross domestic 

product. By 2015, we are projecting it will be 20 percent. But an 

even more startling statistic than that is that Medicare alone today 

is 3.3 percent of the gross domestic product. If you project forward, 

by 2040 it becomes 8.14 percent of the gross domestic product. If 

you go into the same range where you were looking into the 70-

, 75-year range, it becomes 14 percent of the gross domestic product. Once you get to that point——

Senator CONRAD. Medicare alone? 

Secretary LEAVITT. Medicare alone. Medicare alone. 

Now, I have to confess that when I get to that point, I am discouragingly amused by those numbers because no economy in the 

world will be viable at that point. And so for us to project that far 

is a mathematic exercise because we will have been eliminated 

from the competition economically. And the capacity to sustain it 

simply will not be there. So we need to act, and I want to be clearly 

and firmly on record. This budget does present some modest ideas 

on how to get started. The President has been speaking about the 

need for bipartisan action, and I hope we will get a chance to talk 

about that some today. 

This is a Budget Committee. You deal in the strategy of the 

budget and, therefore, I think it would be helpful for you to know 

how I have approached this strategically. There are new initiatives 

that are proposed in the budget. A good example of that would be 

the Health IT budget. These tend to be things that I believe will 

help us find efficiencies and that will help stave off costs in the future. 

Another example of that would be the HIV/AIDS treatment and 

testing program—again, new initiatives you will find. You will find 

some Presidential initiatives that continue to be funded here. For 

example, the President’s community health centers initiative is a 

good example, his faith-based initiatives. Again, these are commitments that he has made that we have continued to press forward 

on. You will see a substantial commitment to bioterrorism and pandemic funding, subjects that I know are of interest to this committee. 

I have found dollars in this budget to fund those new initiatives 

or initiatives that I think are highly efficient initiatives by looking 

for funds that are one-time and moving them into that category, 

looking for programs that are being addressed by a multiple of 

agencies and eliminating those duplications. 

I have looked for funds that are carryover that I could move into 

those areas, and there are a number of programs in the budget 

that we propose be eliminated or cut or reduced before that were 

not, and I have gone back and included those. 

I have also then said to my colleagues who were helping prepare 

the budget, I want to lay out a series of principles, and I want you 

to take every investment that we make and I want you to lay it 

against those principles, and it might be helpful for you to know 

what my principles are. You will obviously have identified your 

own. 

399

I am looking for investments that are targeted. We do a lot of 

general investment in Federal budgets. I am interested in looking 

for places where the specific need is. We are brilliant at proportionate distribution. We are not as good at finding targeted benefit, 

and so I hope you will see that reflected here, targeted benefit. 

I am a big believer in prevention. Health care in general, we 

have to redefine health care not to mean treatment. It needs to be 

prevention giving equal rigor to just treatment. And so prevention 

you will see emphasized. 

You will see an emphasis in actually delivering services as opposed to infrastructure. This is a deficit reduction budget. We all 

know infrastructure is important, but you will see me opting and 

tilting toward treatment of people as opposed to building the infrastructure where I had to choose between two. 

You will see a bias on my part toward consumer choice. You will 

see a bias on my part toward markets because I believe they find 

greater efficiency. You will see a clear inclination on my part to invest in new technology, recognizing that there are a lot of research 

projects that may have run their course, and we ought to be investing in new opportunities as opposed to those things we have been 

perhaps investing in a long time that are not producing benefit. 

HHS is a huge Department. There are many silos, and so you are 

going to find a bias on my part toward things that cover the entire 

Department. I have tried to find ways—things where there are two 

different agencies or operating division that may, in fact, be investing in the same thing, I have tried to bring those together. What 

that means is that sometimes it looks like there is a reduction, 

when in reality I have just brought them together. You will see 

that I have tried to bias our investment toward the things that I 

can demonstrate are being efficient. So those are the principles. 

Now, you will also, as I indicated, you will see an inclination on 

our part to invest on a risk basis as opposed to simply a proportionate basis. Those are the principles. 

Now, we undoubtedly will have disagreements on how to apply 

those principles, and you will have your own, and we are now presenting this budget for the legislative branch to go ahead and exercise its priorities. But I am delighted to be here today to defend my 

own judgments and be helpful in the conversation. So thank you, 

Mr. Chairman. 

Chairman GREGG. Thank you, and I agree with your approach, 

by the way, especially this concept of picking issues you can solve 

versus trying to do a broad-brush approach. 

But on the grounds of being helpful—we are going to start the 

clock here. On the grounds of being helpful, this is the problem: I 

want to do a $35 billion adjustment in Medicare. I think it needs 

to be put in the context of what it represents. I think Medicare 

over the next 5 years will spend something like $2.2 trillion. The 

rate of growth of Medicare is somewhere in the vicinity of 48 percent over that period; that if we were to do $35 billion in savings 

in Medicare and the rate of growth, that would reduce the rate of 

growth to 45 percent or something like that; that it is really—the 

proposals that the White House has put forward came out of the 

MedPAC study, as I understand it, primarily, which was an independent group of health professionals, do not have a partisan axe 

400

to grind, are not part of the administration, and essentially said 

these are places we can save some money that make sense. It is 

primarily changing the market basket for hospitals. And the failure, of course, to move forward in this area means that we are just 

allowing the cliff to come closer, and without any plan for how we 

are going to get over the cliff, get past it. 

So the baby-boom generation is not going away. It is here, and 

it is going to retire, and it is going to double the size of the retirement community. And as Senator Conrad has pointed out in his 

numbers and as we have tremendous testimony in that creates a 

$26 trillion unfunded liability, you mentioned that goes up to 14 

percent of GDP, which is a number that is not comprehensible or 

even viable in any scenario. It would basically wipe out our children and their capacity to have a decent lifestyle. 

So the question becomes: How do we do this? How do we actually put in place $35 billion—which is a lot of money but in the context 

of the overall spending on Medicare, it still means Medicare would 

be growing at 45 percent. It still means it would be spending $2.2 

trillion plus over the next 5 years. So how do we do that? Because 

I have wandered around the halls talking to my colleagues, and I 

do not sense that on the other side of the aisle there is any support 

for it. And, of course, on our side of the aisle, moving into an election year, the response is, ‘‘Well, can’t we put this off?’’

So give me the road map that gives me 51 votes to pass this concept of reducing Medicare by—reducing the rate of growth of Medicare from 48 percent down to 45 percent. 

Secretary LEAVITT. Senator, let me break my thoughts into two 

parts. 

The first is we ought not to have this conversation without acknowledging that underlying all of our worry here is the fact that 

Americans are not living very healthy lives right now, and that it 

is, in fact, driving our health care costs through the roof. Senator 

Conrad used a chart that showed a small percentage eating up a 

big piece. Some of that is end-of-life issues, but a big part of it is 

people who suffer from chronic illness. Roughly 75 percent of all of 

the expenditures in our health care general come from people who 

have chronic illness. That has substantially increased over the last 

number of years. Those are diseases that are to some extent preventable and to a large extent manageable, and in my judgment, 

has to become, as was indicated earlier, part of our focus on how 

can we inspire Americans to live healthier lives, because we are 

paying a price. They are paying a price in—they are paying the 

physical pain. We are all paying the fiscal pain. And we will. So 

that has to be a big part of it. 

But let’s deal with Medicare as a program for just a moment and 

how we go about navigating the treacherous political waters that 

are involved in this dilemma. 

I would just offer this observation: I think it is unlikely that any 

one Congress is going to act in a way as to be bold enough to fix 

this problem with a silver bullet. It is not likely. It is also my judgment that it is difficult to get legislative bodies or political bodies 

in general to deal with these issues, and that we may need to set 

up a construct that over time holds the discipline for that to occur. 

The President’s budget proposes or suggests that we use a hard 

401

trigger, that is to say, that if, in fact, 45 percent of the revenue—

45 percent of the proceeds going to fund Medicare come from general revenues, anything above that would trigger reductions in the 

program or would require some kind of action on the part of Congress to deal with it. 

I think ultimately that is the road map, Mr. Chairman, and a lot 

of refinement will have to be made to that, but this is a first step 

of a series of small actions that would need to be required if we 

were to achieve it. 

Chairman GREGG. Thank you. I will come back. I have additional 

questions, obviously, but my time has expired, and I will turn to 

the Senator from North Dakota. 

Senator CONRAD. Thank you, Mr. Chairman. 

In my questioning, I am going to really try to focus on avian flu 

because I am extremely concerned about the threat to our country. 

I told the Secretary, as he came in, that I have just been reading 

this book. The Secretary tells me he has read it twice cover to 

cover. I have read about half, and half is enough to make your hair 

stand on end. This is about the 1918 flu epidemic and how devastating it was worldwide. Nobody really knows how many people 

died. Some estimates are as high as 100 million people died. 

We know that there is an enormous risk with avian flu, and 

whether it is avian flu or some other pandemic, it leaves us with 

the same questions; that is, are we doing everything we can do to 

prepare for this threat?

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Let me put this up. This is a Washington Post—I am sure you 

read, Mr. Secretary, this editorial from February 13th. And I would 

direct your attention to the last full paragraph, and it says, ‘‘Given 

the overwhelming challenges of preparation as well as the uncertainties surrounding antivirals, it would make the most sense to 

focus on a vaccine. But although meetings among international scientists will be held this summer in the hopes they will exchange 

information and speed up research, officials at the Department of 

Health and Human Services agree they still don’t have ‘visibility’ 

about what everyone is doing.’’ In other words, there is not much 

coordination. 

‘‘Furthermore’’—and this is what I would like you to respond to 

specifically—‘‘some U.S. companies say that they remain confused 

about this country’s vaccine development program which lacks a 

timeline, leadership, and clear incentives for the private sector.’’

Mr. Secretary, is there a timeline? And where is the leadership? 

And what are the clear incentives for the private sector to produce 

a vaccine? 

Secretary LEAVITT. I have met on a number of occasions now directly with the heads of all of the producers of vaccines in the 

United States. The President has met with them as well. They 

made clear to us that they need three things in order to proceed 

with the development of vaccines. The first is protection from the 

liability that historically has been there when a vaccine was developed in a rapid fashion. 

Senator CONRAD. OK. Let’s take them each in turn. Have we 

done that? 

Secretary LEAVITT. Yes, we have. 

Senator CONRAD. OK. 

Secretary LEAVITT. We have done so. 

Senator CONRAD. OK. So they got—that is No. 1. No. 2? 

Secretary LEAVITT. The second is that they need to have some 

certainty that there will be a market if they produce the vaccine. 

The answer to that is yes, we would be the market if such a vaccine were needed. 

Senator CONRAD. And what has been done to make certain that 

they understand that that is the case? 

Secretary LEAVITT. Well, we are now in the process and will 

within a matter of days or a couple of weeks announce a series of 

contracts that we have negotiated after response to requests for 

proposals that will drive forward not just the development of new 

facilities, but also the development of new technologies in the cellbased manufacturing realm. We are quite optimistic. Because we 

are still in procurement, I cannot be more specific than that, but 

I can tell you that in a very short time we will have deployed the 

resources, the first phase of the resources that Congress appropriated just a little under 2 months ago, not just in the area of vaccine, new cell-based vaccine and facilities, but also adjuvant technologies and also rapid diagnostics. 

Senator CONRAD. And, Mr. Secretary, will you keep the committee informed as to your progress on that point? 

Secretary LEAVITT. Indeed I will. In fact, I will be issuing within 

2 weeks a full report to the Congress and to the American people 

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ness, and I will periodically do that. The vaccines are one part of 

a comprehensive plan. I am currently involved now in 50 State 

summits. By the end of this week, I will have done 18, and we have 

virtually every other State now scheduled or in active conversation. 

And by the end of April, we will have accomplished that. 

Senator CONRAD. And what is the third point? You mentioned 

there are three things that pharmaceutical makers have said are 

necessary: point No. 1 was protection from liability; second was certainty of market. The third? 

Secretary LEAVITT. Regulatory streamlining. They made clear 

that if we go through the normal process of approvals through the 

FDA of facilities, that it will elongate the process in a way that 

would be defeating to our ambition. And so I am working directly 

with the Food and Drug Administration. They are going to be using 

a streamlined and—not short-cut, but a streamlined process where 

we are essentially approving as they are developed, as opposed to 

waiting until they are developed and then approving. 

Senator CONRAD. And is there any action required by the Congress to accomplish regulatory streamlining? 

Secretary LEAVITT. No. We got the authorities in the defense authorization budget that appropriated the money, as well as where 

needed. We can proceed and we are proceeding, and I think you 

will find when the report is issued that we are making rapid and 

aggressive progress. 

Senator CONRAD. Do you have a timeline with respect to vaccine 

development? 

Secretary LEAVITT. Well, yes, we do. I can tell you that it will 

likely be 3 to 5 years—now that is a timeframe, but what we are 

essentially doing, Senator, is we are involved in co-venturing with 

the pharmaceutical manufacturers or the vaccine manufacturers a 

series of new technologies. It is possible that one of those will 

break through. We are not just counting on one. We are counting 

on multiple strategies. We have multiple strategies we are working 

at the same time. 

Senator CONRAD. What do we do if the pandemic hits before that 

3- to 5-year period? 

Secretary LEAVITT. Let me provide you some insight or at least 

offer some insights on vaccines as a strategic component of our 

plan. 

Any way you look at it, if we have a pandemic virus that begins 

to transmit from person to person, we are likely to be through—

we will most certainly be the first 6 months without a vaccine because it takes that long, even in our most ambitious plans, to identify the virus and be able to develop a vaccine, go through the testing element and get it manufactured. So let’s assume that it happened in a remote village in Thailand today. It would likely be 30 

days, maybe 45 days before it came to the shores of the United 

States. At that point it would begin to move. We would be in full 

alert by that time and have implemented our National Response 

Plan and will have identified samples and have gone to the process 

of identifying the vaccine. 

Any way you look at it, we are going to be 6 months before we 

have the capacity to start providing those vaccines, and we will undoubtedly have been through the first wave of the pandemic, and 

405

we will be dependent upon good public health measures to protect 

us, and that is why the other components of the plan are so important. 

Chairman GREGG. Thank you. 

Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. I would like an 

opening statement to be put into the record, if it is all right. 

Chairman GREGG. Of course. 

Senator BUNNING. Thank you. 

[The prepared statement of Senator Bunning follows:]

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Senator BUNNING. Your budget that you have proposed for HHS includes a reduction in mandatory spending of $2.5 billion in fiscal 

year 2007, $35 billion over 5 years. The budget also includes some 

legislative and administrative changes that would save about $13 

billion in Medicaid over the same period of time. That is a $48 billion savings. I want you to tell me why the administration feels 

these changes are so important this year, especially, not last year 

or the year before, why are we doing it this year? 

Secretary LEAVITT. Well, Senator, this has to be a long-term 

strategy because what we are doing this year is only an increment 

of what ultimately has to be done to keep these programs sustainable. When you compile the impact of Medicaid and Medicare together, we are seeing growth rates that are simply unsustainable 

in the long term. And, frankly, they are not as efficient. 

Now, we believe that we will see substantial improvement based 

on authorities that were granted in the statutes in the Deficit Reduction Act. We think we will begin to see States innovate and that 

many changes will be made that will improve Medicaid as a program and allow us to begin serving more people with basic health 

care. 

Senator BUNNING. For more efficient spending of our money for 

that? 

Secretary LEAVITT. That is correct. I also am optimistic that we 

will see our capacity to assist more people with basic health care 

as opposed to having relatively fewer people have unlimited care 

increase. And that is a basic strategic change that I believe is beginning in Medicaid. 

Senator BUNNING. You have also proposed in your budget to 

allow States to use drug formularies in their Medicaid programs 

like in the private sector. What kind of change do you think this 

will have on the States’ Medicaid programs and beneficiaries? In 

other words, are we really going to allow the States themselves 

that do get waivers, particularly—Kentucky just got a waiver. Will 

that really impact the cost not only for the Federal Government 

but for the State government, because we are going to run about 

a $750 million deficit in Kentucky unless we do something very 

dramatic. 

Secretary LEAVITT. Senator, the States have needed to have the 

same tools that any private sector manager of benefits would have, 

and one of those would be formularies, the ability to use generic 

drugs where necessary or to find a class of drugs where there may 

be more than one alternative, one being much cheaper. When we 

are providing prescription drugs to a large population, having that 

management tool is an absolute necessity. 

Senator BUNNING. You as the Secretary of Health and Human 

Services, how do you get the message out that when you reduce the 

growth in a program, it is not a cut? 

Secretary LEAVITT. I repeat——

Senator BUNNING. In other words, if you are reducing the growth 

in Medicaid and Medicare over a period of time from 48 to 45 percent, how do you get that message out when other people are trying to pound and say that we are actually cutting the program? 

Secretary LEAVITT. Well, I have found the phrase useful to express the fact that we are allowing it to grow at a slower rate. 

408

Senator BUNNING. Who is listening? 

Secretary LEAVITT. Well, you and I are. 

Senator BUNNING. Well, I know that, but who else? The American people, are they listening? Or can you get that message out 

so that people understand if we don’t do something by 2030 or 

2035, three programs, mandatory programs, are going to take up 

75 percent of the total budget of the United States of America? 

Secretary LEAVITT. Well, not only are the Governors listening, 

they are speaking. They know that this is true, and it is beginning 

to crowd out in their States many of the other important duties 

that they undertake, such as education and public safety. They 

have led the charge to this committee and to others to say we need 

the tools. What we want is to be able to provide coverage, to provide assistance to a larger group of people. And we can do that and 

be able to make the program more efficient if we have the flexibility. 

Now, I believe Congress has made a historic step in the Deficit 

Reduction Act in providing a whole series of tools. We are working 

with States and propose even more tools that would allow States 

that capacity. Medicaid is thought of as one program. The reality 

is it serves a whole series of different groups of people. The dilemma has been we have tried to use one approach to cover everyone. We will be far better if we can acknowledge that Medicaid 

does serve people who are aged and who are disabled and children 

who are in protected classes, and they have very specific needs. It 

also serves a lot of people who just need help buying insurance, 

and the needs of one group are different than the other. And what 

has been important is to provide States with the capacity to meet 

those needs with specific tailored approaches. 

Now, a big step was taken by the Congress with the Deficit Reduction Act. It has given States a new set of tools, and I believe 

that those tools will have a profoundly important role in being able 

to help us meet the needs of those groups in a better way. 

Senator BUNNING. Thank you. My time has expired. 

Chairman GREGG. Senator Stabenow. 

Senator STABENOW. Thank you, Mr. Chairman. And welcome, 

Secretary Leavitt. It is a pleasure to see you again, and while I 

have concerns about the budget, I have great admiration for you 

and have enjoyed working with you in your different hats that you 

have come before us with. 

Secretary LEAVITT. Thank you, Senator. 

Senator STABENOW. First, a couple of comments and then a question. When we look at Medicare cuts in the budget, hospitals, nursing homes, home health providers and so on, in terms of reimbursement cuts, what we see in the State of Michigan, with major manufacturers, major employers providing private insurance, is a cost 

shift. I don’t see that saving money. I think there are things that 

we can do to save money as you talk about managing, whether it 

is chronic diseases or dealing with Health IT that I want to ask 

you about, but just for the record, Mr. Chairman, I do not see 

where we save dollars by cutting reimbursements that mean people 

end up either in emergency rooms sicker than they should be, getting treated, and then the cost is given to employers who see their 

409

rates go up, or hospitals who raise rates because their reimbursements are less through Medicare. 

So this has become a huge issue for our major employers in the 

country and certainly in Michigan when we look at the cost shifting 

that is going on. 

What I believe saves money—and I know you do as well from 

what you have talked about before—are initiatives like Health IT. 

And I am pleased that we were able to pass the legislation dealing 

with interoperability. 

But my question deals with where do we go from here, because 

when we look at the budget, we see $116 million in for the Office 

of—it appears that there is about $53 million in for small grants, 

which is not going to do much. I mean, that is what? A couple of 

hospitals, maybe. I do not know. But it is not very much in terms 

of getting us where we need to go, and yet David Brailer’s office 

has testified that hundreds of billions—hundreds of billions of dollars can be saved by doing what you have spoken about, what I 

have spoken about. 

Senator Olympia Snowe and I have legislation that would allow 

some flexibility by using Medicare trust fund dollars to be used to 

purchase hardware, software, training, which we know will save 

the Federal Government, Medicare, Medicaid, as well as the private sector dollars. Tax incentives for physicians to be able to have 

accelerated depreciation to purchase the hardware, software, and 

so on. 

Could you speak to how you see us moving ahead on something 

that is clearly a bipartisan initiative? We have leaders in both parties speaking out, the President, yourself, and yet I do not see the 

movement in this budget that allows us to get there quickly and 

in the context of what we are talking about in terms of savings 

that has to occur in these programs. I do not understand why we 

are not moving more quickly, and certainly we would welcome your 

support for the legislation that Senator Snowe and I have introduced. 

Secretary LEAVITT. Thank you, Senator. Could I answer your 

question in the context of the first subject you raised, which was 

physician reimbursements and how that in and of itself does not 

‘‘save money.’’ It, in your suggestion, moves it from one account to 

the other. 

This is a prime example of how we have to change the entire way 

we think about health care and reimbursements. If we had Health 

IT in place where we were able to measure the impact of health 

care as opposed to the number of procedures, if we were able to pay 

physicians on the basis of performance and improvement in health, 

we would be able to have a rational way of seeing that trend turn 

down. What is lacking at this point is a way to collect that data 

in a consistent and clear way. 

Health IT is a critical part of that. There are two parts of Health 

IT. The first is adopting, that is to say, how do we get computers 

in every office and have everyone able to use them, and then the 

second is interoperability, the ability for those systems to work together so we have a consistent way of doing it. 

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One of the worries is that if we are not fueling people buying systems that are not compatible, then, in fact, what we are doing is 

essentially investing our way into a state of incompatibility. 

Now, we are working hard on both of those accounts. They have 

to happen at the same time. I can tell you that by the end of this 

year we have four significant breakthrough projects that will begin 

to move us on a pathway of standards. One will be doing away 

with the medical clipboard as we know it. When you walk into a 

doctor’s office, they always ask you to fill out your information 

again and again. We are creating a set of standards where every 

system that is now on the market could essentially have one system so that you could go into a doctor’s office, present yourself, and 

some way that you would identify, and all of that information 

would be available. That will be a big step forward, and we believe 

that by the end of this year, those standards will be available. 

Another area is in chronic disease management. I indicated earlier to Senator Conrad that 75 percent of all expenditures are in 

the area of chronic disease. Many of those diseases now are able 

to be monitored by devices that are external to a doctor’s office or 

a hospital. It is, again, Health IT. But that will allow us to do that 

in a more efficient way. 

Those are the kinds of things we are doing, and by the end of 

this year, we will have not just one but four breakthrough projects 

that are paving the way for this level of interoperability. At the 

same time we have to be working on adoption, as you have suggested. 

Senator STABENOW. Well, and, Mr. Secretary, I appreciate what 

you are working on. I know there are already, in fact, standards 

within the Department, and interoperability, I support doing that. 

But creating standards does not put the PC in front of the person 

that checks you in at the doctor’s office or create the dollars to buy 

the information software that is already out there. There is amazing software, as you know, that is out there right now that could 

be used. 

I would just suggest that we have talked about pay for performance, but the first thing is pay for use. They have to be able to get 

the equipment, and when we look back at this whole question of 

what is being cut, we are talking about reducing hospital reimbursements, home health, nursing homes, on and on, and then we 

are saying, by the way, we want you to go out and invest in hardware and software and train people. I do not see that as compatible 

when we talk about compatibility. And if we—it takes time to get 

these systems in place, and if we wait until every T is crossed and 

I is dotted on standards, we are losing time, critical time that could 

be put into saving money the right way, rather than cutting access 

to health care for people. 

And so I would urge you to look at what we have suggested, 

which is not general fund dollars, but a way for us to jump-start 

this and move it down the line. 

I know that we started our own systems in the Senate before 

they were interoperable. We still do not have all of the systems 

interoperable, and yet everybody got up and going, got on e-mail, 

got their websites set up, and we are connected in some ways. And 

we have built from there. You can also go backward on interoperVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00416 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
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ability, as I understand it, so that it does not have to be waiting 

until the perfect standards are in place. 

In this time when we are cutting and using strategies that take 

away resources and, I would say, take away health care, Health IT 

is a very important way to do something that is positive, bipartisan, and doable. But I think we can be moving much more quickly than we are. 

Thank you, Mr. Chairman. 

Chairman GREGG. Thank you, Senator. 

Senator Ensign. 

Senator ENSIGN. Thank you, Mr. Chairman. 

Mr. Secretary, I would like to followup on some of the issues that 

Senator Stabenow raised. Specifically, I would like to address the 

issue of health information technology. I am going to be holding a 

hearing in my Commerce Subcommittee on technology, innovation 

and competitiveness on this very issue. We held a hearing on the 

issue in July and I believe another hearing is warranted. I would 

appreciate it if you could come and testify at the hearing because 

we do not have the time to delve into the topic of health information technology in detail today. I know that you have issued several 

requests for proposals to accelerate the adoption of health information technology. I would like to invite you and some of the organizations who have been awarded contracts as a result of the RFPs 

to testify before my subcommittee. The hearing will provide Senators with an update on where health information technology 

stands today. Everyone I have talked with believes that health information technology will reduce duplication and cut down on administrative costs such as transcription and billing. Clearly, information technology has enormous potential to reduce medical errors, 

improve quality of care and lower health care costs. 

I was recently in a car accident. If I would have had an electronic 

health record the physician who treated me would have instantly 

been able to obtain personal and medical information about me to 

determine how best to treat me. Instead, I was required to provide 

personal and medical information to the physician while I was in 

a neck brace lying on a stretcher. It is much easier to have that 

type of information readily available on an electronic health record. 

Electronic health records can also help ensure that physicians have 

the information they need to make appropriate clinical decisions. 

I would like to discuss interoperability. We need to develop interoperability standards to support electronic data exchange. Physicians and other health care professionals are hesitant to invest in 

information technology systems. Frankly, they do not want to invest ina system that will not be able to exchange information with 

anyone else. Currently, there are health care systems that have developed their own interoperability standards with their own network of doctors. This is happening today. I have had several meetings in the last several months with groups that have developed 

interoperable systems. We need to rapidly increase these efforts. 

I agree with putting out tax credits and perhaps we should allow 

full expensing to encourage health information technology. There 

are a lot of barriers to the adoption of information systems in 

health care. The interoperability piece is absolutely going to be key. 

412

I would also like you to comment on the area of best practices. 

I believe we need to develop and encourage the use of best practices so that doctors and patients have the information they need 

to make appropriate clinical decisions. However, this has not been 

a big focus of health information technology. It seems to me that 

health information technology is how we drive best practices. Only 

about half of the doctors in the nation are utilizing best practices. 

The use of best practices is very common in business, but we are 

still not using best practices in medicine. I believe we will see dramatic results when through the use of best practices. 

Could you please comment on how we can drive best practices 

into private health insurance programs and large government programs such as the Medicare and Medicaid programs? I would alos 

be interested to learn what types of savings could result from the 

full implemetation of health information tecnology as well as the 

savings that could be achieved through the use of best practices. 

Secretary LEAVITT. Let me say to both you and Senator 

Stabenow, I am as impatient on this as you are. This is something 

that needs to happen. Interoperability is critical to this. There are 

remarkable systems that you can go through and name the systems—Kaiser Permanente, Intermountain Health Care, Cleveland 

Clinic. I mean, you can go all the way through the country and find 

centers of excellence where they have—the Veterans Administration. They have brilliant systems where they can track their entire 

health record, but they cannot talk to each other. And that is what 

we have to solve, is a way to bring them together. 

Now, how do we achieve interoperability? I would suggest there 

are three alternative paths. The first is for the Federal Government to step up and say this is the way it is going to be. This is 

the interoperable standard. You will meet this. Well, that fails—it 

almost always fails and is not a good path. 

The second option I call the last vendor standing. We will just 

let everybody fight it out until they have one standing. Well, that 

does not work because there are lots of different ways to get to the 

same path. 

The third way is messy and it is hard and it is frustrating, but 

it is the only way, and it is a collaboration, and in my mind, it 

ought to be led by Government. And that is exactly what we are 

doing. We have established the American Health Information Community. For the first time, we have brought together the Department of Defense, the Department of Veterans Affairs, all of the 

HHS entities, the States, the private sector, the communities, and 

we are saying to the world we are going to adopt as Government, 

which makes up 46 percent of all the dollars paid, we are going to 

adopt a set of standards, and we want the world to know that. 

But we want them to be the right standards, so we are going to 

collaboratively develop them, and then you need to know we are 

going to adopt them. 

Well, when you are 46 percent of the market, you are going to 

move the market. And we believe that in a very short period of 

time—I indicated at least four breakthrough projects—the market 

will begin to move, and we will start to see interoperability. 

Frankly, the world does not lack computers. It lacks interoperability. And once we have achieved that—now, I don’t think we 

413

ought to be waiting until we have perfect interoperability. I for one 

would be delighted if I could say to my health provider, ‘‘Send my 

lab results to me electronically, and let it fit into a record that I 

will create.’’ That would be not the perfect step, but it would be a 

very important step. I was talking with a colleague of mine who 

went to the doctor. She took her children to the doctor, and she had 

to be away from work for a day. I said, ‘‘How did it go?’’ She said, 

‘‘Well, it went fine, but I spent the first half a day being a medical 

courier. I had to go to three speciality doctors. I had to pick up 

brown envelopes with tests in them. Then I had to take them over 

to a specialist so they could read it.’’

There is no reason that has to be that way. They could, with the 

click of a mouse, send those in electronic form. And they should not 

need to do that. And those are the kinds of policy changes that will 

get us steps forward. 

I will confess to you that this is not happening as fast as I would 

like it to, but it is a big, cumbersome, and complicated problem. 

But I believe we are on the right path. 

Senator ENSIGN. Mr. Chairman, Secretary Leavitt did not comment on the area of best practices. Mr. Secretary—could you please 

address best practices? 

Secretary LEAVITT. Well, you can get lots of estimates on what 

kind of efficiency this would create. Many believe it is as much as 

30 percent. When you are talking about 30 percent of $1.9 trillion, 

that is a lot of money. Now, others say it is less than that but still 

significant. There is no question in my mind that money is part of 

it, but it is not the only reason. 

What is the savings to my colleague of not having to take a day 

off of work? That is big. What is the value of having a best practice 

that will save my life because I did not get a hospital infection or 

an adverse drug effect. Those are huge savings that are not reflected in that 30 percent. 

Senator ENSIGN. Mr. Chairman, the reason that we are focused 

on the money aspect of best practices is because we are beginning 

to work on the budget. Even if we did not save any money through 

the use of best practices it would be worth implementing best practices it simply because of all of the other side benefits. I think that 

best practices is absolutely one of the most important areas that 

we can focus on as far as our health care system and as far as our 

budget is concerned. Best practices certainly have the potential to 

curb health care costs. At the same time, best practices will ensure 

that Americans have access to evidence-based health care when 

they need it the most. This is exactly why this Congress needs to 

be focused on doing everything that we can to bring best practices 

to fruition as quickly as we possible. 

So I thank you, Mr. Chairman. 

Chairman GREGG. Thank you. We just need to apply it to veterinarians. 

Senator Murray. 

Senator MURRAY. OK. I don’t think I will touch that. 

Thank you very much, Mr. Secretary, for being here to talk about 

the budget for Medicare and Medicaid, and I agree with Senator 

Stabenow’s original comments where she started out talking about 

just reducing the dollar amount we spent here does not necessarily 

414

save us a lot of money unless we focus on really prevention and 

programs like preventive health block grants and maternal and 

child health program, HCAP, those kind of programs that are preventive, that keep people from coming in and using costly health 

care dollars. So it concerns me that those programs are cut in our 

budget. 

But I want to focus my questions today on what is happening in 

the reality of us shifting costs in terms of saving money, and specifically let me talk about the VA, because as all of us know, we 

went through a very difficult situation last year where the VA finally told us after months of saying that there are long lines, people are not getting access to care, we have a crisis, that they indeed 

were short well over $1 billion in VA health care. And we had to 

come up with additional dollars to face that last year. 

Well, what I am hearing now—and we had a VA Committee 

hearing yesterday—is that a number of States, because of the shifting burden to them to care for the Medicaid population, looking for 

ways to save money, are working to treat veterans who qualify for 

Medicaid, shifting them back to the VA. And it was shared with 

us that an analysis was conducted by Missouri’s auditor in 2004. 

It found that Missouri could save $5.5 million if veterans who received benefits through Medicaid had instead received care from 

the VA. 

Missouri is not the only State doing this. My home State of 

Washington recently identified veterans who enrolled in public assistance programs and introduced 2,000 veterans back to the VA 

system, saved my State $4 million, but that cost is shifted back to 

us. And it makes me very concerned because 5 percent of Medicaid 

recipients are veterans today. We have an obligation to care for 

them. But we have not budgeted for that. That will have a huge 

budget implication back at us, and I am curious if you are aware 

of this trend and whether you expect it to continue. 

Secretary LEAVITT. I have to confess, Senator, that is the first I 

have heard that. I am not surprised that States are looking to the 

Veterans Administration to cover those who are eligible. That does 

not surprise me. But I am not aware of the trend that you have 

spoken of, and it is worthy of investigation. 

Senator MURRAY. Well, it is an important one because it comes 

back and hits us, and we have to make sure that we have the dollars for the VA. I don’t think any of us want to be sitting there in 

July saying we are $1 billion short again. But I think we need to 

be aware that that is what happens. 

And a second similar shift, a number of seniors are telling me 

that when they call Medicare to ask about the Part D drug benefit, 

they are being told—asked, in particular, if they are a veteran, and 

if they are, telling them, well, don’t sign up for Part D, go into the 

veteran system—which then, by the way, covers all their health 

care and they deserve that and we should not turn them away. But 

it is shifting that cost from Medicare to the VA, and again, it has 

a budgetary implication. 

So I did not know if you were aware that people are being told 

that. 

Secretary LEAVITT. We have been working to help people get prescription drug coverage by whatever means possible, and I will tell 

415

you that I have been in, I think, 44 States talking with seniors 

about the Medicare Part D. And routinely people will say, ‘‘I am 

a veteran, and I am happy with that system.’’ And so as a matter 

of course, people who are eligible——

Senator MURRAY. Sure. I did not have a problem with it. It has 

a budget impact because it is not just their prescription drugs. If 

it a senior just looking for prescription drugs, they shift to the VA, 

and it covers their entire health care. They cannot just go in and 

ask for a prescription. They then get all of their health care there. 

It is a cost. It is one that we owe to our veterans. But it is going 

to have tremendous budget implications, and I think we—it makes 

me very worried about our veterans budget again, as I was concerned last year with these shifts from Medicaid and Medicare 

moving back onto our veterans system and us not providing the resources for it. 

So just saying we are going to reduce Medicaid costs does not 

necessarily save money. I just want us all to be aware of that, and 

we are going to have huge implications from that. 

And my time is short, but I did want to just mention that I appreciated you being out in my State recently working with my Governor to come up with additional—I think it was $15 million for 

our dual-eligibles. It is, as you know, a huge challenge across the 

country as the prescription drug plan is going into effect. The dualeligibles are rightfully—really, it is a very disconcerting problem 

that has an impact on our physicians, on our senior citizen homes, 

on our pharmacists themselves. And I appreciate you coming out 

with the announcement to help our State with this co-payment 

issue for dual-eligibles. 

But I did want to find out from you, this is not new money, it 

is my understanding. It is simply a recalculation of the State’s 

clawback. I just want to make sure my State is not going to end 

up at the end of the day with this bill sitting in their lap, and if 

you cannot provide me with the information today, if you could give 

me a detailed answer on that, I would really appreciate it. 

Secretary LEAVITT. I am actually able to give you a fairly detailed answer on this. The good news on the prescription drug benefit is that enrollment continues to go up dramatically and the 

costs are going down, and they are going down because the competitive nature of the market now has driven them down. And one 

of the benefits of that is that we have been able to reduce the 

amount of money that the States have to reimburse the Federal 

Government. And in the case of the State of Washington, it was a 

little over $14 million. 

That announcement came at a very good time because your Governor was interested in being able to cover the $1 and the $3 copay. Some States have chosen to do that. Washington State was 

not one who had. And so the Governor went to the legislature and 

proposed it, and I understand that authorities have been granted, 

and she is now able to use that $14 million. 

It is important, as I have communicated to her, that she recognize that is a one-time proposition. We do not know what will happen next year. We like to think that they will continue to go down, 

but——

416

Senator MURRAY. And you have the flexibility within the law, 

just so I understand, to be able to say we are not going take the 

clawback? 

Secretary LEAVITT. It was a recalculation of the clawback. It was 

just a recalculation. Because of the cost savings, the amount that 

they would need to pay was $14 million less. 

Senator MURRAY. So it is not an additional cost to the Federal 

Government? 

Secretary LEAVITT. It is not. Nor is it—let me restate it for clarity. The State of Washington had budgeted——

Senator MURRAY. And other States, I am understanding. 

Secretary LEAVITT. Right. When the Medicare Modernization Act 

was passed, it took the dual-eligibles and moved them from Medicaid over to Medicare. That would have been a substantial savings 

to the State because they would no longer carry that responsibility. 

And so Congress concluded that the financial benefit to the States 

should be phased in and started with 90 percent of the first year 

of the cost of that would need to be repaid, and some people have 

called that the clawback. 

Senator MURRAY. Yes. 

Secretary LEAVITT. Each year that reduces by a certain amount, 

5 percent a year until it gets to 75 percent. That was calculated, 

and the amount—let me just say it was this big—

[indicating] for the State of Washington. 

When we recalculated it, seeing the new savings that were involved because the costs of the drugs were less, instead of being 

this much that they needed to pay back, it was this much—

[indicating]. And the savings that they no longer needed to pay to the Federal Government was the $14 million. 

Senator MURRAY. But you are saying that was 1 year only? 

Secretary LEAVITT. I am saying that would be 1 year. 

Senator MURRAY. All right. 

Secretary LEAVITT. Actually, that might repeat because—it very 

well could repeat because the savings will be—you know, one would 

like to think they will be permanent. We do not know. The market 

may continue to drive them down, and it may be even more. But 

the point is the $14 million was coincidental to the fact that she 

needed $14 million. It was a stroke of good fortune, and it solved 

a problem, and they will need to wrestle with a permanent solution. But it may, in fact, be permanent, because the actual amount 

they will have to repay will go down 5 percent every year. So I 

guess now that I think about it, it would very likely be at least dependable, maybe not permanent. 

Senator MURRAY. Sure. All right. Thank you, Mr. Chairman. 

Chairman GREGG. Senator Nelson. 

Senator NELSON. Thank you, Mr. Chairman. 

Mr. Secretary, thank you for your public service, and thank you 

for your service as EPA Administrator as well as Secretary. 

About the time that you were coming in as Secretary—it has 

been a couple of years, hasn’t it? 

Secretary LEAVITT. A year. Time flies. 

Senator NELSON. Well, then, just before you came in, we had had 

a little dust-up in Florida with some harassment of senior citizens 

cracking down on their importation of a minimal supply of preVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00422 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
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scriptions from Canada, either by the Internet or by mail. This was 

before you came in as Secretary, and I had assurances from the 

head of the Food and Drug Administration that since they have a 

lot on their plate, what they were not intending to do was to harass 

senior citizens, and that they were not going to implement a program whereby the confiscation of these prescriptions were occurring, where there was a 90-day supply or less of the prescriptions 

ordered by mail or by the Internet. And so we have gone along the 

last couple of years under that policy. 

Lo and behold, starting about November, apparently that policy 

has changed. And I have been getting complaints from all over 

Florida, and especially so in the last couple of weeks, to the tune 

of 130 complaints. And what that would indicate is there are a lot 

of people out there, because when I get a complaint, it is usually 

the tip of the iceberg and there is a lot underneath. A hundred and 

thirty complaints is fairly sizable, that suddenly their prescriptions 

had been confiscated. 

Now, of course, one of the things that comes to mind, first of all, 

I have raised a lot of sand about this because this was the policy 

of Food and Drug, which is under your administration, but I am 

also concerned, Is there any linkage between trying to drive citizens, senior citizens, out of purchasing where they can get them at 

half the dollar value of the retail price, by driving them out of getting them from Canada into the prescription drug benefit Part D. 

And so I want to ask you that for the record, if you could clarify 

what are your policies. 

Secretary LEAVITT. Senator, I can give you some insight on this. 

I have done some investigation myself. 

The Food and Drug Administration has worked in a cooperative 

way with the Customs Service, and generally what happens, if 

there is an event involving a prescription drug, it is referred to the 

FDA by the Customs Service. The FDA frankly has been spending 

some time, but for the most part focused on other things, but the 

Customs Service in the last year has been given independent authority and developed independent of the FDA the capacity to deal 

with these matters and, you know, not always required to check 

with the FDA on the implementation of such a policy or, for that 

matter, the adjudication of that kind of a matter. 

What you are seeing is a substantial increase in activity by the 

Customs Service, and as I understand it, what they do is send to 

the recipient of the drugs a letter saying: We have these. It is not 

in accordance with the law. Would you like us to refer this to the 

FDA for testing? 

The recipient then has an opportunity to do that, and the FDA 

then receives it, and the FDA then is able to determine whether 

or not it is appropriate or not. 

So I want to make three points. The first is what you are seeing 

is an increase in activity by the Customs Service. 

Senator NELSON. Indeed, and that has been confirmed, to the 

point 7 times greater what it has been in the last couple of years. 

Secretary LEAVITT. The second point is, whether one agrees with 

it or not, it is the law. 

And the third point is I wanted to just give you some sense of 

why there is concern about this. We have a rather well-protected 

418

distribution system of drugs and, for that matter, food in this country. I have been concerned about drug counterfeiting. The FDA recently, as an example, found a website called ‘‘Canadian Generics.’’ 

It had the Canadian flag. It had all kinds of motion to it. I think 

it may even have the Canadian anthem, for all I know, but it was 

all focused on Canadian generics. 

Our investigators bought drugs from this site. We tracked the 

transaction. It turns out the website was actually managed in 

Belize. It turns out that the ISP was in China. It turns out the 

check we sent them was cashed in the Virgin Islands. And the 

postmark on the drugs came from Dallas, Texas. 

When we tested the drugs—there were a series of them that we 

ordered—every single one of the drugs had active ingredients that 

were dramatically different than represented. In some cases, it was 

half. In other cases, it was twice. In one case, we had a syringe 

that was brilliantly counterfeited. You could not tell the package 

from the original one that would be developed by a manufacturer. 

But instead of the solution in the syringe being according to specifications, it was tap water. 

The point is that there is a danger here, and there is a need for 

buyers to beware and to be very careful about who it is they are 

buying drugs from. It is currently the policy of the United States 

to protect the distribution system of our drugs in that way. 

Now, again, I wanted to tell you that in the context of I think 

the increased activity that you are seeing is a function, as you have 

confirmed, of the Customs Service. That is the role FDA plays and 

why we are being quite concerned about counterfeiting. The World 

Health Organization indicates that it is now a $35 billion industry. 

Law enforcement people tell me that if you take a trunkload of capsules of crack cocaine and you set it side by side a trunkload of 

phony Viagra, you will get a lot more money out of the phony 

Viagra than you would the crack cocaine, and the penalties for getting caught are substantially less. 

So we are seeing a substantial amount of increase in the level 

of trafficking in counterfeit drugs, and so the intensified concern on 

behalf of the Customs Service is not just in enforcing the law. 

There is a legitimate public harm that could, in fact, occur here. 

Senator NELSON. I understand that, and you need to understand 

the flip side of this, that we want you to go after all of the counterfeit, and that is what the law is for. There are certain established 

procedures that the Food and Drug Administration over the course 

of the last year, because of its policies, seeing that a small supply 

of prescriptions to seniors coming from reputable pharmacies in 

Canada, that the possibility of harm is de minimis and they know 

it, and given the fact that the FDA has so much on its plate, then 

it was not going to cause the confiscation of seniors’ drugs. And the 

flip side you need to hear from us as we, the legislative branch, advise to you, the executive branch, and hold you accountable is that 

there are seniors out there that are having difficulty making ends 

meet. They cannot afford the retail price of drugs. They either are 

confused and have not signed up because of the multiplicity of 

plans, or where they try to sign up, they find that the cost is way 

more than they could get the drugs. And rather than having to sacrifice on other necessities, since they have to have their prescripVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00424 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
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tions, they buy them where they can get them at half the retail 

price. 

Now, that is the side that you need to hear in the implementation of the policy. So I take it that your final answer then is you 

see no causal connection with trying to force seniors into prescription drug Part D Medicare. 

Secretary LEAVITT. Senator, we have had no change in policy, 

and I can tell you that I know of no causal connection between 

those. I do think your points are sound ones, and that is, we need 

to help seniors have access to the prescription drugs that they 

need. We need to work hard to make certain that they know about 

the benefits of the prescription drug benefit. We also need to do our 

best to inform them of the difficulties that can come in having 

drugs that are not pure and not well protected. 

You know, I acknowledge that there is this ongoing policy debate 

about what our law is, but I do want to assure you there has been 

no change in policy. 

Chairman GREGG. Thank you. 

We doubled the spending on NIH by 2003. We have taken a few 

years basically to pause that spending so they could absorb it and 

effectively use it, which I think was appropriate. 

I notice this budget once again essentially freezes NIH funding. 

Is the demand for research being adequately met by NIH at this 

time? 

Secretary LEAVITT. Well, Senator, you appropriately—this is a 

flat proposal on our part. It ought to be recognized that there is 

a $30 billion investment here, and we are working to find ways in 

which we can use that money better. One example is that we are 

pressing hard on having trans-institute investment. Instead of just 

having institutes invest on their own, this is a good example of 

what I talked about going across agencies and breaking out of silos. 

For example, the genetics and environment initiative that you 

will see represented here, that will benefit all 27 Institutes. Dr. 

Zerhouni has what he calls his road map where they are identifying high-priority basic science that does not need to be done in 

every single one of the institutes. I frankly felt pretty good about 

keeping NIH level-funded in a deficit reduction budget. 

Now, I know that we would all be happier if we had resources 

to do otherwise, but I feel good about the commitment that we have 

made, and I feel good about the strategy that we are deploying to 

make certain that those important initiatives keep going forward. 

Chairman GREGG. Senator Conrad. 

Senator CONRAD. Thank you, Mr. Chairman. 

I would like to go back to the avian flu question. I don’t know 

if you saw the February 17th opinion piece in Newsday. This is 

what they said. The headline was ‘‘The Next Disaster.’’ It said, 

‘‘The U.S. Government has done little of consequence to prepare for 

the possible rise of the epidemic. Congress has allocated $280 million for flu surveillance, but none of it has been spent. Now it is 

too late to use the money effectively. President Bush has set a goal 

of creating 81 million courses of Tamiflu, but the United States has 

a current stockpile of only 4.3 million courses of Tamiflu. And it is 

unclear how quickly pharmaceutical companies can produce more. 

The real hope lies in the development of new, more effective bird 

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vaccines. Crash programs are underway in Asia and the United 

States, but there is little, if any, coordination among them. Bird flu 

may not become a pandemic, but Washington must be prepared for 

it and devote more money and greater urgency to preventing it, 

and time is running out.’’

Can you tell us how much is in this budget to confront a potential pandemic? 

Secretary LEAVITT. In total, the President has requested $7.1 bil- lion. The Congress has funded thus far $3.3 billion of it. We have 

embarked on a multi-strategy comprehensive plan, and I would be 

happy to go through each piece of it. I would like to point out——

Senator CONRAD. But how much money is in this budget? 

Secretary LEAVITT. Well, in this budget we have $2.3 billion, and 

there is an ongoing $350 million. 

Senator CONRAD. $2.3 billion. 

Secretary LEAVITT. When you combine the $3.3 that Congress allocated in the last budget period and this $2.3 billion plus $350 

million, and then we will undoubtedly be making a request for the 

third year, that will get you to the $7.1 billion that the President 

has requested. 

Senator CONRAD. Let me ask you this: Is $2.3 billion all that you 

can use to prepare for this, or could more be done? 

Secretary LEAVITT. Senator, there is always more, but we believe that the $7.1 billion provides a comprehensive approach and, frankly, will have put us on a crusade to create vaccines, to put stockpiles of antivirals in place, to create technologies that do not exist 

today to work with a monitoring network around the world and 

around the United States, and to bring to a level of readiness never 

before achieved in the United States for any kind of a medical disaster. We see this as not just having value in the context of a pandemic, but for any medical emergency, be it bioterrorism, a nuclear 

attack, or in some kind of natural disaster. We believe that this is 

combined with the almost $7 billion that has been spent on surge 

capacity since 2002, this is a rigorous and quite aggressive campaign to prepare. 

Senator CONRAD. Let me just say this to you: that my reading 

of this book on what happened in 1918 is that an awful lot of wellmeaning people did not respond aggressively enough. And I am 

very concerned that we are headed in that direction again. 

When I hear you say 3 to 5 years on the vaccine front, that 

sounds like a long time to me. And in any event, we would have 

to face 6 months of the scourge before we would be ready to respond. 

Is there anything that could be done to shorten those time periods? 

Secretary LEAVITT. That is a question that has been posed to 

every vaccine manufacturer and every scientist I could find, and I 

am persuaded, Senator, that simply the nature of the process of 

building and manufacturing vaccines requires that period. When 

you make a vaccine, it needs to be tested. You are putting into the 

arm of people a virus or some component of a virus that has an 

impact on their body, and we have learned from sad experience 

that if we are not doing it in a safe way, it is possible to cause 

harm. And that is the major component. 

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Now, we do have manufacturing deficits right now. We do not 

have the capacity in this country. That is, frankly, the subject of 

20 years of neglect. One of the good things that will come from this 

is that we will not only create the capacity to generate vaccines in 

a pandemic, we will also take care of the problem we have on vaccines for the annual flu. 

But any way you look at it, we are going to have to do two 

things: more capacity and new technology. You cannot get to the 

300 million courses that we aspire to get to in 6 months using eggs. 

We have to use cells, and that capacity does not exist. When that 

editorial was written, we were 47 days into our funding cycle. We 

are already issuing substantial procurements in that period of 

time. I don’t know how it could be done faster. 

Senator CONRAD. Let’s go back to this question. Is there a way 

through more investment to be prepared for this capacity need 

sooner than the 3- to 5-year time period? 

Secretary LEAVITT. That is precisely the question we have issued 

to the entire vaccine world. We did not give them 3 to 5 years. We 

said: Come to us with your ideas. Show us how you can create a 

vaccine and technology in the shortest amount of time possible. 

They are responding in a competitive marketplace. We have multiple providers who have stepped forward with good ideas and 

smart people. We have asked them not to do anything short of putting their best people, and, frankly, that has been a—we have had 

to offer the kind of co-investment that we are making in order to 

incent them to do that. 

Senator CONRAD. And how much is that co-investment? 

Secretary LEAVITT. Well over $1 billion of the 3.3 this year. 

Senator CONRAD. And let me just go back to this, my final question. If we wanted to do more to speed this process, are there 

things we could do? 

Secretary LEAVITT. Senator, I am persuaded that there are five 

components to readiness. The first is having antivirals in sufficient 

proportion. We will be at 20 million courses of antivirals by the end 

of this year. We have stepped that up substantially. We are working with the States to create their stockpiles and means of distribution. 

The second is vaccines. We——

Senator CONRAD. If I could just stop you, No. 1 is when you say 

antivirals, you are talking there about Tamiflu and——

Secretary LEAVITT. Tamiflu and other antivirals——

Senator CONRAD. Relenza? 

Secretary LEAVITT. Primarily Tamiflu. You and I have had conversations——

Senator CONRAD. Yes. 

Secretary LEAVITT [continuing]. About Tamiflu and its limits, but 

it is a very important part of our plan. 

The third part is in monitoring. We are developing with the 

world a monitoring network. Now, I need to tell you that I have 

personal doubts about whether or not you are going to be able to 

find the spark when it happens. It is a big world, and there are 

lots of people, as we are seeing. It has now spread over—well, we 

have seen it in 20-plus more countries over the course of the last 

2 months. This morning it is being reflected in cats in Africa and 

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in new countries. I mean, it is spreading across the world. I do not 

believe that there is any reason to believe we will not see wild 

birds in the United States with the virus. 

Senator CONRAD. It is just a matter of time. 

Secretary LEAVITT. It is just a matter of time, maybe very soon. 

It is not inconceivable that we could see a domestic flock. Neither 

of those would be emergencies or crises or things that we have not 

seen before. We can deal with that. What becomes a pandemic is 

when we see person-to-person transmission. 

Now, any way you look at this, the first 6 months of a pandemic 

we are dependent upon basic public health, social distancing, every 

business having a plan, every school, every church, every county, 

every tribe having a plan. 

Senator CONRAD. And we do not have that, do we? 

Secretary LEAVITT. When it comes to a pandemic, we are overdue 

and we are underprepared. But we are moving with dispatch, perhaps at greater speed and with greater opportunity to do something about this than any generation in humankind has had before. 

Now, that is exactly the reason why I am going personally to 50 

States with Governors, holding pandemic summits, not just to talk 

to public health people but to talk well beyond public health, to 

school principals, to superintendents, to college presidents, to corporate planners. We are talking with community leaders. We are 

talking with faith-based organizations. 

Senator CONRAD. Can I just say to you, Mr. Secretary, with great 

respect, when I read the reactions of public health people, what 

they are telling me and what they are saying publicly is that the 

response is woefully inadequate, that we do not have the resources, 

that if it comes down to it, if we have a pandemic, the medical essentials are going to be in grossly short supply. 

Ventilators—if there is one thing I have heard consistently, it is 

that we are going to immediately have a crisis with ventilators; 

that we are going to have a crisis with hospital space; that we are 

going to have a crisis with public health providers. And, I mean, 

this is what I get back from them, that we are not prepared. And 

when I talk to people in business, their response is, ‘‘We are not 

prepared.’’ And I have great respect for you. I think we have to do 

more. I think we have to have a more ambitious plan than we have 

that I see so far. 

Secretary LEAVITT. Senator, is there time for me to give you a 

response. 

Senator CONRAD. Certainly. You can always respond. 

Secretary LEAVITT. I am spending a very high percentage of my 

time—I know you do not doubt that. This concerns me greatly. I 

spent weeks walking through medical shelters during Katrina. I 

saw people who had come from every State to help their fellow citizens in distress. I learned a couple of lessons from that. One is 

sometimes we have to think about the unthinkable, and what you 

are suggesting, I agree with. 

Second is that a pandemic is different than any disaster that we 

prepare for. It is different than an earthquake, it is different than 

a hurricane, it is different than a bioterrorism event—in two ways: 

The first is it happens everywhere at the same time. It will happen 

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in Seattle and Santa Fe and Sarasota and Syracuse at the same 

time. 

I saw in the paper recently a public health official, like one that 

you referenced, saying, ‘‘Look, what the Federal Government does 

not understand is that we count on them for ventilators when we 

have any kind of a problem like an earthquake or a bioterrorism 

event, and we are all going to come there at the same time.’’

Senator CONRAD. I just read that very——

Secretary LEAVITT. That is exactly what we do get, and the reason I am going from State to State to say to them any community 

that fails to prepared on the basis of the expectation that the Federal Government will be able to step in at the last minute and 

throw them a lifeline will be sadly mistaken. 

Yes, we have an obligation at the National Government, and we 

are responding to it. We are developing vaccines; we are developing 

antivirals. We are working to develop stockpiles. We are going out 

to the States. We are working on our border issues. We are exercising at the Cabinet level. We are working internationally. All of 

those things are roles that the National Government has to play, 

and we are playing them. 

But communities need to prepare. We have to be a voice, a warning that we will not have the capacity to respond to every community if it is happening at one time. If they need ventilators, we will 

have some, but it will not be nearly enough to go to every community. And maybe they ought to be thinking about whether they 

need ventilators or a new swimming pool. If they are concerned 

about preparation, public health is a public responsibility of local 

government, not because we do not want to respond, not because 

we have not got the wallet for it, but because you cannot manage 

a pandemic in that atmosphere. There are too many places. We will 

be responding to as many as 5,000 different communities at the 

same time. 

This is an important principle in the management of a pandemic. 

The foundation is local preparedness. 

Senator CONRAD. Let me just conclude by saying I agree with 

that. I also believe deeply that the Federal Government has a leadership role. I think you believe that as well. And I must say as I 

look at this and I look at $2 billion to confront something that 

could be the disaster of our lives, could be the disaster of our time, 

I just do not think it is enough. I do not think it represents the 

kind of commitment that we need to make in light of the potential 

danger. This potential danger is so extraordinary, and we need to—

I think we need to do much more. 

Chairman GREGG. Mr. Secretary, we appreciate your time. I 

want to followup on that briefly. You know, as former chairman of 

the HELP Committee and as chairman here, I have been intimately involved in this. And I do not want to leave this hearing 

with the sense that you folks have not been doing an extraordinary 

amount to try to prepare, both in this and the area of bioterrorism. This $7 billion that you have asked for is outside the budget. I 

mean, it is an emergency funding. You have asked for another 2.3, 

I think, outside the budget. It will come to you. And the issue I 

have sensed, looking at it on fairly close analysis, is—as you pointed out earlier, the first issue is how you get people to start proVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00429 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
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ducing vaccine. The vaccine industry in this country basically was 

destroyed by the legal community. And so I drafted language—actually, Vince drafted the language, I think. But we drafted language which Senator Frist has been a strong supporter of, and we 

put it in and we have hopefully taken care of that legal issue. But 

we still do not have a vaccine production capability in this country 

of any capacity, and I know you are working to get that up to 

speed. Because we understand that when this happens, every country is going to need vaccine. There is going to be a unique situation. Every country is going to need vaccine, and the country that 

produces it is going to keep their own, and so we have to have a 

domestic vaccine capability, and I know you are—and we put this 

$5 billion in the pipeline for bioterrorism, and now we have $7 billion in the pipeline for avian flu. That is a lot of money on the table 

that hopefully the marketplace will respond to, and I know you are 

working to make sure they do. 

So it is not an issue in the area of vaccine; it is not an issue of 

having the money or the Federal Government commitment. It is 

the issue of not having the structure; it is not having the infrastructure and building that infrastructure is something we are 

committed to. And I think the Federal Government has done yeoman labor here to try to make the playing field attractive and force 

the action to occur. And so I congratulate you for that. 

The secondary issue is just the nuts and bolt of addressing a 

pandemic or bioterrorism event. It involves things like stockpiling 

ventilators, but other things, you know, masks, syringes, gloves—

none of which are made in the United States any longer in any significant amount. So we have to buy them from somewhere, and I 

have been putting a lot of pressure. We had Dr. Gerberding earlier 

in another forum, and I asked her: When are we going to have our 

stockpiles up to speed? And do we have a timeframe for it? And she 

said yes, we do, we will have the adequate stockpiles by June—and 

she said she would confirm this, and I would like you to confirm 

it—of syringes, of masks, and of the other what you would call 

mundane activities of dealing with people who are sick. So we are 

moving in that area. 

And then we have the issue of quarantine, which I understand 

you are aggressively pursuing. So there is a lot going on in this 

area, and the commitment of resources is huge. Are we moving as 

quickly as we want? No, but I don’t think it is so much a lack of 

commitment on your part—in fact, just the opposite. I think the 

part of the administration has been huge, and it has been a bipartisan support here. Obviously Senator Harkin has played a major 

role. But it is really a fact that we don’t have infrastructure and 

we don’t have production capability. And we have never really 

thought through how you quarantine 20 percent of a population, 

how you do it and how you handle a bed surge of that size. 

So it is not something you can just wave a wand at and solve, 

and so I just—well, first off, I want to make sure that Dr. 

Gerberding was right, that we are going to have this stuff stockpiled by June. And, second, I do want to say that I appreciate the 

huge amount of attention and energy that is being put into this 

and into the bioterrorism effort. And I understand that it comes 

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down to getting the antitoxins and the antivirals and the vaccine 

industry up to speed to accomplish it. 

Secretary LEAVITT. Senator, I want to say if there is a bioterrorism event or an earthquake or a hurricane or a nuclear event, 

we have the capacity to take to a spot stockpile, and we can deliver 

it anywhere in the country in a very short period of time. But I 

don’t want to in any way mislead you or anybody else. If we have 

a pandemic and we are having to deal with, as a country, 5,000 different communities, it is unrealistic to think that we are going to 

be able to serve them out of national stockpiles other than, say, 

antivirals. We will have sufficient, between what we have in 

our——

Chairman GREGG. If I can stop you there, my understanding was 

that we were—our game plan was to stockpile for a pandemic, with 

the capacity to handle mundane activity of dealing with sick people, specifically syringes, masks, gloves, you know, so that we——

Secretary LEAVITT. All that will be in it, and we will be able to 

deliver it to a certain point. But this is a different kind of emergency than what we are accustomed to dealing with, and for that 

matter—well, let me pose it differently. 

I was in Florida at a pandemic summit, and we were having this 

conversation with the Governor of Florida, Governor Bush. He said, 

‘‘How long do these last?’’ Well, that is the second difference. Not 

only do they happen everywhere at once, they last a year or a year 

and a half. They come in waves. He said, ‘‘In a year, a year and 

a half?’’ He said, ‘‘I have had two hurricanes down here—eight hurricanes in the last 2 years.’’

So we have the potential of having a hurricane in the middle of 

a pandemic. There is no reason to think that a bioterrorist event 

couldn’t occur during the middle of a pandemic. 

So for us to empty our stockpiles out with the idea that no other 

event could occur may put the Federal Government in a position 

where we are not able to respond to the things we are uniquely 

prepared to respond to. 

I go back to the fact that we need help here in being able to communicate the urgency of State and local governments, of every 

business, of every school, of every college, thinking through what 

their own needs are going to be. 

Chairman GREGG. I think everybody appreciates that point. Having a State plan is critical, and I know you have asserted and demanded State plans everywhere. But I guess I misunderstood, because my understanding was that we were—that part of this $7 

billion was basically the capacity to stockpile nationally, obviously 

spread across the country, the everyday needs that we would not 

be able to import for medical care. I am not talking vaccine here. 

I am talking, you know, what we just—the things we just——

Secretary LEAVITT. I think there is $212 million going into increasing stockpiles of consumable medical. That is a lot of gauze 

masks and a considerable number of ventilators. But if you try to 

stretch that over 5,000 communities——

Chairman GREGG. Well, OK. 

Secretary LEAVITT. Now, antivirals, that is a different proposition. We are working with the States. The challenge there is not 

having them. It is distributing them. It is having the capacity to 

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put pills in the palms of people’s hands at the right—within 24 to 

48 hours. I think this is an important conversation because if you 

have been left with the impression that in our stockpile is the capacity to respond to every community, every village, every city, 

every hospital’s needs for consumables, I do not think we are there. 

Chairman GREGG. Well, I guess I must have misunderstood, but 

that was the impression I had. So we will followup on it. 

Secretary LEAVITT. Yes. 

Chairman GREGG. Thank you. 

Secretary LEAVITT. Thank you. 

Chairman GREGG. We appreciate your time, appreciate your effort, and appreciate your service. 

Secretary LEAVITT. Thank you. 

[The prepared statement of Secretary Leavitt follows:]

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[Whereupon, at 12:01 p.m., the committee was adjourned.]

PREPARED STATEMENTS

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ANSWERS TO QUESTIONS SUBMITTED

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THE PRESIDENT’S FISCAL YEAR 2007 BUDGET 

PROPOSAL FOR THE DEPARTMENT OF DEFENSE 

THURSDAY, MARCH 2, 2006

U.S. SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to notice, at 10:04 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Judd Gregg, chairman of the committee, presiding. 

Present: Senators Gregg, Domenici, Allard, Alexander, Conrad, 

and Nelson. 

Staff present: Scott B. Gudes, Majority Staff Director; and Mike 

Lofgren, professional staff member. 

Mary Ann Naylor, Staff Director and Jamie Morin, analyst for 

national security. 

OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

Chairman GREGG. We will call the hearing to order. We very 

much appreciate Secretary England and Admiral Giambastiani and 

Ms. Jonas coming up today to talk to us about the defense budget. 

They are obviously a high-powered group representing very well 

the Pentagon and serving our country well and we appreciate their 

service to our nation. We appreciate the difficult task they have, 

especially with the pressures presently on the Department of Defense and the many men and women we have in the field defending 

us across the globe, but especially in Iraq and in Afghanistan. We 

obviously thank them for their extraordinary service. 

The issue, of course, on the budget is one that is difficult. Could 

we pull up that chart, please? The discretionary side of the Federal 

budget is basically half non-defense and half defense. For the last 

2 years, we have essentially frozen non-defense spending and the 

President has actually asked for a decrease in non-defense discretionary spending this coming year. Defense, on the other hand, has 

received extremely robust support as a result of the attack of 9/11 

and the war that we are involved in, primarily, but also because 

we recognize that in the late 1990’s, there was much too much of 

a draw-down in defense. 

But this chart here reflects the rate of growth of defense from 2000, when the core budget was at $292 billion, to 2007, when the 

core budget was up to $460 billion. In addition, on top of that, 

there has been what I call a, well, let us call it a shadow budget 

of emergency spending for defense, which has basically been outVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00469 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
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side the budget process and, as a result, has therefore not been 

subject to any fiscal discipline because there have been emergencies and it has represented fairly significant spending, primarily focused on fighting the war in Iraq and Afghanistan. 

And the question which our committee has is how long can we 

sustain this and at what levels can it be sustained, and I think 

there are serious issues here. Also, whether or not it is appropriate 

to have this ancillary budget moving along for the Defense Department which is essentially outside the Congressional budgeting 

process in that it is all done by emergency and therefore not subject to any significant discipline as the basic budget is. 

The other question which I have, which I know somebody will address, is what is the core? What is it being used for? How is it—

it has grown so large, what is its main thrust? If you look at the 

cost of fighting the war, the actual on-the-ground cost in Iraq is 

about $6 billion a month and the on-the-ground cost in Afghanistan 

is, I think, about $1.5 billion a month. That adds up to $85 billion, 

approximately, a year, and so the question becomes, to what extent 

is the core supporting that versus emergency funding and to what 

extent should the core support that? 

So those are some of the questions I have. We have a bit of a 

conundrum, to put it simply. We are confronted with an extremely 

stringent budget on the discretionary side in the area of non-defense spending, but on the defense side, there appears to be very 

little control. As a result, we have questions about whether there 

is some way to put projections which are more predictable into the 

process and which are going to be affordable as we move into the 

out years in the defense accounts. 

That all being said, there is absolute commitment by this Congress and certainly the administration to support our people in the 

field with whatever they need. That is critical. That is obviously 

why the budget has gone up so much in many areas, but we do 

have issues and questions regarding areas outside the actual fighting of the war. 

So we look forward to your testimony and your thoughts and 

ideas as to how we address this, and we don’t really have a whole 

lot of thoughts and ideas. That is why we are asking for your input 

on it. 

I will now yield to the Senator from North Dakota. 

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD 

Senator CONRAD. First of all, I want to thank the Chairman, first 

of all, thank him for holding this hearing; second of all, thank him 

for the excellent questions that he has just posed because this has 

to be faced up to. 

Let me just start with the first chart that tries to put in context 

where we are in comparison to previous conflicts in terms of defense spending. This chart is expressed in constant 2006 dollars, so 

we are comparing apples to apples. You can see going back to the 

Korean War, we are over $500 billion a year in terms of expenditure expressed in 2006 dollars. The Vietnam War was well below 

$500 billion a year. The Reagan defense buildup got to about $500 

billion a year. And then we went into a long trough of reduced 

spending because of the cold war dividend, the end of the cold war 

465

peace dividend that was through several administrations. And now, 

the very dramatic ramp-up because of the attack of 9/11 and the 

conflicts in Afghanistan and Iraq.

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Where we are now, we can see we have actually reached a high 

compared to previous conflicts. We are above where we were in 

Korea. We are above where we were in Vietnam in constant dollars, so let us go to the next one.

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I think we all recall that at the time we entered into Iraq, that 

there were people in the White House who said it was going to cost 

$100 to $200 billion, and administration officials including the Vice 

President discounted that, said it wasn’t accurate. The Secretary of 

Defense discounted it. Here is one exchange that occurred on a talk 

show. George Stephanopoulos asked, ‘‘What should the public know 

right now about what a war with Iraq would look like and what 

the cost would be?’’ Secretary Rumsfeld, ‘‘The Office of Management and Budget estimated it to be something under $50 billion.’’ 

Stephanopoulos, ‘‘Outside estimates say up to $300 billion.’’ The 

Secretary of Defense said, ‘‘Baloney.’’

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Well, so much for baloney. We are now at $397 billion and counting. The Secretary of Defense suggested it was going to be $50 billion. That is what is known as being wrong by a country mile. So 

here the supplemental in 2003, $63 billion; 2004, $65 billion; 2005, 

$101 billion; 2006, $118 billion; 2007, $50 billion so far and counting. Let us go to the next one.

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In this budget the President has provided in 2006 and 2007 $120 

billion. The numbers from CBO for 2007 to 2016 say we had better 

be counting on almost $300 billion. We have to have full disclosure 

here. It is pretty hard to budget if we are not being given the full 

facts and if we are not being given serious estimates of what the 

costs are going to be. Let us go to the next one.

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Again, to put in context, the United States now spending $552 

billion a year on defense. That is more than the next 39 nations 

combined. Now, I think there are serious questions about this analysis, I would be the first to say. I am not sure how you compare 

us to China, for example. It maintains a bigger army than we do, 

pay them virtually nothing. So just a cost comparison may not be 

fully revealing, but I think we do need to understand roughly 

where we are. Let us go to the next one.

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This also has to be understood and that is the skyrocketing debt 

of the country. If this doesn’t sober up people, I don’t know what 

will. I am about ready to wonder what is going on in our country 

with respect to our leadership when nobody seems to give a fig 

what happens to the debt of the country. The debt is absolutely 

skyrocketing. The President said he was going to have maximum 

pay-down of the debt. There is no pay-down of the debt. The debt 

has gone up, up and away every year. The debt has gone up over 

$3 trillion in 5 years, and if the President’s plan is adopted, it is 

going to go up another $3 trillion and reach $12 trillion by 2012, 

and all of this at the worst possible time, before the baby boomers 

retire. If you think there are tough budget choices happening now, 

we haven’t seen anything yet. We have not seen anything yet, because this is an utterly unsustainable course.

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We had the Comptroller General here before the Senate Budget 

Committee last month. Here is what he said. ‘‘Continuing on this 

unsustainable fiscal path will gradually erode, if not suddenly damage, our economy, our standard of living, and ultimately our national security.’’ I think the Comptroller General is telling the 

truth. Collectively, we have a responsibility to face up to this, and 

that means every part of the budget has to be scrutinized and has 

to be disciplined. 

With that said, I want to say and I want to make very clear, this 

committee will support—the Congress will support every dollar 

that is needed for national security and we will stand shoulder-toshoulder with the President in providing for our men and women 

in uniform and for the defense expenditures that are required to 

protect this nation. That is an absolute commitment from this Senator, and I believe the overwhelming sentiments. 

With that said, we have a major challenge, and Senator Gregg 

said it well. If we are going to budget, we have to have people 

being frank with us about what the real costs are. This continuing 

submission of supplementals that are unpredictable when, in fact, 

we know that the costs are going to be—we have known every year 

that the costs were going to be far more than what was being put 

in the budget. 

So with that, I again thank the Chairman. I think this is a very 

important hearing, and I thank the witnesses. I thank you for 

being here. I thank you for your service to the nation. I also ask 

you to help us begin to grapple with this exploding national debt, 

because it is a matter of national security. 

Chairman GREGG. Thank you. 

Secretary England and other panel members, however you wish 

to proceed. 

STATEMENT OF GORDON ENGLAND, DEPUTY SECRETARY, U.S. 

DEPARTMENT OF DEFENSE; ACCOMPANIED BY TINA JONAS, 

COMPTROLLER, U.S. DEPARTMENT OF DEFENSE 

Mr. ENGLAND. Mr. Chairman, if I can start, and Senator Conrad, 

thanks. I do want to thank you for the opportunity to be here 

today. This is my first opportunity to appear before the committee 

and it is an important dialog. Admiral Giambastiani, who is the 

Vice Chairman of the Joint Chiefs of Staff, and Tina Jonas, who 

is our Comptroller, are with me today who worked in preparing the 

budgets. I mean, we do a lot of the detail work. Hopefully, today 

we can have a constructive dialog and we look forward to it and 

we appreciate the opportunity. I thank you for the opportunity to 

be here today. 

This is a critical time for our nation and I appreciate both the 

comments in terms of your words of encouragement to support our 

men and women in uniform because obviously it is essential. We 

have these magnificent people who are the cloth of our nation who 

literally put their lives and limbs on the line every day to preserve 

our freedom and liberty and it is important that we support them 

in every single way we can and I appreciate your comments in that 

regard. 

Regarding the budget, one comment I will make is in fiscal year 

2007, we are asking for $439.3 billion and also a $50 billion allowVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00485 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
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ance in terms of a supplemental tied to that, and that is a lot of 

money and is 7 percent above last year, so it is a lot of money and 

we recognize and understand that. However, I don’t believe, frankly, that we are crowding out the rest of the Federal Government. 

I worry about it going the other way, frankly. 

If you look at it in terms of the GDP, we are actually a much 

smaller percentage now than we were in the past. I mean, we are 

now, this year, including this supplemental, about 3.7 percent of 

GDP, and so Mr. Conrad, you are right. The numbers are large, but 

in terms of what the country can afford for its national defense, 

and we were spending 4.6 percent during the Gulf War, 9 percent 

during Vietnam, between 11 and 12 at the height of our involvement in Korea, and, of course, it was gigantic during World War 

II. So the percentage today, it is a lot of money but it is not a huge 

percentage in terms of the insurance and the freedom and liberty 

that we enjoy with our men and women in uniform. 

This is a more expensive force, there is no question about it. It 

is an all-volunteer force. That is a more expensive force. On the 

other hand, it is a much more capable force and we ask them to 

do much more than we have asked them to do in the past. 

There are a number of threats. First of all, we are all familiar 

with this long war against the terrorists and that is an ongoing 

war we have today, but we also have other threats that we need 

to be aware of and we need to budget for, we need to deter and 

be prepared to defeat. We have hostile states or non-state actors 

that could acquire and use weapons of mass destruction, and we 

are familiar with those today, and they can use those to devastating effect. Guarding against this threat and preparing for the 

possible consequences of WMD require new technologies and skills 

as well as enhanced counterproliferation efforts. We also have a 

possibility of a major emerging power could choose a hostile course. 

Therefore, it is important that we shape the force to discourage a 

pure military competitor and be able to defeat such a military, if 

necessary, in the future. 

Meeting these challenges requires fostering cooperation with 

emerging powers while hedging against possible surprise while 

maintaining our military superiority. So traditional state-based 

threats are still a concern to the nation. They are being kept at bay 

precisely because the Nation has been so well prepared, and this 

is a case, frankly, if thanking this committee and the other committees and the American people for letting us do that, and it has 

worked. It has worked for this nation now for many years. 

Now, all of these challenges have a bearing on the security of the 

homeland, so detecting, deterring, and defeating threats far from 

shore, in our judgment, is the very best and likely the only way to 

keep America safe. But the Department of Defense is also prepared 

in working to defend America closer to home, and we continue to 

provide support to other agencies of the U.S. Government for our 

homeland security missions. 

So in short, our nation today faces far more diverse challenges 

and far greater uncertainty about the future global security environment than perhaps we ever have in the past. So it is, indeed, 

a dangerous time for America. It is expensive. But on the other 

hand, that is the first obligation of government, is to provide for 

481

the common security of the nation. I can assure you that myself 

and Admiral Giambastiani, Tina Jonas, the Secretary, and all my 

colleagues in the Department of Defense, we understand this is indeed the taxpayers’ money. We understand it is their money that 

they allow us through you to spend on the security and we work 

very, very hard to spend this money appropriately and correctly. So 

we understand this is the taxpayers’ money and you have our 

pledge that we will do everything we can to manage this money appropriately for the American people. 

I will comment, I appreciate both of you being here today and 

your comments because at the end of the day, the war we are in, 

and particularly this war against the terrorists, is a war of will. 

This is a war of will and commitment and resolve. The cold war 

lasted for 40 years. This will be another long but totally different 

kind of war. But just like the cold war, it was many administrations and many Congresses where we had bipartisan support in 

terms of funding to protect and defend a nation and it is going to 

require the same sort of effort. 

I mean, this is, first and foremost, a war of will, determination, 

and commitment that we will prevail over a very, very long period 

of time and it will take a bipartisan effort. While parties may disagree on lots of other issues, this is one issue where they absolutely 

need to come to consensus. Otherwise, we will not be able to prevail in this long war. So I appreciate your bipartisan support and 

your comments here today and we do look forward to your questions, to a constructive dialog. We understand it is indeed a lot of 

money. 

I would like to ask Admiral Giambastiani if he would just make 

a few comments, and then we will get down to questions. Thank 

you very much. 

[The prepared statement of Mr. England follows:]

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STATEMENT OF ADMIRAL EDMUND P. GIAMBASTIANI, JR., 

VICE CHAIRMAN, JOINT CHIEFS OF STAFF, U.S. DEPARTMENT OF DEFENSE 

Admiral GIAMBASTIANI. Thank you, Mr. Secretary, Chairman 

Gregg, Senator Conrad, Senator Alexander. Thank you for the opportunity to represent our men and women in uniform today before 

you. I am pleased and proud to appear here with Deputy Secretary 

Gordon England and also Comptroller Tina Jonas. The three of us 

have worked together very closely over the last 7 months since I 

have returned to the Pentagon from 3 years as a combatant commander and I look forward to working with them as we discuss the 

2007 President’s budget that is presented to you today. 

I would like to make three brief points, if I could. First, I would 

like to thank each of you and the Members of Congress for your 

strong support of our men and women in uniform, to continue that 

support in the midst of this long war that Secretary England has 

talked about against extremists and terrorists, one where the 

enemy is attempting to destroy the resolve of the American people. 

We have carefully examined our requirements against available 

resources. We believe from the military perspective that the President’s budget allocation of this $439.3 billion maintains that support at the right level. I look forward to discussing in more detail 

the capabilities this budget will deliver to our troops. 

While this is a considerable sum of money, as you all have pointed out, we recognize that it is less than we have historically spent 

during wartime as a percentage of our national wealth. I am, along 

with Secretary England, fully committed to ensuring that the taxpayers’ money is well spent. 

Second point, we come today having just completed a several 

year long processes of fundamental importance to the Department. 

These include, one, the Quadrennial Defense Review, which we 

have just submitted to the Congress; the second, and required by 

law, the Chairman of the Joint Chiefs of Staff assessment our ability to execute the National Military Strategy; and finally, of course, 

the President’s fiscal year 2007 budget development. 

In all of these processes that we have gone through to submit 

these papers, we have had unprecedented collaboration and dialog 

amongst the senior civilian and military leaders of the Defense Department, and not just those in the Pentagon, frankly, but also our 

commanders in the field represented by our combatant commanders. We have literally spent thousands of man hours listening, questioning, analyzing, and learning as we have worked together. In fact, this is an unprecedented amount of time, in my experience in all the budgets we have presented in my 36 years in 

the service, that I have ever seen us spend, civilian and military, 

putting these papers, studies, reviews together. 

Based on this, I can tell you categorically that our armed forces 

are fully capable of executing every portion of the National Military 

Strategy and that this budget supports prosecuting the war on terror, it supports accelerating transformation, it supports enhancing 

joint warfighting, and finally, improving the quality of life and 

service of our troops and our families. 

The final point I would like to make, as long as we fight this long 

war against a ruthless enemy, we are doing it with an all-volunteer 

488

force. I have seen both sides of this military, in a conscript force 

and in an all-volunteer status. In fact, I was a recruiter at the beginning of the all-volunteer force. Congress brought that decision 

forward to us, frankly, with the military and the Defense Department resisting moving to an all-volunteer force. It is more capable, 

it is more expensive, but there are none of us in the senior leadership who would ever go back to a conscript force. 

I think this is significant and we need to ensure this commitment is fully recognized, rewarded, and valued. I know that all of 

you value our service members’ service, sacrifice, and commitment, 

and again, we thank each of you for your support. 

Because this is the first war we have fought with an all-volunteer force, attraction and retention of quality people are more important than they have been in our previous history. The fact that 

it will be a long war amplifies this consideration. Although we are 

now on new ground in some respects, experience teaches us that 

we attract individuals, but we retain entire families in our military. A keystone of attracting and retaining the best America has 

to offer is maintaining a superb health care system, a system that 

Congress authorized for service members and their families back in 

1995. 

As you know, the cost of that benefit has increased substantially 

since 1995. Let me give you a couple of figures. The cost has doubled in the last 5 years, from 2001 to 2006. It has gone from $19 

billion to $37 billion, and it is projected to increase to $64 billion 

in 2015. Despite this increase, there have been no premium 

changes since 1995 when Congress instituted this program. It is a 

superb health care program by the response from our folks within 

the Defense Department, but in particular in what we Joint Chiefs 

care about is our uniformed members and their families. 

The Joint Chiefs have discussed this in length and in detail. We 

believe the legislation you passed in 1995 was superb and is superb 

today, and we want to see it sustained going forward with this 

health care program. Because of that, and based on our belief that 

the cost to the individual was reasonable in 1995, we recommend 

that you re-norm the 2006 cost shares to the 1995 level. That will 

allow us to maintain this superb health benefit for our families and 

ensure that it is there 20 years from now. 

Some very important points to underscore about this recommendation that are included in the President’s budget. First of 

all, it doesn’t affect any active duty members. The second thing is 

it applies to retirees under 65 only. And finally, it maintains the 

catastrophic cap of $1,000 for active duty families and $3,000 for 

retirees. So fundamentally, our recommendation is to take the benefit enacted in 1995 and update it in a fiscal sense to 2006. 

Thank you again for the opportunity to testify today and to represent our men and women in uniform and we are ready to answer 

your questions, sir. 

Chairman GREGG. Thank you, Admiral. Did you say you have 

been wearing the uniform for 36 years? 

Admiral GIAMBASTIANI. Yes, I have been wearing the uniform for 

40—four years at the Naval Academy. 

Chairman GREGG. Thank you. That is extraordinary service. 

489

Can we go back to that chart? The essence of the budget question 

is this. How do we, in the context of the overall spending of the 

Federal Government, and accepting your argument, which I do accept, that our commitment to the national defense as a percentage 

of gross national product is not historically high, even though the 

numbers are historically high, how do we get out of this process of 

budgeting by emergency, which basically means we are not budgeting at all. We simply give you an open-ended check subject to 

your sending up a supplemental, and the issue is this. If you look 

at those emergencies that have come up and you look at what the 

spend-out is in Iraq and Afghanistan, which is about $85 billion a 

year right now, we are actually exceeding a spend-out on the onthe-ground costs in Iraq and Afghanistan. 

A lot of this supplemental has been base activity, not a lot, but, 

for example, in the supplemental that was just sent to us, we have 

$3.5 billion for repositioning the Army under the new modular approach, which isn’t an emergency. I mean, that is a decision that 

should have been in the context of the core budget. It does seem 

to me that we have been at this now long enough so that there 

should not be a necessity for these major supplementals to come up 

here, but it should be sent up as part of the budget. 

Are we essentially saying, by sending these supplementals, that 

the core budget is not being used to fight this war in Afghanistan 

and Iraq and that the war in Iraq and Afghanistan is being fought 

by emergency supplementals? If we are not saying that, then why 

are we sending up emergency supplementals? Shouldn’t we be putting it into the core budget? Shouldn’t the budget that was sent up 

to be an accurate reflection of what we are going to spend for this 

year not have been $434 billion, but shouldn’t it have been $550 

billion, because you know these numbers are coming at you. They 

are pretty predictable right now. You have been in Iraq long 

enough to know what the number is for next year for sure. Maybe 

you don’t know what the number is for 3 years from now. I certainly hope it is going to be a lot less, but why this process of running two sets of books? 

Mr. ENGLAND. Mr. Chairman, if I could just comment, first of all, 

I guess I need to say what Secretary Rumsfeld said at a hearing, 

and that is it is above my pay grade how we do this. This is, frankly, worked out by the Appropriations Committees’ leadership, 

OMB, and the President in terms of how to do this and the base 

budget and the supplemental. 

Now, look, you could do it either way. Frankly, the supplemental 

is much later data. I mean, in the supplemental, it is not only the 

costs of the war in terms of the number of troops and what we have 

on the ground, so we know what that is at a later time in the budget when we turn it in. It is much more precise data for you in the 

supplemental. 

We also replace equipment that is damaged or worn out or destroyed as a consequence of the war, and that is included in the 

supplemental. So these are not numbers that are easily predicted. 

In the supplemental, we do have significant support for the numbers because we know—we are a lot closer to what those numbers 

are when the supplemental is submitted as opposed to trying to estimate well in advance. 

490

As you know, like today, we are doing the 2008 budget. I mean, 

if we were trying to plan that far ahead for Afghanistan and Iraq, 

it would be very difficult to do that. So my own judgment is we 

have more accurate numbers the way we are doing it now, but the 

decision in terms of what categories and this process is really 

worked out at a much higher level, and so——

Chairman GREGG. Well, why are you putting in these 

supplementals things which are not related to Iraq that are core 

questions of how the Army is structured, for example? 

Mr. ENGLAND. Well, in some cases, like for the modular Army, 

an agreement was reached that we would have it in a supplemental until 2007, so this time, in 2006, you will see dollars in 

there for the modular Army in the supplemental, but in 2007, they 

are in the base budget. So we are transitioning to the base budget 

where we do have definitive numbers, and we went through a transition in that particular case. 

Admiral GIAMBASTIANI. If I could, Senator Gregg, just to followup 

on this modularity question, one of the reasons why it was put into 

the supplemental was to accelerate the modularity. I just returned 

from Iraq a couple of weeks ago and I was in Tal Afer up north 

in Iraq, where the Third Armored Cavalry Regiment was being relieved by the First Armored Division First Brigade Combat Team. 

That First Brigade Combat Team is the last Army brigade that will 

go over that hasn’t had any of the modularity put into it, and the 

reason why the Army has been able to accelerate it is because on 

very short notice, this modularity money was put in over the last 

2 years into the supplemental. So I would tell you that we are 

doing this on the fly and the Congress has really helped us out 

there. 

Chairman GREGG. I appreciate that, but it just seems to me that 

it is being done in a way that essentially prejudices the rest of the 

budget, because it means the defense budget, what you send up 

here for a defense budget has no relevance to the real budget because you are 15, 20 percent off of what you are actually spending 

every year, which goes to a larger philosophical issue, which is this. 

The defense budget is very large and you are fighting a war on 

terrorism with it. Now, a large percentage of the defense budget 

doesn’t appear to be directed at the war on terrorism. It is directed 

at what you have referred to, I believe, as the pure military threat, 

which is understandable, I guess, although if you take the ten nations after America that spend money on national defense and combine their national defense costs, I think it is less than what we 

spent. But let us assume that there is a rising pure military threat, 

and I presume you are referring to China but don’t want to use 

that term. So you have a core budget directed at trying to make 

sure that we are strategically strong enough to deal with a pure 

military threat. 

If we are fighting terrorism, the fight on terrorism doesn’t appear 

to me to be purely a military exercise. A large percentage of the 

terrorism effort has to be intelligence. A large percentage of the 

terrorism exercise has to be nation building, which is not necessarily a good role for the military, but it is what you have been 

drawn into in Iraq and Afghanistan. A large percentage of the fight 

491

on terrorism has to be defending our domestic homeland and protecting our borders. 

And yet when you look at this budget the way it is coming at us, 

the military is absorbing the vast amount of the structure of the 

fight on terrorism, and we are actually starving or treating as stepchildren things like the Coast Guard and the Border Patrol, who 

basically protect the borders. We are treating as step-children the 

effort at nation building, or we are doing it indirectly through the 

Defense Department, which isn’t the best vehicle to do it through. 

And the question of intelligence, I don’t think we can get into, but 

it has been a robust commitment to intelligence, but certainly there 

is still, compared to what the commitment is to the Defense Department, it is not anywhere near the significance of the rate of 

growth, and that is because you are on the front line in the hot 

war, so to say, in Iraq and in Afghanistan. 

And so I guess, and this probably isn’t something you can answer, but I guess my question is, are we allocating these resources 

for fighting terrorism correctly amongst the various responsibilities 

in light of the fact that this isn’t your typical war? This is a different undertaking. This is an undertaking where you have to 

know who your enemy is before he attacks you because by the time 

he attacks you, it is too late. This is a war where you have to say 

to the nations that are in the Middle East, listen, democracy works 

and we are going to show you how it works because we are going 

to help you rebuild and be democracies. And this is a war that 

says, we have to know who is coming in and out of this country 

because that is where the threat is. 

Mr. ENGLAND. If I could just make a comment, Mr. Chairman. 

First of all, the level of spending, I want to followup a little here 

for the Vice Chairman, because he talked about medical. We 

spent—in our base budget, we have $39 billion is our medical bill. 

That is $2 billion more than the entire defense spending for Germany—$2 billion more than the entire country of Germany. And by 

the way, here is an opportunity, and here is where we ask your 

support, because frankly, we haven’t been able to control some of 

these costs in the past. 

Here is an opportunity for the Congress to help us on this. I 

mean, here is a case where literally we can save $11.2 billion and 

we don’t jeopardize any single person active, nobody over 65. We 

find ourselves in the situation where in this medical arena, our 

premiums are so low and our benefits so significant that companies, when people leave the military and go to work for a company, 

the company pays them cash, some companies, not to take their 

medical but to stay on our program, and municipalities and States. 

They will not even let their people take their medical coverage. 

They are required to take the medical coverage on DOD. So slowly, 

every retired person from the U.S. military is staying on our health 

care program and it is one reason it is going up significantly. 

So if we can just literally adjust our rates for inflation, we help 

ourselves and this committee significantly. So there are some 

things that we can help change, perhaps, the pattern in the future 

which are, frankly, very painless to do. So we encourage you to 

help us in that regard. 

492

Chairman GREGG. We can certainly put language in. Obviously, 

we are not the authorizing committee, but we can say we are assuming in this budget that your recommendation in this area will 

be pursued. I have no problem with that. 

Mr. ENGLAND. Good, and I appreciate it, because we have not 

been successful in the past. I mean, these benefits have basically 

been handed to us to some extent by the Congress and we end up 

paying this very large bill, so here is an opportunity to help us in 

the other direction and I sincerely appreciate your comment, Mr. 

Chairman. 

The comment about the whole fight against terrorism, we have 

just completed the Quadrennial Defense Review that was directed 

by the Congress. We spent a whole year working extraordinarily 

hard at this in terms of the strategic direction of the Nation and 

the Department specifically as we see future threats to America. 

And we went back and adjusted the 2007 budget to the extent we 

could. So the 2007 budget has a number of changes as we transition and transform the force for both the war on terror and the conventional threats in the future. 

My assessment is that we worked very hard to do the very best 

assessment we can as we go forward, and we have put more money 

in our special forces, a lot of moneys in the intelligence side of this 

business. We have done a lot of work to restructure for exactly the 

reasons you have stated. 

I also will tell you, I agree with you completely. The Department 

of Defense cannot win this war. This is beyond just the Department 

of Defense. I mean, this will take the entire Federal Government 

and all aspects of Federal power to win this long war. And in fact, 

in the Quadrennial Defense Review, our view is it not only takes 

all aspects of national power, but all aspects of international power, 

our friends and allies, because these are international threats to 

the peace and security and freedom and liberty. 

So we have in our budgets going forward, and in 2007, we made 

adjustments just for language skills, cultural skills, reshaping the 

kind of force we have. It is all now starting to show up in our budgets and some of that is in the 2007 budget that you will be looking 

at this year. 

Chairman GREGG. Admiral Giambastiani. 

Admiral GIAMBASTIANI. Chairman, I might mention a couple of 

other comments here. One of the things that Senator Conrad put 

up was a chart from the International Institute for Strategic Studies, the lists of expenditures of other countries. What is fascinating 

is there is no section in the IISS that talks about extremists, terrorists, and all of these threats that are non-nation states. And so 

how do you calculate that and who is out there calculating it? 

As a matter of fact, I am making an intervention with them to 

see when they are going to start putting that into what they call 

traditionally today their military balance. I have been looking at 

that for the last 17 years. I did a fellowship back in 1990 and 1991 

where I spent a lot of time looking at that. But I would just tell 

you, there is no comparable section in there that talks about these 

extremist groups that are going after weapons of mass destruction, 

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clear weapon and it only costs them a small amount of money, that 

is very bad. 

So what we have done in this Quadrennial Defense Review that 

the Deputy has talked about is we have looked at asymmetric 

threats. We have looked at non-traditional warfare, irregular warfare, the intelligence it takes to help the overall community so that 

the military and the Defense Department can do its share to respond to these threats. How can we, for example, increase the 

number of capabilities we have to render safe nuclear weapons if 

we find them? How do you deal with biological threats in our chemical-biological defense program, and there is a whole section, frankly, in here, page 52 and 53 in the QDR, that talks about things just 

like that and the weapons of mass destruction area in the render 

safe place, in the dealings with rogue states with nuclear weapons. 

So what I would tell you is that we have spent a significant 

amount of time trying to look at how we can not only deal with the 

conventional side of the military, which is what we were designed 

to do, clearly, in the past, but also how we can increase the amount 

of intelligence we have—we call it intelligence, surveillance, and reconnaissance, for example, in the use of unmanned vehicles—not 

just satellites, but increase our human capability, increase our foreign language capability, and increase our ability to do what we 

call find and fix targets, not just finish them. The military is very 

good at No. 3. It has to be better at the find and the fix, and so 

does our entire intelligence community. 

So a lot of what this Quadrennial Defense Review has done is to 

give us a substantial vector change to try to go after these irregular, asymmetric threats, recognizing again that not just the military in the United States can do it. This is a coalition event. This 

is an allied event. And it is an interagency non-governmental 

event. 

Chairman GREGG. Thank you. 

Senator Conrad. 

Senator CONRAD. Thank you, Mr. Chairman, and I think you are 

asking very important questions. In some ways, this is a bit of a 

frustrating exercise perhaps for both of us because the three of you 

aren’t responsible for the things that cause us to have these questions. 

I must say, I feel there has been some ‘‘hide the ball’’ going on 

here by the administration. I think the evidence is pretty clear for 

that. They tell us early on the war is going to cost $50 billion. Now 

it has cost $397 billion. Every year, they come up with these big 

supplementals. Last year, they asked for $120 billion of 

supplementals for the year that we are in now. So actually, they 

first asked for $50 billion. Now they come and ask for another $70 

billion, so that is $120 billion. Now we are being told it is only 

going to be a $50 billion supplemental for next year, and you will 

excuse us if we are pretty skeptical about that. 

It seems unlikely to this Senator, and perhaps to the Chairman, 

as well, that that $50 billion is really what you anticipate, because 

just doing the math, it would suggest that the cost of the conflict 

in Afghanistan and Iraq is going to somehow going to dramatically 

be reduced in 2007. 

494

Secretary England, I am going to say to you, I have great respect 

for you. I was somebody who is behind the scenes and publicly 

strongly supported your elevation to this position. Admiral 

Giambastiani, I very much enjoyed our visit yesterday and have 

great respect for you and your service to our country. Ms. Jonas, 

I have always been impressed by you. 

But that isn’t the point. The point is, we have to be straight with 

our colleagues about what things are going to cost. That is our responsibility. And it doesn’t look like people are being straight with 

us about what the costs are going to be for 2007, that there is this 

continuing kind of ‘‘hide the ball’’ about what things are going to 

cost. 

I would just say to you, Secretary England, do you really believe that the $50 billion that is in the budget is all that is going to be 

asked for in 2007, or is it more likely that the administration is 

going to come right back like they did this year and ask for another 

big chunk of change? 

Mr. ENGLAND. Senator, my understanding is that the $50 billion 

is not to be a projection of our needs for next year. My understanding, and again, this was a decision by OMB and, I believe, the 

appropriators and leadership, but my understanding is that the 

$50 billion really followed the action by the Congress, that is, the 

Congress put in $50 billion the prior year as a transition funds and 

that this was a follow-on to the Congressional initiative to put the 

$50 billion in. So I don’t believe this was—I am quite confident this 

is not an estimate of future expenditures. It is to have a vehicle 

in the budget so that we can continue to execute the war while we 

then prepare detailed supplementals. 

I, frankly, would disagree that anyone is hiding the ball. In the 

supplemental, you will find a lot of detail in terms of very specific 

costs, and in my judgment, very traceable——

Senator CONRAD. Well, wait, wait, wait. Come on, now. Let us be 

straight. You have just said that this isn’t a prediction of what next 

year’s spending is going to be. That is what a budget is. You know 

that full well. The purpose of a budget is to state what the cost is 

going to be, and this isn’t a statement of what the cost is going to 

be. It is hiding the ball. I don’t know how you can say it is not hiding the ball. Last year, they said $50 billion and then they come 

and ask for another $70 billion right away. 

Mr. ENGLAND. But Senator——

Senator CONRAD. And next year, they say it is going to be $50 

billion and you and I both know they are going to be coming and 

asking for a lot more money. 

Mr. ENGLAND. But the dilemma, Mr. Conrad, is trying to estimate costs when you don’t have a basis to estimate. I mean, we do 

not know what the war will cost us next year. Hopefully, we will 

have less troops. Hopefully, we will have less equipment destroyed. 

There will be more Iraqi military stood up. So it is an unpredictable environment. 

Again, I guess you could do this either way. The decision, like we 

said, is above my pay grade. You could do this either way, but it 

does seem to me that the Congress gets a much better base in 

which to act than if we just literally tried to, quote, guess numbers 

in the future, and it would be largely guessing numbers in the fuVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00500 Fmt 6601 Sfmt 6633 C:\DOCS\26726.TXT SBUD1 PsN: TISH
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ture. So this way, we do give you a defined budget and a defined 

supplemental. But again, it is above my pay grade how to do this. 

It would seem to me, however, that you get much better data 

through the supplementals than if we tried to estimate that far 

ahead, because again, we are preparing today the 2008 budget. It 

would be very hard to predict what those expenditures would be in 

that period of time when we are actually executing a 2008 budget. 

I mean, there is the tyranny of the budget. There is a long period 

of time in preparation before you get to execution. 

Senator CONRAD. I just say to you, hope is not a plan. A budget 

is supposed to be a plan. A budget is supposed to be our best estimate of what things are going to cost, and I would respectfully say 

to you, I don’t believe this is a best estimate of what it is going 

to cost, and that to me is hiding the ball. I don’t think it serves 

anyone well. 

Mr. ENGLAND. Well, again, the $50 billion, my understanding is 

not an estimate of the future. It was literally to follow the Congressional——

Senator CONRAD. I know, but we are just going over the same 

ground. Mr. Secretary, the purpose of a budget is to estimate what 

we are going to spend, and what we have before us, frankly, I don’t 

think is a serious estimate of what we are going to spend, and it 

has proved to be the case repeatedly. I mean, we started this when 

the war began and the Secretary said it was baloney that this 

thing would cost $300 billion. We are over $300 billion now. So, you 

know, it is important—our responsibility to our colleagues is to try 

to have a best estimate of what things are really going to cost. That 

is what a budget is about. 

Chairman GREGG. Would you yield? 

Senator CONRAD. Yes, I would be happy to yield. 

Chairman GREGG. To try to put this in a number context, it does not appear that any part of the core, which is this year $434 billion 

and next year estimated to be $460 billion, is anticipated to be 

used for on-the-ground expenditures in Iraq or Afghanistan. And if 

you take the average of the last 4 years, it is about $90 billion 

supplementals to do the on-the-ground expenditure in Iraq and Afghanistan. 

So I guess my question, which is a follow-on to Senator Conrad’s 

question, is why aren’t you folks telling us, we aren’t going to 

spend any of the core on the on-the-ground expenditure in Afghanistan or Iraq. We have an average expenditure of $90 billion over 

the last 4 years for on-the-ground expenditures. So, therefore, it is 

reasonable to presume that we are going to get a supplemental in 

that range. 

Mr. ENGLAND. Well, again, above my pay grade, Mr. Chairman, 

but I can tell you, my view is if we came in and just said, we need 

$90 billion and we were literally looking ahead 2 years and sort of 

guessing the future, I don’t believe that would be supported by the 

Congress and I don’t believe that you can—the next thing, then, everyone wouldn’t have a great deal of support for that number. I 

don’t believe you can do that. We do not have enough clairvoyance 

to look that far ahead and give you firm estimates for numbers. 

So the choice is, we give you very firm numbers in terms of the 

supplementals or we try to go way ahead and predict them, and 

496

again, we could do it either way, but the decision was to do it this 

way, and again, we are the implementors of those decisions made 

by OMB and the Appropriation Committee and the leadership of 

the Congress and the President. There are different ways to do it. 

That was the way that was decided and that is the way we have 

prepared the budget, sir. 

Senator CONRAD. I would like to ask one other question, if I 

could——

Chairman GREGG. I apologize. 

Senator CONRAD. Why don’t you go around, or go ahead and I 

will catch it on the second round. 

Senator ALEXANDER. Please go ahead, Senator Conrad. 

Senator CONRAD. I will go off that subject. I hope that it gets expressed up the line, the frustration that we have, because——

Mr. ENGLAND. We understand. 

Senator CONRAD. You know, we do try to present our colleagues 

with a realistic estimate of what things are going to cost, and if 

people don’t share with us realistic estimates, we can’t do our job. 

Let me just raise a question that I raised with the Admiral yesterday. I tried to give a heads-up that I would ask this question, 

because I think it is a serious concern. This is from the Washington 

Times of December 3. Funds may be lacking for ample Iraqi army, 

and it goes on to talk about the U.S. general in charge of shaping 

an Iraqi army raised the prospect yesterday the new Baghdad government will not have sufficient money to fund the army envisioned by our administration. The President has said repeatedly 

that we will stand down as the Iraqi army stands up, and the question that is being raised is will the Iraqi nation state have sufficient funding to be standing up an army? Have you had a chance 

to look into that, Admiral, or Secretary England, either one?

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26726.160
498

Mr. ENGLAND. I can say this, Senator, that we have been very 

sensitive that the Iraqi army can stand up an army that can do the 

job they need to do and also is affordable by the Iraqis, and the 

Iraqis do not need an army like the United States of America. I 

mean, they need an army to provide for security and stability in 

their country. So it is a different kind of army than we have, frankly, and we are training the army and, frankly, equipping the army 

now to be able to do those jobs rather than us do those jobs in Iraq. 

So I can tell you it is sensitive. I can’t tell you the detail. I can just 

tell you from a policy, philosophy point of view, we do want them 

to stand up an army that is obviously sustainable by them over a 

long period of time. 

Senator CONRAD. But you must have estimates of whether or not 

they really have the financial capability to provide for the kind of 

army that is necessary to do the job that we envision for them. 

Mr. ENGLAND. Mr. Conrad, I would have to get back to you. Perhaps Tina Jonas or the Admiral. I just don’t have those estimates. 

But we would be pleased—I would be pleased to get back with you 

on that subject and meet with you in your office. I just don’t have 

those numbers——

Senator CONRAD. I just think this is a centrally important question to our strategy. When the Admiral and Ms. Jonas were in my 

office yesterday, I alerted them that I would ask this question, because it seems to me for the purposes of our planning, we have to 

know, do the Iraqis really have the resources to have an army to 

stand up? That becomes a pretty central question. 

Mr. ENGLAND. Tina, can you——

Ms. JONAS. Mr. Conrad, I don’t have the precise number in front 

of me, but the Iraqis are providing—paying for the salaries of the 

army that is being stood up. As you know, we are asking for additional funds in the supplemental, about $5.9 billion between Iraq 

and Afghanistan, to continue to train and equip them. But I will 

say, and Admiral Giambastiani may want to talk to certain aspects 

of the capability, this is a concern of the Secretary, and as the Deputy Secretary just mentioned, we are very conscious of the fact that 

we should not be building something that they cannot sustain. 

Admiral GIAMBASTIANI. I think the only thing I could add, Senator Conrad, to what the Deputy and the Comptroller have said to 

you is, No. 1, General Dempsey, as both a NATO commander and 

as a U.S. commander, has spent substantial time since he has 

taken over as the multinational training head to work with the 

ministry responsible, MOD, and now with the MOI, the Ministry 

of Interior, to look at the needs long-term for the government. Because the government is in transition, clearly, and because they are 

still building ministries, there is still much work to be done. 

But the point is that we are looking for a sustainable Iraqi solution and we are looking for a sustainable Afghan solution in both 

cases. And if that takes help from coalition and allied members, 

which it has—for example, large numbers of tanks have come in 

from Hungary, large numbers of small arms and weapons and ammunition have come in from a number of NATO allies, and these 

are all important parts of equipping. I did that for part of my time 

in my last job as a NATO Supreme Allied Commander. 

499

And what I would say to you is that working with these ministries, the attempt of these estimates, if you will, is for them to 

sustain it and not build something they can’t sustain, as the Deputy has said. 

Chairman GREGG. Senator Alexander, thank you for your generosity in time. 

Senator ALEXANDER. Thank you, Mr. Chairman. 

Mr. Secretary, Admiral, Ms. Jonas, thank you for being here. I 

want to shift the subject a little bit. 

A few weeks ago, in Nashville, I sat down for a couple of hours 

with our Adjutant General, Gus Hargett, and the Commander of 

the Tennessee forces that have been in the National Guard in Afghanistan—the 278th unit, which has had 3,000 Tennesseeans in 

Iraq, and the 844th engineering unit. It was a very interesting 

visit. Ten thousand of our 13,000 National Guardsmen and women 

have been in Iraq or Afghanistan. Much of the equipment used by 

the Guard units, specifically the 278th and the 844th engineering 

unit, was left in Iraq following their return. It is now being used 

by the units that replaced them. That makes sense. Other Guard 

units across the country are in the same situation. Undoubtedly, 

many of the Governors who were here this week talked with you 

about that. 

So my question is about the funding and the pace of replacing 

the equipment of the National Guard units, and I would specifically 

like to know how much money is allocated in this budget to replace 

this equipment, and what is the time line for spending it, and what 

does that level of funding and pace of spending say about the use 

of the Guard in Iraq and Afghanistan in the future years? 

Ms. JONAS. Senator, thank you for the question. I would just like 

to point out that over the program plan that we have in this budget, which is from year 2007 to 2011, we have added $21 billion for 

Guard equipment. On average, we are spending—we are going to 

be doubling—over that program period, we will have doubled what 

we spent during the 1990’s. We were spending, on average, $12 billion during the 1990’s for Guard equipment, so we will have doubled that, and that is in the baseline budget. In addition, we are requesting, I believe it is $1.7 billion in the 

supplemental for Guard equipment. So I think there is a recognition that that is very important and we put some emphasis on it, 

sir. 

Senator ALEXANDER. Would it be possible for you to tell me how 

much of that is in this year’s budget? 

Ms. JONAS. Yes. I am sorry. The amount that we are spending 

for the Army and Air Guard in the 2007 budget is $23.1 billion. 

Senator ALEXANDER. And are your plans definite enough for 

spending to be able to say how much of that would be allocated to 

the 278th and the 844th engineering unit for this next year? 

Ms. JONAS. OK. We would have to get back to you for——

Senator ALEXANDER. No, that would be fine, but, I mean, could 

you—that would be a big help to them. 

Ms. JONAS. Sure. 

Senator ALEXANDER. Following that, your request reduces the 

planned number of National Guard combat brigades from 34 to 28. 

How much does this save over the period of, say, the 4-year period 

500

you just described or any period you might choose, and is most of 

that personnel or is most of that equipment or how do you divide 

that? 

Ms. JONAS. Admiral Giambastiani might want to talk to the restructuring of the Guard. 

Admiral GIAMBASTIANI. Let me just discuss the restructuring for 

a second. What is important to remember is that we are looking 

at fully equipping all of these National Guard brigade combat 

teams. That has never happened in the history of the National 

Guard, that we have——

Senator ALEXANDER. The 28 that we will end up with? 

Admiral GIAMBASTIANI. Twenty-eight, 34, 32, whatever number 

you pick and whatever we have had in the past, we have never 

fully equipped, to my knowledge, any of these brigade combat 

teams, and the intent here within the baseline budget is to fully 

equip 28 brigade combat teams, retain the total number that we 

have today of brigades. These are not just brigade combat teams, 

but support brigades, which is 34, whatever number you take. The 

total is 106 between the combat teams and the support brigades, 

and retain 106, transition a number of these into engineering and 

other support units which we feel will be better postured and structured to support homeland defense, contingency operations, national disasters, and the rest. But we will have a much more capable brigade combat team force where we don’t have to take people 

from one unit to another to send them forward and the rest. 

Now, your question is—one of the questions you asked, I don’t 

have an exact number, but do you save money over the people or 

over the equipment if you take down the number of brigade combat 

teams, and the answer is it is mainly in the equipment because 

most of these brigades would be heavy brigade combat teams which 

require lots of armored personnel carriers, tanks, and other things 

which are very expensive, comparatively speaking, than trucks are, 

engineering equipment, and other things like that. So the cost differentials are really in the equipping of the heavy brigade combat 

teams, Senator. 

Senator ALEXANDER. Thank you. That is very helpful. I assume 

that in all of this, you are working with the States and the Governors to try to make sure that the equipment you replace fits into 

what they perceive their needs are for homeland security and disaster relief, things they may be called upon to do? 

Admiral GIAMBASTIANI. Yes, sir. The Department and the Army 

has made a commitment to equip all of these brigades properly. 

That is very, very substantial. You know, a number of the Guard 

leaders have been skeptical of this in the past, and frankly, you 

have a very solid commitment and the amount of money that is in 

there, the $21-plus billion that are in our program, is unprecedented and is really quite—to the Guard leaders, their eyes——

Senator ALEXANDER. So you are telling me we are going to have 

28 combat brigade units that will be better equipped than they 

ever have been before? 

Admiral GIAMBASTIANI. Yes, sir, both manned, equipped, and 

trained, all three of those. 

Senator ALEXANDER. And that would suggest to me that they, 

while none of us can predict the future, that they would be preVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00506 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
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pared to serve in the same kind of role again that they were called 

upon to serve in Iraq and Afghanistan——

Admiral GIAMBASTIANI. Yes, sir. 

Senator ALEXANDER [continuing]. If that need ever arose? 

Admiral GIAMBASTIANI. What I would tell you is, that our reserve 

force within the military has always been what we call a strategic 

reserve. So if we need brigade combat teams, for example, in the 

combat support, we have always built in some time to get them 

properly trained and sent over and the rest. Well, we have had to 

use them as an operational reserve here during Operation Iraqi 

Freedom, Operation Enduring Freedom. In fact, we have had upwards of 39 percent of our deployed forces have been Reserve component, both National Guard and Reserve. Today, it is actually 

running at a little less than 20 percent. 

But the point is that we need to have them structured as not 

only a strategic reserve, but as an operational reserve in the future, and in order to do that, the Department has to step up and 

properly man, train, and equip them, and that is the purpose of the 

program. 

Senator ALEXANDER. That is very helpful. Thank you. And if you 

could get back to me at your convenience with any details you have 

about those units I asked about. 

Thank you, Mr. Chairman. 

Chairman GREGG. Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. I would like to pursue just a little different line of questioning here. 

About 12 years ago, the Congress passed legislation that dealt 

with the issue of government procedures and results. It is called 

the Government Procedures and Results Act. That program under 

the administration is referred to as PART, and I have pulled down 

off the Internet—the White House has an Internet where these 

programs are listed and there are a number of departments, frankly, that have not done a very good job. But the Department of Defense, you have four program areas in which your ratings were, results were not demonstrated.

RESPONSE TO SENATOR ALLARD’S QUESTION 

The Department of Defense Training and Education Programs-Other Training 

and Education consists of three disparate programs: Off-Duty Voluntary Education; 

Junior Reserve Officer’s Training Corps; and Civilian Education and Training. 

During last year’s PART development cycle it was determined late in the process 

that these programs would be included and, frankly, these programs were improperly combined and the metrics selected failed to properly measure the effectiveness 

of these programs. This was recognized by OMB, but a grade of ‘‘not demonstrated’’ 

was assigned to the programs in order to permit the Department to properly reevaluate them. In coordination with OMB, we have divided these programs into 

three separate areas and are actively working with OMB to successfully evaluate 

them during this year’s PART cycle. 

Funding reductions based on the results of the FY 2005 PART asessment would 

be premature, particularly at a time when costs for pursuing higher education opportunities are escalating around the country. Study after study has proven that the 

Voluntary Education program is a key recruitment and retention tool that impacts 

positively on militaru job performance, mission accomplishment, and disciplinary 

issues. DoD has reacted to this dynamic by changing policy to require fewer outof-pocket expenditures on the part of our Service members. Reduction of funding for 

this program would have a negative impact on troop morale at a time that would 

be inopportune for continued readiness.

502

Now, if the program is listed on here, it is either rated as ineffective or results not demonstrated, and when they list it as results 

not demonstrated, what it means—a rating of results not demonstrated indicates that a program has not been able to develop acceptable performance goals or collect data to determine whether it 

is performing. 

You only have four, which is good, but my question to you is can 

you elaborate on how you are using this and if you can address 

these four programs specifically, I think it would be helpful to me 

and the committee so that we know how these are performing. 

Those four programs, one is the defense communications infrastructure. The other one is defense small business innovative research, 

technology transfer. The other one is Department of Defense training and education programs, other training and education. And the 

fourth is the Marine Corps expeditionary warfare.

The Marine Corps is taking steps to define specific long-term performance measures for Marine Corps Expeditionary Operations. Below is the history of that effort:

a. PART is a component of the President’s Management Agenda to evaluate 

the entire Federal Government every 5 years. In 2005 it included the USMC. 

b. PART consists of responses to a series of stock strategic planning, program management, and program accountability questions and associated cost, 

schedule, and performance data. Two questions pertain to a limited number of longterm performance measures. 

c. The USMC submitted responses to all questions and data requested and 

also provided the USMC Expeditionary Manuever Warfare Capability List (ECL) 

containing a substantial number of goals and measures. OMB deemed this list to 

be too comprehensive and requested instead the USMC provide a subset of priority 

long-term performance measures. 

d. There was no approved short list of long-term performance measures 

used to describe the USMC at that time. This resulted in the USMC PART getting 

a ‘‘Results Not Demonstrated’’ rating by OMB. 

e. The USMC has requested a PART Abbreviated Reassessment for 2006 

to address this. The Marine Corps Combat Development Command (MCCDC) has 

been tasked to develop a short list (approx 4) specific long-term performance measures for evaluating Marine Corps Expeditionary Warfare. Draft measures are due 

to OMB 14 April and final measures 23 June 2006.

The ECL contains 230 pages of desired capabilities (or goals) for near-term 2005-

2011, mid-term 2012-2018, and far-term 2019+ time frames in the key warfighting 

functions of Joint and Multinational Enabling, Strategic Agility, Operational Reach, 

Tactical Flexibility, and Support and Sustainment. These include a substantial 

number of long-term measures that could be tracked. The Deputy Commandant, 

Programs and Resources (DC, P&R) tasked the DC, MCCDC to develop a short-list 

of measures that focus on outcomes and meaningfully reflect the purpose of the 

USMC that can be tracked. The USMC requested 2006 PART Abbreviated Reassessment will address this.

I wondered if any of you, by chance, would be prepared to elaborate on these four programs in the Department of Defense that are 

not meeting the standards as far as that Act is concerned. 

Mr. ENGLAND. Senator, if I can just try here, I can’t speak specifically about each of the four programs, but the last—what I do 

is I try to review a whole set of metrics across the Department, 

both for the Government Procedures and Results Act, then we have 

the President’s scoreboard we have and we have our own measures 

and metrics. We have a large complex department. A lot of it has 

not performed well in the past.

503

Additional Information submitted by Mr. England

OMB’s Program Assessment Rating Tool (PART) review completed in February 

2006 rated the DoD Small Business Innovation Research and Small Business Technology Transfer (SBIR/STTR) program as ‘‘results not demonstrated’’. This is one of 

four DoD programs to receive such a rating. 

The Department is taking several actions to address the issues raised by OMB’s 

PART review. First, we are tracking company commercialization records and utilizing a commercialization assessment in our proposal selction process. Our tracking 

will reduce the likelihood of funding companies that repeatedly fail to commercialize 

their technologies. Second, we are taking steps to help successful awardees transition more SBIR/STTR derived technologies. Section 9 of the Small Business Act prescribes fixed percentages of the extramural budget for research development, test 

and evaluation be expended for the SBIR/STTR programs. Therefore, the Department cannot reduce funding for SBIR/STTR. Lastly, the Department is also participating in OMB’s on-going PART assessment of the Federal government-wide SBIR/

STTR. 

The SBIR/STTR programs have long been a source of high-value technology for 

the warfighter. For example, Small Arms Protective Inserts (SAPI) plates and handheld speech translation devices, both widely in use in critical operations in Iraq, Afghanistan, and around the world, were initially developed through SBIR. The Department is committed to ensuring the SBIR/STTR programs improve and remain 

valuable sources of technology for the warfighter.

Senator ALLARD. Well, I understand all that——

Mr. ENGLAND. But my comment is, in almost every case, our 

trend lines were up. That is, we were doing better in almost all categories, and so I was encouraged, because we do track these and 

manage all the programs now——

Senator ALLARD. I think it has improved gradually, I just have 

these four programs and I think it is important. The President has 

suggested in those programs where they don’t meet these standards, he is reducing their funding by 3.6 percent, and the rest of 

the programs that have done well, he has increased them by 1 percent. You may not be able to give me the specifics on these four 

programs, but I think the committee and I would appreciate, if you 

haven’t, review them a little bit and give us a little more detail on 

these.

Response to Senator Allard’s request for information

The Administration has used the Program Assessment Rating Tool (PART) to assess 70 percent, or $309 billion, of DoD FY 2007 resources requested in the budget, 

and 5 percent, or $16 billion, are in programs rated Results Not Demonstrated 

(RND). A RND rating does not necessarily mean that a program is not performing; 

it means there is not sufficient performance information available to assess whether 

the program has achieved its goals.

Only 4 of the 32 DoD PART programs are rated RND. Those four programs are: 

(1) Communications Infrastructure 

(2) Marine Corps Expeditionary Warfare 

(3) DoD Training and Education Programs; Other Training and Education 

(4) Small Business Innovation Research/Technology Transfer

The first three programs were rated RND because they did not have programwide metrics that adequately measure program performance. To address this issue 

the Department is developing performance measures for these programs that will 

meet the PART standard. For example, the PART on the Other Training and Education program assessed three dissimilar programs; therefore, standard metrics do 

not demonstrate and assess the programs accurately. The Department is seeking to 

divide this program into three separate PARTs to allow a more focused assessment.

504

The fourth program, Small Business Innovation Research, needs to improve its allocation processes. Toward this end DoD is tightening eligibility requirements for 

programs to participate in the Small Business Innovation Research program.

Mr. ENGLAND. No, we will. We will get back to you specifically. 

I will comment, it is an excellent question on the four areas. In the 

Quadrennial Defense Review, Senator, we made a specific effort in 

the Quadrennial Defense Review to address the way that the Department is managed and the processes in the Department to make 

sure that we run everything effectively, and so we are, as a consequence of the QDR, we are putting out road maps in terms of 

how we improve the fundamental processes in the Department so 

that in all these areas of measuring and metrics, we will be able 

to show continuous improvement. 

So it is an excellent question and it is a very sensitive area to 

us to make sure that we continuously improve the way we are running the Department. And as the year progresses, I mean, I would 

be pleased to get with you or have you come meet with us and just 

discuss what we are doing in the Department to improve our business process, because frankly, there is a lot of room for improvement and we understand that.

ADDITIONAL INFORMATION SUBMITTED FROM MR. ENGLAND

The Department has made significant progress towards improving our business 

practices. I would like to highlight a few actions being taken within the DoD to 

transform our business operations:

1. First we have estasblished strong governance and senior executive involvement through the establishment of the Defense Business Systems Management 

Committee (DBSMC). 

a. I chair the committee, with the USD(AT&L) as vice-chair; 

b. Members include USD(C), USD(P&R), ASD(NII), the Servic Secretaries, 

and Directors of the major Defense Agencies. 

2. In September 2005, we established DoD business process standards and systems that are focused on improving our end-to-end integration and financial transparency. These formed the basis for the establishment and implementation of the 

Business Enterprise Architecture (BEA) and our Enterprise Transition Plan (ETP). 

3. I have established four Investment Review Boards (IRB) that collectively review every defense business system as an investment annually and review all system development or modernization programs greater than $1M prior to the obligation of funds. 

4. I have directed the establishment of a new defense agency, the Defense Business Transformation Agency (BTA0, that is charged with consolidating all OSD enterprise level effort on business transformation under a single agency. The BTA will 

become our Center of Excellence for transformational best practives and continuous 

process improvement. 

5. On March 15, 2006, we submitted to Congress our first update to the ETP 

and BEA. We have met the majority of our planned performance milestones, both 

at the DoD Enterprise level and within the Services.

Senator ALLARD. During this last break, I had an opportunity to 

go and visit a number of our defense companies. They specialize in 

satellites, getting the satellites up in the air as well as missile defense. As you know, a good deal of the satellites that we put out 

in space has to do with communications. 

Mr. ENGLAND. Yes. 

Senator ALLARD. It is vital, and I think it is vital for your efforts 

to build this jointness between the various branches of government, 

or of the armed services. The message that I left with the compaVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00510 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
505

nies is that one area that they have been notorious about is not 

sticking with their budgets and not being able to stick with the 

time lines when they bring these proposals into the Department of 

Defense. I explained to them, you know, when you don’t meet 

those—if you don’t make an attempt to stick with time lines, you 

only attempt to keep your agreements, we lose support of the Congress for these, and I am a strong supporter of the armed services 

programs. So that is kind of what I told them. I notice on here the 

defense communications infrastructure is on one of those lists, and 

so I hope that I can get a little more detail back on that. 

While I am on the satellites and our space programs, I have also 

noticed that—and I think space, by the way, is very, very important. If we don’t have our space assets operating, all branches of 

government are impacted. Now, it happens to be under the jurisdiction of the Air Force. The Air Force had combined their space programs with their strategic command and I have heard rumors that 

the current general of U.S. Space Command, who is retiring, his replacement may not be a four-star general. It may be something 

less, and I have written a letter to Secretary Rumsfeld on this. 

I think these programs are so vital that we need to make sure 

we have the best leadership and people that have the experience, 

because these are complicated, difficult, and I am hoping that 

maybe you can respond to the rumors and what we picked up that 

there may be an attempt to downgrade this position and there may 

not be as much emphasis on space communications as we would 

hope there would be. 

Admiral GIAMBASTIANI. Senator Allard, with regard to the commander of the Space Command in the Air Force, I think you have 

just been given bad information, to be frank with you. 

Senator ALLARD. All right. Very good. And my understanding, do 

they have—someone called the office and said that they thought 

they had somebody lined up that would be a four-star or working 

on somebody——

Admiral GIAMBASTIANI. Sir——

Senator ALLARD. You can’t comment on that? 

Admiral GIAMBASTIANI. I will just tell you that the process is 

working and I think you have been given bad information. 

Senator ALLARD. OK, very good. I am glad to hear that, all right. 

The other issue I wanted to bring up, there is some discussion 

among members of the Senate about a 2-year budget. What is your 

attitude about a 2-year budget in light of the fact that we are having a hard time making projections to this committee on military 

spending and we keep finding we are having to go into supplemental spending? I am one that supports the idea of a 2-year budget, but hearing the comments that are going on here from the 

Chairman and the Ranking Member on this committee, the 

thought struck me is how would the Defense Department deal with 

a 2-year budget and if it is an idea that appeals to you or not. I 

would like to hear a comment on that? 

Mr. ENGLAND. Tina, why don’t you try first. 

Ms. JONAS. Sir, an interesting point that you raise, and one thing 

we have done within the Department at the Secretary’s urging is 

to try to reduce the churn and amount of staff time we spend on 

developing budgets, and so we have gone to what we call an onVerDate 0ct 09 2002 11:48 Nov 07, 2006 Jkt 000000 PO 00000 Frm 00511 Fmt 6601 Sfmt 6601 C:\DOCS\26726.TXT SBUD1 PsN: TISH
506

year and an off-year process for current year and out-year budgeting, and that has had some—we were in an off-year this year 

within the Department and we will do an on-year next year. 

You know, we would adjust. If the Congress decided it was the 

best thing to do, I am sure the Department would adjust. I do 

agree that we spent an awful lot of staff hours in the Department 

deciding resource decisions, so anything we can do to simplify and 

streamline the process is a good thing to do. 

We will have every year, probably, some requirement to adjust 

the budget during the year of execution, and we do that in a couple 

of different ways. One way we do it is through a mid-year review, 

which you are familiar with. OMB does that, as well. And we send 

up reprogrammings if we need to make adjustments for fact of life. 

So that is one way that we deal with the year of execution. 

A second way is if we have to ask for a supplemental, and we 

have had plenty of discussion on supplementals here this morning, 

so I don’t need to belabor that. But we would have fuel, for example. In this supplemental that you will see, it is not strictly warrelated. There is some adjustment because of the price of fuel. That 

is just a fact of life adjustment we would always have to make. 

So it is an interesting idea, sir. I would obviously defer to the 

Congress as to what they think is the best for them. 

Senator ALLARD. OK. Mr. Chairman, my time has expired. I had 

one more question. I am wondering if I may pursue that. It has to 

do with National Guard. 

Chairman GREGG. Yes. 

Senator ALLARD. NATO has taken this policy where each country 

in NATO is going to specialize in a certain type of endeavor as a 

part of it. They look at the whole NATO aspect and then each unit. 

And so in National Guard and our National Reserves, I am under 

the impression that we are working at trying to get various units 

or brigades to specialize in certain areas and then take those units 

and then fully manpower them in those areas and also give them 

equipment they need, and by doing this, what we do is we avoid 

duplication and unnecessary costs as far as the National Guard 

program. Is this approach being followed in the National Guard 

and Reserves, and are we seeing cost savings as a result of that? 

Admiral GIAMBASTIANI. Senator, first, if I could just address the 

NATO side to make sure that we all have what I consider to be 

the correct information, as a former NATO commander, along with 

Jim Jones, we have a certain number of countries within NATO 

that we have what we call full-service militaries. Some of the 

smaller countries are working on very—it is not a particularly 

great term, but niche capabilities, special operations, others where 

they are particularly good at them. 

Senator ALLARD. Yes, that is what I am referring to. 

Admiral GIAMBASTIANI. Exactly, and there are a number of countries that, in fact, are specializing in those so that they can be very 

good in certain things. You take the Czechs, for example, they have 

chemical and biological outfits. The Norwegians have fighters, but 

they have special forces. They have mountain training. And we 

spent a lot of time with the centers of excellence throughout NATO. 

So the answer is yes, but there are certain militaries that are fullservice militaries within NATO. 

507

With regard to the National Guard, what I would tell you is I 

pulled out two sheets here just to let you know. Besides infantry, 

if you will, armor, these heavy brigade combat teams, light brigades, and the rest, besides the 28 brigade combat teams we are 

talking about, you have combat aviation brigades where we are 

going, theater aviation brigades, fires, battlefield surveillance brigades, combat support brigades, they are called maneuver enhancement, sustainment brigades, air defense artillery, engineer, military police, chemical, military intelligence, signal, explosive ordinance disposal, quartermaster, medical, and the rest. Obviously, 

there is a sizable number of these. 

Just to give you the breakout for use, as I said, 28 brigade combat teams in the Army National Guard. There are none in the 

Army Reserve. Inside the multi-functional support of that list I 

gave you, the Army National Guard will have 44 and the Army Reserve will have 11, for a total of 55 there. And then for what we 

call functional support brigades, they are directly functional singlesource specialties, there will be 34 in the National Guard and 47 

in the Army Reserve. 

Senator ALLARD. So there is some effort——

Admiral GIAMBASTIANI. Yes. 

Senator ALLARD [continuing]. Moving forward so we avoid this 

costly duplication that happens among the Guards. 

Admiral GIAMBASTIANI. Yes, sir, and I think you will find that 

the Army’s plan here is a sensible one as they have tried to work 

with all of the Adjutants General, as they have explained to the 

Governors, and as they have tried to bring forward that has some 

relevance to not only supporting our forces forward when we need 

to bring them up and support with combat service and service support, but frankly, also provide us homeland defense capability, provide us national disaster and contingency response. 

Senator ALLARD. So you are working with Northern Command in 

that regard, I suppose? 

Admiral GIAMBASTIANI. Yes, sir. 

Senator ALLARD. OK. Was that addressed in the Quadrennial Review? 

Admiral GIAMBASTIANI. Yes, sir. You will find a number of sections where we talk about these types of capabilities and our increase in support of homeland defense, for example, and how we 

are restructuring overseas. 

Senator ALLARD. Thank you, Mr. Chairman. 

Admiral GIAMBASTIANI. Yes, sir. 

Chairman GREGG. Senator Nelson. 

Senator NELSON. Thank you, Mr. Chairman. Mr. Chairman, I 

have three subjects that I want to touch on and I will try to make 

it brief, depending on the comments of the two gentlemen, and I 

don’t mean to leave out the lady but I want to specifically address 

my comments to the Secretary and to the Admiral. 

First of all, I want to thank you, Admiral. You, after many conversations with me and others, weighed in at an appropriate time 

with a letter from Secretary Rumsfeld, to use his words, that oil 

and gas rigs in the Eastern Gulf of Mexico, east of the military 

mission line, would be, his word, ‘‘incompatible’’ with the testing 

and training mission of the Department of Defense. That was a 

508

timely letter because as Senator Martinez and I have approached 

this, trying to look out for the interests of the Defense Department, 

given the fact that the Chairman of the Energy Committee is coming forth with a plan to drill in four million new acres in the Eastern Gulf, I want to thank you. Oh, well there is the Chairman of 

the Energy Committee right here. I didn’t see him. 

Your letter was most timely and I appreciate that as it is under 

consideration in Senator Dominici’s committee right now. So thank 

you for alerting us to that, and Senator Martinez and I have drawn 

the lines in a plan that we have offered and hopefully we will have 

some ability to discuss it and try to work it out with Senator 

Domenici. But thank you for your clear statement of it being one 

of the largest testing and training areas and how important it is 

to the defense preparedness of our nation. 

I want to mention two other items. We have, Mr. Secretary, an 

inconsistency in our policy with regard to widows and orphans. 

Widows and orphans are a cost of war, and that has been an established policy ever since Abraham Lincoln so declared it. Congress 

changed the law to automatically enroll the survivors of those lost 

while on active duty. But because of an offset against disabled and 

indemnity compensation, many of those enrollees end up receiving 

nothing from the survivors’ benefit plan. 

There are those of us who have tried to eliminate that offset, and 

in fact, in an amendment that I offered last fall, the Senate voted 

92 to six to eliminate that offset, and then when it got into conference, it was stripped out. That cost is estimated to be $9 billion 

over 10 years, and it is a cost of war to help those widows and orphans and I wish you all would take another look at that, because 

the administration has opposed the elimination of that offset. I 

don’t think that that is right and I don’t think it is fair. 

Now let me ask you, Mr. Secretary, on the third question. As you 

know, we have been going round and round on the 12 carrier minimum in the midst of a war. I just simply, the QDR has come 

down. It is in law now that we have to have 12 carriers. The QDR 

is saying that you want 11 carriers. Could you try to give some rationale why, in the middle of a war, especially with the evidence 

of China’s naval buildup, for a budgetary decision is it not pennywise and pound foolish to eliminate one of the carriers when, in 

fact, if you ever had to reverse that it takes $10 billion and over 

7 years to build a new one? Would you share with us your 

thoughts? 

Mr. ENGLAND. Senator, I will. 

The QDR examined that earlier decision by the Department of 

the Navy and also concurred that the 12th carrier was not needed. 

First, that 12th carrier is not in very good condition. In fact, today 

it has no airplanes because of years and years of being a reserve 

carrier and not having the planned maintenance, et cetera. So it 

would take years and years to bring it up to par. 

But the main reason is that if you look at our carrier fleet, our 

new carriers will sustain 1,000 sorties a day. It used to be down 

in less than a 100 if you go back in time. So today I believe we 

do like 330. We are going to go to about 630 sorties and eventually 

1,000 sorties a day off of a carrier. In addition, our airplanes, much 

longer range, much more capable. And with precision weapons, 

509

along with our airplanes, our sustainment power of particularly our 

nuclear carriers is much more than our conventional carriers. If 

you put all this together, we just have a vast amount of tactical air 

power. 

In fact, in the QDR we looked at the whole tactical air situation 

because of the Navy, Marine Corps and Air Force, because there 

is this just a terrific capability now that we have. If anything, we 

are vastly overmatched. 

When you look at all of that, we just do not need the carrier. It 

is something that may be nice to have but we do not need it. If you 

go back to the Vietnam war we had, I believe, like 30 different sorties, 30 different attacks against the Tran Quan Bridge. And it took 

30-some airplanes each time. And we did not take that bridge out 

after 1,000 attacks against the bridge until we had our first precision weapons that took the bridge out. Now all of our airplanes 

have precision weapons. We take that out in one strike. 

As a matter of fact one B–52 with precision weapons can take 

out 90 different targets. 

So it is a question of the capability has improved to the point 

that we just do not need that number of carriers anymore. And 

that was the conclusion of the military and the civilians and the 

Department of Defense as part of the Quadrennial Defense Review. 

Senator NELSON. As you know, it is no surprise to you that there 

is a difference of opinion with regard to that. But let us assume 

that at the end of the day that your position prevails and that 

there are less than 12. Maybe there is 11, maybe there is 10. In 

a few years it could well be 10 because the one that is being built 

now is being considerably delayed. So it could be that we are down 

to 10. 

But assuming that is the case. When you were Secretary of the 

Navy and in front of the Armed Services Committee on another 

policy decision, in light of Pearl Harbor, the eggs in one basket theory. Instead of all the carriers being in one port, Norfolk, you as 

well as the CNO had expressed that you ought to disperse those 

assets on the Atlantic coast of the United States. 

Would you care to offer any update on that statement that you 

had made last year? 

Mr. ENGLAND. No, my judgment is still the situation, Senator. 

That is that the Kennedy should be retired and a nuclear carrier 

should be in Florida to replace the Kennedy to get some dispersion. 

That would give us two carrier ports on the East Coast and the 

West Coast. And I believe that is still the plan of the Department 

of the Navy to do that, to have a replacement carrier in Florida, 

a nuclear carrier, which would be advantageous just in terms of 

dispersion. 

The concern there was always weapons of mass destruction. 

Even though carriers are at sea, the maintenance facilities, et 

cetera, are all still there and the crews, et cetera. So having some 

dispersion would be of value to the Department of the Navy. So I 

would say that is still a legitimate conclusion, Senator. 

Senator NELSON. Admiral, do you concur? 

Admiral GIAMBASTIANI. Sir, I have not dealt with the port location issue personally. I have discussed this in some detail with the 

Secretary or with the CNO, and I would just tell you that having 

510

dispersion of all of those assets, I can remember one Christmas, it 

is the only time I have ever seen it where we had five nuclear carriers all sitting next to one another. And that is not something we 

would like to routinely do. 

Senator NELSON. Thank you. Thank you, gentlemen. Thank you 

for your public service. 

Mr. ENGLAND. Thank you, Senator. Good to see you again, sir. 

Senator NELSON. Thank you. Thank you, Mr. Chairman. 

Chairman GREGG. Senator Domenici. 

Senator DOMENICI. Mr. Secretary, I came principally just to 

thank you for all of your hard work. It seems to me you are on double duty these days. And you still look pretty good. 

Mr. ENGLAND. Thank you. 

Senator DOMENICI. You are holding up fairly well. 

Mr. ENGLAND. For a man my age. 

Senator DOMENICI. You do not want to compare ages. That would 

probably put me in a position of outdoing you. 

I guess I am getting a little concerned, more concerned each 

year, about our failure to include the full supplemental, the full expectation of the Iraq war in the budget. I understand this year 

again you are going to use the $50 billion fiction because the rational apparently is that is what we have been doing. 

How long do you think we are going to keep on doing this? 

Mr. ENGLAND. Senator, the $50 billion, again my understanding 

is it is not an estimate. It is only a—it basically does what the Congress did the previous year, which is put the $50 billion in terms 

of along with the budget. 

Senator DOMENICI. I say it is a fiction. We just pick it out. It is 

not realistic. It is not showing us what the Defense Department is 

actually costing. We are sort of assuming that the war is a separate entity, and how much longer does that have to go on until it 

becomes part of the regular budget? We should assume that it is 

part of what we are going to pay. Another 2 years? 

Do you understand what I am talking about? 

Mr. ENGLAND. I understand Senator. We earlier had the discussion, I comment then that this is really above my pay grade. This 

is a decision by the Appropriation Committee and the leadership of 

the Congress and the OMB and the President to have the 

supplementals. And you can either put it in the budget or in a supplemental. 

Frankly, my view is you get much better numbers and much better support in the supplemental because otherwise we are today 

preparing the 2008 budget. We would literally have to ‘‘guess’’ 

ahead. There is this tyranny of the budget process. It takes a long 

time. 

So we are preparing the 2008 budget. We would have to look 

ahead literally several years and try to predict and literally guess 

those numbers, which be very, very hard to do that we could not 

support them at that time. 

So it is a decision as to which way to go. It could go either way. 

But frankly, my judgment is there is better numbers in the Congress with the supplemental but that is obviously a judgmental decision. 

511

Senator DOMENICI. Just one last question that has to do with 

whether we are meeting our quota with reference to the volunteers 

signing up for our military. We had a couple of questions in here 

that I am not going to read back on. But could the Admiral or one 

of you talk to me just for a moment? I am sure it has been asked. 

But where are we? 

I read one thing in the newspaper and then I hear something 

from the military. Could we get something official from you all? 

Mr. ENGLAND. Sure. The Admiral has the numbers but I can tell 

you. For the last 8 months we have met all of our recruiting goals 

for all of our services. Do you have the specific numbers there, Admiral? 

Admiral GIAMBASTIANI. I do. And Senator, what I would like to 

do you is what I am going to give you is that tally as of the end 

of January. We expect the official tally to come out for the month 

of February here within a couple of days. But all indications are 

that we have made goal in February also. That is what I understand. Those are draft remarks. 

But what I will tell you is the U.S. Army has made it, as the Secretary mentioned, for the last 8 months in a row. The Navy has 

made it for the last 11 months in a row. The Marine Corps for 16 

and the Air Force for 16. 

And obviously along with that we are at unprecedented retention 

rates across our services. Every one of them. In fact, all services 

are greater than 100 percent retention, which is pretty remarkable. 

And then on the National Guard side, the Army National Guard 

through the end of January has made it 4 months in a row and 

was at 109 percent in January. The Army Reserve has made it 5 

months in a row and was at 100 percent. The Marine Corps has 

made it 11 months in a row and was at 100 percent in January. 

The Air Force Reserve was at 100 percent and has made it 12 

months in a row. 

The only one that has missed in January was the Navy Reserve. 

And frankly, there are some goal adjustments that are going on inside the Navy with regard to the Reserve, I understand. 

So that is what I can give you for official totals. And we will give 

you a roll up of that here, if you would like. 

Senator DOMENICI. Would you also, for the record, tell us what 

kind of bonuses and/or changes have been made in an effort to 

meet these goals, say over the last year? 

Admiral GIAMBASTIANI. Yes, sir. We will give that to you for the 

record.

ADDITONAL INFORMATION FOR THE RECORD

Through the continued support of the Congress, we are fortunate 

to have a wide range of incentives to offer as we aggressibely compete in a challenging recruiting environment to recruit the best and 

the brightest into our ranks and retain those that we already have. 

The Department has three primary enlistment incentives-enlistment bonuses, the Montgomery GI Bill (MGIB) College Funds 

(Kickers), and a College Loan Repayment Program. The Services, 

based on their needs, offer these incentives to encourage 

512

enlistmens into critical or hard-to-fill specialities and to fill seasonal needs. 

Enlistments bonuses are cash incentives designed to induce people to enlist and serve in military occupations experiencing personnel shortages. The legislative maximum for enlistment bonuses 

is $40,000 for the Active Components and $20,000 for the Reserve 

Components (based on increases enacted in NDAA ’06). Bonuses 

are generally paid for skills that are understaffed, arduous (such 

as combat arms), and those that require a high degree of technological skills. Additionally, enlistment bonuses are used to evenflow the new recruits into the Service training bases by encouraging entry onto active duty during traditionally difficult accession 

months. 

The Montgomery GI Bill (MGIB) and College Funds are valuable 

tools in our professional recruiter kit bags. The MGIB is offered to 

most personnel who enter the Service for the first time. Service 

members may receive up to 36 months of benefits for approved programs of education or training. Those enrolled in the MGIB have 

their pay reduced by $100 per month for 12 months, or $1,200. 

This money is not refundable. 

The current monthly MGIB benefit for an individual serving at 

least 36 months on active duty and enrolling full-time in an approved program in $1034 per month for up to 36 months providing 

a potential total benefit of $37,224. This rate is reduced for less 

than full-time educational enrollment and for less than a threeyear active-duty commitment. Funding for this benefit comes from 

the Department of Veterans’ Affair budget. 

In addition to the basic MGIB benefit, the Services may offer an 

increased benefit, call a ‘‘kicker,’’ for enlistment in certain critical 

or hard-to-fill skills. This kicker plus the basic MGIB benefit are 

commonly referred to as the Service College Funds. The statutory 

limit for the kicker is $950 per month and is currently offered by 

the Army, Navy and Marine Corps. The Services contribute an actuarially determined amount to the DOD Education Benefit Fund 

for each individual accessed with a college fund. 

The Reserve Components offer the MGIB Selected Reserve (SR) 

program as well. Their program is actually a recruiting and a retention incentive since it is not limited to only personnel service in 

their first term of service. The requirement for the MGIB-SR program is for an individual commit to a six-year term of service. The 

member is then eligible to receive an educational benefit of up to 

$292 per month for 36 months. The monthly benefit is based on 

class load and the amount is adjusted annually based on the Consumer Price Index. The cuurent maximum benefit for this program 

is $10,512. The member is not required to contribute financially to 

this program. Additionally, all of the Reserve Component Services 

are authorized to offer a kicker (discretionary, based on Service 

needs/skills requited) up to $350 per month. 

The last in the major triad of incentives legislated and offered is 

the College Loan Repayment Program (LRP). The LRP allows the 

Services to repay certain Federally guaranteed educational loans 

for enlistments in military specialties designated by the Service 

Secretary. Only loans existing prior to entrance onto active duty 

are eligible. Currently, the Army, Navy and Air Force offer LRPs. 

513

The Active Army and Navy will repay loans up to $65,000, while 

the Air Force limits the LRP to $10,000. The Marine Corps does 

not use this incentive in either their active or reserve recruiting 

programs. The Reserve Components (less the US Army and Navy) 

use this program as well, however the level of repayment is less 

than that in the active programs. New recruits that enlist under 

the LRP option are ineligible for enrollment in the MGIB. 

Our retention programs are strong and successful in both in Active and Reserve compnents. Service men and women are staying 

in because they are proud of what they are doing in Iraq and Afghanistan and want to see it through. Here again, the Congress 

has better enabled us to keep the best of our Service members by 

enabling us to offer them first-rate bonuses that show them our 

high regard for their past and future service. These are discretionary programs, which like the enlistment bonuses, are used 

based on the needs of the individual Services. Both the Active Component retention bonus is $90k (increased from $60k in NDAA 06). 

The maximum allowable retention bonus for the Reserve Component is up to $15k (based on needs of the Service, length of reenlistment and number of prior reenlistment bonuses for that individual). Additionally, for critical job specialities (e.g. Special Forces) 

a Critical Skills Retention Bonus (CSRB) Program is provided 

where the Services may pay (based on needs, skills, etc) up to 

$200k (for the Active Component) and up to $100k (for the Reserve 

Component) over the career of the individual. 

In addition to the increased level of enlistment and reenlistment 

bonuses enacted in NDAA 06, this legislation also had other components, which are helping in the recruiting efforts of the Services. 

It increased the maximum age for enlistment to 42 and also authorized the Army a referral bonus program. In this program, a 

serving member of the Army will be paid $1,000 upon the successful completion of initial training for any person that he or she refers. 

The programs detailed above are vitally important to the success 

of our progessional recruiting and retention personnel across the 

Armed Forces. We are confident that with the continued support of 

the Congress on robust programs such as these, the personnel required to successfully prosecute the War on Terrorism will be 

there.

Mr. ENGLAND. I can tell you, Senator, just for the record though, 

in this budget there is close to $2 million, $1.9 billion, for bonuses 

and incentives are included in the fiscal year 2007 budget. And we 

will give you breakdown of those specifics.

ADDITIONAL INFORMATION FROM MR. ENGLAND

The Department has three primary active-duty enlistment incentive-enlistment 

bonuses, the Montgomery GI Bill (MGIB) College Funds (kickers), and a Loan Repayment Program. The Services offer these incentive to encourage enslitments into 

cvritical or hard-to-fill specialites. For Fiscal Year (FY) 2007, the Services have 

budgeted $431 million for these purposes. 

The National Defense Authorization Act (NDAA) for FY 2006 raised the limit that 

may be paid to a new recruit for an enlistment bonus from $20,000 to $40,000. The 

Army and Navy are using this increased authority to target those especially difficult 

514

skills formerly contrained by the $20,000 limit. The NDAA also authorized the Army 

to provide a $1,000 referral bonus to Soldiers who refer an applicant for enlistment. 

The Army alreadly has over 1,000 leads from referrals and sees this new program 

growing daily. 

Thanks to Congressional support, most bonus authorities for Reserve componenets 

have been increased over the past year in an effort to bolster our recruiting efforts, 

and the components are using these increased bonuses and incentives to recruit 

quality Service members. In the education benefits arena the basic MGIB allowance 

received its annual increase, now at $297/month, and the new chapter 1607 benefits 

for Reservists who were mobilized are being implemented-significantly increasing 

the education benefit allowance. In the area of recruiting incentives, Reserve component enlistment and affiliation bonuses more than doubled to $20,000 for six year 

contracts, and prior service enlistment bonuses also increased to $15,000 for six year 

contracts. Additionally, in an effort to resolve some junior grade officer shortages, 

the officer accession bonus was increased to $10,000. To help ensure that we retain 

these quality members, reenlisment bonuses have been increased to $15,000 for a 

six year commitment. Also, the critical skills retention bonus was expanded to include Reserve component members with skills that are critically short. This expanded authority allows us to pay up to $100,000 over the course of the Reservist’s 

career. These benefits, along with innovative programs, are proving to be extremely 

helpful in turning around Reserve component recruiting in a difficult environment.

Senator DOMENICI. Thank you very much. Thank you, Mr. Chairman. 

Chairman GREGG. Thank you. 

Do you have a projection for how many troops will be in Iraq 

over the next 12 months? 

Admiral GIAMBASTIANI. I guess the way I would answer that is 

that it is condition based as we continue to stand up the Iraqi security forces. And by Iraqi security forces I mean both Iraqi army and 

Iraqi police forces, since the Defense Department is now running 

the police training for the last 3 months or so. 

The numbers are about 232,000 I believe today, Iraqi security 

forces. And those numbers are going up substantially. And as they 

come up and continue to take over battle space, which has been 

happening routinely. Just a month ago the Iraqis took over about 

the size of Kentucky where they have the lead. 

Just to give you an idea, yesterday morning I was on a video 

teleconference with General Casey and General Chiarelli. This was 

the Secretary of Defense, the Chairman and myself. And we were 

getting a briefing from him. General Chiarelli has now been in theater for about 6 weeks. He had left for a year, had served as the 

Baghdad area U.S. Commander and came back. 

And when he left there were only three Iraqi security force battalions, Iraqi army battalions that actually owned battle space. 

Today the number is well over 40 and going up very rapidly. 

So from his perspective how those forces are growing is substantial. I just remind you that we also have two less brigade combat 

teams right now than we did 6 months ago. One of them is in Kuwait on what we call a prepared to deploy order if we need it, but 

it is a reserve. This is significant. And we fully expect that as the 

political situation continues to mature hopefully within Iraq, and 

as the security forces continue to build, General Chiarelli felt very, 

very pleased at the performance of the Iraqi army in particular because of their very good performance security-wise here as a result 

of the destruction of the Golden Dome up in Samarra. 

So what I am saying to you sir is it is condition-based but the 

Iraqi forces are making great progress. They have accelerated their 

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fielding. And they are performing exceptionally well based on our 

experience. But again, it is condition based. 

Chairman GREGG. That being the case, it sounds like you are 

saying you are not going to be adding more force? 

Admiral GIAMBASTIANI. I do not expect us to add forces. But of 

course when we have elections, when we have parliamentary 

things, as certain things come up we do get requests from the commanders on the ground and we will move forces, for example, from 

Kuwait into Iraq or somewhere else. 

Chairman GREGG. Assuming that we are not adding more force, 

and assuming that there is a chance we may be drawing down 

force, is it safe for us to assume that the average cost over the last 

4 years would be a number that might be a reasonable number for 

the next supplemental year, next year’s supplementals? 

Admiral GIAMBASTIANI. I cannot estimate the costs. What I am 

telling you is that from a security force standpoint, dealing with 

the numbers. 

Chairman GREGG. What I am saying is we have historical cost 

for maintaining this level of force, which hopefully we will actually 

be drawing down as we stand up force. That historical cost appears 

to be about $90 billion supplemental request. 

Is it reasonable to assume that that is what the supplemental 

will be next year? Or in that range, assuming historical factors? 

Mr. ENGLAND. Senator, I think obviously if you assume historical 

factors you come out with that number. The unknowns are a lot of 

what is in the supplemental is also the repair and replacement, the 

resetting of the force. And until we actually complete this activity, 

we do not know what that end cost is for resetting and the repair 

of the equipment. 

So there is this unknown that is always out there in terms of——

Chairman GREGG. I accept the fact that there is an unknown. 

But I also accept the fact that zero is the wrong number, which 

was the number you sent up last year. So we put $50 billion in. 

And it appears to be the wrong number. 

And so I am trying to figure out what is a number that, assuming all of these unknowns, is still a reasonable number within the 

context of the history of the costs. And it seems to me that $90 billion is probably a number that is somewhere in the ballpark. it is 

lower than last year or this year and higher than the prior years. 

Just a thought. 

In any event, we have to address it. If we do not get guidance 

from you, we still have to address it. So I am just trying to get a 

sense. 

Admiral GIAMBASTIANI. Chairman Gregg, if I could just mention 

one thing. We send over every 90 days, as required by Congress, 

a report to Congress on the stability and security in Iraq. There is 

an unclassified section which is called Measuring Security and Stability. And then there is a classified supplement that specifically 

talks about the Iraqi security forces and makes some projections. 

Deputy Secretary England has signed out that document here 

just on the 17th of February. And we sent it over. We presented 

it to all four of the Armed Services and Defense Appropriations 

Committees, in addition to the Intelligence Committees of the 

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House and the Senate. And in there it talks about some projections 

of where we see the Iraqi security forces being. 

So that happens to be only one component of it, but you will see 

that it talks about the projections that we are giving and the buildup from where we are today of 232,000 forces to a number that is 

substantially larger than that. 

Chairman GREGG. Which is obviously very good news. 

Admiral GIAMBASTIANI. Yes, sir. 

Chairman GREGG. We certainly hope that you accomplish that. 

And one presumes that leads to lower troop levels on our part. 

Admiral GIAMBASTIANI. Yes, sir. And that is what I am trying to 

pass on, sir. 

Chairman GREGG. I am trying to say that we have reached the 

high water mark. So we ought to be able to pick an average of the 

high water mark, which are the last 4 years, and be fairly close to 

where you hopefully will be next year. 

Senator Conrad. 

Senator CONRAD. I just want to associate myself with the remarks of the Chairman and the remarks of the former chairman, 

Senator Domenici. 

I think we have been engaged in a fiction on budgeting. When you talk about Congress doing the $50 billion last year, that was 

in response to the Administration saying nothing. They said you do 

not need to add any money. At least that was what was in their 

budget. 

So the frustration that you are witnessing here is there is a feeling here that we have not been quite leveled with on what the 

costs are and what they are going to be. And there is a lot of reason for us to feel that way. 

Let me just ask a final question, if I can. This is what we are spending on fighters, $11.1 billion, long-range bombers $740 million. And in that context, the proposal in the budget is to retire 20 

percent of our bomber fleet, to reduce the number of B–52s from 

93 to 56 when we are a decade away from the next generation of 

long-range strike planes being available. I just want to say to you 

it strikes some of us as unwise to reduce the bomber fleet that dramatically. 

These B–52s, as was part of your own testimony here this morning, have extraordinary capability. I think, Secretary England, you 

referenced that one B–52 can carry enough armament to take out 

90 targets. 

I found it surprises constituents when they find out we only have 

93 B–52s in the active inventory. We have one more that is at 

NASA, for a total of 94. And they are talking about going to 56, 

when we are more than 10 years away from the next generation 

of long-range bomber being available. 

So I just want to send that message, that some of us are not 

going to be supportive of that kind of dramatic drawdown of the B–

52 force without some replacement in our sights. 

With that I want to again thank the witnesses. I want to thank 

you, Secretary England. Thank you for your service to the Nation. 

I certainly want to thank the Admiral, as well. I very much appreciate it. I did not have the chance, I told you my wife is Italian. 

I did not tell you, she is one of those people that ran away from 

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home and joined the Navy and had a great career and is enormously proud of serving in the United States Navy, and also very 

proud of her Italian heritage. 

Admiral GIAMBASTIANI. I am proud of her being Navy and I am 

glad to see that I was as smart as she was. 

Senator CONRAD. And to Ms. Jonas, as well, we have high regard 

for your professionalism. 

Mr. ENGLAND. Can I take just 30 seconds on the bomber issue? 

Senator CONRAD. Certainly, absolutely. 

Mr. ENGLAND. This is an issue that I think we agreed on, in 

terms of the importance of bombers. As a matter of fact, we said 

we need to start working on the next generation bomber, which is 

in the QDR. So that was one of the efforts of the QDR. And we 

have money in the budget to do that, by the way, to actually start 

the next bomber. 

The B–52s are literally venerable old work horses and they have 

been upgraded and they do a wonderful job. But some of the B–

52s are not venerable work horses. They are worn out old work 

horses and they are really not of value to us and they are past the 

point of being useful. 

So this was really an effort to the very best——

Senator CONRAD. Can I stop you on that point? Because I do not 

think that is true. We have—Minot Air Force Base in North Dakota is home to the Attrition Reserve. Those planes, to my knowledge, have all been upgraded. All of the planes have been treated 

the same, even though some are in the Attrition Reserve. All of 

them have had been given upgrades. 

Is that not correct? 

Mr. ENGLAND. Senator, I will get back with you. My understanding though, as I recall the discussion, and the Admiral may 

recall some of this, I believe there is 18 that do not fly at all. 

Senator CONRAD. No, I will tell you, that is bad information. We 

have talked about bad information here. All of the planes are 

flown. All of the planes have been upgraded. 

That is alarming to me when you say these things that I know 

are not right. Those planes have been upgraded. Those planes fly. 

And we have been very careful to do that. This Committee has 

been very aggressive to make certain that was done. 

Mr. ENGLAND. The Admiral is about to correct me on this subject, sir. 

Admiral GIAMBASTIANI. I normally do not correct my boss——

Mr. ENGLAND. Please do. 

Admiral GIAMBASTIANI [continuing]. But in this case I will publicly help him out here. 

We understand completely what you have said. They are called 

Attrition Reserve aircraft because we do not normally have them 

in a line unit. But obviously, as you well know, we take those Attrition Reserve aircraft, we have upgraded them. We have put them 

in a line unit for a short period of time, flown them, make sure 

they are upgraded. 

The reason is that if you do not do that, you cannot have them 

ready for service if you need them. 

We have looked at the bomber force. We all, most of us within 

the Defense Department, at least for example me as the Vice 

518

Chairman and I will speak for myself, are a very strong proponent 

of the bomber force. I think I am the only Navy admiral I know 

of that has actually flown a two-and-a-half hour mission in a B–

2, for example. 

What I would tell you as that in the beginning in Afghanistan, 

we had Air Force bombers and Navy tactical aviation off of carriers. We did not really have other things flying, other then of 

course tankers and AWACS and all of those big aircraft that we 

are flying which were so important to our effort. 

But the Secretary is dead on. There is a very strong commitment 

to a follow-on bomber force. And in the next President’s budget and 

in our future year defense program that we will present after this 

year of deliberation, you will see more on this bomber force and 

where we are going. We will put lots more granularity into it. 

Senator CONRAD. I appreciate that. 

I just am concerned about the bathtub effect that is being created 

here. I think it is unwise in terms of the national security. And this 

will be something Congress will want to review. 

Admiral GIAMBASTIANI. Yes, sir. 

Chairman GREGG. Again, I want to join my colleagues in thanking you for your service. Thank you for taking the time to come up 

and testify before the Committee. It is very useful for us, obviously, 

and we appreciate all that you do. But we especially appreciate all 

that the men and women who are on the front lines in this war 

are doing. 

Mr. ENGLAND. Mr. Chairman, thank you very much. Mr. Conrad, 

thank you. It is a pleasure being with you today. Thank you very 

much, sir. 

Chairman GREGG. The hearing is adjourned. 

[Whereupon, at 11:54 a.m., the committee was adjourned.]

PREPARED STATEMENTS

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Answers to Questions submitted from Senator Ron Wyden by Mr. Gordon England

The President’s Fiscal Year 2007 Budget Proposal

Question #1

A Pentagon audit identified $263 million in unjustified charges from Kellogg, 

Brown and Root (KRB) as part of its bill for a no-bid contract to deliver fuel in Iraq. 

However, the Army recently announced that it is going to pay almost all of these 

excessive charges.

The Army says that they have to pay these disputed charges because they fall 

within the terms of the contract. When $253 million worth of questionable and unsupported charges are still technically within the bounds of a contract, it indicates 

to me that the Army isn’t reading the fine print before signing contracts.

Is the Pentagon instituting any reforms to ensure that this kind of sweetheart 

contract doesn’t happen again?

Answer

The RIO I contract was a cost plus award fee contract of the type described in 

FAR 16.405-2. Under the contract, the contractor’s costs are reimbursed and the 

contractor earns a 2% base fee and an award fee, which can range from 0 to 5%. 

The award fee is not a ‘‘performance bonus’’ but is an earned fee based on criteria 

set out in the award fee plan in the contract.

No unsupported costs were paid. The contractor either provided support for costs 

or withdrew the costs from the proposal. The contracting officer found most questioned costs, which KBRS actually had incurred in executing the mission, should be 

reimbursed. However, he excluded just over half of those costs from the amount 

used to calculate the award fees paid to KBRS; refused to reimburse some $3.8 

milion in costs; and did not pay a claim for $5.4m in interest. In addition, he excluded the entire amount of the $28.5m claim submitted on Task Order 4 from the 

amount used to calculate the base and the award fees.

The award fee determining official also considered the issues identified in the 

DCAA audits in making his fee determinations. The results was that KBRS also 

earned a lower percentage of the available pool. Award fees ranged from 4% to 68% 

of the maximum 5% award fee. All fees were awarded in accordance with the award 

fee plan set out in the contract, which placed more emphasis on timely mission accomplishment than on cost control and paperwork.

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