S. HRG. 110–162. Vol. I

CONCURRENT RESOLUTION ON THE 

BUDGET FOR FISCAL YEAR 2008

HEARINGS

BEFORE THE

COMMITTEE ON THE BUDGET 

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

January 11, 2007—THE LONG-TERM BUDGET OUTLOOK

January 18, 2007—THE LONG-TERM ECONOMIC AND BUDGET 

CHALLENGES

January 23, 2007—THE GROWING TAX GAP AND STRATEGIES FOR 

REDUCING IT

January 25, 2007—THE CBO BUDGET AND ECONOMIC OUTLOOK

January 30, 2007—DEFINING OUR LONG-TERM FISCAL CHALLENGES

January 31, 2007—EXPLORING SOLUTIONS TO OUR LONG-TERM 

FISCAL CHALLENGES

(

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CONCURRENT RESOLUTION ON THE BUDGET FOR FISCAL YEAR 2008

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34–649pdf 2007

S. HRG. 110–162, Vol. I

CONCURRENT RESOLUTION ON THE 

BUDGET FOR FISCAL YEAR 2008

HEARINGS

BEFORE THE

COMMITTEE ON THE BUDGET 

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

January 11, 2007—THE LONG-TERM BUDGET OUTLOOK

January 18, 2007—THE LONG-TERM ECONOMIC AND BUDGET 

CHALLENGES

January 23, 2007—THE GROWING TAX GAP AND STRATEGIES FOR 

REDUCING IT

January 25, 2007—THE CBO BUDGET AND ECONOMIC OUTLOOK

January 30, 2007—DEFINING OUR LONG-TERM FISCAL CHALLENGES

January 31, 2007—EXPLORING SOLUTIONS TO OUR LONG-TERM 

FISCAL CHALLENGES

(

COMMITTEE ON THE BUDGET 

KENT CONRAD, North Dakota, Chairman

PATTY MURRAY, Washington 

RON WYDEN, Oregon 

RUSSELL D. FEINGOLD, Wisconsin 

ROBERT C. BYRD, West Virginia 

BILL NELSON, Florida 

DEBBIE STABENOW, Michigan 

ROBERT MENENDEZ, New Jersey 

FRANK R. LAUTENBERG, New Jersey 

BENJAMIN L. CARDIN, Maryland 

BERNARD SANDERS, Vermont 

SHELDON WHITEHOUSE, Rhode Island 

JUDD GREGG, New Hampshire 

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, Neveda 

JOHN CORNYN, Texas 

LINDSEY O. GRAHAM, South Carolina 

MARY ANN NAYLOR, Majority Staff Director

SCOTT B. GUDES, Minority Staff Director

(II) 

iii

C O N T E N T S 

HEARINGS 

Page 

January 11, 2007—The Long-term Budget Outlook ............................................. 1

January 18, 2007—Long-term Economic and Budget Challenges ....................... 79

January 23, 2007—The Growing Tax Gap and Strategies for Reducing It ........ 131

January 25, 2007—The CBO Budget and Economic Outlook .............................. 209

January 30, 2007—Defining Our Long-term Fiscal Challenges .......................... 257

January 31, 2007—Exploring Solution to Our Long-term Fiscal Challenges ..... 337

STATEMENTS BY COMMITTEE MEMBERS 

Chairman Conrad ....................................................................... 1, 79, 131, 209, 257,337

Ranking Member Gregg............................................................ 9, 91, 138, 217, 264, 415

Senator Grassley ...................................................................................................... 69

Senator Allard .......................................................................................................... 127

WITNESSES 

Bernanke, Ben S., Hon.; Chairman, Board of Governors of the Federal Reserve System ......................................................................................................... 93, 98

Bixby, Robert L.; Executive Director, The Concord Coalition .......................... 347, 351

Brostek, Michael; Director of Tax Issues, Government Accountability Office...................................................................................................................... 150, 153

Butler, Stuart M., Dr.; Vice President for Domestic and Economic Policy 

Studies, The Heritage Foundation .................................................................. 401, 404

Furman, Jason, Dr.; Director, The Hamilton Project at the The Brookings 

Institute............................................................................................................. 388, 392

Greenstein, Robert; Founder and Executive Director, Center on Budgt and 

Policy Priorities................................................................................................. 266, 271

McIntyre, Robert S.; Director, Citizens for Tax Justice.................................... 140, 143

Minarik, Joseph J., Dr.; Sr. Vice President and Director of Research, Committee for Economic Development................................................................... 377, 381

Orszag, Peter R., Dr.; Director, Congressional Budget Office .......................... 218, 222

Reischauer, Robert D., Dr.; President Urban Institute .................................... 284, 287

Satagaj, John; Sm. Business Legislative Counsel, Small Business Tax 

Comliance & Fairness Coalition...................................................................... 177, 180

Steuerle, Eugene, Dr.; Senior Fellow, Urban Institute..................................... 296, 299

Walker, David M., Hon.; Comptroller General of the United State..................... 12, 23

QUESTIONS AND ANSWERS

Questions and Answers................................................................. 72, 128, 206, 253, 433

ADDITIONAL MATERIALS AND CHARTS SUBMITTED 

Testimony, charts, and graphics submitted .......................................................... 64

(1)

HEARING ON: LONG-TERM BUDGET OUTLOOK 

THURSDAY, JANUARY 11, 2007

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

The committee met, pursuant to notice, at 10:34 a.m., in room 

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

Present: Senators Gregg, Domenici, Grassley, Allard, Graham, 

Conrad, Murray, Cardin, Sanders, and Whitehouse. 

Staff present: Scott Gudes, Majority Staff Director and Mary 

Naylor, Staff Director for the Minority. 

Chairman GREGG. Let me call this hearing to order, which is—

I am sure some people are saying, what is he doing that for, he is 

not in charge any more? They are saying, what is he doing that 

for? 

Due to the vagaries of the Senate’s arcane rules, I technically am 

still chairman, I guess. But that is obviously a technical point. I 

look forward to working with Chairman Conrad. We have had a 

very good, strong relationship. I very much appreciate his and his 

staff’s extraordinarily cooperative and positive approach during my 

tenure as chairman. I intend, and our staff intends, to take the 

exact same approach and really use his example as our template 

as to how we will proceed. 

So at this time I will yield to Senator Conrad as chairman and 

relinquish my chairmanship, even if it is only technical. 

OPENING STATEMENT OF SENATOR KENT CONRAD 

Senator CONRAD [presiding]. I thank my colleague. I thank Senator Gregg very much for the way he has conducted this committee. 

Senator Gregg has been an exemplary chairman. He has conducted 

this committee professionally and with good humor and with fairness. He gives us all a good example of how committees should be 

chaired in the U.S. Senate. 

He has also graced this committee with outstanding staff. We 

have had just a very good, very positive working relationship on 

this committee and we intend to continue it. 

Senator Gregg and I have had lengthy discussions about the 

enormous fiscal challenges facing the country and our desire that 

we enter into a process to be able to address those issues and to 

do it this year. Obviously, whether or not that goes forward is at 

a higher pay grade than ours. It involves the President of the 

United States. It involves the leadership of both the House and the 

Senate. But I think it is fair to say that we are prepared to work 

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in good faith to try to find solutions to these vexing long-term 

issues that, I believe, fundamentally threaten the long-term economic security of the country if they are not addressed. 

Senator Gregg has repeatedly demonstrated that he is serious 

about this. So I very much look forward to the opportunity to work 

with him and others of our colleagues to try to address these 

issues. 

I also want to take this moment to thank and welcome the new 

members of this committee. I see Senator Whitehouse is here. We 

are delighted to have you. 

Sheldon, let me just say to you that when I started on this committee that is where I was. 

Chairman GREGG. No, you were behind the screen. 

Senator CONRAD. I was behind the screen. 

I also want to welcome Senator Ben Cardin of Maryland, who 

served on the Ways and Means Committee and is deeply knowledgeable. We are delighted to have him as a member. Senator 

Sanders of Vermont as well. 

I also should indicate that Senator Lautenberg, the former distinguished ranking member of this committee, has agreed to temporarily serve in Senator Johnson’s spot pending Senator Johnson’s 

recovery. 

Let me say that all of our colleagues are hoping and praying for 

Senator Johnson’s full and swift recovery. We have been delighted 

by the reports of recent days of Senator Johnson’s progress and we 

eagerly await his return. But we so thank Senator Lautenberg for 

his willingness, as a former ranking member of this committee, to 

come back to temporarily serve in Senator Johnson’s slot. 

With that, I want to commend you, Mr. Walker. You are the 

head of the General Accounting Office. You could sit in your office 

and issue reports and nobody could fault you for that. But really 

these circumstances demand more and you are giving more. I want 

to publicly thank you. We do not have to agree on every single 

thing, every statement you have made. I have had a number of 

members of the press closely quizzing me in the last 24 hours, do 

I agree with this Walker statement, that Walker statement. That 

is not the point. I agree with the overall message that you are attempting to deliver to the Nation they we are on an unsustainable 

course and it has simply got to be changed. 

Before I go further I want to again thank Senator Gregg for his 

assistance in organizing this hearing, because we could not have 

proceeded without him as he is still chairman of this committee in 

a formal sense. Again, I deeply appreciate the way he has cooperated so we could have this hearing. 

Since 2001, the Nation has undergone a dramatic budget deterioration. We all know the pattern; record deficits. But more importantly, the debt is going up more rapidly than the size of the deficits. This is a point that I think is too often lost. Last year the deficit was $248 billion, but the debt increased by $546 billion. I think 

this is a point that has too often been lost.

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We are facing a wall of debt. At the end of 2001 the gross debt 

of the country was $5.82 trillion. At the end of 2006 that had 

mushroomed to $8.5 trillion. And if we continue on the President’s 

course we will have the debt soar to $11.6 trillion by 2011.


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The result is that increasingly we are borrowing these very large 

amounts of money from abroad. Fifty-two percent of our debt now 

is financed abroad. We have doubled foreign holdings of U.S. debt 

in just the last 5 years. We owe enormous sums of money to Japan, 

to China, to the United Kingdom.


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This increase in debt is happening at the worst possible time, 

right on the brink of the retirement of the baby boom generation, 

a point that you, General Walker, have made repeatedly, that right 

now is in many ways the budget sweet spot. We have coming at 

us something we have not seen before and perhaps it is one reason 

our colleagues have a difficult time adjusting to it. It is this demographic tsunami of the baby boom generation and it is going to 

change everything, and that is not a projection. These people have 

been born. They are alive today. They are going to retire and they 

are going to be eligible for Social Security and Medicare, and we 

have to get ready.


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The number of Social Security beneficiaries is projected to climb 

to 82 million people by 2050. But we need to remember that Social 

Security is not the biggest budget challenge. Because of rising 

health care costs over the next 75 years, the shortfall in Medicare 

is seven times the projected shortfall in Social Security. And by the 

way, I believe it is far more likely to come true, that is the shortfall 

in Medicare, than the shortfall in Social Security.


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The growing cost of Medicare and Medicaid is simply staggering. 

By 2050, if nothing changes, more than 20 percent of our gross domestic product will be spent on Medicare and Medicaid alone. That 

is about what all of Government costs us now.


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We do not just have an entitlement spending problem. We also 

have, I believe, a revenue problem. If all of the President’s tax cuts 

are made permanent, the cost will explode at the very time the 

cash surpluses in Social Security and Medicare become deficits. In 

other words, the President’s tax cuts will dramatically worsen an 

already deteriorating budget picture. 

Now the good news is these problems are not insurmountable. 

The fact is, we could make a meaningful difference in these longterm projections if we took action here in the Congress and the 

President agreed. 

I believe it is going to take a bipartisan effort. I believe neither 

party can do this acting alone. I think we have to work together 

and act together. It can and must be done, and the American people deserve nothing less. 

The CHAIRMAN.

OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

Chairman GREGG. Mr. Chairman. I thank you, Mr. Chairman, 

and I look forward to working with you, and I want to echo your 

words relative to cooperation and very much appreciate the professional and constructive way that you worked with us over the 

years, and we look forward to doing the same. Also I appreciate 

your starting your tenure with this hearing because it highlights 

the issue. 

I want to thank the Comptroller General for being with us. He 

has basically been the person who has sounded the alarm most efVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00015 Fmt 6633 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH

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fectively and whose numbers most of us have been using aggressively to carry the message which you have delivered to us. I appreciate your being here today to deliver it again. 

To pick up where the chairman left off, this chart, I believe, summarizes the problem in the most concise way.

They are numbers which were referred to by the chairman. Essentially by about the year 2025—three programs, three entitlement programs, Social Security, Medicare and Medicaid, will absorb the historical amount of spending which the Federal Government has done as a percentage of gross domestic product which is 

20 percent. In other words, those three programs will cost as much 

as the Federal Government has historically cost the American people. 

So it would mean at that point that you would either have to 

give up doing everything else the Federal Government does, such 

as national defense, which is the first priority of a Federal Government, or education or environmental protection. Or alternatively 

you would have to dramatically start to expand the taxes, because 

this share consumed by Social Security, Medicare, and Medicaid 

does not level off at 20 percent, which is the historical norm for all 

Federal spending. It actually continues to go up. I think the number was cited by the chairman of 27 percent by 2032 of gross domestic product being absorbed. That, as you can see from that 

chart there, it just keeps going up. 

So you have unchecked entitlement spending in the Federal Government as we head out into the next two decades. You can see 

that it is simply staggering. It is not sustainable. The point has 

been made that this is not an arbitrary number. This is not one 

of those projections which is suddenly thrown on the table by lookVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00016 Fmt 6633 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH

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ing at tea leaves. The problem exists because the generation that 

is going to cost us this problem has already been born and is about 

to retire. We will double the size of the retired generation, the largest retirement generation in history, 80 million people will be retired versus about 35 million today. The level of effort required to 

support that generation will simply stagger those Americans who 

are working during this period, and that will be our children and 

our grandchildren. 

The way I have tried to describe it is that we need to pass on 

a government to our children that is affordable for them and still 

delivers the quality of services that a retired generation needs. And 

that means you have to balance this exercise between spending on 

benefits and revenues. 

But you cannot anticipate, you cannot put the whole burden of 

this exercise on the next generation through raising revenues because you would simply wipe out our children’s capacity to have 

the quality of life we had. We would have to raise their taxes so 

high that they would be unable to send their kids to college, buy 

their homes, and live a good lifestyle. So it has to be a balanced 

approach. 

If you were trying to tax your way out of this problem, the tax 

burden would have would to rise to a level that essentially gives 

us the same tax burden that some of our neighbors in Europe have, 

which has led to, in my opinion, the diminution of their lifestyle, 

their productivity, and their ability to compete with us. So it is 

simply not an affordable event under the present fact pattern. 

Now where the chairman and I depart paths here is how the 

President’s tax cuts affect this exercise. If you look at revenues 

which we have received under the President’s tax cut, we are today 

receiving more than the historical amount of revenues collected by 

the Federal Government. This year we are receiving about 18.5 

percent of gross domestic product in revenues. Historically, the 

Federal Government has collected about 18.2 percent of gross domestic product in annual tax revenue. So actually the President’s 

tax cuts are generating revenues that are equal to, essentially, our 

historical norm. 

In fact, we now have a tax law that is even more progressive 

than the historical tax law. Today, 85 percent of revenues come 

from the top 20 percent of taxpayers. Under the Clinton years, 82 

percent of tax revenues came from the top 20 percent of taxpayers. 

The bottom 40 percent of taxpayers are getting back about twice 

today as they used to get back. They do not pay taxes. They are 

getting about twice as much because of the earned income tax credit as they did under the Clinton years. 

So we have a more progressive law. We have a tax law which is 

generating more revenue than the historical norm. And if we were 

to repeal this tax law, in my opinion, that would be counterproductive. But if you repeal this tax law, you would see that the 

revenues would go well above 18.2 percent which is the historical 

norm. They would end up in the 23, 24, 25 percent range. 

We have never had that type of a tax burden put on the American people by the Federal Government. It would stifle productivity, creativity, entrepreneurship and the creation of jobs, and I 

am not sure that is the way we want to go to solve this problem. 

12

In fact it would not solve the problem because the entitlement 

growth would still be so staggering that you could not catch it up 

with tax revenues. 

So the issue is huge, and it has to be approached in a balanced 

way which is that you are going to have to look at the benefit side, 

you are going to have to look at the revenue side, and you are 

going to have to face up to the reality that our generation has no 

right to pass on to our children this problem. 

We are the Governors now. We are in charge of this nation. The 

baby boom generation is responsible for the leadership of this nation. If we pass on this issue, we will have done a total disservice 

to our children by having passed to them a problem which was our 

creation and our generation’s responsibility to resolve. 

So I very much appreciate the Comptroller General being here 

because most of these numbers are based off of his numbers. We 

look forward to his characterizing the problem for us again. And 

then I look forward to working with the chairman to try to come 

up with some process for actually addressing the problem. 

Thank you, Mr. Chairman. 

Senator CONRAD. Thank you, Chairman Gregg. 

Again I want to thank the Comptroller General for coming back 

from Ohio early. He was there on the Fiscal Wake-Up Tour. I do 

not know if that is what it is called but I think that is what it is 

intended to do. We very much appreciate your coming back early 

so that you could be our first witness before this committee. 

Welcome, General Walker. 

STATEMENT OF DAVID M. WALKER, COMPTROLLER GENERAL 

OF THE UNITED STATES 

General WALKER. Thank you, Chairman Conrad, Chairman 

Gregg, other members of the Senate Budget Committee. Let me 

apologize in advance for my voice. I do not feel as bad as a sound, 

thank God, but I do have a challenge with my voice. 

As you pointed out, I have just come back this morning from 

what was the sixteenth Fiscal Wake-Up Tour outside Washington, 

DC, which was held in Columbus, Ohio. We had probably 300 to 

500 citizens there last night. We had members of the Concord Coalition, fellows from the Brookings Institution and the Heritage 

Foundation, former Senator John Glenn, OMB director Rob 

Portman and myself. 

Many of the numbers that I will use today were in graphics I 

used last evening. And let me say that the American people are 

smart enough to get this. If you state the facts, if you speak the 

truth, if you help them understand where we have been, where we 

are, and where we are headed, what the consequences are to our 

country, our children and our grandchildren, they will enable people to act without losing their jobs. 

In fact, what the Fiscal Wake-Up Tour is all about is to try to 

help till the ground and prepare the way for elected officials, who 

will ultimately have to make the tough choices, to be able to do so 

without losing their jobs. 

I am going to lay out a picture this morning that is not a pretty 

one. It is also getting worse with the passage of time. It is fair to 

say that we have made some progress on our short range deficits 

13

in the last few years. And that is good. It is better to have smaller 

deficits than bigger deficits. But our financial condition is worse 

than advertised. We are on an imprudent and unsustainable longterm fiscal path. While the short-term deficits have improved in recent years, the long term is getting worse every second, of every 

minute, of every day, and the time for action is now. 

If I can, let me show you a few graphics. I understand that each 

of you have your own copies of these available if you have difficulty 

in seeing the screen.

This represents our historical Federal deficits as a percentage of 

the economy. So inflation is taken out. The red represents the onbudget deficit, excluding the Social Security surplus primarily. The 

blue represents the off-budget surplus, primarily Social Security. 

The black line represents the unified deficit; the combination of the 

two. 

You will see that ran larger deficits as a percentage of the economy in the 1980’s. But we got something for it. We bankrupted the 

Soviet Union. We won the cold war. And we declared a peace dividend. 

Then in the early 1990’s the Congress got serious, imposed a 

number of budgetary constraints. We had strong economic growth. 

A variety of things came together and we went from significant 

deficits to surpluses. We even went to on-budget surpluses. We actually started paying down the debt. People were actually concerned that we may pay off all the Federal debt. Oh my God, would 


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that be terrible. Obviously, I am being facetious here. People actually were concerned about thought that that was going to be a 

problem. Needless to say, that problem did not come to pass. 

We took a big turn in the wrong direction, but as I said before, 

things have not better in the short term over the last several years. 

But do not focus on this because this is not the problem. 

By the way, there are plenty of people out there that say, do not 

worry about the deficits. We have had larger deficits as a percentage of the economy. That is like flying a plane or driving a car looking in the rearview mirror. What is important is not where we 

have been. What is important is where we are heading. And by setting goals to say we want to achieve a certain level in 5 years, 

while it is good to make progress, that is not adequate. It is like 

heading to the Grand Canyon at 100 miles an hour and your goal 

is to slow the car to 50 by the time you get to the edge. Quite 

frankly, that is not going to get the job done. So our problem is the 

long term.

Part of the problem is we have three numbers for the Federal 

deficit, which in and of itself confuses people. These are not three 

sets of books, but there are three different numbers for the deficit. 

And unfortunately, the press tends to only focus on the smallest 

one. Last year we ran a unified budget deficit of $248 billion. As 

you know, you have to draw nine zeros to the right of the 248. You 

do not really appreciate it till you write it out. 


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But we spent every dime of the Social Security surplus, as we 

have in most years. So the on-budget deficit was $434 billion. We 

have not been in a recession since November of 2001. We had 

among the highest GDP growth rates of any country on earth last 

year and yet we are running deficits of that size. Most of that deficit did not have anything to do with Iraq and Afghanistan, although they currently do not help. And we had a net operating cost 

on an accrual basis for financial reporting of $450 billion. 

All of these were down from the prior year but they are still imprudently high.

Here is the real problem. As has been shown, whether you go 

baseline extended or whether you assume that discretionary spending grows with the economy and all tax cuts are extended, the 

math just does not work. You have already seen this graph. I am 

going to move on the next one because it is clear.


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In January of 2001 I testified before the Senate and this was our 

long-range fiscal simulation in January of 2001. We had fiscal sustainability for 40-plus years in January of 2001. Now this simulation was based upon assumptions, as all simulations are. Some 

proved valid, some did not. But let me show you where you are 

today on two scenarios.


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No. 1, this is CBO baseline extended, which assumes that all of 

the tax cuts expire, which assumes that discretionary spending 

grows by the rate of inflation for the next 10 years. You can see, 

even on that basis, we have a long-range problem because if the 

bar is above the line that is a deficit. 

Let me show you the next one.


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This one assumes that all tax cuts are extended, something is 

done about the AMT, and that discretionary spending, which includes national defense, homeland security, judicial system, education, transportation, environment, grows by the rate of the economy. 

Under this scenario the fiscal simulation blows up in the 2040’s. 

So we have gone from fiscal sustainability for 40-plus years to the 

model blowing up in 40-plus years.


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As has been shown, this is primarily but not exclusively, due to 

the explosive growth in Medicare, Medicaid, and Social Security. It 

is not the only problem. But entitlements are clearly the biggest 

problem.


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Now these are in trillions, tens of trillions. So you would have 

to write 12 zeros to the right of these numbers if they were rounded to the tens of trillions. 

In 2000, the United States had major reported liabilities social 

insurance commitments, and unfunded promises in current dollar 

terms for Social Security, Medicare and other major items totaled 

about $20 trillion. Last year that total had risen to $50 trillion—

in 6 years, a 147 percent increase primarily due to Medicare. 

Medicare prescription drugs did not exist in 2000. It is about an 

$8 trillion obligation. Medicare prescription drugs alone added 

more unfunded commitments to the U.S. Government than all of 

Social Security. Medicare was already underfunded $15 trillion to 

$20 trillion when the Medicare prescription drug bill was passed. 

We cannot afford the doughnut, much less to fill the doughnut hole 

with jelly.


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This figure shows the Social Security surplus. The budget will 

start to suffer withdrawal pains in 2009 because starting in 2009 

the Social Security surplus will start to decline. In 2017 the Social 

Security surplus will be gone and therefore we will have to redeem 

these bonds. That means raise taxes, cut other spending, or borrow 

more from foreign players. 

By the way, before I summarize, if you take that $50 trillion 

number, let me benchmark that for you because frankly it is too 

big for anybody to relate to. Fifty trillion dollars is 95 percent of 

the total net worth of every American, up from 91 percent last 

year. Fifty trillion dollars is $440,000 per American household. 

The median household income in America is less than $47,000. 

That is like having an implicit debt or mortgage equal to over nine 

times your annual income. And like a mortgage, it will be paid out 

over a number of years. But unlike a mortgage, there is no house 

to back this debt. It is only your citizenship and your ability to 

earn and the opportunity that one is given by being a citizen of the 

United States to reach one’s full potential. 

In summary, our financial condition is worse than advertised. We 

are on an imprudent and unsustainable long-term fiscal path. We 

cannot grow our way out of this problem. Anyone who says we can 

grow our way out of this problem has not studied economic history 

and probably is not very proficient at math. The numbers do not 

come close to working under reasonable assumptions. 

Yes, we want to maximize economic growth. Yes, we want to 

minimize tax burdens. But in the final analysis you have to have 

enough revenue to pay your current bills and deliver on your promises for the future. 


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We need to enhance truth and transparency in our financial reporting and budgeting processes. We need to reimpose meaningful 

budget controls on both sides of the ledger and impose those controls not just on discretionary spending but also impose mandatory 

reconsideration triggers for mandatory spending both that done directly and that done indirectly through tax preferences. We need 

to reengineer and reprioritize the base of the Federal Government 

because it is based on the 1940’s through the 1970’s and most of 

Government is not necessarily generating positive results that can 

be identified. 

We have to reform entitlement programs. We have to reengineer 

and constrain spending. And we have to engage in comprehensive 

tax reform that hopefully will generate more revenues in an economically efficient manner. 

We are going to have to do all three because the numbers do not 

come close to working if you just focus on one or two of the three. 

And the longer you wait, the bigger the gap you are going to have 

to close. And the longer you wait, the less transition time you have. 

And the longer you wait, the more people who are vested in the 

status quo. 

So the time to act is now, not just for the country but also for 

our kids and our grandkids. 

Thank you. 

[The prepared statement of Mr. Walker follows:]

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Senator CONRAD. General Walker, thank you for that really outstanding testimony. This is precisely why we wanted to have you 

as the first witness before this committee, to lay out clearly and 

concisely and in a compelling way the seriousness of the challenge 

confronting us. 

Let me go back to a couple of the statements you made. Yesterday or perhaps the day before I read in one of the major newsVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00049 Fmt 6633 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH

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papers, the Washington Post, they had a little sidebar story in 

which they said, the deficit is only 1.8 percent of GDP and economists say that that is sustainable indefinitely. True or not true? 

Misleading or not misleading? How would you characterize that? If 

you were to write the story trying to advise people of our fiscal condition, how would you characterize it? 

General WALKER. It is accurate but misleading. We probably can 

sustain a deficit of less than 2 percent of GDP for a number of 

years. But that is not where we are headed. Where we are headed 

is to deficits of multiple times 2 percent of GDP. As both of you 

have noted, Chairman Conrad and Chairman Gregg, we are headed 

to the point where Social Security, Medicare, and Medicaid alone 

will consume all of the historical Federal revenues as a percentage 

of the economy. 

And that does not count interest on the Federal debt. The fastest-growing cost in the Federal budget today is interest on the Federal debt. It went up from 7 percent of the budget in 2005 to 9 percent in 2009. And we have relatively modest interest rates. 

When, not if, foreign investors decide, as a matter of mere prudence and diversification, that they are not going to continue buying as much U.S. debt, then interest rates will rise and that will 

start a compounding effect. So what is important is that we act so 

to mitigate the impact and to help avoid their seeking to hold less 

of our debt. We can. We must. I think we will, hopefully, with bipartisan leadership. 

Senator CONRAD. General Walker, you have outlined here what 

the risk is to the economy, that increasingly we are financing this 

debt abroad. Fifty-two percent is the latest figure I have, 52 percent of our debt is now financed abroad. We have doubled the 

amount of our borrowing from foreign countries in the last 5 

years—doubled. We borrowed 65 percent of all of the money that 

was borrowed by countries in the world last year. 

So to me it is clearly an unsustainable course now. And that is 

before the baby boomers retire. How much more serious does it become as the baby boomers become eligible for these programs? 

General WALKER. It becomes clearly unsustainable. Basically 

what is going on right now is we have a national credit card. But 

unlike most credit cards it does not have a credit limit. And so we 

are continuing to charge our national credit card, compounding interest. But we are expecting our kids and our grandkids to pay it 

off. 

We have four deficits today that relate to your point: (1) a budget 

deficit which we have talked about, (2) a balance of payments deficit of which the trade deficit is a subset, (3) a savings deficit. In 

2005 for the first time since 1933, which was not a good year for 

America, Americans spent more money than they took home last 

year. 

And (4) the worst deficit of all is the leadership deficit. That is 

what we have to address on a bipartisan basis because Social Security, Medicare, and Medicaid represent a tsunami of spending. And, 

unlike most tsunamis, this one never recedes. It is a permanent 

change in the landscape. 

What is going on now is as if we are on the beach and we are 

saying, let us just focus on the short-term. We are making progress 

45

on the short-term, but right on the horizon we can see this tsunami 

building. We need to recognize reality and start to act to deal with 

that. 

Senator CONRAD. Final question from me. General Walker, Senator Gregg and I and others have been talking about a structure 

that would be a bipartisan effort to devise a plan to address our 

long-term fiscal imbalances, including but not limited to Medicare 

and Social Security, also looking at the structural deficit, and ask 

the group—Republicans and Democrats equally divided—to come 

back with a plan that would require a super-majority vote here to 

pass. 

Would you endorse such an effort? Do you think it is important 

that we make that attempt in this year? 

General WALKER. I think it is important to figure out mechanisms that will allow the Congress to be able to deal with this 

issue sooner rather than later. Realistically those mechanisms 

must involve the both executive and the legislative branches. They 

must be bipartisan in nature. At least the recommended package, 

I would respectfully suggest, should be subjected to a super-majority vote of the members who comprise this group. 

Senator CONRAD. And it would. 

General WALKER. Whether or not you should require a super-majority vote once it gets to the Congress is a different issue. I think 

you clearly need a super-majority vote on something that comes to 

the Congress but I think it is a different issue as to whether or not 

you should require a super-majority vote once it gets to the Congress. Obviously you have to be concerned to make sure that the 

President is not going to veto the package because then you would 

have to have a super-majority vote. All the more reason why you 

have to have the President engaged in this. Expedited consideration I think would clearly be a desirable feature; no doubt about 

that. 

So without knowing the details, I think that to the extent that 

you could put together something without a commission, that is desirable. But we have to figure out how to get it done and how to 

get it done sooner rather than later in a bipartisan manner. 

Senator CONRAD. I thank you for that and I want to make clear 

that it would require a super-majority of the group that would be 

given the responsibility to come up with a plan. It would involve 

the White House. The President would have members of this working group. 

The reason for both a super-majority from the group and a supermajority when you come back is if it is on an expedited basis and 

you are restricting members’ right to amend, which is the most 

fundamental right of a Senator, people are not going to give up 

that without the assurance that there is going to be a tough hurdle 

here to pass. That is the reality that we confront here. 

I just think what you say is absolutely the case. The sooner we 

get at this the better. Those things we cannot agree on will have 

to wait. 

Senator Gregg. 

General WALKER. Senator, if I may just add something quickly, 

sir. I understand what you are saying about why you are proposing 

a super-majority vote of this body and the other body. Obviously, 

46

one of the possible tradeoffs for your consideration is limited 

amendments and not requiring a super-majority vote. That is 

something I would respectfully suggest you may want to think 

about. 

The other thing is the scope. Does it include all of the elements 

that I talked about? I think it is important that it include all of 

the elements that I talked about: more transparency in financial 

reporting and the budget process, strong budget controls on both 

sides of the ledger, discretionary and mandatory spending including entitlements, and tax preferences. I think it is really important 

that all of these items be on the table in order to be able to get 

to the point where we can really do something meaningful and 

where you can achieve the vote requirement. 

Senator CONRAD. Thank you. Senator Gregg. 

Senator DOMENICI. Senator Gregg, I wonder if you would yield 30 

seconds so I can ask the chairman a question. 

Chairman GREGG. I am sure the chairman will allow it at this 

time. 

Senator DOMENICI. I just wondered, so the whole public will 

know, you keep using and we all keep using the word it. We have 

to do it. What is it? 

Senator CONRAD. It is to address these long-term entitlement 

challenges, these long-term fiscal imbalances, but not limited to 

Medicare and Social Security, but including the imbalances between projected revenue and expenditures so that we are getting 

at not only the long-term entitlements but the structural deficits 

that we have going into this process as well, with everything on the 

table. 

Senator DOMENICI. Senator, I just want to try one more time because I think if it was as easy as you say we would just do it. The 

problem is when you put this budget together or this instrument 

that solved the problem of the world toward America, what are we 

going to have to do to Social Security? What are we going to have 

to do to Medicare? We are talking about fixing it. When we look 

at there at Americans we say we are not going to be able to afford 

Medicare in its current form. So what is going to happen? Generally, what do we have to do? 

Senator CONRAD. I would just say to the Senator, we cannot give 

the results of the exercise before we have started the exercise. We 

cannot give an answer to what the solutions are until we devise a 

process to have a proposal brought back before the Congress. 

So I do not think you can say what the conclusions are until we 

begin and engage in the process. And do it together and do it in 

a very serious way. 

Chairman GREGG. Just to followup on that, I think the issue here 

is to set up a procedure that drives policy. But the key to the procedure is that it be unquestionably bipartisan, that nobody feels they 

are being gamed, that the American people feel that when the procedure is concluded and the policy is proposed that it has been 

reached in a way that is totally fair. That means you have to have 

the presidency in the room and you have to have the Congress in 

the room. 

The situation that we have now is that we have a divided government where that type of fairness is inherent in the process if 

47

everybody’s in the room and the structure is such that you have 

super majorities for reporting and for passage. 

So I think the opportunity is here and let us hope somebody 

takes advantage of it. 

Senator DOMENICI. Thank you. 

Chairman GREGG. If I could pursue some of the thoughts you 

had, Mr. General, to get a little bit into the weeds here, historically 

we have had 18.2 percent of gross domestic product in tax revenue. 

For the last few years we have had 20 percent in spending. If we 

are on this path of entitlement spending, we are looking at 28, 29, 

30 percent spending, which is not sustainable. We all know that. 

The question becomes at some point—we are going to have to 

make a decision where these lines should appropriately cross. In 

other words, the only way you are going to solve the out year imbalance of liability and revenue is to pick a number which is sustainable and which maintains a strong economy for expenditures 

and revenues that is the same. I mean, that is just the way it is. 

So I guess my question to you is do have an idea, do you have 

a thought of what is a number where those lines cross that the 

economy maintains its strength, that you do not undermine the 

economy by having too large a government to support? 

General WALKER. I understand. 

Chairman GREGG. Looking in the historical terms of somewhere, 

I presume, between 18.2 percent and—

General WALKER. Let me try to provide you meaningful information here. 

First, I believe that the imbalance is requires you to address all 

three issues that I mentioned. You are going to have to get most 

of the money through entitlement reform. That has to be No. 1. 

Second, you can and should get money from spending restructuring and constraint outside of entitlement reform. 

And third, you are going to have to get more revenues hopefully 

through fundamental tax reform which, among other things, would 

broaden the base, try to keep rates as low as possible. 

My personal view is you are going to need additional revenues; 

18.2 percent of GDP will not get the job done even if you end up 

restructing entitlementa and constrain spending . The gap is just 

too great. It is going to have to be more than 18.2 percent. 

I believe that you need to try to keep it as low as you can for 

three reasons. No. 1, to maximize economic growth. No. 2, to maximize disposable income. And No. 3, to maximize our competitive 

advantage compared to Europe. 

Europe’s tax levels are about 10 plus percent higher than ours 

when you compare Federal, State and local. They have much higher unemployment rates. They have slower growth rates and much 

higher employment rates. We need to learn from that. 

Now, where will we end up? Is it 20 percent of GDP? Is it 22 percent of GDP? What the exact number is I cannot tell you. But it 

is more than 18.2 percent and it is below 25 percent. 

Chairman GREGG. What I most appreciate is the lead in to it 

where you outline the issues, the spending restraint and the benefit reform and some sort of revenue reform. 

When you are talking revenue reform, there has been proposals 

out there that we should maybe have a dedicated stream of revVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00053 Fmt 6633 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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enue from a consumption tax. Have you ever thought of that? And 

what is your reaction to that? 

General WALKER. There is absolutely, positively no question you 

are going to need more revenues for health care. If there is one 

thing that can bankrupt America, it is health care. 

Frankly, you could reform Social Security and exceed the expectations of every generation of Americans without additional revenue. You may have to have additional revenue to get a political 

deal, but you do not need it to make it work. You are going to need 

it for health care. 

In health care, candidly, I think there are four things we are ultimately going to have to shoot for in health care and it is going 

to take us probably 10 to 20 years to get to where we need to be 

in installments. 

We are going to have to limit the percentage of the Federal budget that is dedicated to health care. If you do not do that, that is 

the ultimate put option on our children and grandchildren. Every 

other industrialized nation does that in some way. We ration 

health care today, we just do not ration it rationally. 

Second, we need to try to move toward providing basic and essential health care coverage for everybody. Basic and essential. Inoculations against infectious diseases, wellness services, protection 

against financial ruin due to unexpected catastrophic illness where 

you are not using heroic measures, and ability to purchase more insurance if you want. Right now we spend 50 percent more of our 

economy on health care than any country on earth. We have the 

largest uninsured population. 

By the way, the third element is quality. We need to achieve 

above average health care outcomes. Today, we are below average 

for an industrialized nation on health care outcomes. We have 

lower average life expectancy, higher than average infant mortality, and way higher than average medical error rates. Finally, 

increase personal responsibility and accountability for one’s own 

health and wellness activities. 

I believe that we can do this but it requires fundamentally rethinking Medicare and fundamentally rethinking what our future 

will look like 20-plus years from now and then taking installment 

steps to get there over years. 

We are not going to be able to move from plan A to plan B overnight. It will have to be done in installments over a number of 

years. But this kind of system, quite frankly, I think could be affordable and sustainable. But where we are at now, no way. 

Chairman GREGG. Thank you for that explanation. That was 

very cogent, to say the least. 

Senator CONRAD. Senator Murray. 

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

First of all, let me congratulate you on your leadership on this 

committee. I am glad you are the chair. 

And Senator Gregg, I want to thank you for your tremendous respect of all of us on this committee under your leadership over the 

last several years, and look forward to working with you. 

Mr. Chairman, I am interested in the process you have outlined 

for all of us to try and work our way forward under a very, very 

difficult scenario that General Walker has set out for us. And I 

49

want to thank you for being here today, and putting all of this in 

perspective as we move forward under very, very difficult—dismal 

I might say—budget situation that we have been left with after 

deficit spending for a number of years. 

I think we know that unsustainable budget deficits have become 

the norm and we have to look at the long-term picture and make 

some very difficult and strategic decisions. And it cannot be done 

alone. We need to all work together to accomplish that. 

Let me go from the macro down to a question I had because this 

situation that you have presented to us in this hearing comes within the timing of the President addressing us last night on his plan 

on his military efforts in Iraq. That will be debated outside of this 

committee, I am certain. We all have our opinions on that. 

But I wanted to ask you, particularly in terms of the budget, 

about the realistic estimate of the long and short-term costs of the 

war in Iraq. Do you think Congress has a clear understanding of 

the cost estimates of the war? And are we budgeting for it in a way 

that is sustainable in the long term? 

General WALKER. No, I do not think Congress has as good of an 

understanding of the cost of the war as it should have. 

No. 2, I have serious concerns about some of the past numbers 

that have been associated with it and the numbers that we are 

hearing with regard to the most recent proposal. For example, I 

have heard that there will be a request for $5.6 billion associated 

with a surge of 21,500 troops. 

Well, the average total annual compensation for a member of the 

active duty military is close to $120,000, fully loaded, with benefits 

and everything. It is about $1.2 billion per 10,000 troops. If you 

multiply that by 2.15, you do not get anywhere close to $5.6 billion. 

Plus, on top of that, most of those people are already getting 

paid. Yes, you have to pay war zone supplementals, you have to get 

them there and back, you have to properly equip them—but that 

is less than the total dollar amount I cited. 

But I honestly have to tell you, I think the defense budget is a 

serious problem. There is a tremendous amount of waste going on. 

And I think that it is important that as much of the defense budget 

get into the base as possible so that it can be subject to Congressional scrutiny and oversight. 

Only time will tell how much longer we will be in Iraq and how 

much it will cost us. I do not think anybody knows that but God 

today. 

Senator MURRAY. There is a number of different scenarios out 

there and the long-term budget projections that you are looking at 

today, what scenario were you basing those long-term projections—

General WALKER. CBO. We do not try to compete with CBO. We 

start with the CBO baseline and, as you know, they must assume, 

that whatever funding was provided for Iraq will continue. 

And then what we do longer-term, Senator Murray, is we do not 

segment out Iraq or Afghanistan or the global war on terrorism. 

We basically make an assumption as to what is total discretionary 

spending going to be as a size of the economy? After the 1st 10 

years it grows with the economy, we assume? So we do not get 

down to that level of detail long-term. 

50

Senator MURRAY. Just as a quick followup, the CBO estimated 

that the care of the veterans from Iraq before the recent plan from 

the President is going to cost about $1 billion per year over the 

next 10 years. Have you looked at that and put that into your longterm? 

General WALKER. I will be happy to provide something for the 

record, but the real question is how is it included in the CBO baseline? We are piggybacking on CBO. I will check it and provide 

something for the record. 

General WALKER. GAO’s long-term simulations do not make any 

assumptions about the path of any specific program within the 

‘‘other’’ category shown in the figures. This ‘‘other’’ category includes both discretionary spending and mandatory programs other 

than Social Security, Medicare, Medicaid (and of course net interest). Under the ‘‘Baseline Extended’’ scenario we use the CBO baseline for the first 10 years. This baseline assumes that discretionary 

spending in the aggregate grows with inflation. After the first 10 

years we keep the level of spending in this category constant as a 

share of GDP. Under the alternative scenario we assume that 

spending in this category grows with the economy for the first 10 

years and the longer-term. 

Senator MURRAY. I do think, Mr. Chairman, that is something 

we are going to have to look closely at and monitor as well, as we 

do this. 

General WALKER. If I may add, Senator Murray too, and I think 

this is important, one of the reasons that the Defense Department 

budget is out of control is because of health care. It is one of many. 

And Congress passed expansion of TriCare benefits for defense. 

I sent letters up to the Hill talking about that was going to just 

enable employees to exercise a huge put option on our kids and our 

grandkids, and that is exactly what is going on. 

Senator CONRAD. Senator Domenici. 

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

Mr. Walker, thank you so much for coming up. Over time I kind 

of wondered what your role was vis-a-vis this effort we are doing 

and that started back when we were not getting along too well. But 

I want to say to you that I think you are a big help. We have our 

own, they have their own, we have you. You have many other jobs 

besides this, but I think that you are very helpful. 

Let me say first, as we all listen, that when we talk about having 

to do something with a long-term program such as Medicare, Medicaid, Social Security, it is not—fellow Americans, it is not that 

what we have to do is easy, or we would just do it. 

The truth of the matter is that something has to change. Normally, when we look at that, we do not want to tell the American 

people that the program that saves America changes these programs so that over time they do not cost as much. That means 

something will change in the program that it will be different 10 

years from now or 15 than it is now. We might as well say the 

truth: it will be less, probably less benefits. 

That is why I was hinting when I was talking to you, not that 

you ever hide from it, Mr. Chairman. But when we speak of doing 

something to it, what we mean is doing something to the programs 

that people currently want because they are getting them. They 

51

like them and they fight for them. And we are just sitting here and 

saying to them well, they will keep on coming. 

You keep telling us but when will it stop? And then we get people saying it is not going to matter, we are going to be able to take 

care of it. And then we are up here as budgeteers saying oh, but 

we have to make some changes. And in the middle of this line, good 

faith Senators are trying to figure out some formulation that would 

put this in a position where we could call upon ourselves in a 

meaningful way. 

Nobody wants to be part of a program of trying to fix these programs when it is not going to fix them. That is a total, total political waste, so you will not do it. So it has to be something that will 

work; right? 

And people have to feel like it will work when they join it. And 

I am not sure that people want to risk that much of their political 

strength. But they are going to have to. 

I want to laud this Chairman and this ranking member and say 

if they can begin to put this together, they will go down much more 

in history than any of the other things that we are talking about 

that Government has to do. 

I, myself, haveten so frustrated, Mr. Walker and Mr. Chairman, 

that I am planning to put together a bill with Senator Feinstein, 

and it is almost finished, and I will bring it to you all, which would 

set up the commission which would do this business for us and report to the public and to Congress on how to solve the problem. 

Sooner or later we are going to have to do that. Somebody is going 

to have to set it together and put it together and move on with it. 

I have a brief summary that I would have given and I would like 

to put it in the record, Mr. Chairman, at this point. 

And with that, thank you for giving me time. Mr. Walker, thanks 

again for your public service. It is admirable and we need it. 

GENERAL WALKER. Thank you. If I can, Mr. Chairman, I think 

we have to be realistic. Senator Domenici, as you properly point 

out, we are talking about real tough choices here. Real tough 

choices, dealing with benefits, dealing with other spending, dealing 

with tax policy. 

Realistically, whether you go the approach that you are talking 

about, Senator Conrad, or whether you go with the approach that 

you are talking about, Senator Domenici—one does not involve a 

commission and the other one does—I would respectfully suggest 

that you are not going to solve the problem in one fell swoop. 

But I do think you could do several things as the first installment. Start by poroviding, additional transparency in a financial 

reporting and the budget. Second, impose tough budget controls to 

stop or slow the bleeding. In terms of sbstantive installment could 

do 3 things: First, a comprehensive Social Security reform that is 

not preprogrammed to have to come back. That is easily doable. 

Second, round one of tax reform. 

And third, round one of health care reform focused on Medicare 

and Medicaid. Those things, I believe, would mean a meaningful 

down payment, would provide more transparency and a structure 

in place to help you going forward, would be a credibility enhancer 

with the American people and a confidence builder for the Congress. 

52

Senator CONRAD. Mr. Walker, let me just say that I think you 

have described very ably and very succinctly what would be realistic goals for this kind of effort. 

Let me say to my colleague, Senator Domenici, who has been 

such an important force on this committee for so long, as chairman, 

as ranking member, as senior member, the notion of a commission, 

we decided that it would be better if it were all members, people 

that have skin in the game, rather than asking outside experts who 

ultimately are not accountable. Because it has to pass here. And 

we need the people who have responsibility here, and I include the 

White House. I want to make very clear that if the White House 

is not on board with his effort, there is no sense even beginning. 

Because ultimately the President has to agree to sign or to veto. 

So everybody has to be on board. And Senator Domenici is exactly right. This is not easy. This is going to be excruciatingly difficult. But if we fail to act, kick this can down the road, that only 

makes the ultimate solution more draconian. 

Senator WHITEHOUSE. Senator WHITEHOUSE. Thank you, Mr. Chairman. 

Mr. Walker, I applaud your remarks on the health care system. 

If there is one thing that can bankrupt America, it is health care. 

And you have identified a lot of the problems that our health care 

system is burdened with. 

My view is that our health care system is ridiculous and that it 

would be disgraceful for the U.S. Congress to seek to cut health 

care spending without taking as hard a look as we can add at the 

reforms that are necessary to drive the costs down not with the 

tough budget knife but by actually making the system work better 

and be more efficient. 

I think it is probably the most inefficient system in the world. 

Many years ago in Rhode Island, I led a reform of the workers compensation system. And we put discipline to that process by hiring 

actuaries who prices the reform legislation as it went. And we 

could not put that thing through until they had signed off on yes, 

this will save the money that you have said it will. 

It is an imperfect discipline but it was a good discipline. I am 

wondering if your office is interested in and capable of providing 

that kind of discipline and support to a health care reform effort 

in this body? 

General WALKER. First, Senator, we are here to support the Congress in any way that you think would be helpful. Obviously, most 

of our work, as you probably know, is focused on supporting the 

committees because those are the entities that end up moving legislation, holding hearings, et cetera. In addition, we do not want to 

compete with our sister agency, the Congressional Budget Office, 

which you know is the official scorekeeper for the Congress. 

But I will tell you this, one of the things that you touch on is 

the need better metrics and for more disclosure of not just the 1-

year, the 5-year and the even 10-year cost of proposals. We need 

a sense as to what the longer-term implications of any major policy 

or proposal would be. 

One of the things I think we have to do, for example, Medicare 

prescription drugs. As you may recall, and I know you were not in 

this body then but I am sure you read the papers then. 

53

Senator WHITEHOUSE. It is a thrill to arrive with this kind of 

problem looking at us. 

General WALKER. You have a challenge and there is an opportunity. 

Let me take that as an example because it goes to your point. 

Congress decided that it could spend several hundred billion dollars over 10 years on Medicare Part D when we had a surplus. 

When the bill passed we had a deficit. There were differences between what CBO said it was going to cost and what the actuary 

at Medicare said it was going to cost, but the actuary was not able 

to disclose his numbers. More importantly, there was never any 

discussion of the discounted present value dollar cost; not until 

three and a half months after the bill passed—and it was $8 trillion. 

For big-ticket spending and tax items we need to have good numbers and those numbers need to go beyond on the short term to 

help us get a sense for affordability and sustainability over the long 

term. 

And so yes, we are willing to help in any way we can. At the 

same point in time, we do not want to duplicate the efforts of our 

sister agency. 

Senator WHITEHOUSE. The other question I have, as I said, the 

budget knife can be pretty unwieldy. If you want to cut your transportation budget in half you do not go out and cut your car in half. 

That takes you to zero transportation. You have to be a little bit 

more sophisticated about it and understand the underlying system. 

My experience as an attorney general, particularly in education, was that very often we were saving money at the $7,000 per pupil 

level, say in a middle school, and losing so many kids through that 

school that then turned up at $100,000 per kid in the training 

school, and whose trajectory of life was dramatically compromised 

by their failure in middle school. 

I have always surmised that the cost of losing them at that age 

and of their ceasing to be productive citizens and creating enormous law enforcement and other costs, was enormous. But I have 

never seen a calculation of that or a looking forward consequences 

analysis of where a failure to invest creates enormous costs later 

on, as opposed to simply cutting as you go. 

General WALKER. I have not seen that either. I can go back and 

see if we have done anything on that in the past. 

I do think this, Washington tends to suffer from two maladies: 

myopia, or nearsightedness, and tunnel vision where you are just 

looking narrowly at one issue at a time. One of the things we have 

to do, which you are touching on, we need to look longer range, and 

we need to understand the collateral effects of things that we do 

or we do not do. 

Education, frankly, is a problem in and of itself because we are 

not even top 20 in the world in math and science. And yet we have 

to compete based on brain power in a more advanced economy. So 

there are a number of issues there I think that are worth exploring. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. 

Senator CONRAD. Thank you, Senator. 

Senator ALLARD. 

54

Senator ALLARD. Mr. Chairman, thank you. 

I just want to raise a word of caution as far as talking about 

things like infant mortality, disease occurrence, and hospital associated accidents or however you want to delineate them. Because 

many times the World Health Organization builds these off of 

records that are kept within the country. 

And so you take a country like Mexico, who does not record 

births, does not record marriages, does not record deaths. These 

figures are not as accurate as what we have in this country, where 

we require physicians and health care professionals to report adverse reactions in hospitals. Infant deaths are recorded. We have 

had a birth certificate, a death certificate, where all of this is documented for the public record. 

I do think that when we make comparisons with other countries 

that we can get some misleading figures there and I think we need 

to keep that in mind when we are working with those figures. 

The thing I would like to bring up is that I agree with everything 

that has been said. We have a complicated problem. I think we 

have put this problem off to the point now where we cannot tax our 

way out of it. You cannot simply cut spending. It is going to take 

a group of things that has to happen. And I think that we need 

to put together a group of experts who can recommend to us what 

groups of things need to happen in order to make sure that our entitlement programs can survive. 

You mentioned the health care sector. As deep a trouble as it is, 

that is new information and I appreciate you bringing that to our 

attention this morning. 

One of the things that we struggle with, obviously, is what is the 

proper level of taxes in order to get the economy to grow? Obviously you cannot tax 100 percent of production or you are not going 

to get any revenues because nobody is going to produce. Similarily, 

you cannot have zero taxes because you will not have any revenue. 

But somewhere in between there is a magic level. And that will 

vary, depending on tax levels and what kind of taxes you are talking about. I think this is part of your discussion on tax reform. 

What tax reform do you think might be easiest to manage by the 

Congress? Answer that question first and then I will bring up another one. 

General WALKER. First, I think you have several issues. One, 

how much of the economy do taxes represent? You are correct in 

saying you want to keep that as low as possible in order to maximize economic growth, maximize disposable income, and maintain 

our competitive advantage compared to Europe. 

Then you have to decide how are you going to go about raising 

that revenue? And then you get into how much are you going to 

rely on individuals? How much are you going to rely on corporations? How much are you going to rely on income taxes? How much 

are you going to rely on payroll taxes? How much are you going 

to rely on consumption taxes or other excise taxes? And then how 

are you going to allocate the burden within those groups? How progressive is it going to be, et cetera. 

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dens while dealing with our fiscal imbalance. So that means we are 

going to need more revenues. 

Corporations do not have duties of loyalty to countries. They 

have duties of loyalty to their shareholders. You must be competitive in your tax structure vis-a-vis corporations because they have 

the ability and an incentive to do business elsewhere if you do not. 

As to individuals: obviously, you want to be fair and equitable 

with regard to the tax burdens there. But most Americans are not 

looking to be citizens of someplace else. Most other citizens are 

looking to be citizens of America. We have to keep that in mind. 

I think that our tax system today is so mind numbingly complex 

it is virtually impossible for persons in good faith who itemize to 

do their taxes and know they have done it corretly. Many Americans pay more in payroll taxes than they do income taxes. That is 

a fact. And yet we are using some of the payroll taxes to pay operating expenses of the Government. We have to keep that in mind. 

I think we need to do several things. We need to broaden the tax 

base, reduce and eliminate a number of tax preferences to keep 

rates as low as possible to be able to help assure equity, consistency, and economic efficiency. We are also going to need to consider 

some type of a consumption tax that may or may not be dedicated 

because income and wealth in this country is distributed fundamentally differently today than it was in the early 1900’s, when 

income taxes came into effect. 

The $345 billion tax gap would be a good place to start—with 

more information returns, more withholding, more targeted IRS enforcement. But you are not going to solve the tax gap until you do 

comprehensive tax reform with simplification. 

Lastly on simplication, I have paid AMT several times now. I 

think that is a massive bait and switch surtax. I think you would 

be much better off to build it into the rates and just be honest with 

people. If you want to have a surtax on the really wealthy, then 

have a surtax on the really wealthy. But the idea of AMT, where 

you in good faith fill out your tax return and think you are done 

and then all of a sudden you have to go do this other one—all it 

is is a surtax. You would be better have a streamlined and simplified income tax that builds it into the rates. And then if you 

want to have a surtax, target it. 

Those are a few thoughts. 

Senator ALLARD. Mr. Chairman, my time is run over but for the 

committee’s benefit I would like to ask for a clarification, if I may 

have the time. 

Senator CONRAD. Sure. 

Senator ALLARD. You talked about consumption tax. I have read 

tax policy experts who will say that a flat tax and a sales tax are 

both consumptive taxes, depending on how they are structured. So 

when you talk about a consumption tax, which one are you referring to? 

General WALKER. It depends on how they are structured. You 

could have an income tax that does not tax savings and does not 

tax certain items that do not represent consumption and pretty 

much get a consumption-based tax, if you will. So there is different 

ways you can get there. 

56

The last thing that I would mention, let me give you one example 

of something that really needs to be on the table. The single largest 

tax preference in the budget or probably in the Government today 

is the fact that no American, no matter how much money they 

make, no matter how wealthy they are, pays a dime of income or 

payroll taxes on the value of employer-provided and paid health 

care, even if they have a very lucrative health care package. That 

is approaching $200 billion a year. 

And it is part of the problem with health care cost explosion because it disassociates people from the cost of health care. And that 

is something that the Mack-Breaux Commission put on the table. 

The good news is there is lots of good work that has been done 

on entitlement reform and taxes. You do not have to reinvent the 

wheel. You can pull from work that has already been done and 

come up with something that hopefully addresses the elements we 

talked about. 

Senator ALLARD. Thank you, Mr. Chairman. 

Senator CONRAD. I thank the Senator from Colorado for his good 

questioning. 

Senator CARDIN. Again, Senator Cardin, you were not here when 

I welcomed the new members to this committee. We are delighted 

that you and Senator Whitehouse are here. Senator Sanders was 

here earlier. 

We very much appreciate your coming and replacing a former 

No. 2 person on our side on this committee, Senator Sarbanes, who 

was an essentially valuable member of this committee. We anticipate that you will make significant contributions here, as well. 

Senator CARDIN. Mr. Chairman, I thank you very much for these 

comments. Serving in the other body, I served on only one committee so it was very much expected I would make those hearings. 

In this body they put me on a lot of committees. 

So I apologize for the fact that Secretary Rice is before the Foreign Relations Committee and that has divided my time today. 

I want to thank you very much for holding this hearing. I had 

a chance to work with you, Mr. Walker, when I was in the House, 

and I always found your information to be extremely helpful, particularly your projections regarding areas that we need to address. 

Today we are talking about the long-term budget outlook. Let me 

just caution you, as you were talking about the Alternative Minimum Tax—and I agree with you on AMT. Remember, we got the 

AMT because Congress wanted to simplify, broaden, and reduce 

rates. 

So let us be careful as to how we move forward because our actions may very well not produce the results that we anticipate. Our 

tax code is the most complicated it has ever been and we have gone 

through I do not know how many tax simplifications. So we should 

be very cautious about that. 

The other point I want to make is that as we look at ways of 

solving the budget dilemma that we are in, and I know that Congress will examine entitlement spending, let us remember that it 

was not too many years ago that the projections for our budget 

were pretty good. 

I remember some of the documents that you prepared for the 

Ways and Means Committee as to how we got this reversal, parVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00062 Fmt 6633 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ticularly your analysis of the 2001 and 2003 tax cuts and the effect 

our budget situation if those provisions are made permanent. 

You already mentioned earlier the impact of the medicare prescription drug law has. 

As we look for ways of dealing with our budget problems today, 

let us be mindful of how we got here so that we do not repeat the 

mistakes we have made in the past. 

Medicare and Medicaid are clearly a challenge for the Federal 

budget. There is no question about that. I do not how we deal with 

that if we address the overall issue of health care in this country. 

How do you get a handle on the Federal Government’s costs health 

care unless you address the lack of affordable health insurance, the 

rising cost of long-term care, and as you point out, a more responsible approach to Medicare prescription drug coverage? 

I do not know whether you have done any projections in this or 

not, or whether you have any views on that, but it seems to me 

that we will not benefit taxpayers or consumers if we just attempt 

attempt to rein in Medicare and Medicaid but do little about the 

entire health care system itself. 

General WALKER. My personal view is, Senator, that while there 

are a number of things that we can and should do in the short 

term to try to moderate health care costs, including moving to national practice standards,—something that would help to reduce 

costs, improve quality, and reduce litigation risk, among other 

things,—that ultimately we are going to have to engage in comprehensive health care reform in installments. Medicaid is really 

not just health care. It is also long-term care. About two-thirds of 

Medicaid now is long-term care. That is really a hybrid. It is really 

life maintenance. It is really not health care. 

So I think that ultimately we are going to have to engage in 

much broader reforms, but we are going to have to do it in installments. We are also going to have to do something about our savings rate. And I would respectfully suggest for your consideration 

one of the things that we might want to think about for Social Security is to reform Social Security to make it solvent, sustainable 

and secure indefinitely, keeping it as a defined benefit program for 

a variety of reasons and adding a supplemental individual account 

on top with mandatory personal savings through payroll deduction—money put into a real trust fund with real investments, with 

real fiduciary responsibilities where people go to jail if they violate 

that responsibility. 

I think that combination could help us not just with Social Security, but also with long-term care; it could help us with our savings 

rate; it could help us with a number of things. And I think that 

could be done in a way that would be broadly supported. 

Senator CARDIN. Some of us have looked at that option for Social 

Security and support trying to provide supplemental accounts. The 

difficulty, of course, is that there is a budget score associated with 

these accouonts. 

General WALKER. Actually, you can because what I am talking 

about is you reform Social Security—and we can talk about that if 

you want, how to do that—to where you make it solvent, sustainable and secure. And then you have individuals, through payroll 

58

deduction, have 2 percent of their pay go into an individual account. It is their money, not our money. It is not a budget item. 

Senator CARDIN. But if you take it out of the Social Security system, you are compounding—

General WALKER. I am not taking it out. It is not a carve-out. 

But Congress is probably poised to increase the minimum wage. 

Senator CARDIN. I think it is an intriguing suggestion, but as you 

pointed out, payroll taxes are rather oppressive already for a large 

number of Americans. 

General WALKER. It is. It is a regressive tax and I think one 

needs to be concerned with that. But here is the difference, this is 

not a tax increase. This is your money. 

The other thing is this would provide for a very substantial preretirement death benefit that one does not get in Social Security 

today, et cetera, et cetera. 

Senator CARDIN. I want to continue this, Mr. Chairman, but this 

is not the right time. I would just urge that for lower-wage workers, supplemental accounts are not feasible unless someone puts 

money on the table in addition to the worker. But we can debate 

that issue at a different point. 

Thank you, Mr. Chairman. 

Senator CONRAD. Let me just say I, for one, I like this basic construct. I think it has to be part of an overall tax reform plan because we are using payroll taxes to fund operating expenses. If you 

were doing this in the private sector, if you were taking retirement 

funds of employees, and using it to pay operating expenses, you 

would be on your way to a Federal institution. It would not be Congress, it would not be the White House. You would be headed for 

the big house. That is a violation of Federal law. 

We have just an incredible mismatch here in terms of our funding mechanisms and the outgo. 

I would like to go for just a minute back to the health care issue 

because that really is the 800 pound gorilla, and that is what has 

the potential to swamp the boat around here unless we address it. 

And I agreed you entirely. I do not think we can solve this in one 

fell swoop. I think it is going to take a series of bite-sized chunks 

over time. Frankly, I do not think we know enough at this moment 

to solve the long-term problem of Medicare. But we have to make 

progress. 

One thing I have talked about repeatedly on this committee is 

the fact that about 5 percent of Medicare beneficiaries use half of 

the money. It is not quite that, is about 6 percent use half of the 

money currently. But it has been in that range, 5 percent or 6 percent use half the money. Now my business school training says you 

focus like a laser on that kind of fact. 

Can you help us understand, we know that these are the chronically ill, people with multiple conditions. Have you had a chance 

to study this? And have you had any sense of how we might make 

progress with respect to that population? 

General WALKER. Clearly, there is an opportunity to use more 

case management approaches, which is what you are talking about. 

A very high percentage of the cost for Medicare relates to a fairly 

small percentage of those that are covered by Medicare. And in the 

private sector typically, and even frankly in the public sector with 

59

regard to some governments, you typically have a much more aggressive case management which is not just to control cost but it 

is also to try to assure quality. For examplel, if you are taking too 

many prescriptions that can actually be a detriment, for example, 

to the individual involved. 

I think clearly that is an area that needs to be explored as well 

as, as I said, national practice standards for medical standards, as 

well as a few other areas. 

But one of the things you have to keep in mind under our current health care system, the incentives are for everybody to do 

more, more, and more. Why? Because providers get paid more, because they reduce their litigation risk, and because individuals are 

not paying for it. 

So the current incentives under our system are, whether it is 

technology, whether it is drugs, or whether it is procedures, is to 

do more, more, more. One of the things we are all going to have 

to come to grips with is there is a difference between whether or 

not people ought to have opportunity to gain access to every technology procedure and drug that exists versus whether the taxpayers ought to pay for it. Because the fact is that if there is one 

thing that could swamp the ship of state and bankrupt America, 

it is health care. There are lots of ways you can get there but one 

of the ways that forces you to get there is to have a budget for 

health care. 

I mean, there are a number of procedures that could be done that 

do not meaningfully improve or extend life but they cost a tremendous amount of money. And it is reality. It is tough but it is reality. 

Senator CONRAD. Senator Gregg, any final comments? 

Chairman GREGG. I want to followup on that, but I had another 

issue I wanted to followup on, too. But let me followup on that. 

This concept of a separate budget for health care might make a lot 

of sense since it is such a large percentage of our budget. 

I have been thinking about how do you address this? How do you 

address this health care issue? Obviously everyone is thinking 

about it. 

But your point earlier that because health insurance premiums 

are fully deductible and health insurance is therefore subsidized 

dramatically by our tax laws, then that creates this disincentive for 

market forces to play a role and creates, in many instances, overutilization and costs which should not have to occur. 

I have always thought that a better health care system might be 

one where we absolutely make sure that everybody is insured for 

a catastrophic event. So nobody has to fear being wiped out because they discover they have cancer in their family or they have 

a serious accident that harms them, so that every American knows 

that they are not going to lose their home or their life savings as 

a result of a catastrophic event. And then you allow the marketplace and individuals, with obviously some support for lower income people, to decide what percentage they are going to want to 

personally cover of the difference through insurance. 

And you could pay for that, it would seem to me, by first allowing the market to create the catastrophic insurance but subsidize 

that by basically limiting the amount of deductibility for health insurance to a number that is reasonable so that gold plated plans 

60

are no longer fully deductible at the corporate level. Does that 

make any sense to you? 

General WALKER. Let me take that, elements of it, I think, do 

make a lot of sense. 

First, as you know Senator, it is not a deduction on health care 

that I am talking about. It is the exclusion. 

Chairman GREGG. Yes, I mean it does not—

General WALKER. But it is bigger that way. 

Chairman GREGG. Of course it is. 

General WALKER. The reason it is bigger that way is because you 

do not pay payroll taxes on it either. You can get a deduction for 

your income tax but you do not get a deduction from the taxable 

wage base. But with an exclusion you get both. It is not included 

in the taxable wage base for Social Security and Medicare nor is 

it in the income tax. 

I think you are on to the right path. My personal view is that 

if you look long-term that if we were somehow to move to a system 

that assured every American that they had certain basic and essential health care services, and I would suggest that might include 

catastrophic, definitely protection against financial ruin due to unexpected catastrophic illness. Now catastrophic is different if you 

are Bill Gates or one of us. 

But I think you also have to think about wellness and inoculations. Those are things I think you have to think about. And I 

think then to create options for people to get more than that if they 

want, but they have to decide how much of their resources do they 

want to allocate off for that. 

And one of the things we have to do, we have to do more to help 

individuals assume more personal responsibility for their own 

health. Right now, even for Federal programs, if you have very 

poor health habits you do not pay a different premium. So people 

who are behaving properly with regard to smoking, eating, drinking, whatever, they are subsidizing people who are not. And I think 

we need to do more to figure out how we encourage people to assume more personal responsibility for their own health because we 

have a number of very negative leading indicators on health. 

For example, we are No. 1 in the world in obesity. Nobody is 

even close. And that is a pre-indicator for heart disease and diabetes. And we need to start doing something about it. But part of 

that has to do with the individual. The individual has to assume 

more responsibility. 

Chairman GREGG. Thank you for that. 

I was pointing out to my colleague that the obesity issue is more 

a function of the subsidized agricultural industry than anything 

else. 

[Laughter.] 

General WALKER. We can get into that in a different hearing if 

you want. 

Senator CONRAD. You will not be invited to that hearing. 

[Laughter.] 

Chairman GREGG. You used the term mandatory reconsideration 

trigger. What did you mean by that? 

General WALKER. What I mean by that is that when a certain 

mandatory programs, take Medicare, Medicaid, whatever, reaches 

61

a certain size of the Federal budget and/or the economy, that it 

forces reconsideration. 

Now something like that was put in the prescription drug bill. 

The alarm is supposed to go off this year to say that by 2012 you 

are going to hit that trigger point. But that is only Medicare. Time 

will tell what is done with that alarm, when that alarm goes off. 

But you need to think about other segments of the budget—both 

the spending side and tax preferences—

Chairman GREGG. Have you looked at my SOS bill, which has 

that? 

General WALKER. I have not, but I will. 

Senator CONRAD. Mr. Walker, I was at an event last week with 

former President Clinton and he was very focused on this health 

care issue. One of the things that he said in his remarks was that 

we are now of 16 percent of GDP on health care. The next highest 

country in the world is 11 percent. And that Delta, that difference 

between 11 percent and 16 percent of GDP amounts to $800 billion 

a year in terms of health care expenditure in this country. 

The second thing he mentioned, and I hesitate to quote him because I am just remembering this from his description and so I 

may have misheard. But he had an extraordinarily high figure of 

over 30 percent on the administrative costs of health care in this 

country. 

Have you looked at that issue? 

General WALKER. I have heard 20 to 30 percent. I can take a 

look at it when I get back. It is very high, there is no question. 

Senator CONRAD. That seems to me, if we were analyzing this 

like in business, these outliers where you have 5 percent using half 

of the money, where you have an administrative cost that is much, 

much higher than you would see in almost every other economic 

segment, those are places it seems to me we have to focus like a 

laser. I would be very interested in any analysis you can provide 

the committee with respect to this administrative cost issue, any 

additional information you could provide the committee with respect to the 5 percent of Medicare beneficiaries who use half of the 

money, any proposals that you would have for how we address that 

to both save money and, I believe, improve health care outcomes. 

(See additional information)

I would also be interested in your national practice standards 

and any proposal that you would have there because we now know 

that there are vast disparities across the country in how much 

money is being allocated to various health care problems without 

differences in health care outcomes. (See additional information)

In other words, I have seen studies in the last 10 days that show 

a 500 percent difference in cost to deal with various health care 

conditions, one part of the country to another, with virtually no difference in the quality of outcomes. That is another thing that ought 

to jump out at us. 

If you could provide that. (See additional information)

Senator Whitehouse, if you have an additional question or 

thought? 

Senator WHITEHOUSE. Mr. Chairman, I was hoping that I could 

add to Mr. Walker’s homework with an additional request along 

62

the lines of the things that you have so wisely asked about. And 

that would be for you to take a look at the information infrastructure in health care. 

The Economist magazine reported not long ago that the adoption 

of information technology in the health care industry is the second 

worst of any American industry, lagging only behind the mining industry. The RAND Corporation has indicated that with adequate 

investment in information technology in the health care sector, we 

could save as much as $162 billion, with a B, per year. 

Those are public reports and public information. I would love to 

have those added to the list for review by your organization if the 

Chairman would permit me to add to his list. (See additional information)

Senator CONRAD. I certainly would. I think it is an excellent 

question. General Walker. 

General WALKER. If I can, first, there are actually a few areas 

where Government leads by example other than GAO. VA is one. 

VA probably has the best technology for medical records in the 

country. And we need to learn from that. 

You are correct, national practice standards could help reduce 

costs, improve consistency and enhance quality. 

Last thing, I want to come back to something that is relevant to 

this discussion that Senator Allard mentioned before. This country 

directly spends $2.5 trillion to $3 trillion per year. It issues tax 

preferences equal to $700 billion to $800 billion a year in foregone 

revenue. And that is backdoor spending. That is what tax preferences are. They both affect the bottom line. 

But for the most part, we do not really know whether the spending programs are effective and whether the tax policies are effective. I think one of the things that we sorely need in order to be 

able to make intelligent decisions to help reengineer not just spending policy but tax policy is a set of key national indicators, outcome-based indicators—economic, safety, security, social, environmental—that will help us to answer three questions: Where are we 

today? How are we trending? And how do we compare with others? 

Senator Allard is correct to say that there are differing degrees 

of reliability of data. But we need to seek to work to develop these. 

Some countries have them. Others do not. We are working with the 

National Academy of Sciences to try to make this a reality, as well 

as with the OECD. 

Frankly, I think it is a great opportunity for a public/private 

partnership because if Congress had this data it could make a lot 

more informed judgments in the executive branch about where we 

should and should not be spending and where we should and 

should not be issuing tax preferences. I think it is something that 

needs to be on the radar screen. 

Senator CONRAD. One final thought, and I like that idea very 

much. We would hope that as you develop these that you would let 

this committee know, because I think there would be strong interest here in this notion of national indicators. (See additional information)

One of the things I have always thought we should do is have 

a periodic review of programs to see how much money is actually 

being delivered to where it is intended. One of the things that has 

63

really concerned me is in the few times I have had a chance to look 

at a program, it may have started a very well intended way, it may 

have worked well at the beginning, but over time hasten ossified 

and calcified and is not delivering the benefits to where they are 

intended at all, or not at least even a majority of the benefits. Instead, it is getting caught up in some kind of administrative 

stream. 

Do you do a review of major programs to see how much of what 

goes in actually comes out the other side for the purposes intended? 

General WALKER. To my knowledge we have not but it is a good 

idea. Obviously, as you know, the executive branch has something 

called the Program Assessment Rating Tool, which is supposed to 

help assess the effectiveness of certain programs. Unfortunately, 

that is just spending programs, it is not tax policies. But I am not 

sure that this is even part of that effort. 

Clearly, it is similar to what you said before about overhead costs 

for health care. We need to understand how much money is actually going to the targeted players. And there is little doubt in my 

mind that we have way too much overhead. I mean, think about 

it. 

Senator CONRAD. Way too much overhead. 

General WALKER. Think about this for a second. I have sent up 

to you and every member of the Senate our 21st Century Challenges document, Re-Examining the Base of the Federal Government. 

Just look at how the Government is organized. We have over 10 

regions. We have all of these different grade levels. That is based 

on the 1950’s. It is based on technology and transportation systems 

and management models of the 1950’s and we are still trying to operate that way. 

Take the Pentagon. If it was 20 percent smaller, it could probably be 50 percent more productive. For example it takes over 20 

units to sign off on activating and deploying 10 reservists or more. 

There is tremendous opportunity to delayer, de-silo, and streamline 

Government. 

Senator CONRAD. And it will never happen unless we have the 

information. 

We would like to talk to you further about this matter because 

I really do think we have to find a way to bring this to the attention of our colleagues. And it will never happen unless we set up 

some kind of structure to periodically review. 

I tell you, I am appalled by what I am seeing in terms of administrative overhead. These agencies take a cutoff the top before the 

money ever gets delivered for the purpose intended. It is not unusual for this to be 20 percent. Now there is no excuse for administrative overhead to be of that magnitude. 

So I would very much like to have a discussion with you about 

how we set up an ongoing program to review the administrative 

overhead that is on these programs. 

With that, I want to again thank you so much for being here 

today. And thanks once again, Chairman Gregg, for his many courtesies that have been extended to our side of the aisle during his 

chairmanship. 

[Whereupon, at 12:19 p.m., the hearing was adjourned.]

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PREPARED STATEMENT AND QUESTIONS FROM SENATOR 

GRASSLEY


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ANSWERS TO QUESTIONS SUBMITTED


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(79)

HEARING ON LONG-TERM ECONOMIC AND 

BUDGET CHALLENGES 

THURSDAY, JANUARY 18, 2007

U.S. SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to notice, at 10:02 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of the committee, presiding. 

Present: Senators Conrad, Lautenberg, Cardin, Sanders, 

Whitehouse, Gregg, Allard, Bunning, and Crapo. 

Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 

Staff Director for the Minority. 

OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

Chairman CONRAD. I will call the hearing to order. 

I wanted to especially welcome the Chairman of the Federal Reserve, Mr. Bernanke, to the Budget Committee. We have, over the 

years, had a tradition in this committee of hearing from the Chairman of the Federal Reserve on the economic conditions of the country and the challenges that we face, the opportunities that are 

there. And so this is a continuation of that tradition. 

Some weeks ago I had a chance to visit with Chairman Bernanke 

over lunch and it was, I thought, a constructive and productive discussion. We certainly valued it for the insights to the fundamental 

underpinnings of our economy and what we could do to make 

things better and more secure for the future. 

Senator Gregg and I are especially committed to facing up to our 

long-term fiscal imbalances, the challenges that we confront with 

Medicare and Social Security, and the embedded deficits that we 

now face. We are very eager for the Congress of the United States 

and the White House to work together to devise a long-term plan 

to face up to these challenges because we think they pose a risk 

to our long-term economic security. 

I have noticed increasing discussion in the press about the need 

to address these long-term imbalances. I wanted to just go through 

a few slides, if I could, and talk about some of the issues that we 

think are important to keep in mind. 

First of all, the deficit last year was reported at $248 billion. At 

the same time, the debt of the country increased by $546 billion. 

All too often these increases in the debt get left out of the reporting. 

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The biggest reason for the difference is Social Security, where 

$185 billion of Social Security Trust Fund money that is in temporary surplus was used to pay other bills.

The result of this pattern of increasing deficits and debt, on the 

debt side of the ledger, is that we are building this wall of debt. 

At the end of 2001, we had $5.8 trillion of gross debt. At the end 

of last year, that had soared to $8.5 trillion. If we stay on the current course, the estimates are by 2011 we will be $11.6 trillion of 

debt.


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All of this is compounded by a dramatic reduction in the savings 

rate in this country. Of course, when you have dissavings by the 

Federal Government, when the Federal Government is running 

deficit, that reduces the savings rate. This is the individual savings 

rate according to the Bureau of Economic Analysis. We see the first 

negative savings rate in 2006 since the Great Depression.


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As a result of the twin deficits, budget deficit and trade deficit, 

we are now borrowing extraordinary amounts of money. Last year 

we borrowed 65 percent of all of the money that was borrowed by 

countries in the world. The next biggest borrower was Spain, at 

about one-tenth as much. Many of us believe this is an 

unsustainable level of borrowing and has to be addressed.


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Of course, all of this is occurring before the baby boomers retire. 

The baby boom generation, that is going to dramatically increase 

the number of people eligible for Social Security and Medicare from 

some 40 million today to over 82 million by 2050, fundamentally 

changes the decisions that we must make.


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There’s been a lot of talk about Social Security and the long-term 

gap between funding and outgo in that program, the 75-year shortfall in Social Security is about $4.6 trillion. That is the estimate. 

But the 75-year shortfall in Medicare is much bigger, seven times 

as much, $32 trillion. This is, many of us believe, the 800-pound 

gorilla. These health care accounts, Medicare being the most promiVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00090 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH

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nent but Medicaid and veterans’ health care also part of the consideration.

Not only do we have a problem on the spending side of the ledger, but we also have a problem on the revenue side of the ledger. 


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This chart shows what happens if you extend all of the tax cuts 

from 2001 and 2003 and you combine them with the trust funds 

going negative because out in the future, as we get toward 2017, 

2018, these trust funds that are throwing off large cash surpluses 

now go cash negative. And at that very time, you can see by the 

chart, the cost of making all of the tax cuts permanent explodes as 

well, driving us right over a cliff into much deeper deficits and 

debt. So we’re going to have to face both the spending side of the 

equation and the revenue side of this equation if we are going to 

be successful.

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Why does it matter? Are these just numbers on a page, not attached to the economic condition of our country? No. We think 

these things are very much linked to the long-term economic security of America. We saw in the Wall Street Journal, the Economic 

Forum warned that U.S. budget deficits in America are causing our 

economy to be less competitive. This is the World Economic Forum 


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judgment last year that reduced the competitive ranking of our 

country because of our very large deficits, both trade and budget.

The Comptroller General who was the first witness before the 

Budget Committee, said this in his testimony: ‘‘When, not if—


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when—foreign investors decide as a matter of mere prudence and 

diversification that they are not going to expose themselves as 

much to U.S. debt, then interest rates will rise and that will start 

a compounding effect. And so what’s important is that we act so 

that they don’t take that step.’’

The Financial Times reported that China was forcing the dollar 

into the spotlight. ‘‘China made its presence felt in the currency 

markets this week’’—and this was in November of last year—

‘‘China made its presence felt in the currency markets this week 

as the prospect of the country diversifying its large foreign exchange stockpiles sent the dollar reeling to a 10-week low against 

the euro and to its weakest level in 18 months against the sterling.’’


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Let’s go to the final chart, that shows what has happened to the 

dollar against the euro. Since 2002 the dollar is down about 30 percent. This should be a warning signal to all of us about the potential effect of our fiscal and monetary policies and how it can have 

an effect on the larger economic well-being of the country.


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Let me indicate to Chairman Bernanke that we are not going to 

ask you about dollar valuation. We are not going to ask about 

short-term interest rate movements, because we know that is not 

appropriate in your role as Chairman of the Fed. We want to indicate to all of the members that the Chairman is constrained in 

what he can say on dollar valuation, on interest rates, and we understand that and respect it. 

With that, Senator Gregg. 

OPENING STATEMENT OF RANKING MEMBER SENATOR JUDD 

GREGG 

Senator GREGG. Thank you, Mr. Chairman. And thank you, Mr. 

Chairman, for joining us today. It is very important to hear your 

thoughts. 

The Chairman has set the table on the issue that we consider—

the two of us, I believe—to be the primary fiscal policy issue which 

we face as a country, which is the out-year cost of our Government 

to America. 

It is a function, as the Chairman mentioned, of demographics. I 

think this just needs to be reinforced. We are facing the largest retirement generation in the history of the country. It will double the 

size of the people in the retirement generation. The practical effect 

of that, of course, is that you will have fewer people working to 

support the retired population. 

The implications of this are really reflected in this chart, where 

three major Federal programs, Social Security, Medicare, and MedVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00097 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH

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icaid, will absorb what has traditionally been the historical amount 

of spending which the Federal Government takes out of the economy, 20 percent, by about the year 2025. So at that point there will 

be nothing else the Federal Government can theoretically do and 

maintain a 20 percent burden on our national economy other than 

pay for Social Security, Medicare, and Medicaid. National defense 

cannot be done, education cannot be done, environmental protection cannot be done. 

And the problem worsens as the baby boom generation goes into 

full retirement. The number goes up and almost hits 30 percent, 

those three programs, as we head into the 2030 decade. 

The practical implications of this are staggering for us as a Nation, as the chairman has outlined. The question becomes how do 

we address it? The issue is reflected, I think, in the fact that if historically we have taken 20 percent of the national economy as the 

Federal spending, and historically taken about 18.2 percent of the 

national economy in tax revenues, how high can the Federal Government go into its burden on the national economy without undermining the productivity of the economy and pushing us into some 

sort of spiraling down in quality of life, quality of experience for 

our next generation? Or to put it in real terms, at what point does 

the cost of the retired generation get so high that the younger generation can no longer afford to have the quality of life that our generation has had? 

This is reflected in the unchecked effect on Federal spending. It 

would go as high as, theoretically, 45 percent of the gross national 

product just on entitlements if it goes forward into the years 2040. 

And that is reflected even though we have seen dramatic increases in taxes. The Chairman has pointed out that, in his view, 

tax revenues in the future, if we continue to maintain the tax cuts 

which we have in place or the tax burden which we have in place, 

would significantly drop. I am not sure. I do not happen to believe 

that. That is a static estimate of what tax revenues are. 

We have actually seen that with a fair tax rate we create more 

productivity in the economy, and has a result we create more revenues for the Federal Government. In fact, in the last 3 years Federal revenues have jumped more significantly than at any other 

time in history. We are seeing that we are now over the historical 

norm. We are over 18.2 percent of the national gross product coming in in revenues. We are about 18.5 percent. We headed toward 

19 percent if the estimates of the administration are correct, and 

I suspect those estimates are going to be assumed in whatever 

budget comes out of this committee. As a practical matter, we even 

have a more progressive tax law today than we had during the 

Clinton years. 

So even though we have cut rates, we have actually generated 

a higher—we have actually caused the higher income people in this 

country to be paying more of the tax burden, 84, 85 percent of the 

tax burden, versus 81 percent under the Clinton years, the top 20 

percent. 

So I do not believe you can tax your way of this problem. There 

are basically four different approaches to this problem: increase 

taxes, adjust benefits, increase the number of people paying in 

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which would be expanding immigration, I presume; or inflating our 

way out of the issue. 

And I guess what I am going to want to focus on with you, Mr. 

Chairman, is at what level will the Federal Government be taking 

too much out of the economy to make the economy work right and 

be productive? And second, how do we address the issue of the fact 

that one of the options here is inflating your way out of this problem? Which would be a horrific decision on our part as a Government, but potentially something that the marketplace might force 

on us, looking at this type of debt burden facing us. 

So I am going to be interested in your thoughts on this critical 

issue of fiscal policy for us and hopefully you can give us some 

guidance. Thank you. 

Chairman CONRAD. Again, our welcome, and please proceed with 

your testimony. We are very pleased that you are here, Chairman 

Bernanke. 

STATEMENT OF HON. BEN S. BERNANKE, CHAIRMAN, BOARD 

OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Chairman BERNANKE. Thank you, Chairman Conrad, Senator 

Gregg, and other members of the committee. 

I am pleased to be here to offer my views on the Federal budget 

and related issues. At the outset, I should underscore that I speak 

for myself only and not for the Federal Reserve. 

As you know, the deficit and the unified Federal budget declined 

for a second year in fiscal 2006 following the $248 billion from $319 

billion in fiscal 2005. 

As was the case in the preceding year, the improvement in 2006 

was primarily the result of solid growth in tax receipts, especially 

in collections of personal and corporate income taxes. Federal Government outlays in fiscal 2006 were 20.3 percent of nominal gross 

domestic product, receipts were 18.4 percent of GDP, and the deficit—equal to the difference of the two—was 1.9 percent of GDP. 

These percentages are close to their averages since 1960. 

The on-budget deficit, which differs from the unified budget deficit primarily in excluding the receipts and payments to the Social 

Security system—to which Senator Conrad made allusion—was 

$434 billion or 3.3 percent of GDP in fiscal 2006. As of the end of 

fiscal 2006, Federal Government debt held by the public, which includes holdings by the Federal Reserve but excludes those held by 

Social Security and other trust funds, amounted to about 37 percent to 1 year’s GDP. 

Official projections suggest that the unified budget deficit may 

stabilize or moderate further over the next few years. Unfortunately, we are experiencing what seems likely to be the calm before 

the storm. In particular, spending on entitlement programs will 

begin to climb quickly during the next decade. In fiscal 2006, Federal spending for Social Security, Medicare, and Medicaid together 

totaled about 40 percent of Federal expenditures, or roughly 8.5 

percent of GDP. 

In the most recent long-term projections prepared by the Congressional Budget Office these outlays are projected to increase to 

10.5 percent of GDP by 2015, an increase of about 2 percentage 

points of GDP in less than a decade. By 2030, according to the 

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CBO, they will reach about 15 percent of GDP. As I will discuss, 

these rising entitlement obligations will put enormous pressure on 

the Federal budget in coming years. 

The large projected increases in future entitlement spending 

have two principal sources. First, like many other industrial countries, the United States has entered what is likely to be a long period of demographic transition, the result both of the reduction in 

fertility that followed the post-World War II baby boom and of ongoing increases in life expectancy. Longer life expectancies are certainly to be welcomed. But they are also likely to lead to longer periods of retirement in the future, even as the growth rate of the 

work force declines. As a consequence of the demographic trends, 

the number of people of retirement age will grow relative both to 

the population as a whole and to the number of potential workers. 

Currently, people 65 years and older make up about 12 percent 

of the U.S. population and there are about five people between the 

ages of 20 and 64 for each person 65 and older. According to the 

intermediate projections of the Social Security Trustees, in 2030 

Americans 65 and older will constitute about 19 percent of the U.S. 

population and the ratio of those between the ages of 20 and 64 to 

those 65 and older will have fallen to about three. 

Although the retirement of the baby boomers will be an important milestone in this demographic transition, the oldest baby 

boomers will be eligible for Social Security benefits just next year, 

the change in the Nation’s demographic structure is not just a temporary phenomenon related to the large relative size of the baby 

boom generation. Rather, if the US fertility rate remains close to 

current levels and life expectancies continue to rise, as demographers generally expect, the U.S. population will continue to grow 

older, even after the baby boom generation has passed from the 

scene. If current law is maintained, that aging of the U.S. population will lead to sustained increases in Federal entitlement 

spending on programs that benefit older Americans such as Social 

Security and Medicare. 

The second cause of rising entitlement spending is the expected 

continued increase in medical costs per beneficiary. Projections of 

future medical costs are fraught with uncertainty, but history suggests that, without significant changes in policy, these costs are 

likely to continue to rise more quickly than incomes, at least for 

the foreseeable future. Together with the aging of the population, 

ongoing increases in medical costs will lead to a rapid expansion 

of Medicare and Medicaid expenditures. 

Long-range projections prepared by the CBO vividly portray the 

potential effects on the budget of an aging population and rapidly 

rising health care costs. The CBO has developed projections for a 

variety of alternative scenarios based on different assumptions 

about the evolution of spending and taxes. The scenarios produce 

a wide range of possible budget outcomes, reflecting the substantial 

uncertainty that attends long-range budget projections. However, 

the outcomes that appear most likely, in the absence of policy 

changes, involve rising budget deficits and increases in the amount 

of Federal debt outstanding to unprecedented levels. 

For example, one plausible scenario is based on the assumptions 

that Federal retirement and health spending will follow the CBO’s 

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intermediate projection; that defense spending will drift down over 

time as a percentage of GDP; that other non-interest spending will 

grow roughly in line with GDP; and that Federal revenues will remain close to their historical share of GDP, that is, about where 

they are today. Under these assumptions, the CBO calculates that 

by 2030 the Federal budget deficit will approach 9 percent of GDP, 

more than four times greater as a share of GDP than the deficit 

in fiscal year 2006. 

A particularly worrisome aspect of this projection and similar 

ones is the implied evolution of the national debt and the associated interest payments to Government bond holders. Minor details 

aside, the Federal debt held by the public increases each year by 

the amount of that year’s unified budget deficit. Consequently, scenarios that project large deficits also project rapid growth in the 

outstanding Government debt. The higher levels of debt, in turn, 

imply increased expenditure on interest payments to bondholders 

which exacerbates the deficit problem still further. Thus, a vicious 

cycle may develop in which large deficits lead to rapid growth in 

debt and interest payments which, in turn, add to subsequent deficits. 

According to the CBO projection that I have been discussing, interest payments on the Government’s debt will reach 4.5 percent 

of GDP in 2030, nearly three times their current size relative to 

national output. Under this scenario, the ratio of Federal debt held 

by the public to GDP would climb from 37 percent currently to 

roughly 100 percent in 2030, and would continue to grow exponentially after that. The only time in U.S. history that the debt-to-GDP 

ratio has been in the neighborhood of 100 percent was during 

World War II. People at the time understood the situation to be 

temporary and expected deficits and the debt-to-GDP ratio to fall 

rapidly after the war, as in fact they did. 

In contrast, under the scenario I have been discussing, the debtto-GDP ratio would rise far into the future at an accelerating rate. 

Ultimately, this expansion of debt would spark a fiscal crisis which 

could be addressed only by very sharp spending cuts or tax increases or both. 

The CBO projections, by design, ignore the adverse effects that 

such high deficits would likely have on economic growth. But if 

Government debt and deficits were actually to grow at the pace envisioned by the CBO scenario, the effects on the U.S. economy 

would be severe. High rates of Government borrowing would drain 

funds away from private capital formation and thus slow the 

growth of real incomes and living standards over time. Some fraction of the additional debt would be likely financed abroad, which 

would lessen the influence on domestic investment. However, the 

necessity of paying interest on the foreign held debt would leave a 

smaller portion of our Nation’s future output available for domestic 

consumption. 

Moreover, uncertainty about the ultimate resolution of the fiscal 

imbalances would reduce the confidence of consumers, businesses, 

and investors in the U.S. economy with adverse implications for investment and growth. 

To some extent, strong economic growth can help to mitigate 

budgetary pressures and all else being equal fiscal policies that are 

96

supportive of growth would be beneficial. Unfortunately, economic 

growth alone is unlikely to solve the Nation’s impending fiscal 

problems. Economic growth leads to higher wages and profits and 

thus increases tax receipts, but higher wages also imply increased 

Social Security benefits as those benefits are tied to wages. Higher 

incomes also tend to increase the demand for medical services so 

that indirectly higher incomes may also increase Federal health expenditures. 

Increased rates of immigration could raise growth by raising the 

growth rate of the labor force. However, economists who have 

looked at the issue have found that even a doubling in the rate of 

immigration to the United States, from about one million to two 

million immigrants per year, would not significantly reduce the 

Federal Government’s fiscal imbalance. 

The prospect of growing fiscal imbalances and their economic 

consequences also raises essential questions of intergenerational 

fairness. As I have noted, because of increasing life expectancy and 

the decline in fertility, the number of retirees that each worker will 

have to support in the future, either directly or indirectly through 

taxes paid to Government programs, will rise significantly. To the 

extent that Federal budgetary policies inhibit capital formation and 

increase our net liabilities to foreigners, future generations of 

Americans will bear a growing burden of the debt and experience 

slower growth in per capita incomes than would otherwise have 

been the case. 

An important element in ensuring that we leave behind a stronger economy than we inherited, as did virtually all previous generations in this country, will be to move over time toward fiscal policies that are sustainable, efficient, and equitable across generations. Policies that promote private as well as public saving would 

also help us to leave a more productive economy to our children 

and grandchildren. 

In addition, we should explore ways to make the labor market as 

accommodating as possible to older people who wish to continue 

working, as many will as longevity increases and health improves. 

Addressing the country’s fiscal problems will take persistence 

and a willingness to make difficult choices. In the end, the fundamental decision that the Congress, the administration, and the 

American people must confront is how large a share of the Nation’s 

economic resources to devote to Federal Government programs, including transfer programs such as Social Security, Medicare, and 

Medicaid. Crucially, whatever size of government is chosen, tax 

rates must ultimately be set at a level sufficient to achieve an appropriate balance of spending and revenues in the long run. 

Thus, Members of the Congress who put special emphasis on 

keeping tax rates low must accept that low tax rates can be sustained only if outlays, including those on entitlements, are kept low 

as well. Likewise, members who favor a more expansive role of the 

Government, including relatively more generous benefits payments, 

must recognize the burden imposed by the additional taxes needed 

to pay for the higher spending, a burden that includes not only the 

resources transferred from the private sector but also any adverse 

economic incentives associated with high tax rates. 

97

Achieving fiscal sustainability will require sustained efforts and 

attention over many years. As an aid in charting the way forward, 

the Congress may find it useful to set some benchmarks against 

which to gauge progress toward key budgetary objectives. Because 

no single statistic fully describes the fiscal situation, the most effective approach would likely involve monitoring a number of fiscal indicators, each of which captures a different aspect of the budget 

and its economic impact. 

The unified budget deficit projected forward a certain number of 

years is an important measure that is already included in the Congressional budgeting process. However, the unified budget deficit 

does not fully capture the fiscal situation and its effects on the 

economy, for at least two reasons. 

First, the budget deficit by itself does not measure the quantity 

of resources that the Government is taking from the private sector. 

An economy in which the Government budget is balanced but in 

which Government spending equals 20 percent of GDP is very different from one in which the Government’s budget is balanced but 

spending is 40 percent of GDP, as the latter economy has both 

higher tax rates and a greater role for the Government. Monitoring 

current and prospective levels of total Government outlays relative 

to GDP or a similar indicator would help the Congress ensure that 

the overall size of the Government relative to the economy is consistent with members’ views and preferences. 

Second, the annual budget deficit reflects only near-term financing needs and does not capture long-term fiscal imbalances. As the 

most difficult long-term budgetary issues are associated with the 

growth of entitlement spending, a comprehensive approach to budgeting would include close attention to measures of the long-term 

solvency of entitlement programs, such as long-horizon present values of unfunded liabilities for Social Security and Medicare. 

To summarize, because of demographic changes and rising medical costs, Federal expenditures for entitlement programs are projected to rise sharply over the next few decades. Dealing with the 

resulting fiscal strains will pose difficult choices for the Congress, 

the administration, and the American people. However, if early and 

meaningful action is not taken, the U.S. economy could be seriously 

weakened with future generations bearing much of the cost. The 

decisions the Congress will face will not be easy or simple but the 

benefits of placing the budget on a path that is both sustainable 

and meets the Nation’s long-run needs would be substantial. 

I thank you again for allowing me to comment on these important issues and I would be glad to take your questions. 

Thank you, Mr. Chairman. 

[The prepared statement of Chairman Bernanke follows:]

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Chairman CONRAD. Thank you, Mr. Chairman. I think you have 

sent a very clear message and one that I hope people are paying 

close attention to. 

As I hear you describe it, we are on a course that is 

unsustainable and requires our action. Let me ask you this, last 

week I read in one of the major newspapers that deficits were at 


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1.8 percent of GDP and so not to worry, that is sustainable for the 

long-term. What would your reaction be to that notion? 

Chairman BERNANKE. Senator, the unified budget deficit is at a 

normal historical level, but other measures of the deficit would suggest a much more serious situation. For example, there are accrual 

methods of the budget deficit which incorporate increased obligations to Federal pensions, to veterans’ programs and the like, 

which show a much higher deficit. 

But in particular, as I mentioned in my remarks, the short-term 

unified budget deficit really has nothing to say about the long-term 

implications of our projected entitlement spending. And that’s why 

I suggested that, in making fiscal plans, the Congress should consider not just the current unified budget deficit, which is sort of a 

flow measure of current debt, but also measures of long-term solvency such as the present value of unfunded liabilities. 

Chairman CONRAD. If we were to put this in plain language for 

the American people, and you were asked how urgent is this situation? How urgent is it that we address these long-term imbalances, 

which as you describe could swamp the boat, could have very adverse affect on our economy if we do not take action. How would 

you rate the urgency of the need for a response by the Government? 

Chairman BERNANKE. Senator, one might look at these projections and say well, these are about 2030 and 2040 and so we do 

not really have to start worrying about it yet. But in fact, the 

longer we wait the more severe, the more draconian, the more difficult the adjustments are going to be. 

I think the right time to start is about 10 years ago. I think we 

are already well into the process of demographic change. The sooner we can make significant progress, the sooner we can begin to lay 

out a plan for dealing with these looming fiscal imbalances, the less 

the adjustment will be, the less the impact will be on the U.S. 

economy and the easier it will be for our fellow citizens to plan for 

their own retirements and for the welfare of their children. 

Chairman CONRAD. Another thing that is said to me very often 

is when Senator Gregg and I have made these presentations, people are watching on television. I have had people call my office and 

say senators, you are you are talking about projections. You are 

talking about projections for what is going to happen in 20 years. 

How can you have any confidence in those projections? Aren’t you 

being alarmist by suggesting that there is a big problem down the 

road? 

How would you respond to people who ask that question? 

Chairman BERNANKE. Senator, you are correct that the history 

of budget projections has not always been the most accurate. We 

have had big swings in recent years, of course. But with respect to 

the entitlement programs, I would make a couple of comments. 

First, the Social Security projections are based on very reliable 

estimates of where our population is going to be in 20 and 30 

years. We know what the population is going to look like because 

the people are already born. We know the composition of our population. We know how they are going to age. 

Chairman CONRAD. So that part of it is really not a projection 

at all? 

105

Chairman BERNANKE. That part of it is not particularly uncertain. 

On Medicare, there is more uncertainty, but I would note that 

some of the projections that are made are actually somewhat conservative in the following sense: an important assumption about 

Medicare projections is how quickly will medical costs grow. The 

standard assumption that is made by the Medicare Trustees is that 

medical costs per beneficiary will grow at 1 percent a year faster 

than the average per capita income. In fact, over the last three decades the cost of medical care has grown at 2.3 percent a year faster 

than average income. 

Consequently, to achieve even these very draconian outcomes 

that the Congressional Budget Office and the Medicare Trustees 

have presented, we would actually have to have a somewhat significant decline in the growth of medical costs. 

So it is certainly true that there is a lot of uncertainty, but there 

is very good reason to believe that unless very extraordinary 

changes occur in the cost of medical care, for example, these budget 

issues are going to be very large and very soon. 

Chairman CONRAD. If you would compare for us the challenge of 

Medicare versus Social Security in terms of the gap between the 

cost and the revenue associated with it, how would you characterize where the biggest part of the challenge lies? 

Chairman BERNANKE. Senator, as I just indicated, there is perhaps more uncertainty about Medicare than there is about Social 

Security. But the best guess estimates that the Medicare Trustees 

and others have put together put the very long run imbalances associated with Medicare on something of the order of six times the 

size of the Social Security deficit. So the Medicare issue is very 

large. 

I would add that to address the Medicare issue we are going to 

heed to think more broadly about our health care system overall—

about how to make it more efficient and how to control costs—so 

that we can deliver good medical care but without such a rapid increase in medical costs. 

Chairman CONRAD. The other thing I think that is important for 

us to address is what difference does all of this make? I am sitting 

out there in my living room watching this. You have these economists sitting around a table down in Washington talking about projections 20 years from now. How is this really going to affect my 

life? 

If you were to try to say to a person who might be watching out 

there, so what? So what if the Government runs a little bigger deficit? How is that really going to affect my life? 

Chairman BERNANKE. First, we are going to be seeing this impact on the deficit just a few years from now. It is not that far in 

the future. If the deficit begins to widen further, we are going to 

see more draining of funds away from capital formation. That is 

going to mean the economy is going to grow more slowly. It is going 

to mean that wages are not going to grow as fast because workers 

do not have as much capital to work with. It is going to mean that 

we will be borrowing more from foreign lenders and increasing our 

obligations to them. 

106

So it will soon have, even if there’s no change in fiscal policy, an 

effect on the vibrancy, the efficiency, the growth rate of our economy, which will be palpable and which Americans will see. 

Moreover, to the extent that Americans are counting, for example, on the current-law Social Security benefits and the current 

payroll taxes, they are going to have a surprise at some point because the two sides are not commensurate in the long run, and 

they are either going to be finding themselves with lower benefits 

at retirement than they expected or higher payroll taxes or some 

combination. And that is also going to affect them in a very real 

pocketbook kind of way. 

Chairman CONRAD. Thank you. I hope people are paying close attention. 

Let me just conclude on this question: how about tax cuts? In 

your judgment and the considered judgment of economists, do tax 

cuts pay for themselves? Do you get more revenue with a tax cut 

than you would otherwise have had? 

Chairman BERNANKE. The effects of a tax cut depend on the nature of the cut, the type of cut it is, and so on. I think the general 

view is that tax cuts do not usually pay for themselves. The fact 

that tax cuts can increase growth or increase the size of the economy means that they partially offset the revenue losses as a usual 

matter. 

But I think the issue with tax policy is not whether the tax cut 

pays for itself. The question really is what is the balance between 

taxes and spending that is right for our economy? We do not want 

to have wasteful spending because that requires higher taxes 

which are detrimental to economic growth. But important spending, spending we need to do, we are going to have to find a way 

to finance, and we just would like to find the best possible way to 

finance that that has the minimum adverse impact on our economy. 

Chairman CONRAD. Really the question here is one of balance is 

it not? If we are going to have a certain level of spending, we have 

to raise the revenue to pay for it. But we have to keep in mind 

when we are setting that level of spending that as we raise more 

and more revenue that has potential adverse impacts on our economic competitiveness, and on economic growth. That is really the 

kind of balance that you are talking about, is it not? 

Chairman BERNANKE. That is exactly right, Senator. 

Chairman CONRAD. Senator Gregg. 

Senator GREGG. Thank you. Picking up where the Chairman has 

left off, it comes to the question of the point I made in my opening 

statement. I happen to believe there are certain tax cuts which pay 

for themselves, capital gains, for example. Certainly, in the short 

run it pays for itself. 

On the reverse side of that, if you raise taxes to a level where 

you create a disincentive for productivity or a disincentive to do 

taxable activity or create an incentive for tax avoidance, because 

you are taking 60 percent or 50 percent or 70 percent of the next 

dollar earned, and people say they simply are not going to go out 

and be productive because they do not want to give the Government the 50, 60, 70 percent. Or they are going to invest in something that is arbitrary and capital flowed then becomes not more 

107

efficiently used but inefficiently used to try to avoid taxes, is that 

not the reverse? That you get tax burden to a level where it is 

counterproductive to the economy? 

Chairman BERNANKE. That is right, Senator. When you raise 

taxes, you almost always distort incentives. You create what economists call dead weight loss or loss of efficiency. One estimate that 

has been made is that for every dollar you raise in taxes you not 

only take a dollar from the economy but you create 20 cents of essentially waste associated with people not making the decisions 

they would have made in the absence of those taxes. 

That is not to say that you should not have taxes. You have to 

have enough taxes to fund your spending. It just says that as you 

think about the right level of spending in the economy, as Senator 

Conrad said, you need to take into account the full effects of those 

taxes on the broader economy as well as on the budget. 

Senator GREGG. I agree with that. And that gets to the point of 

what is the correct burden of the Federal Government on the economy which you have to fund? Looking at these charts, which your 

testimony was even more stark than ours, quite honestly, you are 

looking at numbers that are staggering, 45, 50 percent of GDP 

being used to support entitlement programs or Government spending, if you were to carry these numbers out. But even a conservative number gets you well over 20 percent, gets you up around 30 

percent with the present demographic situation. 

So let me ask you four questions, some of which are related and 

some which are not. The first, is there a range in which the Federal Government should find itself as taking a percent of gross national product? Today it takes 20 percent. It has been as high as 

22 percent historically. It has been as low as 18 percent. The revenues for the Federal Government have historically been about 18.2 

percent. They have been as high as 22 percent and they have been 

well below 18 percent, 16 percent. 

What is the range that is a reasonable number? And should we 

not back into what we are looking at as an entitlement or a Government burden from that range? That is the first question. 

The second question, I think you have focused on what is the essence of the problem for us, which is health care. Social Security 

can actually be fixed rather easily and the burden is not dramatic 

and we can do it. Health care is complex. GAO says it is $60 trillion in unfunded liability. Your number was, I think, $38 trillion. 

It is huge. 

Do you have some concepts as to how we approach the health 

care? Because that seems to be the gravamen of the question. 

On two ancillary issues, because my time will run out before you 

get to these—

Chairman CONRAD. Feel free to let him answer that. 

Senator GREGG. Let me just put these on the table. 

Can you give us your thoughts on hedge funds and monitoring 

hedge funds, and on capital markets and the risk of America losing 

its role in being the primary premier place where people come to 

raise capital? 

Thank you. 

Chairman BERNANKE. Thank you, Senator. 

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On the range of taxes, I should say now what I will probably be 

saying several times, which is I am here to try to give economic 

analysis and help as much as I can. The Federal Reserve, of course, 

is nonpartisan and does not make the value judgments that Congress has to make in the end. And so I am going to try to avoid 

making specific recommendations for tax or spending policies. I will 

just try to comment as an economist on what the issues are that 

you are raising. 

With respect to the range, the fact is that the share of Federal 

spending in the economy varies a lot across countries. There are 

countries in Europe, for example, that have much higher shares 

than we do. I think it is arguable that, for example, they pay some 

cost for that and it involves, for example, less hours of work in 

Western Europe, perhaps slower productivity growth. 

So I do not think there is a magic number. But when you think 

about the share of the economy that you take in taxes, and think 

about the structure of the tax system as well, which is also very 

important, you really have to make a tradeoff, a balance, between 

the cost that that imposes on the economy versus what you are 

paying for. 

So I am sorry that I cannot give you a magic number. I will only 

say that there is a difficult balance and is a variety of international 

experience. It is interesting to look at other countries and see how 

they have fared. But ultimately, it is up to the Congress, to make 

that judgment. 

Health care is an enormous topic and there are many issues associated with it. We have, in some ways, the best health care system in the world—in the sense that when it comes to a difficult 

procedure, this is where people come because we have the best 

technologies and the best hospitals, the best doctors. But we also 

have a very inefficient system in that the total cost we pay is much 

higher than other countries and, in many cases, we do not deliver 

as productively or as efficiently. 

Again it is a large issue. Some of the questions one might want 

to ask are the costs and benefits of, and how quickly we should try 

to move to, universal coverage. The benefits of universal coverage 

include better risk pooling and perhaps lower costs of uncompensated care and the like. But the cost of universal coverage is that 

we have to make sure that the poor and people with pre-existing 

conditions are able to buy insurance, and that can be very expensive. So there is a tradeoff. 

Another question that Congress has to face is, who is going to 

manage the health care system? Is it going to be the Government 

directly, as in the case in parts of Medicare? Will it be via the private sector, as in Medicare Advantage or Part D, where the Federal 

Government pays part but the private sector, private insurance, 

HMOs and so on actually manage the care? How will it be funded? 

There is a raft of questions. 

I think one thing that is encouraging to me, as a general matter, 

is that we are seeing a lot of experimentation: at the Federal level 

with Medicare, for example, and at the various States. We have 

seen a number of States which have tried new things, and I think 

we will learn from that. 

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But it is a very important matter, and we need to keep this front 

and center. 

I think that even beyond the issue of Medicare for Americans as 

a whole, the cost of medical care, the portability of insurance, the 

availability of insurance are very crucial issues for well-being. 

May I continue with your other questions, Senator? 

On hedge funds, the philosophy the regulators have taken since 

the President’s Working Group issued a report after the LTCM crisis in 1998 has been a market discipline approach. We have tried 

to discipline hedge funds not by direct regulatory oversight but indirectly, by making sure that the people they trade with, so to 

speak, have incentives to pay close attention to what they are 

doing. 

So in particular, the Federal Reserve and other bank regulators 

and the SEC work very hard to make sure that commercial banks 

and investment banks who are counterparties to hedge funds, who 

provide brokerage services to hedge funds, are doing due diligence 

to make sure that the hedge funds are operating in a way that will 

not pose excessive risk to those counterparties. 

Similarly, the SEC is working to make sure that investors in 

hedge funds have the opportunity and the incentive to impose discipline on those hedge funds, as well. 

That system has worked pretty well so far. I think it is always 

worth reviewing and thinking about how better to manage the system. But that is the general philosophy that we have taken in the 

regulatory community. 

On the capital markets competitiveness, again this is a very big 

issue. It is true, for example, that the number of initial public offerings taking place in U.S. markets has been much lower in recent 

years relative to capital markets in other countries. To some extent, that is simply a result of the fact that capital markets in 

other countries, the UK, in Asia and elsewhere, are growing and 

maturing, and it is natural that they would take over part of the 

business as they go forward. 

But we also have to look carefully to make sure that our regulatory regime, our broad set of laws and regulations, are not imposing undue burdens on American capital markets and U.S. corporations to ensure that there is a reasonable balance between the costs 

and benefits of those regulations. 

Senator GREGG. Thank you. 

Chairman CONRAD. Senator Sanders. 

Senator SANDERS. Thank you very much, Mr. Chairman. And 

thank you and the ranking member for holding this important 

hearing. Mr. Bernanke, thank you very much for your thoughtful 

comments. 

Mr. Bernanke, I would like to discuss with you three issues. No. 

1, do you have a concern about the growing income inequality in 

the United States of America today? The fact that we have by far 

the most unequal distribution of wealth and income of any major 

country on earth? The fact that the richest 1 percent own more 

wealth than the bottom 90 percent. That the richest 13,000 families earn almost income as the bottom 20 million American families. The fact that the middle class is shrinking, poverty is increasVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00115 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ing, while the gap between the rich and the poor grows wider? I 

would like to comment on that in a moment. 

My second question deals with the Federal deficit. We have had 

a number of record-breaking deficits, of course, in recent years. 

And you and the Chairman and ranking member have highlighted 

the long-term problems, which I certainly agree with. 

But in the midst of all of these deficits, the President of the 

United States has pledged to make all of his tax cuts permanent, 

including those to millionaires and billionaires at the time when 

the wealthiest people in America have never had it so good. Over 

the next four calendar years the cost of the tax cuts for the top 1 

percent of households with average incomes of over $1 million will 

total nearly $350 billion. 

If the President’s tax cuts are made permanent, households with annual incomes of more than $1 million, a group that comprises 

three-tenths of 1 percent, the wealthiest three-tenths of 1 percent 

would receive approximately $648 billion in tax cuts over the next 

decade. 

So my question to you is could you speak to us about the ‘‘wisdom’’ of the President’s policies of continuing to give mammoth tax 

breaks to the wealthiest people in this country who have never had 

it so good, and in the process significantly driving up our national 

debt? 

The third issue I would like you to comment on briefly is our 

trade policy. As you know, our trade deficit is on track to exceed 

$800 billion in 2006 and we now have a record-breaking $900 billion current account deficit. 

There are a number of us in Congress, I think a growing number 

of Americans, who are now catching on that our current unfettered 

free trade policy has not only been a disaster in terms of the loss 

of millions of good paying manufacturing jobs but it is a disaster 

in terms of long-term economic trends when you run up record 

breaking trade deficits year after year after year. 

In your view, given the fact that we have lost millions of good 

paying manufacturing jobs, given the fact that we may be losing or 

on the cusp of losing millions of good paying information technology 

jobs as a result of unfettered free trade, given the fact that our 

manufacturing base is virtually collapsing, do you think it is time 

to perhaps rethink the current trade policies that we have? 

Those are the areas that I would very much appreciate your commenting on. 

Chairman BERNANKE. Thank you, Senator. Those are all very important issues. 

On inequality, it is certainly true that the degree of inequality 

in our economy has been rising. It has been going on for a long 

time, and we now have greater income inequality than many other 

industrial countries. 

Senator SANDERS. Is there any other country in the world, major 

country? 

Chairman BERNANKE. There are some, but—

Senator SANDERS. Major countries? 

Chairman BERNANKE. Brazil. 

Senator SANDERS. OK, Brazil, yes. 

Chairman BERNANKE. I think it is an important issue. 

111

First of all, it is part, of the American ethos that we want everyone to have opportunity, economic opportunity, and a good economic standard of living. 

It is important also for political reasons in the following sense: 

our growth and our dynamism depend in an important way on the 

willingness of the general population to support flexible labor markets, for example, to support the effects of trade on the economy. 

If people are starting to believe that trade, for example, does not 

benefit them personally, then they may become less willing to support trade and that, from my perspective, is a concern. 

So it is a very large topic. I hope to give some remarks on this 

fairly soon about some of the causes and responses to it. 

Senator SANDERS. But it is an issue. The fact that we have such 

a huge gap between the rich and the poor and the—

Chairman BERNANKE. Yes, it is certainly an issue. It is something that would be good to address. 

I would just reiterate that it is a very long-term trend. It is not 

something that happened yesterday. And trying to understand it is 

something economists have been spending a lot of time on. It would 

be interesting to think further about it. 

On the Federal deficit and the tax cut, as I said, I am not going 

to support or defend or oppose specific tax or spending measures. 

With tax cuts you face the usual tradeoff: lower taxes tend to improve incentives and generate more efficiency and more growth. 

Senator SANDERS. But you just mentioned a moment ago, which 

I think most economists agree, that tax breaks do not pay for themselves. My question is if you give hundreds of billions of dollars in 

tax breaks to the wealthiest people who really do not need it, which 

drives up the deficit, I have a hard time understanding how that 

makes any sense at all. Can you help me on that? 

Chairman BERNANKE. To the extent that—and there is disagreement—but to the extent that the lower marginal rates create additional effort and additional work and additional productivity, additional innovation, they will create a broader growth in the overall 

economy. Maybe it is worth it. I am just saying there is a balance 

of issues here. On the one hand is the progressivity issue which 

you are referring to. On the other hand, is whether the tax code 

is promoting growth. 

May I suggest that there are many ways to increase progressivity. Another way to do it would be to broaden the base. There 

are a number of deductions, for example, exemptions and exclusions in the tax code, which are not capped and which benefit higher income people more than lower income people. That is another 

way to look at it. 

So there are many different ways to think about how to address 

progressivity. But in doing so you should think also about the implications for economic growth and efficiency. 

On the trade deficit, this ties in very well to the debate we are 

having today in this meeting. The fundamental source of our trade 

imbalance is that we, as a country, are saving much less than we 

are investing. Therefore, we have to borrow the difference abroad. 

Whereas other countries are saving more than they are investing 

and therefore they are lending to us the difference. That is the essence of the imbalance that we have in the world today. 

112

Senator SANDERS. Let us get back to the question, if we could, sir. We have an $80 billion trade deficit. We have lost millions of 

good paying manufacturing jobs, all of which leads myself and 

many millions of Americans to believe that NAFTA, PNTR with 

China, et cetera, et cetera, are not working particularly well for the 

American people. 

Comment? 

Chairman BERNANKE. I do not agree with that. I think that there 

are certainly people and workers who are displaced, who lose from 

trade. But broadly speaking, I believe that trade and openness are 

good for the economy. Trade creates broader opportunities for 

growth and investment. 

Senator SANDERS. We just have a limited amount, so forgive me. 

You are giving me the rhetoric. But the fact is you are concerned 

about deficits. That is why you are here today; right? 

We have an $800 billion trade deficit. Is that a concern? 

Chairman BERNANKE. The deficit we have been talking about is 

the fiscal deficit. 

Senator SANDERS. Well, but you have a trade deficit that is also 

of concern. 

Chairman BERNANKE. It is a concern, but I do not think it comes 

from our trade policies. It comes from our saving and investment 

policies. 

Senator SANDERS. You do not think our trade deficit comes from 

our trade policies? 

Chairman BERNANKE. No, I do not. 

Senator SANDERS. You do not think a $200 billion trade deficit 

with China and the fact that it is hard to buy an American product—

Chairman BERNANKE. The connection is very marginal. I would 

also like to say that I think it is really a bit of an exaggeration to 

say that the U.S. industrial base is decaying. In fact, we just got 

good industrial production numbers yesterday. The United States 

is the largest manufacturing country in the world. Our manufacturing output is growing. We have some of the best high-tech manufacturing industries in the world. 

The main reason that manufacturing jobs have declined so quickly is, perversely, because manufacturing has been so productive 

that firms have found ways to make do with fewer and fewer workers. And that has led to a smaller number of workers in manufacturing. But I do not think it is the trade issue. I think, in that particular case, it is the productivity issue. 

I do believe that the best way to address the current account deficit is for a balanced adjustment, for us to increase our saving, both 

at the household level and at the fiscal level, and for countries like 

China to increase—

Senator SANDERS. Is it not hard for the average household to increase their savings when, in many cases, the jobs they now have 

are paying lower wages than what they had 20 years ago? 

Chairman CONRAD. Let me just intercede, if I can. 

Senator SANDERS. Thank you, Mr. Chairman. 

Chairman CONRAD. We are a little past the Senator’s time. We 

will go back to another round. 

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

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Chairman CONRAD. We will go to Senator Allard. 

Senator ALLARD. Dr. Bernanke, welcome to the committee. 

I have always believed that there is a certain balance between 

the level of taxation and revenues. In other words, if you tax 100 

percent, you are not going to get any revenues to the Federal Government. If you do not tax anything at all, you are not going to get 

any revenues—but somewhere in between there is this balance. I 

think it is referred to as the Laffer curve. I would like to hear you 

comment a little bit on Laffer’s curve, if it plays in your thinking. 

I am interested to know whether we have the proper balance 

today and are maximizing revenues to government, whether it is 

Federal Government or State governments. If you look at what has 

happened in the last few years, it seems to me that it is working. 

But I would just like to get your perspective on that. 

Chairman BERNANKE. As I indicated before, the conventional 

wisdom among economists is that tax cuts do not necessarily pay 

for themselves. That is not really an argument against tax cuts. It 

is really a question of balancing the benefits of the tax cuts for the 

economy against the fact that you would have to reduce Government spending in the long run to get that balance. 

I think, in general, that it would be a good idea for us to look 

at the tax code, to ask ourselves whether there are ways of simplifying it, broadening the base, reducing complexity, reducing compliance costs, and maybe increasing collection that would allow us to 

get more revenue without greater burden on the economy. The tax 

code has become a very complex system, and I think periodically 

it makes sense for Congress to review it and try to find ways to 

improve it. 

Senator ALLARD. But do you worry, in general terms, about the 

level of taxation and the effect on the economy? 

Chairman BERNANKE. The message I am bringing today is only 

that there is a decision that Congress has to make about how big 

a government you want. Whatever it is, you have to pay for it. That 

is what I am saying. 

Senator ALLARD. But if you have 100 percent taxation, does that 

have an effect on the economy? 

Chairman BERNANKE. Of course. 

Senator ALLARD. Do you understand what I am trying to get at? 

Chairman BERNANKE. Let me try to respond. The Laffer curve 

idea is correct if rates are extraordinarily high. If rates are very 

high—if they are at 100 percent, 90 percent, so high that they essentially drive out the activity being taxed—then it is true that in 

that situation you could actually raise revenue by cutting taxes. 

That is correct. 

But I do not think—there may be differences of degree—that for 

our income tax system we are on that side of the Laffer curve. I 

think that where we are now, if we cut income taxes, we will probably lose some revenue. 

Again, that is not the key question. The key question is balancing the level of taxation and the implications of that for the 

economy against a level of spending that is appropriate and is really providing good benefits for the economy. That is the balance you 

have to think about. 

114

Senator ALLARD. It seems to me that when you look at the economic figures that we are looking at today, that you cannot be that 

critical of where we are today, can you? 

Chairman BERNANKE. The economy has recovered quite a bit 

from the 2001 recession and the weakness that we saw through 

2003. We have had a pretty good run in terms of growth and productivity. 

Senator ALLARD. Your predecessor, Dr. Greenspan, when he 

talked about trade he did not concern himself too much with trade 

deficits. You seem to be more concerned about the trade deficits. 

A question I have is does it really matter who purchases our 

Treasury certificates? In other words, who buys our debt? And if 

it does matter, does it make a difference whether it is domestically 

or internationally owned debt? 

Chairman BERNANKE. It makes a difference only in that if it is 

domestically purchased, then the interest on the debt will go to domestic people and be part of the domestic income. If it is purchased 

by foreigners, it will go to the foreign holders of the debt. 

The existence of foreign lenders, in the short run at least, is a 

good thing because it means that we can invest more than we otherwise could, given the amount of saving we have. So we want to 

invest more than we save. The only way to do that is to borrow 

abroad. 

The concern I have is that the current account deficit is now 

quite large and still growing. There is a good reason to believe that 

ultimately it needs to start coming down slowly. I think that fiscal 

policies that create better balance between taxes and revenues, between spending and revenues, have a lot of virtues in their own 

sake. But they would also, to some extent, contribute to bringing 

down that imbalance on the external side, as well. 

Senator ALLARD. The Bureau of Labor Statistics has recently introduced a new price index. They call it the chain CPI. I wonder 

if you would elaborate on that. They are claiming that that is more 

accurate than the current CPI that we are using today. I would 

like to hear your feelings on that new measurement. 

Chairman BERNANKE. Senator, yes, I think it is somewhat more 

accurate. The existing CPI, the one we are all familiar with, takes 

a fixed basket of goods and values the change in the cost of that 

basket from month to month, from year to year. 

The problem with that is it does not take into account the fact 

that as prices change, people will change the goods and services 

that they choose. If oranges become more expensive, I might eat 

more apples instead. 

The chain-weighted CPI allows, to some extent, for the adjustment that people make to go from higher priced goods to lowerpriced goods, and therefore is probably a better measure of the true 

cost of living increase than the standard CPI. 

Senator ALLARD. Do you think that the procedure that we are 

using now with CBO and OMB, that those projections overstate inflation? 

Chairman BERNANKE. Presumably, the projections they are making are in terms of what they think the standard CPI inflation will 

be. At the Federal Reserve, we have done numerous studies of 

these indices, and we do think, for example, that the standard CPI 

115

does overstate true inflation, if we could measure true inflation, by 

some amount between one-half and 1 percentage point. 

Senator ALLARD. Do you think with those agencies we need to go 

to the chain CPI to get a better result? 

Chairman BERNANKE. A really operational question one might 

ask is whether we should use the chain CPI or some other measure 

to index entitlement benefits and also to index the tax code. If your 

objective—as Congress—is to tie benefits payments and the tax 

code more directly to what I would call true inflation, you would 

have a more accurate measure of true inflation by using the chain 

CPI or some alternative measures. So that would be one consideration. 

Senator ALLARD. Thank you, Mr. Chairman. I see my time has 

expired. 

Chairman CONRAD. I thank the Senator, and I especially thank 

him for his question on the CPI matter because I think that is 

going to be an important part of the discussion here as we try to 

figure out a way to get this horse back in the barn. 

Senator CARDIN. 

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

Chairman, it is a pleasure to have you before our committee. 

I want to followup on the savings issue. We do talk a lot about 

the budget deficit and the trade deficit. We have a major savings 

deficit in this country. 

Although I am not really clear of the relationship between the 

savings deficit and the trade deficit, and I would like to explore 

that at a different time, I am very concerned about the savings deficit in this country. I think we all are. From an individual point 

of view, we know that individuals do not have enough put away in 

savings to deal with life’s circumstances. We are well below what 

economists say we should have for the purposes of individual security. 

This also adds to the wealth disparity in America. Those at the 

lower income levels save the least and are much more vulnerable. 

And it does put more pressure on us, in Congress, to deal with the 

entitlement programs. 

So for all of those reasons, it is important to increase the national savings rate and increase individual savings rates. And from 

a national point of view, our savings rates are very, very low. We 

do not have the amount of savings that are useful for investment 

in America and that makes it necessary for us to borrow capital 

from abroad. 

Now, one can argue whether our economy is hurt by our indebtedness to countries. But I must tell you because of the large sums 

borrowed from financial entities that are controlled by other governments that do not always agree with America’s foreign policy, 

I think there is also a security issue here that could compromise 

country’s independence. 

I have raised the issue of whether we really can challenge China’s monetary policies on how it ties its currency to ours. Are we 

truly independent on our challenges there, knowing how much capital is coming in from China to America today? 

So for all of those reasons, I think we need to improve our domestic savings rates. 

116

I know that you are reluctant to comment on specific proposals. 

We have passed a savers’ credit, which is targeted toward lowerincome people. There are efforts being made to increase the savers’ 

credit, to make it easier for lower wage workers to put money away 

for retirement. To the extent that that type of incentive increases 

savings by lower income people it seems to me, from your testimony, that would have a very positive effect on our economy. 

To the extent that we can encourage businesses to provide retirement plans for their employees, where they put some money on the 

table, workers are much more likely to participate in those plans. 

We know this from our experience, with the Federal Employees 

Thrift Savings Plan (TSP), which the Federal Government contributes to. 

Our savings rates are declining, the number of defined benefit 

plans is declining, and employer-sponsored plans are not increasing 

at the rate that all of us believe is necessary. 

So try to help me on this. I know you are reluctant to make specific recommendations, but the savings deficit, it seems to me, is a 

major problem for our economy. 

Chairman BERNANKE. Senator, first of all, I certainly agree with 

that. 

Senator Sanders asked about inequality. The inequality in 

wealth and savings is far greater than the inequality in income. I 

think it is a problem, both for individual families and for our economy as a whole. It has been a long-standing debate in the economic 

literature about how we can get people to save more. 

I think one promising direction which I will comment on, because 

the Congress has recently moved in this direction, has to do with 

ideas that have been developed in what is called behavioral economics, which is the idea of merging psychology with economics 

and using psychological principles. 

One of the results of those studies is that if people are told that 

they have a 401(k) plan at work and are asked whether they would 

like to contribute to it, they will say no. But if you deduct from 

their income as a default into their 401(k) plan and ask whether 

they want to opt out, most of the time they will not. So having an 

opt-out provision, which still makes it voluntary, actually seems to 

have some impact on saving behavior. 

So recently, in the Pension Bill, there were some provisions that 

made it easier for employers to do that. 

I think that is a promising approach and as you indicate, it could 

be extended. Even if there is not an employer match, it could be 

extended to people without 401(k)’s, either through work or 

through a government program, to allow people to have a tax-favored place to save. So I think that is one promising direction. 

The other approach that Congress has taken over the years is 

various kinds of tax policy, tax breaks and so on, for saving. IRAs 

are an example. Unfortunately, the evidence is really quite mixed 

on how well they work. For some people, having tax-free money in 

an IRA means they can save less or they can just move assets from 

somewhere else and put them into the IRA. There is quite a controversy about how much those sorts of measures help. 

So I think the two things that I would suggest—strangely for an 

economist—would be not the straight incentive measures but using 

117

these psychological methods to try to induce people to understand 

the importance of saving and to make them opt-out of some kind 

of plan. 

The other thing that is important, and the Federal Reserve is 

very involved in supporting this, is that people often just do not 

have the knowledge, the information, about how to invest even in 

simple ways, how to take advantage of the existing tax breaks and 

the like. So we, at the Fed, have worked very hard on financial literacy, for example, to try to get people to understand better what 

their options are. Obviously that is not a magic bullet, but to some 

extent that would also help people budget better and perhaps save 

more. 

Senator CARDIN. It is good advice. Financial literacy is one area 

where I think all of us can agree we have to do a much better job. 

One of the real concerns about the decline of defined benefit 

plans is they are generally better managed than an individual’s 

401(k) or their own defined contribution plans. The automatic enrollment feature, we will see how that works. I am very encouraged 

but I think you are right, I think that will help a great deal in encouraging participation. 

I would just emphasize that when an employer or the Government puts money on the table, individuals at all income levels are 

much more likely to take advantage of that. That is why anything 

we can do to encourage companies to provide pension plans for 

their employees is going to be helpful in increasing our savings 

rates. 

Thank you, Mr. Chairman. 

Chairman CONRAD. Senator Bunning. 

Senator BUNNING. The timing is too good. Thank you, very much. 

Chairman Bernanke, good to see you again. I congratulate you 

and the Fed in keeping interest rates where the American people 

can stand and the economy can prosper. I congratulate you, and 

that is not always the case. 

Current account deficits and things about the budget, I am more 

concerned about out-years, as you have mentioned. I think we will 

see our deficits and our continuing income be at higher levels than 

we anticipated as far as revenues to the Treasury. And therefore, 

the reduction short-term in the deficit will be positive. 

I am completely consumed by the fact that 2030, if we do not do 

something, that the three things called Social Security, Medicare, 

and Medicaid will consume the entire Federal budget. And therefore, we will not have a Defense Department, we will not have a 

Department of Labor, we will not have any other agencies of the 

Federal Government that can function. 

Do you, in your wisdom, see some way that we can manage that? 

Chairman BERNANKE. That is, of course, the question we are 

here to discuss. There are, for each of these programs, both revenue raising measures and ways of reducing expenditure. I would 

be happy to go over the list if you like. 

Obviously though, as I said before, I do not want to pick and 

choose. I think it is up to Congress to make those tough decisions 

about—

Senator BUNNING. We are in need of help. 

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Chairman BERNANKE. Just to take an example, Social Security. 

The major options on the benefit side, I think, are first changing 

the indexing formula. 

Senator BUNNING. The index as far as when a person can retire 

and the aging—

Chairman BERNANKE. No, I am referring Senator, to the way you 

calculate the initial benefit. Currently, the initial benefit is tied essentially to wages, which means that the replacement ratio, the 

share of wages, remains constant. 

Senator BUNNING. I understand. 

Chairman BERNANKE. The strongest measure, which was suggested by the recent Commission on Social Security, would be to 

switch to price indexing, which would keep the real value of the 

benefit constant but not the replacement ratio. That would solve 

the entire shortfall, as I understand. 

A second measure would be something along the lines of what 

Robert Pozen has suggested, the progressive indexing measure, 

which would keep the—

Senator BUNNING. I think Chairman Greenspan also agreed with 

it. 

Chairman BERNANKE. I am simply referring to some of the possible options here. That would keep the 30 percent lowest income 

people still indexed to wages, the very highest people indexed to 

prices, and those in between—

Senator BUNNING. Somewhere in the middle. 

Chairman BERNANKE [continuing]. On a sliding scale between 

them. That would also close a fairly substantial part of the Social 

Security shortfall. 

Increasing the retirement age gradually over time, particularly if 

you indexed the longevity subsequently—as life expectancies increased the retirement age would increase—would also reduce the 

long-term shortfall. 

Senator BUNNING. On the same scale as we are doing now, from 

65 to 67? 

Chairman BERNANKE. Yes. So increasing the retirement age to 

70 by 2029 would be another approach. Again, I am just listing 

possibilities. 

We mentioned earlier the chain weighted CPI. You could use 

that to index the benefits after retirement. That would provide a 

slightly smaller rate of increase in benefits. 

Senator BUNNING. How do we get around the promise that was 

made when people got into Social Security? How do you suggest 

that we tell the American people? Or do we set a date certain, say 

20 years down the road, all those who got into Social Security at 

age 20 who are now 40, when they become 50 will have to get a 

different rate of return on their Social Security? 

Chairman BERNANKE. Congress has made changes in benefits 

promises before. In the early years, the changes were mostly up. 

But in 1983, for example, following that commission, there were 

some changes down. 

Senator BUNNING. We were going to go busted, so is was easier 

then. 

Chairman BERNANKE. It is the same situation now; there are 

stresses on the system. 

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So just to be evenhanded, of course, the other side of the equation is payroll taxes. You could raise payroll rates under either the 

existing ceiling or you could raise the ceiling and the rates. So 

there are revenue side approaches, as well. 

Senator BUNNING. We did that on Medicare and unfortunately 

that is one of the things that is not going to pay its way. We uncapped Medicare completely. And unless we raise the rate as far 

as the tax is concerned, we will not successfully change the policy 

of Medicare going busted earlier. 

Chairman BERNANKE. That is right, Medicare is a much bigger 

problem than Social Security. And the Part A Trust Fund is 10 or 

15 years away from insolvency, as I recall. 

Senator BUNNING. That is correct. 

Chairman BERNANKE. So anyway, Senator, I am just listing a 

number of the possible options one could take. 

Senator BUNNING. Health care is another huge, huge problem 

that we are going to have to consider the fact that either we are 

going to have to lower benefits or share more of the cost with the 

employees and somehow pay the bill. The bill is getting to be a portion that we cannot pay federally. 

Chairman BERNANKE. There is an enormous impending imbalance in Medicare. One way, if I may kill two birds with one stone, 

is to think about reform of the entire health care system. There are 

a lot of things that could be done, I think, to make the health care 

system more efficient and to control costs. That, obviously, would 

be good for the entire economy, as well as provide benefits for the 

fiscal budget as well. 

Senator BUNNING. I think that is an answer, looking at the 

health care system in its entirety and making some new suggestions. 

Thank you very much. 

Chairman CONRAD. I thank the Senator. Senator Whitehouse. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. Welcome, Mr. 

Chairman, good to meet you. 

You opened your testimony, sir, with the description of the deficit in the unified Federal budget as $248 billion. We had Comptroller 

General Walker here just recently and he put that into the context 

of a number of different figures. He identified the unified budget 

deficit of $248 billion. He identified the on-budget deficit, setting 

aside the Social Security cash offset, of $434 billion. He calculated 

a net operating cost on an accrual basis for financial reporting of 

a negative $450 billion. And our Chairman indicated another measure, which was that the national debt increased by $546 billion. 

Among those four different measures of the fiscal slide that we are on, why is it that you picked the $248 billion number? 

Chairman BERNANKE. Senator, first, one of the themes in my testimony was that we need to look at multiple measures to really get 

a full picture of the fiscal situation. So I did mention that number. 

But in the next sentence I mentioned the on-budget deficit, which 

you are correct, is about $434 billion. 

You discussed the net operating costs, the accrual deficit, which 

is another interesting concept. I took it out of this draft for the following reason: the net operating cost which is now currently reported by the Department of the Treasury, which you correctly 

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point out is $450 billion, adds to the deficit the accrual of obligations to pensions for Federal employees, as well as certain veterans’ 

benefits. 

But in a sense it is really an understatement because it makes 

no provision for the increased obligations under the entitlement 

programs. 

The Governmental Accounting Standards Board is looking at 

ways to consider a net operating cost measure that actually includes, in addition, the obligations under entitlements. So as I 

mentioned at the end of my remarks, I think there are multiple 

measures to look at. The current deficit does say something about 

how much extra debt is being borrowed, how much extra debt is 

being issued to the general public, as opposed to the Trust Funds, 

for example. 

But the present value of the unfunded liabilities of Social Security and Medicare is a very important number and is indicative of 

the long run imbalance that we face. 

So what I was trying to argue is that to really understand this 

complex thing we call the Federal budget, you need to look at a 

number of measures. I would agree with what I think was implied 

by your question, that looking only at the unified Federal budget 

deficit, which is less than 2 percent of GDP, while of some interest 

for some purposes, tends to understate the severity of the fiscal 

problems that we face. 

Senator WHITEHOUSE. That was precisely my point. I appreciate 

it. 

Chairman BERNANKE. Including the entitlements. 

Senator WHITEHOUSE. The other point I wanted to touch base 

with you on is, as Senator Sanders asked you about, the increasing 

gap between the rich and the poor. I understand that in your response to him you indicated that you would be speaking more to 

this shortly. I would like to request that if your remarks to be delivered shortly on this do not address certain topics, if you could 

get back to me on them. 

It strikes me that there are secular causes related to the global 

economy for this shift. It is not that the rich have suddenly gotten 

smarter and more productive and the middle class has not. And so 

I would like to inquire of you what you think the secular forces are 

that are at work driving this gap? How bad it presently is compared to historical trends and norms? How urgent you feel it is 

that something be done about it? And what options that the Senate 

might engage in commend themselves to you? 

Obviously, that is a 30 minute speech so please do not feel 

obliged to answer me now. But I do want to lay those down so that 

when your remarks come up, if they do not answer that, you can 

respond. 

The last thing I would like to do is followup on what you said 

to Senator Bunning about the health care system. I could not agree 

with you more. I think our health care system is a nightmare. It 

is disastrous. And I think it would be a real tragedy if our Congress were to go out and reduce benefits and require people to pay 

more into this health care system without having taken the preliminary steps of doing our best to reform what is the most wasteful and extravagant system in the world. 

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And to the extent that you have folks at the Federal Reserve who 

are interested in working on that, I would love to be in touch with 

them, because I feel it is vital that we pursue this. 

Chairman BERNANKE. Thank you, Senator. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. 

Chairman CONRAD. I thank the Senator. 

I would like to go back to the question of health care because everybody on this committee recognizes, this is the 800-pound guerrilla. If we do not make meaningful progress there, frankly all the 

rest of what we do is not going to address this problem meaningfully. 

One of the things that I have tried to focus on is one statistic 

that I find especially powerful. Roughly 5 percent of Medicare beneficiaries use half the money. Five percent use one-half of the budget. They are, of course, the chronically ill. They have multiple serious conditions. 

We did a study with about 20,000 patients, I think it was 21,000 

patients. We put a case manager on every one of their cases to better coordinate their care. The first thing they did was go into their 

homes and get out all of the prescription drugs they were taking. 

On average, they found they were taking 16 prescription drugs. 

And after review, they were able to cut that in half. 

As a result of that effort and the others that were made to better 

coordinate their care, with this group they cut hospitalization 50 

percent. As a result, there were very dramatic financial savings but 

there were also better health care outcomes. People were healthier. 

I did this with my own father-in-law in his final illness. We went 

and got all of the prescription drugs out of the table, and he was 

taking 16. I got on the phone to the doctor and went down the list. 

About the third one the doctor said to me my god, Kent, he should 

not be taking that. He should not have been taking that the last 

3 years. A little further down the list, two drugs he was taking, the 

doctor said Kent, those two drugs work against each other. You 

should never be taking them together. 

I said doctor, how does this happen? It was very simple. He said 

he has four different doctors. He has a heart specialist, he has a 

lung specialist, he has an orthopedic specialist, he has me as his 

family practice doctor. All of them prescribing for him, none of 

them know what the other one is doing. He said he is getting prescription drugs from the hospital pharmacy, he is getting them 

from the corner pharmacy, he is getting them from the pharmacy 

at the beach, he is getting them mail order. He is sick and confused. His wife is sick and confused. And we have nobody, in effect, 

managing the case. 

He said I am supposed to be. I am his family practice doctor. But 

I do not know what the heart doctor has prescribed. I do not know 

what the lung doctor has prescribed. And of course, it is even more 

complicated than that because it was not just one heart doctor. 

There were three heart doctors. It wasn’t one lung doctor, there 

were several. 

Is this something you have looked at at all in terms of focus? 

Does it make sense to you that we further pursue this? What reaction might you give to this basic concept, that we have a small percentage of the population that is using most of the money? 

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Chairman BERNANKE. Senator, first, you have identified some 

important issues. It is the case, because of the conditions you referred to, that a large part of the money is used by a relatively 

small share of the population. 

I think the approach that this cries out for is what you might call 

integrated health care management, in which the health care of an 

individual is coordinated, their prescription drugs are coordinated, 

there is an overall evaluation in what that person is doing. 

From a policy perspective, though, there are some interesting 

questions about how best to achieve that. Let me give you three 

models. One model, which applies at least to some people, would 

be sort of consumer-directed, which says people are primarily responsible for themselves and their families. For people who are 

competent—who are not that ill or are relatively well-educated and 

so on—perhaps self-responsibility may be the right approach. 

For those who need more extensive management from professionals, there are two models. In one Government provides money 

but the patient chooses from a set of providers, HMOs or PPOs or 

other private-sector providers, whose profitability depends on their 

ability to manage the entire health care situation, including preventive care and so on. 

The last model is a Government provision system where again, 

if the Government is providing, it is important that there be serious attempts to make sure that provision is as efficient as possible. 

The kinds of things you are talking about, a caseworker or an integrated approach, would be important in that context, as well. 

Chairman CONRAD. Would it not be important that we have better case management, whatever model we adopt? That somehow, 

we have, especially with this chronically ill population, which tends 

to be older people with multiple serious conditions, somehow—although our health care system is exceptional in so many ways. 

You know, my grandfather was a doctor. He was the medical 

chief of staff of our hometown hospital. When people are ill in other 

countries, where do they want to go? They want to come here. 

It is also true we have by far the most costly health care. We 

here at 16 percent of gross domestic product now in health care. 

I think the next highest country is 11 percent. And that delta, that 

difference between 16 percent of GDP and 11 percent is $800 billion. 

So it would seem to me that whatever system we adopt, providing better case management is part of a more effective health 

care system. Does that strike you as accurate? 

Chairman BERNANKE. Yes. I might add that I think a very important element of that would be improving our health IT, information technology, system which I know is currently, to some extent, 

underway. But if a doctor could look online and see what prescriptions the patient already has and what their previous conditions 

were and so on, that would eliminate some of the problems that 

you are talking about. 

Chairman CONRAD. You know, I just held a health information 

technology summit in my State, with all of the major health care 

providers. One of the ideas that was presented there was a health 

passport, if you will. It would be a record that somebody could have 

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with them. It also be online at their doctors, that would have in 

a computer record all of the contacts with medical professionals. 

So that heart doctor would know what the lung doctor prescribed. The family practice doctor would know what the other doctors had prescribed. And not only meds that were prescribed but 

also tests that were given. I know my stepfather had, I think, three 

MRIs in the last year of his life, from three different sources. This 

is the kind of thing that really does explode cost without improving 

health care. In fact, it probably makes health care, certainly the 

comfort of the patient less. 

Let me ask one final question and that is the matter of the tax 

gap. We have not talked about that today. The Internal Revenue 

Service Commissioner came before this committee and testified the 

tax gap is now somewhere in the range of $350 billion a year, and 

that is based on an estimate. I happen to believe it is a conservative estimate, given how that estimate was arrived at. 

So if our tax system at current rates was generating the revenue 

intended, we would not have a deficit. The deficit would be eliminated. 

Any thoughts you have on this tax gap, the difference between 

what is owed and what is being paid? How we could better capture 

that revenue without a tax increase or a rate increase? 

Chairman BERNANKE. Senator, I agree that is a very important 

issue. You are never going to get 100 percent compliance but you 

could get better compliance. I think it is important not only for the 

revenue, as you mentioned, but also because our system is very 

much based on self-enforcement. People turn in their tax returns 

because they are basically honest and they think other people are 

doing it as well. If people have the sense that lots of people are 

cheating the system and are not paying their fair share, then they 

are going to be less willing themselves to pay their taxes. 

How to increase collection is a difficult issue. Let me raise one 

possibility that might be worth exploring. In the United Kingdom 

there is currently a paperless return system where it is possible, 

essentially through what is the equivalent of W–2 forms or withholding at the employer-level integrated with other types of income, that the tax obligation of the worker could be calculated essentially automatically, and there is no need for a form because 

there is no refund. Basically it is an exact measure. So it is a method of essentially automatic deduction. That would be one approach. 

Otherwise, it is difficult to say. I think some of the areas where 

the tax gap is larger, maybe small business and some others, pose 

some difficult problems in terms of collecting. People who have offthe-books income, things of that sort, so there are some difficult 

issues there. I do not think I have any really great suggestions. 

But to the extent that we can increase compliance, it would be 

good for the system as well as good for the revenue. 

Chairman CONRAD. Do you think we ought to consider tax reform 

as part of an overall effort here? One of the things that strikes me 

is we have a tax system that was largely devised in the 1930’s, 

1940’s, 1950’s, and we have a world that is fundamentally changed. 

One thing that has struck me is maybe we need to have, as one 

part of a strategy, a really thorough review of our tax structure 

and system, tax reform that could make collections more efficient, 

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more effective. And at the same time, strongly consider our economic position in the world and our competitive position in the 

world, because I am more and more convinced, as a member of the 

Finance Committee, that we really do not have a system that maximizes our competitive position. 

Chairman BERNANKE. I think there is a good case for looking at 

alternatives. We have a number of problems now, including the 

complexity of the system, the Alternative Minimum Tax, what are 

we going to do about that, and so on. 

I will say something that I hope will be uncontroversial, which 

is that the current tax code is very burdensome. Some estimates 

a few years ago suggested that the average taxpayer spends 27 

hours on their taxes every year and that the total cost of compliance, including the hours spent, is over $110 billion a year. You 

could think of that as part of the tax gap as well. If that cost could 

be reduced, you would be saving the economy a significant amount 

of money and perhaps making people more willing and able to comply with the law. 

Chairman CONRAD. Senator Gregg. 

Senator GREGG. I am interested to know why you think the markets do not factor in, it appears, the implications of the numbers 

which you have talked about here in the out-years relative to longterm debt? If I was buying long-term debt 10, 15, 20, 30 years out, 

I would sure want a much higher interest rate than what appears 

to be what the markets are demanding today. What are they assuming we are going to do that I am not aware of? 

Chairman BERNANKE. Senator, I think my predecessor commented also on this puzzle. Thirty-year bonds are paying interest 

rates not much more than 5-year bonds. 

Evidently either this is a trading phenomenon and the holders of 

the bonds are not really thinking about 30 years in the future, or, 

the other possibility, is that one way or another the bondholders 

do expect that Congress will take whatever measures are needed 

to ensure that the bonds are paid off and that it is done in the context of price stability. 

Senator GREGG. Which gets me to my second point which you alluded to, price stability. One way that this has been handled in 

other economies has been to inflate the economy. How do we avoid 

that? 

Chairman BERNANKE. The Federal Reserve is independent and 

the Federal Reserve will follow its mandate and ensure that prices 

remain stable. 

Senator GREGG. That is comforting. 

Chairman BERNANKE. Thank you. 

Senator GREGG. On the issue of tax reform, do you believe a consumption tax is a vehicle that we should be looking at? And if you 

do, how do you avoid the inherent problems which come from putting that sort of an engine on the government and causing the government to just explode in size? 

I come from a State that has neither a sales or an income tax. 

We look at our neighbors in Vermont and Massachusetts, where 

our neighbors were told that if they just put in a sales tax their 

income taxes would go down. What they found is that their governVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00130 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ment just got a heck of a lot bigger and their income taxes stabilized for a few years and then started going back up. 

Chairman BERNANKE. Senator, as you know, I cannot really endorse a particular approach. But I will say a word about feasibility, 

which is that consumption taxes can be implemented lots of different ways. One way is through a value-added tax, which a lot of 

European countries use. Another way is through a retail sales tax. 

A third way would be through a saving exemption approach where 

you look at your income at the end of the year and you document 

how much you have saved and that part is deductible. That essentially becomes a consumption tax. 

So there are a number of ways to move toward a consumption 

tax, and so I do not think the feasibility is really the issue. I think 

the issue is whether it produce a more efficient economy. In addition, since wealth is unequally distributed and the higher income 

people are much more likely to have capital income, could we structure a comsumption tax in such a way as to maintain the degree 

of progressivity that we would like to see in the tax system? 

Senator GREGG. Of course, the response to that is that wealthy 

people buy a lot more, so they would pay a lot more in taxes if you 

had a consumption tax. 

But in any event, thank you for your answers. Thank you for 

being here today. I especially appreciate your opening statement. 

I think it was absolutely correct, right on, and a clarion call that 

I hope some folks will listen to. We are certainly going to try to be 

an echo chamber for you. 

Chairman BERNANKE. Thank you for the opportunity. 

Chairman CONRAD. Senator Bunning has a followup. 

Senator BUNNING. I just want to find out if somebody has questioned you about PAYGO? Has anybody here questioned you? 

Chairman BERNANKE. No, sir. 

Senator BUNNING. The Senate PAYGO point of order has existed 

in some form since 1993. The PAYGO point of order currently in 

place stems from the 2004 budget resolution and makes it out of 

order to consider legislation that would increase the deficit by more 

than the amount of the deficit increase, if any, assumed in the 

most recent adopted budget resolution. 

From 1990 to 2002, under statutory PAYGO, any deficit increases that were enacted were added together and put on PAYGO 

scorecards. At the end of the year any balance on the scorecard 

were supposed to be reduced by a sequestration. However, no sequestration has ever occurred, despite large PAYGO balances. 

The original purpose of this mechanism was to encourage Congress and the president to only enact changes to mandatory spending and revenues which were offset so as not to increase the deficit. 

Question: do you think that PAYGO point of order is an effective 

budget enforcement tool? Or does it merely exist to replicate other 

budget enforcement tools that already exist? 

Chairman BERNANKE. Senator, these parliamentary rules that 

have been set up to try to address deficits are very complex. And 

as you point out, their efficacy depends on a lot of things, including 

how willing the membership is to following through. I do not really 

have the expertise to advise on the types of rules, PAYGO and others, for addressing budget issues. 

126

I think the comment I would like to make is one that I made in 

my opening remarks, which is that I do think, from an economic 

perspective, that it is useful not to focus too much on a single 

measure of fiscal stability but to look at a number of different 

measures including, for example, the share of total spending in the 

economy and, very importantly, given the discussion we have had 

today, the long-run solvency of the entitlement programs. 

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

you, Chairman Bernanke. 

Senator CONRAD. Thank you, Senator. 

Again, Mr. Chairman, thank you very much. We promised to get 

you out of here by noon. We will be good to our word and get you 

out even a little earlier. 

We very much appreciate the constructive testimony you have 

provided here. And we hope people are listening about the need for 

us to address these long-term imbalances, to take these challenges 

on, and the sooner we do so the better. 

Thank you, sir. 

[Whereupon, at 11:50 a.m., the hearing was concluded.]

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THE GROWING TAX GAP AND STRATEGIES 

FOR REDUCING IT 

TUESDAY, JANUARY 23, 2007

U.S. SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to notice, at 10:05 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of the committee, presiding. 

Present: Senators Conrad, Wyden, Stabenow, Menendez, Lautenberg, Cardin, Sanders, Whitehouse, Gregg, Grassley, Allard, and 

Crapo. 

Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 

Staff Director for the Minority. 

OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

Chairman CONRAD. The committee will come to order. 

I want to thank members of their participation today. I want to 

especially thank the panel that we have, really three excellent witnesses. Robert McIntyre, the Director of Citizens for Tax Justice, 

good to see you again. Michael Brostek, the Director of Tax Issues 

for the Strategic Issues Team of the Government Accountability Office, the GAO. John Satagaj from the Small Business Tax Compliance and Fairness coalition, welcome. Good to have you here, as 

well. 

The hearing this morning is about the growing tax gap and strategies for reducing it. The tax gap, as we all know, is the difference 

between what is owed and what is actually being paid. And we now 

know that, according to the Revenue Service, the tax gap is running at about $350 billion a year. Let me repeat that. The tax gap 

is estimated by the Revenue Service to be $350 billion a year.

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That is money that should be in the coffers of the Federal Government, according to existing tax law. We are not talking about 

a tax increase here. We are not talking about increasing any rate. 

We are talking about collecting the money that is due and owed 

under the current law. 

The tax gap, I believe, is unfair to the vast majority of taxpayers 

who pay what they owe. We know that the vast majority of Americans do pay their taxes. The vast majority of companies pay what 

they owe. But we have a growing number of both individuals and 

companies that do not. 

Unfortunately, our Nation’s budget picture is not good. As we see 

on the chart, last year the deficit was $248 billion but the debt rose 

by $546 billion. 

While increased spending has contributed to the deficit and debt, 

the dramatic decline in revenues has been an even larger factor. 

In fact, real revenues—that is adjusted for inflation—have experienced little growth since 2000, as we see in this chart. It is true, 

and my colleague will perhaps reference, that the last several years 

we have seen healthy growth in revenues. But if we go back to 

2000, we see that we are only now getting back to the revenue base 

we had then. 

That brings us to our hearing today on the tax gap. The growth 

of the tax gap is one of the factors contributing to the revenue drop. 

According to the IRS’s latest estimate, the tax gap in 2001 was 

$345 billion for that year alone. To put a $345 billion tax gap in 


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some perspective, considered that it is almost $100 billion larger 

than the size of the entire deficit in 2006.

While we will never be able to close the tax gap entirely—and 

make no mistake, we understand we are not going to collect all 

$345 billion a year, there is always going to be some tax gap—but 

it is clear that much more can and should be done.


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In testimony before this committee, the IRS Commissioner stated 

‘‘You can clearly reduce the tax gap $50 billion to $100 billion a 

year without changing the way the Government interacts with its 

citizenry.’’ In other words, we can close a considerable amount of 

the gap without resorting to draconian or intrusive measures.


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It is important to remember that the added burden placed on 

taxpayers from the tax gap is very real. In her 2006 annual report 

to Congress, the National Taxpayer Advocate wrote, and I quote, 

‘‘Compliant taxpayers pay a great deal of money each year to subsidize noncompliance by others. Each household was effectively assessed an average surtax of about $2,680 to subsidize noncompliance in 2001. That is not a burden we should expect our Nation’s 

taxpayers to bear lightly.’’


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To close the tax gap, we need to enhance reporting and withholding requirements for certain taxpayers. We know that taxpayer 

compliance improves dramatically with increased reporting and 

withholding. For example, according to the revenue service, for income that is subject to substantial reporting and withholding requirements such as wages and salaries, we see a 99 percent compliance rate. When reporting requirements are in place we see a 91 

percent compliance rate. But when there is neither, we see a sharp 

drop in the compliance rate, falling to less than 50 percent.


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The other way to close the tax gap is through better enforcement 

by the IRS. In his testimony before the Budget Committee last 

year, the IRS Commissioner noted that the IRS yields approximately $4 in revenue for every additional dollar spent on enforceVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00143 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH

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ment. We simply cannot bring the budget back to balance by looking only at spending, although he must certainly do that.

In my judgment, we cannot do it solely on the spending side even 

with entitlement reform which is absolutely required. There is also 

going to have to be additional revenue. And I would strongly prefer 

that instead of talking about tax increases, that before we start 

talking about tax increases for anyone, we aggressively go after 

this tax gap. It is only fair and, I think, right. 

With that, I turn to my colleague, Senator Gregg. 

OPENING STATEMENT OF SENATOR JUDD GREGG 

Senator GREGG. Thank you, Mr. Chairman, and I want to congratulate you. These first series of hearings that you have held 

have really been right on and they have been addressing issues 

which are critical to our Nation’s economic health and social health 

and our cultural health. This is another one in that series and I 

thank you for holding this hearing. 

This has been an issue that you have talked about a lot over the 

years. And in response actually to your concerns in the last budget 

which we put together—which you regrettably did not vote for, and 

I cannot understand why—we did put in the reserve fund in order 

to fund the IRS to assist them in collecting more money to get 

some of those revenues back that you have reflected in your statements. 

And so I am in total agreement that this is a critical area of 

need. 

I would also like to cite the fact that I do disagree with your 

characterization of revenues as they are presently coming in. I 


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want to congratulate the former chairman of the Finance Committee who is with us today and a member of this committee, for 

having put in place a tax law which has allowed us to generate 

massive increase in revenues as a result of economic activity in this 

country. 

Over the last 3 years, we have seen some of the biggest revenue 

growths in the history of the Nation. Historically the Federal Government has taken 18.2 percent of the Gross National Product in 

revenue. We are now over that number. We are up to about 18.5 

percent of Gross National Product. So we are generating more revenues than we have historically generated. Obviously, not enough to 

close the gap because spending is above where it should be. 

But in addition, the tax laws under the leadership of Senator 

Grassley have become more progressive. The top 20 percent of 

American taxpayers today on the income tax side bear about 85 

percent of the tax burden. Under the Clinton years they bore about 

82 percent of the tax burden. The bottom 40 percent of income 

earners in this country today do not pay taxes but they receive income back under the Earned Income Tax Credit and other benefits 

which actually is double what they received during the years of the 

Clinton Administration. 

So we actually have a more progressive system while generating 

more revenues. That is the good news. I think it is because we 

have incentivized the market. We have said that we are going to 

say to people who are job creators, we are going to give you an incentive to go and create jobs by being more productive by having 

a reasonable tax rate on capital formation. 

Obviously a difference of opinion there, but I believe—I wanted 

to make the point that I wanted to make relative to the fact that 

revenues are up. 

But they could be up further through the collection of taxes that 

are presently owed. That brings us to this hearing. It is an issue 

which is a difficult issue. We can increase IRS support and the 

IRS, in return for that, says they can get us more revenues, maybe 

somewhere between $50 billion and $100 billion can be collected 

simply by having a more aggressive stance from the Internal Revenue Service and giving them the funds to accomplish that. 

But that does not really get to the underlying issue which is the 

tax gap that is over $350 billion or in that range, which is a big 

number. And that really comes back to the structure of the tax 

laws itself, in my humble opinion. We have a tax law that is incredibly complex, massive in size, nobody understands it. After finishing law school I went back to school for 3 years and got a graduate degree in tax policy and taxation, and I do not do my own 

taxes because it is too complex. It is just not a system that encourages efficiency. 

A lot of this failure to comply is not intentional. It is simply that 

the laws are so complex. Some of it is intentional, obviously, there 

is an underground economy. But a lot of it is just simply that the 

law is so complex. 

So we need to take another look at our tax structure and come 

up with something that is more manageable, more understandable, 

and therefore more enforceable. I think the Chairman has pointed 

out that when you have an enforcement mechanism which is easily 

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put in place, such as a payroll tax deduction, you get a high percentage of compliance. But when you do not have that enforcement 

mechanism because you have an economy that is outside of that capacity to collect, you do not get the percentage of participation you 

should. 

So I think we need to look at tax systems which will allow us 

to get a better percentage of return for taxes that are owed. And 

that is something I hope we will discuss in this hearing. 

But in any event, I certainly appreciate the Senator holding this 

hearing and I look forward to hearing from our witnesses. 

Chairman CONRAD. Thank you, Senator. 

We will go to the witnesses now. Mr. McIntyre, welcome. It is 

good to have you before the committee once again. Please proceed. 

STATEMENT OF ROBERT S. McINTYRE, DIRECTOR, CITIZENS 

FOR TAX JUSTICE 

Mr. MCINTYRE. Thank you. 

Senator Conrad and members of the Budget Committee, I am 

Bob McIntyre and I direct Citizens for Tax Justice, which is a tax 

policy and research group that fights for a fair tax system for middle income families all over the country, Federal, State and local. 

I have been doing this for 30 years. 

Today we are talking about something that is an important piece 

of our tax puzzle, and that is the fact that we are not collecting 

taxes from a lot of people who should be paying them. You can 

look, as Senator Conrad pointed out at how serious our budget deficit problem is, how much we have been borrowing. In fact, over 

the last 5 years we have funded 25 percent of our Federal budget 

outside of Social Security with borrowed money, which is just staggering. And that was after balanced budgets in the years before 

that. 

We know why that has happened. Income tax revenues have 

gone through the floor. They were more than 10 percent of the 

GDP in fiscal 2000. They have averaged 7.3 percent over the last 

5 years, which is a 28 percent drop. 

Now we have had a minor improvement lately. Income taxes are 

only 25 percent below where they were in fiscal 2000. That is the 

problem. Now we are not going to solve that problem while George 

Bush is president because he would veto any attempt to repeal his 

tax cuts. We know that. 

But Republicans and Democrats and President Bush, a Republican, must be able to agree that ought to collect the taxes that are 

due, that people who are cheating on their taxes should not be allowed to do so. If we cannot agree on that, well, my. 

So what can we do? Let us talk about the tax gap, the nature 

of it. The IRS has a figure. It is not a very reliable figure. It is 

based on very old data or very incomplete research. They say the 

net figure is about $300 billion after they have collected $50 billion 

or so from catching people. 

But it is bigger than that, in my view, because they do not count 

all of this offshore tax dodging because they do not know about it. 

They do not count all of these corporate tax sheltering deals because they do not know about them or do not know enough about 

them to measure. So it is really an even bigger figure than that. 

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Those are the things that are doing the most damage right now to 

our tax system, in my view. And that is what my written testimony 

focuses on, and that is what I want to focus on in my few minutes 

today. 

As Senator Conrad pointed out, we have a country of honest 

wage earners. They pay their taxes. Maybe not because they are 

morally superior but maybe because their income is known to the 

IRS. There is information reporting, there is withholding, and that 

works. 

But when you get to the kinds of income that the IRS does not 

know about, whether it is capital gains or business profits that 

there is no paper trail that goes to the IRS, then we have a problem. The people who have these kinds of income are not all a bunch 

of crooks. Some are. But they all need help. They need our help to 

pay their taxes honestly and be good patriotic Americans, like I am 

sure they all want to be. 

So how can we help them? Well, we need to get rid of the secrecy 

as much as possible so that there is a paper trail to the IRS, so 

that the IRS knows about these kinds of income. You can do some 

of it with 1099s. You can do some of it with agreements with other 

countries, which is a huge problem, so we get information from 

them. We have a long list in our testimony of proposals that get 

into that area. 

We also need to clarify the law. We have laws against most of 

these offshore tax cheating activities. But arguably they are not 

completely clear. And if you are a lawyer, everything is arguable. 

I went to law school, too. 

We need to make it completely clear so that people do not have 

a leg to stand on when they get into these deals. That means that 

the people who are advising them, the lawyers, the accountants, 

the investment bankers, will be in serious trouble if they help them 

out in these schemes. So clarification is a good thing. 

Penalties would also be a good thing. I know we have been increasing penalties. They are obviously not high enough because the 

chances of being caught are so low. Penalties on the advisers, even 

more penalties, would be a good idea. 

Finally, we need to give the IRS the resources it needs. The IRS 

has been cut back and cut back, so now the number of people who 

are devoted to examinations are down by almost one-third since 10 

years ago. That is a huge problem. 

Let me just say that this may sound easy and I am implying it 

is easy, that everybody ought to agree. But there is a lobby that 

does not agree and they have a lot of power. You could argue that 

the House Ways and Means Committee for the past 6 years has 

been a wholly owned subsidiary of the major accounting firms. 

Every attempt by the Senate to crack down on cheating has been 

resisted in the House up until now. I do not think that is going to 

be the case anymore. 

But there is an organized Tax Cheaters Lobby. It is financed by 

the banks, the accounting firms, and the lawyers who offer this 

kind of advice. They have front groups. One of them is called the 

Center for Freedom and Prosperity, a grandiose title. But I prefer 

to call them all Tax Cheaters Lobby because that is more intelligible. 

142

Fortunately, there are a lot of people, in the Senate, in particular, who have been leading the fight in the other direction, and 

that is the good news. Carl Levin and Norm Coleman over at the 

Investigations Subcommittee. Byron Dorgan, your colleague from 

North Dakota who has been fighting against corporate and offshore 

cheating since he came to Congress. Senator Grassley, who as Senate Finance Committee Chairman has helped exposed some of 

these terrible abuses, and proposed legislation—and occasionally 

adopted legislation—to try to crack down on it. 

So these are the people you should be looking to once you give 

them the mandate do something about it. 

In my testimony, I have a lot of details about going after offshore 

tax evasion. 

There are a lot of little things you can do and there are two big 

ones. One big one is to get the tax haven countries to disclose what 

is going on with our citizens. The only way you are going to do that 

is to have pressure on them so that, for example, if they do not disclose, our banks cannot talk to them, cannot send any money to 

them. They are out. They have to disclose. 

The Cayman Islands, by the way, is worried about that enough 

that it is starting to think about giving us some serious disclosure. 

The problem in the world is if you have just one tax haven country, 

you are up the creek because that is where the money will go. So 

we need to go after them all. And we need to get the European 

countries to work with us on this. They are dying to do it because 

they have the same problem we do. 

We see some of our celebrities moving their money offshore. The 

Levin-Coleman hearings found three people that were moving billions of dollars offshore. Well, the British have the same problem. 

The Rolling Stones and Bono have moved their song writing royalties to the Netherlands, which does not tax royalties. Their tax rate 

on billions of pounds has been 2 percent. So we need to work with 

the rest of the world on this. 

I see my time is up but finally, the IRS. If you could phase in 

a doubling of their enforcement budget over the next five or 6 

years, the returns would be enormous and it would get us back on 

the right path. 

Maybe you need to change the budget rules. After all, if the IRS 

was treated like any other agency, it would have offsetting receipts. 

OK, we spent $11 billion, our offsetting receipts were $2.2 trillion—

do you see what I am saying? 

Why do they not get treated that way? The National Park Service gets to count the fees for going in to the parks? The National 

Taxpayer Advocate has suggested something along these lines. 

Really, it is kind of wacky that you should freeze the IRS budget 

when it costs you 10 times or 15 times what every budget cut that 

you put in saves. 

So those are my recommendations. I have a long piece of written 

testimony and I thank you for the opportunity to be here. And I 

am sorry I went over a minute. 

[The prepared statement of Mr. McIntyre follows:]

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Chairman CONRAD. Thank you very much for your testimony. 

Mr. Brostek, welcome. I should indicate once again, Mr. Brostek 

is with the General Accounting Office, who have studied this issue 

in some detail. We welcome you to the committee. 


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STATEMENT OF MICHAEL BROSTEK, DIRECTOR, TAX ISSUES, 

STRATEGIC ISSUES TEAM, GOVERNMENT ACCOUNTABILITY 

OFFICE 

Mr. BROSTEK. Thank you, very much. 

Chairman Conrad, Senator Gregg, and members of the committee, I am pleased to participate in the committee’s hearing 

today on approaches to reducing the tax gap. 

My statement discusses the need for multiple approaches to successfully reduce the tax gap, including the importance of quality 

service to taxpayers and then covers potential reductions in the tax 

gap that could ensue from simplifying or reforming the tax code, 

providing IRS more tools to deal with noncompliance, and dedicating more resources to enforcement. 

Before I address the approaches for reducing the tax gap, perhaps it would be useful to explain a little more about what the tax 

gap entails. The tax gap, as was mentioned, is the difference between the tax amounts that taxpayers voluntarily and timely pay 

and what they should pay under the law. The tax gap covers the 

individual and corporate income taxes, employment taxes, estate 

taxes and excise taxes. Individual income taxes have the largest estimated gap, about $244 billion out of the total gross gap of $345 

billion estimated by IRS for tax year 2001. 

For each type of tax there can be three different kinds of noncompliance: under reporting of income, under payment of taxes 

that are owed, and non-filing of returns. Of these, under reporting 

of income is by far the largest noncompliance issue with an estimated $285 billion of the total gap attributed to under reporting 

of income. 

Under reporting of income includes not only the direct failure to 

report income that was earned, but also such things as over claiming deductions and credits that offset income. 

In summary, the tax gap is a persistent problem and, as the saying goes, we will keep on getting the same result—an unacceptable 

gap—if we keep on doing the same things. We need to try new approaches. We need to make greater use of current effective approaches. 

While simplification, more tools, and more resources all have the 

potential to help reduce the tax gap, using multiple approaches is 

likely to be the best strategy. No one strategy is likely to fully and 

cost-effectively reduce the tax gap, for example because the gap has 

multiple causes, spans differing types of taxes, and differing types 

of taxpayers. 

Providing quality service is a necessary foundation to achieving 

high levels of compliance. IRS taxpayer services includes such 

things as education and outreach programs, simplifying tax processes, and revising forms and publications to make them electronically accessible and more easily understood by the taxpayers. Quality services can help those who wish to comply but do not understand their obligations, and such services are also needed if other 

approaches are taken to reduce the tax gap. 

For example, even if we simplify the tax laws, as has been suggested, IRS would need to have an outreach program to educate 

taxpayers about those changes and to answer questions that would 

undoubtedly come from the taxpayers. 

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In addition to quality service, a few of the following things are 

also important to tax gap reduction. We need to periodically measure noncompliance and its causes, set tax gap reduction goals, consider the cost and burdens associated with various efforts to reduce 

the tax gap, evaluate the results of any initiatives that are undertaken so we know what works, optimize IRS’s internal allocation 

of resources, and leverage technology. 

Turning to simplification or tax reform, there is no reliable estimate of the degree to which simplification could reduce the tax gap. 

Nonetheless, one indication of the potential is that IRS estimated 

a revenue shortfall of $32 billion occurred in 2001 due to errors 

that taxpayers made in claiming various tax credits, deductions, et 

cetera. Over the decades, the tax code has layered on more and 

more special tax provisions with the number of tax expenditures, 

as they are called, like credits and deductions doubling in number 

between 1974 and 2005. By making the rules across differing tax 

provisions more uniform, by merging multiple related provisions, 

and by deleting provisions that may not be accomplishing their intended purpose at an acceptable revenue cost, the tax code could 

be simplified. And if so, both intentional and unintentional errors 

should decline. 

Further, to the extent that tax simplification reduces errors, IRS 

would be able to relocate its resources to focus on more problematic 

areas of noncompliance. However, of course, each tax code provision 

was created for a purpose and simplifying the code is likely to be 

challenging. 

Tax reform also has the potential to reduce the tax gap, but it 

is most likely to be effective if any reformed system has few, if any, 

tax preferences and importantly, taxable transactions are transparent to the tax agency. These characteristics are difficult to 

achieve and, to my knowledge, all tax systems have some sort of 

tax gap. 

Tax withholding and information reporting are among the most 

powerful tools for promoting compliance. If we can spread these 

tools across more types of income that are the major contributors 

to the tax gap, substantial tax gap reductions are likely. Our recent 

work suggests that requiring information reporting on the basis for 

security sales like stock transactions has the potential to improve 

compliance with capital gains reporting. Importantly, a key additional benefit would be less taxpayer burden to understand and 

comply with the complex basis reporting rules. Additional opportunities for withholding and information reporting exist for payments 

to independent contractors and for payments made to corporations 

for services they provide to businesses. 

Finally, devoting additional resources to enforcement has the potential to reduce the tax gap by billions of dollars. In part, devoting 

greater resources to enforcement could reduce the gap because 

every year IRS identifies far more cases of probable noncompliance 

than it can possibly address. How much the tax gap could be reduced if IRS resources were increased would depend on a number 

of things, including importantly information. Which taxpayers are 

noncompliant? Why are they noncompliant? And what amount of 

tax noncompliance can be corrected for a given dollar of additional 

investment in IRS resources? 

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We and others have frequently called for improved information 

like this to ensure sound management of IRS’s limited resources. 

In part, this is why we have encouraged IRS to undertake compliance studies like the National Research Program that resulted in 

this most recent tax gap estimate. 

As a caution, if additional resources are devoted to enforcement, 

returns on that investment are likely to lag as IRS hires and trains 

new personnel. In the past, hiring initiatives generally have reduced revenues in the initial year because new agents tend to be 

less productive than experienced agents, and IRS uses experienced 

agents to train the new agents which reduces the experienced 

agents’ productivity. 

Also, several years tend to lapse between the assessment of taxes 

and the collection of those taxes. For instance, in a 1998 study we 

found that 5 years after taxes were assessed against individual taxpayers for business income, 48 percent of those taxes had been collected. 

This concludes my oral statement. I would be happy to answer 

any questions. 

[The prepared statement of Mr. Brostek follows:]

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Chairman CONRAD. Thank you, very much. 

Next we will turn to Mr. Satagaj from the Small Business Tax 

Compliance and Fairness Coalition. Welcome. 


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STATEMENT OF JOHN SATAGAJ, SMALL BUSINESS LEGISLATIVE COUNSEL, SMALL BUSINESS TAX COMPLIANCE AND 

FAIRNESS COALITION 

Mr. SATAGAJ. Good morning. My name is John Satagaj. I am 

here on behalf of the Coalition for Fairness in Tax Compliance. I 

co-chair this with my colleagues at the National Federation of Independent Business and the U.S. Chamber of Commerce. 

Bob above mentioned that he has been doing this for 30 years. 

Mike was telling me he has been at GAO 30 years. I have been 

doing small business 30 years. So you have a lot of experience before you. 

It reminded me, when Bob started his remarks, it is all about 

perspective. He started out his comments about we are a Nation 

of honest wage earners. I think of us as a Nation of small businesses and entrepreneurs taking risk, creating jobs, and signing 

the paycheck of those wage earners. So my perspective on this 

comes from that perspective, that of those small business that are 

creating those jobs. We have a few points. 

Our coalition is not anti-tax gap. We are here to find solutions 

to this. But it is important for us that several things happen. No. 

1, we have the proper research to understand what the problems 

are. Mike has mentioned some of the problems that we have there. 

That we find reasonable solutions, the ones that do not create 

burdens, that respect the complaint taxpayer. Do not forget, most 

of this money is coming in a voluntary system and people are compliant. So what we do cannot hurt the compliant folks. So we have 

to remember those things as we move forward on this. 

And as we look at what we need to do, you will find out, as Mike 

as already mentioned, we are failing to get the research done that 

we need to understand what causes the tax gap, why people are 

not reporting their income. Tax gap studies started in the 1960’s. 

I think GAO published the first report in the 1970’s. You can look 

at everyone of those reports, and I guarantee you almost every one 

of them says the same thing about we do not have enough research. 

It is easy to paint this with a nice broad brush. Tax gap, one solution fits all. It does not work that way. When you get below that 

level, it is hard to figure all of those disparate and discrete areas, 

that are the problems in the tax gap and understanding then. Let me give you one quick example, sole proprietors. We say $68 

billion comes from the folks that fill out their 1040, attach a Schedule C and have business income. 21 million taxpayers are sole proprietors. 13 million of them have $25,000 or less on that Schedule 

C. 

What is the problem? Some folks say let us do withholding. 21 

million taxpayers, withholding tomorrow. There is one big question, 

if you are going to do withholding, that no one can answer for me. 

How many of those 21 million do business primarily with consumers? If you do business primarily with consumers, I ask you, 

who is going to impose withholding, telling the consumer by the 

way, when you do business with X, withhold $20 from them? We 

cannot answer that very fundamental question. 

No. 2, if you are going to have a reasonable burden on those folks, on the 21 million, if 13 million of them do $25,000 or less, 

178

you are going to have to look pretty carefully at what you impose 

on them in order to get any sort of revenue. Even if they are the 

worst tax cheats in the world and they are only reporting half of 

their income, that is still a $50,000 business. That is a very small 

business we are talking about here. So you are challenged to come 

up with a solution. 

First, we need the research. Second, we need reasonable solutions that are directed to the problem. And until you understand 

what the problem is, you are not going to come up with a solution. 

Next, about respect. It is easy, and we know how it is here, particularly when we are talking about public policy as opposed to the 

compliance at the IRS. The tax gap. We are going to use the tax 

gap at least 20,000 times in this Congress to pay for something. 

The important thing is that when we work on the tax gap, let us 

be honest with the taxpayers and work on tax gap initiatives, not 

on something that is used for another purpose. 

A good example of one that has already spun out of control in 

the last Congress, Government contractors’ withholding. The notion 

was there was a problem there. Well, now all Government contractors have a 3 percent withholding on them. That spiraled right out 

of control right from the very beginning. 

There are going to be proposals that people are going to say we 

want to use it for PAYGO. But you know what, they are going to 

call it tax gap closing. And I guarantee one that is going to be 

called that way, a proposal to repeal LIFO. It came up in the last 

Congress and I bet it will come up in this Congress as a PAYGO 

for something. And somebody is going to get up on the Senate floor, 

one of you is going to say, you know what, let us close the tax gap 

and repeal LIFO. LIFO is a legitimate concern. If you choose to 

look at that, look at it for that purpose. But do not call it tax gap 

closing, because it is not tax gap closing. There are honest taxpayers out there who have been relying on this for years in order 

to do this. 

What we need to do is get the research, get the reasonable results, and let us respect the compliant taxpayer in the process. 

A couple of last things—

Chairman CONRAD. Maybe I could just stop you on that point because I am sure there are people who are listening who wonder 

what is LIFO about? That is last-in first-out accounting for inventory. 

That is important to say to people who might be listening and 

wondering what is about. 

Mr. SATAGAJ. Good point. And it is one that obviously is allowed 

under the tax code. 

Chairman CONRAD. I think we should make very clear, you are 

right, that does not have anything to do with the tax gap, because 

that is in law. What we are talking about here is people who are 

not obeying the law. 

Mr. SATAGAJ. Exactly. And that is my point exactly, is that we 

need to have the discipline. When we are talking about the tax gap, 

let us stay focused on the tax gap and respect the compliant taxpayers. 

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The last point I would like to make is about the size of the tax 

gap. Bob started out by saying it was $345 billion. It could be bigger. 

I started out $345 billion, it is actually $290 billion. It is smaller 

because there is a net amount that you could collect $55 billion 

really is a timing issue and so forth. So it is actually smaller than 

the $345 billion from a starting point then we discussed there. 

So in conclusion, we are here to work with everybody. We want 

to work with all of you here on Capitol Hill, in Congress, work with 

the GAO. We have met numerous times already with the IRS and 

Treasury looking at identifying the research that we need, what 

kind of solutions we can come up with that meet those things. 

We can do this, but there is no short-term solution and this is 

not going to happen overnight. It is going to take a lot of work on 

all of our part. 

Thank you, Mr. Chairman. 

[The prepared statement of Mr. Satagaj follows:]

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Chairman CONRAD. Thank you, Mr. Satagaj, and thank you for 

those constructive thoughts. 

Just on the question of how big the tax gap is, I believe it is 

much larger than $345 billion because I have looked into how they 

made the estimates. And I do not want to bore people with the details of how that was done. But I think honestly if you evaluate the 


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way they made the estimates, the likelihood is the tax gap is substantially bigger. 

First of all, that is a number from 2001. We are in 2007. If we 

look back historically, we have seen that the tax gap has grown inexorably and, in fact, has exploded in recent years. 

Second, if you talk to people in the accounting profession, they 

will tell you that what we call aggressive accounting has increased 

geometrically. That is because of competitive pressures, accounting 

firms have become much more willing, if not eager, to engage in 

very aggressive accounting practices with respect to taxes that are 

due. 

Let me just go to the question I would ask each of you. If you 

could give two ideas that would make a meaningful difference with 

respect to the tax gap, what would they be? Mr. McIntyre? 

Mr. MCINTYRE. Well, if I only had two things, No. 1 would be to 

get more information from the tax haven countries about our people and corporations who have activities there or pretend to have 

activities there. 

And second, a very substantial increase in the IRS budget for enforcement. 

Chairman CONRAD. All right. Mr. Brostek? 

Mr. BROSTEK. I would first encourage more information reporting. Although I do not have a laundry list of things that would necessarily bring $300 billion down to zero, if we get information reporting on various types of income, it will achieve high levels of 

compliance, as we have seen. 

I would also look for opportunities to simplify some of the complex provisions that help people who would like to cheat figure out 

ways of doing so and that confuse honest taxpayers. 

Chairman CONRAD. OK. Mr. Satagaj? 

Mr. SATAGAJ. There are two things. One is taxpayer education. 

We started on a road in 1998 to encourage better education and 

outreach to the community. If you work with small businesses, you 

know it is hard work to get the message out. You have to repeat 

it time and time again and over and over. And we are still not 

reaching the level we can. We can do better on that. 

Tax simplification, of course, is a way I believe that we can get 

more folks in there because there are still is a lot of folks who say, 

you know what, this is too complex and I am not doing the job. And 

so I think those two things could go a long way to helping us. 

Chairman CONRAD. Let me ask you this question, and ask each 

of the witnesses. How about tax reform? We have a tax system that 

was largely constructed in the 1930’s, the 1940’s, and the 1950’s. 

The world has changed. We have, I think, what is clearly a growing 

tax gap which raises questions about the efficiency of the underlying system. How much emphasis would you put on fundamental 

tax reform in order to achieve a result? Mr. McIntyre? 

Mr. MCINTYRE. If we could take the tax system back to say 

where it was—at least on the base—after the 1986 reform act, that 

would help a lot. Since then we have added all kinds of new special 

tax breaks, made the tax forms finer and finer print to fit because 

of all of the extra lines. And that has annoyed the honest taxpayer 

and created opportunities for those who would like to be less than 

honest. So that would help. 

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But perhaps most important about that kind of a tax simplification reform effort would be to correct a growing problem. You have 

the IRS running half of the Government these days, it seems like. 

Health care, education, savings policies. They have to do all of 

these things. That is not what they are supposed to be doing. It is 

not what they are trained to do. They are supposed to be collecting 

revenues fairly and efficiently. If they could get back to their real 

job, they would do a much better job of it. 

Chairman CONRAD. Mr. Brostek, what would you say about this 

question of tax reform as an essential component? 

Mr. BROSTEK. I do believe that tax reform should be part of the 

strategies that are pursued for reducing the tax gap, in part because if we are able to make the code simpler, reduce the number 

of credits and deductions and exclusions from income, we can have 

lower tax rates. And the lower the tax rate is, the less incentive 

somebody has to escape taxation. It would also help us raise revenues efficiently in the economy. 

I would also point out that tax reform is not necessarily synonymous with high levels of compliance. One of the things that is 

sometimes thought about when tax reform is discussed is moving 

to a consumption tax. Consumption taxes can have high levels of 

noncompliance, as well. The National Audit Office in the U.K. has 

estimated that their value added tax has had a tax gap of about 

15.7 percent. That is roughly what we have in this country. 

So reform itself can be helpful, but it is how that reform is done. 

We really need to have transactions transparent to the tax administrator in order to have tax reform work well. 

Chairman CONRAD. Mr. Satagaj? 

Mr. SATAGAJ. I have already tipped my hand because I mentioned tax simplification as one of the ways I think we do a better 

job, and that is fundamental to tax reform. I think you do have to 

be a little careful of the difference between tax reform and tax simplification. 

As Mike has already pointed out, you can get tax reform without 

actually simplifying. I think the important point is the comfort 

level of the taxpayer has to be high enough, whatever system you 

have, that they are willing to be compliant at the levels that they 

are currently compliant. 

Chairman CONRAD. Let me just say on the point that Mr. McIntyre made, we have a building down in the Cayman Islands, one 

building, a five-story building, that is the home to something like 

8,000 companies. 

Senator GREGG. Do you have a picture? 

Chairman CONRAD. I do, it is on its way. 

This building is home to some 8,000 companies all claiming they 

are doing business out of that building. I have said it is the most 

efficient building in the world, a very modest building. But an 

amazing amount of business activity out of that building. 

I think, Mr. McIntyre, you have hit on something here with respect to information from tax haven countries. There is tremendous 

leakage in those countries. When I was tax commissioner in my 

State, and for a time the chairman of the Multistate Tax Commission, I followed the transactions of one multinational corporation 

and found that in the sale of grain, that grain had changed hands 

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eight times before it left this country and then went offshore. The 

last I was able to follow it, it was down in the Cayman Islands, 

selling from one company to another. It was amazing, no taxes reported in this country, and although they showed tremendous profits in the Caymans, no taxes there because they did not have any 

taxes. 

I found that when I was tax commissioner, one oil company that 

showed losses at every step of the marketing chain in the United 

States, showed huge profits in the Cayman Islands with one employee. Millions of dollars in profits because that is where they 

showed all of their profits. 

Actually, that man is really a hard worker. He is down there producing millions of profits when thousands of employees in the 

United States produced none. 

Look, these are scams that are being run that are really unfair 

to the vast majority of people who are honest. I think, Mr. Satagaj, 

you said it well. The fact is most people, I think a significant vast 

majority of Americans, pay what they legitimately owe. Companies 

pay what they legitimately owe to the extent they understand it. 

But there are a group out there, and unfortunately I think it is 

a growing group, who think they can get away with murder. And 

they are shoving the burden onto all of the rest of us. 

Senator Gregg? 

Senator GREGG. Thank you. 

Picking up on that note, obviously better transparency as to what 

is happening offshore would be very useful. But it does require an 

international effort. I think Mr. McIntyre made that point. If we 

do it unilaterally we actually end up disadvantaging ourselves in 

the international trade. So it has to be done with the Europeans 

and with the major economies in Southeast Asia. But it should be 

done, I am 100 percent in agreement with that. 

I also have some horror stories I could relate that I am familiar 

with, as to people avoiding taxes by using those shelters. 

So I think that is something that can be done. This committee 

does not have jurisdiction over that, but it should be done. 

Something else that could be done is better reporting basis on 

capital assets. I think that is clearly some direction we are moving 

into and it clearly should occur. 

I am interested, however, in this question which you have pointed out, Mr. Satagaj, that is basically that unless you have the system that people have confidence in is fair and understandable, you 

are never really going to get compliance. This goes back to the 1986 

act which has been highlighted here as an example of an attempt 

to make our system fairer and more level, in which a lot of deductions were eliminated in exchange for reducing rates. 

I guess I would ask whether or not people think that is a template that we should return to? It has been 20 years since the 1986 

act, and we have now recluttered the code with all sorts of new deductions for purposes which are outside the intention of raising 

revenue. 

That initiative, in 1986, I was on the Ways and Means Committee. It was a bipartisan initiative led by Chairman Rostenkowski and the President, with the Congressional leaders being 

Jack Kemp and Bill Bradley. I guess the question is should we reVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00195 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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turn to that sort of a really major effort to reduce the underbrush 

and the tax laws and get back to rates that are simpler but collect 

more revenues because there are fewer deductions that are being 

used for the purposes of avoiding taxes? 

Mr. MCINTYRE. I am obviously for it. 

Senator GREGG. That is great. I am impressed that your organization would be for that. I think that is very positive. 

Mr. MCINTYRE. I just want to point out that in 1986 we played 

a major role in getting that bill through the Congress with the 

studies we did exposing the kinds of tax avoidance that got the 

public exercised and got President Reagan on board, as a matter 

of fact, according to his Treasury Secretary at the time. 

So yes, 1986 was the right direction. It had one flaw which was 

easily corrected, that it did not raise enough money to pay for the 

Government. But that is just a rate issue. That is what we need 

to do, establish a tax base like 1986, with rates sufficient to pay 

for what we spend. What we spend and what we take in are obviously two important questions. But whatever you decide to spend, 

you ought to pay for it. 

Senator GREGG. Mr. Brostek? 

Mr. BROSTEK. I think that broad template is quite reasonable to 

return to. It is not that there cannot be legitimate tax deductions 

and tax credits. There can be things that are done well and efficiently through the tax code. But we certainly think that the 

growth of these special provisions ought to be reviewed. And we 

ought to make sure that the provisions we have are accomplishing 

a purpose at a reasonable revenue cost. 

Mr. SATAGAJ. Obviously, I agree. One of the important things, 

though, is you have to decide—which is just what Mike said. You 

have to decide what is the purpose. Not a purely neutral system. 

But our current tax code does have some purposes and we reward, 

for example, home ownership as important. And if you go into a tax 

reform debate, you need to decide that. Are we going to accomplish 

some goals in addition to just raising revenue? 

And that is the big challenge of sorting that out. Once you get 

that decision made, it becomes a little easier how or where you go. 

But the notion that you are just going to do this to raise revenue, 

I do not think, is an acceptable starting point. 

Senator GREGG. I appreciate all of your comments. I would like 

to see us move in that direction. 

Another ancillary point that has been made here is the accounting firms. We are down to four major accounting firms in this country, and that has been a function really of reform. We have essentially reformed our way out of accounting firms and competition 

amongst accounting firms, and therefore we do not have any accounting firms left. 

I guess my question would be to you, do you think having more 

accounting firms and some competition there would create a better 

atmosphere? Or are four major firms doing all of the audits in this 

country the way to do it? 

Mr. SATAGAJ. I will wear my entrepreneurial hat. I would like to 

see more small accounting firms. I think obviously that small businesses—are not going to the big firms anyway. They need good accounting advice and so I think it would be very helpful. 

191

We have talked about it. Commissioner Everson has been very 

aggressive in a lot of areas as it relates to tax shelters and the like. 

We have a lot of work being done in that area. But it is what we 

do with the small businesses and the advice we give them that I 

think is important. And I think some more activity in that area is 

a plus in my book. 

Mr. MCINTYRE. It would be nice to have some more accounting 

firms that were less ethically challenged than the current four. 

Senator GREGG. I would be interested in your thoughts on how 

we do that in the context of today, when you require size in order 

to basically meet the amount of compliance that we put on these 

firms. 

I guess my last question would be in the context of the 1986 act, 

was the Breaux-Mack Commission, did they put forward some 

ideas that would lead to some better compliance? Or do you reject 

their ideas? Because that is the most recent major tax commission. 

Mr. MCINTYRE. They had some fundamental problems. They had 

a $7 trillion add-on to the deficit over the next 10 years. But beyond that, on the international area they said they were going to 

make it harder for the IRS to get compliance. So I was very disappointed in that effort, as well. It was not that fine of a piece of 

work, in my view. 

Mr. SATAGAJ. I do actually. Chairman Rossotti was on that commission, as well. There is actually a large small business component to what they proposed. And intriguingly, it actually promotes 

more of a cash accounting system but it provides incentives to go 

to that. And it is a little bit about the transparency. 

I think those of us in the small business community, maybe we 

would be willing to give some more transparency in return for 

something that makes our life easier. If you could get to cash accounting and in return you did have to make some more transparency, that would be good. 

A lot of folks do not look at the small business proposal in the 

Breaux-Mack Commission’s work. But there are some interesting 

thoughts about how you work with the small business community 

to make it simpler but more transparent. 

Senator GREGG. Thank you. 

Chairman CONRAD. Given the number of senators here, we are 

going to go to 5 minute rounds to accommodate as many Senators 

as we can. 

Senator WYDEN. 

Senator WYDEN. Thank you, Mr. Chairman. This has been an excellent panel. I have been particularly pleased because, having introduced the fair flat tax reform which modernizes the 1986 act by 

closing loopholes so that you can lower rates, I have been really 

pleased with the response that you all have given this morning. 

Ever since I introduced that legislation, when witnesses show up 

they all say we ought to try to update the 1986 kind of concept. 

But gosh, everyone says it cannot ever be done. The newspaper reporters are always describing it will not happen, this is a lonely 

crusade that this fellow from Oregon has taken on. 

What I found striking this morning is you all have given us a 

way to jumpstart the effort to close the tax gap and also do tax reform. And that is through tax simplification. 

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There have been 15,000 changes in the tax code since the last reform. It comes to three for every working day over the last 20 

years. People spend more to fill out forms than our Government 

spends on higher education. 

I have a one page 1040 form with 30 lines in my Fair Flat Tax 

Act. Senator Gregg mentioned the Breaux-Mack Commission. 

Their’s is about seven lines longer. For purposes of Government 

work, it is a no-brainer to put the two of them together. 

I just want to go down the row and ask, we can start with Mr. 

McIntyre, would it not make sense to come out of this hearing and 

say the next step that could promote common ground—and I note, 

Mr. McIntyre, you have been trying to do that with your cleanse 

the code effort, and I have been glad to be part of it—would it not 

make sense to come out of this effort and say let us go now to tax 

simplification and use it to jumpstart a real plan to close the tax 

gap and to reform our tax law? 

Let’s start with you. 

Mr. MCINTYRE. I am certainly in favor of the outlines of your tax 

reform plan. I have a couple of quibbles, but very few. So if we 

could find a way to move that forward, and if this was a good way 

to make that happen I would be in favor of it. 

My big caveat is I cannot figure out how any good tax reform 

could be signed by the current president of the United States. So 

it makes me very nervous that we would end up with something 

bad. 

Senator WYDEN. I told the President that another tall Democrat 

on the Senate Finance Committee named Bill Bradley wanted to 

work this out, as well. My jump shot is not as good as a Bradley’s, 

but I still think the spirit of 1986 can be replicated. 

Mr. MCINTYRE. There is one difference. When Ronald Reagan 

read our corporate studies, finding out that General Electric, his 

former employer, was not paying any taxes, he was appalled and 

said, ‘‘do something about it.’’ When we put out our most recent 

corporate study, saying that under President Bush’s policies 82 

companies out of 275 were paying nothing at all, Bush’s people 

said, ‘‘is it only 82?’’

Senator WYDEN. Mr. Brostek, on starting this with tax simplification, what is your reaction to that? 

Mr. BROSTEK. I think that is a good strategy for starting to try 

to address the tax gap. 

Senator WYDEN. Very good. 

Mr. Satagaj, I was really pleased to hear your comments today 

on tax simplification, because I know, having worked with my 

small business community, that people are just fighting for survival. And so the inclination is to always kind of tinker with the 

code a little more. But I gather you would be comfortable with that 

simplification, as well. 

Mr. SATAGAJ. Simplification, my caveat is the one I said a few 

moments ago, you have to buy into a purpose of what you are going 

to do with the tax code. That is far more difficult. It is nice to look 

at the 1040 and the lines and stuff like that. But if you look, for 

example, at the rest of the recommendations of the President’s Advisory Group, there is a lot of complexity behind that, particularly 

193

on the business side. It is not just a little form to fill out. There 

are a lot of decisions that go behind that. 

So is a far more difficult challenge than getting a little consensus 

that it is time to clean up. It is getting the consensus on the purpose that is far more important. 

Senator WYDEN. Mr. Chairman, I would just note that a number 

of us here serve not just on this committee but on the Finance 

Committee. Given the number of witnesses that constantly come up 

and say you have to drain this swamp, I think we need to do something. One member of the Senate Finance Committee told me, ‘‘I 

do not really know about your bill as it relates to every provision. 

But after 20 years, this has just gotten out of hand. We have to 

cleanse the code.’’

And I hope, Mr. McIntyre, that your group, the Cleanse the Code 

Coalition, can really get out and prosecute the case about what we 

can do in this country by cleaning out some of the clutter, getting 

more transparency, closing the tax gap and jump starting us to real 

tax reform. 

I commend all three of you for an excellent presentation. Mr. 

Satagaj, I am going to be back at you specifically about my legislation. 

Mr. SATAGAJ. I look forward to it. 

Senator WYDEN. I thank you. 

Thank you, Mr. Chairman. 

Chairman CONRAD. Senator Wyden. 

I would like to take this moment to indicate that I am going to 

form at least two working groups of the Budget Committee, one on 

health care and one on this whole issue of tax gap tax reform. I 

am going to ask, on the health care piece of it, that Senator Wyden 

and Senator Whitehouse lead that effort. I am going to ask, with 

respect to that tax reform piece of it, that Senator Wyden and Senator Stabenow be involved with that. I would welcome the interest 

of other members on these two committees. And I am going to indicate that there will be others that we will form. 

The magnitude of the challenges that we face are so large that 

I think we have to establish some working groups of smaller members of the committee to come back to the full committee with specific proposals. I have had long discussions with Senator 

Whitehouse and Senator Wyden on the whole question of the 

health care piece of it. I know that Senator Wyden has been especially engaged in that issue, as well as the tax reform. I do not 

know if it is fair to burden with asking you to also be involved on 

the tax reform piece. 

And Senator Stabenow, you are a member of the Finance Committee. I hope that you would be engaged in that effort. 

We will ask Senator Grassley to be involved on the other side 

with the tax reform pieces, the ranking member of the Finance 

Committee. On health care, we will ask members on both sides 

who is willing to put in additional time with respect to those 

issues. 

But I think it is absolutely urgent that we come back with specific proposals and that is what I am going to be asking these 

working groups to do. 

194

These will not be the only, there will be a number of other areas 

that we need to address as well, and we will be talking about those 

in the coming days. 

Senator Allard, thank you for your patience, sir. 

Senator ALLARD. Thank you, Mr. Chairman, and thank you for 

setting up this panel. 

In this discussion, I think the assumption is that the IRS is the 

perfect agency and they do not make mistakes and some of the 

things that they deal with are ignored, as far as performance is 

concerned. 

I do not know whether anybody on this panel has looked at the 

business system modernization that has been going on at the Internal Revenue Service. But what I see in looking at what shows on 

paper is that that particular program is not meeting its performance goals. The President, in the last budget, actually had decreased its funding because it was not meeting its performance 

goals. 

Can either one of you comment on the purpose of that particular 

program, and whether it is working from your perspective or not? 

Mr. SATAGAJ. Actually, I am glad you brought that point up because earlier when the Chair asked for a couple of suggestions on 

how to close the tax gap, I had a third. One of them is the problem 

in the IRS with its ability to accomplish anything with the information it currently has. For example, if you get into the 1099s and 

the issue of matching them and do you have the capability to do 

that? 

Right now it is my belief that the IRS is behind in exactly the 

way you are saying in those kind of things. I remember the first 

time I saw an IRS Service Center and they had what they called 

a Gideon table. I do not know if you all are familiar with that, but 

is a desk with about a zillion little slots that they throw tax returns into. 

Well, I saw that in 1985 and it is still in use. They may still have 

it. 

But the notion of the computerization and the modernization and 

all of that, it has a long way to go yet. There is no doubt about 

that, in my opinion. 

Senator ALLARD. Anybody else looked at that program? 

Mr. BROSTEK. Although I have not personally be involved in reviewing that program, GAO has looked at it a number of different 

times. And it is certainly true that it is well behind the milestones 

that were originally established and IRS has struggled over a number of years to be sure that it has sufficient management capacity 

to manage this kind of transformation in their IT systems. 

It is also fundamental to getting efficiency improvement in how 

IRS uses its own resources. The ability to process more information 

electronically and to analyze it rapidly, is key to then better identifying how to allocate their own resources. 

Senator ALLARD. Do you think electronic filing would help with 

that particular program? 

Mr. BROSTEK. I do. One of the things that that allows IRS to 

do—and give them some credit, they have begun doing this—is to 

reduce the amount of work force that is doing the kind of things 

that Mr. Satagaj just mentioned, pushing paper around, and inVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00200 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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stead use work force that have higher-level abilities to actually figure out who is non-compliant and audit them and get the money 

that is owed. IRS has been able to close down the paper processing 

pipeline in a couple of service centers because of the increase in 

electronic filing. Further electronic filing will help them continue 

that. 

Senator ALLARD. I have run into several individuals who are just 

starting out in life. They are young families. And the IRS has sent 

a notice to them that they did not pay enough taxes. One family 

pointed out and said well, they are claiming I do not have a kid. 

I said I distinctly remember getting up early in the morning and 

changing diapers. So do not tell me I do not have a kid. 

But to try and correct that, I mean the margin of error on something to correct that form is $85 or $65, it is some amount less 

than $100. And what their accountant will tell them is, you are 

better off just to pay the thing instead of fight the IRS on it. 

Has anybody ever done a study to find out how much effort is 

made to collect money from taxpayers who owe under $100? You 

are getting down to a minuscule amount. On one taxpayer it may 

not amount to much. If you are just a starting family, it is a fortune. If that happens with 500,000 families, for example that file 

joint returns, you are talking about $50 million. 

So has anybody ever looked at those small collections that the 

IRS spends time on and enforces? How much enforcement action is 

put in that particular area? And what do you do about those kind 

of situations? 

Mr. BROSTEK. I am not personally aware of whether a study has 

been done on that exact issue of how much resources go into these 

kinds of small dollar issues. 

I do know that IRS has various thresholds in pretty much all of 

its enforcement programs, and they do try to allocate their resources to go after suspected noncompliance that would be worth 

pursuing. 

It is, in part, a speculation on my part, but a situation that you 

are talking about could be something that is being turned out from 

their information returns program where they match up information returns. That is a fairly inexpensive program for them, because it is largely computerized. The generation of the notice is 

computerized. Their biggest expense is when people call in to try 

and figure out how they can take care of their situation. 

So there are some situations where a relatively small dollar 

amount might still be efficiently pursued by the IRS. 

Senator ALLARD. In that electronic program, how does an error 

like that happen? They did not even recognize the one kid. 

Mr. BROSTEK. Again, I do not know what the circumstances were 

there. It is possible that they had not recorded the Social Security 

number for the dependent on their tax return, or perhaps made an 

error in putting that number down on the tax return, and therefore 

the IRS did not recognize that there was a valid child for the couple. 

Senator ALLARD. Thank you. My time has expired. 

Chairman CONRAD. Senator Stabenow. 

Senator STABENOW. Thank you, Mr. Chairman. 

196

And first, thank you for once again providing us with a very important hearing that is extremely relevant to what our task is. So 

thank you for doing that. 

Also, thank you for the working groups. As Senator Snowe and 

I have been working on the issue of health information technology, 

which I know you are interested in, and Senator Whitehouse and 

I have spoken about it as well. We are looking at at least $100 billion in savings there if we focus on health IT. So I am hopeful that 

we might wrap that into what we are talking about, as well. There 

is tremendous savings there. 

Welcome to all of our panelists. Thank you for your thoughtful 

information. Particularly Mr. Satagaj, I want to welcome you representing small business. You are, I know, connected with the association of a dear friend of mine, Peter Perez. He certainly keeps me 

focused on what small businesses are concerned about. 

Mr. SATAGAJ. Me, too. 

Senator STABENOW. So I appreciate your being here. 

I did want to look from a broad perspective at what we have 

heard today because I am very concerned about what this means 

for middle income families, small businesses, the majority of people 

in our country. 

Mr. McIntyre, you said that the largest cause of the enormous 

deficits has been the drop in personal income taxes, about 28 percent, again the highest income individuals less likely to be a wage 

earner, more likely to be a non-wage earner, a 28 percent drop. The 

lowest, in terms of revenues as a share of GDP, in the last 55 

years. 

But then when we look at that and then we look at also your testimony saying that it is actually a wage earner, a person who gets 

a paycheck, which is the majority of Americans, who are most likely to file their taxes, the most honest in that sense of filing and 

reporting and so on. And that where the challenge is are non-wager 

earners whose income comes from stocks, real estate annuities, foreign income and so on, where there is more of a challenge in under 

reporting for reasons whether that is on purpose or not. And it may 

not be. 

But it shows a picture, Mr. Chairman, that is of great concern 

to me about what is happening to the majority of Americans who 

did not receive a benefit from the tax cuts, are paying their taxes 

dutifully. What they get from the bargain is less resources for their 

children’s school or access to college or challenges around health 

care or whatever. 

And yet we see of the $350 billion, or whatever the number is, 

that if everyone was paying their fair share, we would in fact be 

investing in things that all Americans believe are important for 

quality of life. So I think this is a critical, critical issue. 

In terms of enforcement, Mr. McIntyre, I’m wondering if you are 

recommending that the majority of enforcement go to non-wage 

earners? It seems to me we hear about a lot of folks, middle income 

families and so on, the IRS issues related to working folks. Are you 

recommending that, in fact, we change the focus more toward those 

individuals based on this picture that represent the majority of 

noncompliant taxpayers? 

197

Mr. MCINTYRE. Yes. The increase in enforcement that is needed 

the most is going after these upper income people and large multinational corporations that are moving income and profits offshore. 

There are other tax shelters that need to be investigated, too, and 

Senator Grassley has exposed a number of those. But the offshore 

situation is the worst. And I can tell you that it is not your average 

wage earner engaged in these abusive practices. 

Senator STABENOW. Absolutely. 

When you mentioned the penalties when you were speaking, increasing penalties, could you give an example of what kind of increase, which you would recommend as it relates to penalties to address these kinds of things? 

Mr. MCINTYRE. For instance, we have some penalties for tax preparers that intentionally file wrong returns for people. Some of 

them are only $50 or $100. With an audit rate now in the 0.8 percent range, and clients that will pay you to help them cheat—some 

will, anyway—well, it is just not enough because you are not going 

to get caught very often. So if the chances are one in 100 of getting 

caught, we want a penalty that is very severe, not $50 or $100 but 

thousands of dollars. Maybe that will scare some of these people. 

Senator STABENOW. Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you, Senator Stabenow. 

If I could just put up the—on the question Mr. McIntyre was just 

raising, here is now the picture of the building in the Cayman Islands. I was wrong. I think I said 8,000 or 10,000. 

Mr. MCINTYRE. They probably got 4,000 more in the time you 

had to get that put together. 

Chairman CONRAD. 12,748 companies call this building home. 

Looks like a relatively modest building but it must be wired with 

the latest technology to have 12,000 companies doing business out 

of this building. 

They are not doing business out of this building. They are engaged in a tax dodge out of this building. And that is precisely 

what Mr. McIntyre is referencing when he is talking about these 

offshore tax havens. 

Frankly, if you look at the estimates that the IRS has for the tax 

gap, I think this is where they really missed the boat. I think tens 

of billions of dollars are being flushed through these tax haven operations and it is really terribly unfair to the vast majority of honest taxpayers in this country. 

Senator WHITEHOUSE. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. 

Mr. Satagaj, I assume that the Chairman’s picture, where you 

have 12,000 businesses crammed into a five-story building, is not 

the type of small business that you are representing? 

Mr. SATAGAJ. I was thinking that. I am pretty sure none of our 

members are one of those occupants. 

Senator WHITEHOUSE. When you all talked about the idea of requiring substantially increased enforcement, I could sort of feel a 

chill emanating across the country from this committee room as 

people who spent—we heard from Chairman Bernanke—an average of 27 hours coping with the filling out of their tax forms. The 

ordinary wage earner these days probably has two jobs and also 

moonlights, so it is a little bit more complicated. And I think there 

198

are a lot of Americans who have the sense that if the IRS really 

came after them, somehow or other they would probably be able to 

find something just because it is so complicated. 

So the idea of additional enforcement, I think, carries some real 

hazard in terms of public acceptance. And in terms of dealing with 

that question, I am interested in having you quarter up a little bit 

more the question that Senator Stabenow raised, which is the focus 

of that additional enforcement will fall into four rough categories: 

major corporations, small businesses, high net worth individuals, 

and ordinary folks. Roughly, where do you think the $350 billion 

or more, specifically the $100 billion that you think is readily collectible, where does that fall in rough numbers into those four categories of corporate and individual taxpayers? Or non-taxpayers, as 

may be the case. 

Mr. MCINTYRE. The offshore area, which is my primary focus 

here, is all upper income, very upper income people and large corporations. So those are your two areas that I think should be the 

focus. I think that is where there is a huge amount of money. 

Senator WHITEHOUSE. Out of the $100 billion, what would the 

amount be that you would guess relates just to the offshoring? 

Mr. MCINTYRE. There is probably $100 billion in those two alone, 

according to estimates. Nobody knows for sure because these things 

are all secret. But we do know that there is $11 trillion in offshore 

accounts worldwide, which at some reasonable rate of return is 

probably earning something like $1 trillion in income every year. 

And the United States share of that is probably close to half. So that is $500 billion on untaxed money right there that, even at a 20 percent rate, is $100 billion. 

Senator WHITEHOUSE. So the average American taxpayer can feel 

reassurance that if we double the enforcement, there is not going 

to be somebody knocking on their door? 

Mr. MCINTYRE. The average American taxpayer wants the police 

to go after criminals. If you told the average American that we 

were going to hire some more policemen because there is a crime 

wave going on in your neighborhood, they will be happy about that, 

not sad. 

Well, we have a crime wave going on among people who are very 

respectable and very wealthy and very prestigious, but they are not 

the average American. 

Senator WHITEHOUSE. Thank you. 

Mr. BROSTEK. I am not sure that I can give you a clear answer 

on how to quarter this up. 

I agree with the point that we really do not know well, for these 

overseas transactions, what the level of noncompliance is. It is an 

area that is very difficult to study because of the transparency 

issue that we talked about before. If somebody is trying to hide 

something, it is difficult for IRS to get behind that, particularly 

when you are talking about sovereign nations. There does seem to 

be a potential that there are big dollars involved. We are pleased 

that IRS has been trying to put some emphasis into trying to figure 

out how to tackle that. 

Small businesses, for the universe that IRS has the best measurement of, which is the individual income tax, small businesses do 

stick out as one of the noncompliant groups, in general. It is a 

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tough problem, given what Mr. Satagaj was talking about. There 

are millions of really small businesses. It all adds up to big dollars 

but you are talking about a lot of small dollars to go after. 

And from the taxpayers’ perspective, one of the things that was 

mentioned earlier is that small businesses are less than 50 percent 

fully compliant. That means that those who are compliant are competing against a business that has an unfair advantage. And that 

can be a substantial unfair advantage. 

So I think that is part of what IRS needs to take into account. 

Senator WHITEHOUSE. Mr. Chairman, I think that it is important 

to get after this. And just from my own personal experience, I can 

remember as U.S. Attorney running an FBI investigation that 

ground to a halt, probably in a building very like yours, where the 

FBI, pursuing a criminal matter, simply could not penetrate the 

multiple veils of Cayman Islands offshore corporate shells in pursuit of a criminal case. So to ask the IRS to do it more effectively 

without further help from this committee, I think is a tough burden 

to put on them. 

Chairman CONRAD. I think the Senator makes a very good point 

and a powerful point. 

That this thing is going on right before our eyes, it is inexcusable 

really. Mr. Satagaj, you are here representing small business. I 

come from a small business family. My family was in the printing 

and newspaper business. They paid their taxes. And it was not always comfortable to do so. But to have this kind of scam going on, 

were others just evade and avoid what they legitimately owe and 

stick the rest of us with the bill, this just cannot be acceptable. 

We have to find a way to aggressively go after this. To have 

12,000 companies supposedly doing business out of this building is 

not credible. It is farcical. 

And there are so many other scams. We have a situation now 

where companies are buying sewer systems—this is true, this is 

not a joke. They are buying sewer systems in Europe, depreciating 

them on their books, leasing them back to the cities in Europe that 

paid for them with taxpayer dollars there. I mean, that is inexcusable, that that kind of thing is going on. 

Senator SANDERS. 

Senator SANDERS. Mr. Chairman, thank you for holding this very 

important hearing. 

I just came, and the reason that I was late is I came from a 

meeting of the Veterans’ Committee where some of us believe that 

the VA is grossly underfunded, that our veterans are not getting 

the health care and other benefits that they need. One of the reasons is that there is presumably not enough money available. 

So this is not some kind of abstract issue. This is a question of 

whether children get health care, veterans get the benefits that 

they need. And it is absolutely appropriate for this committee to 

take a hard look at why people who have the capability are intentionally avoiding paying what they are supposed to be paying in 

taxes according to the law. 

I just have a few questions. According to a recent New York 

Times article written by David K. Johnson, he says—and I quote—

‘‘Top officials at the IRS are pushing agents to prematurely close 

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audits of big companies with agreements to pay only a fraction of 

the additional taxes that could be collected.’’

One IRS employee, according to the New York Times, says that 

when it comes to corporate audits the IRS is ‘‘giving away the 

store.’’

Another describes the corporate audit process as ‘‘catch and release.’’

I would like to ask Mr. McIntyre and Mr. Brostek if they believe 

that the IRS is doing all that it can in collecting corporate taxes? 

And if not, what do you believe that they should be doing. Mr. 

McIntyre? 

Mr. MCINTYRE. I think it is a question of resources, not a question of intent on the IRS’s part. As the auditors told the New York 

Times, they are not doing as much as they should be doing. 

Last September GlaxoSmithKline settled a long-running tax dispute with the IRS for $3.5 billion, which is a record settlement. 

Great, except that the IRS pointed out they actually owed $15 billion. So they were only paying 23 cents on the dollar. That is the 

kind of thing that you were talking about from those New York 

Times articles, that they just do not have enough people who can 

sit on these cases and pursue them long enough. So they are doing 

these fast audits, where they get what they can. 

But you were a corporation that for whatever reasons thinks you 

should not be paying taxes hey, you get caught and you pay back 

22 cents on the dollar. 

Senator SANDERS. These large corporations, large drug companies, have incredible resources and can hire the best tax people and 

the best lawyers in America. 

Mr. MCINTYRE. Or the worst, depending on your point of view. 

Senator SANDERS. Certainly, the IRS does not have that capability. Isn’t that our fundamental problem, with a Government 

agency taking on corporations that have unlimited resources and 

incredible capabilities of getting the best, or the worst if you like? 

Mr. MCINTYRE. These cases, typically once they are discovered, 

are not that complicated. You do not have to have a graduate degree in tax sheltering to figure out that they are illegal. The deal 

is that they are covered up so that they are very hard to discover. 

Once they are discovered, with most of these offshore things, a 

first-year law student could win the case. 

So it is not that the Government employees are incompetent. It 

is just they have too much work to do, compared to the number of 

people they have. 

Senator SANDERS. Mr. Brostek? 

Mr. BROSTEK. I certainly would agree that there is a large audit 

universe out there that IRS cannot get to with its current resources. There is a decision for Congress to make about how that 

weighs up against other governmental priorities. 

I do not know precisely how this initiative is working that was 

written up in the article. One of the things that IRS is, I think, 

trying to take into account is the deterrent effect of auditing more 

people. And so I think part of their philosophy or their thinking 

here is we may not get all of the money from some of these corporations that we audit. But if we can audit more of them, have an 

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audit presence across a larger portion of the corporation universe, 

we may actually improve compliance more than if we go for every—

Senator SANDERS. And one can understand that. But isn’t the answer to do both? 

Mr. BROSTEK. If you were unconstrained in resources, that would 

certainly be—

Senator SANDERS. But isn’t that a good investment? Here is a 

case of hiring more staff, which one would think would more than 

pay for itself if we began to make a dent on some of these issues 

that the Chairman was talking about. Am I missing something 

here? 

If you could bring in billions of additional dollars hiring a few 

hundred or even a few thousand more staff would be minuscule 

compared to what you are bringing in. Am I missing something on 

that? 

Mr. BROSTEK. Your logic is generally sound, yes. 

Senator SANDERS. Mr. Brostek, in February of 2004 the GAO 

found that Department of Defense contractors owed about $3 billion in unpaid taxes as of September 30, 2002 because the DOD 

had failed to implement IRS collection procedures. 

In addition, GAO often ‘‘found abusive or potential criminal activity relating to the Federal tax system’’ through a GAO audit investigation of 47 DOD contractors. 

To your knowledge, has the Department of Defense or the IRS 

done anything to collect these unpaid taxes? 

Mr. BROSTEK. I would have to get back to you on that, sir. That 

is not an area that I was doing the work in. Perhaps I could give 

you a response for the record. 

Senator SANDERS. If you could, please. 

Let me ask you another question, sir. In 2004, the GAO found 

59 of the largest publicly traded contractors in fiscal year 2001 reported having a subsidiary in a tax haven country. Do you believe 

that companies with offshore tax havens have an unfair advantage 

over companies that do not in competing for Government contracts? 

If so, what can we do to correct this problem? 

Mr. BROSTEK. As I recall, the conclusion in that report was that 

the contractor who had an offshore presence in a jurisdiction that 

had a low tax rate could have a cost advantage over a purely domestic contractor. We did not have a recommendation for how to 

address that situation and I do not have one for you today, I’m 

afraid. 

Senator SANDERS. That is something that we should be—yes. 

Mr. McIntyre, in your testimony, you gave us a number of options to consider that would reduce the tax gap, ranging from 

cracking down on offshore tax shelters and stock option abuse to 

increased reporting requirements on capital gains and an addition 

of more IRS auditors. What do you think would be the most important step for Congress to take in making sure the corporations and 

wealthier individuals pay their fair share? 

Mr. MCINTYRE. You could raise tax rates, but that only gets the 

honest people. So if you are trying to get the ones who are not paying their fair share, then the answer is you need more enforcement. 

And you also need more disclosure. 

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Because so much of this tax sheltering is happening offshore, we 

need to resuscitate an effort that President Bush jettisoned back in 

2001 and get these tax haven countries to tell us, and tell Britain 

and France and Germany and all of the other developed countries, 

what our citizens and their citizens are doing in those places. 

If we get that information, then most of those schemes can be 

uncovered and people will stop doing them eventually. 

Senator SANDERS. What kind of staff increases do you think the 

IRS needs to do? What has to be done? Do you have any sense on 

that? 

Mr. MCINTYRE. They are down about one-third from where they 

were 10 years ago in enforcement. So you would need a 50 percent 

increase just to get back to where you were 10 or 12 years ago. And 

we are a bigger economy and so forth now. 

Senator SANDERS. And more complicated tax laws as well. 

Mr. MCINTYRE. Yes. You might talk about thinking about how to 

double the size of that enforcement staff over a period of time. You 

cannot do it instantly. It takes a long time to train people and work 

them in. But that would be the kind of goal. 

Senator SANDERS. I presume you have little doubt that paying for 

that increased staff would more than be balanced by the kinds of 

revenue that you are bringing in? 

Mr. MCINTYRE. It is hard to imagine that it would not be. The IRS has an $11 billion budget and brings in $2.2 trillion, so it is 

about 230-to-one on the whole process. With incremental—increase 

in funding, you are not going to get that ratio. But you are going 

to get $10 or $20 or $30 or $40 per dollar spent, depending on 

where you put the money. 

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

Chairman CONRAD. Thank you, Senator Sanders. 

Let me just conclude by asking each of you how much do you 

think can be reasonably obtained by reform of our current processes: increased reporting, increased withholding where appropriate, increased resources for IRS, tax reform, going after this 

international tax haven, requiring reporting of those transactions. 

How much do you think over a period of time—obviously I am 

talking 3 years out because you are not going to turn around this 

ship quickly. But three or four or 5 years out, how much money per 

year do you think could be obtained by an aggressive approach to 

this tax gap? 

Mr. MCINTYRE. That is a hard question because of the required 

training of the IRS employees and so forth. But let us say we had 

not cut back 10 years ago and the IRS still had full manpower. I 

would think you could be picking up—if you also made some of the 

changes I’ve suggested here—$100 billion a year more in a steady 

state. Maybe more than that if people stop doing these things. 

Scaring people out of entering into shelters is even better than 

catching them after they do it. And that is one of our goals here. 

Chairman CONRAD. Mr. Brostek? 

Mr. BROSTEK. I really do not have an empirical basis to give you 

a good estimate there. 

One piece of input on that. Commissioner Rossotti, in his last report to the IRS Oversight Board, estimated that—if they had the 

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resources in IRS to followup on all of the cases of suspected noncompliance; where they were pretty sure someone was noncompliant—he calculated that about a $2.2 billion increase in their budget would yield about $30 billion. 

Again, we did not audit that estimate. I do not know how reliable 

it is. But it gives you a sense just from the enforcement perspective, that there would be large amounts of money that could be 

available. 

Chairman CONRAD. Over what period of time was that? Do you 

know? 

Mr. BROSTEK. He was suggesting that the way to approach this, 

given what we have been talking about, that it takes some time for 

IRS to gear up, would be—and it was his proposal—to give IRS a 

real budget increase of 2 percent a year over a number of years. 

I do not remember the specific number, but it was seven, eight or 

10 years in time, to allow them to increase their capacity gradually. And so that $30 billion would have been after IRS had received 

these budget increases that he was proposing. 

Chairman CONRAD. That would just be on the enforcement side? 

Mr. BROSTEK. Correct. 

Chairman CONRAD. Frankly, I think there is more money to be 

recovered on the reporting side by increased reporting that on the 

enforcement side. I do not denigrate the need to have more enforcement. 

But frankly, I think if you had more transparency on these international transactions, but also in reporting on money flows where 

the IRS then had the ability to match up what is reported versus 

what is actually happening. I think there is bigger money to be had 

there. 

Mr. BROSTEK. I would agree with you, that if you had the ability 

to do more transparent transactions, that you are going to obtain 

higher levels of compliance and probably not need the IRS resources. 

In the charts that were shown earlier, if you have information 

reporting that IRS can make use of, the level of compliance is very 

high. And it stays high because, in essence, we are auditing all of 

those transactions every year. 

Chairman CONRAD. And that is self-policing in the sense that 

people know look, everybody is going to know what it is. 

Mr. BROSTEK. Right. 

Chairman CONRAD. Mr. Satagaj, let me ask you this question, because you are here representing an extremely important constituency group. You earlier talked about how do you do this without 

hurting the compliant taxpayer, those who are already paying—

and they are the significant majority here—who are paying what 

they legitimately owe or pretty close to what they legitimately owe. 

What do you think the tradeoff is here, what could we do that 

would be seen as fair by small business in terms of increased reporting to get the bad actors—especially on this international side. 

Very few small businesses are—I would venture to say none of your 

constituents are over in this Cayman Islands building. I do not 

think they have offices over in the Caymans. 

What do you think? How could this be done in a way that would 

enjoy the support of the small business community? 

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Mr. SATAGAJ. We have been looking at it a lot already. As I said 

at the beginning, we are not against this. We want to find some 

way and find some solutions. 

Do not forget, we are dealing with primarily compliant taxpayers. This is under reporting of income by someone who is in the 

system. So you do not want a proposal that pushes people out of 

the system. We will end up with a cash economy, even with the information reporting or withholding, you will push people in the 

wrong direction. 

And we do not know why they are under reporting. You would 

say yes, well, we can do the information return. But if you are 

under reporting, are you going to capture the information in an information return? Where is that going? 

For example, right now with 1099s—and Mike knows this as well as I do—they require someone to issue a 1099 for $600. That low, 

that is a pretty small transaction. Now who are you missing in there, when you are under $600? 

And why are they under reporting? Is it collusion between two parties? 

There is so much there that what my guess is that what you are 

going to find out—and this is the danger with the information reporting or withholding—is you push people in the wrong direction 

instead of the right direction. I think we just have to figure out and 

identify more carefully who is it that is under reporting? And what 

is the transaction that they are under reporting? We have no sense 

of that in any of the data or the research that I have seen. 

Chairman CONRAD. Let me just say from talking to people in the 

accounting profession, I will tell you what they tell me, and these 

are the people who are on the front lines. I have a lot of people that 

I have worked with over the years who are in the accounting profession. We have had some bad actors in the accounting profession. 

We have also had some—I used to be a tax commissioner. I can tell 

you firms that were the gold standard in accounting who I knew 

were honest and did a good aggressive job of representing their clients. But at the end of the day advised their people to pay what 

they legitimately owed. 

What they are telling me is you have several classes here. You 

have under reporting, especially in places where basis is an issue. 

I see all of the witnesses nodding. I think we all know how that 

works. 

If you are looking, especially at real estate transactions, what 

matters is what you paid for the property, the depreciation you 

took while you held that property, and what you sold the property 

for. Your basis for tax purposes is determined by subtracting from 

what you paid for the property the depreciation you took. 

People in the accounting profession tell me there is tremendous 

under reporting of what is the true basis in a property and real estate. 

That the same is true for purposes of capital gains. Obviously, 

there you do not have the depreciation issue but you have what you 

paid for stock initially versus what you sold it for. And that there 

is an appropriate reporting there. 

The third area is those who are self-employed who are simply 

under reporting their income. 

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The fourth area, and the accounting profession has told me repeatedly, is this offshore business. That this is huge and growing 

and extremely abusive. That companies simply moving this income 

offshore, where there is no transparency, no ability for serious 

oversight, and this is a real hemorrhage of both wealthy individuals and a certain sector of corporate America. A minority, but significant in dollar terms. 

Those are areas that people who are in the accounting profession, 

talking off the record to me, have said they think are the biggest 

areas of abuse. 

Any response to any of that? Any sense from your own experience or own contacts? Mr. Satagaj? 

Mr. SATAGAJ. Just on one point, and we all have anecdotal information, and that is part of the problem. Particularly with the sole 

proprietors, I go back to one of the very first questions I raised. We 

do not know how many sole proprietors do business primarily with 

consumers versus other businesses. And so my guess is that it is 

a consumer-to-business transaction that is most likely not to be reported as income. 

You can hear your accountant friends say that and I do tax law, 

I know what you are talking about, too. But we do not know in any 

way that we can make a systematic decision OK, this is what we 

need to do about it. Because you are going to deal with that under 

reporting far differently than someone who is getting their income 

from business. 

You can go to these areas, but the truth is we are really missing 

some basic information here. 

Chairman CONRAD. That is a point very well taken. If there is 

one thing that is very frustrating, first of all, we are dealing with 

a study that tries to indicate the size of the tax gap in 2001. And 

it is based off returns from the 1980’s, updated through a series of 

attempts to make it relevant to today. 

Truthfully, I believe that I think the tax gap is far in excess of 

the Revenue Service estimate, now that I understand how the Revenue Service made that estimate. I sat down with representatives 

and went through in some detail how they arrived at this number. 

I think, if anything, it just jumps out at me that it probably significantly understates how big it is. 

We have come to the end here. I want to thank all of the witnesses for participating in this panel. It is certainly beneficial to 

this committee, as we wrestle with these issues and try to address 

the longer-term fiscal imbalances that our country faces, which according to the first two witnesses we had before this committee—

the head of the General Accounting Office and now most recently 

last week, the Chairman of the Federal Reserve—they alerted us 

to the very serious nature of these long-term fiscal imbalances and 

the adverse effect it could have on our country of a failure to act. 

We thank you very much for your constructive suggestions here 

today. 

With that, we adjourn the meeting. 

[Whereupon, at 11:45 a.m., the hearing was concluded.]

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THE CBO BUDGET AND ECONOMIC OUTLOOK 

THURSDAY, JANUARY 25, 2007

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

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

SD–608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of the committee, presiding. 

Present: Senators Conrad, Nelson, Cardin, Whitehouse, Gregg, 

and Allard. 

Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 

Staff Director for the Minority. 

OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

Chairman CONRAD. The Committee will come to order. 

I want to welcome everyone to the hearing today on the Congressional Budget Office’s January budget and economic outlook. 

I want to particularly welcome our new Director of the Congressional Budget Office, Dr. Peter Orszag. I notice that Dr. Orszag has 

with him a special assistant. Maybe Dr. Orszag, you could introduce your daughter, who is with you. 

Mr. ORSZAG. Yes, my 6-year-old daughter, Layla, is sitting right 

behind me. And she’s very good at math. So if I need some help 

she might step up here. 

Chairman CONRAD. We will look forward to that. 

We are delighted that Dr. Orszag has taken this position. Dr. 

Orszag is a distinguished economist, one of the most prolific writers in the economic field. He has dealt with almost all of the major 

issues that are facing us as significant challenges in the years 

ahead. 

I am also especially pleased to note that he was a successful 

businessman and brings those skills to the job, as well. 

We also want to recognize Dr. Marron, who is the Acting Director. We are especially pleased that we understand that you will be 

staying and we are delighted by that. We thank you for your service, as well. 

We have this hearing to review CBO’s outlook. 

Senator GREGG. All three of us went to the same high school. 

Chairman CONRAD. Oh, we did? I deny it. 

[Laughter.] 

Chairman CONRAD. I have had a chance now to review CBO’s report, which was released yesterday. I think it is very important for 

us to say there is nothing in this report which alters the fact that 

our Nation’s long-term fiscal condition is completely unsustainable. 

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It is important to remember that CBO is required to assume a 

continuation of current law and is not allowed to add in the cost 

of likely policy changes. So this is no criticism of CBO. They are 

constrained by the requirements under which they operate. 

Looking just at 2007, CBO’s deficit estimate understates the 

shortfall because it does not account for the $100 billion war supplemental President Bush is expected to send to us. Nor does it account for the cost of fixing the Alternative Minimum Tax. 

Again, this is not any fault of CBO’s. This is the way they are 

required to do things. They are required to base their assessments 

on current law without respect to policy changes that might occur. 

Let me put up the first slide and we will try to go through this 

quickly. While CBO estimates with omitted costs that the deficit 

will fall to $218 billion, that number tells only half of the story. Let 

me indicate that $218 billion is not their estimate. Their estimate 

is $172 billion. But when we add back what we see as omitted 

items, the President’s war supplemental that has not come up here, 

the need to fix Alternative Minimum Tax, we come to a deficit of 

$218 billion. But that significantly understates the red ink, because 

the debt will increase by $510 billion during this year.

The 10-year baseline projection by CBO understates actual deficits because CBO, as I have said, has to assume continuation of 


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current law. We get a more realistic picture when we put back adjustments for the following items: we add in the cost of the President’s proposal to make the tax cuts permanent. That is a cost over 

10 years of $2.3 trillion. We add in the cost of Alternative Minimum Tax reform. That is a cost over 10 years of over $1 trillion. 

We add in the cost of the President’s proposed defense buildup, and 

that is a cost of well over $800 billion. No, the defense buildup is 

somewhere around $260 billion. The ongoing war cost is over $860 

billion. We add in the associated cost of debt service on all of the 

above items and that is approaching $900 billion.

We remove the multiyear cost of extending the 2007 emergency 

funding and get a total adjustment of $4.6 trillion over the next 10 

years. The $4.6 trillion is not to the good side, it is the red ink side. 

Once we have made these adjustments to CBO’s baseline estimate, this is the picture we get of our long-term budget outlook. 

It shows that significant deficits continue throughout the next 10 

years at a time we should be paying down debt to prepare for the 

coming retirement of the baby boom generation.


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The reality is that we are facing a wall of debt. At the end of 

2001, the year the President took office, gross debt was $5.8 trillion. Under CBO’s adjusted baseline, we can see the gross debt will 

reach $9 trillion by the end of 2007. And if we continue with these 

policies, gross debt is projected now to soar to over $12 trillion by 

the end of 2012. I want to emphasize, that is not CBO’s estimate. 

That is our estimate, taking the CBO number and adjusting it for 

these omitted costs.


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The revenue improvement in CBO’s report results from adjustments in CBO’s calculations that have nothing to do with stronger 

economic growth. In fact, CBO’s latest figures for economic growth 

in 2006 and 2007 are actually weaker than the Agency predicted 

last August. Let me indicate, for 2006 the forecast for economic 

growth was reduced from 3.5 percent to 3.3 percent. And looking 


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ahead to this year the previous forecast, which estimated economic 

growth would be about 3 percent, now says economic growth will 

be 2.4 percent.

The revenue improvement that we see in this forecast must be 

considered in the context of the serious collapse in revenue that occurred after 2000. Real revenues, that is adjusted for inflation, only 

recently exceeded their 2000 level. I know my colleague will want 

to talk about the last 3 years where we have had significant revenue growth, but that is after we saw significant revenue declines. 

We saw in 2000 we had revenue of just over $2 trillion. We only 

got back to that amount in real terms in 2006. So we have had revenue stagnation for six or 7 years and now the estimate for this 

year is good growth.


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Unfortunately, when we compare this revenue growth to previous 

recoveries, we still see that this is lagging well behind the revenue 

growth we have seen in previous recoveries. In fact, if we look at 

the average of the nine previous business cycles, look at all of the 

recoveries since World War II and compare revenue growth to 

teach of those other recoveries this recovery is running $127 billion 

short of the typical recovery.


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In his recent testimony before the Senate Budget Committee the 

head of the GAO, Mr. Walker, summed up our fiscal outlook as follows: ‘‘We are an imprudent and unsustainable long-term fiscal 

path, and while the short-term deficits have improved in recent 


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years, the long-term is getting worse every second of every minute 

of every day and the time for action is now.’’

Comptroller General Walker has it exactly right. And I am 

pleased to say on that issue Senator Gregg and I are in agreement. 

Our long-term situation is unsustainable. We need to respond to it 

and we need to do it as quickly as we can. 

With that, I welcome Senator Gregg. 

OPENING STATEMENT OF SENATOR JUDD GREGG 

Senator GREGG. Thank you. 

Doctor, it is nice to have you. It is especially nice to have your 

daughter here, future Exeter student probably. 

Let me pick up where Senator Conrad left off, which is the issue 

of the long-term. Because essentially what the CBO projections say, 

and although I do not agree with all of the comments made by the 

Senator from North Dakota, the Chairman, he is correct that there 

is a lot that is left out because of the rules that you have to function under, such as the war costs and the AMT issue. 

But following the mechanics of the CBO baseline, basically if we 

put things on automatic pilot we would end up in surplus in 2012. 

But the statutory baseline obviously leaves things off the table that 

Congress is likely to be put back in, so the baseline surplus number 

in 2012 would end up being different. Even though a possible surVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00223 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH

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plus looks like that is good news, obviously very good news, it does 

not address that truly acute issue which we confront, which is the 

fact that once the baby boom generation begins to retire, all of the 

numbers go south on us in a very aggressive way. 

And in your own estimates you are projecting that there is going 

to be an approximately 6 percent average annual growth in entitlements over the next 10 years, and that by the year 2017, entitlements will absorb close to 11 percent of the GDP. And as we move 

out into the years, that number goes up dramatically and becomes 

unsustainable. 

I think it is important, to note that these short-term deficit projections, which are improved, are a function primarily of revenue 

growth. If you look at what percentage of GDP is the Federal Government generating in revenues, historically we get 18.2 percent of 

GDP. Today we are getting about 18.4 percent of GDP. So our revenues are robust and they are getting stronger. And CBO’s projections are for fairly strong revenue growth as we go forward. And 

as a result, the Government is moving in a very positive direction 

for the next few years from a standpoint of the deficit. 

But that does not resolve the problem in the out years because 

you cannot tax your way out of this problem. You cannot grow your 

way out of this problem. The only way that you are going to address this problem is if you look at the programs which are in place 

and try to make them affordable for our children at the same time 

as we allow them to continue to be strong programs for those who 

are retired. 

So I would be interested in your thoughts on that, and I do think 

it is important that we highlight that and that would not allow the 

short-term good news, which is very positive, to cause us to take 

our eye off the real issue which is the long-term seriousness of the 

problem. 

So we appreciate you coming here today. We appreciate your 

willingness to take on this job. 

I also want to join the Chairman in thanking Donald Marron for 

his wonderful service, extraordinarily good service, and the fact 

that he is willing to stay on and participate at CBO is critical. 

You are our umpire, our fair arbiter, and we appreciate the fact 

that you have been willing to take on this job, and to have your 

expertise at the table is going to be a big assistance to us. 

Thank you. 

Chairman CONRAD. Thank you, Senator Gregg. 

Dr. Orszag, please proceed with your testimony. 

STATEMENT OF HON. PETER R. ORSZAG, DIRECTOR, 

CONGRESSIONAL BUDGET OFFICE 

Mr. ORSZAG. Thank you very much, Mr. Chairman. Mr. Chairman and Senator Gregg, I want to first note that I very much look 

forward to working with you and the rest of the committee and the 

rest of the Congress as I assume this new position. 

I also want to just emphasize how delighted I am to be coming 

into a position that has such an outstanding staff and that allowed 

me to get briefed and ready for this testimony in a short period of 

time. 

219

I want to make five points about the document that we released 

yesterday, and I think it is important in interpreting the economic 

and budget outlook to take all five points into account. So with that 

caveat in mind, the first point is the path of the budget under the 

baseline. 

As you both know very well, that baseline has a particular set 

of rules associated with it which I will return to in a moment. But 

under that path, the budget deficit does fall from $248 billion in 

2006 to $172 billion this year and then falls further in 2008 to 

under $100 billion. It then increases slightly in 2009 and 2010. It 

essentially reaches balance in 2011 as various revenue provisions 

expire as scheduled under current law, and then moves into surplus in 2012 and thereafter, again under the assumptions of the 

baseline. Under that baseline, publicly held debt would fall from 37 

percent of the economy to 20 percent by the end of the 10-year period. 

The second point though is that, as is now well known, that official baseline reflects a particular concept, which is the application 

of current law with regard to both revenues and spending. It therefore leaves out various things that outside observers believe will 

occur in terms of change policy that will affect budgetary outcomes. 

Mr. Conrad, as you have already mentioned, what we did was we 

provided a variety of alternative policy paths, changes in policies, 

that would allow members of this committee and others to evaluate 

the impact on the budgetary outcomes. I provide just one example 

of those changes in policies. 

The baseline, as you know, assumes that discretionary spending 

only keeps pace with inflation and not with population growth or 

with overall economic growth. As a result, discretionary spending 

falls from 7.8 percent of the economy to 5.8 percent of the economy. 

If instead, and excluding the spending on the global war on terrorism, discretionary spending kept pace with overall economic 

growth, the budget balance in 2012 would deteriorate by $122 billion and over the 10-year period by $1.5 billion. Those are inclusive 

of debt service costs associated with the change in policy. 

Furthermore, the official baseline assumes that all of the tax provisions that are scheduled to expire, most of which in 2010, actually do expire. If instead the 2001 and 2003 tax legislation were 

continued past 2010, the deficit in 2012 would be $267 billion lower 

and the 10-year impact is $2.3 trillion. 

Furthermore, the baseline assumes that the Alternative Minimum Tax will rise from affecting 4 million taxpayers in 2006 to 

33 million by 2010. The combination of the assumptions with regard to current law on the EGTRRA and JGTRRA, that is the 2001 

and 2003 tax provisions, and with regard to the Alternative Minimum Tax provide the primary explanation for why revenue increases from 18.6 percent of the economy this year to roughly 20 

percent in 2011 and thereafter. 

If you prevented the Alternative Minimum Tax from growing in 

the way that is suggested under the baseline, again the deficit impact in 2012 would be roughly $50 billion and the 10-year impact 

would be over $700 billion. The Alternative Minimum Tax and the 

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actions into account would add another $61 billion in 2012 and 

$542 billion over 10 years. Put that together and instead of a surplus of $800 billion, under this change in policy there would be a deficit of over $4 trillion over 

the 10-year window. 

Obviously, policymakers can evaluate different courses of future 

policy and evaluate the impact on the budget outcomes under those 

changes. 

My third point is that there is significant uncertainty that surrounds budgetary projections because of future economic developments and other technical changes. Just to put that in context, this 

year spending will be about $2.7 trillion, revenue we project at $2.5 

trillion. That means that if you are 5 percent too high on spending 

and 5 percent too low on your revenue projection, you shift from 

a projected deficit of $200 billion to an actual surplus of more than 

$50 billion. I think it is important for everyone to realize, because 

the deficit is the difference between two large numbers; being 

slightly off on those two large numbers can have a very big impact 

on the difference between the two, the deficit. 

So we try to characterize or present for you the implications of 

that uncertainty. Under our baseline, in 2010 we show a deficit of 

roughly 1 percent of GDP, 0.9 percent of GDP. But based on past 

experience, there is a 20 percent probability the deficit may be 3 

percent of GDP or larger under current law and there is a 5 percent probability that the budget would actually be in surplus of 3 

percent of the economy or more. 

So we are trying to provide some insight into the span of the uncertainty that surrounds future budgetary outcomes. 

The fourth point is that, consistent with the emergence of projected surpluses under the baseline, there has been a significant 

shift in the budget baseline since last August. I would emphasize 

immediately though, and Senator Conrad you already pointed to 

this, this is not the result primarily of changes in economic assumptions. Those changes in economic assumptions have a very 

modest effect on the 10-year numbers. 

Nor are the 10-year numbers primarily due to changes on the 

revenue side. In fact on the revenue side, from all the various components, the overall impact is only a little bit more than $50 billion 

over the 10-year window. There is a more significant impact in the 

short term and then that diminishes over the long-term. For the 

10-year period as a whole, most of what is happening is on the outlay side. 

There are two parts. One part is purely artificial. It reflects for 

how we account for, under current law, discretionary spending. As 

you know, we take enacted appropriations in the current year and 

inflate them out over the rest of the projection window in the baseline. Last August, when we were doing the projections, the enacted 

appropriations included $120 billion for Iraq, Afghanistan, and the 

global war on terrorism and $56 billion for domestic relief activities, for example with regard to Hurricane Katrina. 

This year thus far the Congress has appropriated $70 billion for 

operating if Iraq and Afghanistan and there is no corresponding 

appropriation for domestic relief activities. As a result, our baseline 

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221

lion on non-defense spending. In other words, roughly half of the 

improvement in the 10-year numbers is purely a mechanical implication of how we account for supplemental and unusual spending 

and does not reflect anything about the underlying fiscal environment. 

Another component of it though does reflect changes on the outlay side with regard in particular to Medicare and Medicaid. There 

have been some real changes in projections of those programs. 

There has been an improvement over the 10-year window of roughly $445 billion in Medicare spending, the majority of which is in 

Part D. Part D spending we now project for that 10-year window 

to be $265 billion lower than in August. That reflects both the actual information we now have on enrollee behavior and patterns 

and the fact that bids for this year are coming in 15 percent lower 

than last year, and also that we now expect that larger share of 

beneficiaries will have other coverage and not take up the Part D 

benefit. I would be happy to talk further about those changes during the question and answer period. 

But, I would emphasize that nothing in those changes alters the 

fundamental conclusion that over the long term Medicare and Medicaid will continue to grow more rapidly than the overall economy 

and will put severe pressure on the overall fiscal picture. 

That brings me to my final and perhaps most important point. 

The long-term picture facing the Federal Government is not pretty. 

Under current law, without addressing in particular ongoing cost 

increases in our health programs, we face a very serious fiscal imbalance. I would agree with both Chairman Bernanke and Mr. 

Walker that it is better to address that sooner rather than later because it opens up more options for how to address the problem. 

Even within the budget window you can start to see the pressure 

that is building. Medicare and Medicaid, the Federal share of Medicaid, amount to 4.5 percent of the economy today. By 2017, the 

end of our projection window, we project that they will amount to 

5.9 percent of our economy. If health care costs continue to grow 

at the same rate as they have over the past 40 years, which is the 

top line in this chart, by 2050 those two programs alone would account for 20 percent of the economy, which is basically the size of 

the entire Federal Government today. 

Even if health care cost growth slowed so that it is only 1 percentage point faster than economic growth, those two programs 

would account for 10 percent of the economy. That is the fundamental long-term problem facing the Federal Government, and it 

is related to a problem facing the private sector also, which is cost 

growth in the health sector. 

I look forward to working with you to provide you with the analytical input so that you can start to address that fundamental 

problem in the long-term fiscal picture for the United States. 

So just to very briefly summarize, there is some short-term good 

news in this report. But the good news is not quite as good as it 

might initially seem. And the long-term picture remains very, very 

serious and deserving of attention. 

Thank you very much, Mr. Chairman. 

[The prepared statement of Mr. Orszag follows:]

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Chairman CONRAD. Thank you. And thank you for your excellent 

testimony and the work of you and your staff. I think you have put 

it in perspective that the short term we have seen some improvement. The long-term really has not changed and it is a daunting 

picture. 

I know Senator Gregg has presented this to his caucus and before this committee. I have presented it to my caucus. It is a hard 


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thing to get people, I guess it is very deep in human nature. It is 

hard to get people to respond to something that is over the horizon 

or down the road or off in the future. 

Could you tell us when you say we should act sooner rather than 

later, what would you say if you were addressing our colleagues as 

to why? Why it is important to act sooner? Our colleagues, in fact, 

I had a colleague say to me yesterday, Kent, you are talking about 

a problem that is off in 2018. We have a lot of urgent problems to 

deal with right now. This is not urgent. 

Mr. ORSZAG. I have two responses. The first is the longer we 

wait, the larger the burden that we are putting on future generations, and I am not going to invoke my daughter but people like 

my daughter. That raises not just economic questions but other 

questions as well. 

The second reason though is the sooner that we act, the more 

that we can try things and experiment and see what works and see 

what does not so that we can evolve in our approach. This underlying problem is not going to be solved with the snap of a finger 

and just a one-off solution. 

So I think it is pretty clear that what we need to be doing is trying different things, and it is obviously up to you to decide what 

things we should try. But try different things, see what works, and 

then adapt as we go. 

The longer you wait, the less experience you’ll have. I was, for 

example, interested that in the New York Times this morning there 

is a report on the effort that CMS, the Medicare agency, is experimenting with paying for performance and the early results there. 

But that is the kind of effort—in the so called Premier Program—

the kind of effort that will help give you the information you need 

to bend those lines. If you just wait, you are acting in a void. 

Chairman CONRAD. Let me ask you this question. Last evening 

I was interviewed on television with a colleague and I was asked 

what had been the contributing factors to the deficits. And I said 

well, it is obviously increased spending and tax cuts. The two of 

those together have exploded the debt. 

My colleague said no, the Senator is wrong on the question of tax 

cuts. She said tax cuts produce revenue. I was really kind of taken 

aback and I said you know, in my judgment, tax cuts contribute to 

economic growth but they in no way pay for themselves. That is 

been the testimony of the head of the Federal Reserve. That has 

been the testimony of previous CBO directors. That has been the 

result of the Treasury’s own study that shows tax cuts maybe offset 

10 percent of their costs. There are other studies that have been 

done by CBO. 

CBO said to us, in their analysis, that tax cuts would stimulate 

enough economic growth to replace 22 percent of lost revenue in 

the first 5 years. Those were on optimistic assumptions. On pessimistic assumptions, the growth effects of tax cuts did nothing to 

offset revenue loss. 

So whether it is zero or 10 percent or 22 percent, the studies that 

we have been presented with say that tax cut simply do not pay 

for themselves. They slightly offset their additions to the deficit. 

I would ask for your review. What would you say is the state of 

the economic literature on this question of do tax cuts pay for 

231

themselves? I would just say, if they do, this is the greatest news 

we could have because we could have a whole new round of tax 

cuts and eliminate the deficit. 

[Laughter.] 

Mr. ORSZAG. Senator, the effect of a tax cut depends in part on 

what kind of tax cut it is and how it is financed, whether it is financed by a deficit. Many tax cuts can generate some economic 

growth, some additional economic activity. But the vast bulk, the 

preponderance of the evidence strongly suggests that that additional economic activity, which generates some additional revenue, 

offsets only a modest share of the original cost. So whether it is 10 

percent or 20 percent or 25 percent, some go even higher than that, 

the credible evidence I have seen suggests that the offset is only 

a small share of the original cost. 

Chairman CONRAD. To be fair, I should say Gregg Mankiw, who 

was Chairman of the President’s Council of Economic Advisers, 

said in his analysis where you have capital taxes there you could 

get as much as a 50 percent offset on capital taxes. On others, on 

income taxes, he said 17 percent, which would be pretty close to 

the 22 percent CBO found in the first 5 years under optimistic assumptions. 

I thank you for that answer. Senator Gregg? 

Let me indicate that we are going to have a vote momentarily, 

at 10:30. That is unfortunately why you see attendance is not as 

we would normally have, because they have called a vote for 10:30. 

Senator GREGG. 

Senator GREGG. Thank you. Thank you, Mr. Chairman. 

Picking up on this line of thought relative to the implications of 

tax policy, the reverse of the case the Chairman is making also 

probably applies. That is, you can raise taxes to a point where you 

significantly stagnate economic activity. Would that not be true? 

Mr. ORSZAG. Yes, and actually let me quickly add a very important caveat. I was speaking with regard to studies that apply to basically the current structure of the U.S. tax system. As you move 

up to higher and higher marginal tax rates, that conclusion could 

be different. 

Senator GREGG. Of course, that was Arthur Laffer’s studies that 

showed that. 

The issue, I think, is what is the right tax level? Obviously it is 

not zero and obviously it is not 100 percent. It is somewhere in between. It would seem to me that when you have a tax law which 

is today producing revenues that exceed the average revenues that 

we historically haveten in this country, the average being 18.2 percent and we are now getting 18.5 percent, that you have a tax law 

that is working fairly well. 

My real question here, because the issue is closing the gap in the 

out years between liabilities and revenues relative to entitlement 

programs, gets to the issue of what size Government can the economy afford and still be efficient, productive and growing? And when 

does the Government become so large that it creates an inefficient 

economy and one which is not as productive and thus, does not create as many jobs? 

232

Historically, we have spent about 20 percent of the Gross National Product on the Federal Government and we have taken in 

about 18.2 percent, so we have run a structural deficit. 

But what is the number that you would say the Government can 

afford—at what size? If we know entitlement spending, if it is allowed to continue at its present pace, Medicare and Medicaid being 

the primary drivers of this, will exceed potentially 30 percent of 

Gross National Product by the year 2040, which seems to be a staggering number, and you know you are going to have to rein that 

back to some number that is manageable, do you have a manageable number? Is it 20 percent? Is it 22 percent? Is it 24 percent? 

Mr. ORSZAG. Senator, I think ultimately the level of spending 

and revenue is up to policymakers like yourself to decide. What I 

would say about the economic effects is a lot depends not just on 

the level of revenue as a share of GDP but how you raise that revenue, whether it is through individual income taxes, whether it is 

through corporate income taxes, whether it is through consumption 

or value added taxes, can have a significant effect on the economic 

implications. 

The other thing I would say is I do not think that there is a single threshold. I cannot give you a jump off the cliff kind of threshold. A lot of the effects that are associated with revenue changes 

tend to be gradual and linear so that they just grow bigger as you 

move up a curve, rather than having a single jumping off kind of 

point. 

Senator GREGG. I do not have time right now, but I would be interested in which one of these—you clearly view taxes not as monolithic but as being divisible into some that produce more productivity and some that produce less. I would be interested in getting 

your written thoughts on that, if you had a chance. 

One question I did want to ask, the House just a little while ago 

passed what they call the Medicare Prescription Drug Price Negotiation Act, which basically tells CMS to negotiate prices with drug 

companies relative to Part D premiums, with the representation 

that is going to save some money somehow. 

CBO a year ago gave us a commentary that it would not, for 

what I think are fairly strong and obvious reasons. I am wondering 

if that remains CBO’s view of that position? 

Mr. ORSZAG. Yes, it does, and let me just try to explain both why 

and also why some of the price comparisons that I have seen with 

regard to say the prices that the Veterans Administration gets relative to some of the prescription drug plans are not really appropriate to the legislation that was introduced or passed by the 

House. 

The reason that the Veterans Administration can get lower 

prices than other players is twofold. One is that there is a direct 

price intervention where the Federal Government, under the Federal Supply Schedule and the Federal Ceiling price, requires a particular set of effectively discounts or best prices to be offered. 

The second is that the Veterans Administration then runs a formulary. It includes some drugs on its list and excludes others. 

The House legislation does not take either step. And I would 

note, you can get price reductions through those two steps, but 

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tion by itself is unlikely to produce any significant cost savings because you do not have either of the tools that the Veterans Administration and some other government programs used to get price reductions. 

And if you were to apply those kinds of tools in the Medicare program, there would be other consequences that would need to be 

weighed very carefully. 

Senator GREGG. Specifically rationing. There would be rationing 

the drugs that would be available to citizens under Part D 

Mr. ORSZAG. A formulary does include some drugs and exclude 

others. That is the definition of a formulary. 

Senator GREGG. It is called rationing. Thank you. 

Chairman CONRAD. I would like to just go back, if I can, to this 

question of taxes. And I would say to Senator Gregg, I just asked 

the staff to get for us the effective tax levels in other countries and 

their rates of economic growth. If you look at all taxes in the 

United States, Federal, State and local, we are at 26.4 percent of 

GDP and our real growth, real GDP growth for the last 10 years 

has been just under 1 percent. 

Interestingly enough, Sweden has had a much higher rate of 

growth, 2.2 percent and a tax burden almost double ours, 50.2 percent. Denmark has had a higher rate of economic growth than have 

we over the last 10 years, and they are almost at 50 percent. The 

United Kingdom has had a much higher rate of economic growth 

than we have and they have a tax burden 10 points higher, per 

capita I should say. 

It really raises interesting questions about where the breakpoints 

are. 

I must say I was very surprised by these numbers. I thought we 

would probably have higher rates of economic growth than these 

countries that have much higher levels of taxation. Any comment 

that you would want to make? 

Mr. ORSZAG. A couple of comments. As you know, the structure 

of taxation in European countries is different from here with more 

reliance on value added taxes. 

I would also say a lot of the popular discussion of Europe fails 

to distinguish between the Scandinavian countries, some of them 

that you just mentioned, and continental countries like France and 

Germany. The economic experiences do vary fairly significantly between the Scandinavian countries and the continental European 

countries. 

Chairman CONRAD. I am Scandinavian. I am Danish, Swedish 

and Norwegian. 

Mr. ORSZAG. Almost all of them. 

Chairman CONRAD. Yes, I am sort of the Scandinavian melting 

pot. 

I look even at Italy. Italy has had higher economic growth, substantially higher. Growth of real GDP per capita in Italy, 2.3 percent versus our 0.9 percent, and yet they have a level of taxation 

that is almost 43 percent, 50 percent higher than ours. 

You raise, I think, a very important question, and that is different types of taxation have different economic effects. 

This vote has started so I am going to go and cast my vote. So 

we will come back. There are other members who have indicated 

234

they want a chance to ask questions, as well, and we are waiting 

for this vote. So we will go do that. We will put the committee in 

adjournment awaiting the call of the Chair. 

[Recess.] 

Chairman CONRAD. We will resume the hearing with Senator 

Whitehouse and his questions. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. 

Welcome and congratulations. I look forward to working with 

you. 

I wanted to followup on a couple of things that I heard, I was 

not here but I had reported to me that happened in my absence. 

I had to be in the Judiciary Committee, my apologies. 

The first has to do with Medicare Part D and the so-called noninterference clause. During my campaign, this was a very big issue 

in Rhode Island. There were studies that I cited to during the 

course of the campaign that showed not only were there substantial 

savings available if the non-interference clause were repealed and 

if the Federal Government took the logical next step and began to 

negotiate and drive prices down, but that the amount of savings 

would be enough to fill the so-called doughnut hole and provide 

coverage for folks so that we were not seeing the kind of things 

that I saw in Rhode Island like the 93-year-old lady who, after 93 

years of independence loses her apartment because she cannot afford both her rent and the cost of her pharmaceuticals while she 

is in the doughnut hole. 

I gather that you said that you did not see that there would be 

any savings from that. I am just wondering if you would explain 

what the analysis is that gets you to that point? And what your 

assumption is about what the Federal Government would do in answer to that legislative change that could produce no net savings? 

Mr. ORSZAG. Thank you, Senator. I am glad you asked that question. 

I want to make it very clear that there are potential savings in 

a $50 billion program. The question is how those savings could be 

realized. I did not say and do not believe that there are not price 

reductions that are possible for pharmaceutical prices under the 

Medicare Part D program. 

The question is what steps are necessary to get those deductions, 

and there are other consequences. 

Senator WHITEHOUSE. Are there steps that would involve the 

Secretary of the Department of Health and Human Services? 

Mr. ORSZAG. Absolutely, but just negotiating authority by itself, 

without either legislation specifying a direct price intervention, in 

other words that Medicare Part D plans would be offered, for example, the best price offered in the private market, or without the 

Secretary having the ability to set a Federal Government formulary, that just negotiating authority by itself is unlikely to give 

the Secretary any leverage. 

One could imagine the Secretary taking other nonprice things 

into account. Imagine the Secretary taking steps that involve 

things outside of the price negotiations themselves. But that is difficult to imagine right now and the legislation does not direct the 

Secretary to do so. 

235

So if the Secretary just walks in and says I am here to negotiate 

over price, but there is no statutory requirement that you offer the 

best price that is offered to anyone, and I do not have the authority 

to set up my own formulary, there is very little leverage. And that 

is why we do not think that there will be any significant price reduction. 

I would note just quickly that giving the Secretary that kind of 

authority, what I just mentioned, has other consequences. For example, with regard to Medicaid where there is a direct price intervention also, the evidence suggests that pharmaceutical companies 

raise prices in the rest of the retail market to partially offset the 

reduction that is offered to Medicaid. In a program as big as Part 

D, which is now more than a quarter of retail sales, we will need 

to carefully evaluate the pros and cons of the kinds of steps that 

would unlock the savings that many people believe are potentially 

there. 

Senator WHITEHOUSE. Thank you. I think my time has expired. 

Chairman CONRAD. Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. I also apologize for 

not being here earlier. We had a conflicting hearing that I had to 

attend at that particular point in time. 

One of the things that has concerned me is when we look at the 

baseline we tend to treat expiring taxes differently than expiring 

programs, making the assumption that the expired program is 

going to continue in perpetuity. That is not the case of all taxes. 

Excise taxes, for example, dedicated to a trust fund are assumed 

to extend out in perpetuity. 

But many of those taxes that are set to expire here in 2010 are 

not assumed to be extended. 

Would you share with me what your view is? It seems to me we 

have an inconsistency here. If you have spending, whether it is on 

the revenue side or whether it is on the programmatic side, spending is spending. It ought to be really reflective. I would like to hear 

your comments on that. 

Mr. ORSZAG. Senator, as you know, the baseline rules that we 

apply are long-established historical rules that we continue to 

apply and there is an inherent logic to them. I would say that there 

may be a difference between the baseline for projecting likely future outcomes, for example most people predict that at least part 

of the 2001 and 2003 tax legislation will continue. So in the most 

likely scenario those tax provisions will continue. That is one question. 

A separate question is for budget scoring purposes what baseline 

should you be measuring changes from? The current set of rules do 

have a sort of adding up or internal logic to them. I would just note 

that the purpose of a baseline for predicting future budget outcomes and the purpose of a baseline for measuring policy changes 

and scoring purposes can sometimes come in conflict. And that is 

occurring now. 

Senator ALLARD. Let us take AMT, for example, the Alternative 

Minimum Tax. They continually get extended every year. They will 

likely continue to be extended every year because they have both 

Republican and Democrat support. Why in the world don’t we just 

figure that into the baseline, like an expiring program, for examVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00241 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
236

ple? If you look at the record of the Congress, they are generally 

extended. There is sort of a group of expiring provisions that we 

bring forth every year that we just assume are going to be extended out every year. And yet we have a program out here that 

expires but we assume it is going to be extended, even though we 

do not even have a history in this Congress of extending that program. 

So I think there is some inconsistency there, and I think it needs 

to be addressed. I know that we have certain assumptions built 

into the baseline. My point is that maybe we ought to take another 

look at these baseline assumptions and think if we are treating, 

when we extrapolate out these baselines, taxes the same way we 

are treating spending programs. 

Mr. ORSZAG. Senator, what I would say is I think that a key 

principle should be that the cost of a particular policy path should 

be included in the budget process at some point, either at the time 

of enactment or when something is extended. The current scoring 

goals are intended to produce that outcome, so that for example on 

the revenue side, something that sunsets is not scored for the subsequent years when it is initially enacted. But then, if those provisions were extended, the cost shows up then. 

So I think the important point is that the cost shows up in the 

budget process somewhere, either at the time of initial enactment 

or at extension. 

With regard to other programs that are on the outlay side and 

are assumed to continue, a change that is made now will be continued in the initial scoring even if it expires within the budget window, so that the cost shows up today. Again, I think the important 

principle, regardless of how you do it is that the cost shows up 

somewhere. 

Senator ALLARD. Don’t you think that is an inconsistency? 

Mr. ORSZAG. You could look at it either way. On the one hand, 

on the outlay side, even if you say something is going to stop with 

regard to some of the programs—

Senator ALLARD. Even though it expires, you assume it is going 

to continue on. It seems like an inconsistency there. 

Mr. ORSZAG. But again the important point is that the cost of a 

change shows up somewhere. It adds up and it does not just disappear from the process. I think that is important to the integrity 

of the budgetary process. 

Senator ALLARD. Mr. Chairman, my time has expired. 

Chairman CONRAD. Let me just say, Senator Allard is asking important questions. This baseline, these baseline issues are thorny. 

They are difficult. Let me take a stab at this, and correct me, Director Orszag, if I misstate something. 

You are required by the law to, on the baseline, continue current 

policy. On the tax cuts, Congress chose to sunset the president’s 

tax cuts. They did that for a reason. They wanted to have more tax 

cuts and they wanted to reduce the appearance of the cost of them. 

And so they sunset them. 

Of course, the CBO baseline has to take account of that change, 

because Congress has said these tax cuts end at a certain point. 

And at that point you are obligated by the law to terminate them. 

Isn’t that the case? That is not a matter of choice. 

237

Mr. ORSZAG. Senator, we follow the baseline rules that were initially set by law. That law has expired but tradition and norm suggest continuing them. 

We are looking to you for guidance as to how the Budget Committees believe the rules should operate. One of the reasons that 

there is this tension or awkwardness now is that the size of the 

sunsets in tax provisions are much larger than they were historically. And that creates some of this question about the right baseline to be using for a variety of purposes. That is unusual historically. We have not historically had such a large component of the 

tax code expiring within the budget window. 

Senator ALLARD. Would the Chairman yield on that? 

Chairman CONRAD. I would be happy to yield. 

Senator ALLARD. Look at No Child Left Behind, for example. 

That is up for reauthorization. In all of our assumptions, we always 

said that program is going to continue out. That is a pretty sizable 

program. 

It seems to me there is an inconsistency there, because if that 

was a tax provision, and we know it is sunsetting, then we would 

assume that it is not going to be extended out. 

So I think that maybe the Budget Committee ought to spend 

some time making sure that we treat both of those aspects of the 

ledger in a balanced way, that is my point. 

Chairman CONRAD. It is a point that is not without merit. 

Let me say this, on the tax cuts side of it, the reason CBO has 

to sunset the tax cuts and therefore change the baseline is because 

Congress sunset them. Congress made a choice. And Congress did 

it for a reason. Congress sunset the tax cuts because Congress 

wanted to have larger tax cuts, the administration wanted to have 

larger tax cuts than they really wanted to show in the out years. 

Now on the spending side of the ledger, typically things that are 

put into law, for example all the mandatory programs, those are 

permanent programs. Medicare is not sunset. Social Security is not 

sunset. 

So that is a problem that we are presented with. 

Senator ALLARD. The same argument, we did sunset No Child 

Left Behind. 

Chairman CONRAD. Maybe the Director can help us with that 

specific example. 

Mr. ORSZAG. My understanding is that the spending associated 

with the No Child Left Behind program is on the discretionary 

side. So in the baseline it is a different set of issues than mandatory spending. 

Senator ALLARD. My argument is not with the mandatory programs. My argument is with the discretionary programs that we 

put in. We sunset them and then do not treat them the same area 

as we would a tax cut. That is just the point I am making. 

Mr. ORSZAG. If I could just comment briefly on the discretionary 

side, both to be clear about what we do in our baseline and also 

to point out that the discretionary spending programs generally operate in a different system than, for example, the pay-as-you-go 

rules. There are different rules that are associated with them. 

In our baseline, one of the reasons that some people think that 

our baseline is biased the other way in a sense is that we assume 

238

that discretionary spending keeps pace with inflation. Historically 

such spending has grown more rapidly than that. So there are 

some who say the baseline understates likely discretionary spending because discretionary spending is likely to keep pace with population growth or something else. 

But obviously you are raising a very important set of issues and 

I would very much look forward to working with you about both 

baseline and scoring issues as we move forward. 

Senator ALLARD. Thank you, Mr. Chairman. 

Chairman CONRAD. Absolutely, Senator. Thanks for raising the 

question. 

Let me go back to the question of the tax cuts because my able 

staff reminds those were done in reconciliation, which requires 

them to be terminated. They could not be made permanent because 

of the reconciliation rules. And they chose to do it in a reconciliation process because that allowed them to fast track it, to have 

limited debate, to have limited amendments. And so on the tax cut 

side, those were done under special rules that required their sunset. 

The Senator raises a good point on the discretionary spending 

side of the ledger and I think the rationale has been you have a 

set of domestic spending initiatives. Even if one gets eliminated, 

they are replaced by others. If you look at discretionary spending, 

it has a base which tracks with what is happening to population 

growth, that tracks with inflation. And we are in a situation where 

we are not going to have that luxury. 

The Senator I think, makes a point that is important here. We 

are not going to have that luxury. If we look ahead and look at the 

mandatory programs and the spillover effect on domestic discretionary programs, we are not going to be able to have those programs growing with inflation and population growth. It is not going 

to be affordable unless we do something substantial with the longterm entitlements and on the revenue side of the equation. 

Senator ALLARD. Our surpluses that accumulate in Social Security will no longer be transferred to the general fund. And that is 

entirely right. 

Chairman CONRAD. That is going to be a real moment of truth. 

Senator NELSON. 

Senator NELSON. Good morning. 

Senator Bunning is going to offer an amendment this afternoon 

on the Floor of the Senate that would eliminate the tax revenue 

that is paid on Social Security retirement benefits above a certain 

level. How would you characterize the effect of this upon the budget and the budget in the outlying years? 

Mr. ORSZAG. Senator, we could get you the precise numbers but, 

as you know, Social Security benefits are partially subject to income taxation. That part of the tax code will grow more prominent 

over time because the thresholds are not indexed and so more and 

more people will be subject to them. 

There would be implications also for both Social Security and 

Medicare, those programs, because the income taxes that are collected on Social Security benefits are currently dedicated both to 

the Social Security system and to Part A of Medicare. 

239

Senator NELSON. We have heard that the impact would be some- thing to the effect of reducing revenue by some $200 billion over 

a 10-year period. 

Mr. ORSZAG. I could get back to you with the specific number. We 

cannot rule that out. 

Senator NELSON. In order to approach this on a pay-as-you-go 

basis, to eliminate that tax but to find a source of revenue that 

would pay for that loss of revenue, do you have any suggestions? 

Mr. ORSZAG. Senator, obviously there are many revenue options 

that are available to you. I am not even quite sure of the exact 

magnitude of the revenue change, so it would be premature to be 

providing you with many options. 

I would also, as you know, point to the Joint Committee on Taxation as the lead agency for the revenue side of helping you on revenue options. But we would be happy to provide you with the options that you were interested in also. 

Senator NELSON. I went on the Budget Committee in 1978 when 

I was a member of the House of Representatives. Of course, what 

I quickly realized that it was not just an economic document, it was 

a political document. Numbers can often be made to say whatever 

you want to say. 

In the budget that you have presented, does the budget take into 

consideration additional expenditures for defense that would occur 

later on with regard to a supplemental being offered by the President? 

Mr. ORSZAG. No, it includes only the enacted appropriations thus 

far this year. 

Senator NELSON. Does the budget that you offered, does it assume anything other than existing law with regard to all of the tax 

cuts that are in place cease come 2010? 

Mr. ORSZAG. All of the tax provisions that are scheduled to expire in 2010 do expire in our baseline. 

Senator NELSON. So right there, in reality, what we would have 

to grapple with in working with you is enormous more spending in 

defense because we will see additional supplementals come, particularly with the increased effort in both Afghanistan and Iraq, 

and that we will see a huge amount of change in the revenue that 

will occur as a result of the changes in tax cuts. 

So in the assumptions, would I be correct—and I will ask Dr. 

Orszag and you, Mr. Chairman—that where the current law in this 

budget would be built on assuming that the revenues are going to 

escalate higher as a result of the suspension of those tax cuts that 

are in place, the political reality is that some of those tax cuts are 

going to be reenacted and therefore the budget assumptions made 

by Dr. Orszag is going to be wrong because it is going to have a 

lot less revenue. 

So right there, this is just a country boy talking, if you have increased expenditures and you have lowered revenues in what is the 

reality of the situation, the budgetary reality, you are going to have 

bigger deficits. Is this country boy saying something that make 

sense? 

Mr. ORSZAG. You are absolutely correct, that higher spending 

and lower revenue leads to larger deficits. 

[Laughter.] 

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Chairman CONRAD. Pretty sophisticated country boy over here. 

Senator NELSON. You just take it from there. 

Chairman CONRAD. We have calculated, Senator, that if you extend the President’s tax cuts, if you fund the war, if you deal with 

the need to reform the Alternative Minimum Tax, if you adjust for 

the continuing supplementals, that is a $4.6 trillion difference from 

the CBO baseline over 10 years. And it is not to the positive side, 

it is to the negative side. 

So the reality that we confront here, the ongoing war with the 

need to reform the Alternative Minimum Tax because it is going 

to sweep up tens of millions of people, the President’s proposals to 

make the tax cuts permanent gives you a much different future 

than CBO is able to provide because of the rules that they are 

under, rules that we have imposed upon them by the way. 

And on top of that you have, unfortunately, the retirement of the 

baby boom generation coming on, which is going to really put us 

in a deep hole unless we address it. And we have to address all 

of these things. We have our hands full. Dr. Orszag? 

Mr. ORSZAG. Yes, you do have your hands full. 

Chairman CONRAD. I would just like to go back to this question 

of tax cuts paying for themselves. The Treasury Department, their 

analysis said that you get an offset of about 10 percent. That is if 

you have a $200 billion tax cut, about $20 billion of it comes back 

to you because of the tax cut. So you are left with losing 90 percent 

of the revenue. 

CBO has done the analysis that said the first 5 years you get 

back on favorable assumptions, favorable to tax cuts, you get back 

22 percent of the tax cut. On less optimistic assumptions you get 

back nothing. 

Central to the question of the effect of tax cuts and how much 

of the amount of the tax cut is paid for by the tax cut is the question of whether or not the tax cuts are paid for or not paid for. 

Many of the studies assume that the tax cuts are paid for either 

by other tax provisions or by cuts in spending. 

What happens, Dr. Orszag, when the tax cuts are not paid for 

but are just added to the deficit? Then what do we see with respect 

to tax cuts paying for part of their amount? 

Mr. ORSZAG. In that case, actually the sign can flip. So it is possible that the economic impact of a deficit financed tax change is 

actually negative rather than positive. The reason is that the tax 

change by itself can spur additional economic activity, lower marginal tax rates leading to more work effort. But you then have the 

drag on economic growth from a higher deficit and lower national 

saving. It is the net effect, and depending on the nature of the tax 

change it can go in either direction. 

I would also note, Senator, that how tax cuts are financed consistent with that is absolutely critical to evaluating their full impact. The 22 percent figure that you were citing is actually the 

largest number for the CBO analysis for the first 5 years of a particular tax change that was studied. That analysis was applying 

one model and assuming that the cost of the tax change was offset 

by increases in tax rates after 10 years. 

Different ways of financing—

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Chairman CONRAD. I was trying to be as favorable as I could to 

the group that says tax cuts pay for themselves. It is very clear 

from every one of these studies, including the Treasury Department under this Administration, their own studies show that tax 

cuts do not come close to paying for themselves. And when they are 

deficit financed, they do not even have an additive effect but have 

a potential negative effect. 

Is that not the case? 

Mr. ORSZAG. I think what we can say is that financing tax cuts 

through deficits, rather than immediately financing them with reductions in government spending, tilt whatever you think toward 

it being more likely that the overall impact is negative. 

Chairman CONRAD. Why does deficit financing alter the outcome 

on these studies? What is the drag that is created by deficits? 

Mr. ORSZAG. Budget deficits tend to reduce national saving. 

Lower national saving means that we accumulate less capital. And 

that means that we grow slower than we otherwise would. 

Chairman CONRAD. I know that Senator Allard would like to get 

into this discussion. I welcome you to it. 

Senator ALLARD. In your discussion you talked about taxes in 

general. It was a broad discussion about taxes in general. But I do 

think to really appreciate what can happen in a dynamic tax situation, I think you have to recognize that some taxes have a lesser 

economic effect than others. 

I think in your response, Doctor, you got to that. Take the child 

tax credit for example. Although it has a social purpose and we 

want to help young families that are getting started who have children, it does not have the same economic impact as expensing for 

small business, for example, that we had in our tax cut package, 

where when you expensed out $100,000 all of a sudden you had 

people going out and buying Bobcats, you had people going out and 

buying x-ray machines if they were doctors. 

Chairman CONRAD. Does the Senator know Bobcats are made in 

my State? 

Senator ALLARD. I do know that. I also know how to run one, too, 

Senator, and they are good. 

All of this drives this economic activity. I visited with Dr. Greenspan on this issue and I just want to know how you would view 

something like an expensing provision for small business where 

you target the small business community and you generate all of 

this purchasing and everything with small business, it creates jobs, 

and keeps the economy turning. 

Would you agree that there is a difference in the type of tax that 

you have? And some of them have a greater impact on revenues 

than others. And expensing, for example, on small business may 

have a very large impact on stimulating the economy. When you 

have a growing economy, it increases revenues, as we are seeing 

today, huge increase in revenues, to State governments as well as 

Federal Government. 

Mr. ORSZAG. Senator, I think one of the most important points 

that I am hoping really does come across is that it is absolutely 

true that the effect of tax changes depend on the nature of the tax 

change, the specific provision, and also how the tax change is financed. 

242

Three things actually. Where you are starting from, the nature 

of the tax change, and then how you finance it. And so just talking 

generically about tax changes is too broad. You need to get more 

specific. 

Senator ALLARD. In other words, the level of taxation also has an 

impact, and that depicted on the Laffer Curve. 

There is a place there on that curve where you maximize return 

to the Federal Government. You can have taxes too high and it 

really hurts your revenue, and you can taxes too low. 

Dr. ORSZAG. That’s right. 

Senator ALLARD. And you should apply that to each tax. You cannot apply it to taxes, in general. 

Mr. ORSZAG. Yes, the Laffer Curve, which is the now famous or 

infamous, depending on your perspective, depicts that. 

The reason that CBO and others have reached the conclusion 

that in general tax cuts do not come close to paying for themselves, 

is that we believe that we are on the left side of that curve. 

If you were on the other side of the curve, the conclusion could 

be flipped. 

Senator ALLARD. Can I ask a question on that, Mr. Chairman? 

Chairman CONRAD. Yes. 

Senator ALLARD. In 2003, we had tax cuts. Do you think, in general, we were on the right side or the left side of that curve? Because if you look at the results on today’s economy, it appears we 

were on the right side. 

Mr. ORSZAG. Most of the analysis that has been done suggests 

that while there was some growth impact from the tax changes, especially in an economy that was weak a tax change and spur demand and that leads to economic growth in that kind of setting, 

that those changes were not sufficient to offset the direct impact. 

And thus, effectively we are on the left side of the curve. 

Senator ALLARD. Thank you. 

Chairman CONRAD. And the result is that those tax cuts did not 

pay for themselves, did not come anywhere close to paying for 

themselves, and were additive to the deficit and debt. 

If we are dealing with reality rather than fantasy around here, 

tax cuts at current tax levels do not come close to paying for themselves, especially if they are deficit financed. Unfortunately, all of 

these have been deficit financed. We have had to borrow the 

money. And increasingly we are borrowing it from China and 

Japan. 

Senator WHITEHOUSE. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. I just had one 

followup on our earlier colloquy. 

The Secretary clearly has extremely broad executive authority, 

clearly has rulemaking authority, and clearly has a very broad 

scope of initiative within which enterprises could be undertaken to 

pursue the goal of lower prescription costs through the Part D program. 

Clearly this piece of legislation, the repeal of the non-interference 

clause, would not mandate how within the scope of that discretion 

and authority, the Secretary must act. 

I just wanted to make sure that your comment to me, because 

it do not want to hear it other places as an argument unless I have 

243

clarified it with you, are you saying that there is no way with that 

piece of legislation that the Secretary could exercise his initiative 

to bring costs down? Or are saying that because the scope of it is 

so broad and that change alone provides little information about 

what will happen next, that from a scoring perspective you cannot 

put a dollar value on what would ensue? 

Mr. ORSZAG. The latter, that is correct. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. 

Chairman CONRAD. I would like to go back to the larger issue, 

if I could for a moment. Senator Allard, would you like? 

Senator ALLARD. Yes, if I may. 

Chairman CONRAD. If I could just go with a question and then 

we will come back to you, if that is OK. 

I want to go back to the longer term issue that we face because 

we have been trying to focus on this committee on the longer term 

issues, challenges that we confront. 

You earlier put up a chart that showed under one set of estimates we could be consuming all of what the Government spends 

now just on health care programs. 

Mr. ORSZAG. Correct. In particular, if health care costs continue 

to grow over the next 50 years as rapidly relative to economic 

growth as they did over the past 50, that would be the outcome. 

Chairman CONRAD. I am told that in your most recent baseline 

Medicare, for some inexplicable reason, has not grown as fast as 

was anticipated. Can you talk to us about what you are seeing with 

respect to Medicare expenditures? Why is it—you indicated part of 

it is Part D? In fact, I think if I heard you correctly you said the 

majority of it is Part D. 

What other factors are contributing to Medicare not meeting the 

previous cost estimates? And can we anticipate that continuing? 

Mr. ORSZAG. Projected Medicare spending is $445 billion lower 

now than in August 2006 over the 10-year window that was used 

at that point. The majority of that, $265 billion, is coming from 

Part D. And so let me talk about that briefly and then return to 

the residual component. 

Part D is now estimated to cost less than it did in August for two 

reasons. First, the cost per beneficiary is lower. We now have actual data on experience with the program and again the PDPs, the 

prescription drug plans, are coming in with lower bids than we anticipated. And they are below last year’s level, for example. That 

is the primary cause of that $265 billion. I think that something 

like over half, maybe closer to two-thirds of it, comes from that. 

In addition there is, in the out years, a lower enrollment rate in 

Part D. That is because we now have more information on other 

sources of coverage available to Medicare beneficiaries. And so the 

share of Medicare beneficiaries that we project will take up the 

Part D benefit had been 87 percent. It is now 78 percent for those 

out years. 

Chairman CONRAD. That is what you are anticipating would be 

the take-up rate? Instead of 87 percent, 78 percent? So there are 

savings there, as well. 

Mr. ORSZAG. Correct. 

Chairman CONRAD. How about in traditional Medicare, Part A 

and Part B? 

244

Mr. ORSZAG. With regard to traditional Medicare basically what 

happened is—and we are still looking under the hood. But the 

change there looks like it is mostly concentrated in Part A, in hospital insurance. The previous baseline, consistent with experience 

over the previous several years, projected a more rapid growth 

rate. The actual cost numbers came in lower than that. So what 

happened in this baseline is we just had a one-off reduction in the 

level of costs and then roughly the same growth rate thereafter. 

Chairman CONRAD. So this is more of a temporary thing, is your 

assessment? 

Mr. ORSZAG. At this point, or at least for projection purposes, we 

are treating it as if it is a one-off change and then the growth rate 

resumes at the same time. So we are looking into exactly what the 

causes are of that lower rate. 

There are a lot of things that are changing at the same time and 

obviously disentangling them all will take some time but we are actively working on it. 

Chairman CONRAD. If you could inform the Committee when you 

reach conclusion on that matter, obviously that could be very significant if it is not just a one time—that would be very important 

to us. 

Senator ALLARD. Senator ALLARD. Thank you, Mr. Chairman. I want to follow the 

response on taxes and the impact it has had on the economy. 

The fact is that we are seeing a pretty good jump in revenues 

at the Federal level and nearly all of the States are having a very 

good sizable jump in revenue. If it is not the tax cuts, what do you 

attribute that to? 

Mr. ORSZAG. There are a variety of forces at work. Again, the tax 

changes could have caused some part of it. The question is whether 

they are the only cause. 

Senator ALLARD. I do not think anybody is saying that. But 

would you say they contribute a significant part of it? 

Mr. ORSZAG. They contributed some part to having the economy 

recover from the 2001 recessionary period. The tax cuts spurred demand and helped to boost growth. 

With regard to the particular pick up in revenue over the last 

year or two, there are a variety of explanations being put forward. 

We do not have enough detailed individual information yet to 

evaluate all of them. 

But for example, some things that people are putting forward as 

possible explanations, for any given level of overall economic activity, if that overall activity is more concentrated in higher income 

households than in middle-income households, then revenue will be 

higher than we projected for that given level of economic activity 

because our tax code is progressive. 

We do not know yet, but it is possible that that is one explanation for why revenue is coming in higher than we projected. But 

there are others and we do not have the individual tax data yet to 

be able to give you a full answer. 

Senator ALLARD. Let me move to Medicare Part D. In January 

of this year, CBO acknowledged market-based competitive bidding 

as one of the primary reasons for the significant decline in Part D 

spending of $136 billion to nearly 26 percent of what was projected. 

245

Do you agree with that CBO finding? And do you believe that could 

be attributed to the market-based competition? 

Mr. ORSZAG. Again, the bids are coming in and pricing is coming 

in better than anticipated and that is likely a reflection of the competition that is occurring in the private market. 

Senator ALLARD. Thank you, Mr. Chairman. 

Chairman CONRAD. I would like to go back to the whole question 

of what stimulates economic growth because I think we would all 

acknowledge tax cuts in a certain environment help stimulate economic growth. When the economy is underperforming, tax cuts are 

stimulative. Spending is stimulative. 

Would you agree with that, Dr. Orszag? 

Mr. ORSZAG. In a weak economy, where firms have extra workers 

and plant and equipment ready to produce things if someone would 

just buy them, either additional spending or a tax reduction which 

then spurs private spending will boost economic activity. 

Over the long term, the question is a much different one because 

the question then becomes how do you encourage a greater capacity 

of firms and workers to produce things rather than generating 

enough demand for them? 

Obviously, the tax system is only one of many inputs into that 

question. 

Chairman CONRAD. In fact, running large budget deficits is stimulative, is it not the case? 

Mr. ORSZAG. In the short-term, but not in the long-term. 

Chairman CONRAD. So in the short term, if you have a weak 

economy, running large budget deficits helps stimulate. But there 

is a drag effect over time. 

Mr. ORSZAG. That is correct. 

Chairman CONRAD. And that is why when you look at the question of tax cuts, tax cuts can be stimulative if conditions are—I 

would argue, in fact I proposed very significant tax cuts in 2001. 

I proposed about half as much as the President proposed, because 

I wanted to take the rest and deal with the Social Security shortfall. 

But I think we all understand that under certain conditions both 

tax cuts and spending are stimulative. 

The question I have been trying to raise is do tax cuts pay for 

themselves? I think both the academic research from the Treasury 

Department, from economists outside the Government, indicate 

they simply do not. They can offset part of their costs. But that offset is reduced if they are deficit financed. 

Is that not the conclusion that we should reach if we are trying 

to do this on a rational basis? 

Mr. ORSZAG. That is what the vast preponderance of analysis 

suggests. 

Chairman CONRAD. Let me go to these larger questions once 

again, because if we are looking at the long-term imbalance in Social Security and contrast that with the long-term imbalance in 

Medicare, does CBO analysis show, as the GAO analysis showed, 

that the shortfall in Medicare is maybe seven times as much as the 

shortfall in Social Security? 

Mr. ORSZAG. There are accounting questions regarding how you 

allocate shortfalls but there is no question that the Medicare 

246

inbalance, Medicare and Medicaid combined in particular, is substantially larger, many times larger than the Social Security one. 

Chairman CONRAD. Have your people done any analysis on what 

we might do, a menu of options for how we could have savings in 

those accounts? 

Mr. ORSZAG. Senator, we are actively working on various options 

for basically reducing cost growth in health care that you could 

evaluate. Let me just pause on that for a second because I think 

there is too aspects of it that are very important to emphasize. 

One is I think it is a mistake to look at containing costs just 

within the Federal programs themselves, Medicare and Medicaid. 

The underlying driver of that cost growth, the costs in those programs, is the underlying rate of cost growth in the health sector 

as a whole. And tackling that problem is perhaps the fundamental 

fiscal challenge and an important economic challenge facing the 

Nation. So we need to be thinking about things that will restrain 

that cost growth. 

The second point is I believe that there are opportunities to do 

that while still promoting innovation and imposing no harm on 

Americans’ health. There is a variety of evidence suggesting that 

at the margin for each additional dollar we spend on health care, 

we do not get very much in terms of additional health benefits. 

That opens up the possibility that we could take some cost growth 

out of the system while not harming and perhaps even helping 

many Americans’ health. 

Chairman CONRAD. Let me just say, on behalf of the Committee, 

that we would ask you to come back to us as quickly as you can 

with options for saving money. And obviously, we would like to 

save money in a way that does not adversely affect healthcare outcomes. In fact, I believe there are places where we could actually 

save money and improve health care outcomes. I have talked to my 

colleagues about that many times with respect to better coordinating the care of the chronically ill. 

Senator CARDIN. 

Senator CARDIN. Thank you, Mr. Chairman. Dr. Orszag, welcome. Thank you very much for being willing to come forward and 

we congratulate you on your new appointment. 

I congratulate you for being willing to come into the middle of 

this battle that we have going on regarding our budget, and I look 

forward to your help. 

I want to cover two points, one on savings initiatives. You and 

I have worked in the past on improving savings rates in this country in a fiscally responsible way, targeting as many resources as 

possible to those who need the most assistance, our lower wage 

workers, and also increasing our national savings rate. 

I hope that we will have a chance during the budget debate to 

talk about the impact of our savings rates on our short-term and 

long-term budget situation. 

Let me ask a specific question on Medicare. I know that you have 

answered questions dealing with the pricing of prescription medicines in Medicare Part D. Your projections are a little lower as far 

as the Medicare spending is concerned. And there are certain aspects of the Medicare law on prescription drugs that I would like 

to get your help as to its impact on Federal spending. 

247

The law requires that all of the Medicare Part D plans be administered by private insurance companies. There is no governmental 

insurance option. Statistics indicate that a Federal health care programs have for lower administrative costs than private health 

plans. 

If the Federal Government offered a public option, would that 

have an impact on some of the cost issues? I believe that is one 

way in which we could bring down the cost of Medicare Part D, as 

we do of course in the other parts of Medicare where the Government provides services and private insurance can also provide 

them. 

I am interested as to what impact seniors’ confusion about Part 

D may have had on your projections. Many seniors in my community have not signed up for Medicare Part D because they quite 

frankly cannot figure it out. So are these projections taking into 

consideration that many seniors who perhaps should be in Medicare D are not, and that is contributing to some of our cost savings? 

I know you have been asked this question in the past. But my 

comfort level is not quite there on how much we can save if we allowed Medicare negotiated price. Common sense and Economics 

101 tell me that the larger the market, the lower the price will be. 

So if you can put forward a larger market to a pharmaceutical 

manufacturer, you are going to get a lower price. 

So it seems to me there is a substantial savings that we can 

achieve for taxpayers if we allow the Government to negotiate 

based upon the fall market in the Medicare program. 

I would hope that as we start our deliberations on this year’s 

budget, where entitlement spending for Medicare plays such a 

large role, we will be able to get more information about policy 

changes that could have a major effect on saving taxpayers money 

without adversely affecting Medicare beneficiaries’ access to needed 

services. 

Mr. ORSZAG. Senator, first with regard to complexity. Before answering the specific question, I do want to emphasize that I think 

in a variety of areas the evidence is very strong that complexity 

causes significant problems, whether it is with regard to higher 

education programs or retirement savings programs. That for any 

given level of effort by the Federal Government, the more complex 

it is the less impact it has in terms of improving outcomes for 

households. 

So finding ways of still achieving the same purpose through simplified and default and other options, I think is a broad theme that 

is worthy of a lot of attention. 

With regard to the specific question of enrollment, and just to 

clarify, the new projections entail lower enrollment rates over the 

long-term primarily because we now believe that beneficiaries will 

have—more beneficiaries will have other good coverage for prescription drugs than Medicare Part D and therefore will not take 

up Part D. 

But in the very short term, there’s actually a higher level of enrollment now than we projected last August. So the 2006 numbers 

are coming in with somewhat higher enrollment than we had 

thought in August. 

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Again, just to come back to, I guess, the central question of negotiating authority, I want to again emphasize that the reason that 

negotiating authority just by itself, in the absence of other steps, 

does not generate a large cost saving in our view, is that by itself 

it does not tap the potential steps that could lead to those savings. 

So there are other things that are unimaginable and you would 

had to carefully evaluate the pros and cons. But a lot of the comparisons that have been done, comparing for example the VA program to Medicare, the prescription drug plans under Medicare, ignores the fact that the VA program has a formulary and it also has 

access to basically a direct price intervention through the Federal 

Ceiling Price and the Federal Supply Schedule which requires private firms to offer to the Veterans Administration effectively the 

best price that they offer on private markets. Which is not a feature of the legislation that passed the House. 

Senator CARDIN. Mr. Chairman, your patience. 

I understand there are other moving parts here, and it is very 

important for Congress to consider them also. I could not agree 

with you more. 

But basic economics tells me this: that if government is negotiating a price with a manufacturer and has a larger market share, 

then that in and of itself would generate a more favorable opportunity for the taxpayer than would 40 separate private companies 

each negotiating a price for their enrollees. 

Mr. ORSZAG. The problem is that the Secretary does not really 

control that market share. Part D is a little bit above one-quarter 

of the prescription drug market. If the Secretary could walk into 

a negotiation and say if you offer me this discount that 25 percent 

of the market is going to go your way effectively, very significant 

price reductions could be imagined. But that is not what would 

happen under just giving the Secretary negotiating authority because the Secretary cannot prohibit or prevented the drug from 

being listed or not listed on the PDPs, the prescription drug plans. 

So by itself, the Secretary would then be in the position of walking in and, unless there were other regulatory steps brought into 

the discussion, which would raise a different set of issues, saying 

I am here to negotiate prices but I will not really be able to control 

or steer toward you any additional drug purchases. And in that situation, it is not clear why the Secretary would succeed in getting 

any significant price reductions. 

Senator CARDIN. We need to explore this in greater detail. Clearly Medicare Part D was designed to make it difficult for Government to get directly involved in these areas, in addition to the negotiating restrictions. The history of Medicare is different than 

that. So this is truly different than the history of Medicare. 

As as we look at saving taxpayer dollars, we should be prepared 

to redesign the program to save taxpayer money without adversely 

affecting seniors’ access to prescription medicines. 

Thank you, Mr. Chairman. 

Chairman CONRAD. Let me just go back to this point because we 

have a complex mix here on what is happening with Part D. We 

have lower plan bids. Some have said that one factor there may be 

overall prescription drug spending seems to be slowing. Do you anticipate or do you believe that that could be a factor here? 

249

Mr. ORSZAG. That could be a factor, yes. 

Chairman CONRAD. We also have been told that lower plan bids 

may be, in part, a business strategy by those offering the plans to 

capture market share. Could that be part of the reason we are seeing lower plan bids? 

Mr. ORSZAG. It is possible. The market is, the top few plans account for a very large share of the existing market. 

Chairman CONRAD. Let us talk about that a little bit. How many 

plans now, do you have this information at hand, how many plans 

do we have around the country? And what is the share of market 

for the top five? 

Mr. ORSZAG. I know that the number of plans is quite high, and 

I believe that the share of the top five plans is also quite high. But 

I do not want to cite a number without being sure. 

Chairman CONRAD. Does anybody on your staff here know what 

the top five plans would have, in terms of market share? 

Mr. ORSZAG. We will get you that information. I have seen from 

other sources numbers that, the top five would be, I believe, even 

the majority of the market and perhaps well over the majority. But 

we will get you the precise number. 

Chairman CONRAD. I think that is important to our understanding of what is going on here. 

One closing question for me. Last week, Mr. Bernanke was here, 

the Chairman of the Federal Reserve, and he said this: Official projections suggest the unified deficit may stabilize or moderate further over the next few years. 

Then he went on to say unfortunately, we are experiencing what 

seems likely to be the calm before the storm. 

He went on to warn this committee that notwithstanding the 

likely improvement in the short term, that we remain on an 

unsustainable long-term path. 

I would ask you, do you agree with the assessment by the Chairman of the Federal Reserve? 

Mr. ORSZAG. Very much so. The Nation’s long-term fiscal imbalance is quite serious and the sooner that policymakers address it 

the better. 

Chairman CONRAD. I think that is the case. And that is the consistent message this committee hasten. It is the consistent message 

we got from the head of the General Accounting Office, from the 

Chairman of the Federal Reserve. And I am very hopeful that we 

find a way, Democrats and Republicans, to come together to face 

up to this long-term challenge and to do it sooner rather than later. 

I think that is clearly in the national interest. Senator Gregg and 

I have been endeavoring to devise a process to address that. And 

we thank you very much for your testimony. 

Are there any further questions from members? Senator Allard. 

Senator ALLARD. Mr. Chairman, I do have a couple of things I 

would like to followup on, if I may. 

I want to followup on our earlier discussion where you had said 

that you felt like the tax cuts that were put in place in 2003 actually were deficit financed tax cuts. If that’s true—and then you 

went on further and said that would reduce savings. We have seen 

savings go down in that respect. But what we have not seen go 

down is long-term interest rates. 

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Before the tax cuts, the rates were hovering well over 5 percent. 

Since 2003 until now, they have been mainly around 4.5 percent, 

maybe on the high 4 percent side. 

If we have damaged savings so much, how come those interest 

rates remain so low? 

Mr. ORSZAG. That is a very good question. There are a variety 

of explanations that are being put forward. 

Lower national saving means one of two things. It means either 

lower domestic investment or it means more borrowing from 

abroad. That is sort of an accounting identity. 

So if we are only saving 1 percent of our income on that, it 

means we are only investing 1 percent of our income here in the 

United States or we are borrowing the difference from abroad. 

Over the past several years there has been a very significant increase in the amount that we borrow from abroad. The reason that 

matters to the discussion is the mechanism for a given level of national saving affecting domestic investment is typically the interest 

rate. 

So in short, what may be happening, or at least one explanation 

for what has happened, is as the world economy becomes more integrated and capital flows become easier across countries, the effect 

of domestic changes in budget outcomes, for example, is muted in 

terms of the interest rate effect and it shows up more in terms of 

international borrowing then a purely domestic mechanism. 

Senator ALLARD. In that way, international borrowing may help 

our economy grow because it held our interest rates down. 

Mr. ORSZAG. That is true, although I would note that foreigners 

do not lend us money for free. And so we do ultimately have to 

repay what we borrowed. 

Senator ALLARD. But it is at a lower rate than it would ordinarily be. 

Mr. ORSZAG. There is an interesting question about whether we 

are able, for a variety of reasons, to borrow at relatively low rates. 

In which case, the benefits of the investments that we can make 

with that borrowed money may exceed the repayments that we 

have to make. And there could potentially be some net gain from 

that. But it is smaller than the total. 

Senator ALLARD. What are some of the other theories that could 

be used to explain that? You said there were several theories and 

you suggested this is one of them. 

Mr. ORSZAG. That is one theory. Another theory is that, another 

prominent theory—and I probably should have mentioned in the 

same breath—that financial markets expect that whatever steps 

one takes on the budget, then it generates a certain projected outcome, that you all will take steps before a catastrophe hits to avoid 

that catastrophe. Therefore, they price that into long-term—

Chairman CONRAD. They are counting on us. 

Mr. ORSZAG. Yes, it is all on you. 

What is interesting about that is if that perspective is correct, 

then if at some point financial markets realize that is not the case, 

you will then break from their perception. And you could potentially have a significant adjustment at that point. 

Anyway that is another explanation. There are others and I 

would be happy to sit down and discuss them in more length. 

251

Senator ALLARD. Mr. Chairman, I know you are trying to wrap 

this up but I want to bring up the issue of military spending. 

What you are projecting in the baseline is $145 billion on defense 

spending. We have already moved $70 billion over into 2007. It 

seems to me that that is pretty low. Around $100 billion is what 

we might expect in spending. 

Do we need to take a look at the model that you are using for 

this? Or is this something we are not going to be able to deal with 

through model changes and it is just a problem we have with the 

way the Defense Department is coming in with their increased requests and emergency spending? 

Mr. ORSZAG. A couple things quickly. First, which regard to the 

baseline, we include $70 billion in appropriated money because—

Senator ALLARD. In the $145 billion you do? 

Mr. ORSZAG. $70 billion for 2007. And there is likely to be more 

money appropriated. 

Senator ALLARD. Let me get this straight. I have here in my 

notes: CBO projects a 2007 funding level for the global war on terrorism of $145 billion. 

Mr. ORSZAG. Oh, I am sorry, under an alternative path. Thank 

you. 

So one of the alternatives, not the main numbers, but one of the 

changes in policies or the alternatives includes, yes, total of $145 

billion for 2007. 

I would say two things about the cost of ongoing operations, 

which obviously we are only talking about the fiscal cost. And I 

want to just focus on those and leave up to you other aspects of 

it. 

The cost per month of ongoing operations appears, for the global 

war on terrorism, to be about $10 billion according to our information, and for the Iraq theater about $8.5 billion a month. We do not 

fully understand why those cost numbers are higher that they had 

been previously. And so that is one thing that needs to be better 

understood. 

And in that context, the information that we have access to from 

the Defense Department and their systems do not allow us to have 

full insight into costing out both what is happening and what is 

likely to happen. And I understand that the Administration and 

others, and presumably this committee, are looking at different 

ways of trying to track both the budget authority and the actual 

spending that is associated with that particular set of defense activities, as opposed to everything else, more carefully. 

Chairman CONRAD. Might I just, on this matter, Senator, say 

that in visiting with high level military officers part of what is happening, I am told, is we are living off the balance sheet. That is, 

that we are degrading equipment in a way that is going to come 

back in higher costs. 

That is, when you are at this level of operations, the Army is 

going through Humvees, tanks, guns. The Air Force, at this high 

level of operations tempo, that the operations and maintenance expenses are going up because equipment is being degraded. That 

their requirement for replacement equipment is going up as this 

conflict is prolonged. 

252

Senator ALLARD. I could see how that would happen because it 

is a pretty harsh environment. 

Chairman CONRAD. Very harsh environment, very hot, and they 

sand, they tell me it is eating up engines. Of course, this affects 

all of the services. The leading edge obviously, the Marines and the 

Army, in terms of their equipment losses. The Air Force, they have 

just been up to see me and talking about the additional costs that 

they are experiencing. 

I think as we have analyzed this so far, we think this $10 billion 

a month significantly understates the cost that is going to come in 

on us. And we will have to wait and see what the supplemental request of the President shows. But we are hearing $100 billion, 

somewhere in that range. 

Dr. Orszag? 

Mr. ORSZAG. I was just going to return in the spirit of being responsive to this committee to get back to you immediately on your 

question about prescription drug plans. The top three plans, I am 

told, account by themselves for more than half of the prescription 

drug plan and Medicare Advantage by enrollment by themselves. 

So the top five players would be over half. 

Chairman CONRAD. I have suspected that that would be the case. 

You can see in industry group after industry group that you have 

three or four who overwhelmingly dominate. And I think over time 

we can come to expect, even though you have dozens and dozens 

of plans across the country, that in a relatively short period of time 

there will be concentration in the market and that we can anticipate that that will be the case. There will be three or four that will 

dominate probably somewhere around 80 percent of the market. It 

is rapidly moving in that direction. And that is basically the information you have confirmed for us. 

Let me indicate, we had said that we would try to end at noon 

and we will try to be good to our word. 

Dr. Orszag, outstanding first performance before the Senate 

Budget Committee. We appreciate so much the contribution that 

you are making there and your excellent staff, as well. 

And Dr. Marron, we are so glad to see you as a continuing part 

of this team. 

Thank you very much. The hearing is adjourned. 

[Whereupon, at 12:02 p.m., the committee was adjourned.]

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DEFINING OUR LONG-TERM FISCAL 

CHALLENGES 

TUESDAY, JANUARY 30, 2007

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. Kent Conrad, chairman of the committee, presiding. 

Present: Senators Conrad, Wyden, Stabenow, Menendez, Cardin, 

Sanders, Allard, and Bunning. 

Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 

Staff Director for the Minority. 

OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

Chairman CONRAD. I bring the hearing to order. 

I want to welcome everyone to the Budget Committee today. I 

want to particularly welcome our distinguished witnesses. Dr. Robert Reischauer, the President of the Urban Institute and the former 

head of the Congressional Budget Office; Robert Greenstein, the 

Executive Director of the Center on Budget and Policy Priorities; 

and Dr. Eugene Steuerle, a Senior Fellow at the Urban Institute. 

I very much welcome you all here and we appreciate your guidance 

to the committee. 

Let me begin with a quote from the Federal Reserve Chairman 

Bernanke in his testimony earlier this month to this committee. In 

describing the urgency of addressing our deteriorating budget outlook, he said one might look at these projections and say well, 

these are about 2030 and 2040 and so we really do not have to 

start worrying about it yet. But, in fact, the longer we wait, the 

more severe, the more draconian, the more difficult the adjustments are going to be. I think the right time to start is about 10 

years ago.

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I think Chairman Bernanke had it about right. 

We are now facing, as this next chart shows, a wall of debt. At 

the end of 2001 we had a gross debt for the country of $5.8 trillion. 

Under CBO’s adjusted baseline we can see that gross debt will 

reach $9 trillion by the end of this year. And if we continue on this 

course, gross debt is projected to sore to $12 trillion, more than $12 

trillion by 2012. All of this really at the worst possible time, right 

before the baby boom generation retires.


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The number of Social Security beneficiaries is projected to more 

than double to some 82 million people by 2050. This is the trajectory that we are on. I call this the demographic tsunami. You can 

see all of these people have been born. This is not a matter of a 

projection. These people have been born. They are alive today. They 


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are going to retire. They are going to be eligible for Social Security 

and Medicare. There is no way around that.

We need to remember that Social Security is not the biggest 

budget challenge. Because of rising health care costs over the next 


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75 years, the shortfall in Medicare is seven times the shortfall in 

Social Security. The shortfall, the projected 75-year shortfall in Social Security is $4.6 trillion. The 75-year shortfall in Medicare is 

over $32 trillion.


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But we do not just have an entitlement problem. We also have 

a revenue challenge. If all of the President’s tax cuts are made permanent, the cost will explode at the very time the cash surpluses 

in Social Security and Medicare become deficits. In other words, 

the President’s tax cuts will dramatically worsen an already deteriorating long-term budget picture.


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This chart, I think, is extremely important for my colleagues and 

for the public to understand. The green part of these bars is the 

Social Security surplus that then turned to deficits. The blue are 

Medicare, Medicare deficits. And red is the cost of making permanent the tax cuts from 2001 and 2003. 

This is not a pretty picture because what it shows is right now 

Social Security is throwing off big surpluses. But when those turn 

to cash deficits, at that very time the cost of the President’s tax 

cuts explode. The combined effect takes us right over the cliff. 

Since so much of our long-term budget shortfall can be attributed 

to rising health care costs, health care reform has to be at the 

heart of any solution. Our health care system is not as efficient as 

it should be. The U.S. is spending far more on health expenditures 

per capita than any other country in the developed world. For example, the U.S. spent $5,711 on health care expenditures per capita in 2003 compared to $2,100 in Finland. Despite this additional 

health care spending, health outcomes in the U.S. are no better 

than health outcomes in the other OECD countries.

You can see, I just picked out Finland. Finland is at the low end. 

But you can look at all of the major countries of the developed 

world. The United Kingdom, they are just over $2,300 per capita, 

less than half of what we spend, all the way up to Switzerland. You 

can see they are $3,800, still far below us. 


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The country that is closest to us is Luxemburg, just under $4,000 

per capita. 

As we see the same thing when we look at health care expenditures as a share of our gross domestic product. For example, the 

U.S. spent 15 percent of GDP on health care expenditures in 2003. 

We believe we will be at about 16 percent of GDP this year compared to Ireland, 7.2 percent. The next highest to us is Switzerland 

at 11 percent of GDP, 11 percent of GDP. This year we are at 16 

percent. 

If we were 11 percent of GDP instead of 16 percent, we would 

save $800 billion in 1 year. 

Clearly, just slashing Medicaid and Medicare is not the answer. 

One area, I believe, we need to focus on is the fact that about 5 

percent of Medicare beneficiaries use half of the money. That is, I 

think, a startling and powerful statistic. Approximately 5 percent 

of Medicare beneficiaries use half the money. These are the chronically ill. They are people with multiple serious conditions. I think 

we are learning more and more. If we focused on that category, we 

could both improve health care outcomes and save money. 

I believe our fiscal problems are not insurmountable. We can put 

our fiscal house back in order but it is going to take a good faith 

effort on everyone’s part. And both political parties, and those of 

us who represent individual states, and those of us who have a 

party label by our name, I think all of us have to be prepared to 

give up on some of our fixed positions if we are going to make longterm progress. 

With that, I want to turn to my colleague, Senator Allard, who 

is filling in ably for the ranking member of this committee, Senator 

Gregg, who could not be with us this morning. 

Welcome, Senator Allard. 

OPENING STATEMENT OF SENATOR ALLARD 

Senator ALLARD. Thank you, Mr. Chairman. 

I would like to join you in welcoming the panel members. I am 

looking forward to your testimony, and I know it is not always easy 

to put your personal schedules aside to be able to testify before this 

committee. But we have an important subject before us and I do 

commend the Chairman for his efforts in trying to deal with these 

long-term liabilities. 

It is not really news to anybody. The Congress has known this 

has been coming on for a long time. But there has been an unwillingness for the Congress to respond to these issues. So I do appreciate the leadership that Senator Conrad is bringing forward as 

Chairman of the Budget Committee. 

The baby boomers are going to start retiring in 2008. That is 

next year. If we look at the population growth of those 65 and over 

the numbers are staggering. In 2005 we are looking at 37 million. 

We see that doubling in 30 years, so that in 2035 we have 75 million people that are going to be pulling on our entitlement programs, which are directed to an aging population. That is Social 

Security, Medicare, and Medicaid. 

When this was set up in the 1960’s we had one beneficiary for 

every 5.1 workers and now have about 3.3 workers for 

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everybeneficiary.In 2035, when we are projecting 75 million, there 

will only be 2.1 workers for each beneficiary or retiree. 

It is a huge problem that we have before us. Under current law 

the mandatory spending will grow at an average of 6.1 percent per 

year during 2007 to 2016, reaching somewhere around $2.5 trillion. 

But the entitlements, as the Chairman pointed out with his 

charts, are the real problem. We simply have to establish a will in 

this Congress to deal with the huge numbers that we are looking 

at with Social Security, Medicare and Medicaid. 

If we look at Social Security, Medicare, and Medicaid, unless 

something is done, as a percentage of gross domestic product, 

spending on just these three programs is going to grow higher than 

one-fifth of the economy. Here is what we are looking at: in 2010 

it will make up about 9.5 percent of gross domestic product. In 

2030, about 18 percent of gross domestic product. And in 2050, 25 

percent of gross domestic product. 

But the astounding thing about it is not only are the percentages 

increasing as a percentage of gross domestic product, but gross domestic product is growing at a phenomenal rate. If you look at the 

growth of our entire economy from 2003 to now it has grown in an 

amount equal to the size of the entire Chinese economy. And so 

these are figures that are being extrapolated on top of a very fastgrowing economy that we have currently. 

I am not saying it is always going to be there, but our economy 

seems to be perking along pretty well, and I do not see any signs 

of it letting up. And when you look at those percentages and look 

at the growth of the gross domestic product, it is just phenomenal. 

This problem is serious, and I do not see us being able to tax our 

way out of it. I think it is going to take a balanced solution. We 

are going to have to look at a number of things to do to begin to 

resolve this commitment. It will continually add to our deficit and, 

as a result, add to our total debt. 

Some things have been done in an attempt to address this problem by the previous Chairman, Senator Gregg, with his SOS bill 

that he introduced last year. I think that there are some bipartisan 

groups looking at a commission to put some entitlement recommendations before the committee. While Social Security is a 

problem, Medicare and Medicaid is a greater problem and a much 

more complex issue to solve from my perspective, and I think most 

everybody would agree with that. 

But I think maybe we need to start off with a simple solution 

with Social Security and then begin to address Medicare. But we 

cannot delay it because Medicare is going to be a problem here 

shortly and it is going to be a huge problem when it hits us. 

So I again commend the Chairman for running these series of 

hearings and look forward to your testimony. 

Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you, Senator Allard. 

Next we will turn to our witnesses and we will hear from each 

of them in turn, and then open the panel to questions from the 

members. 

Welcome, Dr. Reischauer. It is always good to have you back before the committee. 

Are we going to start with Gene or with Bob? 

266

Welcome. 

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

Mr. GREENSTEIN. Thank you, Mr. Chairman. 

Yesterday, we released new long-term budget projections through 

2050 that incorporate the new CBO report that came out last week 

and take into account recommendations from a number of the Nation’s leading budget experts. 

There are five key findings. First, the Nation’s budget policies 

are unsustainable. 

Second, the main source of rising expenditures is rising health 

care costs throughout the U.S. health care system and demographic 

changes that would drive up spending for the ‘‘big three’’: Medicare, 

Social Security, and Medicaid. 

Third, increases in health care costs per beneficiary in Medicare 

and Medicaid mirror increases in costs in the overall U.S. health 

care system and a solution to the long-term fiscal problem will necessitate reform in the overall health care system. 

Fourth, Federal programs other than Medicare, Medicaid, and 

Social Security, including entitlements other than the big three, 

are projected to shrink as a share of the economy and are not contributing to the problem. 

Fifth, the tax policy decisions you must make in coming years 

will have a large impact. 

Let me take each of these five areas in a little more detail. 

Our projections show that if you stay on the current course, 

make no changes in the ‘‘big three’’, make all the tax cuts permanent and, continue relief from the AMT without paying for it, deficits will reach 20 percent of GDP by 2050 and the national debt 

will reach 230 percent of GDP by 2050, as this graph shows.

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Another way of measuring the size of the problem is to look at 

what analysts call the fiscal gap, which is the amount of program 

reductions or revenue increases needed to ensure that the debt as 

a share of the economy is no higher in 2050 than it is today. Under 

our projections, the fiscal gap is 3.2 percent of GDP. 

Now what that means is that stabilizing the Nation’s finances 

would require budget cuts or tax increases starting immediately 

equal to 3.2 percent of GDP per year. That would mean budget cuts 

and/or tax increases totaling $460 billion dollars in 2008 alone, because that is 3.2 percent of GDP. That is how big the problem is. 

Second, health care costs rising throughout the health care system and demographic changes will cause Medicare, Social Security, 

and Medicaid to rise by 2050 by a projected 13 percent of GDP. 

Third, the growth in Medicare and Medicaid costs mirrors and is 

driven to a large extent by cost growth in the health care system 

as a whole. For the past 30 years the average annual rate of increase in Medicare and Medicaid costs per beneficiary has been 

very close to the rate of increase in health care growth per beneficiary systemwide. 

This is why Comptroller General David Walker has testified, and 

I am quoting, ‘‘Medicare and Medicaid cannot grow over the long 

term at a slower rate than the rest of the health care system without resulting in a two-tier health care system.’’ And he continued 

‘‘To address the long-term fiscal challenge, it will be necessary to 

find approaches that deal with health care cost growth in the overall health care system.’’

No. 4, programs other than the big three. The new CBO forecasts 

that came out last week shows that entitlements other than the big 


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three as well as domestic discretionary programs will fall through 

2017 modestly as a share of GDP. That continues a trend of the 

past 30 years and is expected to continue beyond 2017. This is why 

it is not really accurate to speak of a general entitlement crisis 

rather than to focus on the projected increases in Medicare, Medicaid and Social Security and the factors that drive them.

Finally, the tax policy decisions Congress must make over the 

next few years will have large effects. Specifically, allowing the recent tax cuts either to expire as scheduled or to continue them but 

to pay for their costs under PAYGO would reduce the long-term fiscal gap by three-fifths. The tax cuts, when fully in effect, will cost 

about 2 percent of GDP. The fiscal gap is 3.2 percent of GDP. Either letting them expire or extending them but paying for it will 

shrink the long-term fiscal gap from 3.2 percent to 1.3 percent of 

GDP. 

Or stated another way, making the tax cuts permanent without 

paying for them will double the fiscal gap through 2050 relative to 

what it otherwise would be. 

Why is that effect so large? Because the decision is occurring in 

the next few years. And if one achieves deficit reduction of about 

2 percent of GDP in the next few years, after 2010, that effect 

quickly compounds year by year in terms of debt and interest payments and ultimately reduces the deficit by significantly more than 

2 percent of GDP. 


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It is simply an illustration of the larger point which you made, 

Mr. Chairman, the sooner you act, both on the revenue and the entitlement side, the larger the long-term effect and the smaller the 

depth of the reductions that ultimately have to be made.

Our bottom line is that it is politically implausible to close a gap 

of this size either solely by cutting programs or solely by raising 

taxes. Doing so would require the equivalent of an immediate permanent 18 percent increase in tax revenues or an immediate permanent 15 percent cut in all programs, including Social Security, 

Medicare, defense, antiterrorism activities, education, veterans 

benefits and the like. All parts of the budget have to be on the 

table and systemwide health care reform must be part of the solution. 

Let me close with a few quick policy observations. As you noted, 

to make these kinds of changes in health care, taxes, and Social Security is going to require a large difficult bipartisan agreement 

which may take a few years to build the basis for. But some immediate, more modest, but still important steps could be taken. And 

there are some immediate things one wants not to do in order to 

keep the problem from getting worse. 

So a few very quick suggestions. No. 1, I would seriously consider 

the medications for Medicare savings in the Medicare Payment Advisory Commission, of which Mr. Reischauer is a Vice-Chairman. I 

would seriously consider the revenue options in the report the Joint 

Tax Committee provided to Congress about 2 years ago, which has 


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a series of options to narrow or curb unintended or unproductive 

tax expenditures and to improve tax compliance. 

Third, I would consider a report issued last week by the Urban 

Institute Brookings Tax Policy Center that provided a series of options for revenue neutral reform of the Alternative Minimum Tax. 

I note here that there has been discussion lately of AMT repeal. 

If the 2001 and 2003 tax cuts are not extended, AMT repeal would 

cost $800 billion over the next 10 years. If they are extended, it 

would cost $1.5 trillion over the next 10 years. And even continuing 

the current practice of providing an AMT patch each year without 

paying for it is becoming increasingly expensive and fiscally imprudent. On that course, it will cost you $70 billion a year by 2010 and 

more thereafter. 

I would also consider freezing costly expansions not yet in effect. 

For example, two tax cuts that President Bush did not request, 

that were added on top in 2001, are only partially in effect now. 

They are slated to triple in size between now and 2010. These are 

two income tax adjustments. 

Analysis by the Tax Policy Center shows that nearly two-thirds 

of these tax cut benefits not yet in effect would go to the 0.3 percent of Americans over $1 million a year, 90 percent will go to the 

4 percent of Americans over $200,000 a year. If you simply held 

them at today’s levels, and did not take away a dollar in tax cuts 

from anyone who is getting it, but did not allow them to triple in 

size between now and 2010, you would save $13 billion in the next 

several years, which is about the amount needed to avert deep cuts 

in the State Children’s Health Insurance Program that will occur 

if SCHIP is frozen for the next 5 years at the Federal budget baseline. 

Finally, I would seriously consider, across the Government, replacing the traditional Consumer Price Index with the new improved alternative CPI that the Labor Department has developed 

that measures inflation a little more accurately. I am talking about 

things from Social Security COLAs to the indexing of the tax code, 

evenhanded across the Government. 

The new CPI rises a few tenths of a point per year more slowly 

than the traditional one. The savings initially are small. They grow 

over time when you need them as your fiscal problem expands. And 

it really should not be viewed as a benefit cut or a tax increase. 

It is simply doing what the law currently intends, adjusting for inflation rather than over-adjusting for inflation. 

With that, I will conclude. Thanks for inviting me today. 

[The prepared statement of Mr. Greenstein follows:]

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Chairman CONRAD. Thank you very much, Dr. Greenstein. 

Thank you for those new numbers that, in many ways, confirm 

what we have been talking about with the previous witnesses, the 

Chairman of the Federal Reserve and the head of the General Accounting Office, who both outlined in some detail the really 

daunting challenges that we face. 


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Now we will turn to Dr. Reischauer. Thank you. Thanks for 

being here. And please proceed with your testimony. 

STATEMENT OF DR. ROBERT D. REISCHAUER, PRESIDENT, 

URBAN INSTITUTE 

Mr. REISCHAUER. Thank you, Mr. Chairman, and members of the 

committee. I appreciate the opportunity to appear before you today. 

With your permission, I would like to submit my prepared statement for the record and confine my remarks to an elaboration of 

a couple of points made in that statement. 

Chairman CONRAD. We would be happy to take your statement 

in full. 

Mr. REISCHAUER. First, today, through Mr. Greenstein’s testimony, and during the committee’s recent hearings, you have heard 

a number of experts present long-run budget projections that show 

that debt and deficits begin to soar around the third or fourth decade of this century as interest expenses, which are the one component of the budget that truly is uncontrollable, begin to explode. 

The fact that the current budget situation appears, at least on 

the surface, to be rather benign and that three-plus decades is a 

long time out, may lead some to believe that we need not rush to 

make the policy adjustments required to make the fiscal situation 

sustainable. This, as you have already heard, would be a big mistake, for it is inconceivable that the paths portrayed in these longrun projections will play out as presented. 

As the fine print that accompanies most of these projections 

notes on, these estimates do not take into account the feedback effects of deficits on the economy which will act to depress economic 

growth significantly and that will further exacerbated the fiscal situation. 

Nor do these projections examine the ramifications of the growing ownership by foreigners of dollar denominated assets on the 

well-being of U.S. citizens. The profits, rents, dividends, interest 

and capital gains associated with those assets will be paid to foreigners, raising their, not our, standard of living. In other words, 

a growing fraction of the fruits of whatever economic growth we do 

enjoy will be captured by foreigners because they will be the ones 

who own the capital. 

For these reasons, it is highly likely that policymakers will be 

forced to begin the adjustment process far sooner than a superficial 

reading of these long-term budget projections imply. If we do not 

begin to take steps to live within our means soon, we run an increasing risk that some unpredictable crisis will dictate both the 

timing and the pace of the unavoidable adjustment process. 

This does not mean that we have to swallow all of our medicine 

at once, that we have to sit down today to work out an adjustment 

of 3.2 percent of GDP, which is the Center on Budget and Policy 

Priorities’ new estimate of the gap. But it does mean that we need 

to show a good-faith effort that we are willing to begin this process. 

In addition to some modest tax and spending restraints enacted 

immediately, we should adopt policies that may go into effect many 

years from now but will indicate the direction that we are headed 

in. 

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Recall that in 1983 we adopted changes to the normal retirement 

age in the Social Security program that did not affect beneficiaries 

until the year 2000, 17 years later. But it gave an indication that 

we were aware of a problem and we were going to do something 

about it. 

In addition, I would urge you to consider enacting mechanisms 

that provide for automatic adjustments when and if things go off 

path. These might include mechanisms that shave the automatic 

indexation both in our tax code and in our entitlement programs. 

They would be a form of failsafe so that those who are skeptical 

about Congress’s ability to address problems in a timely manner 

would know that behind the scenes automatic trigger devices might 

dampen the damage. 

Second, it is clear, as you have heard from other witnesses, that 

the primary cause of the long-run fiscal problem is the inexorable 

growth in per beneficiary health spending which significantly exceeds the growth in per capita GDP. If, through some miracle, we 

were able to hold per capita health spending in Government programs to the level of per capita GDP growth, it would not be a 

heavy lift to get the rest of our fiscal house in order. 

But unfortunately, there are no miracles on the shelf. The problem of rapidly growing health costs is not confined to U.S. Government programs, as Mr. Greenstein has pointed out. The same pressures affect both the private sector and foreign countries. What is 

different is that the private sector and foreign countries have 

mechanisms that force the parties to consider the tradeoffs between 

improved health care and other priorities. 

For example, in our employer-provided health care system, employers and workers must choose between receiving their compensation in the form of better health insurance on the one hand 

or in the form of higher cash wages and more generous non-health 

benefits on the other. In countries that budget explicitly for their 

national health systems, tradeoffs are made between higher taxes, 

charges and premiums on the one hand and new and more costly 

health benefits on the other. 

With open-ended entitlement programs and a seemingly unlimited capacity to borrow, we have only very weak constraints on our 

major Government health programs. 

In my opinion, we will probably need to fundamentally restructure the Nation’s health care delivery system and the mechanisms 

used to finance it if we hope to moderate cost growth without compromising the quality of care. 

This is a daunting challenge because it affects not just public 

programs but rather the entire health system of our country. As 

Mr. Greenstein has noted, and David Walker has said many times, 

we are not about to create in this country a separate delivery system for the elderly, disabled and poor, one that is different from 

that that workers and their dependents enjoy. Nor are we about to 

tolerate one level of care for Medicare and Medicaid beneficiaries 

and another level of care for those enrolled in the employer-sponsored system. 

Over the long run, I think we are going to have to move away 

from the current fragmented, uncoordinated delivery system, a system in which individuals buy their care a la carte using insurance 

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that is heavily subsidized by the Federal Government. We are 

going to have to move toward more coordinated mechanisms for delivering care and are going to have to begin to define what basic, 

essential health care is and provide access to that care to the entire 

population. 

This obviously is an area that goes well beyond the jurisdiction 

of this committee and I close by suggesting that should the will be 

there to move in this direction, it will probably involve some initial 

investment in infrastructure and information technology to facilitate such a transition. 

Thank you, Mr. Chairman. 

[The prepared statement of Mr. Reischauer follows:]

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Chairman CONRAD. Thank you, Dr. Reischauer. 

Dr. Steuerle, welcome. Good to have you back before the committee. 


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STATEMENT OF DR. EUGENE STEUERLE, SENIOR FELLOW, 

URBAN INSTITUTE 

Mr. STEUERLE. It is good to be here. I would like to express my 

appreciation to all the members of the committee for their bipartisan effort to tackle this very important problem. 

One of the reasons I enjoy being before this committee is because 

it has a tradition along those lines, to work together on those 

issues. 

I would like to begin by undertaking an imaginary exercise with 

you. Suppose that during the presidency of William Howard Taft, 

Congress had enacted laws that would predetermine all spending 

and tax subsidies for today and throughout the 21st century. As 

economic growth led to higher Government revenues, these legislators would have continued to prescribe, now from six feet under, 

how to divvy up the spoils. Their ingrained policy wheels would run 

over future elected officials and voters and prevent any new priorities members wanted to enact. Each political party would hope to 

see the other party forced to do damage control in the budget but 

view it as political suicide to do anything substantial itself. 

Ludicrous scenario? Not really. In recent decades, we have essentially wound just such a straitjacket around ourselves. Never before 

has the law predetermined so much of our future spending and tax 

subsidy priorities. Yet it makes no more sense to commit economic 

resources that far into the future today than it would be to decide 

where to station troops into the next millennium. 

In my view, only major systemic reform can restore a normal 

democratic process. We need budget slack—that is wiggle room for 

new policy between future Government revenues and current 

spending commitments. 

I want to be very clear about this. Deficit reduction is not enough 

to get us there, because you would still end up having committed 

all those future revenues. 

In the remainder of my testimony, I would like to highlight some 

extremely important consequences of our current budgetary situation, consequences I think that are of concern to members of both 

parties. 

First, larger shares of our budget spent on retirement benefits 

leaves an increasingly smaller share to finance activities more likely to promote productivity such as nursing advice for pregnant 

mothers, early education for the very young, and after school activities for older children. 

Second, our system of elderly support has morphed into a middleaged retirement system. A couple retiring at age 62 today can expect to get benefits for 26 years. When Social Security was young, 

the average worker retired at about age 68. To retire for an equivalent number of years today in Social Security, a person would retire 

at about age 74. I have a few graphs in my testimony that are 

being shown which try to summarize some of this information. 

Third, most economic projections include a slower rate of growth 

of the labor force, partly because so many people now retire in late 

middle age. Keep in mind that for any given tax rate supporting 

old age programs you may decide to enact or compromise upon, a 

structure of significantly higher benefits can be maintained if peoVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00302 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ple work longer. Why is that? Because if they work longer, there 

are more revenues. 

Fourth, almost every year a smaller share of Social Security benefits goes to the oldest and most vulnerable in terms of health 

needs and capacity for working. If progressivity is defined by how 

well the vulnerable are served, the system is becoming less progressive every year. 

Fifth, lifetime benefits in Social Security and Medicare for an average couple have now risen from about $250,000 in 1960—these 

are real dollars—to over $750,000 today and are scheduled be over 

$1.2 million for a couple retiring in about 25 years. We cannot keep 

adding benefits for this part of the population without shrinking 

services for the rest of the population. 

Sixth, building eternal growth into permanent programs affects 

taxes as well as spending. Two examples provided in my testimony 

are for Roth IRAs and for tax subsidies for the purchase of health 

insurance. These policies are badly designed not simply from a 

budget standpoint (because they give away revenues or spend revenues before we even determine the needs of the day), but also because the additional amount spent on them may actually decrease 

saving and decrease the number of people with health insurance. 

The President has or attempted to address this latter issue in part 

with his recent proposal on dealing with the tax exclusion for 

health insurance. 

Seventh, within a quarter century, close to one-third of the adult 

population is scheduled to be on Social Security. If we add other 

individuals in society who are dependent upon other assistance programs, we are approaching the day when about one-half of the population will be significantly dependent upon Government for its 

support. A Government that treats everyone as needy, treats no 

one as needy. 

Eighth, the squeeze on children and working families is being 

felt now. It is not awaiting for some day in the future. Under reasonable projections within a very short period of time, all revenues 

will be eaten up by Social Security, Medicare, Medicaid, defense, 

and interest on the debt with nothing left for anything else. Your 

charts, Mr. Chairman, as well as those of Dr. Greenstein, also support that fact. 

Ninth, the continually declining share of the budget for discretionary spending means continually declining Congressional control 

over the budget. My own suggestion here to deal with this issue, 

in part, is to change the presentation of the budget at the time 

when the President’s budget comes out. It requires no legislation. 

It only requires the Congressional Budget Office and the Office of 

Management and Budget to present budgetary changes first in a 

way that combines automatic and discretionary changes. 

One example I give in my testimony, and that you can see on the 

monitors next to you, is that according to Congressional Budget Office revenue projections, revenues will be increased in 2010 by 

about $286 billion over and above what they are today. These are 

real revenues, but almost all of those revenues have already been 

pre-committed to growth in Social Security, Medicaid, Medicare 

and interest on the debt.

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This type of presentation shows you—and allows you to show the 

public—the lack of control you have over how to allocate these additional revenues. A more informative presentation requires showing not just changes from current law but total changes from what 

we are doing today, thus, we combine together changes in current 

law and changes from terms of what we are spending today into 

a single presentation. 

My final consequence is a bit personal. As a member of the babyboom generation, I grew up with a cohort who believed we were 

trying to do something about improving what Government can do. 

And yet now, as currently scheduled, our legacy is to bequeath a 

Government whose almost sole purpose is to finance our own consumption in retirement. 

In sum, by abandoning control over the budget, we have put in 

place a system where politicians are forced to compete by giving 

away the future. Projected deficits are merely a symptom, they are 

merely a symptom, of this modern legislative push. 

The budgetary consequences I have outlined follow from neither 

progressive nor conservative principles. They must be addressed on 


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grounds of both fairness and efficiency if Government is to serve 

all of the people, if it is to be nimble in addressing new needs and 

emergencies, and if it is to restore democracy to the people. 

Thank you. 

[The prepared statement of Mr. Steuerle follows:]


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Chairman CONRAD. Thank you. Thanks to the entire panel. 

Let us get right to it, if we could. We have been searching for 

things that we could do on this committee in this budget resolution 

and, as you perhaps know, Senator Gregg and I have been searching for a process that would compel at least the presentation of a 

plan to our colleagues in the Congress later this year of a long-term 

plan to address the fiscal imbalances that we confront. 


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So we are interested in both the short term and the long term. 

Mr. Greenstein, you indicated as one of your suggestions, that we 

deal with the CPI, that we have a more accurate adjustment to the 

CPI than the current formula permits. How much difference, have 

you done any calculation of how much difference that would make 

over time on both the spending and the revenue side? 

Mr. GREENSTEIN. I believe that an estimate was done by the 

Brookings Institution. This is not a recommendation that is peculiar to me. Many budget analysts across the political spectrum have 

made it. It is included in a Brookings book, Restoring Fiscal Sanity, 

that came out a couple of years ago. I am not sure my memory is 

going to be right here. 

My recollection is that by the 10th year it might save something like $30 billion or $35 billion. 

The point is not the 10-year savings. It is when you go further 

out. I am not going to trust my memory for the farther out figures, 

but we can look into them and get back to you and the committee 

and give you our best figures. 

I want to make one caveat about my own recommendation here, 

and that is over time this would be an important change, moving 

to what is sometimes called the superlative CPI. What would be a 

mistake, I think, would be to move to it without firewalls that ensure that the savings are going for deficit reduction and, of course, 

for closing the Social Security long-term imbalance. 

If you were to do this and you simply took the savings and used 

them to finance program increases and tax cuts, you would have 

gained nothing and you would have foregone an important instrument for the future. 

So I think you should make this change with the CPI but I think 

you should not do it until you are combining it with firewalls that 

make sure that money is dedicated to long-term deficit reduction 

and is not used to finance expansions or tax cuts now. 

Chairman CONRAD. Well, you make a very good point. The question is how you construct firewalls that last around here. Sometimes we have constructed them and they last for a few years, but 

as soon as they start to achieve real savings, there is a tremendous 

impetus around here to go after it for additional spending or for additional tax cuts. 

Unfortunately, in the last several years, we have been doing both 

and so keep digging the hole deeper. 

Mr. GREENSTEIN. I do think in 1990 and 1993 there were major 

deficit reduction legislation and the savings helped. Part of that 

was because of the pay-as-you-go rules and the construction of the 

pay-as-you-go scorecard so that you did not get to put the savings 

from those bills on the scorecard and spend them. And it worked. 

So I think we ought to—

Chairman CONRAD. It really did. It certainly helped. All of these 

moves to discipline Congressional action on both the spending and 

the revenue side contribute. But if there is no will, there is no way. 

And we go back to the 1990’s. That held for a period of time and 

ultimately it broke down. 

Mr. GREENSTEIN. One other very quick point. I also think it 

would be helpful to change the rules so that reconciliation can only 

be used for legislation that reduces deficits. Whether someone 

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wants to expand the prescription drug benefit, reduce taxes, or 

whatever, you should not be able to fast track it with 51 votes. It 

should be harder to do that. That, to me, is another one of these 

firewalls that would be helpful. 

Chairman CONRAD. On both the spending and the revenue side? 

Mr. GREENSTEIN. Yes. 

Chairman CONRAD. Dr. Reischauer, I want to turn to you, if I 

could. You indicated in your testimony that there has been work 

done at Dartmouth that shows that per beneficiary Medicare costs 

vary two to one across the Nation’s hospital districts. And health 

outcomes are negatively correlated with the higher spending. 

Can you tell us a little more about that? As I understand what 

you are saying here, is that this Dartmouth study indicates we 

could have one part of the country where they are spending twice 

as much on Medicare beneficiaries as in another part of the country and actually getting worse health care outcomes? Is that the 

conclusion of their work? 

Mr. REISCHAUER. The studies done by Elliott Fisher and a number of other individuals, have shown wide variation in per beneficiary Medicare spending after adjusting for differences in input 

prices and the underlying health conditions of the Medicare population. Spending as the extremes are about two to one apart. 

There is certainly no significant positive relationship between 

spending or service utilization, which is what this is about, and 

health outcomes. To the extent there is any correlation, it is a weak 

negative correlation. What health economists have found is that 

there are wide differences across the country in the practice patterns of physicians and on the expectations of patients. 

And so for the same condition you will see patients in Miami 

going to the doctor, let us say 15 times a year, and those in Minneapolis going seven times a year. You will see across individual 

hospitals within one metropolitan area even wider variation in the 

number of consults from specialists for a particular condition. 

So health care, in a sense, is not a science. It is an art. And we 

have not spent a sufficient deal of resources or time trying to figure 

out what is the optimal amount of health care, what are the right 

procedures, what are the right treatments to give an individual in 

these kinds of circumstances to maximize health outcomes. 

And so a problem arises when we discover that in Miami they 

use twice as many resources for a congestive heart failure case as 

they use for a congestive heart failure case in Minneapolis. What 

do we do? We cannot move the Miami population to Minneapolis. 

We have a very difficult time, changing the pattern of practice of 

the physicians in the high utilization area. 

We have to think of incentives that can bring this wide variation 

more toward some optimal level which will save money without 

jeopardizing the quality of health care. 

Chairman CONRAD. All right, good points. 

Senator ALLARD. Senator ALLARD. You have all mentioned, to some degree, I think 

in your testimony, this concept of shared sacrifice. So how do we 

do this? Do we do something like an across-the-board cut, impacting all programs proportionally the same? How do we prioritize our 

fiscal discipline, I guess is the question that I am asking? What criVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00316 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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teria do we decide to say well, maybe this program is more important than another? Maybe it has more cuts. How do we decide what 

program is maybe performing and which is not performing? And do 

we set criteria along those lines? I would like to hear your comments. 

Mr. STEUERLE. Mr. Allard, if I may speak first, I think the most 

important thing this committee could do with respect to teaching 

Congress would be to try to somehow or another get a refocus on 

the long-term even before the short-term. I realize that is not the 

normal budget process but, as everyone on this committee knows, 

the game that is played in the budget process is to do what you 

can within a budget rule for 3 years, 5 years, 10 years or whatever, 

and then not worry about the period beyond that. So many recent 

enactments that have cut the deficit in the short run have actually 

added to the long-term deficit. 

We all know the games that are played and we know why they 

are played. It is because the budget rules right now orient themselves toward the short-term. And so we constantly attempt only 

to get the short-term in order. 

And while I actually agree with many of Dr. Greenstein’s proposals, a lot of them get us to the short term but they leave us on 

this path of continually rising expenditures as a percent of GDP—

rising expenditures that are not oriented toward our most current 

needs. If you really think about where we are increasing spending, 

where we are talking about having a budget crisis, these are in 

areas where good things are happening to us. We are living longer, 

we are getting better health care. And we are saying we cannot 

control that retirement and health budget, and, therefore, we do 

not have money to spend on homeland security or children’s education or kids that are out of school on the street when they should 

not be. 

So where we have problems, we say we do not have money, and 

where we really having good things happening to us, we are spending more. 

I think the budget process has to focus on the long-term. Now 

how would I do that? How would I think about changing the process? 

One thing I would do is to ask perhaps CBO or the General Accounting Office, but probably the Congressional Budget Office, to 

identify every part of the budget where there is automatic growth. 

And I would include of all the tax provisions, all of the tax subsidies as well, not just direct expenditure. Where is this automatic 

growth preempting you, as a Congress, from making discretionary 

decisions? Then use that information to see if you cannot come to 

some agreement on how to constrain that automatic growth. 

Now controlling some of the growth, as in the case of health care, 

is much, much tougher than others. Some cases, like Social Security, are easier to identify some ways to gain control, although 

there would be the political dynamic of how to decide what to do. 

But I think you have to start there. If you do not start with the 

automatic growth and the long-term, I do not think we will ever, 

ever get this system in order. 

Then you have to address an additional budget rule: are you 

going to allow any new enactments to spend money way into the 

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future, make commitments for the future, for which the resources 

are not provided? It seems to me you have to move toward some 

sort of rule that deals with that issue, as well. 

I am not suggesting all this is easy. I think there has been a 30-

year process of both political parties figuring out more and more 

ways to spend away the future because it was not in the budget 

window. That was not the case in the 1960’s or earlier. When discretionary spending was level, revenues would grow with the economy, and you always moved into a surplus when you went into the 

future. 

We have moved to a world now where each party continually 

tries to spend more and more for the future, take more and more 

control for the future, because they are afraid of what the other 

party is going to do. 

That is why it takes a compromise between the two parties to 

say neither is going to spend the future. We are going to let the 

voters 4 years and 8 years hence start deciding what to do. And 

so you limit what can be done in the future. If there is growth in 

programs, it is capped after 5 years and you have to re-vote whether there would be new growth after that period, whether it is wage 

indexing and Social Security, whether it is the open-ended nature 

of health benefit programs, whether it is a program like Roth IRAs 

and Roth 401(k)’s that spend out in the future. 

It seems to me the trick is to identify all of those automatically 

growing parts of the budget and to try to figure out some way to 

reach an agreement on dealing with them. 

Mr. GREENSTEIN. A few problems. Some of the suggestions I 

made at the end of my testimony were merely intended to be first 

steps. Ultimately, as Gene says and as Bob has said, we have to 

do a much heavier lift. 

I am not a fan of across-the-board cuts. I think they are a bit of 

an abdication of policymakers’ responsibilities to make the tough 

choices. There are some areas in the budget where we are going to 

need some additional resources. The President, for example, talked 

in his State of the Union, about global AIDS, Millennial Challenge 

Fund, alternative energy research. Everything in the budget is not 

equal. And we have to go and make the appropriate choices, rather 

than just saying everything gets cut X percent, which will be inappropriate for some programs and may too small a reduction for others. 

This suggests having a high premium on efficacy. In some areas 

we need more information and evaluation of what is working and 

what is not. And that includes looking at efficacy both on the 

spending side and on the tax side. We have, I forget the figure, 

something like $800 billion a year in tax expenditures in the budget and some of them are not performing as intended. 

I think another criterion that should be put into the mix is the 

fact that due essentially to trends in the private economy and global pressures, we have had a several decade trend toward increasing 

inequality in this country. And it would be unfortunate to deal with 

the budget problems in a way that exacerbated the trend toward 

increasing inequality. 

To kind to put it in a phrase, in the mid-1980’s at one point, 

David Stockman—then Ronald Reagan’s budget director, made a 

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statement that I think sums up a principle. He said when you need 

to deal with the deficit, you should go after weak claims not weak 

clients. The hard task is identifying which are the weak claims. 

Often the weak claims have the strongest clients defending them. 

And reaching bipartisan agreement to pare back the weak claims, 

whether they be on the expenditure or on the revenue and tax expenditure sides of the budget. 

Mr. REISCHAUER. Let me comment on two extreme approaches. 

One would be the technocratic approach where experts would 

measure the effectiveness of every Federal program and the ability 

of various revenue sources to generate additional revenue by doing 

the least harm to the economy. And we would use that information 

to cut spending and increase revenues. And the objection to that, 

besides the fact that we do not have that kind of information, quite 

simply would be that, the reason we do things depends on much 

more than the effectiveness with which we can do them. Some 

things are very important. We know that our policies are not particularly effective but we have to do something to address these 

issues. Where you come out is, of course, where the Congress has 

come out with respect to the distribution of spending and tax 

sources in the budget each year. 

So then you go to the other extreme which is that if current problems reflect what our priorities are why don’t we just shave everything by X percent or raise all taxes by Y percent because that 

would reflect our relative weighing of priorities. 

We know that is not the case either because of the inertia or the 

embedded strength of existing programs, that if somehow we could 

wipe the slate of Federal programs clean and start anew, we would 

probably end up with quite a different set of spending programs. 

So this is a terribly difficult kind of problem to be faced with because neither of these extremes is either possible or appropriate. I 

guess that is why we elect a Congress to grapple with this really 

insoluble set of decisions. 

Chairman CONRAD. Senator Stabenow. 

Senator STABENOW. Thank you, Mr. Chairman. 

First of all, I want to thank for a very thoughtful and critically 

important panel. Thank you to each of you. 

I did want to start by commenting, if I can use the Chairman’s 

charts, one of your illustrious charts, to just emphasize that when 

we are looking at the numbers that you showed us, the cost of extending the tax cuts are more than the combined costs of Social Security and Medicare. I think this is incredibly important. I know 

that just on Social Security alone that if we were to say 30 percent 

of the tax cuts will not be extended instead of 100 percent, you 

could fully close the gap of Social Security alone. 

I think this is a very, very important chart and I appreciate the 

comments related to all of that when we talk about how do we get 

where we need to go. 

On health care, I also very much appreciate, Dr. Reischauer and 

Mr. Greenstein, both of you talking about the fact that as it relates 

to health care it is not just Medicare, is this not just Medicaid. It 

is the health care system, that we need to fundamentally restructure the health care system. 

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Mr. Chairman, I would just make the point that this very much 

is about jobs, as well. I had a chance—I was on a town hall meeting in Detroit with the big three automakers, a major town hall 

last night, where it was very interesting. We know that about 

$1,500 per vehicle is health care costs. But we had a gentleman 

from the Canadian UAW who said that their costs are $200 per vehicle. 

In fact, we have employers, manufacturers, that are literally 

going 5 minutes across the bridge into Canada to set up shop now 

and build facilities because of health care. The wages are the same, 

it is the same bargaining units. Everything is the same but health 

care. This is about jobs, as well as about our economy. 

Last week there was an article in the New York Times business 

section where the president of the Business Roundtable made the 

following statement, which I thought was very significant: health 

care costs are the single largest cost pressure that employers face, 

far exceeding energy, labor, materials, or even litigation. 

So it is not only something that we have to tackle but the business community is desperately asking us to tackle this, as it relates 

to our ability to compete in a global economy. 

There is really something wrong when we look at the fact that 

the average industrialized country spends less—we are spending 

twice as much in GDP as the average industrialized country for our 

health care system, but we have close to 50 million people with no 

health insurance. It just does not add up. 

So I very much appreciate your having this panel. And while I 

believe very strongly that we have to fundamentally restructure 

the health care system, and that we actually save money doing it. 

I believe that. I believe we have done this hodgepodge kind of effort 

that has actually increased costs rather than decreased costs. 

But I would like to ask a couple of questions that relate to something that, as we do that, which is a tough thing to do and we have 

to do it in a bipartisan way to fundamentally restructure things, 

there are costs savings that we have not mentioned today. I wanted 

to just mention two and ask for any comments from the panel. 

First of all, health information technology. Olympia Snowe, Senator Snowe and I have introduced legislation to accelerate the use 

of that both through tax incentives for the private sector, as well 

as support for nonprofits. We have heard numbers anywhere from 

$70 billion a year in savings to $100 billion from the President’s 

own IT expert, Dr. Braylor, to $300 billion from the RAND Corporation, just focusing on e-prescribing alone. 

Those are huge numbers, huge numbers for us. I am wondering 

if any of you would have a comment on that, both in terms of saving lives. I know in my home State of Michigan that has really 

been aggressive on this, we have increased quality, we have created more information for people to compare, as the President talks 

about transparency and comparing prices and so on. And we also 

see the beginning of savings in dollars. 

And then the other relates to the prescription drug front. We 

know that the average retail price of a brand-name prescription 

drug was $102 back in 2005 and the average retail price of a generic was $30. Senator Lott and I have legislation to close three 

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loopholes that brand-name companies are using to stop generics 

from going on the market. 

Those are two shorter term but very significant ways to save 

large amounts of dollars, and I wondered if any of the panel would 

like to speak to that? 

Mr. STEUERLE. Mrs. Stabenow, if I could just address the first 

issue. I am on the National Committee on Vital and Health Statistics, whose job it has been over the years to try to promote the very 

thing you are talking about, health information technology. We 

strongly believe if we could move more to a world of electronic prescribing of drugs, and electronic transmission of information, we 

could provide enormous protection to people—for instance, those 

who are moved, such as after a hurricane, or those who do not get 

all the information on their drugs, or who get duplicate tests. We 

think there is enormous efficiencies that will come about from 

health information technology. 

The one thing we do not know is whether, on net, that will reduce costs. This is one of those areas in health care where we attempt to improve efficiency; it is an effort we should make. But it 

could also lead to an increase in demand for services as people determine that there are more needs that they have, that their drug 

tests need to be improved, and so on. 

And so the answer to your question on the cost saving is tentative. The answer on efficiency improvement is not. I think most 

people agree, we should be moving in this direction. 

That gets us back to the issue that I think Dr. Reischauer has 

raised, which is that you still need, at some point, to decide how 

you are going to try to cap or limit the automatic growth in the system independently of these improvements and efficiencies. 

My own calculations now show that with Government subsidies—Medicare, Medicaid, other health programs and tax subsidies—you are now spending $11,000 per household. That is total 

health care costs per household now are $19,000 per household. 

Total health spending in the United States divided by the number 

of households is $19,000. Government is now providing $11,000 of 

that total. 

In the next 4 years you are scheduled under projections to raise 

government spending to $13,000. You are going to spend $2,000 

more over the next 4 years. And yet you have no control over how 

you are spending that $2,000. 

So you still have to get at this issue of how are you going to try 

to manage and control the money you spend—even at the same 

time that you are identifying what you want to achieve with these 

efficiency improvements. You do not want to achieve cost saving in 

a way that case would cut back on technology improvement as a 

way of saving money, which would be the very area where you are 

actually trying to improve health care. 

Mr. REISCHAUER. I think you have pointed to two very important 

areas. With respect to health information technology, as Dr. 

Steuerle has pointed out, I think there is a general consensus that 

aggressive application of such technology will lead to significant 

improvements in health care quality but that the jury is still out 

with respect to overall how much might be saved. 

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It is clear that if we want to move into a new world, a transformed delivery system, one in which there is more coordinated 

care, more accountability through pay for performance and mechanisms like that, one in which individuals are active in the market 

more than is the case now in the selection of providers and services, that cannot be done without a much more expansive information technology base than we have now. So in a way it is essential 

to move forward in structural reform to have better health information technology. 

Just abstracting from all of that, of course we will save duplicative tests and things like that, which will save relatively small 

amounts of money probably over time because many of these duplicative tests were taken 6 months ago and really, you are now the 

attending physician, do you really want to trust that one rather 

than get a new one? 

With respect to prescription drugs, I think you are right to suggest that there have been some abuse of the patent system and effort by some pharma members to extend the life of their patents 

and restrict the entry of generic drugs and the Congress should act 

and the Administration should act to end those abuses. 

We have seen, over the past decade, a very significant movement 

of the population toward generic scripts and there is more to go. 

Chairman CONRAD. Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. 

Chairman Greenspan, when he was the head of the Federal Reserve and I was a lowly member of the House Budget Committee 

at the time, about 10 or 12 years ago I believe it was, made the 

suggestion about the CPI and using the new improved version, 

whatever you call it. 

The Congress, in their wisdom or lack of will, has not been able 

to get past the results of using the new CPI because of the resulting lowering of certain benefits to a great number of constituents. 

For instance, those collecting Social Security would not get as large 

of increase each year if the CPI were adjusted as you have proposed. 

So if you can somehow convince the Congress that it is a healthy 

thing to do long-term, I am with you 100 percent. But I do not 

know how many members of this committee have the will to use 

the new improved CPI because less benefits will pay to more people. 

Mr. Greenstein, you mentioned entitlement spending and I want 

to get to that because the CBO baseline spending projections for 

January 2007 mandatory spending is $1.455 trillion, and 82 percent of that is in the big three, Medicare, Medicaid, and Social Security. If we project that out 2008 to 2017, $19.937 trillion, of 

which 86 percent are the big three. 

So you mention the fact that mandatory spending in other areas 

were being reduced. It is a very minute 14 percent if we look at 

it long-term. And what is ballooning the mandatory spending is the 

big three, if you look at $19.937 trillion over 2008 to 2017. 

Now our budgeting rules appear not to be equal when you look 

at the current baseline budgeting. Mandatory spending programs 

set up under the law are assumed in the baseline to be extended 

but tax provisions that are set to expire are assumed, under the 

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baseline, to indeed expire. The effect of this is that extension of tax 

provisions are subject to budget enforcement and extensions of 

mandatory spending programs are not. 

Do you think it makes any sense to treat spending and tax cuts 

differently? 

Mr. GREENSTEIN. Several parts to your question. 

Let me just say, before answering, I want to express my excitement on being here. As a young kid, growing up in Philadelphia, 

in the 1950’s, I watched every pitch on TV of your perfect game, 

and went running around my living room cheering when you threw 

that last pitch. 

Senator BUNNING. So did I. 

[Laughter.] 

Mr. GREENSTEIN. Let me start with the CPI. One piece of good 

news is that since Greenspan issued that report, the Bureau of 

Labor Statistics has made a number of changes administratively. 

And actually, the majority of the distortions that his commission 

talked about have been corrected. 

However, there is one key distortion that cannot be corrected in 

the regular CPI, that is why they developed—BLS, the Bureau of 

Labor Statistics—the alternative CPI I mentioned, which I recommend Congress adopt. 

You raise the point of how could you get it adopted politically? 

My thought is the following. I think if one simply moved a piece 

of legislation to move Social Security indexing of the tax code and 

the like to the alternative CPI, as you say, it would fail. However, 

I think if this were part of a larger bipartisan budget agreement 

where you restored long-term Social Security and made substantial 

progress on the long-term deficit, and this were a piece of it, and 

one showed that this was part of how one restored long-term solvency and protected the economy and the budget for the long-term, 

then as part of a larger architecture I would hope that it would be 

more possible to move. 

I think a lot of us also need to do education to explain to people 

that this should not be regarded as either a cut in Social Security 

benefits or an increase in taxes because the intention of the Social 

Security Act and the Internal Revenue Code is to adjust for inflation accurately, not to over-adjust. 

On your second point about entitlements in the big three, I do 

not think we are disagreeing. What I was urging is some more precision in language. I think sometimes when people hear the general 

term ‘‘entitlement crisis’’, they may presume that unemployment 

insurance, the school lunch program, that everything is going 

through the roof. Whereas as we have been doing here today, and 

as you suggested, we really need to focus on the big three. They 

are the drivers. And then the factors that are driving the big three, 

particularly the health care costs. 

With regard to the baseline, I would respectfully disagree. I do 

think that when one looks at it carefully—

Senator BUNNING. What are you disagreeing with? I asked for 

your opinion. 

Mr. GREENSTEIN. I disagree with the conclusion that there is inequity in the treatment of taxes and entitlements in the baseline 

for the following reason. It is true that if a tax cut is set to expire, 

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the baseline does not assume its continuation. But it is also true, 

let us take the 2003 tax cut law as an example, that when the capital gains and dividend tax cut was enacted to run through, I believe it was 2008, no cost was scored for 2009, 2010, 2011, 2012 

and thereafter. 

If there is an entitlement program or expansion and the committee of jurisdiction says well, we are going to let it expire after 

3 years in order to avoid being charged with costs from years of 

four through 10, it does not work. They get charged by CBO with 

costs for all 10 years. 

So the key I think, and maybe one could look at making some 

adjustments, but the key is that whether it is an entitlement or a 

tax, you have to make sure you get scored for a cost in every year 

in that budget window. The current treatment actually does do 

that. If you want to change the rules, you need to be very careful, 

I think, to not have a transition where, whether it is entitlements 

or taxes, you have years in which an increase does not get scored 

at all. 

So again, with regard to the 2001 and 2003 tax cuts, again the 

2003 is a good example, they could have been made permanent but 

then they would have been scored every year in the five and 10-

year windows, rather than only scored for the years until they expire. 

Senator BUNNING. Thank you. 

Chairman CONRAD. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

I want to thank you for the continuing series of hearings that we 

have been having to lay out the Nation’s fiscal picture and its 

health, or lack thereof, and I appreciate the panels you have 

brought together. I appreciate the testimony of this panel. 

Last week the testimony from the CBO Director appears to be a 

rosy fiscal picture for the short-term but it is almost certainly a 

false hope for the deep and long-standing issues we face in the 

long-term. That is some of what I would like to go to. 

Let me start off with Mr. Greenstein. To me a budget is about 

values, both as to how we raise revenues for it, as well as to how 

we spend it. Americans have budgets in their own lives, even if 

they do not think of it in that context. It is how they derive their 

income and how they spend their income for education, keeping a 

home for their family, for health care, tithing to their church or 

synagogue as an expression of their personal values. I think the 

national budget is an expression of our collective values. 

In that context, I think many of us questioned the President’s 

claim that the budget can be balanced by 2012, given the vast 

number of anticipated but excluded costs that, when included, provide a very different picture. 

I believe, I think it is widely believed, the President’s budget is 

expected to also allow for the current tax cuts to be made permanent. Can you talk a little bit about what type of cuts to domestic 

programs might be necessary if that is the reality? 

I know, for instance last year the Center pointed out in a report 

that the President’s budget proposal for this year proposed some 

rather massive cuts to key domestic programs, including $52 billion 

for education, $24 billion in health care programs over a 5-year peVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00324 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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riod, $183 billion over 5 years total. Obviously there is a lot of values of people who depend upon those for their very existence. 

Can you give us a sense of what we might be facing if, in fact, 

the President comes forth with a budget that keeps the tax cuts 

permanent and the consequences that may flow from that? 

Mr. GREENSTEIN. The first comment, I would urge you to look 

carefully at the budget when it comes out and see whether the balance in 2012 is in reality or just on paper. From the reports we 

have so far, it sounds like the budget will extend relief from the 

Alternative Minimum Tax just for 1 year and thereby effectively 

assume that by 2012 about 40 million Americans are under the 

AMT, which we know will not be allowed to occur. If you continue 

the current AMT patch without paying for it, in my testimony I 

recommended AMT reform be done in a revenue neutral manner. 

But if the current course is continued, and it is extended without 

paying for it, that is $95 billion in 2012 that will not appear in the 

budget. 

We are also unclear whether, with regard to Iraq, Afghanistan 

and the war on terrorism, whether there will be anything in there 

for 2012. 

But the point you are particularly referring to is that I think it 

is likely that the budget will continue the practice of the last few 

budgets of having significant reductions proposed in a number of 

domestic discretionary programs in the coming year, this would be 

2008, with specific proposals, but then much larger reductions in 

domestic discretionary as a whole in years after 2008 without any 

of the specifics being there, thereby assuming reductions in the domestic discretionary programs that ought to be viewed either as 

very unrealistic and unlikely ever to occur or, if they really did 

occur, would have some pretty significant effects in a range of 

areas. It could be education, could be child care, could be a whole 

array of issues. 

I also think we are talking here this morning, I think the panel 

in general, mostly about the big three programs, health care and 

revenues. I think it is an illustration of the fact that as you look, 

whether it is to 2012 or to the long-term picture, in my view there 

are not large savings to be had on the domestic discretionary side 

of the budget. It has declined as a share of GDP over time. It is 

actually, by 2007, with the CR that was filed last night, going to 

be a little below where it was in 2001 as a share of GDP, which 

contrary to the popular impression that it has exploded. 

And while there are areas one can and should get savings in domestic discretionary, there are a number of areas in domestic discretionary or some areas that are going to require additional resources, whether they be in the area of global disease and poverty, 

alternative energy research, child care, which has been frozen for 

a number of years and were we are actually reducing the number 

of children in low-income working families who get child care each 

year. 

If we do things that help deal with global warming but raise 

some costs to consumers, we are going to do need to look at the 

low-income energy assistance program. So I think you are right 

that the budget is a reflection of values and it ought to be looked 

at in that context. 

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One last comment. The Urban Institute Brookings Tax Policy 

Center, which I think Gene is a Co-director of, their estimates are 

that if the tax cuts are extended, or maybe it is even in 2010 the 

last year you can take this out, that the average tax cut for people 

with incomes over $1 million a year will exceed $150,000 per 

household per year. 

I think there are some value questions about having tax cuts of 

that magnitude and then cutting programs, including some effective programs, for the less fortunate and struggling families on the 

grounds that the budget requires us to do it. It is why I think the 

suggestion is being made here that all parts of the budget be put 

on the table. And it is kind of why I like that David Stockman 

phrase about let us look at weak claims, not at weak clients. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Chairman CONRAD. Senator Wyden. 

Senator WYDEN. Thank you, Mr. Chairman. 

I, too, appreciate your holding these hearings and giving us the 

opportunity to dig into these long-term issues. I particularly think 

health reform and tax reform are key to getting on top of these 

long-term challenges. 

Let me start with you if I might, Mr. Reischauer. You have 

talked persuasively about the issue of health care and health care 

costs in terms of our long-term picture. It seems to me that it is 

simply impossible to fix health care unless you say you are going 

to cover everybody for the essentials. Otherwise we will constantly 

have cost shifting from the people who have no coverage to people 

who do have coverage and folks in emergency rooms pick up their 

bills and the like. 

Do you share that view that to fixed health care you have to say 

you are going to cover everybody? 

Mr. REISCHAUER. Senator, I do. I think it is essential that when 

we consider alternatives for restructuring the health care system 

that those alternatives encompass the entire population. It need 

not be that everybody has guaranteed access to the same generous 

level of benefits. I think we need to, as a society, begin to define 

what we regard as the basic health care package that no American 

should be without and ensure that everyone has the financial 

wherewithal to purchase or be provided that level of insurance. 

Senator WYDEN. Thank you. And I think that is an important 

part of bringing Democrats and Republicans together, in terms of 

fixing health care. 

One other question with respect to the tax code and health, and 

perhaps I will direct this to you, Mr. Greenstein. I think you can 

have a debate about how exactly you should go about doing this. 

But it is indisputable that the tax code on health is regressive. If 

you are a highflying CEO, you can write off the cost of getting a 

designer smile on your taxes. However, if you are a hard-working 

gal at the local hardware store, you probably do not get much of 

anything out of the tax code. 

Do you agree that—and this is not about the details of how you 

do it—but that fixing the tax code and particularly its regressivity, 

is a part of sorting out what we need to do to fix health care down 

the road? 

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Mr. GREENSTEIN. Yes, I do not think there is much disagreement 

that the current tax treatment of health care is regressive and 

looking at that would be part of overall health care system reform. 

I do think when we look at it, we need to look not only at the 

dimension of progressivity/regressivity. We need to be very careful 

to look at the dimension of healthier people versus sicker people. 

So we have a tax treatment now that supports an employerbased system that has warts. It also has the merit of pooling 

healthier and sicker people. I think the President’s plan commendably raises the issue of the tax treatment of employer-based coverage, but I think it then makes the mistake of doing it in a way 

that would accelerate the unraveling of employer-based coverage 

and put people into the individual market which, as you know, is 

deeply flawed now and does not really work for people with serious 

health conditions or who are sicker. 

So we need to look at both a more progressive approach. But in 

doing so, I think almost the first principle is that we have to make 

sure we have adequate pooling mechanism that pools the healthy 

and the sick together, rather than fragmenting them. 

Senator WYDEN. I think that is a thoughtful point and I tried to 

include that a couple of different ways in my Healthy Americans 

Act. Mr. Reischauer and I have talked about that as well, you have 

to make sure that there is some risk adjustment process to deal 

with it. 

Let me ask a quick question for Mr. Steuerle, who has always 

been one of my heroes on the tax reform debate. My sense is that 

we still have sound thinking from 1986, and that if we say we are 

going to clear out a lot of the clutter, all of those breaks, we can 

have progressivity and still drive down rates. Do you share that 

view? And how does that fit into a sensible approach for our economy in the future? 

Mr. STEUERLE. Senator, like you, I strongly believe that base 

broadening is preferable to rate increases. And I think that conclusion is true whether you are looking at it from a conservative or 

a liberal view point, that this type of tradeoff provides a more efficient tax code and it provides more progressivity. 

My one caveat has to do with the extraordinary level of commitments we now have on the spending side of the budget. My own 

view, in fact, is that we should not label taxes by the revenues we 

collect, but that we should label taxes as equal to the spending we 

actually undertake. For instance, if we are a household and we spend $20,000 and we only earn $15,000 and we leave a $5,000 debt to our children 

it does not mean we did not spend $20,000. The amount of collections we have to do to pay off that $20,000 is still $20,000. 

And so we have, if you think about it, not a tax rate of 17 or 18 

percent of GDP. That represents revenues collected currently. The 

tax rate we have is equal to the spending rate we have, which is 

higher and going much, much higher. 

So the question on how far you can go in lowering rates is largely 

going to depend on whether we also get some of this spending 

under control. You are right, at current levels, given current revenue collections, there is no doubt a broader bass means we can 

have lower rates. Whether we can lower them relative to what we 

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have currently—given that we are not collecting enough to pay our 

bills—is a more complex question. 

If I could just add one footnote to your question on health care, 

too, because I have had a number of proposals exactly along the 

lines that both you and Mr. Greenstein talked about: to try to cap 

or somehow or another limit the current exclusion and convert it 

toward a credit or a voucher. This is the direction that most of us 

think that we should go. 

It is not just an issue of being more progressive. The current subsidy, because of the way it is designed, at the margin increases the 

demand for health insurance—expensive health insurance—which 

increases the demand for health care, which makes health care 

more expensive, which increases the number of uninsured. 

So we have the extremely perverse situation right now where the 

current subsidy is not only not buying more people into the insurance market. We are spending more every year to pay for more 

people to be uninsured. It is that perverse. 

The issue of what we actually enact down the road is one over 

which there will be controversy. That should not, I think, deter us 

from saying we have to cap, at least cap, these subsidies—cap some 

of these very perverse programs. This is on the tax subsidy side. 

We could look on the spending side, too, and not let programs there 

automatically grow when they are operating so perversely. 

If we only get to capping them when we finally are in agreement 

was to what the ultimate health reform is going to be, or the ultimate tax reform, then I think we are in trouble. 

Senator WYDEN. Mr. Chairman, I could not improve on the last 

comment. And I thank you for the questions. 

Chairman CONRAD. Thank you. 

Senator SANDERS. 

Senator SANDERS. Thank you very much, Mr. Chairman, for 

holding this important hearing. 

Let me start off with Mr. Greenstein and others, Dr. Reischauer 

and others, can pick up on it. 

What impact on the deficit situation would occur if tomorrow the 

Congress rescinded all of President Bush’s tax breaks that went to 

the wealthiest 1 percent? 

Mr. GREENSTEIN. I would have to get back to you with the specific figures. In my testimony I note that if all of the 2001 and 2003 

tax cuts, not just those for the top 1 percent, either expired or to 

the degree they were extended were paid for, that three-fifths, 60 

percent, of the fiscal gap through 2050 would be eliminated. 

Now I am trying to recall, the tax cuts for the top 1 percent or 

what about a third of the total? About a third of the total. So it 

would close about one-fifth of the fiscal gap through 2050. That is 

assuming one did it now. 

The reason the effects would be this large would be that—in anything in the tax and expenditure area, the sooner you do it, the 

more years over which the interest payment savings compound. 

And therefore over a period going out to 2050, you get a big effect. 

So on these long-term projections to 2050, the top 1 percent 

would close about a fifth of long-term fiscal gap and the tax cuts 

as a whole about three-fifths. 

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Mr. STEUERLE. Can I put it in some other numbers? The tax cuts 

of President Bush are on the order of 1 to 1.5 percent of GDP, depending on how we measure it. So if you take about a third of that, 

you are talking about one-third to one half of 1 percentage point 

of GDP. 

And just by way of comparison, the scheduled growth in Social 

Security and Medicare and Medicaid is on the order of about 6 to 

8 percentage points of GDP over 50 years. 

So these tax cuts may solve some of the fiscal gap in the short 

run, if you assume a lot of things inherent in Bob’s projections, 

which includes a constantly declining share of the national income 

that goes for discretionary programs and a lot of other things. 

The comparison I usually make is what is the size of the tax cuts 

relative to how Social Security and Medicare and Medicaid are continually dominating the budget and usurping other spending? I 

think it has to be put in that context. 

Mr. GREENSTEIN. I think both ways of looking at it are important. Again, as I said in the testimony, if one dealt with all of the 

Bush tax cuts tomorrow, we would still have an unsustainable 

long-term fiscal path for the reasons Gene mentions. If we were to 

look at a period longer than 2050, which I do not recommend given 

the uncertainty of numbers, dealing with the tax cuts would close 

a smaller percentage of the hole. 

One last small point. Our estimate of the impact of the tax cuts 

is a little closer to 2 percent of GDP. The difference between Gene’s 

figure and the one I am citing is simply the following: when we 

talk about the cost of the tax cuts, we are including within them 

the increase in the cost of Alternative Minimum Tax relief that was 

created by the tax cuts. The 2001 and 2003 tax cuts doubled the 

number of people subject to the AMT and more than doubled the 

cost of AMT relief. 

So I am including that cost in my figure. And when you do, it 

is closer to 2 percent of GDP. 

Senator SANDERS. Next week the President is going to provide us 

with his budget. He has, as I understand it, already indicated that 

he wants his tax breaks to be made permanent and he wants to 

move this country to a balanced budget, I believe, in 5 years. 

We will find out soon enough, but it sounds to me that if you are 

not going to rescind any of the tax breaks, and if you can move the 

country to a balanced budget in 5 years, there are going to be some 

pretty savage cuts on programs that lower income people and working people are now dependent upon. Am I missing something in 

that guess? We will find out soon enough but is that a fair assumption? 

Mr. GREENSTEIN. I think that is probably right. I do not think 

that is the only factor. I think the President will present a 5-year 

budget and that if you extended it beyond 5 years, you would find 

the deficits would come back up as time go by. 

I think the President will help himself get to the goal by leaving 

some costs out. For example, I think he will assume in 2012 that 

there is no AMT relief, that 40 million Americans are subject to the 

AMT. That will lower the cost of his own tax cuts on paper in 2012, 

there is a $95 billion—

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Senator SANDERS. You are not suggesting he is going to raise 

taxes on tens of millions of people, are you? 

Mr. GREENSTEIN. I am just saying I think that is the way the 

budget numbers will be arrayed. And because he is doing that, the 

size of the domestic cuts he needs to show balance on paper in 

2012 will be smaller than if he assumes that AMT relief continued. 

Even with that though, I do think the budget will have significant cuts. I think a lot of them will be unspecified. I think he will 

show a big reduction in 2012 in overall domestic discretionary programs, but that there will be no specifics after 2008 for what the 

cuts in the domestic discretionary programs are. 

Mr. REISCHAUER. It is also conceivable that the budget might 

contain some significant Medicare savings. As you know, next year 

the Congress and the President will be faced with a 45 percent of 

general revenue limitation on Medicare expenditures, which will 

cause the President to submit and you to consider a package of policy changes that bring Medicare spending in compliance with that 

restriction. And the budget could contain possibly unspecified Medicare cuts in 2012. 

Mr. STEUERLE. Can I just add one tiny footnote here? We are 

doing some projections at the Urban Institute on the children’s 

budget, seeing how much children are getting out of the budget. 

They are already scheduled right now to get a decline, even before 

you have any additional savings, because their share of domestic 

spending is being squeezed between what is happening with the 

tax cuts and what is happening with the continuing orientation of 

the budget toward us baby boomers. They are starting to get the 

short shrift already. 

Senator SANDERS. This, by the way, at a time when we have the 

highest rate of childhood poverty in the industrialized world. 

The only point that I would make, Mr. Chair, to conclude my remarks, is when we talk about health care let us never forget as 

part of that discussion that the United States spends almost twice 

as much per person on health care as any other industrialized nation while at the same time we have some 47 million Americans 

who have no health insurance at all. 

I think it is widely understood that our system, our non-system—

it is not a system—is the most inefficient wasteful and bureaucratic of any in the industrialized world. 

Mr. Chair, thank you very much. 

Chairman CONRAD. Thank you, Senator. 

Senator CARDIN. 

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

Let me thank all of our witnesses for their testimony. 

I must admit, this has been a frustrating exercise for many, 

many years here in the Congress. I listened to similar testimony 

as a member of the Budget Committee in the House. And I just 

want to thank the Chairman for having this hearing on long-term 

fiscal challenges, because I see us act over and over again, session 

after session, on short-term objectives, and we have not addressed 

long-term needs. 

Dr. Reischauer, you point out, and I think rightly so and you are 

not the first witness before this committee to point this out, that 

unless American households and businesses increase their savings 

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very dramatically, the continued viability of our Nation’s economy 

will depend increasingly on the willingness of foreigners to accumulate ever larger holdings of dollar dominated assets. We have heard 

over again about the vulnerability of our economy. And our economy’s growth, in large measure, will not generate the revenues we 

need to balance the budget long-term. 

I would be interested as to whether you have certain suggestions 

as to how we can make a dramatic increase in our savings as a Nation through proposals that have some degree of political viability. 

Mr. REISCHAUER. I think, as my colleague at the Urban Institute, 

Ned Gramlich, and others have pointed out to this committee, we 

seem to be incapable of devising policies or encouragements that 

cause the American public to increase its savings. And the most efficacious way to raise national savings seems to be to reduce Federal deficits. 

And that, of course, throws the ball back into your court. And as 

you said, it is very difficult to get Congress to address that issue. 

Senator CARDIN. I agree with you. I think that we could really 

increase national savings if Government took less money out for refinancing its own operations. 

I want to talk, though, about Medicare issues because, as you 

point out, the President is likely to come forward with some Medicare cuts in his budget. In the 1997 Balanced Budget Act, we made 

a very difficult decisions in cutting Medicare costs, thinking that 

we were lowering health care costs in this country. 

Mr. Greenstein, I agree completely with your statement that increases in health care costs per beneficiary in Medicare and Medicaid essentially mirror increases in costs per beneficiary in the 

overall U.S. health care system. So unless we deal fundamentally 

change the health care in this country, and change the way that 

we deliver care in a fundamental way, instead of picking on Medicare will do little to bring down health care expenditures. We 

might shift costs around. We might limit access to care. But it will 

have limited effectiveness in lowering overall costs of the Medicare 

system. 

Senator CARDIN. I saw in 1997, when we changed the physician 

reimbursement system and thought we were doing something that 

would reduce costs. The resulting system has not done that. And 

the use of SGR has created a great deal of inequities within the 

system itself. 

I am worried, as we look at Medicare to solve the health care 

cost issues at the national level, we are liable to cause real access 

problems for our seniors and shift additional costs on to them rather than fundamentally addressing the health care crisis. 

I welcome your thoughts on that. 

Mr. GREENSTEIN. I agree, and that was the theme of my testimony and a lot of the discussion today, that we are not going to 

get big dramatic long-term savings, big dramatic long-term reductions in the rate of growth and Medicare costs without larger 

health care system reform. 

I would note, however, that—I do not know whether the President will include these in his budget or not—but there are proposals that the Medicare Payment Advisory Commission, that Bob 

Reischauer is Vice Chair of, has proposed that would get some savVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00331 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ings in Medicare without harming beneficiaries. They have identified areas where Medicare is actually overpaying, such as in areas 

where private plans are getting paid more by Medicare than it 

costs Medicare to serve the same people in fee-for-service. So there 

are some adjustment that Congress can, and I think should, make 

it short order. 

Senator CARDIN. Let me disagree with you on that. There are 

areas obviously we need to reform. 

Let’s take the Medicare physician reimbursement system. We all 

know we are going to make modifications to it because it is not sustainable in its current form. Those modifications are not built into 

the future projections of Medicare spending. They should be. 

The therapy caps are not sustainable for outpatient physical, occupational, and speech-language therapies. We know that. We keep 

on modifying it every year. Those caps were imposed arbitrarily in 

1997 purely to get cost savings. They were added without hearings 

and without consideration of the impact on patient care. Eliminating the caps and ensuring access will cost Medicare more money 

in the future. 

Congress enacts these cuts because it makes short-term budgets 

appear more manageable; but in doing so, it has built additional 

accrued liabilities into the Medicare system. This is because Congress knows it is not going to allow those policies to persist because 

they are not sustainable from a medical policy perspective. 

Mr. GREENSTEIN. Agreed. And let me defer to Bob here, but I 

would hope that you will make some of those adjustments for sure, 

as you have been doing each year. 

One could finance them and maybe get some net savings with 

some of the MedPAC recommendations. I think those are sounder 

than simply continuing on, I forget what it is, 4.5 percent, whatever the reduction in Medicare physician payments are. 

But I think the MedPAC recommendations, I would put them in 

a different category and I think they deserve careful scrutiny. 

Senator CARDIN. Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you, Senator. 

I would like to just say to the three of you, we have had three 

hearings before this one. We have had the head of the General Accounting Office, David Walker. He said to us our long-term situation is completely unsustainable. 

We had the Chairman of the Federal Reserve, Ben Bernanke. He 

said to us we should have been working on this 10 years ago, that 

the budget, the fiscal outlook for the country, is completely 

unsustainable. 

Then we had the head of CBO, and he delivered some good shortterm news, that is deficits somewhat reduced this year from what 

was previously thought. But he warned very clearly that our longterm situation is unsustainable. 

The three of you have come. The three of you are three of the 

most respected people in the country on these issues. The three of 

you each have a long track record and very substantial credibility 

on both sides of the aisle. That is why you are asked to repeatedly 

come before this committee, because you have credibility. You are 

warning us of the long-term circumstance. 

327

I would just like, before we conclude, to ask each of you to give 

us your best idea to deal with the short-term and long-term. So 

what is your best idea to deal with these things short-term and 

your best idea to deal with the challenges we confront long-term? 

Mr. GREENSTEIN. I do not think any of us have a silver bullet. 

I would distinguish between areas, like Social Security and various 

things in the revenue area where we know what the options are 

but the political will has not been there, and the health care area 

we have been talking so much about where we do not know exactly 

what the things are that will yield savings of X amount and deal 

with the big drivers of systemwide health care cost growth that, in 

turn, are driving Medicare and Medicaid costs upward. 

Given how heavy these lifts are, I do not see how you get there 

from here without a bipartisan agreement that includes both ends 

of Pennsylvania Avenue. And if it takes several years to get there 

and to build the basis for that, then it does. But the sooner we 

start, the better. 

I think we need to get the public—members of Congress on both 

side of the aisle, but the public, they are all related, you represent 

the public—beyond thinking that various things just have to be off 

the table. We cannot touch a dime in anybody’s future benefits in 

Social Security. We cannot change anything in the 2001 and 2003 

tax cuts. As long as there are those barriers, you will not make 

progress because until you can deal with all of those things, I do 

not think you will be able to make many of the really big decisions. 

As I urged earlier, I do think—this is a sort of a suggestion, to 

use a cliche, to walk and chew gum at the same time. That as you, 

you and Senator Gregg, Secretary Paulson, whoever, are trying to 

get things started on what is probably going to take awhile on the 

long-term, at the same time to identify what things can we do immediately first to stop the practice of recent years of digging the 

hole deeper with every session of Congress. 

And second, to look for those things that can start to make some 

progress right away, even though they are going to be modest compared to the bigger things you ultimately have to do. 

Chairman CONRAD. Mr. Reischauer, what would you recommend? 

Mr. REISCHAUER. The problem here, of course, is that there is no 

mechanism to force action and there is no ability to provide protection, political protection, for those who might make the difficult decisions. In a democracy, it is terribly hard when the sun is shining 

to convince people to buy a raincoat and an umbrella for inclement 

weather that may happen 3 weeks from now, may happen 2 

months from now, may happen next year. 

And so what we need is to make the discussion, that you have 

heard three times now from your various witnesses, more real. The 

tendency over the last decade or so has been for individuals like 

us and the leaders that have testified before you in the earlier sessions to paint the picture in ever more dramatic terms. Billions 

turn into trillions, the crisis is looming in the future. But this has 

no reality for people. 

And I think the first and only thing I would have to offer is that 

we really need Presidential leadership. I do not think this is an 

issue that Congress can lead on. Congress can follow, Congress can 

join hands with—must join hands with the executive in this. But 

328

there is an important educational role that only the president can 

play. And this should be cast not in terms of shared sacrifice or 

pain or avoidance of disaster, but rather as an investment, an investment for our children and our grandchildren. 

Because as several of us have pointed out, we are really going 

to hand off to our children and grandchildren an economic and 

budget situation that will bedevil their lives. 

And this, like investments in physical capital, infrastructure, 

technology, is very much a very real way of improving their living 

standards in the future. 

Chairman CONRAD. Dr. Steuerle? 

Mr. STEUERLE. Senator, again thank you for this opportunity to 

be here, and thank you for the compliments you made to all of us. 

In my view there are some things that the committee can do. In 

part, they have to do with presentation. 

I gave one example in my testimony. I think we need to have 

ways of showing what is happening both automatically and on a 

discretionary basis in the budget as a whole, so that you can see 

how much of the revenues you are going to have in the future 

whether three-quarters or 120 percent, depending on what period 

you are looking at—are already committed. I think that is an important part of the process. 

It is also important to change the language so that when we talk 

about increasing education spending by 1 percent in nominal 

terms, and cutting it 2 percent in real terms, that is not called an 

increase. When we cut Medicare spending from an 8 percent to 7 

percent, we should not call that a cut. That is because we are 

measuring it not relative to current levels, but we are measuring 

it relative to something we call ‘‘current law’’ a concept that nobody 

in the public understands, and, I would guess, most members of 

the Congress do not understand, and, quite honestly, I do not even 

fully understand if you really ask me for every detail. I think that 

presentation is enormously important. 

One reason is to make our language more accurate to garner the 

cooperation of the baby boomers who are about to retire. Because 

if we are really talking about where the money is, it is in Medicare 

and Social Security. That is, it is largely the baby boomers who are 

scheduled to garner almost all of the expenditures of Government. 

We have to convince ourselves, in some sense, that we are part of 

the solution. 

I will say—and I did not get into this issue because I did not 

have time in my oral testimony—I think there is enormous opportunity in this approach. As I mentioned before, I think the budget 

is upside down. We are spending more in areas where we are actually improving as an economy. 

Older people 55 to 75 represent for the first half of the 21st century what essentially women did for the last half of the 20th century. They have enormous human capital that has been underutilized in the labor force. In every reform you look at, I would really 

encourage you to look at how we can encourage more work out of 

this more mature, yet not old, population. Because more work 

means we do not have to increase tax rates or cut benefits rates 

because there is more income in the economy and more revenues. 

329

As a practical matter, and several of us mentioned this earlier 

I think you could also work on triggers. I do not think triggers are 

perfect, but they least force some action. When Social Security is 

projected to be out of balance, there could be a trigger that says 

we cut back on the automatic growth. 

The same thing in Medicare. There is a trigger now, which does 

not have a lot of mileage to it, but it requires the president to give 

you a proposal when Medicare spending exceeds a certain portion 

of general revenues. I think it needs a few more teeth. I think we 

could work on some triggers that at least force action. That is not 

a long-term solution to these programs but I think it is a important 

partial step. 

Chairman CONRAD. Thank you. Thank you for that. 

Senator ALLARD. 

Senator ALLARD. The next two questions I have, I am just going 

to try to push the limits a little bit and just see what you think 

about some things that we are looking at. 

We have had suggestions from the Federal Reserve as well as the 

Board of Trustees of Social Security, that to get us out of the 

unsustainable mode on Social Security and Medicare and Medicaid 

that what we need to do is we need to apply—particularly in Medicare and Medicaid—we need to apply kind of a gross domestic 

product plus one formula. 

In other words, you take gross domestic product, you limit spending increase to Medicare and Medicaid to 1 percent over that over 

the next 10 years. What that spells out in percentage of reducing 

Medicare spending would be by 2 percent and it would reduce Medicaid spending by 3 percent over this period of time. 

Do you think that is reasonable? 

Mr. REISCHAUER. The question is not the reasonableness of the 

objective, but how one would implement it, what one would do to 

bring compliance. Would we cut payments? Would we reduce the 

number of people eligible for the program? Would we increase premiums paid and cost-sharing by the beneficiaries? 

That is where the rubber hits the road. 

Mr. GREENSTEIN. I would add, I think there are problems in trying to enforce such a target in the absence of reform in the overall 

health care system. Take Medicaid as an example. Studies at the 

Urban Institute, that Bob is the President of, find that Medicaid 

costs per beneficiary are lower on average than costs per beneficiary of people in comparable health in the private sector system. 

The principal reason is Medicaid pays providers less. Some providers will not participate in Medicaid as a result. If one cuts those 

payments a lot more without changing the fees charged in the private sector, one can destabilize the program. 

Or another issue. Working poor parents. In the typical State, the 

income limit for Medicaid for working poor parents is two-thirds of 

the poverty line. You make 70 percent of the poverty line, you are 

uninsured unless your employer covers you in the typical state. 

You are too rich to get insurance. 

So we do not want to start making blunt instrument cuts in 

areas like that. That is why it comes back to this larger issue that 

we have to grapple with the overall health care system. We cannot 

just single out Medicare, and in particular Medicaid and put artifiVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00335 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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cial caps on the growth if the health care growth systemwide continues at a significant higher rate. 

Mr. STEUERLE. I mentioned earlier that the Government, through its expenditures and its tax subsidies, is now spending $11,000 per 

household, rising to $13,000 within 4 years. The rate of increase 

could go up even faster after that. 

I think a systematic look at how this money is being spent could 

lead to some proposals that would allow you to be pretty tough in 

terms of capping Medicare expenditures, even having for instance, 

by enacting rules that would be somewhat arbitrary in the limited 

price increases or the price decreases you might force on various 

medical services. 

But I think I would take some of that money and direct it toward 

other problems that my colleagues have mentioned. I would also 

move a bit in the direction the President has suggested (but not 

adequately), and perhaps start building up a credit or a voucher for 

the non-elderly. 

I think that combination would accomplish several things. One, 

I think it would allocate the health budget better. Two, if you applied some of the savings as a deficit reduction, I think it would 

represent good budget policy. But three, as a political matter—and 

I do not usually try to jump in political matters—I think it would 

convince the public that you are trying to come out with a better 

health care budget overall. 

It would force, of course, attention to the huge disparities in the 

way spending is done on both the tax and the direct spending side 

of the budget. 

So I think one can go in the direction or suggest. I think it would 

be hard. You probably would have to empower much more strongly 

your MedPAC-type commissions. Bob might not like that (he’s on 

the commission) or he might tell me there are limits on how far 

you can go in the direction or suggest. For instance, a commission 

might). That if they make suggestions, you would take them or you 

would give them some fast track or something and only—there are 

all sorts of details here. 

But I think the objective is a good one and I think there are ways 

to try to move toward it. 

Senator ALLARD. Mr. Chairman, I just have one more question. 

Now we have talked about a solution on the spending side and 

now I am going to push you a little bit on the revenue side. Because my view is that we are not going to get any kind of political 

resolution to this until we deal with both sides, the spending and 

revenue side. Probably, from a practical standpoint, we are going 

to have to do that anyhow. 

So let us look at marginal tax rates. In the 1940’s, marginal tax 

rates were as high as 94 percent. They are now 35 percent. How 

high do we raise marginal tax rates? Or do we leave them where 

they are because they are—apparently, they are an economy driver. 

If you look at adjusted inflation revenues, it has increased from $75 

billion to $1.9 trillion in revenue to the Federal Government. 

So do we look at bringing our marginal rates close to 94, to 90 

percent or something like that? What is appropriate, 70 percent, 50 

percent, or something less? Or do we even mess with marginal 

rates? 

331

Mr. REISCHAUER. I think there is probably a consensus at this 

table that keeping marginal rates low is good and broadening the 

base is a preferable way to raise revenues. 

That having been said, there are certain preferences that are enjoyed by very high income individuals, some as a result of the tax 

changes of the last 7 years, which it might be appropriate for Congress to rethink. 

Mr. STEUERLE. I would say that if I had to identify one major 

concern with marginal tax rates—and it does have to do with 

where we are going with reform—it is that we have built so many 

explicit tax rates and various phase-outs in the tax system and the 

direct expenditure system I see low and moderate income people in 

various income ranges with tax rates that are already 50, 60, 70, 

or 100 percent. I fear that if we go too much futher toward means 

testing, as is sometimes suggested on health benefits, we are going 

to raise those rates even further. 

So I have to say, those are the marginal rates I worry about the 

most. 

The economic logic of marginal rates is that the inefficiency of 

tax system increases with the square of the tax rate. So bumping 

from 35 to 40 is much less severe than bumping from 40 to 45, if 

you understand where I am going. As an extreme example jumping 

from 99 to 100 means basically people would do no work. 

So the higher the rate gets, the more I worry about it. Thus, I 

would especially worry, as I say, about the marginal rates we are 

starting to impose on moderate income people. That requires looking beyond just the statutory rate to all these indirect rates. 

And by the way, we are increasing marginal rates right now anyway through policies ranging from things the Alternative Minimum 

Tax to bracket creep. So we are doing some of it already. 

Mr. GREENSTEIN. I think all of us would agree broadening the 

base and improving compliance is the first step. 

Incidentally, when I was noting additional needs in the discretionary area, I forgot to include and should have, IRS enforcement 

to improve compliance. 

Having said that, as Gene just noted, I think none of us would 

favor going remotely close to the 70 to 90 percent rates you were 

talking to. I think we may very well need, however, to revisit 35 

percent versus 39.6 percent at the top. 

Beyond that, over the longer term, I think we will need to look 

at some other forms of revenue outside the income tax, particularly 

in the area of environmental related taxes, both to deal with the 

global warming problems and from a revenue standpoint. 

We may ultimately need to look at a small value added tax to 

help deal with these health care issues that we have talked about 

at some point down the road. We may need to look at a hybrid of 

a reformed income tax and some more consumption-based taxes. 

Senator ALLARD. Thank you, Mr. Chairman. 

Chairman CONRAD. If Senator Allard does not mind, I would like 

to just followup with something Dr. Steuerle mentioned to you in 

answer to the question. 

I would like you to explain a little more fully if you could, you 

are talking about very high marginal rates on middle income people. What were you referencing there? 

332

Mr. STEUERLE. What we have done in so many parts of our budget process is to try to save money by playing this game of phasing 

out programs. I am not saying that in some cases they should not 

be phased out. But almost all of the phase-outs are based on income. 

So, in point of fact, your income goes up by $1 and you lose 10 

cents worth of a Pell Grant. Or you lose 33 cents of food stamps. 

Or you lose 50 cents of some other program. 

These programs are each enacted one at a time. I have done a 

lot of analysis on these marginal rates on low and moderate income 

people. Many of these people face extremely high marginal tax 

rates. 

Occasionally there is movement to do something about these 

rates, but then we contradict that effort by adding on another program. And as I say, even some of the proposals in the health care 

field have implicit in them something like another 33 percent 

phase-out rate. So you earn another $1 and you lose 33 cents of 

your health voucher or your health credit or whatever else it is 

going to be. You add that rate to all the others, and you end up 

imposing these very, very high tax rates. 

In the tax system we do it a bit also. We phaseout personal exemptions and other items like this. As far as I am concerned, most 

of those phaseouts should not be there. If we are going to have 

rates, let us put them directly in the statutory rate schedule, and 

let us stop pretending about what is being done. We play this game 

of pretending that we lower the statutory rates, and then we come 

in through the back door and catch people through higher implicit 

tax rates. 

There is very little attention to how this combined tax expenditure system is affecting people. 

Chairman CONRAD. I had not thought about that. That is a very 

interesting point that you are making. 

Mr. STEUERLE. They also impose huge marriage penalties, typically, if you look at those also. 

Chairman CONRAD. That very significant marriage penalties are 

imposed by—

Mr. STEUERLE. Typically by the way these things are phased out. 

They are often phased out on a household basis. As long as you 

stay single, you can avoid some of the phase-outs, is what often 

happens... 

Mr. GREENSTEIN. You could have a household of $20,000 year. As 

it earns more money, its EITC goes down. If it has a housing 

voucher, that goes down. If it has food stamps, that goes down. 

These are the points Gene is making, I think. If you look at both 

the tax and the transfer, the means tested program side of the 

ledger, and you add them up, for each additional $1 you earn, you 

can lose more than 50 cents. You can have a higher marginal tax 

rate than people at the top of the income scale effectively. 

Chairman CONRAD. I would be very interested in anything you 

have in writing on this, I would be very interested in reading.

333


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Let us bring the hearing to an end. We have reached the appointed hour. 

I just want to stay personally and on behalf of the committee a 

special thank you to this panel. I think this has been extremely 

constructive. It has certainly helped my thinking. 

Mr. Greenstein, thank you once again for appearing before the 

panel. 


34649.146
335

Dr. Reischauer, thank you. We have missed your steady hand at 

CBO. We have been very gifted, in this committee and the Congress, in who we haveten to replace you and we are delighted 

there. 

Dr. Steuerle, thank you for your very thoughtful presentation 

here today. We appreciate it. 

[Whereupon, at 12:13 p.m., the committee was adjourned.] 

(337)

EXPLORING SOLUTIONS TO OUR LONG-TERM 

FISCAL CHALLENGES 

WEDNESDAY, JANUARY 31, 2007

U.S. SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to notice, at 10:05 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of the committee, presiding. 

Present: Senators Conrad, Whitehouse, and Gregg. 

Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 

Staff Director for the Minority. 

OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

Chairman CONRAD. I would ask the witnesses to take their seats. 

Senator Gregg has just informed me that he is running a little bit 

late, but he has asked me to go ahead and begin the hearing, and 

we will do that. 

I especially want to welcome the really outstanding witnesses we 

have here today. Robert Bixby, the Executive Director of the Concord Coalition, that does such good work on trying to alert the Nation as to the risks of our fiscal imbalances; Dr. Joe Minarik, the 

Senior Vice President of the Committee for Economic Development 

with a distinguished background in dealing with these issues; Dr. 

Jason Furman, who is the Director of the Hamilton Project at the 

Brookings Institution, who has just taken over for Peter Orszag, 

who has now become the head of the Congressional Budget Office; 

and Dr. Stuart Butler, the Vice President of the Heritage Foundation. We look forward to the testimony of all of you. 

Let me just say that we have had a series of hearings now in 

which we have tried to lay the groundwork about the seriousness 

of our long-term fiscal imbalances. We started with the head of the 

General Accounting Office, and maybe we could put up one of his 

statements from that hearing. He said we are on an imprudent and 

unsustainable long-term fiscal path, and while the short-term deficits have improved in recent years, the long-term is getting worse 

every second of every minute of every day, and the time for action 

is now.

338

Next, we had the Chairman of the Federal Reserve come and testify before the Senate Budget Committee, and this is what he had 

to say: one might look at these projections and say, well, they are 

about 2030 or 2040, and so we really do not have to start worrying 

about it yet. But in fact, the longer we wait, the more severe, the 

more draconian, the more difficult the adjustments are going to be. 

I think the right time to start is about 10 years ago.


34649.428
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I think the Chairman of the Federal Reserve had that exactly 

right. 

Even in the short term, our fiscal outlook is worse than some 

have claimed. It is important to remember that the debt is growing 

far faster than the size of the deficit. While CBO estimates with 

omitted costs that the deficit will fall to $218 billion in 2007, that 

number only tells part of the story. The increase in the debt will 

actually be over $500 billion for this year. As I have said to my colleagues over and over, the debt is the threat.


34649.429
340

We are now facing a wall of debt. At the end of 2001, the first 

year of this Administration, the gross debt was $5.8 trillion at the 

end of that year. Under CBO’s most recent estimates, the gross 

debt of the United States will reach $9 trillion this year. And we 

are headed, by the year 2012, for a gross debt of the United States 

of over $12 trillion.


34649.430
341

This increase in debt is happening at the worst possible time, 

just before the retirement of the baby boom generation. As this 

slide shows, the number of Social Security beneficiaries is projected 

to climb to 82 million by 2050.


34649.431
342

And we need to remember that Social Security is not the biggest 

budget challenge that we face. Because of rising health care costs, 

the shortfall in Medicare is seven times the shortfall in Social Security.


34649.432
343

Since so much of our long-term budget shortfall can be attributed 

to rising health care costs, health care reform must be at the heart 

of any solution. Our health care system is not as efficient as it 

should be. The U.S. is spending far more on health expenditures 

per capita than any other country in the developed world.


34649.433
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For example, the U.S. spent over 15 percent of GDP on health 

expenditures in 2003. This year we are expecting we will be at 16 

percent of gross domestic product. That means about one in every 

six dollars in this economy is going for health care. 

And if we compare that to the rest of the world, we see that we 

are spending about twice as much as other industrialized countries. 

In fact, the next highest country is at 11 percent of GDP. That difference, the difference between the 16 percent of GDP we are 

spending and the 11 percent of the next highest country, that difference represents $800 billion of expenditure per year in our country. 

This chart from the Center on Budget and Policy Priorities shows 

that rising health costs are by far the biggest factor driving Medicare cost growth. Demographic changes from the retiring baby 

boom generation are a secondary factor, nonetheless a powerful 

driver as well.


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But we do not have just an entitlement spending problem, we 

also have a revenue challenge. If all of the President’s tax cuts are 

made permanent, the cost will explode at the same time that the 

cash surpluses in Social Security and Medicare become deficits. In 

other words, the President’s tax cuts will dramatically worsen an 

already deteriorating fiscal picture.


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We can see that the Nation’s gross debt explodes if all the tax 

cuts are extended without offsets. In fact, according to the Center 

on Budget and Policy Priorities, we will more than double our debt 

level as a share of GDP by 2050 if all of the tax cuts are extended 

without paying for them.


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Our fiscal problems are not insurmountable. We can put our fiscal house back in order, but only if we have the will to do so. Make 

no mistake, it is not going to be some automatic mechanism that 

is going to save us. It is going to require us to act. The sooner we 

act, the better. 

We have asked all of you to be here today to give us your ideas 

on what we might do to address these challenges. I especially appreciate your taking your time to prepare testimony and to be here 

to give it. I believe these are incredibly difficult challenges. If these 

were easy things to address, we would have done it. My own conviction is it is going to take both parties giving up on some of their 

fixed positions in order to resolve this. I do not believe either party 

can do this on its own. I think it is going to take working together 

to arrive at solutions. And I do believe it is going to require compromise. 

Compromise means both sides have to give in, both sides. Anybody that thinks it is just going to be one side, I think, is not living 

in the real world. 

And so I want to again welcome this panel of witnesses and ask 

you, Mr. Bixby, to begin your presentation to the committee. 

STATEMENT OF ROBERT L. BIXBY, EXECUTIVE DIRECTOR, 

THE CONCORD COALITION 

Mr. BIXBY. Thank you, Chairman Conrad and Senator Gregg and 

other members of the committee. I am very pleased to be here to 


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discuss solutions for the long-term fiscal challenges that you have 

laid out. 

As you mentioned, I represent the Concord Coalition, which is cochaired by two of your former colleagues: Warren Rudman of New 

Hampshire, a Republican, and Bob Kerrey of Nebraska, a Democrat. 

The problems that we face are well defined. You and your prior 

witnesses, have laid them out. Basically an aging population and 

rising health care costs lead to unsustainable deficits and debt over 

the future. 

We can debate, I think, whether the Government should tax and 

spend at 18 or 19 percent of GDP or tax and spend at a higher 

level, 25 or higher. But no one would advocate that we tax at 18 

or 19 percent of GDP and spend at 25 to 30 percent of GDP. That 

would certainly shatter the economy, would be generationally inequitable, and yet that is the path that we are on. 

There are no quick fixes to this, but there are certain things that 

we can begin doing now that would make for a brighter future. The 

Concord Coalition recently took out a full-page statement in the 

New York Times and recommended the following four steps: one, 

balance the budget. Second, began a bipartisn process for addressing, the long-term fiscal challenges, similar to what you and Senator Gregg have proposed doing. 

Third, reimpose budget caps and the PAYGO mechanism that 

applied across the board to both tax and spending policies. 

We also recommended that you might begin putting into the annual budget resolution some targets for long-term spending and 

revenues as a percentage of GDP that would cover several years. 

And that would help focus more attention because, as you know, 

we have sort of a myopic budget process and it is sort of hard to 

focus on the long-term when we are worrying about this year’s annual appropriations. Not that those are not important, but it is 

easy to forget the long term. 

So let me just elaborate on some of those points. Balancing the 

budget, this is not an end in and of itself. It does have long-term 

benefits. It would increase national savings by ending the drain on 

national savings caused by deficits. So it would better position us 

to deal with these long-term fiscal challenges. I think it is also 

generationally responsible because it would lower interest costs 

and interest is, of course, a major expense, about 8 percent of the 

Federal budget. So there are going to economic and generationally 

responsible outcomes that would come from balancing the budget. 

But that is only, of course, a first step. Even if we had a balanced 

budget by 2012 or sooner, we would still have an unsustainable 

long-term problem. So getting at that is really the root of this. 

The next step is to, as you mentioned, reduce the long-term entitlement costs, really the health care and retirement programs are 

what is driving this. There are no easy solutions to this, as everybody knows, but the primary source of the long-range fiscal drain 

is on the spending side. This will require difficult choices. 

So the most effective solutions are those, I believe, that would 

concentrate on ways to rein in the spending. And you cannot get 

away from the two largest, most popular programs in that regard, 

which are Social Security and Medicare. I would underscore what 

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you said before, that Medicare is by far the much bigger problem 

than Social Security. 

This is going to require some very hard choices. I would recommend on Social Security, the Concord coalition has always been 

in favor of steps such as raising the eligibility age. I think the idea 

of progressive price indexing, which has come up, is one that deserves further consideration. I would avoid payroll tax increases as 

a first step. If more revenues are needed to come up with a politically and substantively balanced plan, then so be it. I think everything does need to be on the table. 

Personal accounts are something that could help increase savings, but the money has to come from somewhere. There is no free 

lunch. So if we do add personal accounts to the system, I would recommend some sort of dedicated revenue source to pay for them so 

that they are not just adding to the budget deficit. Because if you 

have deficit-financed personal accounts, you are not adding to national savings. You are putting it in one pot and then taking it 

from another. 

Medicare is by far the more difficult challenge. My red light is 

on. Gee, does that mean I do not have to talk about Medicare? 

Chairman CONRAD. No. You still get to talk about Medicare. 

Mr. BIXBY. I will. I thought I had that timed perfectly. 

That really is the toughest thing. There, some of the traditional 

fixes just do not get you much. Raising the eligibility age does not 

get you much because most of the costs come from the more elderly 

people, 85 and older. 

So I think there you are ultimately going to have to come up 

with some mix of limits on benefits, figuring out what the public 

is willing to afford, what makes sense in terms of a benefit package 

that we can say that all Americans should be guaranteed, at least 

in Medicare. It does have to extend to the entire health care system 

basically. You cannot solve Medicare in a vacuum. 

It probably will require more contributions from beneficiaries. I 

think the idea of adding more income relating to premiums is 

something that you are going to have to do. And anything we do 

should try to add incentives for more careful use of resources. 

Let me just conclude by saying that we cannot ignore the role of 

revenues in all of this. As I said before, I do not think raising taxes 

should be the first option. Low taxes do help economic growth and 

you do not want to stifle that. 

On the other hand, you cannot keep taxes that far below spending for too long without creating economic problems of their own. 

So that is why everything does, at some point, need to be on the 

table to come up with a package. And this has to be done, as you 

said, in a bipartisan way. It also has to be done with the active engagement of the American people. 

We are involved, all of us here at this table, in the Fiscal WakeUp Tour. Dave Walker is involved in that, as well. We have been 

going around the country holding town hall meetings and talking 

to the local media. I think any sort of big effort like you are leading 

here at this committee really needs to bring the public along. 

We are finding, one bit of good news if I may, that the public 

seems to be willing to hear the tough choices. What they want is 

to make sure that you are serious about them. And if they have 

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to endure benefit cuts, if they have to endure higher taxes, they 

may not be happy about it. But they are willing to accept it if it 

will result in a brighter future for their children and grandchildren 

and not just higher deficits and more of the same. 

So I think to end, the good news is that the problem is in our 

own hands. I think the public is willing to hear the truth. And I 

congratulate this committee for pursuing this most important issue 

in a bipartisan way. 

Thank you. 

[The prepared statement of Mr. Bixby follows:]

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Chairman CONRAD. Thank you very much, Mr. Bixby. 

Dr. MINARIK. Welcome. Always good to have you. Please proceed. 


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STATEMENT OF DR. JOSEPH J. MINARIK, SENIOR VICE PRESIDENT AND DIRECTOR OF RESEARCH, COMMITTEE FOR ECONOMIC DEVELOPMENT 

Mr. MINARIK. Thank you, Mr. Chairman, Senator Gregg, members of the committee. 

Your committee’s hearing record thus far has documented clearly 

that following the outlook of large and continuing budget deficits 

would be unwise and even dangerous. In addition, it is morally 

questionable. 

Let me stipulate the committee’s record and move on to address 

the exceedingly difficult question of how the Nation might cure 

these deficits. 

To begin, however, let me make one point of transition between 

cause and cure. Some say today that tax cuts have made our economy strong and yielded a large revenue boost which will eventually 

pull the budget out of deficit. To this view I can only personally observe: been there, done that. 

There was a similar, in fact far stronger, revenue boom in the 

1990’s following, ironically, a deficit reduction program of which 

about half was a tax increase. In retrospect, that revenue boom 

was driven in substantial part by extraordinary returns in financial 

markets. As seasoned financial market professionals will readily 

tell you, markets go up and markets go down. The revenue boom 

of the 1990’s ended, and the current revenue boom will end as well. 

Having watched all of this happen before at close range, I would 

urge you not to let temporary fluctuations in revenues delay sound 

long-term policymaking. 

The Committee for Economic Development, CED, has considered 

the budget problem from virtually every angle. Let me provide our 

conclusions for your consideration, reviewing all of the major components of the budget. 

Briefly, first, CED has called on the Congress to reinstate the 

budget disciplines from the 1990 bipartisan budget agreement. Let 

me congratulate this Congress for taking a long step forward on 

that issue, while urging a full statutory reenactment of these disciplines. 

Second, the CED Trustees have urged the Congress and the Administration to seek out all possible opportunities to weed out 

waste and duplication in domestic appropriated spending and also 

in defense appropriations, which the current war effort obviously 

complicates. CED has also noted that we have no expectation that 

there will be nearly enough in discretionary savings to solve the 

long-term budget problem, especially in light of the national priorities that must be advanced through appropriations. 

This leaves virtually the entire weight of deficit reduction on the 

remainder of the budget. One program mentioned currently as a 

possible subject of legislative action is Social Security. Because Social Security as currently configured is not sustainable in the long 

run, action is needed. Furthermore, the last major restructuring of 

Social Security, in 1983, significantly helped the unified budget and 

therefore the Federal Government’s need to borrow from the public 

to fund its operations. 

However, the kind of action now often contemplated, partial privatization, would make our overall budget predicament enormously 

378

worse. The simple reason, as Bob suggested, is that the current Social Security operating surplus, which is held by the Federal Treasury in cash and therefore reduces borrowing needs, would have to 

be diverted in significant measure to capitalize the individual accounts. That would constitute a net loss to the Treasury for decades. 

There will be no benefit reduction savings from partial privatization for almost a decade and those savings will begin only very 

slowly while deposits into the private accounts must be made at 

full speed from the very beginning. As a result, the unified budget 

that is about to move into substantial deficit would add on even 

more debt. 

It is of absolutely no consolation that the Social Security plan, 

taken on its own, would be actuarially sound over 75 years, or even 

longer. The Federal Government’s finances would be dead long before then. 

My own calculations of several years ago suggested that the Social Security partial privatization plan would not recover to a net 

break even for the unified budget for more than half a century. I 

know of no serious observer of the Federal budget, certainly not the 

President’s own Office of Management and Budget, who would contend that the Federal Government’s finances will remain healthy 

without serious restructuring much sooner than 50 years from now. 

CED issued a statement on Social Security reform in 1997 which 

we reaffirmed in 2005. Specifically, we recommended gradual reductions in benefits that would yield permanent solvency for the 

system with a margin of safety in those calculations. The benefit 

reductions would include changes in the benefit formula, increases 

in both the normal retirement age and the age of earliest eligibility, and the income taxation of 100 percent of benefits. 

To compensate for those benefit reductions, we would add private 

accounts. These private accounts would be mandatory and would 

be funded by contributions equal to 3 percent of covered payroll, 

1.5 percent each from employer and employee. The contributions 

would belong to the employee and would be placed in purely private accounts, without being handled by the Federal Government. 

Again, these recommendations would leave Social Security permanently sustainable under current assumptions, would increase national savings, and would improve rather than deplete the unified 

budget. 

Close observers of the Federal budget will be quick to note that 

the long-term budget problem is driven much more by health care 

costs than by Social Security. In fact, some might go so far as to 

characterize Social Security restructuring as mere batting practice 

before the real contest against rising health care costs. 

Let me offer two cautionary notes with respect to health care 

costs. First, it is difficult to conceive of policies to cut the Federal 

Government’s health care costs without restructuring the health 

care system as a whole. One could not imagine physicians under 

Medicare and under the private market practicing side-by-side for 

very long at significantly different and diverging reimbursement 

rates or levels of productivity. 

Furthermore, our health care system is no more sustainable for 

private employers, who pick up the bill for much of the working 

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age population and their dependents, than it is for the Federal 

Government, which is responsible for much of the bill for the elderly. Thus, to fix the health care system for the elderly, we almost 

certainly must fix it for everyone. 

Second, it is hard to imagine a simple CBO-scoreable fix for 

Medicare or Medicaid short of a reduction of program coverage that 

would not be much less dramatic than offering the very ill only an 

icy lake and a canoe with no paddle. The Federal Government’s experts already have learned that reductions of reimbursement rates 

of the depth that would be necessary to balance the system in the 

long run would elicit almost equally sharp increases in the volume 

of services provided, through which providers would attempt to 

maintain their incomes. 

Moreover, such reimbursement reductions would not be sustainable in the context of our mixed public and private system. Large 

numbers of physicians simply would refuse to serve Medicare patients. 

Therefore, to solve our impending Federal health cost crisis, we 

need a fundamental restructuring of the entire health care system 

along lines that will yield a qualitative, not just a measurable and 

quantitative, change in the way health care is delivered. CED 

looked at these issues in 2002 and we now conclude that we underestimated the magnitude of the structural change required. Accordingly, we are revisiting this issue now. We are starting with the 

employment-based health care system for working-aged persons 

and their dependents in a way that we believe will have important 

synergies with Federal programs for the elderly. 

Although our deliberations are not yet complete, we have tentatively settled on a system that would give to the working age 

population a menu of choices similar to those available today to 

Federal workers under the Federal Employees Health Benefits Program, and to a few consortia of private employers around the country. 

An independent Government agency, perhaps structured like the 

Federal Reserve Board of Governors, would play the regulatory role 

of the office of Personnel Management in the FEHBP including, for 

example, setting minimum standards for the insurance policies 

that are included in the menu. People would receive defined contributions such that everyone could obtain the low price plan that 

meets the appropriate standards, but those who want more expensive coverage would be responsible for the incremental cost out of 

their own pockets. 

Beyond universal coverage, the goal of this approach would be to 

encourage consumers to be cost-conscious choosers of their health 

insurance plans rather than of individual medical services. We believe that giving consumers such cost conscious choices will drive 

both insurers and health care providers to improve efficiency so 

that they will be able to offer better services at lower prices and 

thereby attract more customers, just as other industries in the U.S. 

economy have learned to seek greater efficiencies so as to remain 

competitive. 

Mr. Chairman, I am running over so I get to skip talking about 

taxes. I guess the only thing that I would note is that we should 

consider, when we are concerned about our tax burdens today, the 

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implications of procrastination in dealing with the budget problem 

for the taxes that will be paid by our children and grandchildren 

in later years. 

A large portion of the problem in the budget outlook is increases 

in the buildup of debt. We can forestall that by reducing budget 

deficits in the short term by any tool, even if we believe that the 

ultimate solutions to those problems are longer-term repairs for 

Medicare and Medicaid. 

Finally, Mr. Chairman, I have to note my resentment that my 

friend over here, Mr. Bixby, mentioned the issue of grandchildren 

when he does not have any and I do. 

Thank you and I look forward to your questions. 

[Laughter.] 

[The prepared statement of Mr. Minarik follows:]

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Chairman CONRAD. Thank you. 

Dr. FURMAN. 

STATEMENT OF DR. JASON FURMAN, DIRECTOR, THE 

HAMILTON PROJECT AT THE BROOKINGS INSTITUTION 

Mr. FURMAN. Mr. Chairman, Senator Gregg, other members of 

the committee, thank you for the invitation to testify in one of the 


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most important issues facing our Nation, the long-run budget deficit. 

Restoring fiscal balance is essential to the current and future 

health of our economy. You have done such an excellent job outlining the problems we face that I will move over it very quickly, 

except to underscore that in my judgment there are three main 

sources of the fiscal gap and in order they are No. 1, the health 

system, and that is the private and public health system taken as 

a whole. No. 2, the tax cuts enacted since 2001 which, if made permanent with associated AMT relief, would total 2 percent of GDP. 

And then No. 3 would be the long-run outlook for Social Security, 

which faces a shortfall, its trustees estimate, of 0.7 percent of GDP. 

With that context, I want to briefly review three steps we can 

take to address the long-run deficit. My written submission contains more details on all of these topics. 

Step one, restore the PAYGO rules and stick to them to stem the 

flow of red ink. Remarkably, two-thirds of the 75-year fiscal gap 

was enacted since 2001. Of what I estimate as a 6 percentage point 

deficit over the next 75 years (and people who look at 50 years and 

use different assumptions will get different numbers), 2 percentage 

points are due the tax cut if made permanent, 1 percentage point 

is due to the Medicare prescription drug benefit, and 1 percentage 

point is due to increased discretionary spending on defense and 

homeland security, not counting Iraq and Afghanistan. 

If PAYGO had been in effect and enforced over the last 6 years, 

we would have had a surplus today and a considerably smaller 

long-run challenge. 

Additionally, Congress can adopt budget rules that stop discretionary spending from growing faster than needed to fund current 

policies and that end the practice of using the reconciliation process 

afforded by the budget resolution to increase the deficit. 

Step two, take some simple steps—comparatively simple steps, I 

should say—to reduce the deficit today. To restore fiscal balance 

more must be done than simply restoring PAYGO. Restoring fiscal 

balance will require some combination of spending below and revenues above the baseline that requires the support of both political 

parties. 

In my testimony I discuss the MedPAC recommendations and the 

tax gap. Here I want to go into a little bit more detail on two other 

recommendations. 

First, there should be no more new tax cuts. The Economic 

Growth and Tax Relief Reconciliation Act of 2001 phased in tax 

cuts over a 10-year period. Several of these tax cuts are not fully 

in effect, including the repeal of the personal exemption phaseout, 

the repeal of the Pease rule that phases out itemized deductions, 

and the repeal of the estate tax. 

These cuts were enacted in an era of surpluses and before 9/11 

brought our attention to homeland security challenges. Now that 

we are again in deficit and spending is elevated, further tax cuts 

above and beyond what is in the law today make no fiscal sense. 

Second, let us correct the indexing of Social Security, the tax 

code, and other programs. Policymakers wisely index Social Security benefits and tax brackets to adjust for the cost of living. But 

the consumer price indices used for this purpose overstate inflation. 

390

Specifically, they ignore the fact that consumers partially insulate 

themselves from shifting prices by switching from goods whose relative prices are rising to ones whose relative prices are falling. 

Although policymakers should not substitute their judgment for 

that of the nonpartisan professionals at the Bureau of Labor Statistics, policymakers must use their judgment to pick the most reliable of the many price indices that are available today and compiled by the professional statisticians. A good candidate is the 

Chained CPI. Since its inception in 1999, this index has run 0.5 

percentage point lower than the traditional CPI. If all Federal programs and taxes were switched to the Chained CPI, by the end of 

the decade the Government would save more than $40 billion with 

the bulk of the savings divided roughly equally between preventing 

de facto Social Security benefit increases and tax cuts that Congress never intended. Over time the savings would continue to 

grow. 

Step three entails addressing Social Security, Medicare, Medicaid 

and tax reform. I want to briefly mention one idea in each of these 

areas. First, Social Security reform. Uncertainty about the future 

of Social Security should not be used as an excuse not to act, but 

it should be a motivation to provide for foreseeable contingencies. 

If the future is much better than we expect, benefit reductions and/

or tax increases should automatically be smaller. If it is much 

worse than we expect, the opposite should happen automatically 

without having to wait for Congress to act. In addition to sustainable solvency, policymakers should strive to achieve robust solvency. 

One promising way to introduce more robustness into the system 

is to use dependency indexing, which links changes in replacement 

rates or payroll tax rates to changes in the ratio of workers to retirees. In a pay-as-you-go system, the dependency ratio is the variable 

that determines the payroll tax rate needed for any given replacement rate. It is a function of current and past fertility rates, mortality rates, and immigration. 

If, contrary to current predictions, Social Security does not face 

any financing problems, a measure like this can effectively shut off 

any benefit reductions or tax increases, removing one of the major 

objections to undertaking Social Security reform today. 

Second, in the realm of health, reforming the $200 billion in annual tax subsidies for health insurance, if done right, can expand 

coverage, improve cost-effectiveness, and reduce the long-run deficit. But reform done wrong could undermine the employer-sponsored system without creating an alternative, increasing the total 

number of Americans without insurance. This is a very important 

issue because it is right at the intersection of the private sector and 

the public sector that is so much a part of the health system. 

Converting the current tax exclusion from employer-sponsored 

insurance into a tax credit or a voucher would make the subsidy 

more progressive, provide a bigger incentive for people to get insurance, and reduce the long-run savings. But this would work only 

if it were done at the same time that major steps were taken to 

strengthen pooling arrangements and expand health insurance coverage through the public and private sectors. 

391

Finally, when it comes to tax reform, I have sketched several options in my written submission, including proposing to curb tax expenditures for corporations and convert individual tax reductions to 

tax credits. In addition, we could rely more on taxes that correct 

distortions and improve the functioning of markets. 

For example, as N. Gregory Mankiw has argued, ‘‘A tax on carbon is the best way to deal with global warming.’’ Combined with 

other tax cuts for working families, such a policy need not be regressive. 

The fiscal problems this committee is trying to address are very 

difficult, both economically and politically. 

Thank you for the opportunity to contribute to your efforts. 

[The prepared statement of Mr. Furman follows:]

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Chairman CONRAD. Dr. Butler, welcome. 

STATEMENT OF DR. STUART M. BUTLER, VICE PRESIDENT, DOMESTIC AND ECONOMIC POLICY STUDIES, THE HERITAGE 

FOUNDATION 

Mr. BUTLER. Thank you, Mr. Chairman and members of the committee. 


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I think you will hear there are some elements of agreement on 

this panel on a number of steps, although disagreements on some 

others. 

As Comptroller General David Walker observed, the present 

value of the unfunded obligations of the Federal Government is the 

equivalent of placing $170,000 mortgage, without a house as a corresponding asset, in the crib of every baby born in America. You 

have asked the panel what we should do about this. 

It may be tempting to say that we should raise taxes to keep 

pace with the mounting entitlement obligations, but there are at 

least two reasons why this would not be the right course, in my 

opinion. First, a lack of future revenue is not the problem. Spending is. Federal taxes are already projected by CBO to rise to their 

highest level ever as a percent of GDP over the next 15 years and 

then they will keep rising. Raising taxes faster than that risks 

slowing economic growth. 

Second, we are currently scheduled to pay for the huge cost of 

baby boomer retirement benefit by borrowing money from our children and grandchildren. But the way to stop borrowing money from 

our children and grandchildren is hardly to take their money in the 

form of new taxes. What we need to do instead is admit that we 

have overextended ourselves and seek fair and reasonable ways of 

reducing future entitlement spending by focusing resources only on 

those who really need help. 

To do that, Congress should take the following steps: first, Congress should replace the drug benefit provision in the Medicare 

Modernization Act with a targeted benefit instead. The Part D benefit is a huge and unaffordable new entitlement. Instead of subsidizing drug purchases for all retirees, Congress should repeal the 

general subsidized benefit and replace it with a limited benefit targeted to only needy seniors. 

Second, if you will not revamp the drug benefit, at least introduce full income testing for Medicare Part D and also for Medicare 

Part B. These parts of Medicare are not social insurance programs. 

They are heavily subsidized voluntary insurance programs. Congress should fully income adjust these parts of Medicare, raising 

premiums to 100 percent of their real cost value for affluent seniors. 

Third, it is time to fully income test Social Security benefits for 

higher income seniors. Congress has already accepted the principle 

of including Social Security benefits in taxable income in order to 

recoup some of the benefit costs. The appropriate next step is to 

phase in 100 percent income-related benefits for all single seniors 

with incomes above 25,000 and married couples above $32,000. The 

full 100 percent inclusion in taxable income should apply on single 

incomes over $35,000 and married couples over $45,000. 

Fourth, encourage Americans to work longer. We cannot sustain 

a retirement system in which typical Americans can plan on spending one-third of their adult life in retirement with financial support 

guaranteed from other working Americans. Congress needs to encourage Americans to increase their time in the work force by 

eliminating disincentives that discourage people from working 

longer. 

403

As an incentive to work longer, Social Security taxes should not 

be imposed on people who work after their normal retirement age. 

Since half the payroll taxes are paid by employers, the employers 

themselves would also have an economic reason to retain older 

workers longer. 

We need also to gradually increase the Social Security retirement 

age to at least 70 and to speed up the current scheduled increase 

to 67. After that, the retirement age should be automatically adjusted to reflect projected increases in longevity. And I think the 

dependency aspect that Dr. Furman mentioned is also an important way of changing it. 

Fifth, we need to focus the growth of Social Security benefits on 

those who need them most and trim the rate of increase for those 

retirees who need them least. This can be done through progressive 

indexation where the benefits of upper income workers would increase only at the rate of inflation while benefits accruing to lower 

income workers would continue to grow under today’s wage growth 

formula. 

And sixth, Congress should change the status of retirement entitlements in the budget process. The current process has two major 

shortcomings. The first is that the long-term cost of existing entitlements is ignored in the annual budget cycle, so Congress is not 

forced to tackle the huge unfunded obligations. 

The second is that entitlements have the first claim on spending, 

whether or not benefits for some individuals really should have top 

priority. Today, retired millionaires automatically preempt the 

homeless and our soldiers in Iraq in the struggle for Federal funds. 

To fix this, Congress needs to take two steps. One is to include 

a measure of long-term budgetary situation prominently in the annual budget with a requirement that Congress go on record each 

year with a vote to increase or reduce long-term obligations. 

Building on this first step, I believe Congress should also begin 

to eliminate the preferred status of entitlement programs so that 

all programs are on the same level playing field and have real and 

limited budgets. The way to do this while still preserving a reasonable level of certainty for retirement planning would be to convert 

all retirement spending entitlements into 30 year budgeted programs that must be reviewed and reauthorized by Congress every 

5 years. 

I should note here that I come originally from Britain. Although 

the National Health Service is an open-ended entitlement in one 

sense, it is on a fixed budget and competes year-to-year with other 

budget priorities for the British government. I think that is the 

way to address health in this country, too. 

Congress might utilize the Entitlements Commission proposed by 

Senator Voinovich and Congressman Wolf to propose an initial 

long-term entitlement budget. Thereafter, Congress might also use 

recommendations fro the National Entitlement Adjustment Condition, proposed by Senator Feinstein, to recommend ways of dealing 

with spending that begins to exceed the agreed 30-year budgets. 

Mr. Chairman, this afternoon Mr. Bixby and I, together with 

David Walker and Isabel Sawhill from the Brookings Institution, 

fly to Iowa for a town hall meeting on options for dealing with the 

long-term fiscal problem. This will be our 19th such event. We 

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found at each of these events that Americans are quite willing to 

talk about tough, bipartisan choices to reduce the burden on future 

generations. 

Thank you for inviting me to testify, and I hope Congress too will 

also be prepared to consider tough choices in a bipartisan way. 

[The prepared statement of Mr. Butler follows:]


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Chairman CONRAD. Thank you, Dr. Butler. 

Let me go to each of you and ask first, to me the notion of just 

doing it on the spending side of the equation is not going to work. 

Just doing it on the revenue side of the equation, not going to 

work. It is going to take some combination of additional revenue 

and spending restraint. 


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You know, I come to these meetings and I sometimes wonder if 

there is any possibility of getting these two sides together, because 

on one side they say no benefit reductions, period. And the other 

side they say no additional revenue, period. Pretty soon you have 

no solution, period. And I think that is about where we are right 

now. 

And everybody is dug in. It is our way or no way. No compromise. No revenue, no cuts. That is what got us here and that 

is what is going to continue, that attitude is going to continue to 

prevent action, in my judgment. Because then neither side compromises. 

Anybody that thinks one side is going to give in on their position 

and not the other side, to me is just detached from reality. This is 

going to take both sides giving up on their fixed position. 

With that said, I would also say it is very clear to me the spending side of the equation is going to have to take most of the—is 

going to have to shoulder most of the effort here, because the baby 

boom generation is a reality. It is not a projection. 

So let me first turn to the revenue side. Is there a way to get 

more revenue without increasing tax rates? Mr. Bixby, do you 

know of a way of getting more revenue without increasing tax 

rates? 

Mr. BIXBY. The first thing you could turn to is what you had a 

hearing on earlier, which is the tax gap. We know that the current 

tax system does not collect all of the taxes that are owed. So step 

one would be trying to collect all of the taxes that are owed. 

Now I do not know how much that would get you because there 

is obviously going to be some sort of a tax gap. I do not think we 

can assume that the tax system is going to collect every dollar that 

is owed. But the tax gap may even be wider than official estimates. 

So I think an aggressive effort in that area is warranted. 

Chairman CONRAD. Can I just interrupt you on that and say the 

head of the Revenue Service has told us he believes they could collect $50 billion to $100 billion a year without changing in a fundamental way the relationship of taxpayers and the taxing authority. 

Mr. BIXBY. It would probably take some more investment in IRS 

to give them the tools and then you would run up against a thing 

of how aggressive do you want them to be, and what sort of push 

back you get it that point from taxpayers. 

The second thing you can look at is the so-called tax expenditures or tax entitlements, things that are excluded now or things 

that you have deductions and exemptions for. 

The President has put on the table ending the exclusion for employer-provided health care. He would devote the savings to new 

deductions but I mean there is—you could certainly bring in some 

new revenue that way. 

You can look at things like the mortgage interest deduction, politically very sensitive but the President’s Tax Commission did recommend that, as an alternative to the AMT. You have to look at 

ways to fund the AMT relief if you want to continue to do that. 

So you could look at some of these big tax expenditures and 

think about closing some of those. But I am not sure that that is 

politically any easier than spending cuts because the people that 

benefit from them are quite passionate about them. 

414

So there are ways you can look at—frankly, I know you have the 

big tax cut sunset coming up in 2010. You mentioned not raising 

rates but they all do expire. So it will take legislative action to extend them. And it does give you an opportunity. It is sort of the 

ultimate trigger to look at whether some of them are achieving 

their intended purpose or not, or whether we can afford them. And 

since they all do expire, you can get into a question about whether 

or not that is raising rates or not. 

That is something that is on the table, certainly. 

Chairman CONRAD. Dr. Minarik? 

Mr. MINARIK. You had a hearing on the tax gap. Amen to everything Bob said. I was not able to look at the exchange that took 

place during that hearing in detail, in the remote possibility that 

some of these issues were not mentioned. 

The resource issue for the Internal Revenue Service would be extremely important. In the past, when there have been efforts to try 

to improve their collection activities, they have generally been 

taken forward by taking their best people out of production, as it 

were, and putting them into training. So for a period of time, while 

the effort is underway, the activities are actually down. That suggests that you might need more resources fairly quickly to be able 

to increase the number of personnel and possibly keep some of the 

stronger employees working in the production part of the process. 

A second consideration is informally one can hear that many of 

the major accounting firms consider the Internal Revenue Service 

to be a training program for them. What happens is the Internal 

Revenue Service goes out, hires personnel, gears them up. They go 

to audits, they are observed, the audit that the service is undertaking is in effect a job interview for the employees. And the best 

people get picked off fairly quickly. 

What that suggests, I am an economist, if you want to hold onto 

people maybe you ought to pay them more. That obviously is a very 

difficult decision in our employment system in the Federal Government. 

Bob is very much correct, if you are not going to raise rates 

under your income tax, and collection issues aside, you are looking 

at issues regarding the tax base. The biggest tax expenditure, as 

you look down the list, is the exclusion for health insurance. As 

Bob noted, the President’s proposal, which is very much like many 

others, like what CED is considering, would assume that the exclusion for the employer-provided premiums would be eliminated and 

that those resources would be used to fill some of the gaps in the 

health care system. It would be very difficult to restructure the 

health care system seriously if you did not use those resources, and 

frankly you would just be raising taxes somewhere else anyway. So 

that is a limitation on what you can do. 

Another major tax exclusion in terms of revenue cost is the group 

of tax subsidies for pension savings. Some of those are somewhat 

hidden in the sense that they involve back-loaded tax preferences, 

which is to say you deposit an after-tax dollar today but you never 

have to pay tax on anything that dollar earns forever. Under those 

circumstances, the revenue costs in the future can be extremely 

substantial. That is a very generous subsidy and might require consideration. 

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Bob is also correct, when you get past that you start looking at 

items that are probably even more difficult, including the tax benefits for home ownership. I guess one thought that might be worth 

considering again, which was debated in the early 1980’s in the 

course of the deliberations on what became the Tax Reform Act of 

1986, was the possibility of taking some of the tax preferences in 

the current income tax which operate as deductions, which is to say 

they have the effect of what are called upside down subsidies. They 

are more valuable for people in higher tax brackets than in lower 

tax brackets. In some instances, that seems counterintuitive with 

the purpose of those tax preferences. 

One opportunity might be to take those what are now tax exclusions or deductions, turn them into credits at a reduced rates, perhaps say the 15 percent bracket where most wage earners are. And 

by doing that, reduce the benefit of those provisions to people in 

higher tax brackets. That could be a net revenue increase. Some 

people might consider it a rate increase for that matter. But it is 

one thing that perhaps we ought to think about. 

Chairman CONRAD. Senator Gregg. 

Senator GREGG. Thank you, Mr. Chairman. Thank you for holding this hearing. 

Chairman CONRAD. We will get back. 

OPENING STATEMENT OF SENATOR JUDD GREGG 

Senator GREGG. And I want to thank the panel. You folks have 

had some excellent ideas, excellent proposals, which if we are able 

to amalgamate and sugar off—that is a New Hampshire term. 

When you make maple syrup, you boil the sap and you end up with 

a little bit of sugar. And we could probably solve a lot of this. 

Let me ask you about a couple of specifics and how we would go 

about implementing them because they seem to be reasonable ideas 

that should probably be executed sooner rather than later, even if 

there is not a comprehensive approach, although I would hope we 

would have a comprehensive approach. 

The first is this idea of going to the chained CPI. Can you explain what that is and then explain how it would be implemented? 

Mr. FURMAN. Sure, I would be happy to. 

The official CPI uses an outdated method to calculate inflation. 

It uses a fixed market basket from the initial period. That assumes 

that people cannot substitute between different goods. The fact that 

we observe people changing their consumption prices when relative 

prices change, tells us that people, to some degree, view apples and 

oranges as substitutes for each other to a limited degree. 

The Chained CPI is calculated by the BLS and it takes into account people’s consumption patterns at both the beginning of the 

period and the end of the period. To the degree that people actually 

do substitute when relative prices change, the Chained CPI will reflect that. If you do not want to switch from health care to iPods 

when the price of one rises and the price of one falls, you will not 

actually switch from health care to iPods and the two indices will 

be the same. 

Senator GREGG. I think I understand the concept. How would 

you—

Mr. FURMAN. How would you implement it? 

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Senator GREGG [continuing]. Legislate it. 

Mr. FURMAN. It is released every month just like the regular 

CPI. The only wrinkle is that it is revised for up to 2 years after 

it is released in the way that the regular CPI is not. So the implementation would just be to switch whatever is done on CPI–W, 

which is the Social Security system, or CPI–U, which is the tax 

system, to the C–CPI–U. And then you would just—

Senator GREGG. Would that take legislation? 

Mr. FURMAN. That would take legislation, absolutely. And then 

you would need a catch-up provision to take into account the revision to the index. 

Senator GREGG. Could you do it through reconciliation, a reconciliation instruction, do you think? 

Mr. FURMAN. I am not an expert on budget rules but it would 

certainly take legislation. 

Senator GREGG. Thank you. This idea, this dependency indexing 

method, what is that? Go over that with me, too. 

Mr. FURMAN. Sure. It is a mathematical fact in a pay-as-you-go 

system that whatever tax rate you have, let us say it is 10 percent, 

if you then have three workers for every retiree, your replacement 

rate can be 30 percent. Your tax rate is obviously set by statute. 

The replacement rate is set through the PIA factors, the thing that 

translates your earnings into your Social Security benefits. 

What you could do is either take your payroll tax rate and when 

the dependency ratio gets worse it automatically goes higher. Or 

you could take the PIA factors—

Senator GREGG. Doesn’t that mean you are raising taxes on 

working people? Is that not the practical effect of that? 

Mr. FURMAN. I am giving you the flip side also. You can do whatever—

Senator GREGG. You know the ratio is going to go haywire, when 

we—

Mr. FURMAN. If you want to raise payroll taxes or if you want 

to cut benefits, then I believe a better way to implement that is to 

build the contingency in advance rather than decide today based on 

what the Social Security Trustees think about the future, which 

could be way off in either direction. This is the exact right contingency. 

In terms of raising taxes—

Senator GREGG. Does it affect the benefit structure, as well as 

the revenue structure? 

Mr. FURMAN. Absolutely. It would be up to you how to design it. 

You could either dependency index the payroll tax rate, or you 

could dependency index what are called the PIA factors. 

Senator GREGG. You could do both? 

Mr. FURMAN. You could do 50/50, you could do 75/25, whatever 

ratio on the benefit and tax side. This is a mechanism for taking 

any plan you might have seen that alters benefits and taxes that 

you may like or may not like and make it what I think we would 

all view as an unambiguously better plan if you built this type of 

contingency. 

On the difference between taxes and benefits, I would add that 

Kevin Hassett testified to this committee last year and said ‘‘A benefit reduction is as much of a tax hike to a rational individual as 

417

an explicit tax hike.’’ This is what Kevin Hassett said. And he explained that what matters to people is on net what they get out 

of the system. If you cut their benefits, it makes the existing payroll tax more distortionary than it would otherwise be in the same 

way that raising that payroll tax would be. 

From an economic standpoint there is no difference in economic 

efficiency within the Social Security system of going down the tax 

route or the benefit route. 

Senator GREGG. I would be willing to debate that with you but 

I do not have time. 

Dr. Butler, you cited your thoughts that the dependency rate 

should looked at. Can you piggyback on what Dr. Furman has said? 

Mr. BUTLER. Yes. I think the common thread here is that we are 

both saying that the commitments we are making on the benefit 

side should take into account the ability to pay of those on the 

payer side, that is the workers. That is the common theme. 

I think looking at some relationship between the resources of the 

working population, and the demands of the retirement population, 

is what gets you looking at the dependency measure. 

I also argued that we ought to have a further change in the indexing of Social Security benefits so that you have a reduction in 

the growth of projected benefits for those who are higher income 

workers campared with lower income workers. 

Also, of course, the change in the benefit structure I argued for 

affects those who, as retirees, have higher income. 

So all of these approaches are basically saying it is time to recognize that you the burden of the commitments that we have made 

is far too high because of demographic and other reasons. So in 

that sense, I think we are both on the same song sheet in terms 

of how we go forward. 

Senator GREGG. You are both arguing that the benefit structure 

should be more of a progressive system? 

Mr. BUTLER. Absolutely. I am very much on the progressive side 

when it comes to looking at benefit levels. 

Senator GREGG. I was interested in your comments on Part D, 

which I am totally in agreement with. But I think my time is up. 

Chairman CONRAD. Senator Whitehouse. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. 

Mr. Butler, you recommended that Social Security taxes should 

not be imposed on those who are employed after their normal retirement age. In the present economy, that cohort provides what 

proportion of our Social Security retirement? 

Mr. BUTLER. I cannot answer that right now. I can get you that 

information. I do not know the number. 

Senator WHITEHOUSE. What is your suspicion? Could you get me 

the information? 

Mr. BUTLER. Yes, I certainly can. 

Senator WHITEHOUSE. What is your suspicion? 

Mr. BUTLER. As I was trying to point out, the objective here is 

to encourage people to spend longer in the work force if they do not 

need to retire. And once they—

Senator WHITEHOUSE. I understand that. I am just trying to see 

what the present effect would be. 

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Mr. BUTLER. It is a dynamic effect because you have to take into 

account how many people would be working beyond that point. And 

that, of course, will generate income taxes on those people. It is 

complex. 

Senator WHITEHOUSE. I understand that, but just on the Social 

Security piece. 

Mr. BUTLER. Certainly. I will do that. 

Senator WHITEHOUSE. If you could start with that. 

And Dr. Furman, you said in your written testimony, that twothirds of our fiscal gap has occurred since 2001 and could have 

been prevented had PAYGO rules been in effect. What is the dollar 

number that you would connect to that? 

Mr. FURMAN. We have added about $30 trillion or to the 75-year 

deficit in present value terms over the last 6 years, on an apples 

to apples basis. 

Senator WHITEHOUSE. What presumptions does that make about 

whether those—

Mr. FURMAN. This is if the tax cuts were made permanent. If we 

go down the course that some have set. 

Senator WHITEHOUSE. What is the present number that has been 

run up from 2001 until now as a result of—

Mr. FURMAN. You look at a year like this and the deficit seems not quite as terrible as it would otherwise have been. It is $745 billion worse than what was projected in January 2001 in this year. 

92 percent of that deterioration is due to policy changes made since 

2001. So we have added about $650 billion to $700 billion to this 

year’s deficit through policies. 

Senator WHITEHOUSE. Has that the number grown since 2001? 

Mr. FURMAN. That number has grown both in dollar terms and 

as a share of GDP. Now some of that was unforeseen contingencies, 

but a lot of it was a deliberate policy choice. 

Senator WHITEHOUSE. I will followup with you more on that offline, but I appreciate that. 

I would also be interested in hearing from each of you, we do not 

have much time for it right now, but even if you could just fire me 

a one-pager or pick something out of an article that you agree with. 

I do not understand at all well what the impact of immigration 

is on our fiscal situation, and to what extent new arrivals create 

fiscal benefit early on and then cause it—I assume that there is a 

profile of some kind that is the immigration effect on our fiscal situation. And I just would like to understand that a little bit better, 

if you can make it relatively simple. If you give me a 200 page thesis, I am not going to get through it. But if you can keep it simple, 

I will get through it. 

Thanks very much. Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you, Senator. 

I would like to go back. I had asked Mr. Bixby and Dr. Minarik 

a question and I want to continue with Dr. Furman and Dr. Butler. 

Is there a way of getting more revenue without a tax increase? 

What is your judgment on that? Without a rate increase, Dr. 

Furman? 

Mr. FURMAN. I think that for anyone who thinks that both revenues and spending needs to be part of the solution, and I count myself in that group, it is incumbent on them to make sure that the 

419

revenue increases are as economically efficient as they possibly 

could be. 

I agree with everything that Mr. Bixby and Dr. Minarik said, so 

I am not going to repeat them. Let me illustrate one of Dr. 

Minarik’s points which was the President’s Tax Reform Commission on the mortgage interest and the change they made there. 

They did the worst selling job for a decent idea that I have ever 

seen. Everyone knows that their proposal was to curb the mortgage 

interest deduction. I do not think that anyone knows that 20 million middle-class Americans would have gotten a mortgage interest 

tax break under that proposal who do not get it today. 

Chairman CONRAD. How is that? 

Mr. FURMAN. They were converting the deduction to a 15 percent 

tax credit that was available to everyone. Right now 50 percent of 

middle-class Americans who have mortgage interest on their homes 

do not get any benefit from the existing deduction. So they were 

expanding it to 20 million new people. 

Chairman CONRAD. Why aren’t they getting the benefit of the deduction? 

Mr. FURMAN. Because they take the standard deduction. 

Chairman CONRAD. They probably do not even know they are not 

getting the benefit. 

Mr. FURMAN. Some of them might be making a mistake. Many 

of them do not have enough mortgage interest, so they are making 

the right choice. 

So the panel went out and, to some degree, sold this as curbing 

it from a deduction to 15 percent and curbing the size of the mortgage. They did not go out and say, we could make this thing work 

a lot better, could make it a lot more progressive. We could give 

a tax cut to 20 million families that do not get one today to encourage home ownership, and in the process make the tax system more 

efficient and save money. 

I think some of these things are a matter of packaging things in 

the right way, especially when you do the deductions to credits. 

You can make it more efficient, more fair, have a lot of middle-class 

winners, and still, if you curb it at the top end, save money and 

improve the base—

Chairman CONRAD. How would the 15 percent credit apply? 

Mr. FURMAN. In their proposal you would just take whatever 

mortgage interest you had on a mortgage up to a certain amount—

$227,000 to $412,000 depending on the county. You would just multiply your mortgage interest by 0.15 and subtract that number 

from your taxes. 

The way it works right now is in effect you take your mortgage 

interest and multiply it by your marginal rate, which might be 0.15 

or it might be 0.35, if you are more fortunate. 

So an idea like that, I think, if sold and packaged in a different 

way, as I said, I think could both be good economic policy and good 

politics. 

Two others proposals to add to the list are international taxation 

and pigovian taxation. Our international tax system is completely 

broken. This is not what I am recommending, but as a thought experiment, if we completely eliminated all taxation of foreign companies on the profits they make overseas, would not have to pay any 

420

more taxes on their profits overseas, but also said they could not 

deduct the cost of doing business overseas from their American 

taxes, we would actually raise taxes rather than lower them by 

about $11 billion a year. International tax system serves to lower 

tax revenues rather than raise them. There is a lot of different 

ways to correct that. It gets very complicated, but it is a good area. 

Finally, what economists call Pigovian taxes, taxes that correct 

externalities, are a way to improve economic efficiency and raise 

revenues. The carbon tax would be the main example. You would 

want to protect people. You might even want to make it a revenue 

neutral, distribution neutral tax reform, but that is something most 

economists would review as enhancing economic efficiency. 

Chairman CONRAD. Dr. Butler? 

Mr. BUTLER. Thank you. 

When I look at revenues, as I suggested in my opening remarks, 

my concern is the level of taxes as a proportion of our Nation’s output. I come from Europe. I have seen very high tax systems. Under 

current law we will move forward to higher and higher proportions 

in tax. I think that has to be readily understood, as opposed to 

changes in the baseline revenues. 

When one of Joe Minarik’s granddaughters gets to their middle 

year earnings, they will paying a burden about a third higher today 

as a proportion of the national paycheck. So I just want to make 

that point. 

When one looks, however, at the issue of revenues, to some extent this is a language question. Sometimes the language is important to look at in terms of what one can do. Dr. Furman and I both 

support the idea of changing a current tax expenditure, the exclusion for company-provided plans. The President wants to limit this 

and turn it into a different structure that would give much more 

help to lower income people and so on. I see that as a tax reform. 

But it would have the effect of reducing some of the pressures 

on the Government in the Medicaid program and DSH programs 

and so on to subsidize treatment for people, because they would 

have their own resources. So one can look at that as a reduction—

Chairman CONRAD. There would be some tradeoff there. 

Mr. BUTLER. Yes, you could call it a revenue increase, of course, 

if you are only looking at one piece of it. But you can look at it as 

a reform, and in fact a neutral revenue reform, if you look at the 

whole picture. 

Then also look at what I said with regard to benefits. I said let 

us look at clawing back some of the benefits for people who are 

higher income. If you do that—

Chairman CONRAD. Is this directed at Senator Gregg? 

Mr. BUTLER. By clawing back some of those benefits, if you do 

it through the tax system some people would argue that is a tax 

increase. I would argue it is a benefit reduction. Some of this is semantics. 

If the dollars stay in Washington then we often think of it as a 

reduction in spending. If we send the same dollars out and then 

ask for some of them back, we call it a tax increase. And yet there 

is no difference between the two. 

So I think there is a lot of areas where a lot of this is semantical 

on where reform and what is a benefit reduction as a tax increase. 

421

I think there is enough wiggle room there, quite frankly, to look 

at a political strategy that could make everybody feel that they are, 

in fact, winning in terms of moving forward. 

I think that is the way to look at it. I think the wrong way to 

look at it is to say raising taxes is just a bookkeeping exercise. We 

just simply keep raising taxes because that has to be one side of 

the equation and ignore what has happened in Europe where we 

have reached a tipping point in the 1970’s and 1980’s where that 

level just got so high that we saw all of the downsides associated 

with it. 

That is why countries like Ireland and others are actually moving to reduce taxes as a way of stimulating growth and improving 

their ability to pay for needed services. 

Chairman CONRAD. Let me just say I do not disagree with you 

on the concern that you have indicated that we approach European 

levels of taxation. We went through this in one of our earlier hearings. We look at total tax burden in the United States. We are at 

about 26 percent of GDP, that is Federal, State and local. We look 

at Europe, they are approaching 50 percent of GDP, depending on 

the country. I think Germany is 36, but the Scandinavian countries 

are in the high 40’s. If I recall, Denmark—I am part Danish—49 

percent. 

And yet some of these countries have higher rates of economic 

growth than we do. Why is that? 

Mr. BUTLER. I think the first point is that you have to look at 

it broadly and say there is a concern about the level of taxation 

and to investigate the differences between different countries. 

There are different labor markets in different countries. In Europe 

there are other patterns, including the way taxes are levied. There 

is all kinds of factors. 

But the underlying point that I was really trying to make is that 

we must be concerned about the level of taxation. It is rising in 

this country and it is rising toward these European levels. And 

therefore let us look at what the potential consequences are. 

You look at some of the Scandinavian countries, and I think the 

argument is that their best days are over. That if you look at the 

long-haul—

Chairman CONRAD. Do not tell my friends in Denmark or Norway that their best days are over. They do not see it that way. 

They are very confident about their future. 

Mr. BUTLER. Well, in some other countries, I suspect they may 

feel that their best days are over. 

But still, the point I am trying to get at, I think you accept—

Chairman CONRAD. It is a legitimate point and actually a point 

I agree with. Senator Gregg and I, we may have a difference about 

where that balance point is but we share the concern. One of the 

reasons we have to deal with these long-term imbalances is we are 

headed for either tax increases that will damage our economy or 

benefit cuts at some point that become so draconian that it has a 

very adverse effect on the people we represent. 

So how one reaches a balance here is an enormous challenge. 

Senator GREGG. 

Senator GREGG. I agree with that. 

422

I asked both General Walker and Chairman Bernanke what percentage of GDP would be appropriate for the Government to take. 

Because I think when you take this down to its most basic equation, it is getting the revenues to meet the liabilities. And we know 

we are going to have these liabilities that are fairly significant because we are going to double the retired population. And we can 

obviously address benefits, and we are going to have to. And has 

been pointed out, probably the benefit side should be where the 

majority of the effort is made. 

But we also know revenues are going to have to go up if you are 

going to maintain a stable economy and a productive economy because of the simple fact that you are going to have this huge generation that has to be paid for. 

And the question becomes quite honestly, in my humble opinion, 

at what number do you raise revenue so high that you start to create a down cycle, where productivity falls off, where capacity for 

creativity falls off, where entrepreneurship falls off, where the creation of jobs fall off because people simply have a tax burden that 

they are not willing to undertake? Or the underground economy 

grows so fast that you are not generating revenues. 

And it is that number at which basically you can afford a benefit 

structure. That will drive the process. 

Neither Chairman Bernanke nor General Walker would subscribe to giving me a number. Historically, we know that 18.2 percent of GDP is what we were taking in revenues and we are now 

over that at 18.5 percent, and we are headed up. Historically, 

spending has been around 20 percent and the difference has been 

our structural deficit. Now spending is going to start to go up in 

the post-2015 period. 

The question is do any of you have a number that, in your considered opinion, is reasonable relative to the percentage of GDP 

that can go into the government and still have the country be viable and strong economically? 

Mr. BUTLER. I would say that once you go over 20 percent, you 

are getting into very risky territory. Of course, it does depend, I 

think we would all agree—

Senator GREGG. You are talking Federal Government? 

Mr. BUTLER. Yes. And so therefore, that would mean total Government in the United States—

Senator GREGG. Would be around 30 percent. 

Mr. BUTLER. Around 30 percent, which is getting into dangerous 

territory. Of course, it also depends how you levy that tax, which 

we all have to emphasize. 

But I think also it is important to think about, when you say 

what is necessary for benefits, that there are all kinds of ways of 

enabling people to insulate themselves against the costs of bad developments in say health or retirement. We would all encourage 

the notion of encouraging greater savings during working lives. So 

that would reduce the need for Government to give such extensive 

comprehensive benefits. 

I think other steps are possible in the health area. I work a lot 

in the health care area, and there are all kinds of steps you can 

take to reduce the probability that people will need high cost programs. 

423

So I think it is very important not to think of this commitment 

on the benefit side as somehow a given, and we just have to figure 

out a way for paying for. There is a connection between all of these. 

Senator GREGG. No, I am not suggesting it is a given. 

Mr. BUTLER. I know you are not, but I think some people do. 

Senator GREGG. I am simply asking a question of what percentage of GDP. 

Does anybody else have an opinion on GDP burden of tax? 

Mr. FURMAN. My only observation would just be from our recent 

history. In the 1990’s the top part marginal rate, for example, was 

39.6 percent. 

Senator GREGG. I am not talking about rate. I am talking 

about—

Mr. FURMAN. I understand. And tax rates were such that you 

would collect 2 percent of GDP more than what we are collecting 

today. I am not saying we should go back to exactly the tax structure we had in the 1990’s, but that tax structure, which would be 

about 2 percent of GDP higher than we are right now, was clearly 

compatible with a very successful economy. 

Senator GREGG. I would have to debate that a little bit because 

we had the Internet bubble, which was the most unique bubble in 

the history of the world and generated a huge amount of paper 

gain that did not exist, which generated a huge amount of revenues 

to us which I do not see us getting again no matter what rate we 

had. 

But the question is is 22 percent, which is what during that 

Internet bubble 22 percent of revenue? We got to, I think, 21 percent of the gross national product being Federal revenues. 

Mr. FURMAN. It also fluctuates because of the economy. In a good 

year the economy should collect more. That is part of why it is disappointing that we are so low, so close to average this year when 

the macro economy is doing so well. It should go up as a share of 

GDP in a good year and down in a bad year. 

Mr. MINARIK. Senator Gregg, Jason mentioned earlier, I think, 

an important point which is for whatever level of revenues you are 

going to collect you want to collect them in the most efficient way 

possible. The percentage of GDP that we take out of the economy 

in total could be done any number of different ways. There are 

more efficient ways and less efficient ways. 

We just said goodbye to Richard Musgrave, who was the dean of 

the public finance discipline within economics. One point that he 

made in his textbook, his monumental textbook on the subject, was 

you can perhaps collect more revenues in total with lower distortions by using several different mechanisms to collect the revenues 

rather than loading them all on just one. 

So some would argue, for example, I did not get to talk about it, 

but the Committee for Economic Development has suggested that 

we need a supplemental value added tax to try to raise more revenue at the Federal level with lower total distortions. One could 

argue that you might be able to raise somewhat more revenue with 

a value added tax, in addition to an income tax, than attempting 

to raise the same amount of revenues out of that income tax. That 

is one possible argument. 

424

Senator GREGG. We had testimony last week where somebody, I 

have forgotten who it was, said that the value added tax had as 

poor a level of collection or even a worse level of collection in Europe that the income tax has, as far as avoidance. 

Mr. MINARIK. That point has been debated. There are problems 

of collection with any tax. One argument that has been raised, you 

can go on two sides of this particular argument. One is that if you 

have the States collecting a sales tax and the Federal Government 

collecting a value added tax, the collection efforts at the two levels 

of Government will actually have synergies and they can both be 

more effective. Some others argue that you have a clash between 

the revenue needs at the State level and the revenue needs at the 

Federal level. That would cut the other way. 

Clearly any tax has issues of collection. Our income tax has 

issues of collection. We have all sorts of issues of reporting. We 

have issues at the border. So nothing is going to be easy. 

Senator GREGG. That is true, and I guess my own personal experience, being from New Hampshire, which is surrounded by States 

with both a sales and an income tax and we have neither, is that 

most of the States that have moved to a sales tax have done so 

with a representation to their citizenry that the income tax would 

be cut or reduced. And after about three or 4 years of stable income 

taxes, their income taxes start to go back up, even though they 

have a sales tax added. 

But the first thing I was taught when I arrived here, by one of 

most brilliant people I ever served with, Barber Conable, was that 

all Government moves to the left. The issue is how. If you think 

of it as a railroad train, the question is how many engines do you 

have on the train and how fast is it going to go? And the number 

of revenue collection mechanisms you have defines the number of 

engines. 

But that is a debate for another time. 

I would ask one last question. You said you wanted a 3 percent 

retirement savings vehicle on top. Was that on top of the payroll 

tax? 

Mr. MINARIK. That is correct, Senator. 

Senator GREGG. Where you would have a 15 percent payroll tax 

essentially, or 15 percent withholding and 3 percent of it would go 

into a savings account? 

Mr. MINARIK. The payroll tax would remain as it is today. 

Senator GREGG. Thank you. I appreciate that. 

Chairman CONRAD. Let me go back, in my final round of questioning, to this question of reform. Dr. Butler, we have sort of 

begun that conversation. I would like to include everybody. 

Any proposals on tax reform? Dr. Minarik, I was very interested 

in what you were just discussing. Dr. Butler, you were hearing 

what Dr. Minarik was discussing there in terms of diversifying our 

tax base and basically having an income tax that would be supplemented by a value added tax. Does that make any sense to you? 

Mr. BUTLER. I do not support a value added tax, because of the 

reason that Senator Gregg pointed out. Those who argue it should 

be a replacement and a more efficient way of raising taxes ignore 

that we always seem to end up with both. That was certainly the 

case in Europe. 

425

I think that there is also other issues associated with the value 

added tax in terms of its implementation, and its regressivity. It 

then also means that tax costs have to be factored into services of 

government. Costs of various services that people are paid for by 

government. It is a complicated way of doing it. 

I actually favor much a reform toward a more standard expenditure tax through the income tax system, with lower rates, a much 

wider base of taxation, and elimination of double taxation. But 

through the income tax itself. I think it is a way—

Chairman CONRAD. Could you describe that a little more fully? 

Mr. BUTLER. Just very simply that we would take steps to make 

taxable, many of the items that are currently tax free fringe benefits, such as the tax exclusion for company-based health plans. 

Chairman CONRAD. Broadening the base. 

Mr. BUTLER. Broaden the base and lower the rates, which I think 

will be much more efficient. 

Chairman CONRAD. Better in terms of the economic effect. 

Mr. BUTLER. Yes, but I within that structure, as opposed to a 

value added tax system, it is much easier to say people below a certain income will face a lower burden. And it is much easier to do 

that through an income tax system than to say people are paying 

all that heavy value added tax so we will have to try to figure out 

some way of giving them a credit against the taxes they paid. Well, 

how much tax did they pay? And so on. So I think an income tax 

based system, if reformed, is in my opinion much more economically efficient, easier to administer, and fairer than something that 

has these different forms of taxation that you are trying to link together and somehow make sure that any one individual in different 

situations is treated equitably. I think it is much harder to do that. 

Chairman CONRAD. Dr. Furman? 

Mr. FURMAN. Your question is to talk about a VAT? 

Chairman CONRAD. I am really interested in the what Dr. 

Minarik started the discussion. Dr. Butler had talked about reform 

proposals. Does it make sense to you to have a VAT as a supplement to an income tax? What are the things we should be thinking 

about? 

As you know, there are a lot of discussions swirling around here 

about how we deal on both the revenue side and the spending side 

of this equation. But on the revenue side for the moment, reform 

ideas that you would have. 

Mr. FURMAN. To comment on the VAT, it is something that I 

think is worthy of serious consideration. My recommendation is if 

we decided to do a VAT to raise revenues it would not make sense 

to do a small one, say a 3 or a 5 percent VAT on top of the existing 

income tax because you would get an additional layer of complexity 

associated with the VAT and the paperwork and you would still 

have all of the same complexity in the income tax system. 

If you go down that route, I think you should do, a bigger VAT 

and take a lot of people off of the income tax, with appropriate 

credits on that side. So that when you are adding this new system, 

you are greatly simplifying the old system for a lot of people. 

Chairman CONRAD. One of the ideas that is being discussed is 

something along those lines, where you would take off a significant 

426

majority of people from the income tax system altogether. They 

would not have to file tax returns anymore. 

Mr. FURMAN. This is a proposal Michael Graetz at Yale has 

made. There are a lot of things to be worked out in that proposal 

because a lot of low-income families are getting the Earned Income 

Tax Credit and the Refundable Child Tax Credit. I do not think his 

proposal has worked them out, so I would not recommend going 

down that route. 

A good general principle is that we should take advantage of the 

introduction of a new tax, if that is what you are doing, to simplify 

the old tax system. One of the ways of simplifying it would be taking more people off of it. 

That would be my thoughts on a VAT. And then more broadly, 

we should think about tax expenditures and the conversion from 

deductions to credits, the reform of the international tax system, efficient Pigovian taxes, and something we have not gotten into at 

all, which is that our business tax system as a whole is very much 

broken. We keep adding things that make it so that you do not 

need to pay taxes on income at any level of the system. Even in 

a consumption tax. If that is what you believed in, you would not 

have interest being deductible for companies in the way that it is 

today. 

We have a really incoherent system that supporters of an income 

tax or a consumption tax would reject in the context of business 

taxation. And that is another area that is very important. 

Chairman CONRAD. If we had following goals: we need to raise 

the revenue that we need to meet the needs of a reformed entitlement system, and by reformed I mean obviously we have to save 

serious money there. At the same time, we wanted to simplify the 

tax system. We have had a lot of estimates given to the committee 

of how much is being spent for people to comply with the current 

income tax system. If we wanted to simplify, if we wanted to make 

it as economically efficient as possible, that is we wanted to put 

America in the strongest position we could be in competitively in 

terms of our tax system, what would you advocate as a tax system? 

The current one, reformed by reducing the base? A VAT? Some 

other reproach? I would be interested in each of your—Dr. Butler, 

thoughts that you might have on this. 

Mr. BUTLER. As I said, assuming you wanted to raise revenue, 

than taking that as an assumption I think a much simpler form of 

the income tax with a broad base, reducing incidences of double 

taxation as far as possible, factoring in all forms of compensation, 

and then giving appropriate exemptions or partial exemptions to 

people who really need it in order to obtain adequate income would 

be the right way to go. I think that is simpler. I am very concerned 

about these notions of value added taxes and other taxes which I 

think are complex. They only try to approximate what you can get 

from a much flatter broader income tax. But these other approaches have, I think, endless problems associated with them. 

Chairman CONRAD. All right, Dr. Furman. 

Mr. FURMAN. Sure, and before I sketch that, we have been talking about making the tax system more efficient. I think that is very 

important. But I would also say if you had to, for example, raise 

the top rate back to 39.6 percent, that is completely compatible 

427

with a thriving economy. Steps like that, if you are not able to undertake a more comprehensive tax reform, would raise more revenue and be good for the economy in the long run because they 

would bring the deficit down. 

In terms of a tax reform, I guess a lot of us are in agreement 

here that you take our existing income tax system and broaden the 

tax base. I agree with Dr. Butler that you do not want to double 

tax business income, but we have an awful lot of business income 

that is not being taxed at all right now. 

Chairman CONRAD. Why is that? 

Mr. FURMAN. For a number of reasons, but basically companies 

get to deduct their interest and then pay out a lot of their profits 

in the form of dividends which are taxed at very low rates or not 

taxed for people who have tax preferred accounts. That is one type 

of reason. 

Another would be a whole bunch of loopholes built into the corporate tax system. 

The fundamental reason is that we have something that is half 

a consumption tax, half an income tax, and they are a very incoherent hybrid that I do not think any economist would want to defend 

or explain even. 

Broadening the base in the personal income tax, reforming the 

taxation of business income and the international tax component 

plays an increasingly important role in that. Then, to the degree 

that you are adding new taxes, add ones that we think are simple 

and economically efficient. So with carbon taxes, possibly think 

about a value added tax if you can use it to simplify the income 

tax. 

Chairman CONRAD. Dr. Minarik? 

Mr. MINARIK. I have stored up a couple of observations that I 

think are pertinent to this. 

Going back to Senator Gregg’s original question, and you are 

asking about revenue sufficiency, what percentage of GDP can we 

collect without adverse economic consequences? I guess one answer 

to that question is some meaningful margin less than the next guy. 

And if you think in those terms, the U.S. public sector is significantly smaller than anywhere else around the world. So we have 

some room to maneuver. 

Chairman CONRAD. Other than Japan, I might say. 

Mr. MINARIK. Japan is the closest. They, of course, have no national defense sector to speak of, so that is one reason why there 

is a difference there. But beyond Japan, you—

Chairman CONRAD. That is about it. 

Mr. MINARIK. That is about it. And of course, if you want to 

trade the U.S. economy for the Japanese economy right now—I will 

take the other side of that deal. 

That was one question that was pertinent. Again, in thinking 

about how much revenue we need, Senator Gregg’s observation was 

well, Government expands to fill the taxes you have. It is 2007. 

Senator Gregg’s assertion would imply that we would have balanced budgets most of the time. In the last 50 years, we have had 

four balanced budgets. So nine times out of 10 we have been spending beyond the revenues we have. 

428

So the notion that having revenue sufficient to pay for the Government that you have right now is going to encourage higher 

spending, I think suggests that really the Congress and the administration just have to do their jobs to keep things within the limits. 

Stuart suggested the notion of what he called a reformed income 

tax, which I think is what many people would call a consumed income tax. There was an example of an attempt at that a number 

of years ago, the so-called Nunn-Domenici proposal, which was formulated under the aegis of the Center for Strategic and International Studies here in town. Senator Nunn and Senator Domenici worked together on it. 

One of their chief technical advisors was Rudy Penner of the 

Urban Institute. If you ask him about that experience, he will tell 

you that he went into it as an enthusiastic supporter of the notion 

of a consumed income tax. He finished it with the notion that there 

was no way that was ever going to happen. 

There are a lot of technical issues involved there, including but 

not limited to the question of how you try to accommodate everyone 

who under the current system has some kind of a tax break and 

is going to want it to be translated into the new system. 

You can look at just about any possible tax, come up with a pristine version of it that will look attractive, and then try to make it 

real and run into a lot of problems. 

Just to be a little bit more complete about what CED discussed 

in its document which was released early last year, we did advocate broadening the base of the income tax while reducing the rates 

that would be imposed. A 10-percent value added tax, Jason is exactly right, your administrative ante to have a value added tax is 

the same whether the rate is 1 percent or 10 percent, you might 

as well get some money out of it. 

Stuart is correct, that it is not easy to provide low income relief 

to compensate for the value added tax that you are collecting. That 

is simply a problem that we have to accept. For 30-some years now 

we have had an Earned Income Tax Credit. One side observation, 

we created it in part as a substitute for increasing the minimum 

wage. That notion was we wanted to make work pay for people 

with low incomes. We did not want to impose that on their employers. We thought that would be economically disruptive. So we created an Earned Income Credit. Nothing is free. You have to pay for 

that to make it work. But that, I think, is acknowledged. It has to 

be a problem but it is a necessary ingredient if you want to have 

that kind of benefit. 

Personally, I think that we are getting to the borderline where 

it will be very hard to raise under the income tax the revenues that 

we will need with demographic change, even assuming that we can 

freeze in its tracks the rate of health care cost per beneficiary 

under Medicare. Health care costs through the economy are growing 2.5 percentage points per year faster than GDP. So that is 

going to be a problem. 

We are going to need more revenue. We will have to decide 

whether we can get that revenue out of our existing institutions. 

If we are going to do that, we have to increase their efficiency substantially. If not, we are going to have to look somewhere else. A 

429

value added tax is one possibility. A carbon tax is another possibility. 

One other footnote and I will close, either a value added tax or 

a carbon tax might look regressive and would be regressive taken 

on its own. If revenues from either of those taxes were devoted to 

financing a reformed health care system which would provide universal coverage, the combination of a health care benefit and one 

of those regressive taxes for low income people would probably, in 

the final analysis, look much more progressive because you would 

be removing that burden of paying a health insurance premium. 

Health insurance premiums are virtually the same per person or 

per family up and down the income scale. A person with a very 

high income would pay much more in value added tax than the 

value of the health insurance premium he is getting. A person with 

a low income, it would be the reverse. So put those two together 

and you might be able to get a progress result out of what would 

look like a regressive tax. 

Chairman CONRAD. Let me just say, one of the things that we 

have had testimony before the committee on tax scams that are occurring, especially offshore. In the tax gap hearing one of the recommendations, a very strong recommendation, that came from that 

panel is that you need to have international reporting because all 

countries are suffering from—I held up a picture of a building in 

the Cayman Islands, a five-story building, that is the home to over 

12,000 companies. It is a very efficient building. 

They all say they are doing business there. They are not doing 

business there. They are engaged in tax scams there. What they 

are doing is showing profits in subsidiaries located there because 

they do not face taxes and they are shorting all of the other countries and, in effect, shorting other companies. Because other companies that are domiciled here do not engage in that kind of scam. 

How about reform in an area like that? I assume that nobody 

would object to closing off that kind of taking advantage of the system. Mr. Bixby, does your group have a position on that? 

Mr. BIXBY. It is not an area that we have looked at very closely 

but nobody could have any objection to closing down tax scams, and 

I think they certainly—the IRS has been relatively aggressive in 

that area recently but clearly there is more work to be done. I certainly think that that is an area that you could get into and there 

would probably be a great deal of public support for it as well. 

But I think getting into a real tax reform initiative would be a 

good thing to do in the context of looking at these challenges. And 

you have the vehicle. Aside from what you mentioned, we have the 

AMT issue out there which is really the big driver for a tax reform 

debate because it is so big and there is a broad bipartisan consensus that it needs to be addressed, that I think it really could 

be the engine that drives a major tax reform initiative like we had 

in the 1980’s. 

And you can get into these issues about the tax gap. You can get 

into the issues about the tax scams. You can also get into the 

issues about closing these major tax expenditures that people do 

not even necessarily realize our—I like to call them tax entitlements because that is really what they are. But they ought to be 

on the table. 

430

And the President has put one the major ones on the table. So 

you sort of take that in combination with the upcoming AMT debate and it does provide an opportunity. 

I would agree with Jason and others that if you are looking for 

a new forum and do not want to raise rates right now, the carbon 

tax idea, or raising the gas tax, I know that is not popular. But 

environmentally friendly taxation is another way that you might be 

able to get into a revenue debate that has ancillary good effects for 

the long-term of the environment. 

To top it off, no pun intended, I would endorse Jason’s idea also 

of imposing a top rate. A lot of the revenue boost that we are getting right now seems to be coming from upper income, more income 

being into the upper range. 

I think reimposing a higher, slightly higher, or going back to the 

1990’s top rate, would bring in some needed revenues. I cannot 

imagine it would do too much to damage the economy. But that is 

not tax reform. That is just a good old fashioned tax increase. 

But I think the more opportunity areas are to really get into the 

tax expenditure debate, the tax gap issue, and the possibly of environmentally friendly taxes. 

Chairman CONRAD. All right. Anybody with a closing thought? 

Anybody that wants to have something that they wanted to contribute that we have not had a chance to get on the table? Dr. 

Minarik? 

Mr. MINARIK. Just one thought, Mr. Chairman. To a certain extent when we think about taxes in this connection, realistically 

speaking, and I went into this in my written statement but did not 

get there, you can tax me now or you can tax me later. But one 

time or another you are going to do it. 

If you do not do what you have to do to keep budget deficits 

under control and ideally run surpluses for a while before the retirement of the baby boom starts, if you pay the taxes later, you 

are going to pay them with interest. So you might as well stay current if you can do that. 

Another observation, thinking about interest, you hear a lot of 

people say that they are suspicious of Government because they 

feel like they pay taxes and they do not get anything in return. 

Well, if you are paying taxes to pay interest on the debt, that is 

literally true. You are not getting anything in return. 

And the longer you allow deficits to run, the larger your deficits 

get, the more taxes our succeeding generations are going to have 

to pay just to keep the Acme Collection Agency from backing up 

the truck to the White House to collect the furniture. That is an 

important, I think, piece of reality that we have to keep in mind. 

Chairman CONRAD. Dr. Butler. 

Mr. BUTLER. I would just like to add that we have not actually 

spent any time talking about the budget process itself, in terms of 

how to force action on these issues. I suppose this is almost a question to you, actually. 

I want to stress of the importance that I feel, and I think all of 

us probably feel, of disclosure of the full scale of the unfunded obligations of the Federal Government. It is something, of course, that 

Comptroller Walker is very concerned about, as we are, and supports taking active steps to do that. 

431

And also the notion of saying that the entitlement spending 

should not just be on automatic pilot but should be budgeted in a 

serious way to force serious discussions about the relative balance 

of expenditures in that area, expenditures in other parts of the 

Federal Government, and revenues. That it should be done in an 

explicit way rather, as I pointed out in my testimony—

Chairman CONRAD. Indirect. 

Mr. BUTLER. Automatic preemption of some big chunks of spending is the problem we are talking about, which we do have to look 

at and consider. Yet every day we are trying to find ways of paying 

for our troops in Iraq. 

Mr. BIXBY. I just would want to emphasize something that I 

mentioned at the beginning and Dr. Butler mentioned it as well, 

which is I think this is an issue that really needs more public attention, and of course you are doing everything you can on the committee to draw attention to it with this series of hearings. But a 

major public education, public engagement effort is needed on this. 

We are doing this Fiscal Wake-Up Tour, all of us. Jason has not 

been out on the tour yet, but he has volunteered for it and the rest 

of us have been out on this. 

I would invite members of the committee to join us in their home 

States and maybe do some home and home series, as what I have 

thought about. Maybe a Republican, say for example Senator 

Gregg, and yourself, cosponsoring one in North Dakota and one in 

New Hampshire and drawing some public attention to this issue. 

What we find on the Fiscal Wake-Up Tour is that people love to 

hear a discussion like we have had today, people exchanging ideas, 

not name calling, not pointing fingers at one another or casting 

blame, but talking about a problem, agreeing on the size of the 

problem, agreeing that there are no easy options and sort of debating what the tradeoffs are. Facing the magnitude of the problem 

and the nature of the tradeoffs and getting everybody to understand that is really, really important. That is what we try to do in 

the Fiscal Wake-Up Tour and it has been getting some attention. 

Anything that we can do—because we think we are helping you. 

This is helping you and Senator Gregg and all of the members of 

the committee explain the problem to the public and perhaps to 

some of your colleagues. 

Chairman CONRAD. Let me just say, obviously if the public does 

not understand, there is going to be no sense of urgency and no 

pressure on our colleagues or the White House to act. I think everybody in this room knows, certainly everybody on this panel 

knows, this is a situation that is unsustainable. It just is. And the 

faster we deal with it the better, the less draconian, the solutions 

will have to be. 

It is extremely difficult to get a sense of urgency when the roof 

is not caving in. You have relatively good economic news, deficits 

are going down somewhat. Of course, nobody mentions the debt is 

going up. It is very hard, and I guess it is deep in human nature, 

to put off making unpleasant choices when there is no crisis. 

The problem is by waiting, by failing to act, we make the crisis 

to come worse. That has been the overwhelming testimony before 

this committee. It is as clear as a bell. I do not care what projection 

you use. Anybody who thinks this is a matter of projections, funVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00437 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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damentally it is not. Because the baby boom generation is not a 

protection. They have been born. They are alive today. They are 

going to retire. They are going to start retiring soon. 

And it fundamentally changes what we have had as an experience in the past. I think that is one reason it is very hard for our 

colleagues to get their minds around this. It is different than past 

experience. 

And so I think an awful lot of people are kind of hoping against 

hope this goes away. It is not going to go away. You can say when 

is it going to really start crimping? You can debate that. But the 

fact is we are on an unsustainable course. 

You have helped us, I hope, make that more plain today. And for 

that we are very grateful. I thank this panel and we will stand in 

adjournment. 

[Whereupon, at 11:52 a.m., the committee was adjourned.]

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34649.205
S. HRG. 110–162, Vol. II

CONCURRENT RESOLUTION ON THE 

BUDGET FOR FISCAL YEAR 2008

HEARINGS

BEFORE THE

COMMITTEE ON THE BUDGET 

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

February 1, 2007—THE CURRENT ACCOUNT DEFICIT AND THE U.S. 

FOREIGN DEBT

February 6, 2007—WAR COSTS

February 7, 2007—THE PRESIDENT’S FISCAL YEAR 2008 BUDGET 

PROPOSAL

February 8, 2007—THE PRESIDENT’S FISCAL YEAR 2008 BUDGET AND 

REVENUE PROPOSALS

February 13, 2007—THE PRESIDENT’S FISCAL YEAR 2008 BUDGETARY 

PROPOSALS FOR THE DEPARTMENT OF HEALTH AND HUMAN 

SERVICES

February 14, 2007—THE PRESIDENT’S FISCAL YEAR 2008 BUDGET 

PROPOSALS ON TAX COMPLIANCE

March 1, 2007—THE PRESIDENT’S DEFENSE BUDGET REQUEST FOR 

FISCAL YEAR 2008 AND WAR COSTS

(

Volume II of II 

CONCURRENT RESOLUTION ON THE BUDGET FOR FISCAL YEAR 2008

Volume II

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34–649pdf 2007

S. HRG. 110–162, Vol. II

CONCURRENT RESOLUTION ON THE 

BUDGET FOR FISCAL YEAR 2008

HEARINGS

BEFORE THE

COMMITTEE ON THE BUDGET 

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

February 1, 2007—THE CURRENT ACCOUNT DEFICIT AND THE U.S. 

FOREIGN DEBT

February 6, 2007—WAR COSTS

February 7, 2007—THE PRESIDENT’S FISCAL YEAR 2008 BUDGET 

PROPOSAL

February 8, 2007—THE PRESIDENT’S FISCAL YEAR 2008 BUDGET AND 

REVENUE PROPOSALS

February 13, 2007—THE PRESIDENT’S FISCAL YEAR 2008 BUDGETARY 

PROPOSALS FOR THE DEPARTMENT OF HEALTH AND HUMAN 

SERVICES

February 14, 2007—THE PRESIDENT’S FISCAL YEAR 2008 BUDGET 

PROPOSALS ON TAX COMPLIANCE

March 1, 2007—THE PRESIDENT’S DEFENSE BUDGET REQUEST FOR 

FISCAL YEAR 2008 AND WAR COSTS

(

COMMITTEE ON THE BUDGET 

KENT CONRAD, North Dakota, Chairman

PATTY MURRAY, Washington 

RON WYDEN, Oregon 

RUSSELL D. FEINGOLD, Wisconsin 

ROBERT C. BYRD, West Virginia 

BILL NELSON, Florida 

DEBBIE STABENOW, Michigan 

ROBERT MENENDEZ, New Jersey 

FRANK R. LAUTENBERG, New Jersey 

BENJAMIN L. CARDIN, Maryland 

BERNARD SANDERS, Vermont 

SHELDON WHITEHOUSE, Rhode Island 

JUDD GREGG, New Hampshire 

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, Neveda 

JOHN CORNYN, Texas 

LINDSEY O. GRAHAM, South Carolina 

MARY ANN NAYLOR, Majority Staff Director

SCOTT B. GUDES, Staff Director

(II) 

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C O N T E N T S 

HEARINGS 

Page 

February 1, 2007—The Current Account Deficit and the U.S. Foreign Debt ..... 1

February 6, 2007—War Costs ................................................................................. 79

February 7, 2007—The President’s Fiscal Year 2008 Budget Proposal .............. 145

February 8, 2007—The President’s Fiscal Year 2008 Budget and Revenue 

Proposals ............................................................................................................... 243

February 13, 2007—The President’s Fiscal Year 2008 Budgetary Proposals 

for the Department of Health and Human Service ........................................... 297

February 14, 2007—The President’s Fiscal Year 2008 Budget Proposals on 

Tax Compliance .................................................................................................... 363

March 1, 2007—The President’s Defense Budget Request for Fiscal Year 

2008 and War Costs ............................................................................................. 441

STATEMENTS BY COMMITTEE MEMBERS 

Chairman Conrad.............................................................. 1, 79, 145, 243, 297, 363, 441

Ranking Member Gregg.................................................. 63, 89, 191, 254, 307, 374, 451

Senator Allard .......................................................................................................... 160

Senator Bunning .................................................................................................. 229, 348

Senator Enzi ............................................................................................................. 205

Senator Feingold .................................................................................................. 226, 346

Senator Grassley ...................................................................................................... 405

WITNESSES 

Adams, Gordon, Dr.; Fellow, Woodrow Wilson International Center for Scholars ...................................................................................................................... 102, 107

Bergsten, Fred C., Dr.; Director, Peterson Institute for International Economics........................................................................................................................... 15, 22

Cline, William, Dr.; Senior Fellow, Peterson Institure for International Economics.................................................................................................................... 32, 36

England, Gordon, Hon.; Deputy Secretary, Department of Defense................ 453, 455

Everson, Mark W., Hon.; Commissioner, Internal Revenue Service, Department of the Treasury........................................................................................ 376, 378

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

Department of Defense ........................................................................................ 453

Gilmore, Michael J.; Assistant Director for National Security, Congressional 

Budget Office .................................................................................................... 117, 120

Jonas, tina, Ms.; Under Secretary of Defense (Comptroller) Department of 

Defense .................................................................................................................. 453

Kosiak, Steven M.; Vice President for Budget Studies, Center for Strategic 

and Budgetary Assessments................................................................................ 90, 93

Leavitt, Mike, Hon.; Secretary, Department of Health and Human Services ..................................................................................................................... 309, 312

Malpass, David R.; Chief Global Economist, Bear Stearns .................................. 44, 48

Paulson, Henry M., Jr., Hon.; Secretary, Department of Treasury ................. 261, 264

Portman, Robert J., Hon.; Director, Office of Management and Budget ........................................................................................................................ 162, 171

Page

iv

QUESTIONS AND ANSWERS

Questions and Answers............................................................... 230, 292, 349, 432, 489

ADDITIONAL MATERIALS AND CHARTS SUBMITTED 

Testimony, charts, and graphics submitted .......................................................... 427

(1)

THE CURRENT ACCOUNT DEFICIT AND THE 

U.S. FOREIGN DEBT 

THURSDAY, FEBRUARY 1, 2007

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

The committee met, pursuant to notice, at 10:06 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of the committee, presiding. 

Present: Senators Conrad, Cardin, Sanders, Whitehouse, and 

Gregg. 

Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 

Staff Director for the Minority. 

OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

Chairman CONRAD. I will bring the hearing to order. 

Senator Gregg has indicated he has been called into another 

meeting momentarily, but he will be here shortly and other members are on their way, as well. 

I had one of our colleagues who is on the committee come to me 

yesterday and said you know, we are just having kind of a crash 

landing here with the early days of the session. He said he had 

three hearings simultaneously this morning and wanted to know if 

we could defer ours. I said no, I do not think that will work. 

That is happening to us, but other members will come as they 

are available from other hearings. 

Given the backlog of work from the last Congress, usually we 

start out with a little more calm, but not this year. So it is what 

it is. 

I want to particularly welcome our witnesses here today. Dr. 

Fred Bergsten is somebody who has testified before this committee 

before, and we are delighted to have him back, the Director of the 

Peterson Institute for International Economics; Dr. William Cline, 

Senior Fellow at the Peterson Institute; and David Malpass, Chief 

Global Economist at Bear Stearns. Welcome to you all. We deeply 

appreciate you taking your time, extremely valuable time, to come 

before this committee and help us try to make the case of the importance of dealing with these long-term fiscal imbalances. 

As you know, Senator Gregg and I have been urging our colleagues to develop a process by which we would produce a plan, a 

bipartisan plan, to address these long-term fiscal imbalances. We 

believe it is very important. 

Today’s hearings focus on the danger of the twin deficits, that is 

the Federal budget deficit and the trade deficit. Both of these defiVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00449 Fmt 6633 Sfmt 6633 C:\DOCS\34649.TXT SBUD1 PsN: TISH
2

cits pose a serious threat to our Nation’s long-term economic security. 

Although the U.S. trade deficit has fallen recently, we can still 

see that the trade deficit in 2006 will exceed $700 billion.


34649.438
3

At the same time, our annual budget deficits are contributing to 

the wall of debt that we now face. At the end of 2001, our gross 

Federal debt stood at $5.8 trillion. At the end of this year CBO 

tells us, the Congressional Budget Office, tells us it will be $9 trillion. And if we continue current policies, gross debt will reach over 

$12 trillion by 2012.


34649.439
4

I might say this is at the worst possible time, right before the 

baby boom generation retires. 

We are having a very difficult time. Let me be very frank, we are 

having a very difficult time persuading our colleagues and the Administration of the need for urgent action. In a way, I think people 

are being lulled to sleep by the somewhat modest reduction in the 

deficit. While the deficit has shown some relatively slight improvement, the debt continues to mount in a way that is really unfavorable over the long-term, especially in light of the demographics of 

the country. That is what I think we are having a hard time getting people to fully grasp. 

This demographic tsunami that is coming at us is unlike what 

we have faced in the past, and so I think it is hard for people to 

get their minds around that. 

Over the long term, we can see the Nation’s gross debt will continue to explode if all the tax cuts that the President has supported 

are extended without offset. In fact, according to the Center on 

Budget and Policy Priorities, it will more than double our debt 

level as a share of GDP by 2050 if all of the tax cuts are extended 

without offsets. 

This chart shows how the debt grows, in the case of the tax cuts 

expiring or being offset. That is the green part of this slide. That 

is what happens to the debt if the tax cuts expire or are offset. 

That is the green part of this.


34649.440
5

The red is what happens to additional debt if the tax cuts are 

extended without offset. As much as I would love to support every 

tax cut and every spending program, you know, as a politician 

there is nothing better than being for every tax cut and every 

spending program. The problem is we cannot continue to do this. 

We cannot continue to do this. 

Let me go to the next slide, if we can. The result of all of this 

is we are becoming increasingly dependent on the kindness of 

strangers. We are building up foreign holdings of our debt at a dramatic rate. It took 42 presidents, all of the presidents pictured 

here, 224 years to run up $1 trillion of debt held externally. This 

president, on his own, has more than doubled that amount in 6 

years. This is an absolutely unsustainable course.

6

And here are the top foreign holders of our national debt. We 

owe Japan now more than $600 billion. We owe China more than 

$300 billion, the United Kingdom more than $200 billion, the oil 

exporters almost $100 billion. And my favorite, the Caribbean 

banking centers. We owe the Caribbean banking centers over $60 

billion.


34649.441
7

We are now by far and away the world’s largest borrower. In 

2005, the United States was responsible for 65 percent of all world 

borrowing by countries, 10 times as much as the next largest borrower. We may be starting to see the ramifications of all of this 

debt.


34649.442
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Last September the Wall Street Journal reported that the World 

Economic Forum downgraded the United States from the most 

competitive economy in the world to the sixth most competitive. 

They stated, ‘‘serial budget deficits in the United States have led 

to rising public debt, which means an increasing portion of Government spending goes toward debt service. That means less money is 

available for spending on infrastructure, schools or other investVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00456 Fmt 6633 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH

34649.443
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ments that could boost productivity. Heavy Government borrowing, 

which means competing for money and financial markets with the 

private sector, also tends to drive up businesses’ borrowing costs.’’


34649.444
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In testimony before this committee last month the Chairman of 

the Federal Reserve, Chairman Bernanke, emphasized the dangers 

of this growing debt. He said ultimately this expansion of debt 

would spark a fiscal crisis which could be addressed only by very 

sharp spending cuts or tax increases or both. The effects on the 

U.S. economy, he said, would be severe. High rates of Government 

borrowing would drain funds away from private capital formation 

and thus slow the growth of real incomes and living standards over 

time.

11

Our increasing reliance on foreign debt poses an added threat to 

the economy. Here is what the head of the Government Accountability Office told this committee last month. ‘‘When, not if—

when—foreign investors decide as a matter of mere prudence and 

diversification they are not going to expose themselves as much to 

U.S. debt, then interest rates will rise, and that will start a 


34649.445
12

compounding effect. And so what is important is that we act so 

that they do not take that step.’’

We have already seen the potential impact on our economy from 

the investment decisions made by foreign holders of our debt. Here 


34649.446
13

is a Financial Times article from last November on the value of the 

dollar falling after a comment from a Chinese bank official on the 

need for China to diversify its foreign exchange reserves. The paper 

stated, and I quote, ‘‘The dollar was sent tumbling on Thursday 

after the Governor of the People’s Bank of China said the country 

was considering lots of instruments to diversify its foreign exchange reserves.’’ Just that comment sent the dollar down.


34649.447
14

I hope very much that colleagues are paying attention. In fact, 

the dollar’s value is already down considerably, more than 30 percent against the euro, since 2002, at least in part from market 

fears about our increasing Federal indebtedness. We simply have 

to get hold of this trajectory on deficit and debt. There really is no 

alternative.


34649.448
15

We have now been warned in this committee by the head of the 

Government Accountability Office. We have been warned by the 

head of the Federal Reserve. We have been warned by the head of 

the Congressional Budget Office. We have been warned just yesterday by the former head of the Congressional Budget Office and by 

three other distinguished panelists, including the Concord Coalition 

which is known for their interest in fiscal responsibility. Warned 

by the Heritage Foundation, one of their top economists, that we 

are on a course that is unsustainable. Warned by the head of the 

Hamilton Project, which is overseen, of course, by former Secretary 

of the Treasury Bob Rubin. 

We have been warned and warned and warned. The question is, 

is there a will to act? 

I would submit the first thing we have to do is submit a budget 

that is balanced by 2012, and at the same time engage in a much 

larger effort, a bipartisan effort, to produce a proposal to address 

these long-term fiscal imbalances. That is where the real danger 

lies. 

With that I want to call on the witnesses, and I again welcome 

you to the committee. I would ask you to proceed with your testimony. Dr. Bergsten, why don’t we begin with you. 

STATEMENT OF C. FRED BERGSTEN, DIRECTOR, PETERSON 

INSTITUTE FOR INTERNATIONAL ECONOMIC 

Mr. BERGSTEN. Mr. Chairman, you are about to get another 

strong warning. 

I am delighted to appear before the committee again. I agree 

with virtually everything you have said in your opening remarks. 

I deeply applaud and admire your efforts to forge an action plan 

to deal with the budget problem. I want to suggest in my testimony 

today that the international dimension of the issue may, in fact, 

most likely trigger a crisis that would force action in the absence 

of the kind of constructive and preemptive steps you want to take. 

I start with my punch line, which is that the huge and growing 

international trade and current account imbalances, which of 

course center on the U.S. external deficits and debtor position that 

you have described, represent the single greatest threat to the continued prosperity and stability of both the U.S. and world economies. They could, at virtually any time, trigger a large and disorderly decline in the exchange rate of the dollar, which would initiate sharp increases in U.S. inflation and interest rates, bringing 

on at a minimum stagflation like we saw in the 1970’s but quite 

possibly a deep recession. 

Even in the absence of such a crisis—and that is a critical 

point—continued failure to address the imbalances constructively 

and preemptively, which you are trying to do, will inevitably lead 

to a costly and perhaps wrenching adjustment of the U.S. and 

world economies anyway. They could also lead to a disruption of 

U.S. trade policy, which is very hard to conduct in a sensible way 

with these huge international debts and deficits. That would 

threaten the openness of the global trading system. This is not our 

main topic today but is an element of this. 

The only effective U.S. policy response to the problem, and I will 

describe that in a minute, is a conversion of present U.S., and as 

16

you said, particularly prospective U.S. budget deficits into modest 

surpluses, as the United States had in 1998 to 2001. You just suggested a goal of eliminating the deficit. I suggest that the U.S. 

should aim for modest surpluses. 

The United States should in fact be running modest surpluses 

right now, because with the economy so strong in the last few years 

this would have been the ideal time to run a surplus. The strength 

of the economy has improved the budget and, as you mentioned, 

lulled some people to sleep about the need to deal with the underlying structural elements in it. 

But actually at a time like this, the United States should take 

no comfort even from a modest deficit. It should be running surpluses of 1 or 2 percent of GDP in light of the strength of the economy. That is what then positions us for the inevitable slowdown, 

as well as the structural deterioration in the fundamentals that 

you have talked about. So anybody who is complacent today is really barking up the wrong tree. 

The end of my punch line is that the possibility of a sharp dollar 

fall is, in fact, the greatest short-term risk that emanates from the 

budget deficits and provides the most compelling reason for urgent 

action on them. 

Let me quickly tick off a few facts. The U.S. merchandise trade and current account deficits exceeded $850 billion last year and exceeded $900 billion in a couple of quarters at an annual rate, including the last one for which we have full data. It is now almost 

7 percent of the economy, which is more than double the modern 

record the United States had back in the 1980’s, after which the 

dollar dropped by 50 percent over 3 years against the other major 

currencies. 

The U.S. external deficit has risen by an annual average of $100 

billion for the past 4 years and almost that much for the last 10 

years. In short, it is on a trajectory very much like the one you 

showed on the budget deficit. In fact, the two are quite parallel. 

That trajectory as well as the levels of the imbalances are, in my 

view, totally unsustainable. 

At these present levels, United States current account deficits 

and external debt pose what I would regard as unacceptable risk 

to the United States economy and United States foreign policy. A 

country that spends more than it earns has to finance its deficit, 

just like an individual who spends more than he or she earns. So 

the United States has to attract foreign capital inflows of about $4 

billion every working day to finance the current account deficit. In 

addition, U.S. companies and individuals make a lot of foreign investments and the United States has to offset those by capital 

inflows. The bottom line is that the United States has to attract 

about $8 billion of foreign capital every working day to keep its domestic economy afloat. 

The stunning fact is that a trigger for a crisis would not necessarily be a drawdown of existing foreign dollar holdings, though 

that would make it much worse. All that is needed to trigger a big 

problem is a reduction in the inflow from the current $8 billion to 

say $4 billion or $5 billion. That would still be a lot of foreign investment in the United States It is not as if the world has to give 

up on the United States totally. But if the amount of annual inflow 

17

drops from the current roughly $2 trillion to half that or less, still 

a huge amount of foreign investment, that would trigger a substantial deterioration of the situation, the dollar would go down, et 

cetera, as I will describe. So the situation is really very precarious. 

As a result of all of these deficits, U.S. net foreign debt reached 

$2.7 trillion at the end of 2005. An even more important number 

than U.S. net foreign debt, which you showed in one of your charts, 

may be U.S. gross foreign debt. Foreign entities, mainly private but 

some official, now hold about $14 trillion of dollar denominated assets in the United States. Almost all of it could actually be 

disinvested at any point in time. That could lead to a very sharp 

and indeed precipitous fall in the dollar, which would represent a 

free fall and a crisis. 

So even though we focus on the net debt of about $3 trillion, 

which is big enough, the fact is the United States could not mobilize our private foreign financial assets to deal with a crisis. And 

so we really have to look at the gross foreign debt, which is now 

$14 trillion or more. 

The major risk that the imbalances pose would be an elimination 

or reversal, or even sharp decline, of the very large net capital 

inflows. A cutback in the foreign capital inflow would immediately 

lead to a decline, perhaps very large and rapid, of the dollar exchange rate. That would push up the price of imported goods and 

services and the domestic products that compete with them, particularly now when the economy is close to full employment and 

there is, not much slack to take account of that. 

Interest rates would rise by as much as inflation and probably 

by much more as the Fed had to raise rates to try to limit the decline of the dollar and its inflationary effect. The equity and housing markets would inevitably fall as a result. The economy would 

slow and perhaps drop into recession. 

The operational question is always how much and when? One 

cannot give precise quantitative answers to that. But I suggest several reasonably reliable relationships that one can keep in mind. 

Every decline of 10 percent in the average exchange rate of the 

dollar tends to increase United States inflation by about 1 percent, 

especially when the economy is at full employment like now and 

there is no slack to absorb that effect. 

According to our calculations, and Bill Cline will elaborate on 

this, the dollar is still overvalued by at least 20 percent, maybe 

more. And that is calculated with a goal of simply cutting the U.S. 

current account deficit in half from where it is now. To eliminate 

the current account deficit and the buildup of foreign debt, it would 

have to do twice as much. We calculate that if the United States 

cut the current account deficit to say 3 percent of GDP—

Chairman CONRAD. Can I stop you on this point, because I really 

want this point not to be lost. Would you just repeat what you said 

with respect to what the dollar would have to decline in value in 

order to potentially address what we face here? 

Mr. BERGSTEN. Yes. The first part of that should be the goal of 

the adjustment process. You have set a goal of eliminating the 

budget deficit. I say it ought to be a small surplus. On the external 

side—

18

Chairman CONRAD. Actually, we produce—under the budget I 

will propose, we do produce a small surplus. 

Mr. BERGSTEN. That would be better yet. 

Our analysis, which we have looked at very carefully, half a 

dozen of different senior fellows at our institute, what current account position would tend to be sustainable over time? 

We do not believe the United States has to totally eliminate the 

current account deficit. We believe cutting it to about 3 percent of 

GDP, which is more than half from where it is now, would be sufficient. The reason for that, and Bill has analyzed this in great depth 

in his latest book called the United States as a Debtor Nation, is 

that if United States could level off the current account deficit at 

3 percent, then the ratio of U.S. foreign debt to U.S. GDP would 

stabilize. 

Chairman CONRAD. Stop growing. 

Mr. BERGSTEN. It would stabilize at a riskily high level, around 

50 percent of GDP. 

Chairman CONRAD. Isn’t that a key here—

Mr. BERGSTEN. Absolutely. 

Chairman CONRAD [continuing]. Is that we stop—

Mr. BERGSTEN. Stop the buildup of the debt/GDP ratio. 

Chairman CONRAD. This is one of the goals that I am emphasizing to my colleagues, is we have to turn these trend lines. Right 

now the debt is just up, up and away, both in real and nominal 

terms, as a share of GDP. And what we have to do is stop that 

growth. You would agree with that as a—

Mr. BERGSTEN. Yes, and bringing the external dimension into 

play. We have looked at the history of similar positions for the 

United States and other countries and tried to make some judgments based on the historical record of what is a relatively safe position. What does look like being sustainable if you could achieve 

it? 

Chairman CONRAD. And what would that target be? Could you 

give that to us in GDP terms? 

Mr. BERGSTEN. Yes. The ratio of United States net foreign debt 

to GDP that we think would be barely sustainable over time is 

about 50 percent. 

Chairman CONRAD. Foreign debt to GDP. 

Mr. BERGSTEN. The number is now about 20 to 25 percent. Given 

the current trajectory, there is no way you could level it off before 

you got to 50 percent. But if we took effective action now to start 

bringing the current account deficit down over the next 5 years, as 

you phase in your budget correction, the dollar could come down in 

a gradual and orderly way. Over a 5-year period, we believe the external deficit would come down from the current 7 percent of GDP 

to about 3 percent. 

Chairman CONRAD. Which you think is sustainable. 

Mr. BERGSTEN. If you maintained fiscal rectitude and the exchange rate did not soar and get overvalued again, then you could 

level off at that ratio. We think that would be sustainable. 

Again, that is risky, 50 percent is high by historical standards. 

But given all of the history and our analysis, it is our judgment 

that that probably would be OK. 

19

If you took a more conservative view and said you had to get the 

ratio down further or had to eliminate the current account deficit, 

then of course you would need much bigger adjustment both on the 

domestic side and in terms of the exchange rate. 

Chairman CONRAD. You said earlier, and Senator Gregg is with 

us now, you said something that I think is very important. You indicated you believe the dollar is somewhere in the range of 20 percent overvalued. Is that correct? Did I hear you correctly? 

Mr. BERGSTEN. Yes. Again, overvalued in terms of producing the 

kind of current account level and therefore—

Chairman CONRAD. A sustainable current account level. 

Mr. BERGSTEN. That is right. 

Chairman CONRAD. Let me just say, other top economists and 

policymakers have given me that same number. 

Then you went further and you said—you referenced a 40 percent change in the dollar. I took it to mean that that would be 

what would be necessary to—I do not know if that would eliminate 

the trade imbalance. 

Mr. BERGSTEN. That number would tend to eliminate the full 

current account deficit if you took the view that any further buildup of our foreign debt was too risky and you therefore wanted to 

totally eliminate the current account deficit. You would have to 

roughly double all of the numbers that I have been using because, 

instead of cutting the deficit, in half you would be going all the way 

to zero. 

Chairman CONRAD. Let me just say, that is precisely what other 

top economists and policymakers have told me, those two numbers, 

20 percent and 40 percent. If that does not get our colleagues’ attention I do not know—you begin to wonder what will. 

Mr. BERGSTEN. You would hope. A crucial variable, and I talk 

about it in my statement but we can handle it any way you want, 

is the following: as part of this adjustment, which I believe is inevitable, that the markets will force it on is at sometime if we do not 

preempt and do it in a constructive and orderly way ourselves. 

As part of the adjustment, the dollar is going to have to come 

down by 20 to 40 percent. The real issue is whether it comes down 

in a gradual and orderly way, as in fact it has been doing over the 

last 5 years. Whether at some point confidence in our fiscal and 

other policies collapses and you get a free fall, which we have had 

historically—it in the late 1970’s and mid-1980’s—it is not a theoretical proposition. We know empirically that it can happen and we 

have actually had big declines of the dollar about once per decade 

over the last 40 years. 

Chairman CONRAD. And so what? So what if we had a decline in 

the dollar? 

Mr. BERGSTEN. Then you get three very clear effects. One is inflationary pressure, particularly if it occurs when the economy is 

close to full employment and full capacity utilization like the 

United States is now. You have no slack in the economy. The decline in the dollar is going to push up prices of imported products 

in the first instance, but through them the domestic products that 

imports compete with. So inflation goes up. I give some numbers 

in my statement. If the dollar declined even 20 percent, you would 

20

expect an increase of 2 percentage points or more in inflation. That 

would roughly double the current inflation level. That is step one. 

Step two is that interest rates go up. Nominal interest rates, of 

course, go up with inflation. So that is a minimum effect. But if the 

Federal Reserve fears that the markets are going to keep pushing 

the dollar down more, and therefore generating even more inflation, then the Federal Reserve has to try to preempt that with 

higher interest rates. And so interest rates could go up from the 

current level of 5 percent, both short and long rates, at least to 7 

or 8 percent. We have run models where interest rates go into double digits, at least for temporary periods, as a result of this kind 

of correction. 

Again, it underlines the importance, Mr. Chairman and Senator 

Gregg, of your budget action. If you take the view, as I do, that 

these adjustments in the international position of the United 

States are inevitable, unless all economic history were repealed, 

they are going to happen. The question is how they happen. 

Do they happen in an orderly and constructive way like preemptive action on the budget? Or do we just sit back and let it hit us? 

In which case the big effect could be a skyrocketing of inflation and 

interest rates. That chokes off private investment, which we need 

for long-term growth, and even cuts into consumer demand. A correction of the Federal budget position, which the United States 

needs for lots of other reasons anyway, even excluding the international side, is by far the more constructive way to do it. 

If you start with my premise that adjustment is inevitable, you 

have a choice between the constructive preemptive approach and 

the ‘‘simply sit back and let it clobber you’’ approach. 

In the constructive approach, you work the budget deficit down 

over a 5-year period, aim for a gradual but steady decline in the 

external deficit and the exchange rate of the dollar, which probably 

can be maneuvered in kind of soft landing terms. 

If, by contrast, you do nothing, and let the budget deficit soar, 

which incidentally itself might trigger a free fall of the dollar because markets lose confidence, then the adjustment takes place 

through a skyrocketing of interest rates, maybe to double digits. So 

instead of tightening the fiscal side, you put it all on the financial 

markets and the Federal Reserve, interest rates soar, housing 

tanks, investment tanks, the stock market is tanked, and you wind 

up with an incredibly worse outcome. 

Some people think the deluge can be avoided forever. You said 

it on the budget. Some people take that line on the international 

side, and they point to the fact, admittedly, that I and others have 

been expressing this concern for some time. So have you, Mr. 

Chairman. And they say the rest of the world is financing us and 

the rest of the world will be happy to keep financing us. 

My point is that it is now up to $8 billion a day. We have $14 

trillion of dollar holdings around the world, which at any point 

could be cut into, and it would be the most reckless stance of national policy to just assume that this can go on forever at such levels without triggering a deluge that would be disastrous for the 

economy. 

And so you have to conclude that, it is not a matter of if, but 

when. I would add, when and how through constructive preemptive 

21

steps or through just letting it hit you and then almost certainly 

it would be higher inflation and higher interest rates. 

I speak about this with some feeling, Mr. Chairman. I was running the international part of the Treasury Department in the late 

1970’s when we had the closest thing to a hard landing. There were 

a lot of other things involved like oil shocks. It was not just the 

dollar. 

But the dollar plummeted. The United States needed a $30 billion rescue package for the dollar and drew on the IMF. The Federal Reserve had to raise interest rates one full percentage point, 

the first time in its history. And the United States had to cut the 

budget deficit substantially. 

External uses have forced U.S. fiscal policy to change three times 

in the last period. In the late 1960’s, President Johnson finally got 

his Vietnam War tax surcharge because of a succession of sterling 

and gold crises, which brought huge pressure to bear on the dollar. 

Secretary of Treasury Joe Fowler at the time said that Wilbur 

Mills and the Ways and Means Committee and Congress were finally convinced to finance the Vietnam War only because of the external crises. 

It happened again when I was in the Treasury in the late 1970’s. 

There had been a big debate within the Carter Administration. We 

in the Treasury had been arguing for fiscal restraint right from the 

start. But when the dollar collapsed in 1979, it was clear it had to 

be done and Congress went along. 

To indicate the horrors that can result—people forget now because it is quite a long time ago—in the late 1970’s, the United 

States had three consecutive years of double-digit inflation, interest 

rates above 20 percent, and the deepest recession in the second half 

of the 20th century. A big part of that was a collapse of the dollar. 

And then, just to show that it is bipartisan, in the mid-1980’s, 

when the dollar had become hugely overvalued, Jim Baker worked 

out the Plaza Agreement to negotiate a big decline in the dollar, 

between 30 and 50 percent depending on how you calculate it. To 

get that decline, and then to stabilize the dollar at the lower level, 

the United States had to accept the demands of the rest of the 

world to take some fiscal action to begin putting its own house in 

order. In 1986 and 1987 there was, temporarily it turned out, a 

substantial reduction in the budget deficit. 

The point is that even fiscal policy itself can be forced into an 

unhappy and precipitous adjustment if you do not take preemptive 

action in not taken. 

Chairman CONRAD. Let me just stop you, if I can, on that point 

and say that is the message. I hope colleagues are listening. 

[The prepared statement of Mr. Bergsten follows:]

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Chairman CONRAD. Let me go to Dr. Cline, and then we will go 

to Malpass and then open to colleagues for questions. 

Dr. CLINE. 

STATEMENT OF WILLIAM CLINE, SENIOR FELLOW, PETERSON 

INSTITUTE FOR INTERNATIONAL ECONOMICS 

Mr. CLINE. Thank you very much, Mr. Chairman. 


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It is an honor for me to testify before this committee. I, too, 

strongly agree with your introductory remarks. 

The United States has gone from being the world’s largest creditor nation to its largest debtor nation. In 1971 to 1975 the average 

net foreign assets were 11 percent of United States GDP. At the 

end of 2005, we had net foreign liabilities of more than 20 percent 

of GDP. The cumulative large current account deficits, of course, 

were the proximate cause. Last year our current account deficit 

reached almost 7 percent of GDP or about twice the previous peak 

in 1987. 

The deficit was up from 1.7 percent of GDP in 1997. This was 

closely driven or heavily driven by the 28 percent real appreciation 

of the dollar from 1995 to 2002. That, of course, made United 

States exporters less competitive and made imports more attractive. 

There has been some dollar correction. The dollar has come down 

13 percent from 2002 to 2006 on a real trade-weighted basis. But 

I believe, as my colleague Fred Bergsten has said, that there is a 

long ways to go. 

The adverse trend in United States debt has occurred—external 

debt—despite two very strong unique advantages. The first advantage is that the United States has a higher return on its direct investment abroad than foreign holders of direct investment in the 

United States get. That difference is about 4.5 percent. 

The second unique advantage is that unlike Argentina, who owed 

its debt in foreign currency, we owe our debt to the rest of the 

world in our own currency. We have assets abroad in foreign currency. So every time the dollar goes down, we have a windfall gain 

in the valuation of our net position. 

Despite these advantages, we have had this adverse trend. 

Fred has outlined the near-term hazards of the situation. I would 

like to focus on the longer-term burden, as well as the link to fiscal 

policy. 

On the long-term burden. Even if the current account were to 

stabilize at 7 percent of GDP, then after about 20 years the net foreign debt would be about 100 percent of GDP. But we cannot actually expect it to be that favorable under current trends. With the 

dollar in real terms where it is now, the baseline that I calculate 

is that the current account deficit will reach 14 percent of GDP at 

the end of two decades and net foreign liabilities would reach 140 

percent of GDP. 

One of the main drivers of this is the fact that we are now decisively swinging into negative balances on our capital earnings despite the difference in the rate of return. Why? Because we have 

more foreign debt. 

And then second, imports are about 50 percent larger than exports, so an equal percentage growth on both sides just keeps widening that gap. 

Now the danger, it seems to me, is that there is a threshold beyond which United States foreign debt should not be allowed to 

rise. For developing countries, the critical debt crisis threshold is 

about 40 percent of GDP. The United States economy is obviously 

stronger than developing countries, but the United States has a lot 

of international obligations, a lot of impact on the international 

34

economy. I do not think it is prudent for the United States to buildup net foreign debt that exceeds 50 percent of GDP. This is the 

same threshold that a number of other experts who have analyzed 

this question tend to arrive at. 

So we are not on a sustainable path. The choice is basically between an earlier smoother adjustment and a later painful adjustment. 

In my model simulations, if we try to stay within a 50 percent 

ceiling for net foreign debt by the end of 20 years, if we have early 

adjustment, cutting the current account deficit to 3 percent over 3 

years, then you have a much smoother phasing in of the belt tightening. 

If instead we wait for 10 years, then the gap will be so large that 

you would have to cut consumption and investment by something 

like 13 percent from the baseline in order to get within a path that 

would get you back to that ceiling of 50 percent. 

We need the exchange rate to move to do that. It is critical to 

get China and other Asian economies to stop intervening in the 

currency markets and piling up mountains of reserves in order for 

that to occur. 

It also looks increasingly likely that we will need to have a coordinated intervention to reverse the inappropriate recent decline 

of the yen. After all, there was intervention to reverse the decline 

of the euro some years ago. We will have to make the exchange 

rate adjustment. 

But let me turn to the fiscal adjustment. Fiscal policy is relevant 

because by national accounts identities, our trade deficit is the result of our excess use of resources above our resources available at 

home. Now that also means it is the excess of investment over saving. And Government dissaving is eroding our national saving. 

The fact is that from the average of 1997 to 2000 the fiscal accounts deteriorated by about 4 percent of GDP. The current account deteriorated by about 3 percent of GDP. So we can see the 

handwriting on the wall, that this contraction in the domestic saving that is caused by Government dissaving is a major factor. Obviously there are other factors. Private household saving has declined 

with the stock market boom and then the housing boom, so that 

people did not feel they needed to save as much out of current income. But we cannot count on how soon that will reverse.

And if there is anything we have learned, is that the only way 

to affect saving is through affecting Government saving. We do not 

have policies that can affect private saving in any reliable way. 

So the second component of an adjustment process has to be fiscal adjustment that complements the exchange rate adjustment. 

And that is especially important because of the long-term challenges of Medicare and Medicaid, in particular, and also Social Security. 

So I agree, I think we need a swing in the fiscal accounts from 

about a 2 percent deficit, and if you look at the CBO projections, 

it is 2 percent if you make realistic assumptions about the discretionary spending, the alternative minimum tax, if you also extend 

the tax cuts. We need to squeeze that or reverse that to about a 

1 percent surplus, which ironically is what the CBO baseline is 

35

doing. If we could actually reach the CBO baseline, we would be 

home free. 

So with that, I would simply say there are many reasons that we 

need to get the fiscal adjustment in its own right, but I think a 

strong reason for doing so, in addition, is a need to get our external 

house in order. 

Thank you. 

[The prepared statement of Mr. Cline follows:]

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Chairman CONRAD. Thank you very much for that important testimony. 

Mr. Malpass, thank you very much for being here. We appreciate 

your taking your time to contribute to the work of the committee. 


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STATEMENT OF DAVID MALPASS, CHIEF GLOBAL ECONOMIST, 

BEAR STEARNS 

Mr. MALPASS. Thank you, Mr. Chairman and Senator Gregg. It 

is a pleasure to be here. Thank you for the invitation. 

I surmise that I am here, in part, to take a different point of 

view, which I will try to launch into here. 

I listened with great interest to Fred’s recounting of some of the 

historical hard times that we have had related to dollar weakness 

and inflation, and I think we probably all share an interest in not 

going back to that. 

In recent years, the good news is that United States growth has 

been faster and steadier than most expectations. Even so, there is 

a frequent view that the United States is on the wrong economic 

path. And that is primarily where I want to take a different point 

of view. 

People have been talking for several years now about us heading 

into a slowdown or a recession, in part due to the trade deficit. Instead, the United States has enjoyed a strong multiyear expansion. 

Growth in 2006 was faster than in 2005, despite the view that 

things were hard. And 2007 looks equally robust to me. 

If that is the case, we will end up with having 5 years in a row 

with over 3 percent real growth, a very strong economic performance. Rather than the trade deficit slowing the economy or causing 

higher interest rates the rising trade deficit and the net foreign 

debt, have coincided with strong growth, profits, and job creation 

for the United States economy. Unemployment has fallen to 4.5 

percent. The fourth quarter of 2006 saw a net 1 million new jobs 

created in the United States, again associated or coinciding with a 

large trade deficit. 

I will go through some of the graphs in my written testimony. 

The unemployment rate has fallen steadily and that has been one 

of the sources of strength for the United States economy. 

I am expecting some inflation problems because of the weaker 

dollar, and I agreed with Fred’s concerns over dollar weakness generating inflation. In 2005, we already saw the United States economy get to 4.7 percent CPI inflation. So we have already had some 

experience with severe inflation in this expansion. 

The fiscal situation is worth pointing out. The debt to GDP ratio 

is already falling at a relatively brisk clip. We are down to 37 percent of debt to GDP. The fiscal deficit has fallen to an expected 1.5 

percent of GDP in fiscal 2007 and CBO projects a surplus in the 

near term. 

Turning to the trade deficit, I will go through briefly some of my 

thoughts in this area. First and most importantly it is normal for 

the United States to run a trade deficit. With the exceptions of war 

time and recessions, the United States has usually been running 

a trade deficit. One exception was after World War II when the 

United States was helping rebuild Europe and Japan and there 

was a capital outflow. But for most of our economic history, it has 

run a trade deficit. 

Countries with trade deficits often produce more growth and jobs 

than countries with trade surpluses. We have only to look at 

Japan, with its large trade surplus and difficulty creating jobs, the 

45

European Union in that same condition running a trade surplus, 

having difficulty creating jobs, to see that point. 

The trade deficit is large as a share of GDP right now, in part 

because the differentials that drive it are large. The differentials 

driving the trade deficit include the growth differential. Between 

1992 and 2006, the United States grew 110 percent, whereas the 

rest of the world grew roughly 95 percent. So there was a big expansion of the United States relative to the rest of the world. This 

causes our imports to go up more than our exports. That is part 

of the trade deficit. 

A second driver for the trade deficit is the demographic differential. There has widened out now an unprecedented gap between 

United States demographics and those of Europe and Japan in 

terms of aging. To dramatize it, think of Japan, where the under–

60 population is expected to decline 3 to 4 percent every 5 years 

for the next generation. They have fewer and fewer people needing 

capital and they have an urgent need for capital abroad. Thus, a 

powerful driver for the trade deficit is the demographic differential. 

The United States alone among the major industrialized countries 

has a growing population of people under 60 that need capital and 

need goods. And that is going to go on for the next 50 years. It is 

not going to shift. And I am expecting the trade deficit to be with 

us for a long time. 

The third strong factor creating this particularly wide trade deficit that we have now is the investment differential. The United 

States invested $842 billion more than national savings in 2005. In 

contrast, foreigners invested $670 billion less than their savings. So 

the lack of an attractive investment climate abroad urges foreigners to put their money into the United States, where they get 

a better return on investment. There is data in my statement 

showing the higher returns offered in the United States and the 

attractiveness to the United States for that foreign investment. 

Now an important point in this is how can this be normal, to—

as Fred put it—spend more than we produce? Actually, that is a 

very normal condition in economic theory and practice. Growth 

companies do that all the time. Most corporations are spending 

more than they produce. The difference is the increase in their 

debt. And if you stop that increase in debt, the company would not 

be able to grow. The United States is doing the normal thing, 

spending more than we produce, and funding the gap with capital 

in the same way that a corporation does with a bond offering. 

So as you think about the trade deficit, remember that each time 

a corporation in the United States does a bond offering, that is 

causing it to spend more than it produces, invest more than it 

saves, and some of that is the trade deficit and the capital inflow 

that we are running from abroad. 

Regarding the sustainability of the foreign debt, in the 12 

months through November 2006, the latest data, foreigners increased their net holdings of longer-term maturity debt in the 

United States by $860 billion. No signs of difficulty for the United 

States in financing the trade deficit anymore than a corporation 

issuing bonds. It fuels growth, controls whether it has a sustainable process of investment taking place in the corporation, and 

takes on more debt, perhaps perpetually. 

46

The idea that somehow the United States has to stop this process 

is not consistent with what a normal leveraging process is, whether 

for countries or for companies. 

Just as with corporate borrowing, the United States needs to 

maintain the quality of its new investments, whether funded by 

United States or foreign capital. I think the focus should be on the 

quality of investment taking place in the United States We know 

we are borrowing from foreigners, usually at low interest rates. 

The issue: is are we using that capital wisely to build a growing 

economy? Yesterday’s data showed that we were. In a nominal 

GDP basis, we are running 6 percent nominal growth year after 

year versus lower borrowing costs, which is a very powerful positive leverage that the United States is enjoying. 

The argument that foreign funding will dry up has been made 

since 1984–1985. In fact, I was a staffer for the Senate Budget 

Committee in the previous Congressional focus on the twin deficits. 

I do not know if Fred testified in those hearings in 1984–1985, but 

there was a big concern about foreigners withdrawing their funds 

from the United States in that situation. And I think, it ended up 

without that being a particularly sensitive part of the United 

States economic equation. 

One of the reasons for that is foreigners own a small and declining portion of overall United States assets. The data that we have 

discussed so far has been the foreign debt relative to United States 

GDP. I think a better measure is to look at the foreign debt relative to United States assets. United States assets have been growing very fast and, in reality, foreigners are losing share of the rapidly growing United States asset base in part because they are not 

investing enough into the United States economy. 

As we talk about trade deficit numbers, remember that the data 

is quite suspect in many areas. For example, when a United States 

company produces something abroad, ships it to the United States, 

makes a profit on it, we count that as part of our trade deficit even 

though it is coming from a United States company. 

A second problem with the data is that on a global basis exports 

and imports do not add up. One of the primary reasons is that 

United States exports are not counted very well. We do a really 

good job of counting all of our imports of goods and services but not 

nearly as good a job counting the exports. Most people looking at 

this think that our actual trade deficit is much smaller than the 

numbers being reported. 

As we think about the risks of the trade deficit, then I will name 

three issues. One is we want to have the investment that is taking 

place in the United States be profitable. That is true whether it is 

from foreign capital or our own capital. 

Second, protectionism, is not the right approach even if you do 

end up thinking that there is a concern with having the trade deficit itself. 

Third, a weak dollar policy, in my mind, will not solve the trade 

deficit at all. It encourages capital flight from the United States 

and makes our overall economic situation worse. 

What can be done to reduce the trade deficit? The primary burden, I think, should be on the trade surplus capital outflow countries. Remember those countries running a trade surplus are shipVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00494 Fmt 6633 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ping capital to the United States because we have young people. 

How can they change to make it more attractive for that capital to 

stay at home? Probably more population growth, more productivity 

growth, and a more attractive investment climate. 

As you are thinking about the problems of the trade deficit, the 

primary thing to be focused on is how can foreign growth and investment climates be enhanced. 

I am a critic, in some ways, of our international economic policy. 

I do not think the United States does a good job at all in making 

clear to the rest of the world that we would like them to grow faster and invest more in their own countries. 

A tax cut in Japan would make a lot of sense. Japan needs desperately to boost its investment and consumption and its tax rates 

are too high to contribute to that right now. And I think the United 

States should more aggressively promote prosperity abroad as part 

of the response to our trade deficit. 

In conclusion, rather than an unsustainable situation with the 

trade deficit and the net foreign debt—it has been called that for 

25 years with no real evidence of it being unsustainable—I think 

the trade deficit will continue as long as the United States grows 

faster than our trading partners and it will contract when we do 

not. It comes down to the growth rate differential that we have and 

it is unlikely to be narrowing. 

Thank you. 

[The prepared statement of Mr. Malpass follows:]

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Chairman CONRAD. Thank you. 

Let me start, if I can, with you, Mr. Malpass. We are talking 

here about twin deficits. Trade deficit, you have really focused on 

that. We are also talking about budget deficit and we are talking 

about the long-term fiscal challenges facing the country, because 

that is the distinctive purview of this committee and responsibility 

to our colleagues. 


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With everything that you have said, do you have any concern 

about the long-term fiscal situation of the country with respect to 

the budget deficits and the retirement of the baby boom generation 

and what we see it as the long-term fiscal outlook? 

Mr. MALPASS. I think in the long run it is hard to project deficits. 

One thing we find is that they are very sensitive to growth rate assumptions. Since I tend to have a pretty optimistic view of the 

United States future, I think that we will find ways to meet most 

all of the commitments of the Government. 

The problem, though, becomes when the Government makes expansive commitments, and those are presenting challenges now, 

particularly in the Medicare realm. We have made a big promise 

to the elderly about a broad, sweeping, robust, very generous 

health care program. That is going to be incumbent on the United 

States then to have a flexible, liberal, small-business-oriented 

growth environment and just keep growing 3 percent a year, as we 

have been these last 5 years. 

Chairman CONRAD. I would say this with respect to Social Security, if the economy grows in the next 20 years as it has in the previous 20 years, 80 percent of the projected Social Security shortfall 

disappears. So I think that should be something that colleagues 

keep in mind as we talk about Social Security. 

That is not the case with respect to Medicare. With respect to 

Medicare, the long-term projected shortfall is seven times the projected shortfall in Social Security. And in my judgment, when I 

look at the numbers to try to pierce the veil, I think that is the 

800-pound gorilla here. And that has the potential to swamp the 

boat. 

Your reference to Medicare, perhaps we are on the same wavelength with respect to that long-term challenge. 

Mr. MALPASS. Yes. I think there is a big modeling issue. If current trends continue, there is a big Medicare problem. 

If you look at the assumptions underlying the Medicare Trustees 

reports and so on, one thing that is notable is that they assume 

that the real rate of growth of medical services will continue. 

Meaning that people will go to the doctor more and more often, 

they will use more and more services apart from their age. One of 

the ways that we can see a little more daylight on the Medicare 

side is if we think that the systems will become more productive 

and that people may become satiated with their use of some of the 

medical services over time. 

Chairman CONRAD. OK. 

Let me turn to our other witnesses, Dr. Bergsten and Dr. Cline. 

And ask them, you have listened now to Mr. Malpass. Anything 

that he said that you would want to take issue with or have a different point of view. 

Mr. BERGSTEN. Yes, I have several things, but two big ones at 

the start. 

David said that it is natural for the United States to run a trade 

deficit. As I said in my testimony, I do not disagree with that. The 

issue is how big. I suggested that if we cut it to roughly 3 percent 

of GDP, I would be modestly confident that we would be able to 

sustain it. That is because, as we said before, it would level off the 

62

ratio of net foreign debt to GDP and keep it from escalating forever. 

So the difference between us is really over magnitudes, not signs. 

And I am not saying we should try to run a trade surplus. 

Second, it is just wrong to day, as he said right at the end, that 

there has been no real evidence of unsustainability for over 20 

years. Why did Jim Baker call the Plaza Agreement 1 year after 

the time period David cited, 1985? Jim Baker called the G–7 together and insisted that they cooperate with the United States in 

a huge adjustment of our external imbalance. 

There were two reasons for that. The most immediate was that 

Congress was about to go protectionist in a big way. My friends on 

the Ways and Means Committee at the time said that if the SmootHawley tariff itself had come to the floor in 1985, it would have 

passed overwhelmingly. 

That was because Reaganomics—and I am not being political, I 

am trying to be analytical—big fiscal deficits and very high interest 

rates pushed the dollar to such high levels that the United States 

shifted from being the world’s biggest creditor to the world’s biggest debtor. Not only was there a risk to our international financial 

position but also there was a domestic political unsustainability because of the adverse effect on manufacturing, agriculture, and 

many other parts of the economy. 

And so Jim Baker literally insisted, from a United States interest 

standpoint, that the world agree to a huge decline in the dollar. 

The rest of the world said it would do so only if the United State 

did something about the budget and that, in fact, was a partial 

component of the solution. 

But that immediately showed the unsustainability. Again in the 

early 1990’s, the dollar—people forget this—fell to its all-time 

record lows in 1994 and 1995, when Bob Rubin was Secretary of 

the Treasury talking about the strong dollar, again because the imbalances were rising and there were doubts about the U.S. position. 

So there have been big fluctuations in our international position. 

David did not say this, and I do not want to put words in his 

mouth, but I think he implied that there has been a steady increase in external imbalances, external debt and the like, indicating that all of this is OK. That has not been the case at all. 

There have been very large fluctuations. After the dollar came 

down and the budget was corrected at least a bit in the late 1980’s, 

United States current account deficit basically disappeared in the 

early 1990’s. And then it started a rising trend again. 

But over the last 5 years, as both Bill Cline and I indicated, the 

dollar has again been coming down. Fortunately it has been gradual and orderly. But again, it is an indicated that even though the 

foreign capital continues to come in, they want a better price. They 

want to be able to buy the dollar cheaper. 

Chairman CONRAD. Let me just stop you there and say that we 

have gone over my time. I want to turn it over to Senator Gregg. 

But I did want to say to Mr. Malpass, when you are talking 

about debt to GDP coming down, you are talking about publicly 

held debt. And remember, that is the baseline. When we add back 

the things that are left out of the baseline, we get a different picture emerge. 

63

And certainly on gross debt, on gross debt quite a different picture emerges. And that is where we are concerned, I can say Senator Gregg and I and other members of this committee, especially 

given the fact we have this baby boom generation coming. That is 

where we think we have to make an adjustment. 

Senator GREGG. Senator GREGG. Thank you. This has been a very interesting 

panel. 

And I think what it shows is that the trade imbalance is an extremely complex issue. Unfortunately, it tends to get, in the political arena, simplified into catch phrases, and as a result becomes 

a short commercial. And it is not. It is something that has so many 

moving parts that it takes you three folks quite a while to explain 

them, and I am sure you could have gone on for much longer. 

But to some extent I have always thought it came back to the 

basic Adam Smith theory that it is not the dollar that is important. 

It is the productivity under the dollar that is important. The dollar 

is just a representative item. It is a piece of paper. It means nothing unless there is productivity under that dollar. 

I guess my question is isn’t the trade imbalance a reflection of 

the fact, to a large extent, that the world sees our economy as the 

place to put their money to get the best return? 

I would ask you all to react to that. 

Mr. CLINE. I wonder if I might respond to that, Mr. Chairman. 

It is certainly the case that the attraction of our capital market is 

a major source of the strength of the dollar. I think, though the 

case has been exaggerated, there is this argument out there that 

there is a global saving glut because Asia and Latin America had 

their crises and their investment rate went down. The Chairman 

of the Federal Reserve, Ben Bernanke, has made this argument on 

other occasions. 

When I parse that particular argument, I get a much smaller effect, only about 0.7 percent of United States GDP is our fair share 

of that excess savings. But we have had a widening of our current 

account deficit by 4 or 5 percent of GDP. 

To me it is a much more obvious smoking gun to look at the decline in Government saving, as I say, a decline of something like 

5 percentage points of GDP in the critical period. 

Now David was saying that well you know, isn’t it wonderful 

that the rest of the world that does not have anything profitable 

to do with its money is sending it here where we are very creative 

and we have good investment. If you look at net private investment 

in 1994 it was 7 percent of GDP. In 2004 it was 7 percent of GDP. 

So it is a misleading argument to say that the reason we have 

this large increase in our current account deficit is that we have 

had this huge increase in private investment. It is, I think, rather 

clear that part of the problem is the decline in Government saving. 

But that being said, I am a little bit concerned with precisely 

what you say, that we will be given enough rope by the foreigners 

precisely because our capital market is attractive, to well and truly 

hang ourselves. And what I am really asking is what does a logical 

consistent picture look like over a long period of time? 

I challenge Dr. Malpass to tell us what his ceiling safe level is 

for foreign debt relative to GDP? And it has to obey the following 

64

rule: the long-term rate of foreign debt to GDP equals the current 

account deficit as a percent of GDP—right now 7 percent—divided 

by the nominal growth rate. That is 6 percent. So right now our 

eventual stabilization is 110 percent of GDP. 

That is why we think it needs to come down to 3 percent so it 

will stabilize at 50 percent. 

But those who argue that there is no problem have one of two 

things. They think the sky is the limit in terms of foreign debt for 

the United States, unlike all the rest of the world, A. Or B, they 

count on this thing naturally turning around at a comfortable time 

when we do not really have to do anything about it. I am not sure 

that that is a prudent approach. 

Senator GREGG. I do not think my point was that there is no 

problem. My point was that correcting the problem may create 

issues which are going to undermine the economy and the productivity of the economy if you inflate the dollar, reduce the value of 

the dollar arbitrarily, or create other mechanisms that essentially 

make America less attractive as a place to put capital, because capital is the essence of growth and jobs. 

Mr. BERGSTEN. Could I perhaps respond to that? I think it is not 

only a fair but critically important question. But I actually would 

come out the other way, depending on how the adjustment takes 

place, going back to some of the dialog we had earlier on. If the 

dollar went into free fall, if it triggered a prolonged period of 

United States inflation, you would be right. And I have argued that 

that is the ultimate thing we want to avoid, and that is why we 

should take preemptive action. 

I think the alternative correction paths are between preemptive 

adjustment, mainly by gradually reducing the budget deficit and 

keeping the pressure off interest rates and inflation, and at some 

inevitable point getting a very sharp fall of the dollar that pushes 

interest rates up to a level that would reduce our level of investment, and therefore reduce our productivity growth, which would 

be very damaging to the economy indeed. 

So I agree with you, but the way we manage the adjustment of 

the external imbalance could have a decisive effect on the outcome. 

And I would opt strongly for trying to preempt a dollar crash, a 

run-up in inflation, a soaring of interest rates where the burden of 

working out the adjustment would fall on the Federal Reserve and 

monetary policy and higher interest rates. 

In a way it is back to the simple point of increasing budget deficits, putting pressure on the financial markets, raising interest 

rates, and such. 

We have been relieved of that dilemma by the foreigners. As Bill 

Cline said, we have not gotten crowding out of private investment 

from our budget deficits because the foreigners have come in and 

financed the difference. And if you think that can go on forever at 

almost any level, then you sit back and enjoy it. And there is no 

doubt it is enjoyable while it happens. It is like drawing on your 

credit card if nobody sends you monthly bills. 

So as long as it persists it is enjoyable and, of course, it is politically difficult to take any of the steps to correct it. And so the tendency is to just sit back and enjoy. 

65

But as I said in my testimony, unless all laws of economic history 

are repealed, you cannot count on it and it literally could hit you 

just at the most unhappy and politically inconvenient time. 

Senator GREGG. You want to comment on this, Mr. Malpass? 

Mr. MALPASS. This is an interesting discussion. I agreed with 

your point that productivity in the United States, I think in terms 

of the quality of investment, is a key determinant of whether this 

goes well or not. Throughout its economic history the United States 

has tended to borrow money from foreigners and make a profit on 

that in the same way that a corporation does. A corporation issues 

bonds and tries to make enough extra to pay the interest on the 

bond, then roll it over and keep the process going. It gets older and 

older as a corporation and gets bigger and bigger. And that is basically how the United States has run since colonial times in terms 

of bringing in foreign capital to the United States and making a 

profit on it. 

It is easy to look at the buildup of our debt. But it is important 

to then also look at the buildup of our assets. As we use foreign 

capital, we compound our assets. We have a multiplier effect going 

on in the United States economy. It makes the process sustainable. 

The final point I will mention to you then is the demographics. 

This is at an extreme right now because we are at this massive 

crunch point where the populations in Japan and Europe are already declining. And in China within a decade, the population will 

roll over and begin to decline at a time when the United States 

population is growing rapidly. It is magnifying the normal historical behavior of the United States to borrow foreign money. We are 

doing it more than ever before because we are growing relative to 

the foreign economies. 

Add to that the quality of the investment climate. We are in a 

world climate which is particularly favorable to what the United 

States does. 

Mr. BERGSTEN. David just said the United States has been doing 

this since colonial times. Not right. 

As recently as 25 years ago, as Bill Cline mentioned in his statement, the United States was the world’s largest creditor country. 

We had built up a huge net foreign asset position. For over 50 

years, from roughly the start of the 20th century, at least World 

War I, until literally 1980, the United States increased its net asset 

position. 

Indeed, the previous big trade deficits in the 1980’s were running 

down the asset position built up in the previous 50 years. 

One reason it is more precarious now is that we are running 

these big deficits on top of already having the world’s No. 1 debtor 

position. We do not have a cushion now. We used up the cushion 

in the last big run up. 

We built up net assets for a long time. We were the world’s largest creditor country. That came to be viewed as a natural thing because we were a rich country and we exported capital to the rest 

of the world. Now it has all gone topsy-turvy. 

Second, David keeps making this comparison with companies 

floating bonds. Well yes, but not without limit. No prudent company just says it will take whatever amount of money the capital 

66

markets gives me, and find some way to use it but not worry about 

the buildup of its debt. 

They do a very careful corporate plan, have a financial strategy, 

and have a finite amount they want to borrow. They do not just 

borrow without any limit and let it go on a trajectory that gets 

more and more explosive. 

Third, David made the correct point that how you use the funds 

is critical. But, look at the increase in U.S. external borrowing over 

the last five or 6 years. What has it financed? As Bill Cline just 

said, not an increase in private investment. An increase in the Government budget deficit, which went from surplus as recently as 

2001 to deficit now, and more domestic consumption. The numbers 

today indicate that the United State private saving rate for 2006 

was minus one, the first time since 1933. 

So what has the big foreign borrowing financed? A big increase 

in U.S. capital stock and investment? No. A big increase in domestic consumption and an increase in the Federal budget deficit. And 

those things, to put it mildly, are not self-financing of the imbalance for the future. 

Chairman CONRAD. Senator Cardin. 

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

Let me thank all of our panelists. I found this discussion to be 

very, very helpful. And I certainly concur with the predominant 

view that our trade imbalance is a matter of concern and that it 

is not sustainable. 

And I agree that we should be taking constructive preemptive 

steps. 

I was proud of the work that we did under President Clinton to 

bring the budget into balance. It was not easy, but we got it done. 

It had a very positive impact on the economy, and yet within a very 

short period of time we have returned to a situation of uncontrolled 

deficits, and it is very frustrating. 

I am always amazed that economists rarely will mention enforcing our trade rules as a way of fixing our trade imbalance back into 

balance. And I preface that with the fact that I have voted for most 

of the trade agreements, including the most controversial ones with 

Mexico and China. I strongly believe that it is in our national interest to enforce our trade rules, and I do not see how anyone can 

justify China’s practices of tying its currency to ours and say that 

that is not manipulation and it is not adversely affecting the fair 

exchange between our currencies. China has a reputation for not 

honoring our intellectual property issues. That has an impact on 

American’s opportunity to penetrate the Chinese market. 

I mentioned China because that is obviously the largest imbalance we have. I could be talking about Europe and its nationa’s 

practices. And I find that America has the most open markets, 

which I support. 

But why aren’t we talking about enforcing trade policies and as 

a method of resolving our trade imbalances? 

Mr. BERGSTEN. Senator, I totally agree with that. In fact, I spent 

2 hours before the Senate Banking Committee yesterday on precisely the China exchange rate issue. Secretary Paulson testified 

and tried to defend the continued failure of the Administration to 

achieve necessary adjustment of the Chinese exchange rate. China 

67

is now the world’s biggest surplus country, with a global surplus 

last year of $250 billion, 10 percent of its GDP. And the reason, as 

you say, is that they intervened to the tune of $15 billion to $20 

billion per month to keep their currency from rising. 

So I absolutely agree. When we talk about getting the dollar 

down in a gradual and orderly way, its most critical component on 

the other side—of course the surplus countries whose currencies 

need to go up—is China, not only because China is the biggest surplus country but, also because when they hold their currency down 

against the dollar, it prompts all of the other Asian currencies to 

hold their currencies down against the dollar too, because the other 

Asians do not want to lose competitive position against China. So 

they take half the world, and the biggest surplus part of the world, 

out of the adjustment process. 

Therefore, I am for very tough action and testified yesterday that 

while there are still some multilateral steps we can try, there may 

be some unilateral steps the United States has to take to get the 

Chinese exchange rate to move, and to move by a lot. 

My estimate is the Chinese exchange rate needs to go up about 

40 percent against the dollar. That would be only 20 percent in 

terms of its average because other currencies would go up with it. 

But it needs to go up a big amount. 

Without that, you are absolutely right, we will not get the kind 

of adjustment we need. 

The other steps, in terms of enforcing trade laws, are essential, 

including to maintain an open policy, which I strongly support. 

Most of the others will not generate big numbers in terms of reducing the trade deficit. If we got all of the intellectual property 

enforcement we wanted, we would get a few billion dollars of extra 

exports, which would be useful, and it is important and we should 

make every effort to do it. 

Senator CARDIN. It is very important for those people who work 

in jobs that otherwise are going to be eliminated. 

Mr. BERGSTEN. Absolutely. There are all sorts of reasons to do 

it. I fully agree with that as well, only to say that any of those specific trade policy measures, while they are essential, will have 

much less impact on the trade imbalances, the big trade deficit, 

than moving the exchange rates and relative growth rates and 

some of the other things we have talked about. 

Senator CARDIN. I want to give our other two witnesses a chance 

to respond. 

Mr. MALPASS. Thank you, Senator. 

I agree with your point about enforcing our rules. And I agree 

with the way Fred phrased it, that we need to keep our market 

open and that the rules will have a positive effect, but on the margins compared to the magnitude of the trade deficit. 

I am thinking it is driven by the fast growth rate of the United 

States, the attractive investment climate, and the demographic differentials. So it is going to be hard to address through the rule—

Senator CARDIN. I just want to make one point. We have been 

told that often the decisions by foreign-owned banks to purchase 

United States dollars are not because America is a good investment. Rather, it is because they want to make sure the market remains open and that they can penetrate it with products the way 

68

they do now, and because they have the luxury to be able to buy 

dollars and the capacity to do it. But it is not because of the return, 

it is more because of the impact of their investment on stability of 

the United States dollar. 

Mr. MALPASS. Yes, I think central bank intervention is along 

those lines. They are often buying instruments that are the lowest 

yielding within the United States economy. They are not particularly driven by yield but by the effect on their own currency. 

I have some thoughts about the manipulation side of this issue. 

China is maintaining a currency peg and has for a long time. So 

has Hong Kong, as you know, using the same techniques. But it 

extends more broadly. Brazil, each day this year so far, has been 

intervening in markets to keep the real from strengthening. Japan, 

over the years, has built up some $800 billion of United States 

treasury deposits, in part for the purpose of keeping their currency 

from strengthening. Russia, of course, is maintaining the same policy. 

While we have tended to single out China as breaking the rules, 

it is actually a widespread common behavior by foreign central 

banks to do this. 

The mushrooming of this intervention process has coincided with 

the very low interest rates that the United States has been running. Part of what the other countries are trying to do is not have 

their rates as low as the United States because they are afraid of 

overlending within their own economies. 

The United States had a 1 percent interest rate in 2004, at a 

time when the economy was growing fast. That is part of the reason the foreign countries are having to buy up so many dollars. We 

were putting out a lot of dollars in that period. 

Mr. BERGSTEN. To put a fine edge on it, most of the private foreign investment in the dollar, which is still by far the larger part 

of it, is probably motivated by financial return and economic considerations. But David put it very nicely, the buildup by foreign 

central banks is very much driven by their mercantilist interest. 

To put a sharp edge on it, the China and other countries are buying dollars through their official entities as a means of subsidizing 

their exports and their jobs, and it is part of their development 

strategies. They know they are going to take a capital loss because 

they know the dollar will go down at some point. They never mark 

to market so they will not be held accountable for that. They have 

not suffered any international reaction either. So it is a wonderful 

policy tool. 

But you are right to flag the point. It is not because of some wonderful financial attraction of the dollar, it is because of the export 

subsidy policies of the other countries. 

Senator CARDIN. Mr. Cline, my time is up, so if you could be brief 

it would be helpful. 

Mr. CLINE. Just to make the point that the subsidized currency 

as a form of unfair trade is a much murkier area in terms of protection than good old fashion quotas and tariffs. Whatever we do, 

I think it is important we try to stay within the WTO/IMF framework. 

I can see, if the Chinese do not eventually change, the case for 

taking a countervailing duty case to the WTO on grounds that the 

69

practice is a subsidy to exports that ‘‘frustrates the intent of this 

agreement’’ which is language that is right in the GATT when it 

refers to exchange rates. 

I was interested that Fed Chairman Bernanke called it a subsidy, that is a very loaded word which I am sure many people immediately sensed. 

So sooner or later this new area of unfair trade may have to be 

addressed. We hopefully can get changes without going down that 

route. If we do go down that route, I think it would be important 

to try to stay within the IMF/WTO—

Senator CARDIN. I would agree with you, but I would tell you, we 

have run out of patience. It is time for action. 

Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you, Senator Cardin. 

Senator WHITEHOUSE. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. 

Would you gentlemen be good enough to give me some historic 

context on where you think our present current account deficit is 

vis-a-vis other moments in our history where we have run significant current account deficits? Mr. Cline? 

Mr. CLINE. Yes, I have a chart—

Senator WHITEHOUSE. Dr. Cline, my apologies. 

Mr. CLINE. I have a chart on page two of my book which shows 

United States current account balances as a percent of GDP from 

1869 to 2004. We were in deficit from 1869 to about 1877. Then 

we were more or less in balance through 1914. Then we were in 

surplus from 1914 until 1979, with the occasional exception. The 

surplus was 6 percent of GDP in 1917. It would seem to be an average about 1 to 2 percent of GDP during that extended period. 

We only began this period of secular deficits in basically the 

1980’s. We have had two cycles. We had the big cycle with the overvaluation of the dollar in 1983–1984. Then there was a correction 

by 1990 and we were back to balance in 1990. And then we have 

had this second cycle, which has shown a steady widening to 7 percent. 

Senator WHITEHOUSE. So fair to say that from the point of view 

of history, at least since the Civil War, we are running the biggest 

current account deficit we ever have by a significant margin? 

Mr. CLINE. That is unambiguously true. 

Senator WHITEHOUSE. With respect to how that corrects, you 

have talked about the hard landing scenario and the soft landing 

scenario. There was an article some time ago that I remember, I 

think it was written by James Fallows, that was in the form of a 

memo to the president looking backward on the consequences of a 

hard landing. Do any of you remember that article? It was in Atlantic or Harpers, one of those magazines. No? 

In terms of the brutal correction that Dr. Bergsten referred to as 

a potentiality, in terms of the likelihood of whether we are going 

to have a hard or a soft landing, how would you advise us at 

present that likelihood shakes out? Is it a 1 percent chance of a 

hard landing or a brutal correction? Is it kind of 50/50 now? What 

is your educated guesstimate on what the likelihood of is of the 

brutal correction versus the soft landing? 

70

Mr. BERGSTEN. I still think it is better than 50/50 that we can 

achieve a soft landing because the economy is basically strong and 

there is not such a huge attraction for capital in Europe or Japan, 

including for some of the reasons David Malpass said. 

And if the dollar did start to go into a free fall, the G–7 and the 

Asian countries, I think, would come into the market with official 

intervention to try to slow it down. Neither we nor they would 

want to see a crash. So there are defenses against it, and I think 

that is the more likely case. 

However, that is premised on our not doing something ourselves 

that would trigger a substantial loss of confidence in the dollar and 

our economy, such as a renewed explosion of budget deficits. The 

issue we are talking about here has the potential to move in either 

direction. 

Now all sorts of other things could happen. If the world lost confidence in the Federal Reserve, which again I do not anticipate, but 

if that were to happen; if for whatever reason—higher energy 

prices or the dollar decline itself—United States inflation were to 

crank up. David Malpass shared some of the concerns about inflation perking up—if all that were to be seen as likely and being sustained, then that would erode a lot of foreign confidence in the dollar. 

If the other key surplus countries like China took the advice to 

shift the focus of their own growth strategy away from relying on 

exports to relying on domestic demand, they would not need to subsidize their exports so much. So that buildup of foreign official 

holdings would decline. 

In short, there are a lot of possibilities for converting it from 

what I still think is more likely, which is a soft landing, to a hard 

landing for us to be complacent and fail to take preemptive action. 

Senator WHITEHOUSE. I guess the last question on this, to what 

extend do you all believe that the prospect of a hard landing is one 

that could strategically be triggered by an outside economy or an 

outside government, for instance China? And to what extent do you 

think the threat of that is realistic in the foreign policy perspective? Are we vulnerable to that. Or are the checks and balances 

that you referred to such that there really is not anything that a 

government could realistically do to trigger a hard collapse if very 

adverse relationships began to develop and they were using it as 

a strategic vehicle? 

Mr. BERGSTEN. They certainly could do it. They certainly have 

the wherewithal to do it. 

Senator WHITEHOUSE. And consequently, the wherewithal to 

threaten seriously. 

Mr. BERGSTEN. Right, so it is not idle to worry about it. However, 

that is one of the things I worry about least, because it is hard to 

see what the motivation for any foreign country, be it an ally like 

Japan or a potential adversary like China, to drive down the exchange rate of the dollar. Yes, they could do us some damage, but 

they do themselves a lot of damage, too. They would trash the 

value of their remaining horde of dollars. More importantly, they 

would drive down the dollar against their own currency, hurting 

their export competitiveness and their subsidy. 

71

Central banks, who hold these dollars in virtually every country 

around the world, have a fundamental mission of avoiding financial 

disruption for their own countries and for the world. So it is very 

hard to see the scenario under which any of them would do it. But 

they do have the wherewithal. 

And I will go back to what Senator Conrad said at the start, rumors of such action can destabilize markets. The big dollar decline 

in the 1970’s was triggered in part by rumors that Kuwait was 

going to sell $100 million of its dollar holdings. We never found out 

if they did it, or even thought about it, but rumors thereof are important. 

And the chairman showed an FT article that noted that even 

some talk in that direction by Chinese officials could bring the dollar down. 

When people say the dollar fell sharply as a result, usually it is 

1 or 2 percent. It is not very serious. And since we need a somewhat lower dollar for competitive reasons anyway, I do not worry 

about that. But it is true that such rumors could trigger market 

sentiments, which, if they snowballed into the private investors, 

could start the free fall and hard landing I talked about. 

But if you ask analytically where significant downward pressure 

on the dollar most would come from, my view is overwhelmingly 

from the foreign private investors, not the foreign officials. If the 

foreign private investors lost confidence in the dollar for the reasons I was suggesting, then you could get the big dollar decline. 

There has been a big dollar decline once a decade for the last four 

decades. And it has always been triggered by private foreign investors. 

Senator WHITEHOUSE. Because they do not have the export 

externalities, if you will. 

Mr. BERGSTEN. Exactly. And so they decide that, the euro looks 

better. 

I mentioned one point in my testimony that I have not had a 

chance to mention orally, and it is important. The creation of the 

euro is a big structural change in the world financial situation. One 

reason it has been easy for the United States to finance its deficits 

for the last 25 years since it has been running deficits is the dominance of the dollar in world finance. And the reason the dollar has 

been dominant in world finance for a century is that it really has 

had no competition. There has been no other currency based on an 

economy anywhere near our size or with financial markets anywhere our size. 

That has all changed with the creation of the euro, which is 

based on an economy almost as big as ours, with more trade and 

more financial reserves. So there are now two global currencies. In 

fact, in the last couple of years there has been more flotation of 

bonds in euros than in dollars; more euro currency is now held 

around the world than dollar currency. 

The potential therefore to move out of the dollar elsewhere or 

just to put those new investments every year into another currency 

is now very different than it has been for the whole earlier period 

of our external imbalances. 

The role of the euro is steadily creeping up vis-a-vis the dollar, 

taking more market share from the dollar in world finance. And 

72

that pace could accelerate very sharply if people, for whatever reason, lost confidence in the United States and/or if the Europeans 

started doing better. If in Europe productivity picked up like it did 

in the United States in the mid-90’s, and there is no reason it 

should not happen at some point, then you could see a big flood of 

investment going into the euro. A lot of that investment would 

come out of the dollar or at least would prevent new investment 

in the dollar. And then you could get—a sharp enough decline in 

the dollar to cause us real trouble and propel a hard landing. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. 

Chairman CONRAD. I thank the Senator. 

One thing I would just like to mention is well, we have been advised now there will be three votes at 11:55 and I want to make 

certain that Senator Sanders has the time that he deserves with 

the panel. 

One other observation I would make, to take this back to a budget context, because we have kind of veered off into mostly talking 

about the trade imbalance, which is critically important. It is the 

two of them in combination that I think has to concern us. 

And in the budget context, the thing that we have to be most 

concerned is the dissavings by the United States created by large 

increases in the Federal debt and this tremendous run-up that we 

forecast with the retirement of the baby boom generation. 

And it is, as you said earlier in your testimony, Dr. Bergsten, it 

is that effect that we have to be concerned about in terms of this 

committee’s jurisdiction and we have to focus on. 

I think even Mr. Malpass would agree that is a place where we 

have a special responsibility. 

Senator SANDERS. 

Senator SANDERS. Mr. Chairman, I apologize for being late and 

I welcome our panelists. I am sorry but I have not figured out yet, 

as a new senator, how to be in four places at exactly the same 

time. So I do apologize. 

This issue that you are discussing, actually, is one that I consider 

to be of enormous importance and of great interest to me. 

I would like to make a brief presentation and then I would like 

to ask you a kind of dumb bunny question, if I might. My presentation is this: it seems to me at least, as somebody who had been 

in the House of Representatives for 16 years, was there in the beginning of NAFTA and that debate, that corporate America and the 

corporate media was very solidly and is very solidly behind unfettered free trade. We were told from the beginning of NAFTA and 

PNTR with China that this is really going to be a good thing for 

American, in the sense of creating good paying jobs in this country, 

reducing our trade deficit, dealing with immigration, et cetera, et 

cetera. 

It seems to me that the evidence is quite overwhelming that 

what we were told by corporate America and by Presidents Reagan, 

Bush I, Clinton, Bush II, was going to happen, in fact has not happened. That the reality is not only that today we have a trade deficit of over $800 billion, of great concern to everybody, we have lost 

3 million good paying manufacturing jobs. 

Mr. Chairman, I do not know about North Dakota but in the 

State of Vermont in the last 10 years one new company has come 

73

into our State which is providing very good paying jobs. One new 

company in 10 years. I do not know how different it is in North 

Dakota. 

I was in China 5 years ago and, as all of you know, China is exploding. You cannot walk into a town without seeing a huge 

amount of building activity and so forth and so on. In my State, 

a small State, not a manufacturing State, we have lost 20 percent 

of our manufacturing jobs in the last 5 years. One out of five of our 

jobs. 

We are losing good paying jobs. Most of the new jobs that are 

being created pay lower wages than the jobs that we are losing. We 

are running up a huge trade deficit. There is speculation, for example, that the automobile industry in the United States may be in 

China in 20 years. 

My dumb bunny question is in the midst of all of that reality of 

the decline of the middle class, the increase in poverty, the loss of 

good paying jobs, the growth of our trade deficit, why is anybody 

continuing to defend our current trade policies? And why are people not saying excuse me, it is not worked, we need to rethink them 

very fundamentally? Dr. Bergsten? 

Mr. BERGSTEN. The huge trade and current account deficits cannot really be attributed to trade agreements. They can be attributed to these big macroeconomic imbalances that we talked about, 

including the exchange rates. 

I spent 2 hours before the Senate Banking Committee yesterday 

talking about the Chinese exchange rate and laying out a very aggressive program for attacking it, including with unilateral U. S. 

action if needed, because that exacerbates the problem so enormously. 

Senator SANDERS. But let me ask you this, and I share that concern. But if you are an employer in North Dakota or in Vermont 

and you can move to China and hire people, hard-working good 

people, at 50 cents an hour, you do not have to worry about unions, 

you do not have to worry about environmental protection, why 

would you not do that? 

Mr. BERGSTEN. The reason you would not is because the productivity of those Chinese workers is, in most cases, equally lower 

than their wages. 

Senator SANDERS. I do not believe that. 

Mr. BERGSTEN. In the aggregate it is true. But, I will grant you 

in some sectors it is not true, and that incentive exists in some sectors. 

Senator SANDERS. The people who run companies like General 

Electric are not dummies. When you have the CEO of General 

Electric saying that he sees the future of GE in China, or when you 

see white collar companies, information technology companies, 

moving as fast as they can to India, I understand the productivity 

in the United States is going to be higher in China. But if I am 

paying somebody 50 cents an hour, as opposed to $15 an hour or 

$20 an hour, I could compensate for that. If you work half as effectively I still make a lot more money. And the proof is in the pudding. 

Mr. Chairman, how many new plants have been built in North 

Dakota in the last 10 years? 

74

Chairman CONRAD. I do not know how many new plants. We do 

not have—we are very different, on almost any national metric, 

North Dakota is different. 

[Laughter.] 

Chairman CONRAD. We have had an increase in manufacturing 

in North Dakota but that is an unusual set of circumstances that 

relates to—you know, most people do not think of North Dakota as 

an energy state, but we are. So that changes things. 

Senator SANDERS. But in Vermont, and I think in the Northeast, 

what I am telling you is truth. There has been one major plant 

that has come in. 

My point gentlemen, and I would love to hear other discussion 

on it, is I think what has been distorted is you have—I remember, 

Mr. Chairman, because I was here for the NAFTA debate, every 

major newspaper in America editorial, down to the Toledo Blade, 

supported NAFTA. And I do not know how much change there has 

been in mentality. But I think if you look at it objectively, it is very 

hard to defend from the standpoint of the middle class or working 

families of this country, our current trade policy. I think more and 

more Members of Congress are beginning to understand it. Certainly the American worker understands that. 

But other discussion on why, at this point, somebody should say 

oops, we made a mistake. We have to rethinking this. And not just 

blue collar. I worry about white collar information technology jobs, 

as well. 

Any other comments, I would appreciate it. 

Mr. CLINE. If I might, I think it is fairly important to remember 

that Americans, the modest income households in this country also 

get a tremendous benefit from the availability of goods at bargain 

prices. Their real incomes would be considerably lower if we had 

protection like we used to, sky-high protection on apparel, for example. 

But I fully agree with my colleague, Fred Bergsten, that these 

huge widening trade deficits have much more to do with our macroeconomic policy, our fiscal policy, with exchange rates than they 

have to do with any massive change in our trade policy. 

There are other industrial economies, Europe is not in a situation of big trade deficits because of low-wage foreign competition—

your way of looking at it, which is an understandable initial approach. But if you parse it through, it seems to me it would imply 

that, of course, Europe and Japan would have tremendous deficits 

because they, too, have industrial country wages, in many cases 

higher than our wages. And neither can they compete with China. 

Well, we know that is not true. Europe actually had a surplus. 

It is about in trade balance. Japan has a huge surplus. 

I think you have your finger on the right concern, that the external sector is making life harder for American manufacturing than 

it need be. But I do not explain that because of NAFTA, and I do 

not explain it because of low wages in China. I do attribute to the 

constellation of macro policies that have led us to where we have 

the largest external deficit in our history. 

Senator SANDERS. My last question, and thank you for the time, 

Mr. Chairman, is worker productivity in the United States has 

risen quite rapidly. And yet in the last 6 years real wages or meVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00522 Fmt 6633 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
75

dian family income has gone down, workers are working, in many 

cases, longer hours for low wages, poverty has increased substantially. Why? And how can that not have something to do with our 

trade policies? 

Mr. CLINE. If my colleagues will forgive me, let me address that, 

too. Because I did a book in 1997 called Trade and Income Distribution. And it tried to parse out what was the role of trade and 

other factors in the rising wage differential between skilled and unskilled workers. And that had been going on since the 1970’s. 

My conclusion was that we should have expected that wage differential to decline because we had a huge increase in the supply 

of skilled workers from universities cranking out graduates. Instead, it increased. 

So there must have been large unequalizing forces. And the bulk 

of the unequalizing force seems to come from technological change 

that shifted out the demand for skilled workers more than the supply had shifted out. 

My calculations did show some modest further contribution from 

open trade, but it was much less important, far less important, 

than the technological change. And also, a very substantial contribution from the erosion of the real minimum wage and from the 

erosion of unions, de-unionization in the country. 

So I think there are a number of factors that have given us this 

uncomfortable period of a widening of the income disparities. I 

think it is wrong, though, to think that trade is the most important 

of those. 

And I would reiterate that trade protection hurts the consumers 

who are buying a lot of goods that are imported at prices that otherwise would not be available. 

Senator SANDERS. I do understand that, but I have a real fear 

that a great nation is not going to be a nation where millions of 

low-wage workers go to Wal-Mart. I do certainly agree with you. 

You can buy products very, very reasonably at Wal-Marts and 

other stores, no question about it. 

But that is not, I hope, what the future of American is, that we 

have workers who are working at low wages who survive by buying 

cheap labor made by people who make 30 cents an hour abroad. 

I would have a different vision for America. 

Yes, sir. 

Mr. MALPASS. Thank you, Senator Sanders. 

I wanted to underscore Fred and Bill’s points, and would agree 

with those in diverting the attention from the trade agreements 

into the macro climate. 

I do not think it is a fair characterization to describe the United 

States as headed in the direction that you are saying. This is a vibrant economy that is growing fast, that is creating a lot of well 

paying new jobs. 

The challenge is the amount of change going on in the United 

States Each quarter there is a tremendous number of Americans 

that leave a job and go to a new job. 

One of the things happening has been a migration from New 

England to the South. I am from New York State. New York State 

is losing population each year, and quite dramatically, at a time 

76

when the rest of the country is adding population. That creates 

particular strains. 

We can think in terms of transition assistance for people migrating to different parts of the country or different types of jobs. I 

think that we have to put some of these concerns into the overall 

manufacturing transition of the United States economy to services. 

In many ways, the United States is ahead of the rest of the world 

in doing the products of the future rather than products—you mentioned automobiles—the products that were invented a long time 

ago. 

One final point—

Senator SANDERS. I am not quite clear on what that means. Manufacturing jobs are in decline in the United States; is that correct? 

Mr. MALPASS. Yes. That decline has actually been a straight-line 

process for 50 years. 

Senator SANDERS. And the new jobs, service industry jobs—I am 

not an economist, but my impression is—pay substantially less 

than manufacturing jobs? 

Mr. MALPASS. No, I do not think that is correct. 

Senator SANDERS. Service industry jobs, working at Wal-Marts 

does not pay less than working at General Motors? 

Mr. MALPASS. That would be correct. 

Mr. BERGSTEN. Working at Goldman Sachs. 

Senator SANDERS. Goldman Sachs is a service industry jobs? 

Mr. MALPASS. On average, services jobs pay more than manufacturing jobs. 

Senator SANDERS. Waiters and waitresses? I mean, I guess the problem is working at Goldman Sachs they are going to get a $50 

billion bonus. Do we equate that in the same category as working 

at McDonald’s, does not make a lot of sense to me. 

Mr. BERGSTEN. No, but workers in the big services sectors—hospitals, health care, education, teachers, administrators, and government employees. Those are the big parts of the services sector. And 

even some retail and wholesale trade jobs actually pay pretty well. 

You are right, of course: A hamburger flipper or a low-wage janitor are services jobs as well. But so are some apparel and footwear 

workers, who to the extent that they still exist get very low wages 

as well. But services, on average, do pay higher than manufacturing jobs. And that is fortunate, since that is 80 percent of the 

work force now. 

Mr. MALPASS. May I add one more point? You raised the median 

income issue. 

We have gone through a remarkable 10-year period with the 

swing in the value of the dollar. Some portion of the median income weakness of these last 5 years has been related to this. As 

the dollar weakened in 2001, 2002, and 2003, with low United 

States interest rates, commodity prices went up a lot. Wages are 

just now beginning to go up as much. 

There is a timing cycle that is adding to this sense of the median 

wage being weak. The first prices to adjust, after a big devaluation 

of the dollar as we have gone through, are for things that are not 

so much produced in the United States That is going to have a negative effect on the median wage until workers catch up, which is 

the process we are in now. 

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Chairman CONRAD. Can I just say—

Senator SANDERS. Do we have a vote? 

Chairman CONRAD. Yes, the vote has started, and we are probably 3 minutes into the vote. I would say to my colleague, we would 

give Mr. Bergsten a chance to respond and then if you would have 

a final question. 

Mr. BERGSTEN. To be clear, we as a country do a lousy job equipping our lower-skilled, lower-educated, lower-income people to compete in a globalized economy. We have done intense studies of 

globalization’s effect on the United States economy. We conclude 

that the United States economy as a whole is today $1 trillion per 

year richer than it would otherwise be as a result of our integration into the world economy and globalization. That is $10,000 per 

household. 

However, it does add to the unequal income distribution. And 

therefore, there is a cardinal need for the country to do a much better job in K–12 education, in training programs, and in transitional 

safety net assistance to help the losers, which there clearly are as 

part of the process, to reap some of the benefits. 

We gain $1 trillion a year. We spend $1 billion a year on trade 

assistance. 

Senator SANDERS. My constituents do not gain part of that. Most 

of that or much of that $1 trillion goes to people very much on the 

top. 

Mr. BERGSTEN. That may be for the next debate, but as Bill Cline 

said, a lot of it goes to low-income people because of those cheaper 

goods at Wal-Mart. 

Chairman CONRAD. Let me just put a final question to you. 

In terms of the responsibility in this committee, and I would just 

ask you to respond briefly, do you believe it is important that we 

work to address especially these long-term fiscal imbalances that 

we confront? 

I would start with you, Mr. Bergsten. 

Mr. BERGSTEN. It is imperative that you fashion and implement 

soon a decisive answer to the long-run fiscal problems. In addition 

to all the domestic problems it would cause, we would almost surely be triggering at some point—sooner rather than later—an external crisis that would be enormously damaging to the United States 

economy, United States foreign policy, and all of the objectives that 

you and the committee, but Congress more broadly, are pursuing. 

Chairman CONRAD. Dr. Cline? 

Mr. CLINE. Yes. I think it is critical. Some of the numbers are 

just mind-boggling in terms of the rise of Medicare and Medicaid 

as a percent of GDP. It is a rise from 4 percent of GDP to 12 percent of GDP or something like that. That is critical. 

I would also underscore that I think even in the shorter term, 

three or four or 5 years, it is highly desirable to move from our 2 

percent of GDP realistic deficit to something like a 1 percent surplus. 

Chairman CONRAD. Mr. Malpass? 

Mr. MALPASS. Mr. Chairman, and I agreed with your point that 

it is imperative that we do things. I will list four. One is be very 

cautious of new entitlements. They kind of creep up decade after 

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decade. Also, be cautious of expanded entitlements. They quietly 

gather more reach. 

With regard to Medicare, pay particular attention to possible efficiencies within Medicare. 

And then fourthly, a glaring need is tax reform. We have a tax 

system that does not work, and there is no real plan to begin to 

fix that. 

Chairman CONRAD. Let me just say that is one of the things Senator Gregg and I have tried to put on the agenda here, is a procedure that would involve eight Democrats, eight Republicans. They 

would be given the responsibility to come up with a plan that 

would involve both the long-term imbalances and tax reform and 

revenue issues and come back with a plan that would take a super 

majority of that committee to report, and it would take a super majority here to pass on a fast-track basis. 

That is what we are trying to advance here. And that is a challenge in and of itself. 

We are well into this vote. I just want to conclude by thanking 

this really distinguished panel. You have been, I think, especially 

interesting to the committee. 

Thank you very much. 

[Whereupon, at 12:06 p.m., the committee was concluded.] 

(79)

HEARING TO CONSIDER WAR COSTS 

TUESDAY, FEBRUARY 6, 2007

UNITED STATES SENATE, COMMITTEE ON THE BUDGET, Washington, DC. 

The committee met, pursuant to notice, at 10:08 a.m., in room 

SD–608, Senate Dirksen Office Building, Hon. Kent Conrad, chairman of the committee, presiding. 

Present: Senators Conrad, Murray, Wyden, Stabenow, Menendez, 

Cardin, Sanders, Whitehouse, Gregg, Domenici, and Allard. 

Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 

Staff Director for the Minority. 

OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

Chairman CONRAD. I would bring the hearing to order. 

I would like to welcome everyone to today’s Budget Committee 

hearing on war costs. I would like to particularly welcome our witnesses. Dr. Gordon Adams, a Fellow at the Woodrow Wilson International Center for Scholars, and a former Associate Director of the 

Office of Management and Budget for National Security. Welcome, 

Dr. Adams. 

Dr. Michael Gilmore, the Assistant Director of the Congressional 

Budget Office and the head of CBO’s National Security Division, 

somebody who is very respected on these issues. We are glad to 

have you here. 

And Steve Kosiak, the Director of Defense Budget Studies at the 

Center for Strategic and Budgetary Assessments. 

Thank you all for your contribution to the work of the committee. 

I want to indicate that, in addition to today’s hearing, next 

Thursday we expect to hear from the Secretary of Defense, Mr. 

Gates, on the question of war costs, as well as the overall defense 

budget. 

The Administration has been financing this war not through the 

regular budget process but, as you know, through a series of supplemental appropriations bills. We very much believe that these 

war costs ought to be considered in the regular budget process so 

they get the oversight that they deserve. 

To do the war funding the way the Administration has been 

doing it avoids accountability and oversight. When we are spending 

over $10 billion a month, we think it is critically important that 

Congress conduct its oversight responsibilities. 

Let me be clear, we will provide our troops with everything they 

need for as long as they are in harm’s way. I want to be crystal 

clear on that point. We will stand shoulder to shoulder with those 

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who are supporting the resources that are necessary for our troops 

in the field. That is a responsibility that all of us on this committee 

recognize. 

But we will also conduct the oversight that has been lacking because these provisions have not been in a budget request. 

I want to, at this moment, commend my colleague who chaired 

this committee previously for his vigorous insistence that these 

costs be included in a budget. Senator Gregg was a leader on this 

matter, is a leader on that matter, and I want to commend him for 

it. 

The fact is that the Bush Administration has not shown, in its 

previous budgets, the full cost of the war. At one point at the beginning of the war the head of the Bush Administration’s USAID 

said, and I quote, ‘‘That is correct, $1.7 billion is the limit on reconstruction for Iraq. In terms of the American taxpayer contribution, 

that is it for the United States The rest of the rebuilding will be 

done by other countries and Iraqi oil revenues.’’

He could not have been more off the mark. We have already committed $28 billion for Iraqi reconstruction, and that does not count 

the money for their security forces. 

At another point, in testimony before the Congress, the Deputy 

Defense Secretary, Mr. Wolfowitz, said this ‘‘The oil revenues of 

Iraq could bring between $50 billion and $100 billion over the 


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course of the next two or 3 years. We are dealing with a country 

that can really finance its own reconstruction, and relatively soon.’’ 

That prediction was also wrong.

Secretary of Defense Rumsfeld was even more dismissive of predictions that the war could be costly. Here is the transcript of an 

interview on This Week With George Stephanopoulos. 

Stephanopoulos: What should the public know right now about 

what a war with Iraq would look like and what it would cost? 

Secretary RUMSFELD. The Office of Management and Budget estimated it would be something under $50 billion. 

Stephanopoulos: Outside estimates say up to $300 billion. 

Rumsfeld: Baloney.


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It was not baloney. We now know that the $300 billion estimate 

does not cover the cost of the war this far. In fact, it was far below 

the cost of the war to this juncture. 

Including the requests in the President’s budget released yesterday, the Administration has now asked for a total of over $520 billion in emergency funding on top of the regular defense budget. 

That is more than 10 times the Administration’s original war cost 

estimate.


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To put this cost in perspective, the Iraq war is now approaching 

the cost of the Vietnam War. In 12 years of major involvement in 

Vietnam, we spent $650 billion in today’s dollars. Less than 4 years 

after the invasion of Iraq, we are now considering a request that 

will bring the total cost of the Iraq war to more than $500 billion. 

And that is without including the $50 billion placeholder the President included in his budget for war costs in 2009.


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If we add Iraq and Afghanistan costs together, we are already 

well above the cost of the Vietnam War. Unfortunately, Iraq has 

diverted resources from our effort in Afghanistan. The news from 

Afghanistan has been troubling and disturbing. The situation there 

looked like it was improving a few years ago but now has deteriorated. We, I think, all understand the absolute necessity of prevailing in Afghanistan. 


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The budget also reflects these wrong priorities. Between what we 

have spent and what the Administration has requested, Iraq has 

received $3 for every dollar in Afghanistan. That is despite the fact 

that it was Osama bin Laden, based in Afghanistan, who attacked 

the United States and not Iraq, led by Saddam Hussein.


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The Bush Administration’s cost estimate on the buildup, the further buildup that he is calling for in Iraq, has also been subject to 

question. The Administration has indicated to us that the cost of 

the escalation in Iraq would be $5.6 billion. Yet last week the Congressional Budget Office informed the committees that the surge 

would actually cost $9 to $27 billion, depending on the duration of 

the escalation because the Administration was not fully accounting 

for the cost of all of the support troops needed.

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In addition to questions about the number of support troops 

needed for the President’s plan, there are also questions about 

whether our troops lack the equipment needed to get their job 

done. Here was a Washington Post headline last week ‘‘Equipment 

for added troops is lacking: new Iraq forces must make do, officials 

say.’’


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That is a serious matter. We should not be sending our troops 

into harm’s way without the equipment that they need. I see no indication that the President’s plan will cover the costs, his budget 

plan will cover the costs that CBO has alerted us to. 

I look forward to hearing our witnesses thoughts on the costs of 

the President’s proposals and look forward to the chance for questions from the panel. 


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With that, I turn to my colleague, Senator Gregg. 

OPENING STATEMENT OF SENATOR JUDD GREGG 

Senator GREGG. Thank you, Senator Conrad. And I do think this 

is a very appropriate hearing. I wish we had someone from the Defense Department testifying, but I know it is difficult to get them 

to come to the Budget Committee, having been chairman and requested that a number of times. 

I appreciate the Senator’s comment that the troops in the field 

will get the support they need. Obviously, I believe that is the correct policy. I know the Senator is very sincere in his belief in that. 

I just wish the Majority Leader were equally sincere and would 

allow us a vote on that specific language this week, which appears 

to be something the Majority Leader is now going to allow us to 

do. That is a fairly reasoned position. But the troops in the field 

should be supported. But as of right now, the Majority Leader 

takes the position that the amendment should not be allowed to 

the floor as one of the three things we vote on or four things we 

vote on this week. Very strange in my opinion, inconsistent to say 

the least. 

On this next issue, however, of budgeting for troops and our 

costs, I do agree with the Chairman. We have very serious concerns 

about the way the Administration has brought forward their budget. I will begin by congratulating them for at least including this 

year what they project as the full cost in 2008. I thank Director 

Portman for insisting on that. I do not think the Pentagon would 

not have done it without the Director’s insistance. 

However, once again they have designated it as an emergency. 

This is unacceptable. It is very clear, after 5 years of war, that it 

is not an emergency, that it is something that we have to do. We 

have to fight this war and we have to make sure our troops that 

go into this battle are fully supported with the resources they need. 

And it should go through the regular order. Because we have seen 

in a couple of the other supplementals that have been sent up that 

things which were not war fighting have been included. And it has 

been represented, at least in press reports, that that may occur 

again, such as the repositioning of the Army and aircraft would be 

purchased for the out years, and even boats that do not deal with 

the immediate issue of fighting the war. 

So I do think this language should have the emergency designation stripped from it, and it should go forward as a sidecar. That 

is the way I would describe it. I do not want it folded into the core 

budget because I do not want, two or 3 years from now when the 

war does wind down and we are out of Iraq, which we all hope will 

happen, I do not want the defense base to have grown by the 

amount of the war cost. And then we have to go back in and pick 

the money out in order to get the defense repostured at its proper 

level. 

I believe we should have a base budget for the Defense Department and we should have what I call a sidecar for fighting the war. 

But it should not be an emergency event, it should go through the 

authorizing process. 

I will be interested in the proposal that comes forward from our 

Democratic colleagues, as they are now responsible for the reins of 

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Government, and specifically the budget. As we all know, the budget is not signed by the president, it is truly a work of the Congress, 

about how you are going to handle these war costs. 

My own view is you need to put more in for 2009. I think the 

White House and the Administration has grossly underrepresented 

that number with a $50 billion plug. That is not anywhere near 

what the 2009 cost is going to be. A more correct number is probably going to be on what the historic average is, somewhere around 

$90 billion or $100 billion. 

But it will be interesting. You have a difficult task, and I will 

be happy with you on that. 

But I do think we should get this number right and we should 

give the military the dollars they need to make sure the men and 

women who are in the field are properly supported. And we should 

do it in the regular order, not outside the regular order. 

I thank you for having this hearing. 

Chairman CONRAD. I thank Senator Gregg for those observations. 

We will now go to the witnesses, and we have asked each of 

them to limit their remarks to five to 7 minutes so there are sufficient time for questions by colleagues. 

We will start with Steven Kosiak, the Director of Budget Studies, 

the Center for Strategic and Budgetary Assessments. 

Welcome, Mr. Kosiak, and please proceed with your testimony. 

STATEMENT OF STEVEN M. KOSIAK, VICE PRESIDENT FOR 

BUDGET STUDIES, CENTER FOR STRATEGIC AND BUDGETARY ASSESSMENT 

Mr. KOSIAK. Thank you. 

First I want to thank Chairman Conrad and the rest of the committee for inviting me to testify this morning on this very important subject. 

In my testimony, I want to make four points related to the costs 

and funding for the global war on terror, or the GWOT. My first 

point is a simple one, and that is that the GWOT has proven to 

be very costly, and those costs have grown substantially over time. 

All together, the money that’s been appropriated so far through 

2007, is $502 billion for the GWOT, and that includes—you can get 

somewhat different estimates—something like $345 to $375 billion 

for Iraq, $100 billion for Afghanistan, and $25 to $55 billion for a 

variety of other programs and activities. 

Yesterday, the Administration requested another $93 billion for 

2007 and $142 billion for 2008. 

Assuming these two measures are enacted, total funding for the 

GWOT would rise to about $737 billion through the end of next 

year. That would make the GWOT more expensive than either the 

war in Vietnam or the war in Korea. 

GWOT funding is not only high today, it has been growing significantly over time. Back in 2001, when we first sent troops into 

Afghanistan, the budget was about $14 billion. In 2003, after we 

sent large forces into Iraq, the budget jumped to about $88 billion. 

In its most recent request, if you add together what’s already been 

provided by Congress in 2007 with the new request, it would 

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amount to about $163 billion. That is roughly a doubling of GWOT 

costs in just the past 4 years. 

The second point I would like to make is that it is unclear why 

the GWOT has proven to be so expensive and why there has been 

such significant cost growth in recent years. 

Chairman CONRAD. Mr. Kosiak, when you refer to GWOT, just 

for those who are listening, you are referring, I assume, to the global war on terror? 

Mr. KOSIAK. Yes, yes. 

Chairman CONRAD. That is kind of the shorthand here in Washington, but those who are listening in might not be able to translate that. 

Mr. KOSIAK. Good point. 

If you look at the estimates of the cost of conducting military operations in Iraq and Afghanistan, those have grow significantly 

over time, and this is true even if you adjust for changes in force 

structure, and in force levels that have occurred. 

In September 2002, CBO estimated that based on the cost of past 

conflicts like Desert Storm/Desert Shield and operations in Bosnia 

and Kosovo, sustaining an occupation force consisting of 75,000 to 

200,000 United States troops in Iraq would cost something like $20 

to $50 billion a year. And that works out to about $250,000 per 

troop. 

CBO’s high-end estimate of the number of troops required turned 

out to be fairly close to the mark, but its per troop cost estimate 

turned out to be far too low. 

In 2004, CBO released another estimate. In this case, the costs 

per troop work out to something like $320,000 per troop. In its 

most recent 2006 estimate, CBO increased its estimate of funding 

for the global war on terror once more. This time the costs per 

troop work out to something like $540,000 per troop. 

This is more than twice what CBO estimated in 2002 prior to the 

war in Iraq, and nearly 30 percent higher than what they were 

projecting just a few years ago in 2005. 

If this cost growth in CBO’s analysis were based on data they 

had gotten from DOD, rigorous detailed cost data, then this cost 

growth might not be so troubling. But that is not really what it is 

based on. CBO’s latest estimate is basically a simple extrapolation 

of enacted appropriations from 2006 adjusted for inflation and 

changes in force levels. It is not a truly independent estimate of the 

cost of military operations in Iraq or Afghanistan or other activities 

related to the global war on terror. 

This cost growth might also be less troubling if it were clearly 

linked to changes in OPTEMPO or changes in the amount of equipment that needs to be replaced and repaired, or the inclusion of 

costs related to training and equipping Iraq and Afghan security 

forces. But even taking these factors into account, much of the 

growth I have described is left basically unexplained. 

I want to make clear that nothing I am saying here should be 

taken as a criticism of the Congressional Budget Office. The problem is that CBO has not been provided with the kind of data it 

needs to do these kinds of estimates, either to do independent estimates of GWOT costs or to verify the accuracy of DOD’s estimates 

of GWOT costs, as well as funding requirements. 

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It has also made it very difficult to project future funding requirements with any level of confidence. This is a point that CBO 

has made on multiple occasions over the past year and going back 

at least, I think, as far as 2004. 

The third point I would like to make is that an increasing share 

of funding for the global war on terror appears to be going to programs and activities that are, at best, only indirectly related to the 

military operations in Iraq or Afghanistan. This may be part of the 

explanation for this cost growth that we have seen in recent years. 

There has always had some funding in these supplementals that 

has been unrelated or only loosely related to the wars in Iraq and 

Afghanistan. The most obvious example of that is funding for the 

Army’s modularity program. But it is unclear just how much 

money funding in these past supplementals was in this category. 

Whatever has been true in the past though, it seems likely that 

in the future more of this kind of funding is going to be included 

in the GWOT, in the global war on terror appropriations. In part, 

this is because in October of 2006, Deputy Secretary of Defense 

Gordon England sent the services a new guidance, telling them 

that they should not feel that they have to limit their requests for 

supplemental funding for the global war on terror to programs and 

activities closely related to the operations in Iraq and Afghanistan, 

but should feel free to include, with a few caveats, funding for a 

broad range of other programs and activities that fit within the 

broader global war on terror. 

Unfortunately, in my view, this basically removed any principal 

distinction for the services between what they should include in 

base budgets, long-term budgets, and what they should include in 

special global war on terror appropriations. 

The most significant problem with this approach is that this 

guidance basically tells the services that they do not need to find 

room in their regular baseline budgets for fully covering the costs 

of their long-term force structure readiness and modernization 

plans. The services already have a serious and persistent problem 

in coming up with and presenting long-term plans that actually fit 

within realistic projections of what level of funding is going to be 

available. This change will only make the matter worse and, in the 

end, the services will have inevitably suffered the most from this 

weakening of their planning and budgeting process. 

The fourth and final point I want to make is just that we really 

do need to improve our understanding of these costs. If we are 

going to appropriately and effectively budget for the global war on 

terror in the future and if we are going to appropriately budget for 

the service’s long-term force readiness and modernization plans. It 

is not just a question of getting the global war on terror right, it 

is getting their long-term plans right. 

CBO has done the best that they can do with the data available, 

but that data has not been very good. And I think CBO could do 

a much better job, and other analysts could do a much better job, 

if the Department of Defense would provide more rigorous data, 

and more detailed and more timely data. 

At present, at this point I cannot say whether that data has been 

provided in the most recent budget request or whether it will be 

provided in the coming weeks. But if it is not provided, then I 

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think Congress needs to once again pressure the Administration to 

provide better data. 

With that, I will end my comments and again, thank the committee for inviting me here this morning. 

[The prepared statement of Mr. Kosiak follows:]


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Chairman CONRAD. Thank you for your testimony. Now we will 

turn to Dr. Gordon Adams, a Fellow at the Woodrow Wilson International Center for Scholars and a former Associate Director of the 

Office of Management and Budget for National Security. 

Welcome, Dr. Adams. 


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STATEMENT OF GORDON ADAMS, FELLOW, WOODROW WILSON 

INTERNATIONAL CENTER FOR SCHOLARS 

Mr. ADAMS. Thank you, Mr. Chairman and ranking member. 

Thank you for holding this hearing. 

I think it is a very timely and important matter you are dealing 

with here today and it is not going to stop here. It is a matter that 

you are going to have to deal with, sadly, for sometime to come. 

I also want to commend both you Mr. Chairman, and the ranking 

member, for stepping up to this issue over the past year, addressing yourselves directly to the Department of Defense and the Administration and urging legislating the expectation that budget expenditures for the global war on terror, and Iraq will be brought 

forth as part of the regular budget. I will make a comment about 

that in a moment in terms of the current budget request. 

I want to talk about a couple of areas this morning, but let me 

start by saying that spending on the global war on terror, roughly 

80 percent of which is for the conflict in Iraq, is consuming a rapidly rising share of defense spending and of the overall budget. If 

you take all of the requests for the global war on terror together, 

over the next 18 months we will be increasing spending for the 

global war on terror by 50 percent over all prior spending for the 

global war on terror. So it is a very rapid slope upwards. 

I want to talk about two areas briefly this morning. One of them 

concerns defense programs and it will reinforce some of the points 

that Steve Kosiak has just made, about the integrity of the defense 

budget process and the quality of the justification for this spending. 

And I want to mention briefly the budget implications of the Administration’s proposal to expand the size of United States ground 

forces overall for the long war on terrorism. 

The second area I want to mention, which we do not talk so 

much about, is international affairs spending which is also, a concern of this committee. I want to talk a bit about the adequacy of 

our estimating and budgeting for Iraqi security assistance and economic reconstruction, and about the issue of the relationship between Defense and the State Department and AID with respect to 

the delivery of these kinds of programs. 

First off, defense. As Steve Kosiak has said, this war is getting 

increasingly expensive and it is, as the Chairman has said, being 

funded largely through emergency supplemental or bridge funding. 

What is interesting is if you go back and look at the overall share 

of total resources available to the Department of Defense over the 

last eight budget years, there has been a very sharp increase in the 

share of the total resources coming through emergency and bridge 

funding supplementals. That share has risen from something like 

6 percent in fiscal year 2001 to 21 percent in 2006 to, if you accept 

the President’s current request, 27 percent in 2007, and 23 percent 

in 2008, with more likely on the way. 

In other words, about a quarter of the total resources available 

to the Department of Defense right now are coming through these 

emergency supplementals and bridge funding for the global war on 

terror. 

What this has meant, in effect, is that the Defense Department 

has been conducting two parallel budget processes. One process 

that is, the PPBES, the normal programming planning, programVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00550 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ming budgeting and execution system. And the other is the emergency supplemental and emergency bridge funding requests. 

These latter are out of phase with the normal budget cycle in the 

Department of Defense and tend to be given much less scrutiny of 

the kind that is given to the normal budget in the PPBES system. 

The Administration has decided it will comply with the language 

of Section 1008 of the Authorization Act and send up with its fiscal 

2008 budget the fiscal 2008 request it has in mind for the global 

war on terror. That is a good thing and I commend them for taking 

that step. I think Director Portman deserves a lot of credit for 

pushing that very hard. 

On the other hand, this spending was still prepared outside the 

normal budget process in the Department of Defense. The guidance 

for the FY 2007 supplemental and the guidance for FY 2008 both 

came out long after the PPBES system had been dealing with scrutiny of the Defense Department’s regular budget. So it still does 

not get the same kind of scrutiny. 

That dual process has had a corrupting effect on the normal Pentagon PPBES system, because the Department tends to treat these 

two budgets as fungible. Steve Kosiak has talked about programs 

that show up in the emergency supplementals that are really 

longer-term, such as long-term delivery of aircraft, helicopters, and 

long-term planning for forces. But they show up in the emergency 

supplemental request. 

Operations and maintenance funding, in general, is fungible between the resources provided for the war and the resources provided for the normal operations of the Department of Defense, outside the conduct of the global war on terror. 

So, to reinforce the points that both of you have made, there 

needs to be a clearer separation between the two. Gordon England’s guidance to the services to prepare the FY 2007 second supplemental muddied the waters even further by allowing items related to the long war to be included in the emergency supplemental. 

Let me address my second point briefly, and that is the expansion of the Army and the Marine Corps, which is also included in 

the President’s budget. This is relatively unrelated to Iraq, maybe 

even to Afghanistan, because troops that are needed under that 

process are likely not to be available in time to solve the stressful 

rotation problems there. 

But here, too, there is a budgetary problem. Aside from the question of whether such an expansion is justified, which I have written 

about in other contexts, the emergency supplemental for FY 2007 

includes $1.2 billion for this force expansion. So it is put on an 

emergency basis, though it is not an emergency program. In timing 

terms, this may get it going but, it is in the wrong place in the 

budget. There is $12 billion in the 2008 budget for this process. 

As a budgetary matter this force expansion has grave implications for the defense budget and for the overall Federal budget and 

for your work. Forces in the end drive budgets. This will be an expensive proposition. Press reports now say that it will cost as much 

as $117 billion and it may lay $15 to $20 billion a year against 

each annual budget to accommodate the future costs. 

104

Forces drive defuse budgets, and we have had a ‘‘consumption 

driven’’ buildup over the past 6 years that will further drive the 

defuse budget. We will have a lot of people who will require a lot 

of training, who will require a lot of equipment. 

This is a problem if defense budgets turn around and start to 

come down because there will need to be bill payers. And some of 

that bill paying may happen inside the defense budget itself. That 

will have a potentially dramatic impact on the acquisition of technology and new equipment in the services as procurement budgets 

become the bill payer for expanded force size. 

And it may, as well, be a problem for the Federal budget as a 

whole. In the President’s budget, submitted yesterday, something 

like 56.2 percent of all discretionary spending, was committed to 

what is called ‘‘security spending’’. A useful concept actually, defense, homeland security throughout the Government, and Function 150 (international affairs). By 2008, that security share would 

rise to 60 percent, and it would be 65 percent if one fully included 

the costs of the global war on terror. 

In other words, about two-thirds of Federal discretionary spending by 2008 would be committed to security issues. And the Administration has been quite up front about the priority that they put 

on those expenditures. That is likely to make your job considerably 

difficult, year by year, as those programs consume larger and larger shares of discretionary spending. 

Finally, let me turn to the two implications, I want to mention 

for the international affairs account. We do not talk about it much 

and yet arguably the critical contribution that diplomacy and foreign assistance make to our national security obligates us to focus 

on those tools of statecraft that reinforce, supplement, may even 

make unnecessary certain military operations. 

In the global war on terror related budgets, there are $6.3 billion 

worth of global war on terror-related nondefense programs in the 

2007 emergency supplemental and another $3.5 billion in the fiscal 

year 2008 emergency part of the budget. And of this, 95 percent is 

in international affairs. 

I want to make two points about this. Point No. 1: we are not 

doing a very good job of estimating the fiscal needs involved here. 

As the Special Inspector General for Iraq Reconstruction has pointed out in his latest quarterly report, the United States has 

comitted over $38 billion to security assistance and foreign assistance in Iraq since the war began. 

That understates, however, the level of the resources committed 

to these purposes. Over $50 billion of Iraqi government funds, some 

seized funds, some budgeted over the past 2 years, have gone to the 

same purpose. And there is $15 billion worth of international funds 

coming in quite slowly, that have been committed, for this purpose. 

Put another way, the total commitments and expenditures on 

Iraqi reconstruction and security assistance since the war began 

come to over $100 billion. Not $20 billion, not $38 billion, but over 

$100 billion. 

We have not done a very good job of estimating that cost. Even 

the international community has not done a very good job, since 

the 2003 World Bank/UN estimate of the costs of reconstruction in 

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Iraq was $55 billion, or just a little over half of what has been 

comitted. 

There is another $18 billion worth of security assistance and economic reconstruction assistance in the 2008 budget request. So that 

cost is going up. 

Senator DOMENICI. Mr. Chairman, might he go back 2 minutes 

and repeat what he has just said? 

Mr. ADAMS. I am happy to, Senator. Where do you want me to 

pick up? 

Senator DOMENICI. Do you know where you talked about this last 

set of estimates being out of—

Mr. ADAMS. The reconstruction and security assistance estimates. 

Senator DOMENICI. It is much bigger, and I did not understand 

what that was. 

Mr. ADAMS. Absolutely. The Special Inspector General for Iraq 

Reconstruction, Stuart Bowen, estimated in his last quarterly report, that the United States has committed over $38 billion to security assistance and economic reconstruction assistance in Iraq. 

Iraqi government funds have amounted to over $50 billion. Some 

of it is funding that we retained control over because it was seized 

in oil-for-food assets. Some are assets they have budgeted through 

their own capital budget for economic reconstruction. 

And third, there is about $15 billion worth of international community—World Bank, International Monetary Fund, European 

Union, Japan, Britain and other countries—commitment to Iraqi 

reconstruction. 

The total is $104 billion. That is setting aside the $18 billion requested for fiscal year 2008 in the President’s budget, which would 

be in addition. 

Is that clear? 

Senator DOMENICI. Thank you, Mr. Chairman. 

Mr. ADAMS. Finally, the last question I want to deal with, Mr. 

Chairman, is the question of responsibilities for these programs. 

Iraq and Afghanistan have been a test bed for a different way of 

delivering foreign and security assistance by the United States 

Government. It is a test bed for a concept that has the Defense Department increasingly assuming responsibilities for security assistance and foreign assistance delivery. This includes a major training 

and equipping program in Iraq and Afghanistan, not dissimilar to 

what we might have done under foreign military financing, but we 

are now doing directly through Department of Defense funding. 

They are seeking to globalize that training and equipping program in order to stabilize and restore authority to ungoverned 

areas and prevent terrorist havens elsewhere. 

Second, the Commander’s Emergency Response Program, 

(CERP), has become a billion-dollar item in the fiscal 2008 budget 

request. It is for local rapid delivery of what is, in effect, economic 

and reconstruction assistance. The Pentagon seeks to globalize that 

program, as well. 

And two new fellowship programs, a counterterrorism fellowship 

program and a stability operations fellowship program, both of 

which are operated independently of the International Military 

Education and Training Program, (IMET). And budgetary support, 

106

because through Pentagon funding and emergencies we are, in effect, reimbursing the Pakistani government and other governments 

for their support with the global war on terror. 

The argument is that the Defense Department itself has the 

skills, the logistics, the equipment, the budget, the direct contacts 

to do this in an effective and efficient and agile way and the State 

Department and AID do not. They lack the budget, cannot raise it, 

do not have the training, do not focus on these issues. 

As a consequence, we are walking down a road without really 

evaluating where we are going. The consequence for the State Department is that as we charge Defense more and more with foreign 

and security assistance responsibilities, we begin to disempower 

the State Department and AID to oversee policy and to supervise 

and implement such programs. 

And the consequences for the Defense Department are that we 

increasingly are putting our men and women in uniform into the 

job of security and foreign assistance providers, which diverts them 

from their core military mission. 

In effect, we may be underfunding and disempowering our diplomacy and foreign assistance, and, at the same time, distracting the 

military from their core mission. 

So I urge you, when you talk with other witnesses both from the 

State Department and AID, and from the Defense Department, 

that you raise these issues about the balance and integration of our 

security assistance and foreign assistance efforts. 

Thank you, Mr. Chairman. 

[The prepared statement of Mr. Adams follows:]

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Chairman CONRAD. Thank you, Dr. Adams. 

Now we will turn to Dr. Gilmore, the Assistant Director of the 

Congressional Budget Office and the head of CBO’s National Security Division. 

Welcome, Dr. Gilmore. 


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STATEMENT OF J. MICHAEL GILMORE, ASSISTANT DIRECTOR 

FOR NATIONAL SECURITY, CONGRESSIONAL BUDGET OFFICE 

Mr. GILMORE. Mr. Chairman, Senator Gregg, members of the 

committee, I appreciate the opportunity to appear here today to 

discuss Iraq war costs. My remarks will focus on the estimate of 

the cost of implementing the President’s plan to increase forces in 

Iraq that CBO released last week. 

At the request of the House Budget and Armed Services Committees, CBO has estimated the costs of that plan, in which CBO models the maximum increase in forces to span 4 months, namely from 

May through August, as well as two other scenarios increasing the 

span of that surge to 12 months and 24 months. 

CBO estimates that the incremental costs, that is over and above 

the costs of the previously planned operations which would have 

sustained 15 brigade combat teams in Iraqi, of the President’s plan 

would range from $9 billion to $13 billion through fiscal year 2009, 

with $7 million to $9 billion of that cost occurring in fiscal 2007. 

I will discuss the reasons for that range in just a minute. 

If that increase in forces were extended to last 12 months, CBO 

estimates that costs through fiscal year 2009 would range from $20 

billion to $27 billion. 

Now CBO’s estimates depend critically on the answers to three 

questions. How many additional troops will actually be deployed? 

How long will the deployments last? And what are the additional 

costs associated with incremental troop deployments? The rest of 

my remarks will focus on those three points. 

The President announced his plan on January 11th, indicating it 

would comprise about 20,000 troops. The Administration has now 

confirmed that that figure referred only to the number of troops in 

the brigade combat teams to be deployed, not to the additional support troops that might be needed. All major military operations involve support units in the theater other than those included in the 

combat brigades. That is support at echelons above brigade and 

echelons above division. 

Historical experience, including experience with Operation Iraqi 

Freedom, shows that substantial numbers of such support troops 

always accompany combat brigades deployed to conduct combat operations. Support functions performed outside the brigades include 

almost all logistics, higher-level headquarters, military police, military intelligence, signals—meaning communications—engineers, 

medical and other services. Providing the needed level of these 

services is essential to conducting an effective combat operation. 

The number of support troops necessary to perform these tasks 

increases when the number of combat troops expands and, in particular, Army planning often assumes the need for these services 

increases in direct proportion to the number of combat troops in 

the theater. It is worth noting that it is difficult to rely on contractors to perform all of these services, particularly in combat zones. 

The Army plans to, and has structured its force to, and historically has deployed one to two support personnel per combat person. 

Based on historical deployment data from DOD for Operation Iraqi 

Freedom, CBO’s higher cost estimate assumes about 5,500 additional support personnel deployed to the theater per 4,000 person 

combat brigade. Those are average figures. Obviously, the composiVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00565 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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tion of individual brigades differs. That is the average support-tocombat ratio for such deployments in Operation Iraqi Freedom 

since September 2003. 

In that case, building the 20 combat brigades in theater will 

raise ground force levels from about 142,000 currently—and that is 

in the entire Iraq theater, including Kuwait and other areas—to 

190,000 by May, an increase of about 48,000. 

CBO’s lower cost estimates assume that about 3,000 additional 

support personnel deploy to the theater per 4,000 person combat 

brigade. That number is consistent with the lowest support-to-combat ratio achieved in the Iraqi theater overall during the larger 18 

brigade deployments that have occurred since September 2003. In 

that case, bringing the 20 combat brigades in theater will raise 

ground force levels from about 142,000 currently to 177,000 by 

May, an increase of about 35,000. 

Now to put CBO’s estimates in context, consider what happened 

during the increase in forces executed by DOD during the January 

2005 parliamentary elections in Iraq. There were about 16 brigades 

and 137,000 ground forces deployed in the Iraq theater at the end 

of September 2004. Deployments increased to 20 brigades and 

about 189,000 personnel by the end of December 2004. Forces then 

fell to 17 brigades and about 165,000 personnel by the end of 

March 2005. Throughout that 6 month period the average increase 

or decrease in personnel averaged 9,200 per brigade, consistent 

with CBO’s higher estimate. 

And on November 17th, 2006, just last fall, DOD announced 

units for the upcoming Operation Iraqi Freedom rotation, including 

five brigade combat teams and a division headquarters comprising 

20,000 personnel, an average of 4,000 per brigade combat team, as 

well as 37,000 support personnel. That was in the announcement. 

All told an average of 11,040 personnel deployed per brigade. Those 

are the support personnel DOD identified as needed in theater to 

service the brigades whose deployment is now being accelerated. 

The Administration has recently suggested the possibility of 

much lower levels of support troops than those incorporated in 

CBO’s analysis, stating that only 10 percent to 15 percent of CBO’s 

estimates would be needed. Assuming that those percentages refer 

to CBO’s high case estimate of 28,000 support personnel, that 

would imply that DOD plans to deploy about 4,700 total personnel 

per newly deploying brigade. This would result in support-to-combat ratios in the overall Iraq theater during the upcoming increase 

significantly lower than any indicated in the OIF deployment available to CBO. 

CBO has not explored the implications of conducting such a historically anomalous deployment in which the number of troops in 

combat brigades theater-wide would increase by 33 percent with a 

corresponding increase in higher echelon support personnel of 4 

percent. 

As I indicated previously, the length of the maximum increase in 

force levels analyzed by CBO spanned four to 24 months. Costs for 

increases of different durations are roughly proportional to the 

total length of those increases, including the 3-month buildup and 

ramp down period CBO assumed. Thus, through 2009 the 24 

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month increase, spanning 30 total months, would cost three or four 

times more than the 4-month increase, spanning 10 total months. 

All of the force increases CBO considered would require that 

DOD’s goals for the use of its active and reserve forces be exceeded 

by more than they have been over the past year. CBO has not yet 

analyzed the implications of those increased levels of stress on our 

forces. 

Now as Steven Kosiak mentioned, we find estimating the cost of 

the wars in Iraq and Afghanistan difficult and have routinely underestimated the costs relative to the Administration’s requests. 

Estimation is difficult for all of the reasons Steve mentioned, because thus far the available cost reporting and budget justification 

information have lacked sufficient detail to prevent robust cost estimating relationships to be developed. And some of the support material that I reviewed last night that accompanies the President’s 

budget submission, the supplemental submission, and the new 

budget lack the kind of detail that we would need still, although 

there may be more details coming. 

Thank you, and I look forward to your questions. 

[The prepared statement of Mr. Gilmore follows:]

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Chairman CONRAD. Thank you, Dr. Gilmore, for that testimony. 

Let me just indicate that we have a pattern here of the Administration hiding the ball from the Congress and the American people 

on the cost of this war. It started at the beginning and it has continued right through. Until last year they told us in every one of 

their budget submissions there was not going to be any cost to the 


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war. Last year they told us it was going to cost $50 billion and we 

are at $163 billion and counting. 

Now you tell us, Dr. Gilmore, that the so-called surge or the es- calation which the Administration has told us is going to cost $5.6 

billion, you have told us that if it lasts a year the more likely cost 

is $20 to $27 billion. 

Have I got that right? That your estimate for a year-long additional deployment as called for in the President’s plan would be in 

the range of $20 to $27 billion? 

Mr. GILMORE. If the increase were extended to 12 months, including 3 month buildup and 3 month ramp down, the total cost 

through 2009 that we estimate would be $20 to $27 billion. 

Now for our understanding of what the President’s plan calls for 

at this point, which is a buildup hitting about 20 brigades in theater in May, extending through August, and then a ramp down, the 

total costs through 2009 would be $9 billion to $13 billion, and in 

fiscal year 2007 would be $7 billion to $9 billion, depending on the 

level of support forces. 

Chairman CONRAD. Let me just say, the President has told us 

consistently that he is opposed to a timeline. It all sounds like a 

timeline to me. For 2008, he is calling for $140 billion; for 2009, 

$50 billion; in 2010, no money. If that is not a timeline, I do not 

know what a timeline is. 

And with respect to the escalation, the President is saying it is 

going to cost $5.6 billion. If that is accurate, what could we conclude would be the amount of time that this escalation would last? 

Based on history of what these troop levels cost. 

Mr. GILMORE. Well, $5.6 billion would be a shorter increase in 

forces than the 4-month increase that we have estimated. Now, we 

have seen none of the detail behind that $5.6 billion. I have heard 

that $2 to $3 billion of it is associated with the naval forces, the 

deployment of the additional carrier to the Persian Gulf and then 

covering for what that carrier would have done in the Western Pacific by having the Ronald Reagan sail and pick up the Kitty Hawk 

Air Wing. 

Chairman CONRAD. That would make the estimate even further 

off then. 

Mr. GILMORE. Yes. 

Chairman CONRAD. Because your estimate does not include naval 

costs. 

Mr. GILMORE. Our estimate excludes naval costs. So if it were $2 

billion, if it were really $2 to $3 billion, then it would be a surge 

that would compose a length a third of the one that we have looked 

at. 

Chairman CONRAD. One third of how long? 

Mr. GILMORE. It would just be a month or two, according to our 

estimates which, of course, the Department disputes. 

Chairman CONRAD. When you hear the Department say they are 

going to do this but they are only going to have a troop level over 

and above the combat troops that are deployed of 10 or 15 percent 

in terms of the cost, what is your reaction to that based on your 

professional experience? 

Mr. GILMORE. I don’t understand it. 

Chairman CONRAD. Do you believe it? 

129

Mr. GILMORE. As I said, I do not understand it. We have asked 

for additional information. In fact, we met with the Army on January 25th. Unofficially, we received information which is consistent 

with the estimates that we made in terms of the number of support 

forces, but obviously Secretary Gates is disputing that. 

I can only point out again that our estimate is based on our understanding of Army planning, we do understand that, and on historical experience, and I am not talking about ancient historical experience. I am talking about recent historical experience. I went 

through the force levels that occurred during the increase in forces 

to cover the parliamentary elections. At that point they had 20 brigades in theater, 189,000 forces. Our estimate would be 190,000 

troops in the theater. Our higher estimate would be 190,000 troops 

in the theater beginning in May, when they hit 20 brigades. 

As far as I understand what the Administration is saying at this 

point, they would say that there would be 160,000 to 166,000 

troops in theater in May. 

And that is just absolutely inconsistent with Army planning, 

what we know of Army planning, and what the Administration has 

executed in the past and what the Administration announced last 

November in terms of the needed support package for the forces 

that are going to be part of the rotation. 

Chairman CONRAD. Let me just say that in looking at this, it 

seems to me that the Administration’s claim is just not credible. It 

is not credible based on what the history has been, not only in this 

conflict but other conflicts. It is not credible with respect to what 

we have seen in Iraq. 

Senator GREGG. 

Senator GREGG. Thank you, Mr. Chairman. 

It appears we went through a surge in 2004 that was actually 

larger than what the President has proposed in 2007; is that correct? 

Mr. GILMORE. It was a surge of about the same size, as far as 

we understand. It was up to 20 brigades. It hit 20 brigades in January and then it ramped down by March, so it was actually a bit 

of a shorter surge. 

Senator GREGG. So we have been through this exercise before. 

Mr. GILMORE. Correct. 

Senator GREGG. The issue which you raise, Mr. Kosiak, of the 

supplemental being used to fund the base, can you document your 

view on that, that the supplementals have been used to fund the 

base, and that the supplemental that we are going to get, I presume in February, will be used to fund the base? Can you document that in the specifics? 

And can you highlight and get us a paper to that effect? And 

pending your doing that, in specifics, could you sort of highlight 

what you see as some of the costs that have been in past 

supplementals and that you would see coming in the future 

supplementals, other than the Army modularity issue, which we 

are all familiar with, that you think are base issues versus war 

fighting issues? 

Mr. KOSIAK. That is an excellent question and it is hard to do 

that. I will try to answer it partly at least. 

130

Because of the justification materials, problems with the justification materials, it is hard to tell, it is harder to tell than it 

might otherwise be. But I think there are a couple of reasons to 

suspect that this is going on. 

One is that if you look at the Administration’s request, if you 

look at the level of funding that was provided in 2006 for military 

operations, about $116 billion for the Department of Defense, and 

compare that with the $163 billion projected for this year, that I 

think raises questions as to why costs have grown that much, because it would not be explained simply by an increase in the number of troops. 

Also, if you look at OMB’s own estimates of what the costs were 

going to be for 2007, up until as late as August of 2006, they were 

estimating total cost for the global war on terror in 2007 of $110 

billion versus $163 billion. 

There are also, if you look at some of the programs like the Joint 

Strike Fighter, it seems to me programs that really belong in the 

Department’s long-term plans not in their short-term special global 

war on terror funding, which is sort of emergency funding. 

Also, if you look at their funding totals in the 2007 supplemental 

and for 2008, they include I think for 2007 the total amount of 

funding provided for reconstitution or what had been called reset, 

is about $37 billion. That seems substantially higher than what 

they were estimating a short time ago. 

My understanding was that the Army and Marine Corps basi- cally said that the $23 billion that was provided in the 2007 regular appropriations, the $70 billion that Congress provided in 2007 

in their bridge fund, that the $23 billion in that that was for reconstitution was what they needed. So to get an additional chunk of 

money to bring it up to about $37 billion for 2007 just raises, I 

think, my suspicion. 

And then finally, go back to the memo by Gordon England, which 

invites this to happen. 

But it is hard to pinpoint particular programs. 

Senator GREGG. I appreciate that brief thumbnail review of it, 

but do you think you could do a little more extensive review and 

get it to us? 

Mr. KOSIAK. Yes, I would certainly be happy to try to do that. 

Senator GREGG. I understand O&M costs are fungible, but I 

would be interested to know what percentage of the O&M costs 

that we are hearing is war fighting is really not war fighting, it is 

simply base operation activity. So I thank you for that. 

This whole issue of developing the emergency, I think it was Dr. 

Adams who said that when the Pentagon develops their emergency 

supplemental request they do it outside their own budget criteria. 

I have always thought the biggest problem is that it gets outside 

our budget criteria. But I had not thought of it, in the terms that 

it actually goes outside of the Pentagon’s criteria. 

What is the practical effect of it skipping the Pentagon’s budget 

criteria internally? I know what the practical effect is here, it does 

not go through the authorizing committee and the appropriating 

committee ends up looking at it with about a 48-hour window. 

But what is the practical effect for this occurring at the Pentagon 

level? 

131

Mr. ADAMS. There are a couple of effects. Emergency 

supplementals are developed with a timing that puts them outside 

the normal PPBES cycle in the Department of Defense. They generally happen when, as Deputy Secretary Gordon England did in 

late October, the Deputy Secretary sends guidance to the services 

and says come back within this given timeframe with the programs 

and data you will require to go into the fiscal year 2007 second 

supplemental. 

Anything that is in that response has not gone through the scrub 

of PPBES, where there is an orderly process of looking at all these 

requirements, determining whether they are absolutely needed, 

winnowing out things that are not necessary, trading them off 

against other programs in the budget cycle when you know you 

have a funding limit. 

Without that funding limit, the temptation is to do what Steve 

Kosiak was talking about, put things into that budget that you 

were not able to obtain through the normal PPBES cycle. 

That is most clear with hardware programs like the F–35. Because of the fungibility of O&M, it is harder to sort out what goes 

to war costs and which does not. The Pentagon does not give us 

data to help us do that. 

So in part, the problem is that things that should be in the normal budget process get hived over into a supplemental process that 

is not going through the same kind of scrub and the same kind of 

tradeoffs. 

The consequence of that for those who work the PPBES process 

in the Department of Defense is that they never quite know what 

is in and what is out, what they are being asked to scrutinize, what 

they are not being asked to scrutinize. This has a dispiriting effect 

on the job that they do in the PPBES cycle. 

If their job is to say A is more important that B, that hardware 

program is more important than this alteration in the force structure, or pay or benefits or whatever one proposes, and they are told 

do not worry about it, we will go over to the supplemental to get 

it fixed, then the integrity of their own process is called into question. 

So it has that kind of effect on their process, the dual process 

they have there. 

Senator GREGG. Thank you, very much. 

Chairman CONRAD. Senator Murray. 

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

I think this hearing is very important and it is critical that we 

get, finally, the facts on the cost of this war so we can hold this 

Administration accountable and, from my point of view, change the 

direction we are going in Iraq. 

Listening to your opening statement, Mr. Chairman, it was stunning to remember what we have been told about the cost of this 

war. I remember in 2003 when the White House Budget Director 

said the war would cost $60 billion, and now what are we, six 

times past that? 

I remember Defense Secretary Paul Wolfowitz telling us that 

Iraq would finance its own reconstruction. I remember Vice President Cheney, back in 2003, saying Iraqi oil would cover the costs 

of reconstruction. Obviously none of that has come true. 

132

And at the same time we are paying for this all off budget, in 

a supplemental, which really hides the true cost of the war. 

So this, I think, is really essential that we have this hearing and 

have an understanding so we can make critical decisions about the 

future. 

I am sorry Senator Gregg left. I did want to respond to one thing 

he said in his opening statement. I am deeply troubled that the Republican leadership did not allow us to go to a floor debate on the 

surge in Iraq. Senator Gregg mentioned his amendment as part of 

that. 

It is the fact, my colleagues should know, that Senator Reid has 

offered, on more than one occasion, a vote on the Gregg Amendment up or down, along with several other resolutions. His amendment really talks about the cost of war, which is a debate we are 

going to have on the budget and on the supplemental and I am 

sure many other things. 

The point of the debate that we want to have is about the surge. 

And critically to this budget hearing, we need to know how much 

that is going to cost. I am deeply concerned that we are going to 

be sending our troops overseas without a vote of the Senate, without a discussion in the Senate, and they will not have the equipment and the supplies they need because we have not adequately 

budgeted for it. And I think that should be of deep concern to every 

one of us in this committee and in this country. 

I would say, as the Senator representing Washington State, that 

has striker brigades going over, these are families that we are responsible for. 

So I am troubled, Dr. Gilmore, when I heard your statements 

about CBO’s estimates versus what the Administration is saying, 

that this is 48,000 troops. I understand that Secretary Gates said 

that the support troops would only number 10 to 15 percent of the 

CBO estimate. I would like to know who is right and who is wrong? 

Can you fill us in? 

Mr. GILMORE. As I said earlier, I do not understand the basis for 

what the Secretary said. As I said, we have asked the Army about 

this and received some information. We will meet with them again 

and perhaps receive some more. 

I can only just say again that our estimate is based on recent historical experience and what we understand of Army planning. We 

would have, in our higher estimate, force levels of about 190,000 

in theater and 20 brigades. That is consistent with what happened 

in January 2005. 

Senator MURRAY. Which is the surge that Senator Gregg was 

talking about? 

Mr. GILMORE. Correct. And it is consistent with what we know 

of Army planning, which is that they deploy one to two support 

people for every person in a combat brigade. 

So I do not know what more to say. I am just trying to explain 

to you why we think our estimates are reasonable and what the 

basis for them is. We have asked for information from the Department about the basis for what they apparently are saying they are 

going to do and we have not received it. We are anxious to receive 

it. 

133

If they do do that, if they do deploy with that smaller number 

of support forces, then it would be inconsistent with what we understand of Army planning, certainly inconsistent with the history 

of these deployments, and I think that it would then mean that the 

Administration is willing to accept risks that they are not normally 

willing to accept in order to execute this deployment. 

There can be good reasons for that. 

Senator MURRAY. That is deeply disconcerting. Without a vote or 

a discussion or debate in the Senate, the President has been given 

the green light to move forward with the surge. And from what I 

hear you saying to us, not making sure that our troops that are 

going to then be on the ground have the support, the supplies, the 

equipment, and the training that they need. 

And to this Senator, that is very, very troubling. It seems to me 

that what we have is the Bush Administration just trying to minimize the number of troops that will be required so we do not question it. 

Maybe our other witnesses would like to comment on why they 

think there is such a discrepancy between what we are being told 

this will cost by CBO and what we are being told it will cost by 

the Administration. 

Mr. ADAMS. Senator, I know no more than Mike Gilmore, having 

not directly pursued the Pentagon myself, and I know they have 

pursued the Pentagon assiduously to try to get data on what explains this discrepancy. I would be making assumptions. 

One assumption might be they think existing support in field is 

adequate to cover the increment of troops that they are sending, 

which does not sound true to historical practice in the Pentagon. 

Senator MURRAY. Nor does it sound true to my ears, just as an 

observer. If you are going to keep Stryker brigades on the ground 

longer, they are going to be still using their equipment. If you send 

over other brigades earlier that they are supposed to, they are 

going to need equipment. So you do not have duplicate equipment. 

It does not make sense to me. 

Mr. ADAMS. I think you are right, Senator, they will need the 

support. I am not sure that the support in the field is going to be 

adequate for what they require. But I do not have independent 

knowledge of what has moved them to this particular judgment. 

Senator MURRAY. Medical officers, people capable of helping 

them in the field? This is really disconcerting. 

Mr. ADAMS. There is a history of now, since 2003, of both underestimating the cost and underestimating the requirement. I worry 

that we may be in another situation where that is the case, that 

we have understated for reasons that I cannot describe, perhaps 

just not worry too much about the impact. The consequence of this, 

of course, is it takes longer and it is a lot tougher job to do. 

Senator MURRAY. Mr. Kosiak? 

Mr. KOSIAK. I would just say that I think CBO did the analysis 

the only way you could do the analysis and it is up to the Pentagon, I think, to explain why that does not make sense. 

Chairman CONRAD. Thanks, Senator. 

Just for the record, I would like to make sure that we get it very 

clear that the support personnel that you are talking about are logistics, police, intelligence, engineers, communications, medical. 

134

What other support personnel, Dr. Gilmore, are we talking about 

here? 

Mr. GILMORE. Those are the ones that I highlighted in my verbal 

remarks. 

Chairman CONRAD. So we are talking about, we just now have 

a—

Mr. GILMORE. These are all support personnel outside the brigades. The Pentagon likes to make the point that the new brigade 

combat teams have support integrated within them, and that is 

true. 

Chairman CONRAD. That has been the case in the previous surge, 

is it not? 

Mr. GILMORE. Yes. In the previous surge, not as many of the brigade teams were modular. But even in the Army before it was 

modularized, when they deployed brigade combat teams, they 

would pull the support down from division and then it would be incorporated as part of the brigade combat teams and deployed. Now 

it is integrated. 

But that is not the support we are talking about. That support 

is there to receive things from higher echelons. And the support we 

are talking about is that support at higher echelons. 

Chairman CONRAD. Is there any possibility that they are using 

contractors for these purposes? 

Mr. GILMORE. They certainly do use contractors for things like 

feeding and housing and that sort of thing. We did a study back 

in late 2004 of the costs of what is still called the Logistics Civil 

Augmentation Program that at that time was being executed by 

KBR. At that time they had a substantial presence in the theater 

of over 38,000 people. That was just that contractor element. And the costs were about $5 billion a year. From what I have seen of the budget justification material, that has risen to about $6 

billion a year. The Pentagon likes to make the point that the theater is mature and perhaps because of the support that is there 

and all the contractors that are there we do not need as many support forces to accompany the units in this surge. 

I would just simply point out that at least the so-called LogCAP, 

Logistics Civil Augmentation Program contractors were there in 

force in 2004 when the increase was executed during the parliamentary elections. And the level that they are funding those 

kinds of activities now is about the same as they were funding 

them then. 

Chairman CONRAD. We have a real discrepancy and it has been 

repeated. I have just been handed a news account that the Secretary has repeated that they will add as many as 3,000 troops to 

the 21,500 and we think the number is going to be around 21,500. 

Secretary Gates told a Senate panel that it would not be more than 

10 percent more, 10 to 15 percent more, which directly contradicts 

the estimates that you have provided, which been based, as I take 

it, on what has happened historically. 

Senator ALLARD. Senator ALLARD. Thank you, Mr. Chairman. 

We have heard testimony here where the cost has not related to 

the number of troops that get deployed, particularly when we are 

looking at a cost per troop basis. Has there been any attempt to 

135

analyze it as it might relate to the level of arrests and occurrences 

of violence and everything within Iraq or other countries? We have 

had surges, you understand, where we have had increased violence 

in these various countries. I am wondering does anybody suspect 

any correlation to the level of violence? 

Mr. KOSIAK. My understanding is that according to Department 

of Defense reports, that only about 10 percent of the costs for the 

global war on terror are those kind of costs that vary with operational tempo, which is what I think you are getting at, the more 

intense military operations. So that having these more intense 

military operations, most of the costs are really driven by the number of troops that are deployed and all the sustainment costs, reserve activation, things like that. Actual operational tempo doesn’t 

tend to have that big an impact. 

That may well have had some impact, but I think we need—and 

maybe it has a bigger impact. But we do not have the data from 

DOD to have that verified, I think. 

Senator ALLARD. You know, when we started this conflict, we did 

not have enough body armor. And so a big effort was made for body 

armor. It was sort of delayed because the manufacturers could not 

keep up with demand. And I assume that when they have to go 

and on a short-term basis ramp up their manufacturing lines or 

what not, I suppose they do not do that on the cheap because they 

have to recover the costs quicker. 

Then after that, we had issues about the Humvees having to reinforce the underside. We see the same phenomenon there. And 

then we see the striker, for example, vehicle. That vehicle is a very 

modern kind of a vehicle, loaded with technology. 

How much of a factor have these things played in trying to make 

our environment more secure, make the soldier more secure on the 

ground in Iraq? Has there been any effort to analyze that? 

Mr. KOSIAK. I guess the only thing I would add is that even if 

you look at these numbers and you take out the amount that has 

gone to procurement and reconstitution or reset, you still see—it is 

not as large a trend. I think that explains part of it. 

But even when you take that out of the initial cost estimates and 

the later cost estimates, you still see a significant growth in costs. 

There presumably are answers to this, and I am not suggesting 

that all of this is nefarious on the part of the Pentagon, by any 

means. 

The bottom line is the data we have does not provide us with a 

real handle on what is driving those costs. And so it makes it very 

difficult to look at DOD’s justification details and figure out is this 

the right amount of funding? And also very difficult to look forward 

and try to guesstimate about how much we are going to need in 

the future. 

Senator ALLARD. We have made an effort to bring some accountability to the process by making this part of the regular budget request. It has been going on for a while to see that, where we can 

look back and make some analysis there and what we are going to 

do there and build in inflation and what not. Probably do a little 

better job of that. And that means that we will have more oversight, I think, if we go through the regular process from the various committees, authorization and appropriation both. 

136

One of the things that happens over time, I think, is that the 

base can get built artificially high during times of conflict. We have 

tried to manage this by setting up an emergency fund and then 

going back and providing that. 

Anybody have any thought on how we manage a fund like that? 

The war is not going to go forever yet there will be a build in to 

the base there. And when that does drop down, how do we manage 

those appropriations? Or do you just think it is the best thing for 

the Congress to look at on a year-to-year basis and say well, our 

priorities have changed, we shift dollars, or we cut back on spending? How do we deal with that? 

Mr. ADAMS. I think the first step, Senator, is one that the Department of Defense has at least opened the door to by providing 

a much larger volume of justification for the supplemental requests, for the war than they have provided in the past. 

Senator ALLARD. So we are getting more detail on the requests 

now. 

Mr. ADAMS. A first step has been taken. I have had a chance to 

glance through some of that. I have to share, to some degree, Mike 

Gilmore’s view that it is not quite clear that there is enough there 

to really tell what this is going to cost, but it is a lot more than 

we have had. That is two very thick documents, at this point, 

worth of justification and they have said they will deliver even 

more justification than that. 

So step one, I think, is for this committee and the other committees responsible to take that documentation on board and scrub it 

very, very hard to make sure that the right things are in place for 

the right reasons. 

You will find things that are going to demand very close scrutiny. 

One that is of interest to me is the rather large and rapidly growing investment that we have in continuing what is the major 

source of casualties of our troops in Iraq, and that is IEDs. There 

is now an enormously expensive $6 billion request for the IED Center that is looking at technologies and ways to combat the IED 

threat in Iraq and Afghanistan. 

Given the volume of that expenditure, it is worth taking a look 

at now, what they are producing, whether they are producing results, how they are being tested on the ground, whether they are 

working, whether they are in fact reducing casualties and reducing 

fatalities in Iraq. 

So there are bits and pieces now that you can pull out and say 

all right, give us a witness on this, give us some documentation, 

give us a bit more. 

In a broader sense, the concept of creating a kind of ‘‘sidecar’’, 

which is what Senator Gregg was referring to, for war costs is a 

good idea. It will help you deal with some of the very knotty issues, 

about what is appropriate to the war and what is not appropriate 

to the war. 

One of the big areas that you are going to need to look at is this 

reset issue, with $37 billion in the request. You really need to go 

into that reset program and say all right, which of these are really 

contributing long-term hardware capabilities for the long-term operations of the United States military? And which are reset costs 

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ther the weather, operations on the ground, or combat and fixing 

it so it is re-usable? 

There is a gray area in there. If you buy a new and improved 

Abrams tank or a new and improved infantry fighting vehicle, have 

you really bought it because you intend to deploy it for the war? 

Or are you buying it because it is next in line, it is the next program that you need to reset the force, to equip an expanded force? 

So pushing very hard to get those details separated out and 

worry the troubled gray areas in hardware, in O&M, is a very important first step to answering your question. 

Senator ALLARD. And replacement costs are a problem when you 

are in such a harsh environment. 

Mr. ADAMS. Absolutely. 

Senator ALLARD. All the sand and everything, your depreciation 

on the vehicle is so much—

Mr. ADAMS. Clear wear and tear on the equipment. 

Senator ALLARD. If I might, just one other thing, on benefits to 

the people who serve over there, have you looked at that at all? 

There are going to be veterans and there will be veterans benefits. 

And I guess this could be attributed to the costs. I wonder if you 

have tried to extrapolate that in as a long-term cost, medical care 

and what not? 

Mr. ADAMS. Some of the work that I have seen has been done 

at CBO. 

And there is some that the CRS has done. And there is some 

that Professor Linda Bilmes at Harvard has also done. There is a 

very broad range of what those costs may be; CBO’s is on the low 

end of the range, as I understand it. 

Mr. GILMORE. It is about $1 billion a year. 

Mr. ADAMS. Bilmes’s is a very high end, $300 to $600 billion over 

the lifetime of the veterans affected. 

That is an issue that is very much worth looking at long-term 

because the implications of that in budgetary terms are very, very 

large. 

Senator ALLARD. Thank you. 

Chairman CONRAD. I thank the Senator. 

Let me just indicate that I have just been notified that Secretary 

Gates now, who was scheduled to come before the committee next 

Thursday will not come before the committee next Thursday. 

I just say that I find that very disappointing. We have serious 

issues that have been raised and for the Secretary to now change 

what was a commitment to this committee is just unacceptable to 

the committee. I just want to make that very clear. 

This is an overwhelming driving element to this budget. And for 

the Secretary, who was scheduled to come here next Thursday, this 

morning to tell us now he will not come, I just find unacceptable. 

Senator SANDERS. Mr. Chairman, just a point on this. 

It is not just unacceptable. This is a huge amount of money that 

impacts education, health care, every aspect of our life. 

I would hope that this committee acts in a very strong way. Why 

should we give consideration to a budget when they refuse to send 

analysts up here to defend the budget or the Secretary to tell us 

why they need it? 

138

Chairman CONRAD. I think it is very clear this committee, I 

think on a bipartisan basis, will be very disappointed, in the least. 

And I just find it unacceptable that the Secretary had committed 

to coming before this committee next Thursday to talk about what 

is absolutely central to the deliberations on the budget. And now 

the Secretary does not want to come. 

Senator STABENOW. 

Senator STABENOW. Thank you, Mr. Chairman, and I share not 

only the frustration but I would say outrage at what I have seen 

and heard. And if we are not even going to have the opportunity 

to talk to the Secretary, that is a very concerning thing. 

I also think though, and to use one of the Chairman’s charts to 

re-emphasize again how incredibly off they have been. I really 

question, with all of these numbers, whether we can believe at this 

point. We have not seen anything that was accurate that we could 

believe. 

On the Sunday talk show, when Secretary Rumsfeld was asked 

what should the public know right now about a war with Iraq, 

what it would look like and what the cost would be, and he said 

the Office of Management and Budget estimated it would be something under $50 billion. It was said outside estimates say up to 

$300 billion, and he said baloney. 

I would suggest that we are choking on that baloney, Mr. Chairman, the American people and the tradeoffs that we have had to 

make and the costs for our grandchildren and great-grandchildren 

for decades to come is extraordinary. It is hard to know where to 

begin on this, looking at all these numbers. 

One thing, and then I have a couple of questions, let me just put 

in perspective in terms of choices. We are struggling, in the budget, 

to find a way to provide health insurance for every child in this 

country that does not have health insurance. I think everyone 

would agree, I think the American people would say, we ought to 

be starting from a premise that every child is uninsured ought to 

be able to get health care. Every parent ought to know that their 

children can have health care coverage. 

That would cost $12 billion a year. That is a little bit more, not 

much, than 1 month in Iraq. So all of these numbers do have consequences, as we know, and I know the Chairman knows more that 

anybody else, stunning, stunning consequences when we are looking at over $500 billion. We are upwards now, Mr. Kosiak was saying, $737 billion overall in the global war on terror. 

We certainly know that there are costs and that we need to address it, no question. But this is stunning to me. 

The question I would have that relates to military preparedness. 

Those of us who did not support proceeding with this war have 

voted for the budget every year, which I have. It is because I do 

not want to send people to war and not let them know that we intend to have them have the equipment they need, have the training they need, and to have all of the support services they need so 

they can complete the mission, they can be successful, and they can 

come home safely. 

I am astounded, Mr. Chairman, when you show a chart that 

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139

ment they need. That is the No. 1 question I want to ask the Secretary. 

And I guess I would ask our panel, I am very grateful for all of 

your information. And I know it is job just to analyze and provide 

the information. But when we look at the fiscal year 2006 base 

budget, which was $410 billion for Department of Defense, this 

year we gave them a $29 billion increase when we look at base 

budget. Next year they asking for $42 billion base budget, which is about 

a 9.6 percent increase in the base budget, which does not include 

Iraq, Afghanistan, or any of the costs that have been called emergency costs. 

Why can’t we provide people with equipment? Have you looked 

at any of the analysis? Have you broken it down at all in terms 

of the amount of dollars going for the equipment and support for 

our troops? Where is this going, Mr. Chairman? Where is the 

money going? It is not that we are cutting their budget. We are increasing their budget, almost a 10 percent increase for next year. 

I am wondering if any of the panelists could speak to where the 

dollars are going that relate to making sure our troops have the 

equipment they need. 

Mr. GILMORE. Well, about 60 percent of that base budget is for 

peacetime operations and maintenance and pay for military personnel. The other 40 percent is for researching new equipment, designing new equipment, and then buying new equipment, about 

$100 billion in procurement. 

That procurement is mostly for new systems. And those systems 

such as, for example, the Joint Strike Fighter and Future Combat 

System when it starts being procured, they tend to enter the force 

very slowly and they are not really, for the most part they are not 

really relevant to supplying the troops in the field right now with 

equipment. 

Those costs, the costs to repair that equipment and replace it 

have been in the supplementals primarily. And those costs have 

been growing very rapidly, as Steve Kosiak mentioned. In fact, in 

2007, I think there is going to be about $32 billion for Army procurement in the supplemental and the bridge, and that compares 

with about $15 billion for Army procurement for these future systems in the base budget. 

So the base budget is really funding, at least in terms of equipping troops, is funding the acquisition of these next-generation systems that are coming into the force relatively slowly. And so when 

you have troops in the field who are using equipment now and 

damaging it in the harsh environments, that money to handle 

those problems and replace that equipment has all been in the 

supplementals. 

Senator STABENOW. So Dr. Gilmore, you are basically saying 

none of the Department of Defense base budget goes for making 

sure our troops currently have the equipment that they need; is 

that correct? 

Mr. GILMORE. No, that is not really correct at all. That is not 

really what I meant to say. 

The base budget funds the peacetime operations and the procurement of the next generation of systems. There is also, of course, 

140

there has been historically money in there for upgrading existing 

systems to keep them current. But a lot of that funding has migrated to the supplementals now, because there is a lot of equipment in Iraq that is being used. When they bring it back, they do 

not just repair it, they upgrade it. 

So it is a mix of the two. But when you look at the investment 

program, it is mostly future looking, forward-looking, whereas the 

money in the supplementals is covering the costs of the damage 

and wearing out of the equipment in theater today. 

Mr. ADAMS. Senator, if I could make just two points to supplement what Mike Gilmore has been saying, I think there are a couple of elements that need to be taken into consideration. One is 

that in the early emergency supplementals for the war, most of the 

money is going for supplemental pays and especially operations 

and maintenance. There is usually very little funding there for the 

acquisition of equipment. 

So you have a gap between the technology modernization Dr. Gilmore is talking about and a recognition that you require some 

kinds of procurement and R&D work going on immediately because 

of the requirements of the troops in the field. 

The other element is that when you see that gap what it often 

means, and it clearly meant it here, is very poor anticipation of 

what you thought you were going to run into. That is a broader 

characteristic of our planning for this conflict. But in this particular case, not anticipating body armor requirements, not anticipating up-armored Humvee capabilities, not anticipating the threat 

from IEDs in the field, have all led to a ‘‘scramble’’ effect—let’s 

hurry up and find a program. 

And of course, those things take time. When you put those programs in place, you have to put the acquisition system in place, as 

Senator Allard was saying. You have to find out what the technologies are that you need to combat IEDs. And so you are behind 

the curve. 

So poor anticipation is part of this problem, as well. 

Senator STABENOW. Thank you, Mr. Chairman. 

I would just say in conclusion, if I might, that basically what you 

are saying is that we, because of the lack of understanding of what 

we were putting our men and women into, in terms of the situation 

and so on, and not planning and preparing and so on, we sent people into a situation without the equipment that they needed. And 

I think that adds insult to injury with all of this. 

Thank you. 

Chairman CONRAD. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Mr. Chairman, I appreciate your Midwestern demeanor. But I 

have to be honest with you. I think and I hope the Chair will either 

author a joint letter or have a vote of this committee, that I hope 

would be a bipartisan vote, to demand the Secretary to come here. 

This saddles the Nation’s future. Iraq, our expenditures, saddles 

the Nation’s future. And to not have the Secretary come here to 

make the case, whatever case that might be, about something that 

saddles the Nation’s future, blows my mind. 

So I hope and I would urge the Chair to do that, and I would 

be happy to join him in that effort. 

141

Let me get past maybe the politeness of budget speak. First, I 

appreciate you having this hearing. But I want to start with a reference point that is not about money. It is about lives, 3,084 American lives. That is invaluable. There is no cost that can be associated with it. Twenty-three thousand men and women, sons and 

daughters of America, who are wounded in ways that affect their 

lives forever. And the costs, staggering. We have not included in 

this equation. We spend about $8 billion a month in Iraq. We spend a $2 billion a week in Iraq. We spent $280 million every day in Iraq. We spend 

$11.5 million every hour in Iraq. 

And we cannot get the Secretary of Defense to come here and 

justify that. That is outrageous. 

But then again, I am not surprised, Mr. Chairman. This Administration has lied to the Congress and to the American people from 

the very beginning. They lied to us about weapons of mass destruction. There are none. They lied to us when the President landed 

on the aircraft carrier and said mission accomplished. Well, we are 

far away from that. 

Lied to us when we were told we were going to be liberators and 

greeted as such. Lied to us when victory was just around the corner. Lied to us went in 2003 there were press reports where the 

Administration was downplaying the question of how much this 

war was going to cost, downplaying then $50 billion or $60 billion. 

Now we have the escalation, and the escalation easily, as we 

have heard today, could very well be triple the projection. 

Then, when we look at how much money we are spending, we 

had the Inspector General that this Administration wanted to 

eliminate, new report: waste and fraud in Iraq rebuilding projects. 

Cannot account for so many things, including $36 million in weapons that we cannot even account for. And we want more. 

And we want a justification and say we want to give our troops 

everything in the field. Yes, but how can we know that they are 

even getting it. 

And then we have another Business Week, military equipment, 

missing in action. New defense audit says the Pentagon has failed 

to properly equip soldiers in Iraq. Those that are there, before we 

send anybody. 

Mr. Chairman, it is beyond belief. I appreciate all of witnesses’ 

testimony. I just want to ask Dr. Gilmore, as it relates to some of 

what you said. You said the words it would be a historical—I think 

this is what you said—anomaly. That is a nice way to say they 

would be totally out of line with how much support personnel 

would be added per the troops that would presently be added in the 

field. 

Is that basically what you are saying? 

Mr. GILMORE. It would be out of—what the Secretary seems to 

be claiming, would be inconsistent what we know of Army planning 

and also what they have done in terms of the deployments in Operation Iraqi Freedom. 

Senator MENENDEZ. And you said that means, I can only believe 

that means that they are willing to accept risks that they have not 

been willing to accept before. 

What type of risks are associated with that? 

142

Mr. GILMORE. It is the risks that they will not able to fully support the operational tempo that they will want to engage in, that 

they will have to constrain the operations of the forces in ways that 

they might not, they may not desire, otherwise desire. 

But of course, this is all just speculation on my part. It is dangerous for me to speculate. 

I think the simplest thing for me to say is I do not understand 

what the Secretary is proposing, and I have explained why I do not 

understand it based on what they have done and what we know 

they plan to do. 

Senator MENENDEZ. I do not think it is so speculative if you have 

Army planning that says we generally provide X support personnel 

for the number of troops deployed, if that is your standard operating. Then you have a historical reality in Iraq. And then you deviate from that substantially. Something significantly is wrong. 

My last question is in this escalation that they are talking about, 

you say that that means they would have a downturn in August; 

is that correct? 

Mr. GILMORE. That is the way we modeled it based on what we 

have heard. 

Senator MENENDEZ. Mr. Chairman, every briefing we have received says that they will finally be at full force in May. 

That means in 2 months we are going to do everything we need 

to do? We are going to secure Baghdad and we are going to start 

down-forcing in August? 

You know the part of the Nation that I come from, we were born, 

but not yesterday. And the bottom line is this is outrageous. No 

one can believe the Administration, as you so aptly said, has been 

unwilling to except timelines for anything. And yet for this purpose, in order to hide the real costs of the escalation, we are going 

to have timeline that suggests that in August we are going to actually reduce forces. It is just not going to happen. 

Mr. Chairman, we need the Secretary of Defense here. We need 

answers. This is overarching. 

Chairman CONRAD. Let me just say that the President said, as 

recently as yesterday, no timeline. It seems to me very clear there 

is a timeline associated with this, when you overlay the budget 

numbers with what he said. 

Let me just say, the discrepancy between the testimony of the 

witnesses today and what the Administration is telling us is so 

stark that I understand why the Secretary does not want to come 

up here and testify. But that just is not acceptable. 

We have gone through this war for 4 years and no Secretary of 

Defense has come before this committee to testify. I think it is 

abundantly clear why not, because they have played hide the ball 

with this committee, with the Congress of the United States, with 

the people of this country on the true cost of this war. 

It is no longer arguable. It is very clear. 

I am going to ask this committee, I am going to circulate a letter 

and ask, on a bipartisan basis, that we write to the Secretary, insisting that he hold to his commitment, his previous commitment, 

to come before this committee next week. 

Let me just say, at the same time, I am researching sterner 

measures and we will not go further with that now until we find 

143

out what that research discloses. But it is not acceptable to this 

committee to have the Secretary of Defense refuse to come before 

this committee and defend these numbers. 

Senator SANDERS. 

Senator SANDERS. I am glad to hear that, Mr. Chairman. I want 

to go on record as concurring with the Senator Menendez. 

But frankly, I am not surprised that they are not here. I do not 

blame them. If I had their record of distorting the costs of this war, 

if I had their record of how they misled the American people into 

this war, if I had their record in terms of being as unprepared as 

they were to fight this war, I also would not want to come before 

the United States Congress or this Budget Committee. 

But I do have to say, Mr. Chairman, the fault is not totally with 

them. The fault is with us. We have abdicated our constitutional 

responsibilities on this issue. We do not have to beg them to continue to come. If they do not want to come, I tell you what I think 

the assumption is. The assumption is that cannot defend their figures because they are dishonest figures. They are not accurate. 

And I think that you should say to them, and I would hope the letter would suggest, that we assume that you have overstated overstated what you need. We have going to significantly underfund 

your request unless you tell us otherwise. 

If you do not have the courtesy to come before this committee, 

we will not take you seriously. 

So I am not just blaming them. I am blaming us. And that gets 

back to the whole broader issue of how we bring our troops home 

as soon as possible and the need to begin to use the power of the 

purse to do that. 

Mr. Chairman, I just received a letter from Vermont and I have 

the feeling that every member of this committee has received similar letters. This is an article from a newspaper in Central Vermont 

dealing with a school board meeting of a very small high school in 

Plainfield, Vermont, Plainfield and Marshfield, Vermont. 

And I quote a young person, a kid in the school. The kid says 

‘‘The changes in the school budget, the cuts in the school budget, 

scare me more than I could have ever expected. I cannot imagine 

getting an education at Twinfield High School without the honors 

English class I took my junior year and many other scholastic programs that are being compromised.’’

In other words, in Central Vermont, all over my State, all over 

America, kids are not getting the education that they need. They 

cannot afford to go to college. Our child care and Head Start programs grossly underfunded. 

And yet the Department of Defense comes in with huge budgets 

to fight a war that we never should have fought in the first place. 

I think, Mr. Chairman—

Chairman CONRAD. Let me be clear to the audience the rules of 

the Senate. There can be no expression by the audience during the 

functioning of this committee. 

If anybody violates those rules, they will be removed from the 

hearing room. Let me just make clear, that it is rule of the Senate 

and it will be enforced in this committee. 

The Senator may proceed. 

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Senator SANDERS. I just find it a very tragic that when our children need support so that we can end the shame of having the 

highest rate of childhood poverty in the industrialized world, there 

is no money for them. 

Senator Allard mentioned a few moments ago about the situation 

of our veterans. I know in Vermont, I do not know about Colorado, 

there are waiting lists, waiting lines for veterans to get into VA 

hospitals. 

Somehow, we do not have enough money to take care of our veterans. We have 47 million Americans who have no health insurance. The problems facing the middle-class and working families of 

this country are enormous. 

And somehow when we need money to fund those needs, we do 

not have the money. But when the President comes in with a huge 

military budget to continue a war that should never have been 

fought in the first place, apparently this Congress is giving that serious consideration. 

I think that that is wrong. I think, Mr. Chairman, we should use 

this Budget Committee to rethink our national priorities. I think 

we should use this Budget Committee to begin the process of beginning our troops home as soon as we possibly can. 

Thank you very much, Mr. Chairman. 

Chairman CONRAD. I thank the senator. 

Let me just indicate that we will be circulating a letter to committee members with respect to asking once again that the Secretary come before this committee. He had previously committed to 

do so. I think it is essential, given the extraordinary costs associated with these requests the Administration has made, that the 

Secretary himself come before this committee. I do not think that 

is an unreasonable request. He had previously agreed to do so. It 

is just unacceptable for him to back out. 

I can tell you, for too long the Secretaries of Defense have been 

bucking this to somebody else. This committee, I think, deserves to 

hear from the Secretary of Defense. The discrepancy between what 

he is saying the cost will be and the professional testimony of the 

nonpartisan Congressional Budget Office about what this cost will 

be are so sharply different that we simply must insist that the Secretary of Defense come before this committee and explain his intentions. 

That is something we are going to insist on. I hope that message 

is received. 

I again want to thank the witnesses and we appreciate very 

much your participation in this hearing. 

[Whereupon, at 11:47 a.m., the committee was adjourned.] 

(145)

THE PRESIDENT’S FISCAL YEAR 2008 BUDGET 

PROPOSAL 

WEDNESDAY, FEBRUARY 7, 2007

UNITED STATES SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to notice, at 10:05 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of the committee, presiding. 

Present: Senators Conrad, Murray, Wyden, Feingold, Menendez, 

Sanders, Whitehouse, Gregg, Allard, Enzi, Bunning, Crapo, and 

Ensign. 

Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 

Staff Director for the Minority. 

OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

Chairman CONRAD. We will bring the hearing to order. 

Let me indicate that Senator Gregg, of course, because of events 

on the floor, will be there for at least some part of the morning. 

Senator Allard will be filling in ably for him, and we appreciate his 

doing that, in light of the events that have developed over the last 

24 hours. 

We want to welcome Director Portman, the head of the Office of 

Management and Budget, to the Senate Budget Committee. I am 

appreciative that the Director has taken his time to be here and 

that we can have a discussion on these critically important issues 

facing the country. 

I have high regard for Director Portman, both personally and 

professionally, and we very much appreciate his public service and 

look forward to his testimony today. 

Let me just start with concerns we have about the budget, and 

these are things that we can discuss during the hearing. As we 

look at the budget we see a number of things that are left out, full 

Iraq war costs beyond 2008. In saying that, I also want to acknowledge and commend Director Portman for pressing to get at least a 

realistic war cost put in for 2008. I do not think that would have 

happened without his pressing the issue, and we appreciate it. It 

was certainly a step in the right direction.

146

We also note that while this is a 5-year budget there is only 

money for alternative minimum tax reform for the 1-year, so it 

leaves out detail past that for the alternative minimum tax. 

It also leaves out, the budget leaves out discretionary spending 

levels beyond 2008. So this is a 5-year budget, but we only have 

discretionary spending details for the 1-year. 


34649.476
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Let me go to the next—one of the, I think, serious issues that 

we have to confront as a Congress and a country is the revenue 

side of the equation. Our friends on the other side only want to 

focus on the spending, and while I would completely agree we have 

to be disciplined on the spending side I think we also have to look 

to the revenue side of the equation.


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Our friends on the other side of the aisle point to the rapid revenue growth of the last several years, and indeed there has been 

rapid revenue growth the last several years. But they neglect to 

mention what happened before then. They neglect to mention that 

we have had revenue stagnation for 6 years. In fact, revenue went 

down after the last peak we had in 2000, where we had revenue 

of just over $2 trillion, revenue was below that for 2001, below for 

2002, 2003, 2004, 2005. Only in 2006, on a real revenue basis, did 

we get back to the revenue of 2000. 

Let’s go to the next slide, if we can. So revenue was down but 

spending was up. In fact, under the Administration’s spending 

plan, the spending side of the equation increased by 40 percent. So 

revenue was down, spending was up. The consequence is the debt 

exploded.

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Let me have that slide, if we can. Here is what happened to the 

debt of the country. We have a $3 trillion increase in debt during 

this Administration. And over the next 5 years we are anticipating, 

if the President’s policies are adopted, another $3 trillion of debt.


34649.478
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Let’s go to the next slide. 

The President, in this budget, advocates a number of spending 

cuts. But he also advocates additional tax cuts, making the current 

tax cuts permanent. And with the other omitted items, if we look 

at the 10-year outlook rather than just the 5-year outlook—because 

the 5-year outlook we see some improvement. But then if we put 


34649.479
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back the omitted items, we see the fiscal condition turning back on 

us, back into deeper deficits and more debt.

Let’s go to the next slide. 


34649.480
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Perhaps most serious, and I think all of us share the understanding of our long-term situation is unsustainable. And when I 

look at the President’s budget, he makes that situation worse because, in making the tax cuts permanent, the cost of those tax cuts 

explode at the very time the trust funds of Social Security and 

Medicare go cash negative. And the combined effect of all of this 

is to take us right over the cliff.


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That cannot be the fiscal future of the country. Let’s go to the 

next slide. 

This next chart shows what happens if the tax cuts expire or are 

offset. That is the green part of this bar. If they are not paid for, 

if they are not offset, here is what happens to the trajectory, the 

fiscal trajectory of the country. It is a trajectory of rapidly rising 

deficit and debt, and at the worst time, right when the baby 

boomers are retiring.

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Let’s go to the next slide. 

I look at the President’s budget and he has savings in Medicare 

and Medicaid which, over a 10-year period would equal $280 billion. But the cost of the President’s tax cuts during that same time 

are $2 trillion, $2 trillion when we add debt service into it.


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And then there are the question of priorities. We look at the 

President’s budget. For 2008 the cost of tax cuts for those earning 

over $1 million a year for that year alone is $55 billion. The President says cut education $2.3 billion. These are not priorities that 

on our side we share. We do not think that is the proper balance 

for the country.


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We see the same thing with respect to the COPS program. The 

President’s budget proposes cutting the COPS program 94 percent. 

It would take $520 million to restore the COPS program for 2008. 

Again, that same year the President is advocating continuing tax 

cuts for those who earn over $1 million a year of $55 billion, 100 

times as much.


34649.484
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Let’s go to the final slide, if we could. 

LIHEAP, low income heating assistance, the President’s budget 

proposes cutting that nearly 20 percent. It would take $420 million 

to restore it. Again, the comparison is the tax cuts for those earning over $1 million a year.


34649.485
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I would say this is especially sensitive in my home State. The 

other day it was 46 below in North Dakota. We have a real understanding of the need for heating. 

This is what Chairman Bernanke told us. And what I want to 

focus on in my time is the long-term outlook because we have differences on this 5-year budget. Those are differences I believe we 


34649.486
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could bridge. I am far more concerned about where this is all headed in the long-term. 

This is what Chairman Bernanke told us: one might look at 

these projections and say they are about 2030 and 2040, we really 

do not have to start worrying about them now. But in fact, he said, 

the longer we wait the more severe, the more draconian, the more 

difficult the adjustments are going to be. I think the time to start, 

he said, is about 10 years ago.

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That puts this discussion where I think it needs to be. 

With that, I call on Senator Allard. 

OPENING STATEMENT OF SENATOR ALLARD 

Senator ALLARD. Good morning, Ambassador Portman. 

I would like to welcome you to the committee on behalf of Senator Judd Gregg and myself. As was explained, Senator Gregg is 


34649.487
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tied up on the floor of the Senate. We anticipate him joining the 

committee later on. 

Mr. Chairman I wonder if I might provide a further explanation 

of the first chart that you pulled up. Do you mind if we used your 

first chart there? 

Chairman CONRAD. I do not mind at all. 

Senator ALLARD. Thank you. 

It would be the first chart that he pulled up. 

What I would like to point out on that chart, he talked about the 

problem with the first 6 years. But if you remember, 2001 is when 

we had 9/11, and then shortly after that we had the technology 

bubble break, the Internet bubble, however you want to describe it. 

And 2003 is when we passed the economic growth package that 

was signed by the President. Look what has happened to revenues 

after that economic growth package. Every year after that they 

have increased. I just thought that we needed to have that further 

explanation. 

Chairman CONRAD. Let me just say, the first and biggest round 

of tax cuts were passed in 2001, and you can see revenue went 

down. 

Senator ALLARD. Well, 2001 related—we dealt mainly with 9/11. 

We got to 2003 is when we passed the economic growth package. 

Chairman CONRAD. No, no, no, 2001, let’s be factually accurate 

with people. If you are going to use my chart, let’s be factually accurate. The biggest tax cuts were in 2001. You see, you put those 

tax cuts in effect—in fact, your side told me you are underestimating, Senator, the effect on growth. We are going to have 

much more revenue. 

Well let’s see. We did not have more, we had less revenue in 

2002, less revenue in 2003, less revenue in 2004, less revenue in 

2005. 

Senator ALLARD. Let me make this point, if I might. In 2003 that 

economic growth package that we passed was a growth stimulant 

package. Those cut tax cuts were designed to encourage the economy to grow, and they have been successful. 

Now we have had discussions in the past that not all tax cuts 

stimulate the economy equally. There are some that do more than 

others. And I just wanted to make a point that those we had in 

the 2003 package has made a difference, and I think that chart reflects it. 

I do want to go ahead and make some formal comments on behalf of this side of the aisle. 

This, of course, is an annual exercise in that once a year the 

President submits and Congress receives a comprehensive budget 

for the United States Government. And every year there will be 

people who criticize and say the budget is dead on arrival. 

And yet, regardless of who controls the White House and who 

controls the houses of Congress, the legislative branch pivots off 

the President’s budget and is largely reactive. 

The President’s budget, regardless of which president and which 

OMB draft, becomes the memo for the meeting and drives all other 

action. 

This fiscal year 2008 budget proposes some notable changes and 

reforms. First, it is clear that the President’s economic policies 

162

have been a major success and have led to recovery from the recession caused by 9/11 attacks and the burst of the Internet bubble. 

The economy is growing at 3.5 percent and is now in its fifth consecutive year of expansion. 

Since 2003, over 7 million new jobs have been created. The President’s policies of holding down taxes and stimulating private sector 

growth resulted in a continuing rise in Federal revenue collections. 

Federal revenue collections are over their historic average, and just 

last month once again showed that everyone’s estimates—that is 

OMB’s, CBO’s, and outside experts, have been too cautious. For the 

first 4 months of this year tax collections were over 9 percent above 

this same period last year. 

The President’s budget gives priority to keeping taxes fair and 

low and by allowing Americans to retain their hard-earned money. 

The President’s tax policies have been a major success and this 

budget keeps tax relief in place and proposes additional changes 

such as ensuring that American companies invest in research and 

development to improve our economic competitiveness. 

Second, the budget includes an annual estimate in 2008 for the 

cost of the global war on terror and support of our American men 

and women in Iraq and Afghanistan. Thank you, Director Portman, 

for listening to the Congress and including a requirement that we 

can now review. 

In fact, the 2008 President’s budget clearly and unequivocally 

puts a priority on defending our Nation. This is the core duty of 

our Federal Government. The President’s budget supports our military personnel and grows our force structure. It provides ample operation and maintenance resources so as to not allow a hollow military to reoccur. It provides for procurement of modern weapons systems and research and development to stay ahead of any threat or 

foe. 

Third, the budget tackles the long-term entitlement bow wave 

that threatens to undermine our economy and our children’s future. 

The budget goes in specific programmatic detail and makes program adjustments to rein in some of the uncontrolled growth of 

mandatory programs, $61 billion in net mandatory program savings are proposed. 

And fourth, the budget continues overall spending discipline, especially for non-security programs. 

I thank the Chairman and I yield my time. 

Chairman CONRAD. Thank you, Senator Allard. 

We will go now to Director Portman or Ambassador Portman, 

both titles apply. Welcome to the committee. 

STATEMENT OF HON. ROBERT J. PORTMAN, DIRECTOR, 

OFFICE OF MANAGEMENT AND BUDGET 

Mr. PORTMAN. Thank you, Mr. Chairman, very much. And I want 

to also thank other members of the committee who are here this 

morning, including Senator Allard. Thank you for filling in. And to 

Senator Murray, Senator Bunning, Senator Feingold, Senator 

Sanders. 

I look forward to the opportunity to engage in some of the issues 

that were raised by the Chairman and ranking member this mornVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00610 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ing, including that chart, which we will see again, I am sure, and 

I do have some comments about that. 

It is good to be before the committee again and have the chance 

to talk about this budget. As Senator Allard said, it is our fiscal 

year 2008 budget. It is a 5-year budget building on the reduction 

of the deficits over the last 2 years of $165 billion. The President’s 

5-year 2008 budget continues to reduce the deficit every year and 

achieves balance by 2012. 

We do so while keeping taxes low, but also meeting our Nation’s 

priorities. Although we will have differences on how to achieve balance, as Chairman Conrad said, I believe we have an opportunity 

to bridge our differences with regard to the short-term outlook. And 

our sincere hope is that this budget helps provide the basis for us 

to work together across party lines to achieve balance in the shortterm, but also to prepare us better for the long-term. Because I 

agree with what Chairman Conrad said with regard to our more 

difficult fiscal challenge. 

I believe this is a realistic budget. Instead of painting a rosy scenario on revenues, I believe it is cautious. We can talk more about 

that in a moment. 

We have also responded, as Senator Allard and Senator Conrad 

acknowledged, to congressional concerns about showing more war 

costs. For the first, we have included these supplementals in the 

budget, as you know. We have done it in a more transparent way. 

All of these war costs, by the way, are calculated as part of the reduction in the deficit every year and the balanced budget in 2012. 

We have changed our projections a little bit from past years. We 

have gone from a freeze, or some years a cut, to a slight increase 

in non-security discretionary spending. And we have done that 

throughout the budget window. 

It is consistent with what Congress and the President have actually enacted for the past few years, by the way. It is below inflation. It is 1 percent. It is also, by the way, just about where we are 

on the continuing resolution this year. 

You will also see we have eliminated some policies that show 

budget savings but are unlikely to materialize because of congressional opposition. One that I have heard from members of the committee about is the TSA user fee, as an example, which is $1 billion. We did not include that in the budget this year. 

I have had a lot of conversations with Chairman Conrad and 

Senator Gregg, and others on this committee, about our biggest fiscal challenge. And it is this unsustainable growth in the entitlement programs, important programs, Medicare, Social Security, 

Medicaid. I will address this further in a moment but the progress 

we are making in getting our fiscal house in order in the short 

term must not distract us from this longer-term challenge. 

In this budget, as you will see, we have proposed some sensible 

reforms, primarily in Medicare, that are less than a 1 percent reduction in the annual rate of growth over the 5-year period and 

over the 10-year period, but they do represent an important step 

in beginning to reduce the unsustainable growth in these critical 

programs. 

I hope we will be able to begin addressing these unfunded obligations through the budget process. I also believe that Senator 

164

Conrad and Senator Gregg’s idea of a bipartisan working group has 

promise, and I commend them for their personal commitment to 

addressing these broader entitlement challenges. 

While restraining spending overall, the President’s budget also 

provides resources for key priorities. As Senator Allard said, it increases funding for national security to combat terrorism and protect the homeland. It includes new policies to address issues of concerns to America’s families including educating our children, access 

to affordable health care and reducing energy costs. On the whole 

we have attempted to give you a credible and more realistic plan 

to try to maximize our chances of working together to achieve balance over 5 years. 

Over the past 2 years we have been able to reduce the deficit by about $165 billion. We have been able to do it for two primary reasons. One is a strong economy. We have been blessed with a strong 

economy that has generated record revenues the last couple of 

years. 

Second, we have done a little better job of restraining spending, 

and Congress deserves some credit for that, especially in the nonsecurity spending, keeping it under inflation for the past 3 years. 

I talk about that a lot publicly. The press very seldom pick up on 

that point, but it happens to be true. 

It is exactly these elements, the solid economy and reasonable restraint on spending, that can now lead us to balance, working together. 

As you can see from this first chart, because I will have a few 

of my charts, too—not as many as Senator Conrad. I am building 

up. Maybe next time I come before you I will have as many. 

The budget reduces the deficit every year and results in a surplus in 2012. In fiscal year 2007, this year, we project the deficit 

will decline to $244 billion, which is a reduction, by the way, of $95 

billion since our last estimate in July of 2006. The deficit in 2008 falls again to $239 billion. As you will see 

from this chart, the 2008 deficit is 1.6 percent of our economy 

which I believe is the key measurement of the deficit, percent of 

GDP, because it shows the impact of Government borrowing on economic activity. This projected 2008 deficit, by the way, is lower 

than 18 of the past 25 years as a percent of our economy. 

The deficit then continues to decline each year, both in nominal 

terms and as a percent of the economy, until we reach a budget 

surplus of $61 billion in 2012. 

You will recall that 3 years ago the President established this 

goal of cutting the deficit in half from its then projected height in 

2004. At the time, a lot expressed skepticism that this goal could 

be met, including some members of this committee. But it was 

achieved. We achieved that goal together. We achieved it back in 

September, 3 years ahead of schedule. We will now build on that 

success and again work with this committee and others to come to 

balance over a 5-year period. 

To keep the economy vibrant, we need to continue the pro-growth 

economic policies that have been in place and help fuel the economy, and therefore the revenues. The 2008 budget continues to 

support growth, innovation and investment by making permanent 

the tax relief that was talked about earlier that would otherwise 

165

expire in 2010. As you can see from this chart, and it is a very interesting chart to respond maybe to one earlier—

You might want to just hold it up. Senator Conrad has his held 

up. I kind of like that. 

[Laughter.] 

Mr. PORTMAN. Since the tax relief took effect in 2003, you see in 

2001 there was a big reduction in revenues. That was not because 

of the tax relief. Primarily it was because of the recession. When 

there is a recession, our revenues go down. 

Senator Allard is right, 9/11 hit, the bubble burst in the stock 

market and so on, but when you have a recession this is what happens. It was the most shallow and shortest recession we have had 

in our recent history, but we did have a recession and revenues go 

down. 

The 2001 tax relief was fully implemented in 2003. In 2003 there 

was additional tax relief, as you know, on the investment side, primarily capital gains relief, dividend relief. Amazing correlation 

there, you see between the 2003 full implementation of the tax cuts 

and the change in business investment, which is the green line, 

and the change in jobs, which is the purple line. Dramatic increase 

in jobs, 7.4 million new jobs since that time, a big increase in business investment, productivity, and paychecks are growing. 

This is what we want to be sure continues. 

After 2003, the economy not only strengthened, but Federal revenues also surged, as I said earlier, in fact hitting record revenue 

levels. The President’s 2008 budget uses 5-year economic projections that are in line with those of outside experts. As you can see 

from this chart, we assume GDP growth will average about 3 percent over the budget window. The first quarter of this year, as you 

know, was 3.5 percent, just reported last week. 

But our projections over that 5 years closely track those of the 

so-called Blue Chip projections, which is a compilation of various 

outside forecasters. This year we have a 2.7 percent projection. I 

said earlier I believe our revenues are cautious. So is our GDP 

growth, 2.7 is relatively low. Most outside forecasters are now well 

above 2.7, partly again from the information that we have received 

since our budget was put together. 

As you can see from this next chart, with solid economic growth 

our total receipts are now 18.5 percent of our economy. That is 

slightly above the historical average of 18.3 percent as a share of 

the economy. We project receipts remain at or above this historical 

average, by the way, for the 5-year period. 

So the notion that we are under-taxed relevant to again our history is just not accurate. In fact, we are already over the historical 

average. Yes, we dipped down in 2001 and 2002. That is absolutely 

right. But we are back up, not just to the historical average but a 

little above it. And our projections are we stay there during this 

entire 5-year period. 

I termed our revenue forecast as being cautious for this fiscal 

year. Our forecast for this fiscal year is 5.5 percent growth in revenues. And then, over the 5-year period our average is 5.4 percent 

per year for 5 years. 

166

This is, of course, below the 40-year historical average, which is 

7.6 percent. It is also well below the dramatic 11.8 percent increase 

of last year and 14.5 percent increase of the year before. 

That is one reason I call it cautious, but in fact it is below the 

actual first quarter numbers that are now in, which is 8.2 percent 

in the first quarter. As some of you know, CBO reported yesterday 

on some January figures that are even higher than that of the first 

month of the next quarter. 

As in the past, our revenue projections are being produced by the 

career professionals at the Office of Tax Analysis at the Department of Treasury. We have chosen to use them. You do not require 

us to, but we have chosen to use those projections. 

I will also say, as was the case in the past 2 years, we may well 

find that our revenue projections are low, and thus our 2007 deficit 

projection is high. I want to say that now because I remember what 

happened last July when we came out with our reduced projection 

of the deficit. And people said gee, you lowered expectations when 

you put the budget out. 

I am not trying to lower expectations. I am giving you what our 

tax professionals are saying, career professionals. I think they are 

very cautious. I think that is just where we have been the last 2 

years and we are likely to be there again this summer when we 

do our mid-session review. 

Even with his cautious forecast on revenues, the budget demonstrates we can achieve balance by 2012 and do it without raising 

taxes. In addition, we plan to more effectively and efficiently collect 

the taxes owed through an unprecedented effort to close the tax 

gap. This is something that Chairman Conrad and others have 

talked about a lot. 

It is a problem. And we approach the problem in two ways. First, we improve the effectiveness of IRS’s activities with a $410 million 

package of new initiatives to enhance enforcement and taxpayer 

service and to improve IRS technology, all focused on compliance. 

Second—and by the way, relying on standard conventions, we do 

not show any additional receipts from this. We do not score these 

additional resources to the IRS in our budget. That is the way CBO 

has traditionally done it, that is the way we have traditionally 

done it. 

This is increased compliance. I believe it will result in increased 

revenues. We can talk more about what some of those figures 

might be, but it is not in our forecast. 

Second, we include in the budget 16 carefully targeted tax law 

changes that promote compliance while maintaining that critical 

balance between taxpayers and taxpayers’ rights on the one hand, 

and our shared interest in collecting the taxes due. 

These changes in the legislative side are estimated to raise $29 

billion over a 10-year period, which as those of you know who follow this tax gap is a relatively small part of the tax gap, but it is 

scored in our budget as raising revenue because these are specific 

legislative changes. 

As noted, the 2008 budget proposes to hold the rate of growth for 

non-security to 1 percent. Again, we think that is fiscally prudent 

and also realistic. Congress and the President have done a better 

job at that. You all have done a better job on the non-security side 

167

of domestic discretionary spending. In fact, the growth over the last 

3 years is about 1 percent. It is about 1.2 percent the last 3 years 

on average, including this year. 

Again this year, the House just passed a continuing resolution 

that you all are going to look at, I understand this week and next 

week, that is at about the same level. We believe we can address 

our Nation’s top priorities at this level of funding. You have shown 

we can do it and our budget does just that. 

Within discretionary spending, the Administration closely examines programs to determine whether it is a priority or not, whether 

it is effective, whether it is producing intended results. Based on 

these thorough reviews the budget proposes to terminate or reduce 

141 discretionary spending programs which save about $12 billion. 

These reforms will help us reduce the deficit, but it channels resources to higher priorities and more effective programs. 

We are able to make these judgments as to how taxpayer dollars 

are spent, in part, because of tools that we have developed working 

with this committee, the Homeland Security Committee and others 

on the President’s Management Agenda. I encourage you to look at 

our analysis of these programs. 

Last year to ensure greater Government accountability, we 

launched this new website called ExpectMore.gov. This site includes information for taxpayers on the programs that have been 

assessed for effectiveness using what we call the PART, Program 

Assessment Rating Tool. With this website, Congress and the public now have an unprecedented view into our Federal programs, 

which ones work, which ones do not, and what we are doing to try 

to improve them. It is another way we are providing greater transparency, holding ourselves accountable and demanding results. 

The new and improved version of this website was launched yesterday. We now have program level information about the performance of nearly 1,000 Federal programs representing 96 percent of 

Federal Government spending, about $2.5 trillion of spending. I 

urge members, I urge their staff, I urge any viewers that might be 

watching, to checkout ExpectMore.gov. It is an interesting view 

into your Federal Government and how we made some of our decisions. 

The President’s 2008 budget also outlines a comprehensive series 

of budget reforms that will help improve fiscal restraint, transparency and accountability. This committee has taken the lead on 

a number of these. 

Legislative line item veto is, of course, one. I commend Senator 

Gregg for his efforts recently in leading a bipartisan effort that resulted in a close vote, but a majority vote, of the Senate to move 

the legislative line item veto through the Senate. The House actually passed such a bill last year, as you know, by a 247 to 172 margin, so a bipartisan effort in the House. By allowing Congress to 

take a second look at legislation through the process, I think it will 

help. I think we can work together to help reduce unwarranted earmarks or other wasteful and unnecessary spending. 

I also think it is complementary to the key reforms to the earmarking process that you all have just been through. The President 

has some additional ideas there to take earmarks out of report language, put them in statutory language so you actually vote on 

168

them, and so you have an opportunity to strike those you think are 

inappropriate. The President also believes we ought to reduce those 

earmarks by half. 

Our budget also proposes discretionary spending caps. In effect 

this expands PAYGO from no new spending in the mandatory side 

unless it is paid for, to the discretionary side as well. We also have 

additional proposals with regard to mandatory spending. They are 

specific, as I mentioned earlier, but also some process reforms that 

get to not just new spending in mandatories but the existing problem that we talked about earlier. 

Our budget shows how we can work with you to achieve a balanced budget by 2012, but that accomplishment will be short lived 

without addressing what Senator Conrad has talked about, which 

is the long-term challenge, the unsustainable growth in the entitlements. 

As you can see from this chart, mandatory spending is overwhelming the rest of the budget. In the space of four decades, we 

have gone from about 26 percent of our budget to over half of our 

budget devoted to these programs, and it continues to grow. 

As the next chart shows, the trends are just not sustainable. 

Senator Conrad has a good chart where he talks about that, as 

well. Under this chart what you will see is that by 2040 spending 

on these three programs and the debt that is attributable to those 

programs crowds out all other Federal spending. So there would be 

no spending for education or homeland security or defense. 

It seems to me that there is now nearly universal bipartisan 

agreement that the unchecked growth of these programs does provide real long-term threats to beneficiaries, to our Federal budget, 

to our economy. We now face, by the way, a $32 trillion unfunded obligation in 

Medicare alone. That is over a 75-year period. 

Our choices are pretty stark: massive benefit cuts, enormous 

deficits, or huge tax increases. Unless we act. And we can act. And 

we can act to make relatively small changes in these programs now 

to avoid that happening. 

The balanced budget is important, in part, because it positions 

our country better to address these looming fiscal challenges. But 

our 5-year budget proposal also makes an important down payment 

toward sensible reform of these mandatory programs, reducing 

spending growth by $96 billion over 5 years. 

Again these reforms are primarily in the Medicare program, but 

also in Medicaid and other programs. The proposals are similar in 

character to those this Administration has offered in the past, also 

to what the previous administration has offered, also to what a lot 

of Members of Congress have offered, and what we did together 

back in the 1990’s. 

To put these reforms in some context, you can see from this 

chart, the size of our budget proposal is a lot smaller than what 

we did on a bipartisan basis with divided government back in 1997, 

the last time we attempted to achieve balance together. 

Although an important first step, the savings in this proposal, as 

you see here, would only reduce the unsustainable annual growth 

rates of mandatory spending by less than 1 percent. Back in 1997, 

it was 2.8 percent. 

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What we are proposing is also less than what we did in 1990 

with OBRA and 1993 with OBRA, and some of you were involved 

in those efforts. 

Specifically, over 10 years the annual rate of growth in Medicare 

would be reduced under our proposals from a projected 7.4 percent 

annual growth to 6.7 percent annual growth. So it is still a very 

healthy increase. Of course, more than double inflation, maybe triple, and considerably higher than domestic spending. 

However, while these proposals deliver relatively small savings 

in the short-term, the effects that build over time are more substantial. The challenges that we face are great and the changes 

that we are proposing are relatively small compared to the challenge in the first five and 10 years, but over time they do help reduce the unfunded obligation of the program, by about 25 percent 

actually over the 75-year analysis of the unfunded obligation. 

Frankly, under our policies, we can achieve a balanced budget 

within this 5-year window without any of these mandatory 

changes. So the budget we are giving you today, the proposals you 

see, we can get to balance, we can show you how we can get to balance with a surplus in 2012 without making any of these changes 

on the mandatory side. That would be the wrong thing to do. We 

would only be digging a deeper hole by ignoring it for another year. 

Balance is not coming at the expense of our Nation’s commitment 

to seniors and low-income Americans. Quite the opposite. We have 

to begin to reform these programs now in order to protect these 

commitments in the long-term. Addressing entitlement spending is 

the right thing to do because small changes now can have a bigger 

impact later. I urge the committee to take a careful look at these 

specific proposals but also the general issue that the Chairman and 

others have raised. 

As we restrain spending, we are also investing in our Nation’s 

highest priorities, combating terrorism, protecting the homeland, 

addressing pocketbook issues that affect the standard of living of 

American families. We have talked about the fact that the budget 

supports our troops, fighting terrorism abroad. It also invests substantial resources to maintain high levels of military readiness in 

our DOD base budget and to continue transforming our military to 

meet the challenges of the new century. 

I want to make this point clear, the cost of the war is reflected 

in the Administration’s deficit projections. In fact, again there has 

been a $165 billion reduction in our deficit the last 2 years, even 

including substantial war costs. 

As noted earlier, the Administration supports greater transparency and accountability in the war costs for Iraq, Afghanistan 

and the global war on terrorism generally, and this budget does improve the timeliness and specificity of the information provided to 

you. 

With the 2008 budget, we go further than we have in the past. 

We show full costs of the war through the remainder of the President’s term. We provide full costs for 2007 and 2008 for the first 

time, including account level detail of our request and also justifications. 

Specifically, we are requesting additional resources of $99 billion 

for 2007 for Iraq, Afghanistan, the global war on terror; $145 bilVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00617 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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lion for 2008; and an allowance of 50 billion for anticipated war 

costs in 2009. 

The Administration welcomes more oversight of our war spending and we hope these details we are providing with this budget 

this week will help you more fully understand our war-related requests. 

This is a good faith effort. It is a good faith effort on our part 

to be as transparent as possible in what we anticipate the needs 

will be as far out as we can reasonably project. 

Mr. Chairman, there is a lot more to talk about in this budget 

but I will leave it for the dialog with members of this distinguished 

committee. I will say, in concluding, that the budget before you 

shows that we can reduce the deficit every year. We can achieve 

balance by 2012 by keeping the economy strong and imposing sensible and realistic spending restraint. We are committed to working 

with all members of this committee to ensure that our fiscal house 

is in order for the time that all of us will be in office, but also for 

the future. 

I am optimistic that we can do it. I think we can do it across 

party lines, as the American people expect, and as the American 

people deserve. 

Thank you, Mr. Chairman. I look forward to your questions. 

[The prepared statement of Mr. Portman follows:]

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Chairman CONRAD. Thank you, Director Portman. 

Let me address a couple of the things that you have talked 

about. You talked about the deficit as being in comparison to previous deficits. 


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The problem, of course, it is very difficult to compare now because we have such large temporary surpluses, especially in Social 

Security, that are not counted in your deficit calculation but that 

are added to the debt. 

For last year, the reported deficit was $248 billion. But the gross 

debt of the country increased by $546 billion. So when the assertions are made that the deficit was less than 2 percent of GDP, the 

fact is the debt of the country increased by more than 4 percent 

of GDP. And the biggest difference is the Social Security funds that 

are in temporary surpluses that are being used to pay the operating costs of the Federal Government. 

In the private sector, if anybody tried to do this, if anybody tried 

to take the retirement funds of their employees and pay operating 

expenses, they would be headed for a Federal institution. But it 

would not be the Congress of the United States and it would not 

be the White House. They would be headed to the big house, because that is a violation of Federal law. 

So I hear this over and over, that our deficit as a share of GDP 

is manageable. Nobody is talking about the debt. This debt is being 

run up at the worst possible time, before the baby boomers retire. 

The second point that you made that I want to respond to is the 

correlation you have made between the tax cuts and the economic 

recovery. I would point out that if you compared it to the Clinton 

years, you would see a similar pattern, actually an even better pattern of both job creation and economic growth. And that was after 

a tax increase. 

So I do not know if you would now say well, it was the tax increase that drove those remarkable economic results of the Clinton 

years, that showed the strongest economic growth in the Nation’s 

history, showed the strongest business expansion in the Nation’s 

history, the lowest unemployment in 30 years, the lowest inflation 

in 30 years, after a tax increase. 

It reminds me very much of the story of the elderly woman who 

was on her porch and it was a very hot day, the pavement was 

melting. And she fainted. And her nephew concluded that it must 

be the melting pavement that had caused her to faint. 

I think you are attributing the economic growth to the wrong 

cause. I think it is the recovery. And we see, in every recovery revenue growth, jobs expand. And we have seen it, we saw in the Clinton years after a tax increase. 

Let me just say, this recovery is running on revenue. We went 

back and looked at all of the recoveries since World War II. This 

is by far the weakest. This recovery on revenue is running $127 billion behind the average of the nine major recoveries since World 

War II. 

On job creation, let us go to that next slide. On job creation, this 

recovery is running 6.5 million private sector jobs behind the typical recovery since World War II. 

So I think the analysis here of what is causing what is just misplaced. 

And the longer-term implication of the President’s plan is to dig 

the whole much deeper. The President’s plan, that says we are 

going to extend all of the tax cuts at a cost of $2 trillion over 10 

189

years, dwarfs the savings that the President has called for on the 

mandatory side. I indicated your savings on the mandatory side, $280 billion over 

10 years, is absolutely dwarfed by the tax cuts. So you wind up in 

a worse position. 

Let’s go to where we might agree, because there are places that 

you and I agree. The place we agree is our long-term prognosis on 

the need to face up to the fiscal imbalances. We have tried, Senator 

Gregg and I, to bring both sides to the table to devise a solution. 

To me, the only way that happens is if both sides are prepared to 

compromise. 

You have said everything is on the table. What do you mean by 

that? 

Mr. PORTMAN. Thank you, Mr. Chairman, and welcome to Senator Gregg. I talked about you and Chairman Conrad talked about 

you, so it is good you are here to defend yourself. 

First of all, I agree with you. I think it is incredibly important 

that we, as public officials on both sides of Pennsylvania Avenue, 

and both sides of the aisle, acknowledged the problem. I commended you for that in my testimony and you and I have talked 

about that a number of times. Because the long-term unobligated—

the long-term liabilities and obligations that are currently unfunded is really the fiscal challenge we face. 

We are doing a much better job in getting our fiscal house in 

order short-term. And what the President has said recently is not 

only a specific proposal for a bipartisan commission to deal with 

the entitlement challenge, but he has said that there should be no 

preconditions, meaning that, in fact, everything should be on the 

table. 

He has also, as you know, shown some political courage in taking 

on some of these specific issues. We do it again in this budget. I 

have laid out for you what we think are sensible and reasonable 

changes in some of the programs that create the biggest challenge 

longer term. We talked about the $32 trillion unfunded obligation in Medicare. The President has also been way out front on the issue of Social Security and, as you know, we were not successful in getting 

Congress to take up those reforms. But he continues to believe that 

this is the biggest fiscal challenge that we face and we should address it and we should do so in a bipartisan way. 

Chairman CONRAD. Let me just followup and ask you, if I can, 

this question: when you say no preconditions, does that mean that 

you can foresee a resolution that includes both additional revenue 

as well as reduction in expenses for the long-term entitlements? 

Mr. PORTMAN. I think it is critical we not pre-judge at this point 

where we are going to end up in the long-term, because in that 

case—

Chairman CONRAD. I am not asking for a conclusion. I am asking 

though, when your side says there is no preconditions—because 

you say this, Secretary Paulson says it. But then I see the President and the Vice President, when they are interview publicly, 

slam the door in terms of revenue. 

So we need to know, if there is really going to be a serious discussion, it cannot be a circumstance in which one side, clearly 

190

Democrats are the preeminent defenders of Medicare and Social 

Security. Republicans are the preeminent defenders of tax cuts. 

That is the reality. 

So the question is are both sides to compromise? Are both sides 

to give ground here? Or is only one side to give ground? 

Mr. PORTMAN. I would take issue with your premise that Republicans who are trying to be sure these programs are around for future beneficiaries are not defenders of Medicare and Medicaid and 

Social Security. It is precisely because we think these programs are 

so important that we are willing to take what are politically difficult steps to try to ensure the commitment is there for future generations. 

I think that is the responsible thing to do. 

Chairman CONRAD. I would just say the problem is you are cooking a fiscal stew that is going to guarantee that there have to be 

more draconian cuts because you are using Social Security—we can 

get into that debate. I had hoped to try to reach conclusion on is 

there a serious chance for a discussion on the longer-term. 

But look—

Mr. PORTMAN. There is absolutely, absolutely a serious change. 

But I would not—

Chairman CONRAD. The fiscal reality is the President has run up 

the debt $3 trillion. That threatens Social Security and Medicare. 

It threatens Social Security to take $180 or $190 billion of Social 

Security money and use it, instead of paying down debt or prepaying the liability, to use it to pay the operating expenses of the 

Government. But that is the President’s fiscal plan every year for 

the next 10 years. 

That makes the long-term solvency of Social Security more difficult. 

Mr. PORTMAN. The issue on Social Security is that we need to reform the program so that it is able to sustain itself over time. I totally agree with you on the way you were calculating various approaches to looking at the deficit or even the long-term debt. We 

should have all that information. All of that is provided, by the 

way, in this financial report of the United States that I sent to you 

all personally. It is up on our website. I encourage every American 

to look at it. You can look at the debt and the deficit in a number 

of different ways. 

Chairman CONRAD. So is revenue on the table? If there is a discussion, if we come together for a negotiation, is revenue on the 

table as far as the Administration is concerned? 

Mr. PORTMAN. Again, I do not know how I can be more clear, but 

what the President has said recently—and this is not, again, something that was being said a year ago or even 6 months ago. And 

I think we should note that we have a long-standing view, and I 

have laid it out in our budget very clearly why we believe that we 

do not need additional revenues to get to a balance in 2012. I have 

shown you what the percent of the revenue is as to the economy, 

which is the burden on the economy, how it grows and does not go 

down—

Chairman CONRAD. But I am talking Beyond—as you know, I am 

talking beyond 2012. 

191

Mr. PORTMAN. Our long-term figures show the same thing, which 

is we do not fall below that historic average. The question is what 

should the burden be on this economy? Do we want to risk the 7.4 

million new jobs we have created since 2003, the economic recovery 

that has enabled us to generate those revenues. 

Chairman CONRAD. Director Portman, you are doing exactly 

what I feared—

Mr. PORTMAN. No, no, but this is nothing new. 

Chairman CONRAD [continuing]. Which is that this is all going to 

be done—

Mr. PORTMAN. This is our policy view. 

Chairman CONRAD. What I am hearing from you is exactly what 

I hear publicly from the President and the Vice President, that this 

is only going to be done on the cost-cutting side, which clearly has 

to be done, but nothing on the revenue side. If that is what you 

postulate, then there will not be a conclusion because then you are 

only asking one side fundamentally to compromise. If both sides 

are not prepared to compromise, there will not be a resolution during this administration. And that would be a tragedy. 

Mr. PORTMAN. What I am saying is we should have the discussion with no preconditions on either side. 

Chairman CONRAD. Senator Gregg. 

Senator GREGG. This is the gravamen, to use a legal term, of the 

fiscal year issue of this Nation, which is how we handle the longterm entitlement costs and the fact that those costs exceed significantly revenues, and the fact that you cannot tax your way out of 

this problem because the burden of these costs is accelerating at 

a point that they could easily absorb not only the entire Federal 

budget but well beyond the Federal budget, maybe as much as 30 

percent of gross national product. Today, of course, the Federal 

Government only—that is three programs, 30 percent of gross national product. 

I want to congratulate you, though, for—I had hoped we would 

reach a resolution that would allow us to sit down and set up a 

process which would lead to a policy which would take a global response and would address the entitlements, the major entitlements, primarily the health care entitlements and Social Security, 

and would also have to address revenue side. We are not going to 

get there without looking at both pictures, but the majority of the 

effort has to be on the benefit side. 

But it does not appear that the climate is going to allow that for 

a variety of reasons. I do not think the blame lies at the White 

House entirely, although some comments were not constructive. I 

think there is also a problem with some skittishness on the other 

side of the aisle, relative to making what would be a very courageous act of actually addressing the benefit structure of these programs. 

But I do want to congratulate you folks for putting forward a 

major step in the area independent of a global settlement with your 

proposal on Medicare which, as we know, Medicare has approximately a $35 to $40 trillion—that is with a T—unfunded liability 

over its actuarial life, the actuarial life being essentially the retirement of the baby boom generation. 

192

That liability is so huge that it will essentially bankrupt our children’s capacity to have a decent lifestyle. Our children will not be 

able to afford that system. And they well be left with a lifestyle 

much less of quality than what our generation has had, and our 

generation will have done an incredible unfairness to our children 

by leaving them with this debt and putting this debt on them. 

We have to address that. Now I would hope for a global settlement but we are not going to get there, it appears, because the parties are backing away. 

But least you have come forward with a proposal which reduces 

significantly that number. As I understand your proposal, which 

represents about $90 billion over 5 years, translates into about $8 

trillion over the actuarial life, which is about 25 percent of the 

problem. That is a huge step. 

As I also understand your proposal, it does not address—it does 

not reduce benefits to beneficiaries. It calculates more accurately 

the reimbursement inflation rate for hospitals and for provider 

groups, which should be gone. And it also says that Bill Gates’s father and other people who are fairly wealthy, very wealthy, should 

not be subsidized by working Americans who are working at restaurants and gas stations across this country, and their doctors’ 

cost and their drug costs. And those two items primarily are the 

drivers of this very dramatic reduction in the out-year liability. 

I guess I have two questions for you. First, is that an accurate 

description of what you are doing? I am sorry that I was not earlier, maybe you have already gone through this. There was some 

issue on the floor that has drawn me away on occasion. 

And second, I would hope that if that is true, that at least our 

colleagues on the other side the aisle, when they draw up their 

budget, would at least take this element of the major reform effort, 

which is a significant element, and run with that one. 

Mr. PORTMAN. I appreciate the fact that you have described it 

well, and better than I did in my testimony, because you have 

talked about what the impact is on beneficiaries. You are right, for 

the vast majority of Medicare beneficiaries there is not only no impact, it is a positive impact in the sense that their premiums will 

go down. Because as you know, in Part B they pay 25 percent of 

the premium. 

Senator GREGG. And the system will be made more solvent. 

Mr. PORTMAN. And the system is made more solvent, which is 

the ultimate benefit to all of us, to be able to protect these programs over time. For higher income seniors there is more means 

testing. I am told I should use the word income relating. But what 

it means is—

Senator GREGG. No, we are just going to make high-income seniors pay the fair cost of what we are giving them. That is reasonable. 

Mr. PORTMAN. It is 5.6 percent of seniors. Again, every other beneficiary will see a reduction in their premiums, not an increase, a 

reduction. But for 5.6 percent of seniors there will be less of a Federal subsidy under Part B and under Part D for the premiums. But 

it is 5.6 percent of seniors. It is actually 2.7 percent of seniors in 

Part D. 

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Senator GREGG. What percent of that $8 trillion is tied to the adjustment of premiums for high-income seniors? 

Mr. PORTMAN. About half, over time. 

Senator GREGG. And the other half is to get the COLA right for 

reimbursement; is that correct? 

Mr. PORTMAN. That is correct, what we believe is an appropriate 

reimbursement for the providers, clinics, labs, hospitals. 

Senator GREGG. I do not think either of those should be controversial. I mean, obviously the provider groups are going to go 

crazy. But a fair reimbursement rate is a fair reimbursement rate, 

and having high-income seniors pay a much higher percentage of 

the cost of their premium is a reasonable thing. 

I would hope that as our Democratic colleagues develop their 

budget, they would consider putting that in there, too, so we would 

have it in both budgets and there would be consensus. 

Thank you. 

Mr. PORTMAN. Thank you, Senator. 

Chairman CONRAD. I would just say for me, I voted to do that. 

One night in the Finance Committee a number of years ago, a 

group of us just got so tired of this stale debate that we did a whole 

series of things. And it actually passed the Finance Committee 

overwhelmingly on a bipartisan vote. And when we told our other 

colleagues about it, they retreated. But we were prepared—

Senator GREGG. I think we should give the Finance Committee 

another opportunity to do that. 

Chairman CONRAD. That may be a very positive idea. 

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

Rob, how are you? 

I look at the world a little bit differently than you do and a little 

bit differently than some of my colleagues. Let me tell you the 

world that I look at. 

Since the Bush Administration has been in office, and I did not 

hear you mention this word once, poverty has increased by 5 million Americans. Is that an issue that maybe we might want to be 

talking about? 

Not only does the United States have the highest rate of poverty 

of any major country in the industrialized world, but I think more 

outrageously we have by far the highest rate of childhood poverty, 

way above what Europe and Scandinavia does. I do not hear one 

word coming out of the Administration on that issue, 37 million 

Americans living in poverty today. 

Median income for working-age families has declined for 5 years 

in a row while the price of health care, housing, energy and college 

tuition has skyrocketed. 

Meanwhile, and this is an issue that we have to place on the 

table as well, while poverty is increasing and while millions of 

Americans are working longer hours for lower wages, the people on 

top have never had it so good. You cannot just look at an economy 

and say everything is going well. Well, it is not. Poverty is increasing, middle class is shrinking, people on top have never had it so 

good, not since the 1920’s. 

According to Forbes Magazine, the collective net worth of the 

wealthiest 400 Americans increased by $120 billion last year, to 

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$1.25 trillion. The 400 wealthiest Americans are worth $1.25 trillion. At the same time, 37 million Americans are mired in poverty 

and 47 million Americans have no health insurance. 

That is the reality that I see, and maybe that is the reality every 

now and then this committee might want to talk about, just occasionally. 

Now a budget is a reflection our values. It tells us what we believe and where we want to go. The way I see the budget being presented is at a time when the wealthiest people have never had it 

so good, what you do is suggest that we maintain huge tax breaks 

for millionaires and billionaires. It does not seem fair to me. It does 

not seem right to me. 

Meanwhile, while poverty is increasing and millions of Americans are really struggling just to keep their heads above water, 

what I see, as the chairman indicated, Vermont may not be as cold 

as North Dakota, it gets pretty cold in Vermont, it gets pretty cold 

in New Hampshire. LIHEAP, 40 percent of whose participants are 

seniors, will be cut. The Commodity Supplemental Food Program, 

which provides a package of groceries to low income seniors once 

a month, is cut. Community Service Block Grants, which provide 

the infrastructure for the delivery of services to low-income people, 

is cut. 

Now we talk about a war budget and the war in Iraq, and yet 

in my State, and almost all over this country, veterans today are 

on waiting lists. And what you propose in your budget is to raise 

fees on veterans for their health care by $355 million in 2008, the 

result of which will be driving, which is the purpose, hundreds of 

thousands of veterans off of VA health care. 

Now maybe some people think that is a way to say thank you 

to the people who have put their lives on the line defending our 

country. I personally do not. 

When we have the highest rate of childhood poverty, you are proposing cutting back on Head Start and child care. 

Now Rob, I do not know what goes on other parts of the country, 

but I will tell you that in Vermont, child care is a disaster. It is 

very hard for families to find affordable quality child care. And you 

are cutting back on that. 

Question: at a time when we are seeing an escalation of millionaires and billionaires at the same time as we are seeing a huge increase in poverty and a decline in the standard of living of millions 

of American workers, do you really think it is appropriate to cut 

back on programs for low-income people and maintain tax breaks 

for millionaires? 

A pretty simple. 

Mr. PORTMAN. Senator Sanders, I thank you for your question 

and I know we are going to have differences in our views or approaches. But just, if I could, tell you a little bit about what we are 

looking at now in terms of the economy, where it is relative to 

where it was maybe a few years ago in terms of what you were 

talking about, working families and their paychecks. 

Senator Conrad talked about the fact that recoveries typically involve not just an increase in revenues, but they also involve, I will 

say, an increase in wages. If you look at what is happening today 

and in the last year in particular, we have seen real wages going 

195

up. We did not see that early in the recovery. By the way, we DID 

not see that in the recovery in the 1990’s either. In fact, we are 

ahead of the 1990’s recovery in terms of from the recession until 

now how much wages have gone up. Talking about real wages, 

after inflation. And we are able to show that now. And thank goodness, and it is a great thing for working families. 

So over the last 12 months, we have seen a change in that, partly frankly because energy prices have gone down some. But mostly 

it is because, as with the recoveries over the last four decades, 

wage growth tends to follow the productivity growth, the GDP 

growth, and it is now happening and it is kicking in. And working 

families and people who punch a time clock around this country 

every day are now seeing the benefits of the better economy. That 

is a good thing. And that is affecting some of the income inequality 

issues that you raise. 

I can give you all of the data on that that we have now got from 

Treasury and from the Labor Department and so on, but that is 

good news. And it was not true a year ago. 

Senator SANDERS. If I could, my time is limited and I do not 

mean to be rude. 

Child care, a horrendous situation, I think, all over this country. 

I do not know if you acknowledge that or not, affordable child care 

hard to come by almost any place. And yet you guys are cutting 

back on child care, you are cutting back on Head Start. 

Explain to me why you think that is a right thing to do within 

the context of our country, having the highest rate of childhood 

poverty? 

Mr. PORTMAN. Let me get the Head Start numbers. 

I have a little bit of a challenge here because, as you know, Congress is about to pass a new Head Start provision, or the Senate 

I think is poised to pass something. The House has passed in the 

last week, new numbers. 

Our number is based on the expected changes. The 2007 request 

would have been a slight increase. The number I have now in front 

of me on, at least what the House passed and what I assume you 

all will pass, is our request is actually an increase of 1.45 percent. 

Senator SANDERS. We see it as a reduction from the continuing 

resolution. That is the numbers that I have. 

Mr. PORTMAN. I have all of the numbers. We can share these 

with you. But it takes me a minute because this H.J. Res., which 

is the new long-term CR, changes the numbers somewhat. You are 

providing—

Senator SANDERS. Tell me about the—

Mr. PORTMAN. Can I talk about the fees just for a second, because it is a very important issue. 

Chairman CONRAD. We need to close this out because the Senator’s time has expired. 

Mr. PORTMAN. I am happy to get with you afterwards, but we 

think we have a good policy here, a big increase again, 7.6 percent 

in the veterans budget, 7.4 percent increase in medical care for our 

veterans this year, building on the increases we have had of 64 

percent since 2001. 

Chairman CONRAD. Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. 

196

We had some discussion about the debt, as opposed to the deficit, 

and how Social Security plays into that. Is there some way that we 

can change our debt problem without changing the law pertaining 

to Social Security and the transfers of dollars from Social Security 

to the general fund? I do not see how that happens. 

Mr. PORTMAN. No, it would require legislation. 

The point I was making earlier was that I agree the Chairman 

in the sense that we ought to look at our deficit and our debt in 

various ways. One is the unified budget. That is how we have done 

it since 1967. That is how this committee will, I assume, propose 

your own budget. It will not include the surpluses in Social Security. 

That is how the CBO does it, the non-partisan Congressional 

Budget Office. That is how the Clinton Administration did it. That 

is how we do it. 

My point was I think it is helpful, frankly, to look at it another 

way, which is to look at not just our net operating costs, which 

would include our real liabilities like veterans or military retirees 

or Government retirees—which by the way, again, is here. You can 

look at the net operating cost of the Government as well as our 

unified budget. 

Also, I think it is helpful to look at it in terms of what are our 

unfunded obligations, which would include Social Security and 

Medicare? 

But the point, Senator Allard, that you made and that I am trying to make, is at a minimum we should agree to get to balance 

on a unified basis. The unified budget that we all have been using 

since 1967 is all money in and all money out. So all fees, all payroll 

taxes, all income taxes into the Government, and then all the 

money we pay out. At a minimum, let’s get to balance on that 

basis. And that will require some spending restraint. 

On the other hand, if you look at what Congress has done the 

last couple of years, we are on track to be able to achieve that, as 

long as the economy continues to grow. That is why keeping the 

tax relief in place is so important. 

The one thing I did not get a chance to do, in responding to Senator Sanders’ comments, is to say that one reason we feel so 

strongly about the tax relief staying in place is because of this correlation we see between its implementation in 2003 and the growth 

in jobs and productivity and investment. But also because if you reduce the existing tax relief that is in place, it will be a tax increase 

on America’s families. 

Or if you are focused more on the economic impact overall, you 

have to acknowledge that it is a big increases in taxes on America’s 

small businesses, which are creating so much of the economic activity and new job growth. More than half of the new jobs are being 

created by small businesses, 90 percent of whom filed their taxes 

through the individual tax system. 

So if you raise people’s taxes, Mr. Sanders talked about going 

after the wealthy individuals. Well, you are also going after America’s businesses. In fact, it is the more profitable small businesses 

that, of course, are generating more jobs, expanding their plant and 

equipment and people. And 75 percent of those small businesses 

have income in these top two brackets that we are talking about. 

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So this is a very important part of the President’s tax relief, as 

well. 

Of course, on the capital gains side, on the dividend relief side 

that you supported so strongly, Mr. Allard, very important to encourage investment to keep that moving forward. 

Chairman Conrad talked about the difference between this recovery and the last recovery. He noted that there were tax increases 

in the early 1990’s. That is true. But when the economy really took 

off in the late 1990’s, including 1997 when we came together as Republicans and Democrats, we actually cut taxes. 

Senator Bunning was on the Ways and Means Committee there 

at that time and he helped do that. It was on capital gains. And 

it resulted in new revenues in capital gains that were beyond anybody’s expectations. It helped us, as you know, get to balance in the 

late 1990’s sooner than anybody thought we could. 

We had a 5-year balanced budget then, as we are proposing now. 

We actually got there a couple of years early, partly because of 

those capital gains receipts that came in because of a tax cut in 

1997. 

Senator ALLARD. I want to make an additional point here, my 

time is running out here. I just put a chart up on the screen there 

to the right which shows high income taxpayers bear a greater burden under Bush. If you compare the Clinton Administration, it is 

81.2 percent. If you compare the Bush Administration, who brought 

in tax cuts, we see it goes up to 84.9 percent. 

So in real figures what is happening in revenues coming into the 

Federal Government, we see a greater proportion of that coming 

from the high income taxpayer. 

Mr. PORTMAN. That is a fair point and it is accurate. After all 

the Bush tax cuts are implemented, the top 10 percent pays about 

66 percent of the burden rather than 64 percent of the burden, and 

that would be consistent with your chart. 

That is because of the refundable nature of the child tax credit, 

as you know, the expansion of the 10 percent bracket. Also the way 

the marriage penalty works. As you know, 4 to 5 million taxpayers 

do not pay any Federal income tax now who did previously, who 

are lower income Americans who benefit from the tax relief. 

So you are right to point that out. The point I was making is another aspect of it, which is among those higher income taxpayers 

a lot of them are small businesses. Because of the way our tax system works small businesses, for the most part, are in the individual tax system, not in the corporate tax system. 

Senator ALLARD. Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you, Senator Allard. 

Senator MENENDEZ. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Director, it is good to see you. I enjoyed my time in service in 

the House with you. 

Let me start off by saying that in 2003 a different White House 

Budget Director told the Congress that the war in Iraq would 

maybe hit $50 or $60 billion at most. We have spent seven times 

that much. So I want to look at the present request by the Administration in this budget on Iraq. 

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As I understand it, the President is asking for about $179 billion 

for Iraq in 2007 and 2008; is that correct? 

Mr. PORTMAN. That is correct, Senator. It is $170 billion roughly total, a little less than that, but about $170 billion for 2007 when 

you add the bridge that you all passed back in October. And then 

it is, for 2008, another roughly $145 billion, about $141 billion on 

the DOD side, and $145 billion total for Iraq, Afghanistan, global 

war on terror for 2008. 

Senator MENENDEZ. One of the things I would hope that you 

would make more clear in the future, you have to be a CPA/rocket 

scientist to go through the way—instead of very clearly saying here 

is how much we want for the war in Iraq, here is how much we 

want for Afghanistan, the Administration mixes it in such a way. 

It should not have to take a rocket scientist to figure it out. 

But having figured it out, isn’t it a fact that these numbers, CBO 

has told the Congress that they see the escalation of the war costing much more than that. And it is either oversight or deceit by 

the Administration not to have an extrapolation of the facts that 

there is going to be a lot of support personnel in addition to the 

actual troop deployment that is necessary. And that does not seem 

to be factored in in this budget. 

Mr. PORTMAN. I am glad you asked that question. It is neither 

oversight or deceit. It is a different plan. I spoke to the director 

CBO, for whom I have a lot of respect, I know you know him well, 

Peter Orszag, about this. I just wish they had called us because 

they assume that this goes into 2008. First, we do not. It is a different policy. You can hold us accountable for our policy, but our 

policy is this is a fiscal 2007, not a fiscal 2008/fiscal 2009 exercise. 

Senator MENENDEZ. So the Administration is going to deviate totally away from the military standard operating procedure for the 

purposes of support personnel? It is going to move totally away—

Mr. PORTMAN. That is another issue. 

Senator MENENDEZ [continuing]. From its historical realities. 

And you are not going to come back to us for a supplemental this 

year; right? 

Mr. PORTMAN. That is another issue and I should have addressed 

that earlier. On the plan that the President has laid out for increased brigades he is assuming, and this is our plan, that we will 

extend the deployment of many troops who are in Iraq now. The 

CBO assumed that we would be sending reinforcements in that 

were brigades from the United States or other bases. So it is just 

a different plan. 

The support troops that you are talking would also, under our 

plan, many of whom would be in Iraq now or in the theater, they 

would be extended, as well. 

Senator MENENDEZ. So you are going to send 22,000 troops more 

and not send virtually any more support troops for those 22,000? 

Mr. PORTMAN. No, we have built into our estimate, which is $5.6 

billion, the support troops necessary to support the additional brigades. 

Senator MENENDEZ. So you are not going to come back to us for 

a supplemental? 

Mr. PORTMAN. Well, we will see what happens on the ground. 

With regard to the particular issue of what we are doing on the adVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00646 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ditional brigades, the reinforcements in this new plan, we have our 

full costs in the fiscal year 2007 supplemental. 

Senator MENENDEZ. How do you go in 2009 to $50 billion? How do you go from $170 billion, especially with the President’s escalation of the war, and then tell the Congress that in 2009 you are 

going to have $50 billion? 

Mr. PORTMAN. It is not an estimate of full war costs in 2009. You 

are correct. 

Senator MENENDEZ. So it is going to be a lot more than that. 

Mr. PORTMAN. I do not know. Nor does anybody on this committee. 

Senator MENENDEZ. How can you talk about a balanced budget 

when you are throwing out a figure that is clearly underfunded 

from its present reality? 

Mr. PORTMAN. If the President’s plan works as we believe it will, 

and as I know Americans hope it will, which is that it will result 

in less of a commitment by our country to Iraq because we will be 

able to quell some of the sectarian violence that has flared—

Senator MENENDEZ. Two-thirds less? Two-thirds less in 1 year? 

Mr. PORTMAN. No, I am talking about 2007 now. We are in 2007 

now and that is the funding that provides for the increased reinforcements in 2007. 

In 2008, we actually provide, and this may make you feel better 

about things, a straight line. In other words, in 2008, we do not 

assume, for purposes of our budget, that there will be a decrease 

in our activity. We hope and expect there will be, but to be prudent 

in 2008 it is just a straight line. 

Senator MENENDEZ. What will have you come back here for a 

supplemental? What facts will change on the ground that will have 

you come back here for a supplemental? 

We had testimony here by a panel of experts that say they believe that notwithstanding what you have put in the budget, you 

are going to be coming back for a supplemental. What would be the 

factors that you might have that you will have to come for a supplemental? 

Mr. PORTMAN. Changed circumstances on the ground, and it can 

go either way, honestly. What we have provided is, I think, a prudent 2007 and 2008 estimate. And 2007–2008, by the way, are 

being provided to you for the first time at the account level, breaking out Afghanistan. I agree with you that in the past we have not 

provided the kind of transparency that is most helpful to Congress 

for oversight. 

These two boxes, that I will not make somebody put on the table, 

include the justifications. So it is not just the account level, which 

we have not provided previously with the budget, but it is all the 

justifications now, not justifications to come later. 

It will not take a rocket scientist to look through it. It will take 

some time because there is a lot of detail there. And we are saying 

for 2007, we believe this to be our full cost. You can look at our 

assumptions. You can look at our request for 2008, which is something that is difficult for military planners to do because much of 

this money will not be spent for 18 months or 2 years or more. We 

are basically giving you a straight line from 2007 in terms of military operations. 

200

Now again, we believe that we will be able to see some success 

with the reinforcements that will not make that necessary. But out 

of prudence, we are providing that. 

I just want you to be aware of that. There is no opportunity for 

members of this committee or for war planners at the Pentagon to 

have a window into exactly what is going to happen. Nobody has 

a crystal ball. So that is why I cannot answer your question as to 

whether there might be another supplemental request sometime in 

the future. I just do not know. 

But I do think that by providing more information to you and 

giving it to you in a more transparent way with all of the justifications and account level detail, we are being more responsive to the 

concerns that have been raised. 

Senator MENENDEZ. Mr. Chairman, I just want to close by saying 

that I am concerned that we do not have the full figures here, that 

we will end up with a supplemental. And supplemental is deficit 

funding at the end of the day. That is how the Administration has 

largely funded this war. 

Thank you. 

Chairman CONRAD. Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. 

Director Portman, I am concerned about the rate of growth of our 

entitlement programs. You are also, particularly Medicare and 

Medicaid. 

The President’s budget takes steps to slow the rate of growth in 

these programs. In other words, we are not cutting but the growth 

rate is slowed. For example, in Medicare the President has proposed reducing the growth rate in the program from 6.5 to 5.6 over 

5 years. In Medicaid the rate of growth is reduced from 7.3 to 7.1. 

And I looked at it over a period of 75 years. Out-years are particularly a concern to my 35 grandkids and my four greatgrandkids. If we do what is proposed to be done, the Medicare unfunded 75-year unfunded liability is reduced by 25 percent or $8 

trillion. I think that is very important. 

Is that the reason that we are biting the apple now, not reducing 

any benefits, but if we do not take that reduction in increase now 

that the out-years just get worse and worse as we go down the 

pike? 

Mr. PORTMAN. Yes, you are absolutely right. We talked about 

this a little bit earlier, but by making relatively small changes now 

that are sensible policy changes, we can have a significant impact 

in the out-years. 

I will also tell you this is not enough to address the problems 

that Senator Gregg and Chairman Conrad discussed earlier. In 

other words, we will need, as a Congress and as an administration, 

to sit down and work out even further sensible reforms to not just 

Medicare but also Medicaid and Social Security. 

On your numbers, you are absolutely right. Over the 10-year period, by the way, the Medicare growth is 7.4 percent under current 

projections. The implementation of all of these proposals we have 

on Medicare takes it to 6.7 percent. So it is less than a percentage 

point decrease in the rate of growth over the 10-year period, as 

well as the 5-year period that you mentioned. 

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On Medicaid, the 10-year number is 7.4 percent under current 

law annual increase, and all of our proposals on Medicaid, which 

again we believe are all good policy, takes it to 7.6 percent, 0.1 percent. 

I would say that is the least—

Senator BUNNING. Out-year projections, am I correct on the outyear predictions? 

Mr. PORTMAN. Yes, you are, sir. You are correct. In the out-years 

it has a greater impact. In the out-years the $32 trillion unfunded 

liability in Medicare over the 75-year period that was talked about 

earlier would be reduced by roughly 25 percent or $8 trillion under 

the full implementation of these Medicare proposals because the 

savings grow over time. 

Senator BUNNING. I have to get back to Social Security because 

you were on my subcommittee over in the House, as chairman and 

he was a member of my subcommittee in the House on Social Security. 

How many times did I say we have to change the law if we want 

to change the unified budget? Because the law requires exactly 

what we do with our money when we take it in in Social Security. 

I do not know how many people up here at this forum or this 

table, this wonderful Budget committee I sit on now, are willing to 

change the law and do something else with the receipts of the Social Security funds. 

But if we are going to change that then the unified budget would 

look different? Is that correct? 

Mr. PORTMAN. That is true. Under current law there is a requirement that they be invested in treasuries. 

Senator BUNNING. And what do we do the other money that is 

invested in treasuries? In other words, the money that the Treasury sells out on a monthly or bimonthly or quarterly or whatever, 

the 5-year notes, the 2-year notes, the 10-year notes, the 30-year 

bonds. What do we do with that money? 

Mr. PORTMAN. It is used to help finance our debt. 

Senator BUNNING. Yes. 

Mr. PORTMAN. I will say there is a big distinction between publicly traded debt, which is the debt that we offer to the public, and 

so-called internal debt. 

What you are talking about is the importance of looking at both 

of those. The internal debt is the obligations that we have to Social 

Security and beneficiaries over time, now in a surplus. But in 10 

short years, as you know, the line crosses. In a sense, we do not 

have the payroll taxes coming in to afford the—

Senator BUNNING. No, we go into the interest and in about 2046, 

if we do not do something dramatic, we will be paying 75 percent 

of the benefits that we now are obligated to pay under current law. 

Mr. PORTMAN. But in 10 short years that surplus is no longer 

there. 

Senator BUNNING. That is correct, we are into the interest. 

Thank you very much. 

Mr. PORTMAN. Thank you, Senator Bunning. 

Chairman CONRAD. Thank you, Senator Bunning. 

Senator CRAPO. 

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

Portman, we appreciate you being here. 

I look back with fondness on the time we served in the House 

together, as well, on a number of these critical issues where we 

struggled then to try to find solutions to develop a path forward. 

But I want to pursue with you a little further the same line of 

questioning that you have gone through here with Senator Gregg 

and Senator Bunning, the 75-year outlook on our entitlements. 

I understand that we have gone over the numbers several times, that you are proposing about a $90 billion reduction in the first 5 

years, in the 5-years of this budget, but that that $90 billion reduction will translate into approximately $8 trillion of savings over the 

next 75 years of the entitlement programs that we are talking 

about; correct? 

Mr. PORTMAN. That is correct. 

Senator CRAPO. Could you give us a little more detail about how 

that $90 billion is proposed to be achieved in terms of the savings? 

Mr. PORTMAN. Thank you for asking. I had an opportunity with 

Senator Gregg to talk about this a little bit earlier. But in the first 

five and 10 years, the majority of the Medicare savings do come 

from what we believe are changing the payment from what it currently is projected to be to providers to what we think is a more 

appropriate payment. That number is on the market basket, which 

is the biggest part of it, a 0.65 percent reduction. We come at that 

number in part from analysis that has been done by outside groups 

and experts. But also it happens to be about half of the productivity gain that is expected. 

In other words, through efficiencies and more productivity, we 

would expect about twice that amount. So we think the 0.65 percent is reasonable, again also based on what many experts have 

given us in terms of the actual health care provider community and 

what would be an appropriate level. So we think it is good policy 

and in the first five or 10 years it is the majority of the relatively 

small savings relative to the growth of the program we talked 

about. 

Over the longer haul, it is shifted somewhat more to the means 

testing side so it becomes, I believe, nearly half of the savings over 

time is telling those individuals who make over $80,000 a year or 

as a couple over $160,000 a year that the Federal Government will 

continue to provide a subsidy for their premiums under both Part 

B and Part D, but a little less of a premium subsidy from the Federal Government. 

That is the proposal that Senator Conrad talked about the Finance Committee has taken up in the past, maybe the distant past 

now, and we think is also a crucial element to a comprehensive 

plan to looking at our entitlement problem. 

I will also say we have not talked as much about Social Security. 

I know you have a strong interest in that and you have been out 

front on some specific proposals in that regard. The 75-year projection on the Social Security unfunded obligation is $15 trillion. So 

less we only focus on the Medicare $32 trillion, there is also a big 

unfunded obligation in our Social Security program. 

Senator CRAPO. And we still need to deal with that, which is not 

done in this budget proposal. 

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Mr. PORTMAN. No, it is not. 

Senator CRAPO. Back to the details you were just talking about, 

if I understand them correctly then, with the exception of those reductions or changes in the benefit structure for the more wealthy 

citizens, there is not a proposed change to the benefit structure of 

the Medicare or Medicaid system? 

Mr. PORTMAN. That is correct. For those Medicare beneficiaries 

who are not part of what is now 5.6 percent of beneficiaries under 

Part B or 2.7 percent of beneficiaries under Part D who would be 

subject to some of this slight reduction in the Federal subsidy on 

premiums, for the rest of Medicare beneficiaries, meaning the vast 

majority of beneficiaries, the impact is a slight reduction in their 

premiums. Why? Because they pay 25 percent under Part B, as you 

know, of the premium, the Federal Government pays 75 percent. 

And they are going to see a little lower premium as a result of 

these changes that we have proposed on the provider side. 

So for most beneficiaries, the difference will be that they will see 

a slightly lower premium. 

Senator CRAPO. So the message there with regard to the beneficiaries is that the proposals you are making will actually have a 

slight reduction, except for the small number we talked about at 

the higher end, and that they could look for about a 25 percent reduction in the long-term issue that we have. 

Mr. PORTMAN. That Is correct. 

Senator CRAPO. Let us look at the provider side. Are the proposed reductions on the provider side going to cause a problem in 

terms of providers being able to effectively work in a market that 

we are seeking to have them work in to provide these benefits? 

Mr. PORTMAN. That is a fair question and, again, we have done 

our own analysis. You will do more analysis in the Finance Committee and here on this committee. Our belief is that we can continue to provide the kind of care that is currently available because 

we think, again, the 0.65 percent reduction is a fair reduction. It 

right-sizes, in effect, what the payments have been. 

It is also very similar, as you know, to proposals that this Administration has made in the past. The Clinton Administration 

made proposals of a similar character, but before us. On a bipartisan basis in 1997, we did a lot more in terms of the market basket. Instead of 0.65 in 1997 the number was 2.7 percent as compared to 0.65 percent, which is the chart I showed earlier. Either 

in nominal terms or as a percent of the program, we have done 

more as a Congress previously when we have tried to work together to get to a balanced budget. 

We also did more in 1993 and 1990 with the OBRA reforms to 

try to get at a growing deficit. 

I know it is not going to be easy. Politically, it never is. But I 

do believe that this is the appropriate policy approach. I also believe that it is a first and important step toward dealing with this 

unfunded obligation that Senator Gregg and Senator Conrad talked 

about. 

Senator CRAPO. Thank you, and our time is up. 

I just want to thank you for paying attention to that, because I 

did note, and we all in America noted, that the President has proposed a budget that moves to balance in the year 2012. And I 

204

would expect that any other budgets that this committee may come 

up with will also balance, because we have the dynamic in the 

short term, the five to 10-year range term, to be able to do that. 

But the real looming liabilities out there, those unfunded liabilities that are going to start driving deficits in the future and driving debt in the future have to be paid attention to. 

And I appreciate the fact that while submitting a 5-year budget 

that balances, the President also has made proposals for how we 

will start dealing with the long-term liabilities that are such a 

giant issue for our country. 

So thank you very much. 

Chairman CONRAD. Thank you, Senator. 

Senator ENZI. 

Senator ENZI. Thank you, Mr. Chairman, and I want to thank 

the Director for his fine presentation and his capability for answering our questions. 

The Higher Education Act is going to be up for reauthorization 

this year, and I do want to work with the Administration through 

that reauthorization process and support many of your spending 

initiatives, particularly the increase in the maximum Pell Grant 

award. But I do feel that it has to be responsibly paid for. And I 

am sure several of us have some concerns about mandatory savings 

being used for discretionary spending. 

And rather than have you give me the details right now on how 

that proposal is going to work, I am going to submit that question 

in writing for you because I think it is more than what we can do 

in the time limit here. 

But I am drastically interested in that. 

I would also ask unanimous consent that a full statement be put 

in the record. 

Chairman CONRAD. Without objection. 

[The prepared statement of Senator Enzi follows:]

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Now I see them in the budget, there are some premium increases 

that are being proposed. We put some premium increases in the 

legislation last year and now there are some being proposed for 

this fiscal year. Again, I will cement that in writing to see why you 

are proposing them and we need a lot more detail on that. 

To actually get to a question, another thing that the HELP Committee is working on is sufficient funding for the FDA to carry out 


34649.295
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its important mission. I did notice in the President’s budget request 

that there are three new user fees that will be required. These new 

user fees totaled $53 million. What I noted was that they have not 

been authorized through legislation, and that is close to half of the 

proposed increase for the FDA budget. 

So it has been typical that the industry would negotiate new 

agreements, fees, and goals and then set it to Congress and then 

we would do something with it. Has the Administration discussed 

these fees, particularly with the proposed generic users in the affected industry? 

Mr. PORTMAN. [Nodding affirmatively.] 

Senator ENZI. You are nodding your head so I will not ask if not, 

why not? But are they receptive? 

Mr. PORTMAN. You note there is an increase in the FDA funding 

and that is because we want to assure FDA has the resources to 

be able to even accelerate some of the approvals that are so important. 

We have worked with not just the generic community, but the 

users in general. And I believe that you will find that certain fees 

are viewed as acceptable so long as they go back in the system. I 

will let you do your independent analysis of that, but we have 

spent the time to talk to some of the users to be sure they understand why we are making these increases that they have asked for, 

but also to talk about to what extent fees should be part of it. 

I think you will find again, as long as the resources are devoted 

back to the FDA process, that there is more receptivity to it. 

Senator ENZI. I appreciate the emphasis, too. 

I did notice that the budget included, and these are really small 

amounts compared to the whole budget, but $30 million for the African Development Foundation. That group is doing such spectacular work at actually getting the money to the people not to the 

governments and having it absorbed there, but to the people. And 

they are getting the governments to match whatever we do, which 

I think has a tremendous impact for the United States and much 

greater impact than some of the ones we are spending billions on. 

So I really appreciate that emphasis. 

Something of more immediate concern for me though is we 

passed the Surface Mining Control and Reclamation Act amendment last year. That is abandoned mine land money. That implementation is very important to the State of Wyoming. And I want 

to ask that you keep me in the loop on that, and the budget does 

not detail where you are in the implementation process. You may 

not know that, again compared to the whole budget it is a very significant amount. But for Wyoming it is a huge amount. So I would 

like to know where that is. 

Also the coal-to-liquids technology, I think that will play a huge 

role in the future of energy for this country. The President placed 

quite an emphasis on it. And I would like to know if the Administration plans to help move forward with that development of coalto-liquid technologies as part of the loan guarantee program, and 

if we are ever going to get that in place? 

Again a question you may not be able to answer here but if you 

would find the answer for me. 

208

I have some other questions of a similar nature that I would like 

to put in there because that can make a huge difference in where 

we go with policy. And Wyoming, with its huge coal reserves, is 

ready to step forward and change a lot of that coal into diesel fuel, 

which would allow the refineries in this country to concentrate on 

gasoline. 

It is also low sulfur coal, so it meets the criteria for low sulfur 

diesel. So we want to know where those funds are, as well. 

Again, I thank you for being here? My time has expired. 

Mr. PORTMAN. Thank you, sir. We will get back to you on every 

one of those issues. And I want to thank you for working with us 

on so many these issues, the pension reform last year, the education issues. 

I appreciate your working with us on increasing funding for Pell 

Grants to help low income families be sure they can afford the cost 

of college. We have about a 40 percent increase compared to 2006, 

about a 30 percent increase even above what Congress has just increased—at least on the House side—in the long-term continuing 

resolution there. 

And then, as you know, we have K through 12 funding increases, about $1 billion over 2006, and actually about $700 million over 

again the long-term continuing resolution, which provided more 

funding for K through 12. And then a $1 billion increase in NCLB. 

The focus there is again on lower income students and the schools that serve them. Therefore, there is a $1.1 billion increase 

in the budget, as you know, in Title I. 

So we look forward to working with you. We are prioritizing 

within our resources. 

And I know that you have a strong interest in the PBGC. The 

reason that we have reproposed—none of these are new proposals, 

as you know—some of our reforms in PBGC is we still see an unfunded liability there. We still see a gap. It is to try to deal with 

that solvency issue. 

But we look forward to working with you on that, and congratulate you on a good step with the Pension Reform Act, which you 

and other of your colleagues worked on last year. 

Senator ENZI. Thank you. And we did have a great bipartisan 

meeting this morning of people interested in education on the committee. In fact, that was almost everybody on the committee. We 

met with Secretary Spellings and found some good ways to make 

good use of the money that you put in there, and probably a couple 

of other reorganizations of the budget too. 

Thank you. 

Chairman CONRAD. Senator Wyden. 

Senator WYDEN. Director Portman, welcome. 

People in my part of the country feel betrayed this morning. As 

you know, the Federal Government owns more than half of our 

land. God blessed us with an awful lot of trees. And, historically 

when those trees were cut, we would get in the form of timber receipts money for our schools and roads. 

I wrote a law in 2000 that gave us some semblance of stability. 

That law has now expired. We have been trying to get the Administration to put forward a proposal that at least has a pulse around 

here in terms of actually going forward and winning support. 

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As you know, the Administration has recycled the proposal from 

last time to, in effect, sell off the crown jewels of this country, our 

national treasures and our forest land, to pay for this program. 

Not one single member of the Senate, Director Portman, not one, 

not on the Republican side, not on the Democratic side, has been 

willing to support this in the past. This is a proposal that does not 

have a pulse. 

Now we have closures in the rural part of my State. We are hearing that schools may shut down and we have a real question about 

whether rural counties in Oregon even going to survive. That is 

what this is about. 

I would like to know when we are going to get a proposal from 

the Administration that really has a prospect of winning bipartisan 

support here in the Senate? When you advance a proposal that cannot get even one Senator, even one, that is betraying our part of 

the United States. We have nowhere to turn in these rural counties 

where the Federal Government owns 58 or 60 percent of the land. 

I think you know me pretty well. I am interested in working with 

you on a bipartisan basis. We are trying to do that in health care. 

We are trying to do that in a variety of areas. 

But this is unacceptable. Senator Baucus and I have even given 

you alternatives. So it is not a question of the Administration not 

seeing any alternatives. 

When are you going to give us a proposal that has a chance of 

winning some measure of support here in the Senate? 

Mr. PORTMAN. I can tell you are not very enthusiastic about—

Senator WYDEN. There will be a strong message to follow. 

Mr. PORTMAN. This is a new proposal. As you know, it is not the 

same proposal from last year. It is a new proposal, frankly, because 

of meetings that I had with you and some other members, but primarily a conversation we had about 9 months ago when I first 

came on the job. And it is quite different. 

I thought you might be more interested in it than you appear to 

be, because it does not say that there is going to be a sale of what 

we view as excess Federal lands and then have that money all go 

into the rural schools. 

Senator WYDEN. What is new about it? 

Mr. PORTMAN. It says that half of that funding can now go back 

into acquisition of more important lands that States want to acquire for public use. So it was an attempt on our part to provide $400 million more 

than last year for the very schools you are concerned about, and 

do it in a way that actually we thought would be a lot more attractive not just you but, as you say, to your colleagues to be able to 

work through it. 

So let’s sit down again. This proposal, we may not have explained it to you properly yet. We will do that in person. Half of 

the land sales, again, go to county payments and half will go for 

national forest acquisition in the States. 

The counties benefit because they get four additional years of 

payments and the States receive a big environmental benefit because they get to exchange land that has very low environmental 

value for lands that have high environmental value. It seemed to 

us that that made sense. 

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The parcels to be sold have already been identified as suitable 

for sale or exchange because they are isolated land or they are difficult or inefficient to manage. The lands with higher environmental value will not be offered for sale. Acquisitions would focus 

on parcels that enhance the environmental integrity of our national 

forest. That is a change from last year. 

So we will continue to work with you on it. We want to see an 

extension. We want to see that it is paid for by some mutually 

agreeable offsets. We think we have a better proposal this year for 

purposes of passage. 

Senator WYDEN. You are a hiker and an outdoorsman. I can tell 

you when you are talking about selling off lands within the Mt. 

Hood National Forest—

Mr. PORTMAN. And buying more important plans for Mt. Hood or 

other important parks or Forest Service system, so it is not the old 

proposal. It is a new proposal. 

Senator WYDEN. But it essentially involves something which is 

going to be a full employment program for lawyers. You are not 

going to get any support here. There is going to be lots and lots 

of litigation while schools, law enforcement, and other essential 

services close. 

My biggest regret with this program is I wish I had kept my hold 

on every one of those Administration appointees. I took it off last 

year because I thought the Administration was going to work with 

us in a good faith. I think these counties now, we have Curry 

County, Grant County, a whole host of them that are looking at 

closing. There is a real question about whether they are going to 

survive. I hope that and I, in fact, challenge you to find somebody 

here in the Senate who is going to support this new proposal. Because it is not new. It is essentially a recycled version of what we 

had before. It will get no more support. 

That is why we are going to be sitting here again while all these 

schools are closing. That is unacceptable to me. 

Thank you, Mr. Chairman. 

Mr. PORTMAN. Thank you, Senator. 

Chairman CONRAD. Director Portman, you said that you have 

balanced the budget without any tax increase. Isn’t that the case? 

Didn’t you testify that you—

Mr. PORTMAN. While permanently extending the President’s tax 

cuts. I will look back at my testimony to see how I described it. I 

said we do so while keeping taxes low and meeting our Nation’s 

priorities. I talked earlier about the fact that we believe the tax 

cuts ought to be extended, and we extend them permanently in the 

budget. 

Chairman CONRAD. Are there any tax increases included in your 

proposal? 

Mr. PORTMAN. Net, there is a lot of tax relief, I think about $600 

billion net. But there are tax—

Chairman CONRAD. But are there any tax increases? 

Mr. PORTMAN [continuing]. Increases and tax relief throughout 

the budget, as always. 

Chairman CONRAD. Where would be the biggest tax increases 

that are in the budget proposal? 

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Mr. PORTMAN. Probably fees. We talked about the FDA fee earlier. 

Chairman CONRAD. Don’t you have a large tax increase built in 

here for the alternative minimum tax? 

Mr. PORTMAN. Well, it will be viewed as a tax increase by middle 

income Americans if we do not do something to reform it. 

Chairman CONRAD. But you have only reformed it—

Mr. PORTMAN. It is current law, as you know. You and I have 

talked about this. 

Chairman CONRAD. But you have reformed it for 1 year but you 

have not reformed it for 5 years. 

We just got numbers. This is the question I want to ask you. We 

just got, from the Tax Policy Center at Treasury, that this is the 

alternative minimum tax revenues contained in your budget. This 

will be felt by people as a huge tax increase, as you know, because 

they are not paying these taxes now. 

Mr. PORTMAN. That is why we need to reform it. I agree with 

you. 

Chairman CONRAD. But you have a 5-year budget here and you 

reform for 1 year. So this is what they are telling us is the effect. 

That is a $500 billion tax increase. To be precise, $499 billion. 

So when this Administration says, when I hear the President say 

there is no revenue increase, there is a revenue increase. People 

out there are about to experience, those primarily in the $100,000 

to $200,000 income range, are going to find they are going to be 

in for a big surprise here. They thought they were getting tax cuts. 

All the talk is tax cut, tax cut, tax cut. The effect of the alternative 

minimum tax, as you know, is to explode the number of people who 

will be swept into the alternative minimum tax, approaching 30 

million people a year by the end of this period. 

So at least some of what I have heard, not from you—I want to 

make clear—but from others in the Administration, I think, misrepresents the plan. The fact is to balance, you have substantial expansion of revenues in the alternative minimum tax. 

Let me go back to the question I asked before. 

And now I see Senator Murray has arrived, so I will defer—oh 

and Senator Whitehouse, as well. Senator Murray had been here 

earlier, as had Senator Whitehouse. But Senator Murray had been 

here first, so we will go to Senator Murray, but then I want to 

come back to this. 

Mr. PORTMAN. I would like to talk to you about it. 

Chairman CONRAD. And we will have a chance. I will not leave 

you hanging out there without a chance. 

Senator MURRAY. 

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

I apologize for having to leave and come back. It is a busy day 

here. But I did want to come back. You have been asked a lot of 

broad questions and I want to go back to the Chairman’s opening 

remarks and share with him my concern about the priorities in the 

budget. We will have more discussion about that. 

I wanted to address a couple of regional issues really quickly and 

then go to the broader picture. The first one is about BPA. We are 

again dealing with a proposal from OMB that is going to take 

funds out of the Northwest economy and direct them to the United 

212

States Treasury. This is not the first time we have been down this 

road. It is just the latest in a series of proposals to circumvent our 

regional process and impose a rate increase on BPA customers that 

would have a huge impact. 

We have been down this road before on a bipartisan basis. We have defeated it. We will again and it will leave a $91 million hole 

in your budget. 

So instead of doing this every year, I would just like to ask you 

today, can I get a commitment from you that we can have a real 

discussion on this rather than just having a budget battle that you 

know you are going to send over here and it is going to be defeated? 

Mr. PORTMAN. Well, you and I have talked about this in an earlier meeting and I do think, if you look at this proposal, it is different than last year’s proposal. 

Senator MURRAY. They all are, every year there is nuances. But 

it is the same. 

Mr. PORTMAN. This one drops altogether the debt clarity proposal 

that BPA was very concerned about, which has been in our budgets 

in the past. We think it is a significant compromise. So does BPA. 

We also, at you are urging—and I think you were right about 

this—we engaged directly with BPA rather than coming up with 

our proposal without dialog with them. We have had a lot of dialog 

with them. 

We still do have a fundamental difference that we apply not just 

to BPA, as you know, but across the Federal Government that 

when you have these kinds of revenues coming in—and the net secondary revenues have been about $500 million per year—that they 

ought to pay down some of their debt. It is not putting it into the 

Treasury. It is paying down some of their debt. 

Senator MURRAY. Which they do a regular basis and they keep 

that commitment without putting our ratepayers responsible for 

paying off money at the national debt level. So we will have discussions again but I just want you to know, working with senators 

from Idaho and in the region, Oregon, this is not going to go anywhere again. And it is going to leave a $91 million hole in the 

budget. 

I want to ask another really important home issue. As you know, 

Washington State, my home State, is home to the Hanford site and 

the Pacific Northwest National Lab. Both of those were born out 

of the Manhattan Project, both very crucial. 

I think you know, as well, DOE is right now in the process of 

cleaning up that site. And we have a unique situation of a national 

laboratory with facilities in the middle of a cleanup site. 

In these facilities PNNL conducts a lot of really important work 

for issues ranging from national security to environmental remediation. We have to make accommodations to continue the cleanup 

of the Hanford site and still preserve those research facilities. 

For the past couple years, I have been working very closely with 

the Department of Energy and with the Department of Homeland 

Security in support of a plan to do that. But in the 2008 budget, 

you do not allow that plan to go forward. 

This is a project that relies on third-party financing. It has been 

very carefully worked out with all parties involved. My underVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00660 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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standing is now that OMB is not going to allow that third-party financing package to move forward. 

I would like to know from you when OMB is going to allow that 

to happen? 

Mr. PORTMAN. I apologize, I do not know the answer to that this 

morning, and I will get back to you on it. I do know what the numbers are for Hanford which, as you know, is $690 million. 

Senator MURRAY. I know the Hanford numbers and I appreciate 

the Vit plant. We have some concerns, HAMMER was not funded, 

and things like that. 

But the critical issue for us right now is this very important research facility that is in the middle of a cleanup site that we cannot preserve its ability to continue to do important critical national 

research unless we are able to move forward on this. 

Mr. PORTMAN. Is this the Army Corps issue? 

Senator MURRAY. No, it is not. It has to do with PNNL, a research facility, located in the middle of a cleanup site. And in order 

to continue the clean up, the facility has to either be changed or 

moved, and we need to make sure that the third-party financing 

moves forward. For some reason, OMB is the one party out here 

saying they are not going to allow that to move forward, and it is 

going to either lose critical, critical research for the Nation, or it 

is going to cause clean up not to occur. 

So if you can get back to me on that, I would appreciate it. 

Mr. PORTMAN. I appreciate that, Senator. I will get back to you 

on it. 

Senator MURRAY. And then in my last 10 seconds a broader 

topic, veterans. 

We have gone back and forth with inaccurate projections from 

the VA on how much they need to cover the cost of veterans. As 

you know, we went through a very bad situation a couple of years 

ago where they did not tell us what they needed and ended up billions of dollars short that we had to make up in a supplemental. 

It was not just us complaining. The GAO did a report. And what 

they told us was pretty shocking. The GAO told us that the VA had 

misled Congress, that they concealed funding problems, that they 

based their projections on inaccurate models, and that they did not 

adequately plan for the impact of service members from Iraq and 

Afghanistan. 

Now we have an ongoing war. The President is now asking to 

send more troops over, 48,000. And we are getting a budget from 

you that many of us are deeply concerned is based on flawed numbers. 

How can you expect us to have confidence in the number you 

have projected when the history tells us that we are not being told 

the truth about the cost to the VA because of the war in Iraq and 

numerous other costs that are coming at them? 

Mr. PORTMAN. First of all, I think you will be, I hope you will 

be pleased with the budget because it is a big increase again, 83 

percent increase, as you know, over the life of this Administration 

for VA health care. 

Senator MURRAY. Because we beat you up over it. 

Mr. PORTMAN. Well, we worked with Congress on those issues 

over the years, including when I was in Congress. But it is a $6.1 

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billion increase in VA health care this year. I am sorry, in VA overall, $2.5 billion for health care. That is a 7.4 percent increase on 

health care fraud. We will give you total transparency and let you 

know how we are—

Senator MURRAY. I will have my staff get you the numbers, but 

what we are seeing is that the VA is basing their projections on 

the number of Iraqi and Afghani soldiers coming back on fewer 

than they saw last year, when we know more soldiers are going to 

come into the system. 

Mr. PORTMAN. As you know, we are using the new model. We believe that the concern that you raise, which is a legitimate one, has 

been fixed in this model. We will share all of that with you. 

The new model does have an additional obligation on behalf of 

the VA on health care side, and it is fully funded in the budget. 

So we will provide you with all that. 

Senator MURRAY. We will look forward to seeing all of that. 

Mr. PORTMAN. It is based on the new model. 

Senator MURRAY. But again, remember, it is not just us that 

have not been happy with this. The reports that come back that 

show us that we have been misled and inaccurate models continue 

to really concern all of us. 

We need to make sure we have adequate funding in the budget 

that we pass out of Congress to care for the men and women who 

are protecting us, no matter whether we agree with the President 

or not. And we take that responsibility very seriously. 

Thank you, Mr. Chairman. 

Chairman CONRAD. I thank the Senator. 

I thank her very much for raising, once again, the issue of veterans. She has been extremely diligent on this subject and has 

been a very strong advocate for our Nation’s veterans, not only in 

the public councils of this committee but in the private counsels of 

this committee, for a very long period. So she comes to this with 

credibility. 

Senator WHITEHOUSE. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. 

Ambassador, how are you? 

Mr. PORTMAN. Well, thank you. Sorry I did not acknowledge you 

earlier. We have not had the chance to meet before. 

Senator WHITEHOUSE. I had to go to another meeting. 

My first question or I guess comment to you has to do with what 

I heard you saying as I was going out the door, which I think was 

that unless we do something about the entitlement costs, we are 

looking at benefit cuts, we are looking at tax increases or we are 

looking at massive debt explosions. 

I would just urge you to add, in your list of ways to cope with 

the forecast, particularly health care problems we have coming, 

that reforming the way in which the health care system operates 

is, absolutely critical. It makes me crazy when I hear people say 

well, we can only do this with benefit cuts or tax increases or massive debt, because I see a health care system that is so wasteful, 

so badly designed, so disgracefully counterproductive in so many 

different ways. 

215

And then to just sit there and say, well, we are going to leave 

that alone but we are going to cut people’s benefits so that we do 

not have to go to the trouble of fixing it. 

Mr. PORTMAN. You are absolutely right. Maybe you did not hear 

as you went out, unless we make reforms—and I think that is obviously the better alternative. 

Senator WHITEHOUSE. Good. 

Mr. PORTMAN. You are right on health care. 

Senator WHITEHOUSE. Keep that in your focus because it would 

be a national disgrace if we had to cut people’s health care. 

Mr. PORTMAN. I think that is a good point. I did not make that 

point clearly enough, that so much of what drives, as you know, the 

Medicare and Medicaid numbers is the inflation in health care. 

And until you get at that problem, it is difficult to get at that larger problem that we have with our obligations going forward. 

Senator WHITEHOUSE. The other thing I wanted to talk with you 

about is I am new to this committee and I am sort of working my 

way down into the details. But starting at a very macro level, I see 

major economic shifts happening in our economy that are the result 

of the, to use the popular word, flattening of the world economy, 

creating big-time winners and losers in the American economy, 

very often perhaps even usually, through no particular fault or no 

particular achievement of their own. They just happened to be in 

the right place as the economy shifted or caught in the wrong place 

as the economy shifted. 

I see that playing out in the statistics that we all see about the 

evaporation of the middle class, the increasing income gap between 

rich and poor, the fact that CEOs make 400 times now the average 

worker salary and it used to be 40 just a couple of decades ago; 

that we are headed for what I consider to be considerable social/

political/economic problems if we do not do something about this. 

And I would like your comment on whether you think that this 

is a sustainable course. Or alternatively, are there actually social 

and political consequences to allowing our country to turn into that 

sort of an almost economic royalist economy, to use a friend’s phraseology? And if there really are problems coming at us on that, 

what should we be doing about it? 

Because it strikes me that this Administration’s tax policy has 

compounded the problem by making the people who are the winners, as a result of this really secular shift, even bigger winners 

and throwing the people who are the losers under this economy 

even further under the bus. 

Mr. PORTMAN. I think you raise a really interesting question 

about what the impact of the global economy is on winners and 

users. You are absolutely right, the pace of change is increasingly 

fast, too. So it is hard for us almost to get ahead of it sometimes. 

And a lot of it, as you say, is not driven by Government, it is driven 

by market forces beyond Government. 

As you know, I was the Trade Representative before this job so 

I was more familiar with some of those market forces. They are 

both a challenge and a huge opportunity. 

As other countries grow and prosper, it does not hurt us. It can 

actually help us because it expands markets for service providers 

in your State, farmers, manufacturers and so on. 

216

Senator WHITEHOUSE. I am thinking less internationally than domestically. 

Mr. PORTMAN. Absolutely, and my point is that it affects our 

economy a lot and there are winners and losers. 

I think the tax policy, and we talked about this earlier when you 

were out at your other responsibilities, but we talked about the fact 

that if you put all the President’s tax policies from 2001 and 2003 

together, the upper income Americans are actually paying a bigger 

part of the burden. 

Now admittedly, they are always paying a bigger part of the burden. And so when you do tax relief across the board, give everybody 

tax relief, they got tax relief. And more significant tax relief if they 

were paying more taxes. 

But the burden is now, for the top 10 percent for instance, you 

are talking about 66 percent of our income taxes. It was about 64 

percent. About four or five million Americans are off the rolls altogether who are lower income Americans because of the refundable 

nature of the child credit, 10 percent bracket expanding, marriage 

penalty and so on. 

So I do not think the tax relief has had that impact. In fact, arguably it has shifted the burden more to the upper income Americans. 

Senator WHITEHOUSE. It certainly has not offset it, as we can see 

from the—

Mr. PORTMAN. What would have happened otherwise is something we can look at. We can maybe get you some data on that. 

But in terms of wage growth, which is key to this, it has taken 

a while in this recovery to see real wage growth, partly because inflation was relatively high the last couple of years. But we are now 

seeing real wage growth, which is a difference. Within the last year 

we have particularly seen some market increases in hourly wage 

growth, which is again addressing some of this income inequality 

issue you are talking about. 

I said earlier it is happening a little sooner than it did in the last 

recovery, in the 1990’s. The wage growth now is higher as a percent than it was at this point in our recovery in the 1990’s. But 

it always takes a while to catch up with productivity growth and 

GDP growth. 

And finally in this budget, and you may not like all of aspects 

of the budget, but I do want focus—

Senator WHITEHOUSE. Nobody has ever liked all aspects of any 

budget anywhere. 

Mr. PORTMAN. I do hope you will focus on the American Competitiveness Initiative, because it is trying to get at this very issue you 

address, which is a rapidly changing global economy that challenges us to be more competitive than ever in order for America to 

keep our edge. 

Right now we are the envy of the world. We are growing faster 

than any of the other G–7 countries. So the major developed countries in the world are looking at us saying why do you have lower 

unemployment than we do? Why do you have faster growth? I 

think it goes to our entrepreneurial and innovative nature as 

Americans. But we need to do more as Government to encourage 

that. 

217

So if you will look in the budget, for instance, we have additional 

resources for research. We make a commitment to double that over 

time. We have that again in our budget this year, as we did last 

year. 

Congress, on a bipartisan basis, has been very supportive of that. 

But it includes everything from the research and experimentation 

tax credit, the R&D tax credit it used to be called, which I know 

is important to your State, but also increases in funding for research about American competitiveness, engineering, math, science 

and so on. 

So that is part of the response, I think, that you will see in this 

budget that we, as a Government, ought to be focused on to address the challenge that you rightly raise. 

Senator WHITEHOUSE. But in terms of the dislocation of people 

who are the losers and the economic shift when having to compete 

with very low-wage workers in India, Indonesia or China or wherever, in terms of the concern that I just see so deeply in Rhode Island as I travel around, is people really are very, very concerned 

about their economic futures. And for the first time in their lives, 

worried that things do not look so good for them and starting to 

lose their own optimism. 

For those people, the message is just hang in there and wait for 

the economic forces that will ultimately drive wage growth to come 

to fruition? 

Mr. PORTMAN. No, again if you look at our budget, which your 

colleague Senator Sanders said is a reflection of policy and how we 

view what the Governmental’s role ought to be. Not only do we 

have these increases in funding for competitiveness, which directly 

addresses some of the issues you raised in the global economy. 

But the reason we have increases in funding in unprecedented 

levels for K through 12 education is that we see an incredible correlation between education level and that wage gap you talked 

about and the sense of insecurity that many people feel as a result 

of, in part, the global economy. 

By the way, it is not just the global economy. It is our own economy, because our own economy is increasingly competitive. 

We also have resources devoted more toward lower income students within that mix, about a $1 billion increase in Title I here, 

because those tend to be some of our lower performing schools that 

would be eligible for Title I. 

And then of course, the Pell Grant increase that you know about 

that you all, I think, are going to vote on soon. We increase that 

even more. We would have about a 40 percent increase, after you 

finished increasing it—which we had not expected frankly—for 

2007, it will be about a 30 percent increase. But, Pell again focuses 

more on ensuring that some of those folks who may feel that they 

are not enjoying all of the benefits of a good economy, at least have 

more of an ability to be able to afford the higher cost of higher education. 

So there are some things in our education part of the budget and 

the competitiveness part of the budget. Health care, of course as 

you know, in your State is a huge issue. We have the focus on 

health care and the uninsured and the cost of health care, which 

you talked about earlier. Also energy, in the budget reflective of 

218

what the President talked about in terms of energy, that our kitchen table issues that I think add to that insecurity. 

So we have some proposals here. I know that you will have others. 

Senator WHITEHOUSE. Good. I have exceeded my time. Mr. Chairman, my clock in front of me is broken, which I think gives me a 

bye on any time restrictions. 

Chairman CONRAD. You did very well. 

Senator WHITEHOUSE. I apologize, Mr. Chairman. 

For the record, Pell of Rhode Island. 

Chairman CONRAD. No apology required. We knew that it was 

not working. 

The first thing I want to ask you is, Ambassador Portman, Director Portman, will the Iraq war be over by 2010? 

Mr. PORTMAN. I do not know. 

Chairman CONRAD. The budget says that we do know. The budget says there is no money in 2010. 

Mr. PORTMAN. As I said earlier in the response to Mr. 

Menendez’s question, we are showing more war costs, as you have 

acknowledged, and I thank you for that. And we are showing it in 

greater detail than we ever have before. We are also showing for 

2008 a substantial commitment that is, as I said, effectively a 

straight line commitment. Secretary Gates, who has been testifying 

this week—

Chairman CONRAD. That would be for 2008—

Mr. PORTMAN. That is for 2008. 

Chairman CONRAD. But then a very sharp reduction for 2009. 

The President has told us repeatedly there is no timeline. But 

when I look in his budget, there appears to be a timeline, that the 

war will deescalate, will dramatically be reduced in activity in 

2009. That is what the budget says. It is going to go from $145 billion down to $50 billion. That is a dramatic reduction. And then 

no spending at all in 2010. 

And so it looks to me like, at least with respect to the budget, 

there is a timeline. 

Mr. PORTMAN. We will have to see how it goes. Our hope is that 

the 2008 supplemental request, which as you acknowledged earlier 

we have never presented to Congress before, and we have never 

presented the next year, will end up being high. That is our hope. 

Chairman CONRAD. I say, I give you credit. I especially give you 

personally credit for getting in the 2008 budget something that is 

far closer to realistic, I believe. But I look in those out-years. When 

we talk about this budget balancing, I know that that is the assertion. But when I look at the war spending, when I look at the alternative minimum tax, those are big moving parts. 

Mr. PORTMAN. Can I make one comment on defense that I know 

you will appreciate? I am not sure that I can explain this properly, 

but I will try. 

If you look at our 2008 request, you not only see a substantial 

commitment to the global war on terror through emergency supplemental spending, which is part of the budget but supplemental to 

the base budget, you will also see in the Department of Defense 

and in the Department of State substantial double-digit increases 

in funding. 

219

There is a reason for that, and it relates to the global war on terror and readiness concerns that have been expressed in this Congress on both sides of the aisle. 

I am not suggesting that that increase in the base is going to 

solve every problem. Our international situation will change and 

we will see what our needs are. 

But I will say that in terms of your concern about what numbers 

do you show in the budget, to have an 11 percent increase in the 

base funding for defense and have that fully funded within our declining deficit for 2008, and to have an over 12 percent increase in 

State’s budget, much of which is security-related and GWOT-related, does show a commitment on resources that we have not 

shown previously and is part of our deficit calculation. 

And I hope you will note that those are made part of the base, 

not supplemental. And that was also part of our intent this year, 

was to provide more in the base to show what we think those costs 

are. 

Chairman CONRAD. And we appreciate that, and I have tried to 

acknowledge that, both publicly and privately. 

Let me just talk about several other issues. There has been mention of Social Security and it would take a law change to do something different on Social Security. No it would not. It would not 

take any law change. 

If we were not running these massive fiscal deficits the money 

in Social Security would be used to pay down debt. That is a huge 

difference. If we were paying down this debt instead of adding to 

the debt, that would be in line with what the intention was when 

Social Security was changed to prepare for the retirement of the 

baby boom generation. 

They increased the taxes on Social Security for a purpose, and 

it was to make it solvent long-term. And it was decided to either 

pay down debt so that we were better prepared for the retirement 

of the baby boom generation or be able to prepay the liability. Neither of those things are happening. 

Instead, Social Security money that is in temporary surplus is 

being used to pay operating expenses. Now to suggest that some 

law has to be changed to change that trajectory is just not correct. 

With respect to the assertion I have heard repeatedly that the 

tax code has been made more progressive, I listened to you very 

carefully and you talked about the income taxes. If you look at payroll taxes and income taxes, and remember the vast majority of 

Americans pay more in payroll taxes than they pay in income 

taxes, you get a very different answer. No. 1. 

No. 2, it is not surprising on the income tax side that higher income people pay more because their incomes have grown much 

more rapidly than the rest of the American population. So of course 

their taxes have grown, even though they have had a disproportionate benefit from the tax cuts. 

We indicated in one chart that for 2008 alone those earning over 

$1 million a year, the cost of their tax cuts is $55 billion for that 

1 year alone. 

That takes me to the thing I really want to talk to you about, 

which is long-term we agree the debt of the country will explode 

absent our action. To your credit, you have come forward with a 

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proposal on long-term entitlements, especially in the health care 

accounts, in this budget submission. 

What I fault you for is at the same time you have come forward 

with massive additional tax cuts by making permanent all of the 

tax cuts previously enacted. In fact, the weight of those tax cuts, 

the cost of them, far outstrip the savings that you have from cutting Medicare and Medicaid, or at least reducing the growth in 

those accounts. 

That is just not a balanced approach. It is just not balanced. And 

that is the only conceivable way that there is a long-term resolution is if we have savings out of the long-term entitlements and 

that will have to bear a disproportionate part of the load. I do not 

dispute that. 

But to suggest we do not need revenue to lessen the impact on 

the least fortunate among us, especially our revenue from the most 

fortunate among us—and I include myself in that category—is just 

divorced from reality. It is just divorced from reality. 

And there is no way there is going to be a long-term settlement 

between Republicans and Democrats absent both sides, both sides 

compromising on their cherished positions. The fact is Democrats 

do not want to cut or reduce Medicare or the other entitlements. 

They do not. Republicans do not want to abandon any tax cut. You 

know what? It takes two to agree. It takes both sides to demonstrate a willingness to break from their fixed position. 

And what I am asking you again today is is your side willing to 

break from their fixed position in which they say not only no tax 

increases, no additional revenue, but an insistence on more tax 

cuts? 

Mr. PORTMAN. Interesting that we were accused of massive tax 

cuts and massive tax increases all in the same 45 minute period. 

Chairman CONRAD. We are talking two different periods, aren’t 

we? We are talking the near-term and the long-term. 

Mr. PORTMAN. No, I am talking about the chart that you held up 

saying that we—

Chairman CONRAD. That was for 5 years. Now I am talking, as 

you know, I am talking about the long-term beyond the 2012 period. 

Mr. PORTMAN. I am talking about your long-term chart on your 

AMT chart, saying that we had massive tax increases. 

Chairman CONRAD. That was for 5 years. That is the 5-year 

budget. Now I am talking about the long-term. 

Mr. PORTMAN. The savings over the long-term, I do think that it 

will be difficult politically, as you say, but I also think that there 

is greater acknowledgment and recognition of it, partly because of 

your efforts and others. 

I also think, and I was very interested to hear what Senator 

Whitehouse said about the cost of health care relating to that, because it does. So it is reform, but it is also reform that can be outside these systems on health care generally, because that drives so 

many of the costs now in Medicare and Medicaid, which is our biggest unfunded obligation. 

On the revenue side, we have gone through this today in various 

ways. I will just say that we will be able to show you in this budget 

short-term but also longer-term that going at roughly our historical 

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level of revenues and somewhat above, because that is where we 

are in our budget—and this may not be something that all economists who might represent views closer to my side of the aisle are 

happy about. In fact, I know they are not. In fact, some of them 

talk to me about this. 

As a percent of our economy, our tax burden—

Chairman CONRAD. Quit talking to them. 

Mr. PORTMAN [continuing]. Is greater today than it has been historically, and far greater than it was, as you know, a few years ago. 

But we have an opportunity, I think, to come together because 

of the increasing recognition of the problem, because of some solutions that are now out there being talked about, including some 

that we have. 

Chairman CONRAD. Does your budget, long-term, solve the debt 

crisis that is looming over us? Does it solve it? 

Mr. PORTMAN. No, it does not. 

Chairman CONRAD. That is the point. Let’s be direct with each 

other. You know and I know—

Mr. PORTMAN. —But it—

Chairman CONRAD [continuing]. It does not deal with it. And the 

only way we are going to deal with it is if the two sides get together and there is a compromise on both sides. 

And the question I keep putting to you is your prepared to really 

compromise? 

Mr. PORTMAN. We are prepared to engage in the debate and the 

dialog—

Chairman CONRAD. No, no, that is not what I asked. We can debate. That is not getting us anywhere. The only way we are going 

to get somewhere is to actually compromise. 

Mr. PORTMAN. Mr. Chairman, with all due respect, if I put you 

on the spot as to what you think the conclusion of a dialog would 

be—

Chairman CONRAD. I have said—

Mr. PORTMAN [continuing]. On your side, I think you would—

Chairman CONRAD. That is what the problem here. I have said 

I am prepared—

Mr. PORTMAN. I think you would not think that is very productive. 

Chairman CONRAD [continuing]. To get savings out of long-term 

entitlement programs. 

What I do not hear from your side ever is that you are prepared 

to do something on the revenue side of this equation, other than 

you want more tax cuts. You talk about divorced from reality, that 

is it. 

Mr. PORTMAN. We are not talking about more tax cuts, just to 

be clear. 

Chairman CONRAD. You are talking about making all the tax 

cuts permanent—

Mr. PORTMAN. That is talking about extending the—

Chairman CONRAD [continuing]. That have a cost of nearly $2 

trillion over the next 10 years. 

Mr. PORTMAN. Extending the existing tax relief. 

Chairman CONRAD. But the law does not extend the existing tax 

relief. You are coming here asking to change the law to make all 

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the tax cuts permanent, including ones that go overwhelmingly to 

the most advantaged and the wealthiest among us and with no—

and at the same time saying we have to cut things that help the 

people who are the least among us. 

I have to say to you, I do not know of any religion that teaches 

let us take from the least to give to those who have the most. 

Mr. PORTMAN. Again, if you look at the tax relief that we are attempting to extend, in our view this is not only, factually speaking, 

a more progressive system than it was previously. In other words, 

the top end is paying a higher burden of taxation thanks to the—

and by the way, on the payroll taxes, we have changed nothing. So 

whatever the policy was in the previous administration and previous Congresses, we have continued. 

With regard to the importance of this tax relief to the economy, 

we feel very strongly that it would be exactly the wrong thing to 

do right now to abandon the tax relief which we think has been 

critical to the robust economy that has put us in a position to even 

talk about balancing the budget. 

In going forward, Senator, let’s be honest, we are not going to be 

able, as Senator Gregg has said well, to tax our way to a solution 

here. 

Chairman CONRAD. And we are not able to cut our way, either. 

The hard reality is you guys have come up here with this line every 

year and the debt just keeps getting bigger. 

Mr. PORTMAN. Let me finish. Part of—

Chairman CONRAD. Look, it has not worked on your side. You 

promised us in this Administration that the debt would not increase, that in fact the President told us he have maximum pay 

down of the debt. And the fact is the debt has exploded. Now it has 

not worked, sir. 

And what I am saying to you, unless there is a serious—serious 

now—I mean we can play these political games all day and all 

night. And I am disappointed. Because I hoped that this year, with 

what is so clear in terms of the threat facing this country, that 

there would be a chance to work together to do what we all honestly know needs to be done which is to work on both, on both the 

spending side of the equation and the revenue. 

And the idea that it is just going to be on the spending side and 

you are going to have more tax cuts, that is not real. That is not 

serious. That is not good faith. 

Mr. PORTMAN. If I could just finish my point for a second on the 

importance of the economy side and therefore the revenue side, we 

have made progress the last couple of years. The reason I mentioned, we have reduced the deficit by $165 billion in the last 2 

years is to show that there is a model here and that is the reason 

we are—

Chairman CONRAD. How much did the debt go up in the last 2 

years? The debt went up—

Mr. PORTMAN. Let me answer. 

Chairman CONRAD [continuing]. Approaching $1 trillion in the 

last 2 years. 

Mr. PORTMAN. Let me answer. The way economists on the right, 

on the left, or nonpartisan would react to that question is they 

would say what matters about the debt is our debt as a percentage 

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of our economy because that is what affects the markets, that is 

what affects our economy and that is how people look at it. 

Chairman CONRAD. Agreed. And it is going up. 

Mr. PORTMAN. And as a percent of our economy, it is going 

down—

Chairman CONRAD. No, gross debt, gross debt in the United 

States is going up. 

Mr. PORTMAN. Publicly traded debt has gone down as a percent 

of the economy—

Chairman CONRAD. Gross debt is what we are going to have to 

pay back. And the gross debt is doing up. 

Mr. PORTMAN. That is another discussion. 

Chairman CONRAD. What used to be—

Mr. PORTMAN. But if you look at the publicly—

Chairman CONRAD. No, no, let’s have that discussion. 

Mr. PORTMAN [continuing]. Traded debt, because that is the issue 

here, it has gone down the last couple of years. Why? Because our 

economy is growing at about 3 percent. Our deficit is growing at 

about 1.8 percent. 

Chairman CONRAD. What does that leave out? What does that 

leave out? 

Mr. PORTMAN. That means we actually have—

Chairman CONRAD. That leaves all of the money you are taking 

from every trust fund in sight—

Mr. PORTMAN. No. 

Chairman CONRAD [continuing]. To float this boat, that is going 

to have to be paid back. 

Mr. PORTMAN. It is publicly traded debt. And at the end of the 

12 years—

Chairman CONRAD. But the gross debt is all of the money that 

we owe. And the gross debt under your plan, when you put back 

the things you have left out, is growing faster than the economy. 

The gross debt of the United States has grown enormously in the 

last 6 years. Do you disagree with that? 

Mr. PORTMAN. I do not disagree that the internal debt, if you include that, if you think we should not be reforming any of these 

programs, and you look at that—

Chairman CONRAD. Did the gross debt of the United States—

Mr. PORTMAN [continuing]. As an unfunded—

Chairman CONRAD [continuing]. Over the last 6 years as a share 

of the economy? 

Mr. PORTMAN. When you include internal debt. 

But when you deal with the publicly traded debt, which again is 

what—

Chairman CONRAD. Do you know what? 

Mr. PORTMAN [continuing]. Affects our economy, it has actually 

gone down because we are making progress. 

Chairman CONRAD. But what affects the budget is all of the debt. 

Mr. PORTMAN. That is because of two things, a little better restraint on spending and a strong economy, which has record revenues. 

My only point is as you get into this discussion on revenues, we 

have to keep in mind that we are not going to be able, as Senator 

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Gregg said and you have acknowledged, tax our way through this. 

We are going to have to make some changes, as you say—

Chairman CONRAD. And we cannot tax cut our way through it, 

either. 

Mr. PORTMAN. But we also need to rely on a strong economy. We 

cannot grow our way out of the problem. I am not saying that. But 

it is a critical element—

Chairman CONRAD. Let me ask you this: do tax cuts—

Mr. PORTMAN [continuing]. A critical element to dealing with the 

long-term problem is to keeping a strong economy. 

Chairman CONRAD. Do tax cuts pay for themselves? 

Mr. PORTMAN. Some do and some do not. It depends on the tax 

cuts and—

Chairman CONRAD. No, no, no. No tax Cuts—According to the 

Treasury Department of this Administration, no tax cuts pay for 

themselves. 

Mr. PORTMAN. Certainly the 1997 capital gains did. 

Chairman CONRAD. No. 

Mr. PORTMAN. Certainly—

Chairman CONRAD. No. 

Mr. PORTMAN. Certainly it did. 

Mr. PORTMAN. No. Mr. Mankiw, are you familiar with Mr. 

Mankiw? 

Mr. PORTMAN. I am familiar with Mr. Mankiw. 

Chairman CONRAD. Is he part of the Republican administration? 

Mr. PORTMAN. Yes. He was. 

Chairman CONRAD. What does he say? He says at most the tax 

cuts paid for 50 percent. Those are the capital tax cuts that you 

are referring to paid for half. So if you have $100 billion tax cut, 

you added $50 billion to the deficit. That is his finding. 

On those that are not capital tax cuts, he says they only pay for 

17 percent of them. So if you have $100 billion tax cut, you get 

back $17 billion in increased economic activity, you add to the debt 

$83 billion. 

The proof is in the pudding. 

Mr. PORTMAN. It depends on the timing. 

Chairman CONRAD. We have had this experiment going on and 

all that has happened is the debt of this country has exploded at 

the worst possible time, before the baby boomers retire. 

Mr. PORTMAN. You and I can have this discussion in detail—

Chairman CONRAD. The Treasury Department—that was Mr. 

Mankiw. 

Mr. PORTMAN [continuing]. But if you look at the timing—

Chairman CONRAD. Let me tell you what the Treasury Department has concluded. 

Mr. PORTMAN [continuing]. And the type of tax cut, it can indeed 

have a salutary effect on revenues. We have seen it. The last 2 

years we have had revenue increases because of a robust economy. 

Chairman CONRAD. So are you saying tax cuts pay for themselves? 

Mr. PORTMAN. No, I explicitly did not say that. What I said was 

it depends on the tax cut—

Chairman CONRAD. Well, that is a very important distinction. 

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Mr. PORTMAN [continuing]. And the timing of the tax cut. And I 

think it is a big risk right now, when we have an economy that 

again is hitting on all cylinders in terms of employment, wage 

growth now, GDP—3.5 percent GDP in the first quarter of this 

year, which no one expected frankly. Ours was 2.7 percent. 

Chairman CONRAD. And we are adding $500 billion to the debt. 

Mr. PORTMAN. No, we need to be sure that we continue—

Chairman CONRAD. And we are financing the debt—

Mr. PORTMAN [continuing]. To have that economy growing so 

that Americans can have better jobs, but also so that we can have 

this revenue coming in to be able to keep reducing the deficit, as 

we have done the last 2 years. That is a fact. 

Chairman CONRAD. Unfortunately, the debt—

Mr. PORTMAN. And getting the surplus under the unified budget 

is the first good step, and I look forward to working with you on 

your budget and our budget to get there. 

Chairman CONRAD. Let me just say, the debt has exploded. And 

the debt of this country has exploded at the worst possible time, 

before the baby boomers retire. And the plan the President has put 

forward does not fundamentally address where we are headed. 

I just say this to you, we have an opportunity here to work together. But the only way I know in human relations for there to 

be resolution between parties who have different views is for both 

sides to compromise. And unfortunately, I see virtually none on 

your side. And I regret that more than I can say. 

[Whereupon, at 12:33 p.m., the committee was adjourned.]

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PREPARED STATEMENTS


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ANSWERS TO QUESTIONS SUBMITTED


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THE PRESIDENT’S FISCAL YEAR 2008 BUDGET 

AND REVENUE PROPOSALS 

THURSDAY, FEBRUARY 8, 2007

UNITED STATES SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to notice, at 10:06 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of the committee, presiding. 

Present: Senators Conrad, Nelson, Menendez, Cardin, Sanders, 

Whitehouse, Gregg, Domenici, Bunning, and Crapo. 

Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 

Staff Director for the Minority. 

OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

Chairman CONRAD. The hearing will come to order. 

We apologize for being somewhat tardy in beginning this hearing. We try to start these hearings on time every morning and I 

think we have succeeded every morning. But we wanted to have an 

informal discussion with the Secretary and see if we could not have 

a constructive discussion about things in a way forward. 

I want to welcome the Secretary to the committee and say that 

we have enjoyed our discussions with him since he has come into 

this office. We see him as a very constructive player and want to 

acknowledge that publicly. 

Let me just begin by talking about the revenue. The Secretary 

of Treasury, of course, as the preeminent responsibility in the administration on the revenue side of the equation. Let me just talk 

about it. 

You saw this the other day in the Finance Committee. It is true 

that we have had good revenue growth the last several years. But 

if one looks back on a comparison basis to 2000, and these are real 

revenues adjusted for inflation, you see it took until 2006 to get 

back to the revenue we had in 2000.

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On the other hand, spending has gone up by 40 percent and the 

result of this combination, revenue down and spending up, has 

been to explode the deficit and the debt.


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We can see we have had an increase of the debt from $5.8 trillion 

at the end of the first year of this Administration to $9 trillion projected at the end of this year, which is exactly what you would expect. If you cannot pay your bills in the first place, and you cut revenue and raise spending, the imbalances grow.


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One of the results of this is we have become increasingly dependent on what I call the kindness of strangers. We are increasingly 

borrowing this money from abroad. As this chart shows, it took 42 

presidents 224 years to run up $1 trillion dollars of United States 

debt held abroad. That is now more than doubled in the last 6 

years.


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This chart shows if you make the President’s tax cuts permanent 

at the very time the trust funds go cash negative, the cost of the 

tax cuts explode, and it takes is right over a cliff. That is, if we 

extend these tax cuts without paying for them.


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You know, I like tax cuts as much as anyone and I have been 

a great beneficiary of these tax cuts, personally. But we face a situation with this demographic change that—we face a demographic 

change that is going to require us to do a lot of things we would 

prefer not doing. That means we have to have savings out of the 

entitlements. I believe, as part of a package, it means we are also 

going to have to find more revenue. 


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Let me be swift to say I think the first place we ought to look 

for revenue is not a tax increase. The first place we ought to look 

is this burgeoning tax gap, $350 billion a year. 

This chart shows what happens if the tax cuts are extended 

without paying for them, without offsetting them, and the debt in 

the out-years explodes. Every single witness before this committee 

has acknowledged we have a very serious long-term problem and 

an unsustainable budget condition.


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This is the question of whether tax cuts pay for themselves. We 

have heard a lot of discussion from people that suggest that tax 

cuts pay for themselves, perhaps more than pay for themselves. 

This is the Chairman of the Federal Reserve saying I do not think 

that, as a general rule, tax cuts pay for themselves.

And he is not alone in that judgment. This is former Chairman 

Alan Greenspan who said it is very rare and very few economists 

believe that you can cut taxes and you will get the same amount 

of revenues.


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The former Chairman of President Bush’s Council of Economic 

Advisers, Dr. Mankiw, wrote in his introductory college economics 

textbook there is no credible evidence that tax revenues rise in the 

face of lower tax rates. And economists claiming tax cuts pay for 

themselves is like a snake oil salesman who is trying to sell a miracle cure.


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The fact is that even with the recent revenue improvement, real 

revenues are still lagging behind what they would be in a typical 

recovery. We have looked at the nine previous recoveries, major recoveries, since World War II, and we see in this recovery revenue 

still lagging behind the average of the nine previous recoveries, and 

by a substantial margin.


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We see the same thing when it comes to jobs. We do not need 

to put up that. 

As I noted earlier, what is really missing from this budget and 

from our discussions is a commitment to tackle these long-term fiscal imbalances. Let me just say, we have had the head of the General Accounting Office tell us we are in an unsustainable situation. 

We have had the Chairman of the Federal Reserve. We have had 

the head of the CBO. We have had a parade of witnesses here, 

from every philosophical stripe, tell us we have a serious long-term 


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problem. That is really what I would like to focus on today, to see 

if we cannot find a method or a means to get us to a discussion 

about how we begin to resolve these long-term imbalances. 

I believe, I know you do, Mr. Secretary, that it would be entirely 

in the country’s interest if we were able to find a way to take steps, 

the beginning steps, of reducing these long-term fiscal imbalances. 

Again, I thank you for being here and I now ask Senator Gregg 

for his remarks. 

OPENING STATEMENT OF SENATOR JUDD GREGG 

Senator GREGG. Thank you, Mr. Chairman, and I also wish to 

welcome the Secretary of the Treasury, who has already, in his 

short tenure, been a very constructive force, in my opinion, for trying to move forward the debate and discussion as to how we resolve 

our long-term fiscal issues which, as the Chairman has appropriately and effectively alluded to, are the gravamen of the problems for our Nation as we move into the future relative to policies 

that do not involve terrorism. 

If you are looking for the biggest problem we have, it is the fact 

that we are going to pass on to our children a Government they 

cannot afford because it will simply be far too expensive to support 

the entitlement programs for the baby boom generation. 

But I also think that there has not been enough focus on how 

well things are doing right now in many places and in many ways. 

We have now had 21 straight quarters of economic recovery in 

this country. That is good news. These are significant growth numbers, and they are continuing.


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As the result of this recovery, employment has expanded for 41 

straight months and we have added over 7 million jobs. That is a 

lot of people who have a much better lifestyle because they have 

a job that is, in most cases, a very good job and they are generating 

income.

We have seen that the unemployment rate as a percentage is 

lower now than it has been in almost all of the prior major recoveries. So we are actually getting a larger amount of employment 

and we are getting a very strong recovery in this economy.


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Real wages are up over the Clinton years. That is a very important statistic. We are hearing a lot about wage gap and we are 

hearing a lot about the middle class being squeezed. But the fact 

that we have had an expansion now for over 5 years and an employment increase for over 41 months and that those jobs are real 

wage benefits to working Americans, that shows that—that is good. 

That is what you want. You do not want the opposite, which is a 

negative situation.


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The growth in revenues has exceeded projections now in the last 

4 years. The fact is, revenues have not only exceeded projections, 

they have essentially blown through the projections from CBO and 

OMB during the last 4 years. And we have seen, in the last 3 

years, the three largest years of increase in revenue growth in the 

history of our country. That is very significant as a reflection of the 

growth of the economy, of course, and more people having jobs. And 

again, this is another chart that reflects the fact that growth is exceeding the projected growth for the last 3 years.


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The Chairman says that cutting taxes does not generate more 

revenue. Well, we cut the capital gains rate and we generated a 

heck of a lot of revenue. It is just common sense. 


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It may be that economists tell you that cutting rates does not 

generate more revenue. But common sense tells you that when you 

cut the capital gains rate, you are going to generate some significant revenue because people who have locked up assets that they 

are not willing to sell because they do not want to pay that high 

tax rate, will start to sell those assets. And the ancillary effect, the 

unintended consequence effect, is that that revenue, once it is freed 

up, is then reinvested in much more productive capital activity, 

much more productive things. As a result you generate more economic activity, which creates more jobs, which is the bottom line 

we are aiming for, more jobs and a better economy.

There is another point that should be made. The tax cuts which 

the President put in place generated this economic recovery which 

has gone on now for over 5 years, which has created over 7 million 

jobs, which has generate huge revenues to the Federal Treasury. 

Those revenues, by the way, today exceed the national averages. 

Traditionally, we get 18.2 percent of gross national product as Federal revenues. Now we are up to almost 18.4 percent of gross national product as revenues. 

By cutting the rates and putting a fair tax law into place, we’ve 

created an environment where people are willing to pay their taxes 

and go out and take risks, be entrepreneurs, create jobs and, as a 

result of doing that, create more revenues for the Federal Government. That created a better revenue stream for the Federal Government. 

At the same time, the President’s tax cuts have actually created 

a more progressive tax system, which is never talked about, regrettably, by folks on the other side of the aisle. They are always talkVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00707 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH

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ing about how high income people are always getting a better tax 

benefit under this Administration. 

Well in fact, high income people are paying a higher share of the 

income tax burden in America today, than they paid in the Clinton 

years. 85 percent of the tax burden today is being paid by the top 

20 percent of wage earners, of people with high income. Whereas 

under the Clinton years those 20 percent of high income individuals only paid 81 percent of the income taxes. So we have the higher income people paying more in taxes as a percentage of what we 

collect.

And I think the next chart shows that the low-income individuals 

in this country, who do not pay any income taxes who receive 

money back through the Earned Income Tax Credit, are actually 

receiving twice as much back today as they received during the 

Clinton years.


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So what we have is a tax law which is significantly more progressive, where the high income individuals are paying more of the tax 

burden, and low income individuals are getting more benefit from 

the tax law than during the Clinton years. 

And at the same time, we are generating dramatically more revenues than we historically have generated, and especially in the last 

3 years we are generating significant revenues. 

The practical effect of that is the deficit is going down. It is going 

down not because we are spending less money, but because we are 

generating more revenues. We have an expanding economy. We are 

creating more jobs. And that is all good news. 

I think we ought to talk about it a little bit, so that is why I took 

these few minutes to talk about it. 

I appreciate the Secretary of Treasury being here. 

Chairman CONRAD. Thank you, Senator Gregg. 

Again, welcome, Secretary Paulson. Please proceed with your testimony. As you can see, we have an amicable committee here, but 

we do not always agree. 

STATEMENT OF HON. HENRY M. PAULSON, JR., SECRETARY, 

DEPARTMENT OF TREASURY 

Secretary PAULSON. Chairman Conrad, Senator Gregg, thank you 

very, very much. 

I am going to make a brief statement for the record and then we 

will be ready to take your questions. 

As you know, I am very pleased to be here today to provide an 

overview of the President’s budget for fiscal year 2008. 


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As the Secretary of Treasury, my top priority is keeping America’s economy strong for our workers, our families, and our businesses. And the President’s budget supports that goal. 

We start from a position of strength. Our economy appears to be 

transitioning from a period of above-trend growth to a sustained 

level of about 3 percent growth. More than 7.4 million jobs have 

been created since August of 2003. 

Our unemployment rate is low, at 4.6 percent, and over the last 

12 months real wages have increased at 1.7 percent. Economic 

growth is finding its way into workers’ paychecks as a result of low 

inflation. That means family budgets are going further. 

Strong economic growth also benefits the Government’s fiscal position. In the first quarter of fiscal year 2007, budget receipts totaled $574 billion, an increase of 8 percent over the same period 

in fiscal year 2006. As a result of increased revenue over the last 

2 years, we have brought the Federal budget deficit down to 1.8 

percent of GDP. 

The President has submitted a budget that reflects our strong 

economy and our Nation’s priorities: continued job creation and 

wage growth, vigorous prosecution of the War on Terror, increased 

access to affordable health insurance, improved energy security, a 

strong fiscal position from which we can address the long-term 

challenges such as sustaining Social Security and Medicare for future generations. 

This budget supports a strong economy by maintaining fiscal discipline. It maintains our current tax policy, which has helped our 

economy rebound from recession to its current robust health. With 

a steadily growing economy, tax revenues combined with fiscal discipline should bring the Federal budget into balance in 5 years. 

In fact, we are submitting a budget that includes a surplus in 

2012, which is achievable if we keep our economy growing. While 

no one has a crystal ball, our economic assumptions are close to the 

consensus of professional forecasters. 

The President’s budget addresses important domestic priorities. 

Health care is high on this list. Under current law, the tax subsidy 

for health insurance purchased through employers will average 

more than $300 billion a year over the next 10 years. For that 

large expenditure we get a system in which rising costs are a burden to families and businesses, and in which millions of people 

have no insurance at all. 

The President’s proposal would make health care more affordable 

and more accessible. It would give all taxpayers who buy health insurance, whether on their own or through their employer, and no 

matter what the cost of the plan, the same standard deduction for 

health insurance: $15,000 for a family or $7,500 for an individual. 

The President’s proposal would help hold down health care costs 

by removing the current tax bias that encourages overspending. 

Costs would become clearer, giving patients more power to make 

informed choices about their health care spending. The proposal 

would also jumpstart the individual insurance market, so consumers have more choices than are available today. Health care 

would become more consumer driven, more affordable, and more 

accessible for millions of Americans. 

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Energy security is another concern of the American people, and 

it is a priority addressed in the President’s budget. President Bush 

has put forward an ambitious goal of reducing America’s projected 

gasoline consumption by 20 percent over the next 10 years. We can 

achieve this goal by dramatically increasing the supply and use of 

alternative fuels, and improving fuel efficiency by reforming and increasing CAFE standards. The expanded fuel standards will provide entrepreneurs and investors a guaranteed demand for alternative fuels, which will accelerate private investment and technological development. 

Reforming CAFE standards will allow us to increase the fuel 

economy of our automobiles as fast as technology allows. With a 

more diverse fuel supply and better fuel efficiency, we can make 

our economy less vulnerable to supply disruptions and confront climate change through technologies that reduce carbon dioxide emissions. 

Finally, the President’s budget, by emphasizing fiscal discipline 

and economic growth, lays the right foundation for dealing with entitlement reform, a challenge we all have a responsibility to address. 

Strengthening Social Security and Medicare is the most important step we can take to ensure retirement security for our children 

and grandchildren, the long-term stability of the Federal budget, 

and the continued growth of the American economy. 

I look forward to sitting down with Democrats and Republicans 

without preconditions and finding common ground in these critical 

issues. 

Mr. Chairman, the President’s budget priorities, a strong economy, national security, fiscal discipline, health care, energy innovation, and laying the groundwork for entitlement reform, are the 

right priorities for America and for the workers, businesses, and investors who drive our economy. 

I am confident that working together we will keep our economy 

strong and chart a course for maintaining our global leadership in 

the years ahead. 

Thank you for the opportunity to discuss this today, and I now 

welcome your questions. 

Thank you. 

[The prepared statement of Secretary Paulson follows:]

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Chairman CONRAD. Thank you, Mr. Secretary. Thank you, again, 

for your testimony and thank you for your service. 

Let me go to one of your last statements, a discussion about 

going to the table without preconditions with respect to the challenges our country faces because, in large part, of this demographics tsunami that is coming at us of the baby boom generation. 

When you say without preconditions, what does that mean to 

you? 


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Secretary PAULSON. Let me step back and say it was very clear 

in your charts that entitlement reform is the biggest issue. We had 

a good conversation yesterday at the House Budget Committee, and 

Chairman Spratt there showed some numbers. They disagreed with 

our assumptions, with our budget, and he said that we are wrong 

and that the deficit will be $145 billion based upon the numbers 

he is looking at in 2012. 

I said that I very respectfully think that we can work toward, I 

believe, our numbers, and we can reduce and eliminate the deficit 

and have a surplus in 2012. 

But the differences we are talking about are very small, $145 billion in 2012 is 0.8 percent of our GDP. And so what we have staring us in our face, and the reason we all care about this, is because 

of the long-term problems. 

So what it means to me is that we are not going to solve this 

unless we have a bipartisan solution. And so what I am trying to 

do, at the President’s direction, is to take the politics out of this 

and to say, without prejudging outcomes, without trying to negotiate this in the public arena, let’s bring people together and say 

any idea. Anything you want to talk about, I want to talk about. 

And we will take any idea seriously. 

There is no doubt that the President feels the way he does about 

tax relief. You saw his ideas on Social Security reform over the last 

couple of years. He does not believe you need to increase taxes. He 

thinks personal accounts are a good idea. And other people feel 

very strongly on the other side. So the President has said let’s start 

over. Let’s have a clean sheet of paper. Let’s come to the table 

without preconditions. 

So to me that is really what it means. It means that people on 

both sides will present their ideas, and we will not do it in a public 

forum. We will do it in a way in which we can make progress and 

take some of the political rhetoric out of this. 

Chairman CONRAD. I thank you for that. I think that is a very 

constructive statement. And I am absolutely persuaded that you 

come to this with sincerity and a conviction that we have an opportunity here, and really a responsibility, to try to make progress. So 

I welcome that statement. 

I want to go back to the question, because it really is very central 

to this debate, whether or not tax cuts pay for themselves or generate more revenue than they lose. 

Last summer the Treasury Department, and this was before you 

were there, the Treasury Department under your predecessor did 

a dynamic analysis of tax cuts. And here is what they concluded. 

Treasury’s dynamic analysis of the President’s tax relief indicates 

that making the tax relief permanent can be expected to increase 

the level of annual output by about 0.7 percent. 

The Congressional Research Service then translated that into 

what it means in comparison to the cost of the tax reductions, and 

here is what the Congressional Research Service told us last summer. The base case estimates in the Treasury’s dynamic analysis 

suggest that the induced effect on output, were the tax cuts to be 

extended, would lead to a revenue offset of 7 percent of the initial 

cost. 

267

Now that is your own department’s analysis. This was before you 

were in the department. I want to be fair, this was under the previous Secretary of the Treasury. 

Let me go to the Washington Post article. Greg Mankiw, who I 

cited, who was a top official, was Chairman of the President’s 

Council of Economic Advisers, has tested the notion that tax cuts 

pay for themselves. He is a very distinct economist, as you know, 

again Chairman of this President’s Council of Economic Advisers. 

He looked to the extent to which tax cuts stimulate extra growth 

and the extent to which the growth generates extra revenue. Here 

is his conclusion: even over the long-term, once you have allowed 

all of the extra growth to feed through into extra revenue, cuts in 

capital taxes—which Senator Gregg was referring to—juice the 

economy enough to recoup half of the lost revenue. This is the tax 

type that has the biggest payoff. Senator Gregg is right about that, 

taxes on capital have the biggest payoff. 

They do enough to recoup half of the lost revenue. Cuts in income taxes deliver a boost that recoups 17 percent of the lost revenue. 

So $100 billion cut in taxes on capital widens the budget deficit by $50 billion. A $100 billion cut in income tax widens the budget 

deficit by $83 billion. That is Dr. Mankiw’s conclusion. 

We have our own Congressional Budget Office that did an analysis on what the effect of a 10 percent reduction in personal taxes 

and how much of that would be paid for by the cut. On the most 

of optimistic assumption it could muster, the CBO found the tax 

cuts would stimulate enough economic growth to replace 22 percent 

of the lost revenue in the first 5 years and 32 percent in the second 

five. On pessimistic assumptions, the growth effects of tax cuts did 

nothing to offset revenue loss. 

In fact, in the most optimistic of these analyses, done by your 

own department, done by Dr. Mankiw, the former Chairman of 

Economic Advisers under President Bush, done by our own Congressional Budget Office, in no case did the tax cuts come close to 

paying for themselves, nowhere close. And these are under the 

most optimistic assumptions, the assumptions being that the tax 

cuts were financed by cuts in other Government spending. 

As you know, these tax cuts are not financed by cuts in other 

Government spending. These tax cuts are financed by deficit spending. When you finance tax cuts with deficit spending, the conclusion of all of these analyses is that there is virtually no offset. 

Now I would just ask you, do you agree with your department’s 

analysis on tax cuts not paying for themselves, not coming close to 

paying for themselves? 

Secretary PAULSON. Mr. Chairman, as I said when I answered 

the same question at the Senate Finance Committee and at my 

confirmation hearings, I have never argued that tax cuts pay for 

themselves entirely. In terms of getting into the details about how 

much, this is something I do not think we really can do with precision. 

What I have said, which I really believe, is that I have seen it 

in the real world. I was in Wall Street when the bubble burst, the 

stock market bubble, when we went into a recession after 9/11. And 

I watched behavior change with these tax cuts. I have no doubt 

268

they created a foundation for growth. I do believe it is very hard 

for economists or anyone to evaluate behavioral changes. 

One thing that I have used before as an example is to look at 

the upper rate. But that is really tax relief for a big part of small 

business, the Schedule C filers. You probably have known small 

businessmen. I have known small businessman all my life. 

Chairman CONRAD. I come from a family of small businessmen. 

Secretary PAULSON. What do you do if you are a small businessman? Oftentimes, every penny you save, you plow back into your 

business. 

So there is no doubt in my mind that we have an economy that 

is robust and that revenues are coming in well above the estimate. 

One of the things I am trying to study and I am spending time 

trying to figure out is actually why we have been so wrong in estimating, underestimating the revenues. 

Chairman CONRAD. Let me ask you this. My time has really 

passed. Your department has concluded, with a dynamic analysis, 

a dynamic analysis, that the base estimate of your department is 

that the tax cuts only pay for 7 percent of their cost. 

Do you dispute that analysis? Or do you agree with it? Or do you 

want to back and review it? 

Secretary PAULSON. I have to tell you, I have not read that analysis carefully or looked at it carefully. 

Chairman CONRAD. I would just ask you if you would do that and 

get back to us and let us know do you agree with it, do you disagree with it, and the reasons. 

Secretary PAULSON. I will do it, but I would speculate that I will 

get back to you and say it is a very inexact science. And I will probably come back and say I would never try to influence the way the 

great people at Treasury—very, very independent economists—are 

doing their analysis. 

So I will understand what they have, but to me that is not critical to the discussion we are having today. But I will get back to 

you. 

Chairman CONRAD. Let me just say, I think it is critical in the 

sense that we look to your department for professional guidance. 

And we need to have the best guidance we can on this issue, 

among many others. 

Senator GREGG. Senator GREGG. Thank you, Mr. Chairman. 

Of course, the issue is not whether the tax cuts pay for themselves. That is a straw dog. The issue is whether or not you have 

a tax law which generates enough revenue to support the Government or whether you grow the Government to the point where you 

simply will never be able to catch up with the taxes because you 

will make it impossible for people to bear the burden of the taxes 

that they would be hit with. 

Let me show you a chart which reflects this fact. If you just take 

the three major entitlement accounts, Medicare, Social Security 

and Medicaid, you will see that they presently are around 5 percent or 6 percent of gross domestic product. But as the baby boomer generation retires, those accounts, as a percentage of the gross 

domestic product, grow radically. And by the year 2030, 2028, they 

absorb 20 percent of gross domestic product. The historical mean 

269

of what the Federal Government has spent is 20 percent of gross 

domestic product.

And that just continues to grow. So historically, the amount of 

taxes which the Federal Government has taken, is about 18.2 percent, which would be a little bit below the 20 percent of spending. 

But the practical implications of this chart is that you cannot tax 

your way out of this problem unless you are willing to put a tax 

burden on the American worker which is so high that the younger 

people in this country will end up paying so much in taxes that 

their quality of life will drop dramatically and the productivity of 

the economy will probably drop dramatically. 

But certainly the younger people, my children and your children 

and our children’s children, will not be able to send their kids to 

college, will not be able to buy the house they want, because they 

will be paying taxes to support this burden of Government. 

So the issue is not whether tax cuts pay for themselves. The 

issue is whether or not the tax law that you have in place generates enough revenue to support the Government, and at what 

level will the Government be set? How much is the Government 

going to take out of the economy? 

Now today we know that the present law, the President’s tax 

proposals are supporting an income to the Government that exceeds what the Government has historically received. We are getting about 18.4 percent of gross domestic product in revenue, as 

versus the traditional revenue of about 18.2 percent. 

So the tax cuts are working. They are generating a fair amount 

of revenue to the Federal Government. The problem is we are just 

spending a lot more than we are taking in. And we are going to 


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spend even more in the future than we are taking in because of the 

retirement of the baby boomer generation. 

So my question to you, Mr. Secretary, is independent of whether 

or not the tax cuts pay for themselves, is the tax burden that we 

have on the American people today a fair one? Or are they 

undertaxed? 

Secretary PAULSON. I would say that I totally agree with your 

numbers. You look at the last 40 years, the last 50 years, the average has been 18.1 percent. And it is now 18.4 percent. You can look 

at that and then look at the fact that revenues are coming in, 

frankly, faster than any of us had expected, any of us on either side 

of the aisle had expected. 

So I agree with your point. 

Senator GREGG. The point that the Chairman has made that I 

do agree with—and we actually agree on quite a few things, and 

we very much agree on this point, and we consider it to be the essence of the problem—is that chart, which I just held up, shows 

that we are facing an explosion in costs for this Government that 

will be inordinate and historic and unsustainable. And everybody 

that has testified before us says that. 

The question becomes you have to match revenues to expenditures in order to have a strong Government or come fairly close to 

that. In the out-years what percentage of the economy, and I have 

asked this of everybody who has testified, what percentage of the 

economy should the Federal Government take? Today it is taking 

20 percent. Should it take 22 percent, 23 percent, 24 percent? Is 

there a number at which, when the Federal Government starts to 

take that amount of the economy, the economy goes into a nonproductive spiral because the burden of the Government has become so high? 

Secretary PAULSON. Senator, I do not know the answer to that 

question, and I will tell you why. It is because as I have looked at 

it and looked at the problem, the problem is so big in a number 

of years that I do not think we need to answer that question with 

great precision. We do not have to go too far out to know that we 

are going to be hitting a situation where there is either going to 

be no money left for any other discretionary spending, our taxes 

are going to be at the level where they stifle all of us, or we are 

going to be really hurting our children and our grandchildren in 

terms of their retirement security. 

I know I am singing to the choir because I see both you and the 

Chairman nodding your head. As I look at this, I tell people I have 

no doubt that this country will solve this problem, this entitlement 

problem, at some time. The frustrating thing for all of us is the 

longer we wait, the more costly it will be, and the more difficult 

it will be. And the longer we wait, we are going to have to answer 

these questions you have asked with a lot more precision. I think 

we are not going to like the answers because there is clearly a level 

at which the taxes will really burden this economy and make us 

noncompetitive. 

There is clearly a level at which we are not going to be able to 

have the amount of discretionary spending we need to take care of 

our other needs. 

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Senator GREGG. And the collateral point to that is that you obviously are going to have to do the majority of this on the spending 

side. 

Secretary PAULSON. Right, yes. 

Senator GREGG. Thank you. 

Chairman CONRAD. The ranking member may be surprised by 

this. I happen to agree with him. We cannot tax increase our way 

to a solution of this problem. 

I also believe, and the point I was trying to make, is you cannot 

tax cut your way to a solution to this problem. It is going to take 

a balanced, comprehensive approach. And I think most of it is 

going to have to be on the spending side of the equation, given the 

magnitude of the baby boom generation. 

Senator SANDERS. 

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

Mr. Secretary, let me take this discussion in a little different direction. Very often when we talk about the economy, we talk about 

the economy in a general sense. But the American people are not 

a general, they are real human beings who have real concerns. 

What is your judgment on the fact that the United States has 

the most unequal distribution of wealth and income of any major 

country on earth? That we have, to our shame, by far the highest 

rate of childhood poverty of any industrialized nation, depending on 

the studies that you look at, between 18 percent and 20 percent? 

Should we be proud as Americans?

We hear people telling us how wonderful this economy is doing. 

Mr. Secretary, how wonderful is the economy doing when we have 

by far the highest rate of childhood poverty in the industrialized 

world, with some 20 percent of our children living in poverty? Can 

you tell me how that reflects on our economy? 

Secretary PAULSON. Senator, first of all, in terms of your numbers, I have looked a good bit at income distribution. And what I 

have seen is a trend that I have seen in most parts of the world 

that has been going on for 30 years. In some countries it was more 

pernicious. And so when you look at what I saw going on in Mexico—

Senator SANDERS. But we are not Mexico, sir. 

Secretary PAULSON [continuing]. And China. 

Senator SANDERS. We are not China. 

I do not have a lot of time and I know that the Chairman will 

use his gavel. 

Secretary PAULSON. Let me answer your question. 

Senator SANDERS. In the United States, the wealthiest 1 percent 

own more wealth than the bottom 90 percent. The gap between the 

rich and the poor is growing wider, and we have the highest rate 

of child—forget China—in the industrialized world. What do you 

think about that? 

Secretary PAULSON. I would say that what is going on right now 

is something that is happening all over the world. It has been happening here for 30 years. But what I think about it is that we are 

doing a lot, and we need to continue to do a lot. 

Senator SANDERS. What are we doing? I do not have a lot of time. 

Secretary PAULSON. OK, I will tell you—

272

Senator SANDERS. Let me ask you a question and please give me 

an answer. I do not have an endless amount of time. 

When we talk about childhood policy, one of the issues related 

to that is the disastrous situation with regard to child care and 

Head Start in this country. We underfund Head Start, huge numbers of families cannot get it. The budget that the President has 

just presented us would cut by $300,000, between 2006 and 2010, 

millions of children from getting child care. 

Do you think that that is an effective way of dealing with childhood poverty? 

Secretary PAULSON. To get back to your question of what are we 

doing about it, I will answer that very directly. What you have seen 

under this President is 5 million taxpayers taken off the Federal 

income tax rolls. So 5 million additional people do not pay taxes. 

Senator SANDERS. But what else have we seen? You use the 5 

million—

Secretary PAULSON. And you have seen—

Senator SANDERS. Sir, unless the Chairman wants to give me 

some additional time. 

But we have also seen, more importantly, since President Bush 

has been in office, 5 million more Americans slipping into poverty. 

Can you tell me, is that a good thing, 5 million more Americans 

are poor today than before President Bush took office. 

Secretary PAULSON. I would say to you, Senator, that I have focused a lot on income distribution. It is something I am very focused on. I think the No. 1 thing we can do for all Americans, rich 

or poor, and particularly for people at the low end and in the middle, is keep an economy growing, keep creating new jobs. They will 

all do better—

Senator SANDERS. But sir, that is not the record. Since President 

Bush has been in office, almost all of the new income created has 

gone to the very wealthiest people and 5 million more Americans 

have slipped into poverty. Millions of people have lost good paying 

jobs and are working jobs for lower wages. How is that good news? 

Secretary PAULSON. I would say to you that I do not agree with 

the numbers. 

Senator SANDERS. You do not agree that 5 million Americans 

have slipped into poverty? 

Secretary PAULSON. I have not heard that number. And I would 

just tell you, when you talk about the millions of Americans that 

are losing good jobs, I will say there are good jobs being created 

all of the time. And the thing I look at most carefully is what is 

happening to the average worker. 

And I am very pleased that over the last year we have seen real 

increases in wages. 

Senator SANDERS. In the last year. 

Secretary PAULSON. In the last year. 

Senator SANDERS. That is good, but President Bush has been in 

office for 6 years. 

Secretary PAULSON. I would say that what we have seen in other 

recoveries, and it was very similar in the 1990’s, is that if you can 

keep productivity high, keep creating new jobs, productivity will 

find its way into real wage increases. And we are making progress. 

273

Senator SANDERS. I think, sir, you have a tough sell. What you 

are trying to do is convince the middle-class and working-class of 

this country that things are going well. They are not buying it, because they know that they cannot afford increasingly health care. 

And since President Bush has been in office 6 million Americans 

have lost their health insurance. 

They know that more and more people are becoming poor. We 

see some young people here. Middle-class families know that they 

are finding it increasingly difficult to send their kids to college. We 

have lost 3 million good paying manufacturing jobs. And while, in 

fact, we have seen in recent years a growth in new jobs, many of 

those jobs are paying lower wages and lower benefits than the jobs, 

in fact, that we are losing. People are seeing folks on Wall Street ending up with $50 million 

bonuses while they are losing their pensions. They are losing their 

health care, when they retired, the health care benefits that they 

were promised. 

So what you are seeing is a Nation in which the people on top 

are doing very, very well. The middle-class, in fact, is shrinking, 

not because of President Bush. This is a long-term trend. But right 

now a two-income family has less disposable income that a one-income family did 30 years ago. 

I am not blaming this all on President Bush. It has a lot to do 

with trade policy. It has a lot to do with the lack of unionization 

in this country. 

We will continue this discussion another time. Thank you very 

much, sir. 

Secretary PAULSON. Actually, I thank you for your comments. I 

would like to talk with you some more, particularly about trade 

policy. 

Senator SANDERS. I would love to do it. 

Chairman CONRAD. Senator Domenici. 

Senator DOMENICI. Thank you. 

First, let me say to you, Secretary Paulson, I got a chance to 

meet you since you have been appointed and I have not had a formal opportunity. But the private one was very exciting for me because I thought that where you came from and what you worried 

about, based upon what you have written, that you are the right 

person for this job. 

What a tough job we all have, and it is not all yours. But I would 

suggest a couple of things that I think I know from having served 

here for a long time. 

One, there is just no way we are going to solve the deficit problem by continuing to attack almost singularly the appropriated accounts every year. It has now reached the point where we cannot 

produce a budget, in my opinion, of the President’s level in that account, that big account, that can pass and be implemented 

throughout the year. I will start with that. Whomever that helps, 

I am not saying where I am voting. I am just saying each year that 

one is getting where it can less and less do the job. 

I hope you will think that true because I think the conclusion is 

absolutely inevitable. 

But that does not mean that our problem is still not that we 

must cut growth in Government. That is what we must do, instead 

274

of worrying so much about increasing taxes. We have to find a way 

to solve the problem of ever spiraling costs of Medicare, Social Security, and Medicaid, although Medicare is a different breed of program. 

And I wanted to suggest to you that there is a bill called Senate 

Bill 355. I put that in with Senator Feinstein, and I would hope 

you would look at it. 

The reason I put it in is because I have given up on Congress, 

even with leader president, I have given up that we will modify 

Medicare or Social Security in any significant way. And both are 

doable. But I do not think Congress will do it. 

Therefore, this is for a bipartisan commission to recommend how 

to do it. And I truly believe if you could read it and give us your 

views, I think it can do the job. It has the right input, the right 

people, the right rules, and reports its results to the right people, 

who must act. 

And I think that is a lot better than wringing our hands, that we must squeeze the appropriated accounts another time for $3 billion or $4 billion or $5 billion, when the debt is so much bigger and 

we know it—the deficit, excuse me, and we know it. 

Having said that, just do you agree theoretically that what we 

have to do is what I said? Not my bill but—

Secretary PAULSON. Senator, I do agree philosophically that the 

biggest issues we face are the long-term spending—Medicare and 

Medicaid—and other entitlements—Social Security. 

Senator DOMENICI. I think it is good if you become a little bit 

more of an expert on them. You are a quick learn. Because you 

cannot just deal what the theoretical Treasury problems and help 

us solve our problems. 

Let me tell you another one that is quick, but everybody is trying 

to come up with an idea on how to fix our global warming, that is 

some carbon containment so it does not get out there as we burn 

it. 

I submit to you that everybody is looking for a law that will do 

it which will put all kinds of impacts on business and it will become just another master of bureaucracy on trying to collect carbon 

tax or whatever it is. Now just think with me for a minute. 

The real problem is that we are not getting enough in investment 

or solution to new technology that takes the carbon out of the coal. 

Instead of trying to solve that, we are trying to change the law and 

burden business one way or another. 

Question to you: what if we introduced a bill that said this bill 

has, as its purpose, the financing for the next decade of those who 

wish to invest in new technology that will direct itself at converting 

coal and getting the coal sequestered permanently in the process. 

Would that not be just the same as passing one of these burdensome bills, if not better? 

Secretary PAULSON. Senator, let me say it is a complicated topic. 

But I will tell you that technology has been very important to this 

president. And as I have looked at it and studied the issue, there 

is no doubt that coal is the backbone of power generation around 

the world. 

In our strategic economic dialog with China, one of the things we 

talk about a lot is clean coal technology, the FutureGen project. So 

275

I do believe that in any solution we come up with, one important 

part of it should be new technology. Clean coal has to be a very 

big part of it. So I agree with you there. 

Thank you. 

Senator DOMENICI. Mr. Secretary, it seems like the Federal Government is going to have to push the technology. And I submit to 

you that a very big program of loan guarantees or the like for this 

kind of work on a 10-year basis will find the breakthroughs sooner 

than just insisting that we have a new law that takes away things 

from business. 

Secretary PAULSON. I do agree there is clearly a role for Government. And right now you will see we have a very rigorous approach 

to this, and we are funding, at the Federal level, clean coal technology. There is a lot of work being done on this. 

I think it is actually quite encouraging, some of the progress. 

Senator DOMENICI. Thank you, sir. Thank you, Mr. Chairman. 

Chairman CONRAD. Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. 

Speaking about economists, as the Chairman did earlier, I can 

put 25 economists in a room and ask them and give them exactly 

the same circumstances. And guess how many answers we will get? 

Twenty-five different answers. 

Chairman CONRAD. Fifty. 

Senator BUNNING. Fifty, that may be true, too. 

Secretary PAULSON. That is right, on the one hand, and then on 

the other. Unless they are all one-armed economists. 

Senator BUNNING. You are taking my time now, and I have not 

asked a question. 

[Laughter.] 

Senator BUNNING. Under the Bush Administration, we have increased earned income tax credit dramatically and we have doubled 

the child tax credit in the last 5 years. And there are 40 million 

senior citizens now getting prescription drugs that did not get them 

before the Bush Administration took office, just as a matter of fact, 

under prescription Medicare Part D. 

Let me just ask you a couple of questions. Thank you for coming, 

first of all. 

I was pleased that the President’s budget calls for a repeal of the 

sunset of the marginal tax rate relief. I am very concerned about 

some proposals I have heard from Members of Congress to increase 

the marginal rates and the impact such proposals could have on 

our small businessmen and women. 

Given the enormous number of jobs created by small business in 

this country, what effect could such a tax increase have on the 

strong job growth and overall economic strength that we have enjoyed in recent years? 

Secretary PAULSON. I would just say to you that I would clearly 

not recommend a tax increase. I think that is why it is important 

to make this tax relief permanent. I think one of the positives, 

which you have pointed out Senator, which I do not think is generally understood, is when you look at that top bracket it applies 

to the individual Schedule C filers, which are—

Senator BUNNING. And S–Corps, too. 

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Secretary PAULSON. Yes, and S–Corps, which are small businesses. 

Senator BUNNING. Yes, which are all small businesses. 

Secretary PAULSON. This is a marvelous thing, this American 

economy, just a marvelous thing. We all sit here and think we are 

doing things in Washington that are responsible for everything, but 

it is the American businessman, the American worker. And I do believe we need to look for ways to help them. I take your point, and 

I agree with it. 

Senator BUNNING. Since our economy is extremely strong, and 

there are people that are debating whether it is or not, and our unemployment rate is very low at 4.6 percent, which historically over 

the 1960’s, 1970’s, 1980’s, and 1990’s and into the 2000’s, is at a 

historic low for a period of long-term. 

Economic growth has averaged over 3 percent growth for more 

than 20 straight quarters. Yet some Chicken Littles are trying to 

convince the American public that the sky is falling in, or else they 

are trying to ignore the fact that record performance of the economy was engineered by sound economic policies. 

Do you believe that the policies put in place by the President and 

the Congress over the past 6 years have contributed to this remarkable growth of our economy? What would be the economic impact of reversing the President’s tax relief or allowing the tax relief 

to expire? 

Secretary PAULSON. I would say, Senator, I do believe, as I said 

earlier, that these economic policies—the tax relief—has been very 

important, provided a real foundation for growth, helped investor 

confidence, changed behavior, and made a very big difference. 

I think all of us should feel fortunate that this expansion is continuing. It is stronger now than I believed it would be. So I would 

not—

Senator BUNNING. I have one more question. 

Secretary PAULSON. I am sorry. I would not recommend that we 

raise taxes. 

Senator BUNNING. OK. 

We talked about entitlements and the reduction in the rate of 

growth that has been put into the President’s budget. It is less 

than 1 percent in Medicare and less than 1 percent in Social Security or Medicaid and on down. But when we project that reduction 75 years out, it saves $8 trillion long-term. I would like your comment on that. 

Secretary PAULSON. I think you have it. And so you look at Medicare, and what we are doing is putting some ideas on the table to 

reduce the trajectory of growth over 10 years from 7.4 percent to 

6.7 percent. You are right. You are dealing with such big numbers, 

just changing the rate of growth a small amount makes a big difference. 

I can see you have studied these things very carefully, and I appreciate it. 

Senator BUNNING. Thank you very much. 

Chairman CONRAD. I heard you say, in response to Senator 

Bunning, that you would not recommend a tax increase. Is that 

correct? 

Secretary PAULSON. Correct. 

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Chairman CONRAD. I assume that you are saying that in reference to the extension of the 2001 and 2003 tax cuts that otherwise expire? 

Secretary PAULSON. Yes. 

Chairman CONRAD. But does not the President’s budget have, in 

just the same way, a tax increase on the alternative minimum tax, 

since those provisions, under the President’s budget, sunset after 

1 year? The provisions to prevent a massive tax increase. 

And so in the President’s budget, and this is from the Tax Policy 

Center at Treasury, you have almost $500 billion of tax increase 

as you have defined it here. Is that not the case? 

Secretary PAULSON. Yes, Mr. Chairman, let me address that. I 

think we are all agreed that we do not want the alternative minimum tax to go into effect without extending the current patch. As 

I have said before, it would be cruel and unintended, and it would 

be a real surprise to hit the middle class. 

And so what we have done in the President’s budget is put forward a budget where there is an additional year of relief. That is 

to give us time to work together to solve this problem. 

Chairman CONRAD. But the President’s budget would not balance 

without the revenue that flows from what you have defined here 

as a tax increase. 

Secretary PAULSON. I would say that what we have seen now, I 

think for the last 6 years, is that this 1-year patch is what Congress has done. What we thought made most sense was to go ahead 

with that 1 year of additional relief, and then work together. And 

I am hopeful that we will work together and come up with a solution. 

Chairman CONRAD. I appreciate that, but the reality is as you 

have defined tax increase, this is a tax increase. And it is a large 

one. It is $500 billion of revenue that, if you did not have in this 

budget, this budget would not balance. Is that not the case? 

Secretary PAULSON. There is no doubt that if the alternative 

minimum tax went into effect without extending the patch, it 

would be a cruel tax increase. It would be an unintended one. 

Chairman CONRAD. Because my time is fleeting, as well, let me 

ask you this if I could. Are there ways that we could increase revenue without increasing tax rates? 

Secretary PAULSON. I would say obviously you can, by reducing 

spending. 

Chairman CONRAD. No, I’m talking about on the revenue side 

now. 

Secretary PAULSON. On the revenue side I do believe it is very 

interesting. When we looked at our budget, and when I did the 

analysis and compared it with our projections, with the CBO projections, and others, it is just clear to me how dependent all of this 

is on a growing economy and keeping an economy strong. And that 

is really where the biggest sensitivity is. 

Chairman CONRAD. Let me try to help you and suggest that—

Secretary PAULSON. So I would say to you that I think the biggest way we increase revenue without increasing tax rates is 

through economic growth. 

Chairman CONRAD. Without question. And what other ways? 

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What I am trying to lead you to is the tax gap. As I see it, and 

help me understand how you see it, the Revenue Service has told 

us before this committee that they now believe the tax gap, the difference between what is owed and what is paid is now $350 billion 

a year. And while the vast majority of us pay what we owe, I believe the vast majority of companies do as well, we have some number of individuals and companies who are not. Is that not a way 

of increasing revenue without a tax increase? 

Secretary PAULSON. How much time do I have to respond to 

that? 

Chairman CONRAD. Go ahead. 

Secretary PAULSON. I am going to try to be brief, but this is one 

that I have thought about a lot because when I arrived here Chairman Baucus told me how serious he was about this. 

I looked at the numbers, and the numbers are not as good as we 

would like. The last real serious estimating efforts were in 2001. 

Under my direction we are going to be taking a much more careful 

look this year. 

But the estimates, the number I would use was $290 billion, 

which was the net tax gap. I began looking at this the way all of 

us look at it, which is to say that it is outrageous to any of us who 

pay taxes that we all are paying more taxes because some people 

are free riding and are not paying anything. For some of them, it 

is done through intent, and for others, it may be because they inadvertently do not pay the taxes. 

But as I looked at this, what I found, and we are working hard 

on this, is that the vast majority of the tax gap come from individual taxpayers, and it is the result of underreporting. You can 

look at it. There are some non-filers, and there is some underpayment. But the biggest piece is underreporting. 

As you delve into that and you look at that, the majority of the 

underreporting comes from business income. So it is Schedule C, 

and a lot of it is small business and farmers who are underreporting. 

And then you say OK, so how do you get at that? The conventional wisdom was if we make the tax code simpler this will help 

shrink the tax gap. That is right, it will help shrink it. But frankly, 

to get at the big numbers and the biggest portion of it, we would 

have to make it more complicated because it means more reporting. 

As I have looked at it, there are a number of things if we wanted 

to get it, we would have to do, which I think, frankly, none of us 

will want to do. That is because they would be the kinds of policies 

that will be very onerous. It would be the sorts of things like a lot 

of reporting, 1099s. I have used the example that if you hire a 

plumber, you would have to fill out the 1099, give him a coypy and 

send a copy to the IRS. Or on the family farm where the wife is 

selling eggs, going through the same procedure. 

Another way to get at it, and I spent a bunch of time with our 

people on this, would be to have electronic receipts or credit card 

receipts for everything. Moving in that direction, moving away from 

the cash economy and having all of those receipts go to the IRS. 

Or big withholding. I remember when Dan Rostenkowski had 

withholding on dividends and interest. There was big objection to 

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that, and Congress repealed it. Well, you could have withholding 

on pension payments, on interest, on dividends. 

And so as I have looked at it, what I have to say to you is that 

I would love to come up with ways to finance through the tax gap. 

We are going to be working hard on this. But it is not a pot of gold. 

I am just convinced that this is not a pot of gold that is going to 

finance the AMT or other things. 

I wish I could tell you otherwise. We have 16 legislative proposals that have to do largely with reporting. I am urging Congress 

to pass those. And I understand why there may be some resistance, 

because even those—

Chairman CONRAD. How much will that raise? 

Secretary PAULSON. That will raise about $30 billion over 10 

years. And even there, some of them are going to have a delayed 

effect. One of them, for instance, involves the securities industry 

and would require brokers to report the basis of securities. And 

there will be a lag effect because that proposal would go into effect, 

if it is passed, in 2009 and would apply to securities that are 

bought after 2009 and then are sold thereafter. 

But this is not going to be easy. We have what we think is an 

aggressive IRS budget. We would like to get that funded. I appreciate your support over the years in always funding the IRS in any 

of our efforts there, supporting the budget, and helping pass our 

legislative proposals. 

Chairman CONRAD. Senator Gregg. 

Senator GREGG. Thank you. 

What you are saying is that most of the tax avoidance is a cash 

economy that is very hard to track without a lot of paper and a lot 

of bureaucracy. 

Secretary PAULSON. Boy, I wish I could have said it that quickly 

and clearly. I am going to take lessons from you, Senator. 

Senator GREGG. One of the things we have been talking about in 

this committee, and I think appropriately so, is the amount of ownership which we have of our debt by foreign holders and the fact 

that our debt, as a percentage of gross national product, has gone 

up. And it will go up radically if we have these numbers facing us. 

And you are, unquestionably, the best expert we have ever had 

in the Government on the issue of debt since Mr. Rubin was serving, I suspect. You are probably even better than Mr. Rubin. 

Secretary PAULSON. I would not say that. 

Senator GREGG. Anyway, your expertise is unquestioned. 

I would just like to get out your thumbnail thoughts on having 

foreign ownership of debt? Is it worse than having American ownership of debt, our own debt? And at what point does foreign ownership of debt become a risk because they lose their confidence in 

us? Is that a potential that we should fear? And if it is, what would 

lead to that? 

Secretary PAULSON. Thank you, Senator. Again, I have looked at 

this carefully. 

First of all, we all should know why we have the foreign ownership of debt. We have a current account trade deficit. We also have 

an economy that is growing, and we really want to keep our economy growing. We are not saving, in this country, and we have very 

high savings rate in other countries. China has a 50-percent savVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00727 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
280

ings rate, for instance. And so it is very important that we have 

foreign ownership of debt. 

And as I have looked at it, there is great diversity in the holdings—in foreign holdings, individuals, governments—great diversity. 

I will give you a couple of numbers that are fresh in my mind 

because, as I testified before Senator Dodd’s committee on China, 

I was asked these questions. We have roughly $4.4 billion of treasuries outstanding and held by the public. When you look at that, 

we have about $346 billion of them held by Chinese. That is 8 percent of the total. 

Now some of those are held by individuals and some by the Gov- ernment. We do not break that down publicly. But we have $500 

billion of our Treasury securities traded every day. So that is less 

than 1 day’s trading volume. 

Japan is the biggest holder when you look at individuals and the government. That is $650 billion roughly, a little bit more than a 

day’s trading volume. 

So as I look at this, there are many other things I am more concerned about than this. The key to all of this is to keep with policies that generate confidence in our economy, so that all holders of 

Treasuries, whether they are overseas or in the United States, buy 

Treasuries because they think it gives them the best risk-adjusted 

rate of return and because they have confidence in our economy. 

The way I think about this is we need to work on these imbalances. It is going to take a number of years to work our way out 

of these imbalances. I am encouraged by the fact that with regard 

to the trade deficit, we have now had four quarters in a row where 

our exports are growing faster than our imports. This last year, our 

exports to China grew at 33 percent, our imports at 19 percent. 

Our exports added 1 percent to our GDP in the fourth quarter. 

So we are making progress but it is going to take a while as we 

work through these imbalances. And I do not believe the foreign 

holding of debt is a symptom. It is a natural outcome of the trade 

imbalance. Given the diversity of holdings, the liquidity of Treasuries, I am not particularly concerned about that problem. 

Senator GREGG. I appreciate that explanation. 

If I could just make one comment—I really do, those were very 

substantive thoughts. 

But on the issue of how you do not have to increase rates to generate revenue, you mentioned expanding the economy obviously as 

the best. And the Chairman has mentioned collect taxes that are 

owed. 

I would like to put the third item on the table, which is that you 

go back to the 1986 Tax Reform Act which is that you clean the 

code of deductions and you actually cut rates and generate more 

revenue. 

Secretary PAULSON. Absolutely, simplification. You are absolutely 

right. 

Senator GREGG. Thank you. 

Chairman CONRAD. If I could just follow for one moment and 

then Senator Whitehouse is next. 

If I could ask you any proposals you would have with respect to 

what Senator Gregg just raised, that is tax reform proposals, base 

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broadening proposals that Treasury has worked on, that would be 

of interest to the committee. 

Secretary PAULSON. Thank you very much, Mr. Chairman. 

In light of the fact that there has been very major tax reform in 

2001 and 2003, and given how important this entitlements issue is, 

our major priority had been coming up with incremental tax reform, and a big effort in terms of this incremental reform is with 

a standard deduction for health care. 

And I am quite interested and am doing work on tax reform. We 

will continue to do work on tax reform as it relates to competitiveness and base broadening, looking at the corporate sector, and 

what it takes in this century to be competitive. 

And so you will see work as we go through the course of this 

year. 

Chairman CONRAD. That would be very interesting and very 

helpful. 

Secretary PAULSON. Thank you. 

Chairman CONRAD. Senator Whitehouse. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. I see that my 

clock has been restored to working order so I am no longer operating in a time-free zone down here. 

Mr. Secretary, first of all welcome, pleasure to have you here. 

I would like to touch base following a little bit on what Senator 

Sanders said. We see an expanding income gap between the rich 

and the poor, a dramatic one that goes back and is unmatched 

since robber baron days. It strikes me that it is not attributable to 

any particular fault collectively on the part of the middle class. Indeed, working folks seem to be producing at a higher level production than ever, or an increasing one anyway. It does not appear to 

be the result of any particular new level of achievement on the part 

of the wealthy and more fortunate members of our society. 

It appears, rather, to be the product in significant measure of 

secular economic forces around the world, of the flattening economy, of new levels of competition for labor and so forth. 

Secretary PAULSON. Technology. 

Senator WHITEHOUSE. And technology. And it is having a really 

pronounced societal affect that is beginning, I think. I guess the 

question is where does that go? 

I see huge risk of climate change from global warming creating 

enormous stresses. And the obvious solutions to it would appear to 

me to be price driven and likely to result in increases in fossil fuel, 

utility, heating oil, gas costs, all things that, as a portion of the 

household budget, are a larger portion for lower and middle-income 

families. 

So as we solve that critical national and international problem, 

again, a second hit on these families on top of the secular drift that 

is taking place right now. On top of that I see tax, trade and budget policies of this country that accelerate that drift even further, 

supporting wealthy and corporate interests and cutting what are, 

in many cases, vital supports for working families. 

And the three seem, to me, to be adding up to a kind of a perfect 

storm. And I am interested in your thoughts on just how far you 

think we can go, as an American society, in terms of this increasing 

and potentially limitless discrepancy between the trajectory of 

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wealthy families and the trajectory of working-class families before 

it creates social, political, economic, and really moral issues that 

change the face America presents to the world and change the way 

we look at each other? 

And if you think it is serious, where in this budget do we find 

anything that helps? 

Secretary PAULSON. Senator, thank you for that comment. It is 

very consistent with Senator Sanders’ comment. 

Senator WHITEHOUSE. It is a New England thing. 

Secretary PAULSON. And I think, this is something that many of 

us are thinking about right now—the growing dispersion of income 

And what is causing it. 

As I learned long ago, it is very interesting to know there is a 

problem. It is much more valuable to ask what do you do about it? 

But I do want to say one thing in terms of the cause. I really 

do believe that a very big part of what is going on is technology. 

Part of it is integration into the global economy. 

The reason I mentioned that is because I do not hear anybody 

say, and I am sure you would not say, let us turn back technological growth, let us put that back. 

Senator WHITEHOUSE. I think, actually sir, on a net basis it has 

been hugely positive. The problem is that some people are losers 

and some people are winners in that net forward and that itself becomes a problem at some point. 

Secretary PAULSON. I agree. 

And the reason I say that is because I feel the same way about 

trade. Your statement about technology I would make about trade, 

also. We have been net gainers. The reason I would say that is I 

think if we move toward protectionist policies, it would be very 

similar to try to pull back technological advancement, and it would 

hurt the very people we are trying to help. 

Now having said that, I think a bit—

Senator WHITEHOUSE. That still leaves the people who, because 

of the trade changes and because of the technological changes, are 

getting hurt. How do you help them? 

Secretary PAULSON. I think there has to be a big focus on what 

we do. And I like the way you are approaching it, not in terms of 

class warfare, but how do we help the people on the bottom? How 

do we help the average worker? 

I am just going to say what I said to Senator Sanders. First of 

all, I am not saying this alone is sufficient. But keeping this economy growing and keeping new jobs growing is essential, because 

whatever the issues, they are going to be greater if we do not have 

that, if we do not have the position of economic strength. 

The more you study it, the more you see it really comes down, 

to a large extent, to education and training. It also involves thinking about how in this century we think just more precisely about 

it, practically about what we do there, and coming up with programs that also are more effective at dealing with the job losses 

and dislocations. 

Because no matter what we are doing just generally, there is no 

doubt that trade does cost jobs. It does not cost net jobs, it adds 

jobs. But to those who lose their jobs—

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Senator WHITEHOUSE. That doesn’t help the family who just lost 

their job. 

Secretary PAULSON. To those that lose their jobs, we need to ask 

how do we deal with those specific situations because society overall is benefiting, and there is a higher standard of living because 

of it. 

So I think you really are pressing on the issue that we are all 

going to have to deal with together over the next 10 years. I am 

sorry. 

Senator WHITEHOUSE. No, no. I just wanted to get permission 

from the Chairman, because I have gone over my time, just to 

make one additional point. 

Secretary PAULSON. I went over for you. I am sorry. 

Senator WHITEHOUSE. No, no, that is fine. 

Chairman CONRAD. Let me just stop you, if I can, at that point. 

Let me just say kind of my rule of thumb here is we have 5 minute 

rounds, but I try to give each Senator about a 2-minute additional 

bump. That is how I have operated here, as you can probably tell. 

But we will have additional round. It really is Senator Sanders’ 

turn, if we could. 

Senator SANDERS. Senator Whitehouse, I will pick up where you 

left off. So you did not lose time, we are raising the same issues 

here. 

It seems to me, Mr. Chairman and Mr. Secretary, that sometimes here in D.C. we get a little bit isolated from reality. You 

made a statement a moment ago, this is a paraphrase that ‘‘this 

is a marvelous thing, this American economy’’ roughly speaking. 

Now I have to say I think that if millions of people all over 

America were listening to your statement, people who had fallen 

into poverty, people who today are working longer hours for lower 

wages than used to be the case, maybe one of the 6 million Americans who have lost their health insurance, maybe one of the millions of workers who were promised a pension but that pension was 

reneged, taken away from them, maybe a mother who is desperately seeking affordable child care in her community as she goes 

out to work 40 or 50 hours a week to earn enough money to take 

care of her family. 

Do you know what she would say? Sir, what world are you living 

in? And that maybe, maybe we are hanging around with folks in 

the country clubs and CEOs of large corporations for whom this 

economy is a very, very marvelous thing, to use your word. But it 

is not a marvelous thing for the middle class. We have to get our 

act together. 

The fact is, and I think all of the evidence suggests this, that the 

middle class is shrinking. When you and I were growing up the expectation was that one breadwinner in a family, usually the men 

back in those days, could work 40 hours a week and earn enough 

money to provide for the family. One person, 40 hours a week. 

How many people, Mr. Chairman, do we know in America today, 

middle-class families, where one person is working 40 hours a 

week? Quite the contrary. The vast majority of middle-class families, husband and wife are working. And it is not uncommon for 

them to be working more than 40 hours a week. 

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In fact, in this marvelous economy that you are talking about, 

you may or may not know that in the United States our people 

work the longest hours than in any other industrialized country. I 

believe a few years we surpassed the Japanese, who also work very 

long hours. How is this a marvelous economy? 

Now, my question to you, and I am a little bit blunter than my 

good friend from Rhode Island. I look at what is going on having 

to do a lot with one word, and that is greed. Frankly, I do not believe that the Bush Administration is trying to help all of the people. I do not believe that at all. I think you guys work day and 

night to help the people on top. And I think you have turned your 

backs on middle-income people, working people, and low-income 

people. 

Sir, the United States is the only nation in the industrialized 

world that does not have a national health care program. The only 

one of any major country. In your judgment, should health care be 

a right of all people, as is the case in every other major country 

on earth? 

Secretary PAULSON. You know. I feel very strongly that we need 

to work toward a system where everyone has access to affordable 

health care. But to me that is not a nationalized program. 

Senator SANDERS. Not nationalized. But every other country has 

said that, as a right of citizenship, people should have health care. 

We are the only one in the industrialized world that does not. And 

I am hearing you say that you do not think that that should be the 

case. 

Let me ask you another question. We have heard a lot of discussion about Social Security. In my view, Medicare is a very serious 

problem. I do not think Social Security is. Right now Bill Gates and 

the wealthiest people in this country contribute into the Social Security system the same amount of money as somebody who makes 

$94,000 year, roughly speaking. 

My understanding is that if you simply lift the cap and you said 

to the wealthiest people in this country, people who by and large 

their income has soared in recent years, if you lift that cap as we 

have done with Medicare and ask them to contribute proportionally 

into the system, we would not have a Social Security problem. 

Now given the fact that the wealthiest people in this country 

have seen huge increases in their income in recent years, why 

should not they be asked to contribute more into the Social Security system so that we can solve that problem and make sure that 

Social Security is vibrant and strong for the next 75 years? 

Secretary PAULSON. Senator, you could also do that by taking a 

progressive approach to benefits. 

Senator SANDERS. Well, you could. 

Secretary PAULSON. Of course you could. 

Senator SANDERS. You could. But this, I think, would be the simpler way, if you want to keep Social Security as a universal system 

protecting all people. I frankly think that Bill Gates, not that he 

needs it, is entitled to Social Security, too. And once you start 

doing away with universality, you are going to eventually make it 

into a welfare program, which is not a good idea. 

Secretary PAULSON. I did not suggest doing away with universality. I suggested progressivity. 

285

Senator SANDERS. Should we ask, should we lift the cap and 

solve the Social Security problem by asking the wealthy to contribute more into the system? 

Secretary PAULSON. That would not be my suggestion. 

Senator SANDERS. Why? Don’t you think it is fair that at a time 

when the wealthiest people have never had it so good, and the gap 

between the rich and the poor is growing wider, that simply lifting 

that cap can solve the problem? 

Secretary PAULSON. I think you and I are not going to solve the 

situation right here at a public hearing. Maybe you will be one of 

those who comes to the table and that will be your idea. 

Senator SANDERS. Let may go back to an issue that I feel very 

strongly about, that as the middle class declines and as you see 

husbands and wives out working, we see in the budget that the 

President submitted a program which would reduce the number of 

children receiving child care assistance by 300,000 at the same 

time as the budget provides $739 billion in tax breaks to households with incomes exceeding $1 million. 

In addition, your budget asks veterans in this country to pay 

more for their health care. 

Can you explain to me the morality of cutting back on child care, 

asking veterans to pay more for their health care at the same time 

as we sustain huge tax breaks for billionaires? What is the morality of that? 

Secretary PAULSON. I see you have a point of view, and I would 

suggest that when Secretary Leavitt is here and is talking about 

the health care program, maybe he can go into the details of that 

with you. 

Senator SANDERS. Just let me conclude, Mr. Chairman, and 

thank you for the extra time, we are not just talking about economics. We are talking about a moral perspective. We hear a lot about 

moral values. Let me be very clear. You do not give tax breaks to 

billionaires, ask veterans to pay more for their health cut and drive 

them off of health care, cut back on child care, cut back on Head 

Start. 

To me those are not moral values. 

Thank you, Mr. Chairman. 

Secretary PAULSON. Can I just say one thing that I think you 

and I can agree on? When I said it is a marvelous economy, what 

I meant is this is an economy that makes it better for virtually everyone. Better than we would have if the economy, were a no 

growth or a slow growth economy. This is an economy that is a 

very strong economy in terms of jobs that are being created, inflation, et cetera. 

I did not mean to suggest that there are not some people in this 

economy that we would all like to see do better. And so I am very 

aware of what is going on with income distribution, and I am very 

focused on the average worker and people at the bottom. 

So I look forward to talking to you. 

Senator SANDERS. I hope that we can continue this discussion. 

Thank you very much. 

Chairman CONRAD. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. Thank you, Mr. 

Secretary, for your testimony. 

286

I have one overarching question and then some specific questions. I read your testimony. But I have a problem in believing that 

we can tell the American people that we can afford $1.7 trillion in 

permanent tax cuts that will continue to benefit a disproportionate 

number of higher wealthy taxpayers, continue to fund the war at 

more than $8 billion a month with no real end in sight, ignore the 

exploding costs of a middle-class tax crisis under the AMT that we 

will almost certainly have to finance. 

Looking at that and looking at continuing to deal with the AMT exemption every year, roughly $50 billion a year on average from 

now until 2012. 

How do you do all of that, not offset the tax cuts? How is that 

fiscally responsible? Would you have run your former company that 

way? You would have? Would you have run your former company 

that way? 

Secretary PAULSON. I would say that looking at a firm, there is 

an appropriate role for debt. And again, as I look at the fiscal situation—and you missed some of the discussion we had earlier, so I 

will repeat it—we have a situation today where our debt as a percent of GDP, is 1.8 percent. Looking over a period of time, that is 

within a range that I do not think would concern many—

Chairman CONRAD. Mr. Secretary, might I just stop you for a 

moment, because I think you just misspoke. You said our debt is 

1.8 percent. I think you meant to say our deficit. 

Secretary PAULSON. Deficit, absolutely. I am sorry. Thank you. 

And so I look at it from that perspective, I was at the House 

Budget Committee yesterday and Chairman Spratt looked at our 

budget and said, I do not believe you are going to balance it in 

2012. He said, I think that instead of having a surplus you are 

going to have a deficit, and it is going to be $145 billion with your 

policies. 

I said that I think we will achieve a surplus or balanced budget. 

But if he is right, the deficit would be 0.8 percent of GDP. 

The concern that all of us have, and the reason we have the fiscal concern, is because of what we see coming with the entitlement 

program. I think there was sort of a general agreement, before you 

had come in, that that is the issue. 

And so if I were running a company and I was looking—

Senator MENENDEZ. So the answer is yes? The answer is yes? Is 

that what you are telling me, this is how you would run your company? 

Secretary PAULSON. I would say it is not a simple yes or no. I 

would say that a deficit of this level right now would not concern 

me. But if I was looking at accrued liabilities staring me in the face 

a number of years down the road, I would be very concerned. And 

I would ask how do we deal with it. 

Senator MENENDEZ. Let me ask you about values because I think 

budgets are about values, both personally and nationally. 

How is it that we can explain a value that we have $1.7 trillion in tax cuts, including those that would provide $160,000 break to 

millionaires in 2012 and not have an extension of the college tuition deductibility when we are more globally competitive than ever 

before? 

Is that a value that make sense? 

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Secretary PAULSON. I would say that, as far as I know, the college tuition deduction is in the law now. 

We did not put in the budget a proposal to extend it, but it is 

there thorough 2007? 

Senator MENENDEZ. The deduction expires at the end of 2007. 

Secretary PAULSON. We did not include an extension. 

Senator MENENDEZ. You did not. So it is evidently not a value 

the Administration decides is a value. 

Secretary PAULSON. I would say education is an important value. 

Senator MENENDEZ. But not when we take away the single most 

significant way that average middle class and those struggling to 

get into the middle class have to help them fund their education. 

Yet, we have these tax cuts geared in such a way that clearly 

speak of a different set of values. 

Let me ask you this, speaking of values. The overwhelming part 

of the tax paying base of this country is the middle class. How is 

it possible that if we make the tax cuts permanent, what is the cost 

of the long-term AMT relief? It is a lot more, is it not? 

Secretary PAULSON. Yes. The long-term AMT relief is something 

that is very important to all of us. And it is a cruel and unintended 

tax. And we are very committed to coming up with a permanent 

solution there. 

Senator MENENDEZ. It seems to me, Mr. Chairman, and I see my 

time is up and I do not want to belabor it before my colleagues, 

that addressing the pretax cut AMT issue relief would be about 

$400 billion, compared to about $3 trillion of the cost of AMT relief 

with extending the tax cuts. 

So I just do not believe, I have been here 15 years—not in the 

Senate but in the Congress—and I just do not believe that everything I hear is that we can have it all. It is like having a kid in 

a candy store. We can have it all, do not have to pay for it, do not 

have to be worried about any consequences, not going to affect the 

domestic discretionary spending, not going to hurt programs that 

help people achieve the goals in their lives and fulfill the American 

dream. 

I am just bewildered by the Administration’s testimony that constantly leads down that road. 

Thank you, Mr. Chairman. 

Chairman CONRAD. Senator Cardin. 

Senator CARDIN. Thank you, Mr. Chairman. 

Mr. Secretary, it is a pleasure to have you before the committee. 

I think you are very much committed to trying to deal with the 

long-term budget problems that we have. Our chairman has held 

a series of hearings on the long-term challenges that we face, not 

just the 2008 budget. I look forward to working with you. 

But I just want to comment that there are several elements of 

this budget that make it more difficult for us to move in that direction. Senator Menendez mentioned the alternative minimum tax. 

We all agree we have to deal with it. Yet, the budget does not provide any relief beyond 2008. 

And I mention that specifically because, you have said that we 

will bring it into the budget debate at some point. But the budget 

does talk about Social Security. That is an area that you and I 

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have talked about, and I think it is important that we strengthen 

Social Security, and that we do this on a bipartisan basis. 

But the budget includes, in 2012, the privatization of Social Security and diversion of funds. I do not think that is very helpful 

in trying to get a commitment to deal with Social Security. 

I believe you strengthen Social Security by strengthening it. Adding additional burdens, such as privatization does in 2012, does not 

make it easier for us to deal with it. 

Secretary PAULSON. Would you like me to respond to that? 

Senator CARDIN. Absolutely. 

Secretary PAULSON. Absolutely. 

First of all, let me say I know how committed you are to retirement security. I have appreciated our conversations and I look forward to having more of them. I also know you are very knowledgeable in this area. 

With regard to the personal accounts, it should not surprise anyone that the President had a plan he put out. It was a plan, personal accounts were part of it. He thinks personal accounts are a 

good idea. So it should not surprise people that personal accounts 

are in the budget. 

I hope you did notice that they were put off a number of years. 

And I hope you see an important signal in that. 

But what the President has said, and what I have said, is we 

would really like people from both sides of the aisle to come together without any preconditions to talk about their ideas. 

So again, it should not surprise people that one of ideas that the 

President will have is personal accounts. That does not mean that 

you are going to like it, that other people are going to like it. But 

again, as I have talked with people individually about it, although 

there has been some push back publicly, most people have said how 

can you tell people to come to the table and tell them that you cannot talk about one idea or another. All ideas should be welcomed, 

and we will work through it. 

When you and I talked individually, I understand what you 

think about personal accounts. 

Senator CARDIN. And it has not changed. 

Let me assure you that I am interested in talking about supplemental accounts, and other ways that we can improve private savings and retirement, in addition to Social Security. I think that is 

important. I think we have a responsibility to strengthen Social Security, but we also have a responsibility to increase private savings 

and retirement in addition to Social Security. 

We have heard over and over again, during our hearings on longterm budget issues, that we must increase savings rates, deal with 

national savings, and correct the trade imbalance through increasing national savings. 

So when I have a chance to talk to the USTR about the trade 

imbalance, you are always mentioned. As the Secretary of Treasury, you have the responsibility for the currency issue with China. 

And China cannot justify its currency practice. I must tell you, 

we are running out of patience in the United States Senate on this 

issue. I expect you will see some activity that will take place. 

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It would be far better if we could negotiate an orderly process for 

China to allow its currency to reach its appropriate market rate, 

rather than tying it to the United States dollar. 

Secretary PAULSON. Senator, I have that message loud and clear. 

I testified before Senator Dodd’s committee on January 31st, and 

I will be very brief in just saying to you that we have a process 

in place. I do believe the strategic economic dialog lets us speak 

with one voice on a regular basis to the decisionmakers of China, 

and that we are pressing for much greater flexibility and movement in their currency in the short term. And they have been moving it, and they have been moving it more quickly, but it is not 

nearly quickly enough. 

But we are also working on some structural things they need to 

do to get to the point so we will not be having the debate about 

what is the appropriate level. They will have a market determined 

exchange rate. 

And then what is really underlying your question are the imbalances. When you look at the imbalance in order to get at that, as 

important as currency is—what really gets at the imbalance are 

structural changes. And so, when we are not saving, and I know 

you understand this very well, and when they are saving at 50 percent, and they have an economy that does not have domestic-led 

consumption, but is led by exports, and we are growing, we are 

going to have these imbalances. 

And so, again, we are working on some benchmarks and working 

toward progress on the kinds of intermediate-term and longer-term 

structural change they need to make to really open up their economy. 

And to the extent they open up for more competition for United 

States products, more competition in the services area, and get 

some structural changes, that will make a big difference. 

The one positive thing I mentioned before you came in, is that 

this year we reached the crossover point on exports. And every 

quarter for the last four quarters our exports have been growing 

faster than imports in this country. And this last year our exports 

to China grew 33 percent, our imports 19 percent. And because exports grew faster than imports for our country they added a percentage point to our GDP in the fourth quarter. 

So we are making progress. We have more to do. I have the message. You gave it to me when we talked to you personally. I have 

it here. I know what I need to do. We need to get some progress. 

Senator CARDIN. I would just point out the urgency of this matter. Each month there are more and more United States companies 

that cannot compete with a 40 percent discount given to Chinese 

products and more American jobs are being lost. It is truly urgent. 

Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you, Senator Cardin. 

If I can go back to the question of what is in this budget with 

respect to tax increases, you had earlier stated in your testimony, 

in response to a question from Senator Bunning, you would not recommend a tax increase. We talked about the alternative minimum 

tax and you defined a tax increase as one where you failed to extend expiring tax provisions, with respect to the 2001 and 2003 tax 

cuts. AMT, that expiring provision, because you only handle it for 

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1 year in your budget, is a $500 billion tax increase contained in 

your budget. 

I started looking at other tax provisions that you do not extend 

or extend for just a brief period of time: work opportunity and welfare to work credits, you only extend for 1 year in this budget. So 

you have 4 years of a tax increase there. 

State and local sales tax deduction in the budget presented by 

the President, not extended at all. Not even for 1 year. That is a 

whopper of a tax increase for people. 

Deduction for qualified college tuition, that is not extended at all. 

And under your definition that would be a tax increase. That is a 

big tax increase for people who have kids in college. 

Depreciation of leasehold improvements, something I have been 

very involved in, the Administration’s budget does not extend that 

at all. That would be a big tax increase for business. 

Indian employment tax credit is not extended at all. The renewable energy credit, the energy efficient building credit, the bio-diesel credit, the energy efficient home credit, the clean renewable energy bond, solar and fuel cell credits, none of them are extended 

in this budget. All of them, under your definition, are a tax increase. 

So this budget that the President sent up here, the more time 

I have to examine it, is filled with tax increases by your definition, 

is it not? 

Secretary PAULSON. Well no, I would not say that. Let me start 

with the big one and just say again, because Senator Cardin was 

not here when I said it before, what we did on AMT was put in 

an additional year of relief, the 1-year patch, which as you know 

has gone on for 6 years. We have said that this is a tax that is unintended and cannot go into effect without extending the patch. 

Chairman CONRAD. But you used the revenue to balance the 

budget, Mr. Secretary. 

Secretary PAULSON. We want to work on it together. 

Now with these others, I would not read anything into this. 

These expiration dates are set by Congress, they are not set by us. 

And we will have a chance—

Chairman CONRAD. But Mr. Secretary, let us be frank now. Do 

not hurt your credibility here. Do not hurt your credibility. 

You cannot, on the one hand, say if the 2001 and 2003 tax cuts 

that are going to sunset. And if we fail to do that you call it a tax 

increase. And then in all these other tax provisions that are set to 

sunset and you do not extend them in your budget, by simple definition, your definition, these are tax increases. 

And this budget, as I have a chance to examine it, you have hundreds of billions of dollars of tax increase. At least you are using 

the revenue to balance. 

Secretary PAULSON. I would say, Mr. Chairman, as I think about 

tax increases, there are a lot of fine points of the whole budget 

process that are rather Byzantine to me. But I would say to you, 

in terms of the taxes you are talking about, I have no doubt that 

if and when any of them expire and the tax goes up, the person 

that pays that tax will know it is a tax increase. 

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Chairman CONRAD. Well then, everyone of these, by your own 

definition, they have an awful lot of people who should be told the 

budget the President has sent up here is loaded with tax increases. 

Secretary PAULSON. They have not expired yet. 

Chairman CONRAD. You do not extend the state and local sales 

tax deduction for even a year. You do not extend the qualified college tuition for even a year, that deduction, or the renewable energy credit or all of the others I have listed. 

So I would just say to you, if we are going to be frank with each 

other, if not extending the 2001 and 2003 credits constitutes a tax 

increase, then all of these others constitute a tax increase because 

the budget the President sent up your does not extend them. 

Secretary PAULSON. I would say that they will be a tax increase 

when the taxes actually go up. 

Chairman CONRAD. But the budget guides policy around here. 

And in the President’s budget, he does not extend them. So the 

taxes are going to go up unless we take action. The President has 

used the revenue to balance his budget. 

Let me just indicate, there is a vote that has now started. 

Senator Whitehouse. 

Secretary PAULSON. Shucks. 

[Laughter.] 

Chairman CONRAD. Mr. Secretary, you are saved by the bell. 

Secretary PAULSON. You have ruined my morning. I wanted to go 

all the way to noon. 

Chairman CONRAD. All right we will, first of all, thank you again 

for your appearance here. Thank you for your service to the country. And we will close the hearing. I understand the Secretary is 

leaving for a trip, as well, and we wish you well. 

Secretary PAULSON. Thank you very much. 

[Whereupon, at 11:57 a.m., the Committee was adjourned.]

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THE PRESIDENT’S FISCAL YEAR 2008 BUDGETARY PROPOSALS FOR THE DEPARTMENT 

OF HEALTH AND HUMAN SERVICES 

TUESDAY, FEBRUARY 13, 2007

UNITED STATES SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to notice, at 10:07 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of the committee, presiding. 

Present: Senators Conrad, Feingold, Nelson, Menendez, Cardin, 

Whitehouse, Gregg, Allard, Bunning, Crapo, and Cornyn. 

Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 

Staff Director for the Minority. 

Chairman CONRAD.

OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

Chairman CONRAD. The hearing will come to order. 

We thank everybody. Senator Gregg is on his way. 

Secretary Leavitt and I have just had a chance to talk about 

some things that are important and some of those things we will 

talk about as the hearing progresses. 

We especially want to welcome Secretary Leavitt to the committee. We thank him for his service. We thank him for his excellent leadership. And we very much appreciated the opportunity to 

work with him and have enjoyed the relationship. 

This is an important hearing because our Nation’s physical 

health is directly linked to our fiscal health and the challenge of 

Medicare and Medicaid and the other health accounts is among the 

most daunting that we face. I personally believe it really is the 

greatest challenge. It is the 800-pound gorilla. And together we 

have to find ways to address it, and the sooner the better. 

We know that we face a demographic tsunami. We have this 

baby boom generation that is poised to retire. They are out there. 

This is no projection. They are alive. They are going to retire. They 

are going to be eligible for Social Security and Medicare. 

This is a chart that shows what happens. It is unlike anything 

we have ever seen before, which I think is one reason we find it 

difficult to cope with. It is just not something in our experience. 

We need to remember that Social Security is not the biggest 

budget challenge confronting us, although it is certainly part of the 

puzzle. But the biggest part, by far, is Medicare. We see the comVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00745 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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parison here. The 75-year shortfall in Medicare, over $32 trillion, 

seven times as much as the projected shortfall in Social Security.


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The growing cost of Medicare and Medicaid is simply staggering. 

By 2050, if nothing changes, more than 20 percent of our gross domestic product, 20 percent of our economy, will be spent on just 

these two programs. That is as much as now goes up for all of Government. So we are clearly on a course that is unsustainable if the 

current trend lines continue.


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This next chart from the Center on Budget and Policy Priorities 

shows that rising health care costs are by far the biggest factor 

driving Medicare cost growth. Demographic changes are a significant but secondary factor. So the biggest driver of all of this is rising health care costs. The demographics clearly play a role, an increasingly significant role. But the thing we have to remember is 

that it is underlying health care costs that are the biggest driver.


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The fact is that our health care system is not as efficient as we 

would like it to be. The United States is spending far more on 

health expenditures as a percentage of our gross domestic product 

as any other country in the developed world. Those are the leading 

economies in the world. For example, the United States, we are at 

15.2 percent of gross domestic product. Back in 2003, these are the 

last international numbers, we are making an international comparison here, we know that our spending now has reached 16 percent of gross domestic product.


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The next highest country when this was done was Switzerland 

at 11 percent of gross domestic product. That difference between 11 

percent and 16 percent of gross domestic product is $800 billion in 

a year, $800 billion in a year. That would completely take care of 

not only our on-budget deficit but our off-budget deficit, as well. 

Unfortunately, the budget before us does not deal with the underlying problem of the rapid growth in health care costs. Clearly, 

we are going to have to find savings in the entitlement accounts. 

The President’s Medicare and Medicaid cuts will save $280 billion 


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over the period 2008 to 2017. But those savings would be more 

than wiped out by the $2 trillion in tax cuts the President also proposes, tax cuts that are not paid for.

If all of the 2001 and 2003 tax cuts are made permanent, the cost 

will explode at the very time the cash surpluses in Social Security 

and Medicare become deficits. In other words, the tax cuts will dramatically worsen an already serious situation.


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I am talking now about tax cuts that are not paid for. I would 

be delighted to be able to continue all of the tax cuts. I have been 

a significant beneficiary of those tax cuts, and many of my constituents have. But we have a very serious problem making things add 

up here. 

I am not the only one who believes that changes to Medicare and 

Medicaid should be done in the context of overall health care reform. Here is what our new CBO Director told us in his recent testimony before the committee, and I quote, ‘‘I think it is a mistake 


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to look at containing costs just within the Federal programs themselves. The underlying driver of the cost growth—of the cost of 

those programs is the underlying rate of cost growth in the health 

sector as a whole. And tackling that problem is perhaps the fundamental fiscal challenge and important economic challenge facing 

the Nation.’’

Let me just say I believe that. I endorse that. I think that is precisely what we have to face up to. 


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And we are delighted, Secretary Leavitt, that you are here today 

to discuss these issues and others. 

Let me just conclude by going back to one of the things that I 

have returned to repeatedly, and my colleagues know it well, is this 

notion of those who are chronically ill. Because there 6 percent of 

the population, 6 percent of the beneficiaries are using half of the 

budget. When I went to business school they told us to focus on 

that, any time you find a statistic like that, where you have a small 

percentage of the population has a disproportionate share of the 

cost. That is really where we have to first focus our attention. We 

will have more chances to talk about what we might do in that 

area.

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Again, welcome, Mr. Secretary. And now I will turn to my colleague, Senator Gregg. 

OPENING STATEMENT OF SENATOR GREGG 

Senator GREGG. Thank you, Mr. Chairman. It is a pleasure to 

have the Secretary here to talk about the health care elements of 

the President’s budget. 

I obviously agree with the groundwork laid by the Chairman on 

the issue of the problem, which is the demographic shift in our popVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00755 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH

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ulation that we are going to have to support as a Nation and what 

the effect of that will be, and the fact that a large percentage of 

the issue is health care and how you deliver quality health care to 

80 million retirees versus 35 million retirees and do it in a way 

that does not bankrupt the younger generations who are paying for 

it. 

Where I think we depart ways, of course, is that I am willing to 

step forward, and I admire the Administration and respect the Administration for stepping forward with some specific proposals 

right now and not to play the verbal game of well, if we just did 

it on a global basis, if we just did this, if we just did that, we might 

be able to accomplish this or that. I think you have to have specific 

proposals. 

The proposal the Administration has put forward is a legitimate 

specific proposal which would reduce the long-term unfunded liability of Medicare by almost 25 percent. That liability is approximately $32 trillion. That is not a sustainable liability for us to pay 

for. 

What the Administration has suggested is major changes in 

Medicare which do not affect beneficiaries, certainly do not affect 

poor beneficiaries or moderate income beneficiaries, but rather give 

us a better accounting of the costs of health care and reimburse on 

that better accounting system, and also require high income people 

to pay a fair price for the benefits they get from the Government. 

Specifically, Bill Gates’s father should not have his Part B physician premium subsidized and he should not have his Part D drug 

premium subsidized at the rate that we subsidize it. 

These changes are very appropriate and they save significant 

dollars over the term and move us toward—closer in the direction 

of solvency, which is very appropriate. 

What has been the Democratic response so far? Well, I have 

heard, not the Chairman—in fact, I think the Chairman has been 

very responsible on this. But members on his side of the aisle who 

represent the ideology of the Democratic Party, or at least they assert that they do because they are running for president, saying 

that these Medicare proposals of the President’s are cuts, they are 

slashes to the system, they are a dramatic disassemblage of the 

system. And of course, they are not anything like that. 

They are very reasoned, very appropriate attempts to try to bring 

under control a system that is not going to be sustainable. What 

will be a slashing to the system is if we continue on the path that 

we are presently on, which will give our children a system they 

cannot afford and give the retired people a system that cannot be 

paid for. So starting now make sense. 

A second idea that has come forward from the other side of the 

aisle and has now passed the House and which I know the Secretary is very familiar with because it tells the Secretary, is to give 

the Secretary the authority to negotiate drug prices relative to the 

Part D premiums. What is the practical effect of that? Well, you 

cannot have that authority unless you also have a formulary, we 

all know that, which is a list of drugs that would be acceptable because that is where the club comes from. 

So what essentially it is is a rationing proposal. What the other 

side of the aisle is suggesting that our senior citizens should have 

309

their drugs rationed, and the decision on what they want and what 

they will not get will be decided by the Secretary of HHS, whoever 

that person may be. 

It is put forward in the motherhood language of negotiating drug 

costs but the practical effect would be that, like veterans, who only 

have the access to about 37 percent of the drugs that are on the 

market today, American citizens would no longer have access to all 

of the drugs that are out there, which would reduce their quality 

of life. And we have seen the marketplace has had a fairly significant impact on pricing of drugs relative to Part D, so much so that 

we have saved almost $100 billion off the baseline in that program 

as a result of the competition. 

So to go to a system of rationing seems to fly in the face of what 

is working, which is a market oriented system. But that is the proposal from the other side of the aisle. 

So I look forward to the Secretary’s outlining in further detail 

the Department’s position, both relative to Medicare and its proposal, and relative to the rationing proposal that the Democratic 

party has put forward as the essence of their health care plan. 

I also look forward to the Secretary giving us some thoughts on 

how we deal with Medicaid because states are being overwhelmed 

by the cost of Medicaid. We are not doing a very good job of managing Medicaid. And I would be interested in his thoughts relative 

to using the States as more aggressive incubators of ideas in the 

area of Medicaid. Having been a former Governor, I know he has 

been very aggressive in that issue. 

Thank you. 

Chairman CONRAD. Thank you. I would just say to my colleague, 

I do not know if he was able to see the press from over the weekend but on the question of income relating Medicare, I said this 

weekend I think that has to be done. 

Senator GREGG. I think I was very—I hope I gave you enough 

praise for your position, which is what I think is a correct position. 

And you have been a voice of reason on the issue. 

Chairman CONRAD. Let me just say, I do not, for the life of me, 

I cannot understand how it is progressive in any way to have very 

wealthy retirees being subsidized by working families. It makes no 

sense to me and we cannot continue that, of course, in my judgment. 

When I look at what is going to have to be done here, that is one 

thing that is going to have to be part of a solution. I think the Administration was constructive in putting it forward. 

There are other things the Administration has proposed, we will 

have a chance to get into momentarily, that I have a less favorable 

view of. But I thank my colleague for raising the issue. 

Thank you, Mr. Secretary, and please proceed with your testimony. 

STATEMENT OF HON. MIKE LEAVITT, SECRETARY, 

DEPARTMENT OF HEALTH AND HUMAN SERVICES 

Secretary LEAVITT. Thank you, Mr. Chairman, Senator Gregg, 

and members of the committee. 

Mr. Chairman, I have submitted a statement that I would like 

to have entered for the record. 

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Chairman CONRAD. Without objection. 

Secretary LEAVITT. Thank you. 

I would like to take a few moments and just give you a sense of 

overview of the way we went about creating this budget. As you 

know, a budget of this size takes hundreds of people and is worked 

on over the course of a year, and requires guidance from the Secretary as well as guidance from the President. The President very 

clearly wants this to be a deficit reduction budget. 

And so when we are dealing with deficit reduction, we are dealing with priority selections that we have all had to deal with. They 

are hard. I have made decisions that some of you will disagree 

with. I am here to basically give you a good sense of the rationale 

for that. But I would like to give you a sense of the guidance that 

I gave my colleagues as they went into the tens of thousands of individual decisions that made it. 

First, may I comment on the issues related to the entitlements. 

I am here as Secretary, but I also wear the mantle of a trustee of 

the Medicare Trust Fund. As we began work on this deficit reduction budget, it was clear to me that those things had to be dealt 

with as well. The proposals that I have made today, I am prepared 

to defend on each of the specific issues. When you roll them all up, 

they come up with a sum of money. But there is a whole series of 

individual decisions that have been made that I think bear scrutiny 

and I am prepared to defend them. 

I will say that as we started into it I told my colleagues, I want 

this to be about weight loss, not amputation. And each one of these 

reductions in the growth rate that we have made, that add up to 

a lot of money when they get out into the future, have been 

thought through in a way that I believe can be defended. 

If we put them all together on that graph that you created, they 

still only make the Trust Fund sustainable from 2018, it goes out 

to 2022. So there is a lot more work to be done but this is at least 

a start and the kinds of things that we are all going to collectively 

have to face. 

With respect to the discretionary budget, may I say that I gave 

my colleagues four basic priorities to follow if they were going to 

add anything to this budget. The first is I wanted to focus on high 

demand highly efficient programs, and you will see that we have 

protected some programs like the Indian Health Service and Head 

Start and the way we treat refugees and so forth. 

You will also see that there are some Presidential initiatives that 

I wanted to assure were completed. One of them is the community 

health centers. The President made a commitment for 1,200 of 

them. This budget completes that. The commitment we made to 

HIV/AIDS, this continues that. The commitment we have all made 

to fight pandemic, this continues that effort. 

It recognizes there are new pressing needs that have not been 

contemplated before, like the FDA and drug safety. You will find 

initiatives in that area. 

Then You will find a series of things that we have approached 

before that have not been funded to the degree that I believe they 

need to be. One is health IT. Right at the center of that cost problem is the need for electronically connected records. 

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Now turning to the savings side of this budget, I gave my colleagues a series of guidelines that I wanted them to follow. For example, you will see situations where we have not repeated one-time 

funds. There will be a lot in this group that are a fan, like I am, 

of CDC. We have undertaken a big building program there. You 

will see that CDC’s budget is not what it was last year because we 

did not repeat those one-time funds. 

You will see that I have given a bias to direct services, as opposed to just building infrastructure. I suspect we will talk about 

health professions. That budget has been reduced in favor of having more community health centers. That is an example of the 

tradeoff I am talking about. 

You will see that I have looked for grant programs, grant activities that may have reached the conclusion of their activity and I 

have not automatically proposed those be renewed. A good example 

of that is the National Cancer Institute, where we have more actually competitive grants that will go out but the actual budget itself 

is slightly smaller. 

I have also looked for under performing programs, I have looked 

for reductions. I have offered some reductions we have offered before, for example in Medicare again, the issues related to durable 

medical equipment. We had an opportunity to talk about that. I 

think there is a lot of fraud in that area and I think there are 

things we can do to reduce it. 

But that will give you an overview of the kind of guidelines. And 

as we talk about specifics, I will do my best to put the specifics into 

that framework. 

And I am eager now, Mr. Chairman, to entertain your questions. 

[The prepared statement of Secretary Leavitt follows:]

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Chairman CONRAD. Well, thanks again, Mr. Secretary. And we 

do very much thank you for your service. I have found you to be 

one of the most responsive people I have ever worked with in an 

administration, and we appreciate very much the way you have 

been open in your work with members of the committee. 

Let me talk about something in the budget that I am not a fan 

of, and that is the way you have treated the cuts to doctors. As you 

know, we have a scheduled cut to doctors in their reimbursement 

of 10 percent. This goes back to the last time there was reform of 


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the entitlement programs and a series of cuts to doctors were put 

in place that have been on a schedule. And every time one of these 

cuts comes up, Congress finds a way to put it off and to kick the 

can down the road. We have done that again and now the next 

scheduled cut is 10 percent. 

We all know that that is not going to happen. But in the Administration’s budget, you assume that it will, at a savings of $250 billion, as I understand it, over 10 years. 

You know that is not going to happen, we know it is not going 

to happen. Why does the President’s budget assume that we are 

going to cut doctors 10 percent? 

Secretary LEAVITT. I presume the reason that they have done it 

in the out-years is because that is what the statute would call for 

absent a statute change. 

Let me say I think this system has to be improved. There is no 

question about the fact that doctors have to have an economic 

model that will allow their practice to function. But I would suggest that one of the things that needs to change as we look for a 

better formula is that we have to begin to pay physicians not simply on the basis of how many procedures they perform, and begin 

at least in part to pay them on the basis of the quality of their 

work and also the value of what they provide. 

I would like to see the entire system begin to be a system of competition based on value, which requires that we begin to measure 

quality and have costs that can be compared. 

The new head of CBO called it a health sector. I think that is 

absolutely right. We do not have a health care system. What we 

have is a large sector, and we need a more systemic way of connecting all of it together and paying physicians properly as part of 

that. 

Chairman CONRAD. Let me just say that the statute, the existence of a statute, requires CBO to score a budget in the way you 

have described. It does not require the Administration to write a 

budget that way. The Administration has an assumption here that 

I think is just totally unrealistic, that they are going to save $250 

billion by cutting doctors 10 percent. 

So let me just say that when I look at this budget, I do not think 

it is realistic with respect to how it is going to treat physicians. 

And that savings, which is needed to make the President’s budget 

balance, is not real. 

Let me go to health IT if I can, just quickly. My time is rapidly 

fleeting. 

You have a number of major projects underway with respect to 

information technology. Can you give us a brief update on where 

we are with those major projects and when we might expect to see 

results in that area? 

Secretary LEAVITT. Mr. Chairman, the most important project, in 

my assessment, is the development of standards for health information technology systems. We have formed a national collaborative group called the American Health Information Community. 

We have laid out the most important standards that need to be established and created a means now of making progress in that 

area. 

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I can report to you that we are making very serious progress. We 

have also created a way of certifying systems so that we know they 

are on a pathway to interoperability. 

I met with a young physician who was just going into practice 

in Tennessee. He said, ‘‘I like health IT. I want to buy a system. 

I just have a question, which system should I buy? I can only afford 

to do this one time.’’

He was asking the question that doctors all over the country 

have been asking, ‘‘which system do I buy to know that I am able 

to achieve interoperability?’’ I now have an answer to that, and it 

is that you buy a system that is CCHIT, which is the Certification 

Commission on Health Information Technology. If it has been certified by the time, you are on a pathway to interoperability. 

I believe that we now have nearly 40 vendors who are receiving 

this CCHIT certification and more applying. The standards are becoming more robust. I think that we will begin to see interoperability pick up steam and we will also now begin to see more adoption of health IT systems. 

Chairman CONRAD. We will have a chance for further discussion 

on that. My time has expired. 

Senator GREGG. 

Senator GREGG. I am glad you brought that issue because I have 

something called the Medicare Quality Enhancement Act, which 

does exactly that, and which we had hoped to get through last year 

and we hope to get it through this year. I would just highlight it. 

Talk a little bit, if you will, about your proposal on Medicare. I 

have three issues. Let me write them down because by the time 

you finish you will have used up all my time. 

Tell us a little bit about the Medicare proposal and why it does 

not affect the low income and middle income beneficiary, but is directed at basically getting a fair reimbursement to providers and 

also high income individuals. 

Second, if you could talk a little bit about a proposal that has 

passed the House, which would authorize you to negotiate drug 

prices, which would require you, I believe, to have a formulary—

although it says you cannot have a formulary but you cannot really 

negotiate without a formulary—and what the effect of that would 

be on supply and options for seniors, the fact that seniors would 

have fewer options, in my humble opinion, if you are going to have 

that authority effectively. 

And third, I would like to get your thoughts on an idea that was 

put forward by another former secretary and Governor and now 

senator, Senator Alexander, who was Secretary of Education, of 

course, and Governor of Tennessee, and has suggested that we do 

a swap with the States where we take all of the Medicaid and they 

take all of the education, elementary and secondary school costs 

and we do a direct swap. The States are winners financially and 

we both specialize in an area where we can make sense. 

Secretary LEAVITT. First, on the Medicare proposal. May I say 

again that the guideline here is this is weight loss, not amputation. 

If we were to impose all of these reductions in the growth rate, we 

would see Medicare continue to grow. It would grow at roughly 5.6 

percent into the next 5 years, as it is slated now to be 6.5 percent. 

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So this is not a reduction. This is not a cut. It is a reduction in 

the growth rate. 

Now we frankly achieve that, in many cases, by looking at the 

projected growth rate in various services and trimming them back 

just a little. And if you trim them back just a little in the early 

years, by the time you are out 5 years or 10 years they are very 

large savings. I think that begins to make the point that you did 

earlier, the sooner we deal with this the better. 

There is a point in the life of every problem when it is big 

enough you can see it but small enough you can still do something 

about it. And while we may be moving beyond that point in Medicare, the sooner we act the better. 

You will see proposals similar to the one that we mentioned earlier, where we recognize that there are those who are receiving full 

subsidies for Medicare, both in the drug benefit and in Part B. It 

makes very little sense to me for a young family, 28 years old, who 

do not have health insurance, to be taxed in a way that contributes 

to their ability not to have it, so that they contribute to a person 

who is 70 years old, making $250,000 a year to have full coverage. 

That does not make sense. And this includes that kind of change. 

On the second question you asked with respect to Medicare Part 

D, it has been a resounding success. We have 90 percent of those 

who are eligible now receiving the benefit. Every independent survey I know says that between 75 percent and 80 percent of the 

beneficiaries are happy. The cost started out at $37 a month, it is 

now this year it will be $22. When you ask the actuaries why, they 

will tell you one word. It is competition. When you give the people 

the ability to choose and information about the cost and the quality, they will choose those which will drive quality up and costs 

down, and that is exactly what happened. 

There is only one way to negotiate drug prices and it is to negotiate the formulary. You say I am going to take your pill off my 

plan if you do not reduce the price. If we allow that to be a Government function, we will have fewer choices and less happiness with 

the plans. It will not do anything to reduce the cost. That is not 

my estimate. That is the CBO estimate. It is independent actuaries 

making the same point. 

With respect to the third question on the swap, there have been 

a number of discussions. One would be to have the States take welfare, or long-term care rather, and the States—or the Federal Government take long-term care. I would be open to any of that kind 

of thinking. We have to do something. Medicaid is not only eating 

away our economic capacity as a country, it is also starting education in the States. It is also starving many of the other aspects. 

At the root of it, however, is what the Chairman said, it is the 

high cost of health care. I would hope when I have more time that 

I could talk a little bit about some of the things that I believe need 

to be done to reduce the escalation of costs. 

Senator GREGG. Thank you. 

Chairman CONRAD. Senator Feingold. 

Senator FEINGOLD. Thanks very much, Chairman Conrad and 

Senator Gregg, for holding this hearing. Thank you, Secretary 

Leavitt, for being here. I am glad we are focusing on the Health 

and Human Services Budget. 

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But some of the cuts in the budget will directly affect my home 

State of Wisconsin. There are two health care programs, very important in my State, SeniorCare which is the prescription assistance program for Wisconsin seniors, and BadgerCare, which is Wisconsin’s Children’s Health Insurance Program. The President’s 

budget appears to cut this as well. 

I hope this is not the case. There are 108,000 Wisconsin seniors 

enrolled in SeniorCare and 64,000 Wisconsinites enrolled in 

BadgerCare. 

These programs, I can tell you because I go to every county every 

year and hold a town meeting, are effective, popular, and cheaper 

than private coverage and other alternatives. So I do not think it 

makes sense to pull support from these programs. 

To follow on that, as I mentioned, 108,000 seniors in Wisconsin 

are enrolled in the State’s prescription program known as 

SeniorCare. Governor Doyle of Wisconsin has a waiver application 

pending with HHS. Approval of this waiver would allow the program to continue, but the State still has not received a final answer and the current waiver is set to expire in less than 6 months. 

Mr. Secretary, are you familiar with Wisconsin’s SeniorCare program and this waiver? 

Secretary LEAVITT. Yes, I am, Senator. 

Senator FEINGOLD. Thank you. 

Your budget request appears to assume that the SeniorCare program, Wisconsin Pharmacy Plus demonstration, will lose its Federal funding after fiscal year 2007. Is this the case? And does that 

signal that HHS will be rejecting the waiver application? 

Secretary LEAVITT. That matter is still being deliberated on. I 

will tell you that I am very familiar with this. I have had many 

conversations, both in Wisconsin and with Governor Doyle. The 

SeniorCare waiver was approved at a time when there was no prescription drug benefit. And the issue before HHS will be a question 

of whether SeniorCare should be continued or not. It is whether or 

not Federal money will continue to support it. 

We supported it before because there was no prescription drug 

benefit. The issue that will be before us now is should we continue 

to support it, given the fact that there are several hundred thousand members of the Wisconsin public that are on Part D. 

Senator FEINGOLD. I want to check my facts but I believe one 

waiver was granted after the program was enacted, I believe that 

is the case. 

Secretary LEAVITT. I think we put a waiver into place to help coordinate the integration of Part D and SeniorCare, and we have 

been working very closely with Governor Doyle to make certain 

that the coordination was effective. 

The issue of whether or not the Federal Government continues 

to support both plans is a matter that is being deliberated on right 

now. But we have been very clear with Governor Doyle that we 

wanted to make Part D work, and he has been very cooperative to 

make certain that it did. 

Senator FEINGOLD. I appreciate the attention that is being paid 

to it. It is very important to our State. I take it from your briefings 

you are aware that SeniorCare costs the Federal Government $617 

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per participant, and the Federal Government spends $1,174 per 

participant on Medicare Part D. 

This program cost the taxpayers less money and I think it is 

more popular than Medicare Part D. I can tell you that from my 

knowledge of Wisconsin. It is what the State of Wisconsin wants. 

It is budget neutral due to savings generated in Medicaid, and is 

the primary source of prescription coverage for over 100,000 seniors 

in my State. 

I just want to make it clear that if this waiver extension is denied it will, in effect, cost the Federal Government more money 

while simultaneously dropping seniors from their preferred drug 

coverage. 

I think that is a lose-lose situation. To use your excellent phrase, 

more like an amputation than weight loss. I think it could be easily 

remedied if you approved this waiver. So I hope you will seriously 

consider that. 

The budget discourages coverage of childless adults under the 

State’s of Children Health Insurance Program, SCHIP. I am concerned that this will lead to a policy of not covering any adults 

with program funds. 

My State of Wisconsin covers parents of Medicaid and SCHIP 

children in addition to pregnant women. There is good evidence 

that family based coverage is better for children and families and 

there is no other affordable insurance for these adults. 

Does the President support States being able to cover these adult 

populations under SCHIP? And would the Administration support 

States like Wisconsin continuing coverage of adults with SCHIP 

funs? 

Secretary LEAVITT. We do support continuation of adults who are 

currently on the program. We will not be supportive of extending 

coverage to new adult populations. We believe that SCHIP should 

be focused on its original intent, which is to help lower income children and we are enthusiastic about its reauthorization. But we do 

have the feelings I have expressed. 

Senator FEINGOLD. Secretary, thank you for your testimony and 

for your attention to these matters. 

Chairman CONRAD. Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman, and welcome, Mr. 

Secretary. 

I want to followup a little bit on the physician reimbursement. 

If the Congress does not enact the changes to physician reimbursement that the President recommends, what is the plan? Do you 

have a plan in place to deal with that? 

Secretary LEAVITT. The reduction is a matter of statute and in 

order to cure the circumstance, it will require a change in the statute. We remain eager to work on that. If we end up with seeing 

a 10 percent reduction in Medicare, it is clear to me—or reimbursements, it is clear to me that there will be a certain number of physicians who that will affect. And that becomes a big problem for the 

Secretary of Health and Human Services, given that I have 43 million beneficiaries—including my parents—who depend on them. 

Senator ALLARD. Have you talked about getting that statute 

changed to Members of Congress? 

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Secretary LEAVITT. There is an ongoing discussion that we are a 

participant in. We have made clear that we believe that some part 

of the improvement or change in the formula needs to include payment to physicians and hospitals on the basis of performance or 

their adherence with good quality procedures. We think that is not 

only important from a cost standpoint but it will improve the quality, as well. 

Senator ALLARD. On the issue of reimbursement, some States 

seem to get better reimbursements—at least the physicians do not 

seem to complain as much as in other States. My State is one 

where physicians are complaining a lot that they are not getting 

adequate reimbursement. 

In fact, I heard from physician whose practice is solely Medicare. 

When I heard that I could not believe that he is still in business, 

frankly. 

I did go and visit his practice. It is a very austere practice. He 

does not have a lot of office furniture. He is not located in a high 

rent area. 

He is near the point where he just cannot sustain his practice. 

He is ready to go out of business. It looks to me like an efficiently 

run practice, although I do not know what the quality is like. I 

know that he has more patients than he apparently is able to handle. 

What do we do? In Colorado, our physicians are taking fewer 

Medicare patients. 

Now some of those, they can cost shift a little bit and probably 

do to some degree. But what do you do when somebody like that 

who strictly specializes in Medicare patients, becomes a primary 

care physician. Because that is his entire clientele, he is probably 

very much of an expert in that area. 

Secretary LEAVITT. We monitor this very closely for the reasons 

I just expressed. I will say that we have not yet seen a dramatic 

reduction in the number of physicians who are receiving Medicare 

patients. But it is a concern and it is a problem, in my judgment, 

we have to deal with on a long-term basis. 

We continue—

Senator ALLARD. But let me catch you there. The number of physicians that are accepting Medicare patients, what you ought to 

look at is the number of physicians that are taking on new Medicare patients. I think that would give you a more accurate reflection of what is going on. 

I want to move on. There is a Government Performance and Results Act. Are you familiar with that? It measures performance of 

various programs. 

Secretary LEAVITT. I know the function. I did not know it by that 

name. 

Senator ALLARD. The President’s program is called PART. There 

are some 32 programs in the Department of Health and Human 

Services that are considered non-performing. There are six of them 

that are characterized as ineffective. 

What do you do when you get these recommendations from the 

Office of Management and Budget? 

What do you do with these programs? Some of them, maybe one 

or two, it is kind of hard for me to tell, might have been some that 

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you talked about. Some of them are popular programs. There is the 

domestic HIV/AIDS prevention program that is classified as results 

not demonstrated. I think you mentioned something about doing 

more on AIDS. I even see that some of those programs that were 

brought up as perhaps non-performing, you might even still continue to promote. 

So my question is what are you doing with these programs? 

Secretary LEAVITT. I mentioned earlier in my remarks that one 

of the criteria I gave those who make the tens of thousands of judgments that go into this budget, that we should pay particular attention to ineffective, under performing programs. If they are not 

absolutely vital to our mission, then they are reduced in funding 

or eliminated. You will see that reflected in this budget. 

If they are a vital program that simply needs to be improved, 

then we have gone about the business of remediating them. 

Senator ALLARD. Are there any of them that are classified as ineffective that you did completely eliminate? 

Secretary LEAVITT. Yes, block grants under the—

Senator ALLARD. I saw that somewhere here. 

Secretary LEAVITT. That is one example. A big one. 

Senator ALLARD. Yes, it is a big one. 

I see my time has expired but when you testify in front of me, 

expect a question on the performance of the various programs that 

are under your jurisdiction. 

Thank you for your testimony. 

Chairman CONRAD. Senator Cardin. 

Senator CARDIN. Thank you, Mr. Chairman. 

Mr. Secretary, I think the Chairman pointed out in the beginning 

the need to focus on our health care budget. The amount of money 

we spend as a Nation and our health care performances have us 

all reason to pause. We are spending a lot of money and we are 

not getting the results we should. 

So I want to talk about one of the cost centers that jumps out 

at me, and that is prescription drug costs. For medicines that are 

manufactured at the same location, American consumers pay a lot 

more than consumers in Mexico and Canada. Why? What is the 

reason for it? 

Why do we pay so much more for drugs than other countries? 

Secretary LEAVITT. Senator, I think at the root of that is a trade 

problem. We need to deal with it as a trade problem. 

Our effort at HHS is to assure that the drugs we do have are 

safe and effective, and we do that through the FDA. The manufacturers of the drugs oftentimes will go to another country, they will 

be subject to trade negotiations that provide for them to sell it 

cheaper, I suppose. I do not know the full answer to that. 

Senator CARDIN. I took economics in college and learned that 

market share is an important issue in negotiating price. All of 

these other countries, including Mexico and Canada, basically negotiate with the strength of a larger market share than we do in the 

United States because the payers have relatively a small market 

share of the full cost. 

So all the other countries seem to want to organize their market 

in a more efficient way to negotiate a fairer price. You seem to resist that as a way to deal with the reducing costs in America. 

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Secretary LEAVITT. No, actually negotiation is a very important 

part of what we do. Almost all of the prescription drug benefit 

would be negotiated through PBMs and they negotiate with—people think the United States Government is the largest purchaser 

or the payer of prescription drugs. That is not true. The PBMs are, 

in many cases, three of them are substantially larger and they are 

the ones doing the negotiating. 

Senator CARDIN. There is no reason why we could not have the 

PBMs have a larger share, if we could figure out a way to negotiate 

on a larger basis. 

I heard Senator Gregg and you talk about restricting drugs to 

our seniors. And yet nearly all of our consumers other than seniors 

who are buying medicines are doing so through third-party payers 

that use some form of negotiated formularies. And I do not get a 

lot of complaints in my office about being denied access to drugs. 

In fact, when a doctor believes it is essential to use a specific drug, 

normally the plans provide a process for that. 

So trying to scare seniors that organizing the market more efficiently would lead to the rationing of drugs is not helpful to this 

debate. It is wrong for consumers in America to pay the prices they 

are paying for drugs. And our health care system cannot afford to 

continue to make those payments. 

We have to figure out a way to get a fair price for medicines. I 

appreciate your support for us having tougher trade negotiations. 

I agree with you on that. And I do think we need to talk about the 

trade policies of America. 

But you are the Secretary of Health and I think we should have 

answers as to how we can bring drug costs down for consumers in 

this country, including Medicare beneficiaries. 

I want to mention one other point before my time expires because I mentioned it last year when you were before the Ways and 

Means Committee. And that is racial and ethnic disparities in 

America. I was disappointed last year that it was not a part of your 

testimony. I am disappointed again this year that you have not 

specifically mentioned dealing with the disparities in this country. 

According to the National Center for Health Statistics, infant 

mortality rates for African-Americans are double that for whites. If 

you are an African-American male, you have a one-third higher 

chance for heart disease than a white man. American Indian 

women are three times more likely than white women to receive 

late or no prenatal care. Diabetes is much higher among MexicanAmericans. 

And your budget nearly zeroes out health professional training 

activities, which is a vital program for training minority health 

care providers. 

I just want to focus for a moment on trying to use our budget 

to reduce these disparities. I would hope that this is a priority of 

the Administration, and I would hope that it would be included as 

one of the pillars of programs that we should be considering to reduce disparities among Americans. 

Secretary LEAVITT. Senator, just two comments. One, with respect to the negotiation of prescription drugs, I believe that the 

reason you do not get too many complaints about people not being 

able to get the drug they want is because they have a choice of 

330

plans. And because they have a choice of plans, they can find a formulary that fits their needs and they can do it at the lowest possible price. I think that is why we have had 90 percent or 80 percent of them are happy. 

With respect to the—

Senator CARDIN. But they have formularies. All these plans have 

formularies. 

Secretary LEAVITT. They do, and they can choose one that has a 

formulary that fits their needs. if we had one play, they would not 

have that capacity. 

Senator CARDIN. No one is suggesting one plan. What is being 

suggested is to negotiate on a larger market share the pricing with 

the pharmaceutical manufacturers. 

Secretary LEAVITT. But that does not work in the construct of our 

economy. We have a free market economy where people—we do not 

have the drug stores owned by the Government and being able to 

act as dispensaries. 

Senator CARDIN. I understand that and that is the same way 

that the private market negotiates prices. If you have a larger 

share you are going to get a lower price. It is economics 101. 

Secretary LEAVITT. I took economics 101 and I agree that that is 

the way that it works. I believe we are currently seeing the benefits of robust negotiations that are taking place when consumers 

make those decisions as opposed to the Government, but—

Senator CARDIN. My time has expired. 

Secretary LEAVITT. May I just say, Mr. Chairman, on this, we 

have robust programs on obesity, HIV/AIDS, and prenatal care. 

And they need to be because inequities exist. The fact that I did 

not mention it in my opening statement does not mean it does not 

loom large in my heart. 

Chairman CONRAD. Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. 

I took economics 101 also, but I did not take it where they had 

a controlled economy. I took it in a free economy. And the Federal 

Government did not set prices like they do in Canada. They also 

had a chance to control the quality of the drugs. And the development is being paid for by the American consumer for almost every 

other economy in the world, because we are the only ones developing new drugs. 

So there is an explanation for difference in Canada, Mexico and 

the United States. 

Discretionary spending at HHS makes up only about 10 percent 

of your budget, 84 percent of the budget goes to two programs: 

Medicare and Medicaid. Long-term what does this mean for your 

agency? How critical is it that we get a handle on the entitlement 

spending? 

Secretary LEAVITT. It is critical not just for my Department. It 

is critical for the country. We are now measuring Medicare as a 

percentage of the gross domestic product. It is 3.2 percent of the 

gross domestic product. By the time my grandson becomes an adult 

it will be 8 percent of the gross domestic product. By the time he 

becomes my age, it will be 14 percent of the gross domestic product. 

None of us believe that will happen because we will have either 

been eliminated from the economic competition in this world, or we 

331

will have changed the direction of it. The sooner we change the direction of it, the better off we will be. 

Senator BUNNING. I will followup on that in just a minute, but 

one of the things that really hit me between the eyes is a 17 percent reduction in Low Income Home Energy Assistance Program 

that is in the President’s budget. Mr. Secretary, you know and I 

know that that is not going to happen. 

Last year, in the 206th Congress, we put in $1 billion more in 

emergency spending into that program. My home state of Kentucky 

received over $45 million in LIHEAP in 2006. 

Under your budget, Kentucky would receive only $21 million. 

Now costs for heat and low income people have not diminished in 

Kentucky. So what you are proposing is a direct confrontation with 

me and everybody sitting up here on LIHEAP. 

Now you ought to know better. You ought to know better because 

you know we are not going to allow that to happen. Even though 

it is one of the programs that consumers, particularly low income 

consumers, use this program need desperately. 

Now we have had a fairly light winter but we are going to have, 

as we are getting right now, a heavier winter, maybe later, maybe 

not as big as last year, maybe as good as last year. But that is not 

a reasonable assumption on the budget of the President of the 

United States, to make a 17 percent reduction in LIHEAP. 

Secretary LEAVITT. I can, at least, offer some explanation. The $1 

billion that we added last year was actually by agreement, $1 billion we accelerated from the 2008 budget. 

Senator BUNNING. Yes, because we did it in an emergency supplemental program. 

Secretary LEAVITT. Everyone at this table or in this room knows 

that members of the public who do not have heat need to have it 

and that we are going to meet that obligation. That was done because it was in the 2008 budget—

Senator BUNNING. Do you think somebody is cheating LIHEAP? 

Secretary LEAVITT. No. 

Senator BUNNING. Do you think consumers are cheating? 

Secretary LEAVITT. No, no, no. I did not say that. 

Senator BUNNING. The fact of the matter is that there is a huge 

need out there. 

I want to get back, I am almost out of time, concerned about entitlement growth, particularly in Medicaid and Medicare. The 

budget slows the rate of growth, as you said in your opening statement, from 6.5 to 5.6 over 5 years. In Medicaid the growth rate 

from 7.3 to 7.1. 

Our-year, 75 years out, it saves $8 trillion, $8 trillion. That is not 

going to be enough to save the program but we better make the 

start. And we have to have a reasonableness about these two programs or we are not going to have any programs, as the chairman 

has said, in 2045 or 2050, depending on who is doing the addition 

and subtraction. 

So please stick to your guns on this, because we have to have 

this if we are going to have a program for my 35 grandkids and 

my four great grandkids. They are not going to have a program. 

Secretary LEAVITT. It is our budget and we are sticking with it. 

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Senator BUNNING. It is going to take some negotiations to stick 

with it, but I hope you do. 

Chairman CONRAD. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. Mr. Secretary, 

welcome. 

Mr. Secretary, can you tell me, do you believe the SCHIP program has proven to be effective in covering children and families? 

Secretary LEAVITT. It has. 

Senator MENENDEZ. I am glad to hear that. In New Jersey we 

are successfully covering over half a million children under SCHIP. 

But I am concerned that the President’s budget request undermines the future of that ability to do so. 

So I have heard you say in other hearings that you do not believe 

that children will be dropped from the program under the President’s budget proposal. Is that still your belief? 

Secretary LEAVITT. That is our belief. 

Senator MENENDEZ. Are you going to be guaranteeing the States 

will be reimbursed for children’s coverage at their current rate? 

Secretary LEAVITT. It is our position that children who are currently covered need, under the construct of reauthorization, to continue as well as adults. We do, however, believe that in the future 

we should focus SCHIP on the core mission which is children. And 

we do not support the addition of additional adults. And we believe 

that children who are in excess of 200 percent of the poverty line 

should be matched at the normal Medicaid match rate, as opposed 

to the enhanced match rate. 

Senator MENENDEZ. So as I hear your answer, because I am concerned that instead of weight loss we have a gastric bypass here, 

that, in fact, all of those who are presently covered, children and 

adults, it would be the Administration’s position that the rate of reimbursement would be the same as that which they presently are 

enjoying. Is that what I understand you to say? 

Secretary LEAVITT. I want to confer with my colleague. 

Senator as I have expressed, our position is on anything in excess of 200 percent of the Federal poverty line we would support 

continuation of coverage, but only at the normal match rate, not 

the enhanced match rate. 

Senator MENENDEZ. So that means, in fact, if a State—for argument’s sake—had 225 percent of coverage and you are presently 

covering them at the enhanced rate, then you would drop back 

down by, in that example, 25 percent. 

Secretary LEAVITT. We would continue to support it at the normal rate but not at the enhanced match rate. 

Now, I would add that we feel strongly that our objective ought 

to be to have a basic affordable plan available to every American 

and that SCHIP is a very important part of that and that we 

should be working with States to integrate what they are doing 

with SCHIP into their other efforts. 

We do not see SCHIP as the vehicle to cover all Americans, but 

we do think it is important component of—

Senator MENENDEZ. I appreciate that. But the bottom line is that 

you cannot quite make the statement then that those children and 

adults presently covered under State programs, like New Jersey’s 

program, will continue to receive the current rate of assistance 

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from the Federal Government because if that rate is beyond the 

200 percent then you will not fund it beyond that. 

That means that, in fact, States would either have to make a decision to cover it themselves out of their own resources or drop 

those individuals who do not qualify above 200 percent. 

Secretary LEAVITT. They would remain eligible for the program 

but we would standardize our reimbursement in the way that you 

have acknowledged. That does not mean they would be dropped 

from coverage. It does mean that in our partnership with the State 

they would be required, on those efforts that are above 200 percent, 

to offer more support or to find a different way to cover them. 

And we think there are many. I have been working with Governor Corzine to look at ways that we could offer a basic affordable 

policy to every citizen of New Jersey. 

Senator MENENDEZ. Well, I appreciate that. But the bottom line 

is that, in essence, to me, this means that there are States who are 

clearly going to receive cuts. We can dance around how we describe 

it. But the bottom line is if there is a present rate of reimbursement and that is no longer to be held, that means the States will 

receive a cut and they will have to make choices as to whether or 

not they can cover someone and how they do so. 

And that is different than when I see the President get up at the 

State of the Union and talk about enhanced coverage. I just do not 

see enhanced coverage in this process. I see a diminution of coverage to some of the individuals who are among the most neediest 

in our society and the most vulnerable in our society. 

So I appreciate the President’s suggestion of a program of a tax 

deduction. The only problem with that is, first of all, that flexibility 

has already existed by waiver. And second, it is only good if you 

have the money in the first place to dish out to buy health insurance. 

In a high cost State like New Jersey, in the family incomes that 

I am talking about, which exceed 200 percent but certainly not put 

them anywhere near the ability to do that, it is meaningless. 

Secretary LEAVITT. Well, the President has made clear that we 

should be willing to contribute Federal resources to assure everyone has a basic affordable plan. We do not view SCHIP as the logical vehicle to extend that coverage to every resident of the State 

of New Jersey or any other State. We think it ought to focus on 

its core mission, which is children. 

Senator MENENDEZ. I have no doubt that—I am not suggesting 

that this is a vehicle to create universal coverage. What I am suggesting is that the Federal Government should at least keep its obligation to that which has—to those which are presently enjoying 

the benefit of the coverage and for which the Federal Government 

made a determination to be supportive of the enhanced rate. Absence of that means a cut and a cut ultimately means decisions as 

to whether you keep children and certain parents on or whether 

you release them. 

Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you, Senator. 

Senator CORNYN. 

Senator CORNYN. Thank you, Mr. Chairman. 

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Mr. Secretary, thank you for your service and for being here 

today. 

Last year 19 senators, including eight on this committee, sent 

you a letter urging you to make diabetes screening in the Medicare 

population a priority in the budget. As you know, more than 61 

percent of the Medicare population has either diabetes or 

prediabetes, and most of those with prediabetes are undiagnosed, 

almost 14 million people. 

When you combine this number with the fact that NIH’s diabetes 

prevention project proved that people age 60 and older could reduce 

their rate of diabetes and its complications by a staggering 71 percent, it is clear that we could save money and lives by identifying 

those seniors and helping avoid diabetes and its devastating complications, including blindness, amputation, and kidney failure. 

Could you tell me whether your new budget responds to the concerns that were raised in this letter last year about diabetes 

screening? 

Secretary LEAVITT. It does in several ways, Senator. One that I 

point to that I believe is perhaps the most important is the effort 

to assure that we are beginning to measure quality in practice. One 

of the most important quality measures, for example, in a practice 

would be the testing of hemoglobin A1c among those who have diabetes and testing for diabetes generally among the larger population. 

We are proposing, in our efforts, that as physicians are able to 

meet those quality measures that the costs will be improved and 

lives will be saved. Rather than just spending more money to test, 

we want to hold the testing as a standard of practice so that we 

discover it early and save the money and the lives that are accomplished by that. 

Senator CORNYN. When I went out to the NIH last and talked 

about the challenges they face and the opportunities that they see, 

they mentioned to me that—and I believe this was confirmed also 

by the American Diabetes Association—that about $134 billion in 

avoidable costs could be saved if we did a better job of preventing 

diabetes which, as you know, is largely preventable in its most 

common form by improved diet and exercise. 

What can we do to provide the financial incentives to the health 

care community to focus on prevention and obviously save a lot of 

money and avoid a lot of human misery? 

Secretary LEAVITT. I mentioned earlier in our conversation today 

here in the committee that health care costs are primarily a function not just of efficiency in the system but also prevention. We 

make prevention, if we pursue it as tenaciously as treatment after 

we are sick, we will start to see reductions in dollars. But we will 

also see a lot of lives saved. 

I will tell you that we are currently spending about $600-plus 

million a year on the subject of obesity, how can we begin to 

change the patterns of Americans that are producing the tens of 

millions of people who suffer from diabetes? It will be obesity and 

the inherent diseases that result have to be considered among our 

most significant health threats in this country. 

Senator CORNYN. Is there something we can do in terms of 

health care provider payments, to provide them the financial incenVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00782 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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tive to do the early intervention and prevention? I appreciate your 

comment earlier about calling it the health care sector rather than 

a health care system, because we do not really have a functional 

system. And some have observed we actually have a sick care system, not a health care system. 

So are there financial incentives that we can create to give providers the incentive to actually act to intervene before people become ill? 

Secretary LEAVITT. I look forward to the day when we have electronic health records that will allow us to measure how many patients have proper preventative measures taken by physicians and 

by health care providers at various stages that will result in fewer 

cases of diabetes. And we can reward physicians for having done 

that. 

Now physicians do not control everything their patients do but 

they can control what they do when they come in and whether they 

talk with them and counsel them and whether they are doing the 

kinds of things that could begin to drive those down. 

Senator CORNYN. Thank you, Mr. Secretary. 

Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you, Senator Cornyn. 

Senator WHITEHOUSE. Senator WHITEHOUSE. Thank you, Mr. Chairman. 

Welcome, Secretary Leavitt. 

Secretary LEAVITT. Thank you, Senator. 

Senator WHITEHOUSE. I would even go so far as to say we do not 

just have health care system, we do not even have a health care 

sector. We have a health care mess and we really need to straighten it out. It is very, very urgent. 

In the context of that, I just want to react to some things you 

said. We had testimony in this room not long ago that the cost of 

the Part D program to American taxers looking forward was $8 

trillion. We have seen reports just out recently that the difference 

between the cost that the drug companies get through Part D 

versus what they get through the United States Government Veterans program is as much as 58 percent. If you take the 100 percent cost and add the 58 percent, it is about one-third extra. 

If the $8 trillion is right, that is $2 trillion over the life of this 

program. By any standard that is big money. And the idea that we 

are not going to pursue that just astounds me. 

It is not a formulary. I just want to make it clear to anybody who 

is watching what the expectation would be here. It would be that 

you would be the power to negotiate, the one that your predecessor, 

Governor Thompson said was the biggest thing that he missed in 

that position. And that with that power to negotiate, you could 

bring together the different providers so that through their existing 

formularies the same drugs that there are in, you could negotiate 

collectively to bring the price down. 

And ideally, I would like to see you have a competing program 

of your own which would add to the choice of seniors. So when people come in here and say well, it is a formulary or it takes away 

choice, that is just nonsense. That is just not true, not I think if 

you try to understand where people who are pushing for this are 

coming from. 

336

I think you can be effective if you picked the top 10 or the top 

20 drugs and get the providers together and negotiate with the 

pharmaceutical industry to the prices that they are already paying 

the VA. I do not know what the exact number is but it is a big, 

big number. And it is extraordinarily frustrating to have us be 

stonewalled when we are having these discussions about how much 

money we need to save and we are talking about cutting things like 

SCHIP, to have the Administration unwilling to pursue what 

seems to me to be obvious. 

I would love to work with you more on that but I really think 

that you are just talking past me when you say these things and 

you are not even talking realistically from where I am coming from. 

So maybe off-line we should have a further conversation, if you are 

interested. But I just do not get it. 

The other place where I just do not get it is with health information technology. You said it was the most important thing that we 

are working on, that you have a very serious program. The RAND 

Corporation says that we could save either $81 billion a year with 

adequate investment in health information technology, that is their 

lowball bid or estimate, $162 billion a year was the mid-line number. By comparison to other industries, they said it could be $345 

billion a year. If you take the lowest number, the $81 billion a year, I calculate 

that—maybe my math is no good. I did not take economics 101. 

But my arithmetic is that that is $221 million a day in savings 

from adequate health information technology in our health care 

system. Your entire on-CHIP budget is $118 million, less than 1 day’s 

savings. Mr. Braylor is gone for months. There is no replacement. 

I appreciate the energy of your words on this subject but I would 

like to see appointments and budget money that gets behind the 

need that we have. Because I agree with you. I think that health 

information infrastructure is the key to colossal savings in the system. 

And we in this room are going to have a tragic choice coming up 

between cutting benefits or raising taxes if we do not get under 

why this health care mess is broken. And we need that information 

technology to make it happen. 

And I urge you to consider real investment in this, and really 

getting behind it, not the kind of investment where you could get 

it back in 1 day of the projected savings. 

Secretary LEAVITT. Senator, there are hundreds of millions, billions of dollars being invested right now in health information technology throughout our economy. The proper function of the Federal 

Government is to assure that they are operating on standards that 

will allow them to interconnect. We are making dramatic and rapid 

progress toward that. 

Senator WHITEHOUSE. In Rhode Island, the leading edge of 

health information technology is a group of private physicians—

Secretary LEAVITT. My point exactly. 

Senator WHITEHOUSE [continuing]. Who got so frustrated with 

this that they are trying to develop an electronic health record on 

their own. 

Secretary LEAVITT. Senator, they joined—

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Senator WHITEHOUSE. I have to tell you—

Secretary LEAVITT. They join 200 other vendors who are offering 

health information technology. And if they do not connect, they 

have value in their practice but they do not create a system of 

health information technology. 

With respect to the matter of the drug benefit, may I just say our 

time is up but I completely disagree with your characterization. Do 

not take my word for it. Take the word of CBO or for independent 

actuaries who make very clear that there would be zero savings if 

the Government were negotiating. And what you would have are 

a lot of unhappy beneficiaries because they would not be able to get 

the medications that they seek. 

They are currently able to do it because they can choose a plan 

with a formulary. We are saving money, a lot of it, and people are 

happy. 

And by the way, former Secretary, former Governor Thompson, 

indicated that he sees the program working and sees no reason to 

change it. 

Senator WHITEHOUSE. I am out of time, Mr. Chairman. 

Chairman CONRAD. We will have another round. 

Senator NELSON. Senator NELSON. Good morning, Mr. Secretary. 

Secretary LEAVITT. Good morning, Senator. 

Senator NELSON. Mr. Secretary you have covered a lot of different questions here. I want to get on one that you have not covered and it is a particular matter that we have a lot of unfortunate 

experience in my State of Florida, in the confiscation of senior citizens’ prescription drugs when they order them from Canada. 

We have been through this for several years and naturally your 

Department has an interest in seeing that the drugs are safe. And 

the Acting Administrator before you became Secretary, the Acting 

Administrator of the Food and Drug Administration, assured me 

that what the FDA was looking at was trying to get at the people 

who are gaming the system with counterfeit drugs and so forth, 

that the individual citizen that is ordering by mail or by the Internet or by telephone for a limited supply for personal use—and that 

FDA Administrator defined a limited time a 90-day or less supply—that it was the position of FDA that they were not going to 

try to confiscate those drugs. 

So we rocked along and we have had an up-and-down on this. 

But finally last October, Customs Department threw up its hands 

and said we are not going to confiscate these drugs anymore. 

I thought that was the end of it. But what has happened just in 

the last month is that at least just in my State, just in South Florida, 37 packages of medicine shipped to South Florida for senior 

citizens was confiscated. 

Now Senator Vitter and I thought that we had taken care of this 

problem on one of the appropriations bills last year by putting an 

amendment on that said that if the drugs were from Canada and 

it was for limited supply and it was for personal use that that was 

going to be legal. But you know the trouble that we got into with 

11 of the 13 appropriations bills. When they went to conference 

they never passed it and that is what we are dealing with where 

I have just come from the floor right now with an emergency conVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00785 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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tinuing resolution to keep funding the Government in those 11 departments that were not funded. 

So that amendment that we put on is not the law, and yet customs said it was not going to confiscate, but here we go again. Now 

confiscations are occurring. 

So I need some direction from you. 

Secretary LEAVITT. Senator, I am not able to respond with respect to the Customs. Our role at FDA is typically to test and to 

determine the efficacy and legitimacy of drugs that are presented 

to us by the Customs, Immigration and Customs. The specifics of 

the 37, I am not able to respond to. I can tell you there has been 

no change in policy during that period. And so perhaps we ought 

to pursue the specifics of those proposals off-line. 

Senator NELSON. OK. Let me just give to you the commentary for 

additional elucidation. On a Friday in early February, a Food and 

Drug Administration spokeswoman said that the Canadian pharmacy shipments were detained at the Miami International Airport 

for routine reasons. 

And so we have—what I am afraid is we have one hand that 

does not know what the other hand is doing. And I would appreciate it if you would get in. Now, of course, you and I know that 

this does not solve the problem. What solves the problem is a lot 

of these other issues that have been discussed here today with regard to the cost of medicine. 

But it is, for some of our seniors who are having difficulty in 

making financial ends meet, it is a lifeline to help them be able to 

afford their drugs and also to afford groceries to eat. Because in 

most of these cases they are getting these drugs from Canada at 

half the price that they would pay in a pharmacy in the United 

States. 

So if you would like to do this off-line, I would appreciate it if 

you would then respond in writing so that we can get to the bottom 

of this and solve a problem that otherwise should not be a problem. 

Secretary LEAVITT. Can you supply me with the specifics of this 

situation? Because I do not know them and I would be happy to 

respond to that specific. 

I know that the time is up, this has been an ongoing problem 

and one we are all trying to solve. It does not eliminate, however, 

the potential for unsafe drugs under the banner of the Canadian 

flag coming into this country in a way that is hurtful, harmful, and 

dangerous to people. Counterfeit drug making is a big industry and 

it is a worry to me. 

Senator NELSON. Well, I understand that. And of course, that is 

the reason that Customs and FDA have given in the past. But you 

all have to worry about people really taking advantage of the system and getting in big quantities of these things where they can 

then be resold and who knows what is in them because they are 

counterfeit and so forth. 

But the likelihood of that occurring from a Canadian pharmacy 

for an individual prescription prescribed by an individual doctor for 

an individual person for a supply of 3 months or less, that likelihood is de minimis compared to what you are looking at. 

And when you balance that against the financial need of the seniors until we can get the overall cost of these drugs down, it is—

339

you have to make choices. And this is the choice. And the Senate 

has made this choice, and so has the House. But for the appropriations bill not passing we would have this etched into law. 

And I thought we had solved our problem but we have not, now 

that we are seeing these additional confiscations, Mr. Chairman. 

Mr. Chairman, I know you want to close. I will just say this, that 

really what we ought to do is go on and passed the bill that you 

filed and I have cosponsored, which will etch this thing in law. And 

then I will not have to go around and try to amend it on appropriations bills. 

Chairman CONRAD. I thank the Senator. 

Secretary Leavitt, I have a couple more questions and I think 

Senator Whitehouse would like another round as well. 

On your means testing proposal, I want to understand this better 

if I can. First of all, I have stated publicly and I have said here 

today, I support a means testing or income relating, whatever one 

wants to call it these days. I think it is going to be essential to 

dealing with the long-term imbalances that we confront. We are 

going to have to make tough choices. I am thoroughly prepared to 

make that as one. 

But when I look at your proposal, the proposal that is in this 

budget, it is not indexed. And so the question comes to mind what 

happens over time as you have a means testing not indexed? 

It seems to me unavoidable that you would have more and more 

people who would be forced out of Medicare or choose not to participate, especially as this goes on for an extended period of time. 

Have you done any analysis of the 10-year effect, the 15-year effect 

and beyond? How many people would choose not to participate or 

be forced out of Medicare because your plan is not indexed? 

Secretary LEAVITT. Analysis has been made, only a small percentage of all eligible Part D beneficiaries would be paying higher 

premiums, 2.7 percent in 2008, and just 4.7 percent would be paying in 2017. 

We do not believe that it would ultimately force people out of 

Medicare. For the most part, people find Medicare a very helpful 

service because—

Chairman CONRAD. But I am talking now further out. If you 

have a limit here, an income test, and again I support the basic notion. But when you do not indexed it over an extended period of 

time it starts small. But they are talking here about $8 trillion of 

savings from your various proposals—and this is one of the biggest 

ones. I assume substantial part of that $8 trillion is from this proposal. 

Over 20 years, 25 years, the percentage has to increase dramatically. 

Secretary LEAVITT. It removes any indexing so, as you say, it is 

not indexed—or indexes it rather, so that it does go up over time. 

Chairman CONRAD. It is indexed? 

Secretary LEAVITT. It is not indexed. 

Chairman CONRAD. Well, that is my point. If it is not indexed, 

then it over an extended period of time many more people have to 

be affected. 

340

Secretary LEAVITT. You asked if we had done analysis. We have. 

It would affect 2.7 percent in 2008 and it would affect 4.7 percent 

in 2017. 

Chairman CONRAD. Many people is that? 

Secretary LEAVITT. Two million. 

Chairman CONRAD. Two million by 2017. But beyond that, what 

are we talking about—

Secretary LEAVITT. That is Part D I am talking about. 

Chairman CONRAD. Part D. 

I am talking about all of the parts because this is a proposal that 

just does not affect Part D. This affects Part D. This affects, as I 

understand it, all of the elements. 

So how many people would we be talking about—and again I am 

not talking about just the 10-year effect. Because if it is not indexed as you go out to 2025 and 2035, this thing must have an effect on millions of people. 

Secretary LEAVITT. The information I have just been presented 

indicates that beneficiaries paying the higher premium in 2017 

under Part B would be 9.5 percent that would be affected. Again, 

the principle is the same. 

Chairman CONRAD. But how many people would leave? How 

many people would choose not to participate? 

Secretary LEAVITT. I do not have information that would reach 

that conclusion. I think you could draw conclusions recognizing 

that there will be some who will, as they get into higher incomes, 

will have greater income to pay. The principle is the same, Senator. 

Chairman CONRAD. Hasn’t the CMS Actuary given you an estimate? 

Secretary LEAVITT. If they have, I do not have it with me today. 

Chairman CONRAD. Let me tell you, the estimate that I have 

from CMS, which is your agency, is that by 2017 43,000 people 

would leave Medicare. That is just Part B. That is just Part B. 

That is the near-term effect. What I am concerned about is if you 

do not index, when people up here are talking about $8 trillion in 

savings, we have to understand what that assumption means. 

So I am going to ask you today, I would like to have CMS give 

us their estimates of how many people would be affected, how 

many people would leave Medicare or, in essence be forced out, because it is not indexed. 

We have to understand before we pursue this, and let me just reiterate I am for the basic notion. I think it has to be part of the 

solution. But I do not want to have something that winds up excluding tens of millions of people because it is not indexed. And 

when you get out 40 years all of a sudden you have excluded 10 

million people. 

Secretary LEAVITT. That will be helpful information and we will 

be happy to provide it. 

Chairman CONRAD. I think we need to know that. 

SCHIP, our staff estimates are that it takes $15 billion to maintain the SCHIP program as is and that this budget only provides 

$5.6 billion. So that the basic SCHIP program that is available now 

is significantly underfunded, and could not be maintained under 

this budget. 

341

Do you have estimates of how many children would be excluded 

from SCHIP as a result of this budget, in comparison to the budget 

required to maintain the SCHIP program as it exists? 

Secretary LEAVITT. Senator, I have articulated the position of the 

Administration as clearly as I can. It is our belief that the budget 

proposal we have put forward would allow that policy to be implemented. The actuarial figures I do not have today. Obviously, as 

the conversation goes forward we would be happy to provide whatever backup we can. 

Chairman CONRAD. I have a very specific question. And that is 

with this budget, in comparison to a budget that would maintain 

the SCHIP program as it currently is, how many children would be 

excluded from coverage? 

Because we have roughly 4 million children, as I understand it, 

covered. As we look at these numbers that are in the budget, there 

is no way to maintain the program as it is for those people. 

A final question I would like to go to, and I thank my colleague 

for his patients, is the question of fraud. A number of years ago we 

had a series of hearings on fraud in the Medicare program and I 

tell you it was truly outrageous. 

We found in wound kids, for example, wound kits, there was a 

scam going on around the country—in fact, I held a hearing in 

North Dakota and we had several providers stand up and say they 

had been presented with this scam operation which was to cheat 

Medicare by getting wound kits that normally, as I would recall, 

cost $8. And they would basically defraud Medicare by charging 

three times as much to Medicare than what the things really cost. 

It was a scam that involved some operations on the East Coast 

and then they were being aided and abetted by people who delivered the service around the country who were invited to share in 

the fraudulent returns. And so they set up a giant network. 

Now you mentioned at the beginning of your testimony and in 

our conversation, and I do not want you to go into things that 

would in any way jeopardize your ongoing investigation. But can 

you give this committee insight, to the extent you can, on what you 

are finding with respect to fraud? 

Secretary LEAVITT. Senator, I indicated to you that I had recently 

participated in activities of the Office of Inspector General where 

we have actually gone out and begun to inspect the compliance of 

various durable medical equipment providers in certain communities around the country. 

I will confess to you that it was one of the most disheartening 

experiences of my public service career. We walked up to a strip 

mall in a particular area. There are 21 different criteria than a 

provider has to give if they are to be given a number and be able 

to do business. Those things include you have to have a place of 

business, you have to be able to demonstrate you have a supply of 

medical equipment, you have to have your name posted prominently and a telephone number. 

And so we would walk up to these strip mall places and rattle 

the door during the middle of the day and there was no one there. 

And you would look inside and there would be three chairs and a 

little supply of medical equipment. And then you would see the 

name—that had met the requirements of the number but there was 

342

clearly no business going on there. And when you would go back 

and check against it you would find that there were hundreds of 

thousands, often millions of dollars, billed against that number. 

I then went to an office building of about 20,000 square feet, two 

stories. There are four rows on the marquee of businesses, probably 

70 or 80 businesses in this building. I would guess three-fourths of 

them were durable medical equipment suppliers. 

Chairman CONRAD. In one building? 

Secretary LEAVITT. In one building. I walked up and down the 

aisles and it was like a dormitory. On each side you would see 

doors. When you would knock on the door there would be no one 

there. When you would finally get somebody to open it, it would be 

a woman who would have children and generally they would not 

speak English. It was very clear that this was a building full of 

businesses that were front operations. 

Chairman CONRAD. Front operations. 

Secretary LEAVITT. In the particular city where I was on that 

day, the agents told me that there were four such buildings. We inspected several hundred different providers and found that nearly 

half of the number were fronts. And we are proceeding to cancel 

and we are working with all of our resources to convict and to ferret this out. 

Chairman CONRAD. Do you have any estimate, Mr. Secretary, on 

what the losses might be from these kinds of operations? 

Secretary LEAVITT. We are working, at this point, to try to establish that. It is very clear that in a program that you are going to 

have some losses. But it is at a rate that is untenable and unacceptable. Our budget includes $183 million which we believe to be essential to be able to beef up our enforcement activities. It is clear to 

me, Mr. Chairman, that the payback return on that investment is 

multiple. 

Chairman CONRAD. Mr. Secretary, for the purposes of this committee, if you could provide us—given you have to submit a budget 

long ago. We understand that. You have new information here. 

If you could give us some idea of what additional resources are 

necessary to pursue these scams. I think the message needs to be 

loud and clear. If you are engaged in this kind of scam, we are coming after you and you are going to regret that you ever entered into 

this kind of fraudulent enterprise. The Federal Government is coming after you and we are going to have the full resources to put you 

in jail and get full restitution. And this will be—you will regret you 

ever went down that road. 

Secretary LEAVITT. Mr. Chairman, we will provide it and we appreciate your interest in it. 

Chairman CONRAD. We thank you. 

Senator WHITEHOUSE. 

Senator WHITEHOUSE. Thanks, Mr. Chairman. 

It sounds like your building in the Cayman Islands that we had 

featured in an earlier hearing. 

As our time ran out, Mr. Secretary, you mentioned a CBO report 

that suggested that negotiating by Federal Government would not 

save any money for taxpayers or for the system. I am aware of one 

conclusion that was drawn by CBO, which is that passing the statVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00790 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ute that withdrew the bar or on your negotiations would not save 

any money. I have talked to CBO about that and I just want to 

make sure you are aware of why they decided that. 

They decided that because all that would do would be to take 

away a restriction on you doing what Director Thompson said was 

the most important power that he did not have as Director. But it 

would not guarantee that you would. 

And because they have to kind of read the future and prognosticate, because there was the prospect of the Department of Health 

and Human Services would simply sit on its hands and not negotiate or do so halfheartedly or not be effective in the way it went 

about doing it, they could not tell where it would fall and they 

could not provide a number. 

But you should not believe that the CBO does not think that 

there are significant opportunities for savings for American taxpayers from getting the Government involved in these negotiations. 

They just cannot identify them because they do not know what you 

are going to do about it yet. 

Secretary LEAVITT. Well, then let us talk about the independent 

actuaries who drew the same conclusion, or let us begin to look at 

the—

Senator WHITEHOUSE. Would you send me that because I do not 

have those. I would love to continue this debate because I think is 

vital. I mean, $8 trillion, sir, is $27,000 per American. And most 

Americans—a lot of Americans do not pay taxes. So for people who 

are watching this, and are actually tax paying Americans, they are 

looking at a good deal more than $27,000 skin in the game on this. 

And if, as reports that we have seen from independent folks are 

saying, there is a 50 percent extra premium being paid to the pharmaceutical industry because we will not negotiate, that is trillions 

and trillions of dollars and we, I think, have to have a really honest 

discussion about that and understand exactly what the CBO said 

in its report. And I am happy to followup with you and look at 

these other things. 

But please do not count the CBO as having said no, no, no, negotiate will not save money. All they said is that just by changing the 

statute they could not tell whether you would actually do anything 

under it and so they could not put a number on it. 

Secretary LEAVITT. Senator, I am prepared to remain open-minded on that point if you would remain open on the point that there 

is no way that there are trillions of dollars that can be saved over 

an efficient marketplace. You have—

Senator WHITEHOUSE. What makes you think this is an efficient 

marketplace? 

Secretary LEAVITT. Because you have the largest payers in the 

business competing. And when they compete, they very clearly say 

if I do not have the lowest possible price, then there is no way for 

me to keep the business of 38 million people. 

Senator WHITEHOUSE. We are going to disagree about that because I think the fundamental problem is that we have market failure in the health care system. And until we straighten it out, the 

marketplace effects are muted and dissolved and we do not really 

take advantage of it. 

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Secretary LEAVITT. We will agree on the point that we did not 

have a system of competition in health care, generally. But one of 

the best examples we have where competition has been injected 

and where it has worked has been in the Medicare Part D. It is 

indisputable that the actuarial estimates started at $37. And this 

year they will pay $22. And the actuaries very clearly indicate that 

that is because of competition. 

And with the number of plans we have if there is anyone who 

has the capacity to deliver a drug program at a dime cheaper, they 

are going to get a lot of business. And they will. 

Senator WHITEHOUSE. And I think if the Federal Government got 

involved, it would drive it down even further. 

Secretary LEAVITT. I do not think there is evidence on that, but 

we will—

Senator WHITEHOUSE. A separate point. On the reduction to 

Medicare doctors of 10 percent, in addition to what Chairman 

Conrad suggested, which is that is probably not going to happen 

in this building, I would suggest to you that if you tried to implement it, even if we put it through, it would not affect 10 percent 

savings across the board anyway. Because there is such an elaborate system out there for fighting back and forth over claims payment, and so many different ways that providers can reconfigure 

their claims filing methodology, that an enormous amount of that 

goes out the door. And a lot of it that does not go out the door gets 

lost in patient care to the people who this is designed to do. 

So I think is a very, very effective and inefficient way to try to 

pursue savings in the system. But I have never seen a good number for how much you think that costs, the battle between the insurance industry on the one hand with all of its utilization review 

technology, and the providers on the other side. I am drilled into 

this reasonably far in Rhode Island, sir, and I want you to know 

that the doctors in Rhode Island, they are involved so heavily in 

trying to fight for payment, in many cases 50 percent of their staff 

is doing nothing but fighting for payment. We have trench warfare 

over payment in the health care system and it produces, by my 

lights, not a dime of health care value. 

So to me the trick is how do you dissolve that trench warfare? 

How do you get clarity as to what should be paid for and what 

should not, rather than putting more pressure into the trench warfare by saying OK, across the board 10 percent reduction? 

I just think it backfires. I do not think it is a good strategy. 

Secretary LEAVITT. Listen, Senator, I think the way we reimburse health care is a witch’s brew that no one understands. I 

think that it is saturated with inefficiency and that it clearly, over 

time, should be replaced with a system of competition based on 

value. Where we have a system of electronic health records that 

connects us into a system where consumers can have an independent assessment of the quality that they are receiving, where 

they can have care that is provided to them in episodes of care 

where the price is understandable, and where the incentives for everyone is to drive the costs down and the quality up. 

We are pursuing all of those policies aggressively. And I would 

love to spend some time talking with you about the way I view this 

system. Because it sounds to me as though we could reach agreeVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00792 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ment on the fact that the system we currently have does not work 

well and that we ought to be migrating toward—

Senator WHITEHOUSE. That is the understatement of the day. 

Secretary LEAVITT. I want to underscore it and make it the quote 

of the day. 

Senator WHITEHOUSE. I appreciate it and I do look forward to 

working with you. I think this is urgent. I think we are late. I 

think it is scandalous how we have allowed the system to develop 

to this point. 

And the fact that we, in this building, are going to start to have 

to look at benefit cuts for people who are at the very most difficult 

part of their lives, seniors, people just making it economically, that 

we are going to have to look at giving them a hit because we have 

not done our jobs in supervising and administering and creating a 

system that cleans itself and that does these things right. 

I mean, it is just an absolute disgrace. And I really want to work 

as hard as I can with you to solve that problem. 

Secretary LEAVITT. Good. 

Chairman CONRAD. I thank the Senator. Let me just say I have 

asked Senator Whitehouse, because of his very strong background 

in this area, he was put in charge of a very serious problem in the 

State of Rhode Island that required immediate action, and he did 

a remarkable job there on these issues. 

And so he has a very significant expertise that this committee is 

drawing on. I have asked he and Senator Wyden and Senator 

Stabenow to lead a subpanel of this committee to focus on health 

care and the opportunities that we have to rein in these costs and 

to provide better health care outcomes. So I thank Senator 

Whitehouse for his attention to this. 

And I thank you, Mr. Secretary. Thank you for coming before the 

committee. We thank you for your service. You know, we have disagreements, we have debates. That is what the system is about. 

That is how we get at the truth. But I think all of us know you 

are an outstanding public servant and we very much appreciate 

your service. 

Secretary LEAVITT. Thank you, Senator. 

Chairman CONRAD. Thank you. 

[Whereupon, at 11:49 a.m., the committee was adjourned.]

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PREPARED STATEMENTS


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ANSWERS TO QUESTIONS FOR THE RECORD


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THE PRESIDENT’S FISCAL YEAR 2008 BUDGET 

PROPOSALS ON TAX COMPLIANCE 

WEDNESDAY, FEBRUARY 14, 2007

UNITED STATES SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to notice, at 10:07 a.m., in room 

SD–608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of the committee, presiding. 

Present: Senators Conrad, Wyden, Lautenberg, Stabenow, 

Whitehouse, Gregg, and Grassley. 

Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 

Staff Director for the Minority. 

OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

Chairman CONRAD. The hearing will come to order. We thank everybody for being here. We especially thank the Commissioner for 

braving the snows of Washington. We thank our colleagues, as 

well. It seems to be that much of Washington is shut down but we 

are open and ready for business. 

I also want to wish Senator Gregg a happy birthday. He is 29 

years old today. It is amazing how gracefully he has aged. 

Senator GREGG. Do you have a chart to that effect? 

Chairman CONRAD. I am bringing a cake. So happy birthday to 

Senator Gregg, and best wishes for this day. 

I do not know exactly what the Senate schedule will be like with 

the weather outside, but we are going to go forward with this hearing. 

I especially want to thank Commissioner Everson for coming 

today, and for sharing his insights with us. It is good to have the 

former chairman of the Finance Committee with us as well, but 

now ranking member, Senator Grassley. 

Let me begin by highlighting the serious fiscal challenges that 

we see facing the Nation. I call it the wall of debt. We started out 

this administration, after the first year, with almost $6 trillion of 

debt. By the end of this year it wail be $9 trillion, headed for $12 

trillion by 2012 if we do not respond.

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It is very interesting, I would say to my colleagues on the Committee, in my work on this budget I find among our colleagues such 

a deep impulse to embrace every tax cut and embrace every spending initiative. Even though we all know we have to change, there 

is, among our colleagues, a great impulse not to change. It has 

been made very clear to me over the last several days. 

While increased spending has contributed to this growing debt, 

lower revenue has also been a factor. If we look at the revenue 

since 2000, back in 2000 we had just over $2 trillion of revenue. 


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We did not get back to that amount in real terms until 2006. We 

did not get back to the revenue base we had in 2000, in real terms, 

inflation-adjusted terms, until 2006.

And my colleagues are quick to talk about the revenue increase 

of the last several years, and they are absolutely right about that. 

If you just focus on the last several years, we have had strong revenue growth, which is typical of any recovery. 

But what nobody wants to talk about is we have had 6 years of 

no revenue growth. The result is, with increased spending, is the 


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debt has jumped dramatically. This is before the baby boomers retire. We are faced with a very inconvenient truth. And the inconvenient truth we are faced with is the baby boomers are going to 

retire and they are going to be eligible for Social Security and 

Medicare. We are going to have to do something about it. 

Even with the recent revenue improvements, real revenues are 

still lagging behind where they would be in a typical recovery. We 

have looked now at the nine recoveries since World War II, the 

nine major recoveries, and we find we are still running $127 billion 

short of the typical recovery.

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According to IRS’s latest estimate, the tax gap in 2001 was $345 

billion. The tax gap is the difference between what is owed and 

what is paid. My own belief is since 2001 that it is likely that the 

tax gap has grown even larger. I have long believed that closing 

the tax gap is one of the first steps we should take on the revenue 

side. 

Let me be clear, closing the tax gap is not about raising taxes 

on anyone. It is simply collecting taxes that are already due and 

owed.


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I want to salute the Commissioner for the strides that he has 

made in addressing the tax gap because he has moved on the enforcement side of the equation and moved aggressively. Frankly, I 

do not think we have given you the resources you need. I am especially troubled by the CR that took $100 million away from you on 

the enforcement side. That, to me, is going in the wrong direction. 

The tax gap is simply unfair to the vast majority of American 

taxpayers who pay what they owe. And I believe the vast majority 

of taxpayers do pay what they owe. But we have, unfortunately, 


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some number out there, and it appears to be a growing number, 

that do not. And that is true on the corporate side, as well. 

To put a $345 billion tax gap in perspective, consider that it is 

almost $100 billion larger than the size of the deficit in 2006. It 

is important to remember that the added burden placed on taxpayers from the tax gap is real. The National Taxpayer Advocate, 

in her report to Congress, wrote compliant taxpayers pay a great 

deal of money each year to subsidize noncompliance by others. 

Each household is effectively assessed an average surtax of about 

$2,600 to subsidize noncompliance. That is not a burden we should 

expect our Nation’s taxpayers to bear lightly.

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That is her conclusion, and I agree with it entirely. 

To close the tax gap we need to improve reporting and withholding requirements. We know that taxpayer compliance improves 

dramatically with increased reporting and withholding. For example, according to the IRS, for income that is subject to substantial 

reporting and withholding requirements, such as wages and salaries, we see a 99 percent compliance rate. When reporting requirements are in place we see a 91 percent compliance rate. Where we 


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have neither, we see the compliance rate dropping to below 50 percent.

So that is one part of the way forward, increased reporting. The 

other way is through better enforcement by the IRS. I am particularly concerned about enforcement that involves offshore tax havens. I used to be a tax commissioner. I have gone after these myself in my career. I have seen how incredibly lucrative it can be. 

For six years I was tax commissioner in the State of North Dakota and four of those years I was chairman of the Multistate Tax 


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Commission. I dealt with this not only in the North Dakota context 

but on behalf of about 20 other states. And I personally reviewed 

the records of many large multinationals, and I saw how much revenue is hemorrhaging because of the games that are being played. 

This very modest building in the Cayman Islands is the home to 

12,000 companies, all of them claiming they are doing business out 

of this building. Amazing how many companies can do business out 

of there.


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Of course, they are not doing business out of there. They are engaged in, for the most part, a giant tax scam. Those are the kinds 

of things we simply cannot permit to continue. 

So with that, I am looking forward to the testimony of the Commissioner, and I again want to commend him publicly for the leadership he has provided there. 

Senator GREGG.

OPENING STATEMENT OF SENATOR JUDD GREGG 

Senator GREGG. Thank you, Mr. Chairman. Thank you for your 

wishes. I appreciate them. 

It is nice to have the Commissioner here. 

Chairman CONRAD. Can you tell us what birthday it is? 

Senator GREGG. You know, being a member of the Budget Committee, I do not think I can add that up. It is too big a number. 

It is nice to have the Commissioner here. He has done a very 

good job, I believe, and I thank him for his excellent work. 

Obviously, this has been an issue, this issue of tax gap has been 

a major issue for the Chairman for many years. And I believe he 

has managed, through his perseverance and energy, to finally get 

us fairly well focused on it. And I will be interested in the Commissioner’s thoughts on what the real numbers are that we can recover 

of this number that we know is the tax cap and how much we have 

already recovered. 

I think the Commissioner’s testimony may be that of that 2001 

number, a significant effort has been made and there is significant 

recovery already occurring, and so that number has probably been 

reduced. 

This is legitimate and what we need is a number that is reasonable so that we can figure it out and then give you the resources 

to accomplish that. 

On the second issue, though, of what the tax cuts have done and 

what they have not done I must, whenever the Chairman puts his 

charts up, respond kindly to him that I think he is living in the 

past and maybe not looking at results that are current. You can obviously make a fairly effective argument that in the early 2000 period the revenues dropped precipitously. 

I would argue they dropped precipitously primarily because we 

went into a recession, which was a function of two major events: 

the bursting of the Internet bubble which was the biggest bubble 

in the history of the world, bigger than the South Seas bubble, bigger than the—

Chairman CONRAD. Tulip. 

Senator GREGG. Tulip Bubble, that is right, which was a big bubble, actually. But a bubble of disproportionate effect on our economy when it did burst. 

And then second, the attacks of 9/11, which threw us into disarray as a Nation, emotionally, psychologically, culturally, and economically. 

We have come out of that, though. We have come out of it primarily because we have put in place an economic program which 

has energized the economy. We have created 7.4 million jobs. We 

have had, I think, 34 months of continuous recovery and growth. 

We see revenues jumping dramatically in the last 3 years and 9 

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percent just in the last quarter, which is a huge jump considering 

that 9 percent is off a base that actually jumped by about 11 percent in the prior quarter, comparative quarter, and about 7 percent 

in the prior quarter to that. 

We are now generating revenues, and this is the most significant 

point, which actually exceed the historic average of revenues to the 

Federal Government. We are up around 18.4 percent of gross national product coming into the Federal Government. Historically, 

we have been at 18.2 percent. And we are headed toward 18.6 percent, which are big numbers. Those are big numbers between 0.2 

and 0.4. 

So we are generating significant revenues at the Federal level. 

It is also important, I think, to appreciate the fact that the income 

tax has become even more progressive under the President’s proposals, under the Republican proposals that were passed in the 

early 2000’s under the leadership of Senator Grassley. We now 

have more progressive income tax law, where the top 20 percent of 

income tax—of earners in our society are paying almost 85 percent 

of the burden of the income tax, whereas under President Clinton 

they were paying about 81 percent of that burden. 

And the lowest 40 percent of income earners, they do not pay 

taxes. They are getting more back under the Earned Income Tax 

Credit, almost by a factor of two, then they received back under 

President Clinton’s period. 

So we now have a tax law that is generating more revenues to 

the Federal Government than historically it has generated, and is 

more progressive. It taxes higher income—higher income people are 

paying more. 

I congratulate Senator Grassley for having orchestrated that. I 

think the success story is significant and we should acknowledge 

that. 

But there still remains this issue, which the Chairman and I totally agree on, which is that in the out-years we do not have a Government we can sustain because of the fact that we are facing a 

baby boom generation that is going to double the size of the retired 

population, which increases exponentially the cost of health care 

benefits and retirement benefits, and that our children will not be 

able to afford our generation when it is retired. 

And so we should be looking for more places where we can more 

efficiently raise revenue. And I guess my questions to you will be 

along the lines of—after you have explained to us what really is 

the tax gap that we can still recover, what is that number—is there 

a better way to raise revenue independent of the tax gap? Is there 

a better way we can do this? Should we go back to an 1986 type 

of tax reform exercise where we basically consolidate, reduce the 

number of deductions? Actually reduce rates but clean out the underbrush of deductions? 

I think you can be very helpful to us not only in explaining what 

the real number is that we could score and generally use, a hard 

number for covering the tax gap over the next 5 years, but if you 

have ideas as to how we can actually have a better system of taxation. 

I thank you. 

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Chairman CONRAD. I am sure my colleague misspoke when he 

said 40 percent of the people do not pay taxes. I think he meant 

to say income taxes. 

Senator GREGG. That is correct, I was talking about income 

taxes. 

Chairman CONRAD. As he so well knows, a significant majority 

of the people in the country pay more in payroll taxes than they 

pay in income taxes. 

Senator GREGG. But I would note that my statistic is correct, 

that for the bottom 40 percent who pay income—who are subject 

to income taxes, those folks do not pay an income tax, but rather 

they receive money back under what is basically an inverted tax 

system, through the Earned Income Tax Credit. And they are now 

receiving more money back, as almost twice as much money back, 

today as they received under the Clinton years. 

Chairman CONRAD. And of course, not all of the 40 percent received earned income tax credit but some of them do. 

Where we have a difference is there is no question that tax reductions help fuel economic growth. There is also no question that 

tax cuts do not pay for themselves. If they did, we could just cut 

taxes more and balance the budget. 

So all of this is a matter of balance. How do we ultimately 

achieve balance so that we are not continuing to run up this massive debt? And that is a place where the ranking member and I entirely agree. We have to have some balanced approach to deal with 

this demographic tsunami that is coming at us. 

And one approach that we hope is fruitful is to deal with the tax 

gap. And that is why we have asked for this hearing and asked, 

Mr. Commissioner, to have you here. So please proceed with your 

testimony. 

STATEMENT OF HON. MARK W. EVERSON, COMMISSIONER, INTERNAL REVENUE SERVICES, DEPARTMENT OF THE TREASURY 

Commissioner Everson. Thank you, Mr. Chairman, ranking 

member Gregg, members of the committee. 

I am pleased to be with you this morning to discuss the President’s 2008 budget proposals on tax compliance. I am glad that the 

committee has again expressed an interest in this subject of tax administration, and is holding this hearing, even in this inclement 

weather. 

Actually, I am not really surprised that two individuals from 

North Dakota and New Hampshire failed to be intimidated by 

what sends Washington into something of a tailspin. 

And we did note in our records, Senator Gregg, your birthday, 

and we wish you many happy returns. 

Senator GREGG. That must be an inside joke. You use that a lot, 

don’t you? 

Commissioner Everson. Thank you for your interest in our activities. I have been on this job almost 4 years now. And during this 

period we have worked hard to restore IRS enforcement capabilities. We have made a great deal of progress. As we discussed last 

year, for a period of time our enforcement functions largely stood 

377

down. Over the last several years I would suggest we have restored 

respect for tax enforcement and the need to comply with the law. 

But I would add that we have not done so at the expense of service to taxpayers. In fact, Senator Grassley recently visited the IRS 

and he made this point, and made it publicly, that we have been 

able to bring up the enforcement level without a lot of complaints 

about service. That has been very important. 

At the IRS, our working equation remains service plus enforcement equals compliance. I think we have a pretty good balance 

right now and are making strides in both areas. 

Turning to the President’s budget request for the IRS for 2008, 

I want you to know that I am pleased with the submission, which 

provides almost a 5 percent increase from the expected 2007 funding levels. Most significantly the request not only augments our enforcement activities, but also devotes moneys to rebuild our systems infrastructure and increase our research capabilities. I feel 

that the request reflects Secretary Paulson’s and Director 

Portman’s confidence that the IRS will use these moneys wisely 

and generate a positive return for the Government. 

I know that a subject of keen interest to members of the committee, and to many others in the Congress, is the tax gap. By the 

tax gap, I mean the difference between taxes owned the Government and those actually paid on a timely basis. 

Before taking your questions, I would like to make several observations about the tax gap. First, while the most recent National 

Research Program study did a good job of updating our numbers, 

we need more research to better identify the sources of noncompliance. We need to conduct this research on a timely and continuing 

basis. 

Second, I think it is well understood that we will never be able 

to audit our way out of the tax gap. While simplification of our tax 

laws will surely help the vast majority of Americans who already 

voluntarily comply with those laws, I would note that we will actually have to complicate the code to change the behavior of noncompliant taxpayers, for example, by requiring more information 

reporting. 

Third, in recent years we have, as you noted Senator Gregg, 

made progress in improving compliance, as indicated by the steady 

growth in our enforcement revenues—the direct moneys we receive 

from collections, audit, and document matching activities. 

Fourth, to reduce the tax gap dramatically would take some draconian steps, ones that would fundamentally change the relationship between taxpayers and the IRS, require an unacceptably high 

commitment of enforcement resources and risk imposing unacceptable burdens on compliant taxpayers. 

Nevertheless, there are reasonable steps that can be taken to improve compliance. We have made 16 such proposals. In order to 

further improve tax administration, I ask the Congress to fully 

fund the President’s 2008 budget request for the IRS and to enact 

the 16 accompanying legislative proposals into law. 

Thank you. 

[The prepared statement of Commissioner Everson follows:]

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Chairman CONRAD. Thank you, Commissioner. I appreciate very 

much your testimony. 

Let us get right to it. In previous testimony before the committee, you have indicated that you believed that we could capture 

$50 billion to $100 billion a year in additional revenue without dramatically affecting the relationship between the taxing authority 

and taxpayers? 

Commissioner Everson. Yes. 


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Chairman CONRAD. You have now come forward with 16 proposals, many of them on the information side which I completely 

agree with. That is a place that you need our support. 

Let me talk first about the budget side, because I look at what 

was done to you in the CR and I regret very much that you were 

reduced $100 million on the enforcement side from what was in the 

President’s proposal. Is that not correct? 

Commissioner Everson. I believe that is about correct, yes, sir. 

Chairman CONRAD. That is an area, it seems to me, that should 

be made up to you. That would be the first area. 

The second area, as I look at, being a former tax commissioner, 

I look at the infrastructure, especially on the technology side, especially on the information technology side. And I know what a profound difference it made to my operation when we had a great leap 

forward. 

I have looked at the spending there and I believe it would be 

prudent to add some money there. We do not want to waste money. 

We do not want to give you money that you could not spend efficiently. 

So it looks to me like the combined effect of those two would be 

$200 million or $250 million for 2008 and then something on that 

order, adjusted for inflation, going forward. If we were to provide 

you that kind of additional resources, could you employ them efficiently? 

I know you are not here asking for more money. You have made 

that very clear to me. And I understand the way it works in an administration. I understand how that works. You fight for a budget. 

But I will tell you looking at this, I look at the enforcement, I see that Congress took action to deny you $100 million that the 

President thought you should have. It seems to me that is just a 

mistake by Congress not to give you what was requested on the enforcement side. 

And then I look on the information technology side and I know, 

I used to work very closely with the IRS on these issues when I 

was chairman of the Multistate Tax Commission. If you are going 

to be as efficient as you can be and have the spin off benefit of an 

improved information system, we need to put some more money 

there. 

So I would ask you, if we were to give you another $200 million 

to $250 million, could you give us a plan on how you would deploy 

that and could you deploy it efficiently? 

Commissioner Everson. Let me respond first that I would ask the 

Congress to give us a budget. We are now 4.5 months into this fiscal year and I do not have a budget for the IRS. That is not the 

way to run a railroad. 

I would ask you, first and foremost, to finish your work on the 

budget and the appropriations before fiscal year 2008 starts. We 

can plan, we can make adjustments, we can be much more rational 

in how we run an agency if we have a budget before the year 

starts. 

Second point I would make is I am pleased with this budget. I 

am asking for every penny of this budget and not a penny more. 

As you know from our discussions, I have been through four budget 

processes so far, and we have never been fully funded on the infraVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00843 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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structure. If you look at the combination of the infrastructure and 

the enforcement side, this core infrastructure line has been held 

sort of stable. 

Chairman CONRAD. In fact, is it not the truth of the matter you 

have been—as I look back—you have been cut every year? 

Commissioner Everson. We have been cut about $570 million 

from the President’s request in the enforcement and infrastructure 

categories over that period of time. I would note the infrastructure 

is particularly important in the 21st century and that it does not 

just help on enforcement. It helps on the services side of the organization, too. It is very important in terms of processing returns, 

being able to answer questions, processing notices, a whole host of 

things that happen. 

But what I would caution the committee, again I am not asking 

for this additional money. If you have a tight budget or you cut a 

budget, an organization responds by cutting capacity. That is what 

we do. If you grow a budget too quickly, you lose control. You do 

not want to lose control at the IRS. We will head back down a road 

that is not good. We have been very careful as we have brought 

back up enforcement. 

So particularly on enforcement, I think there is an issue here. 

We have attrition and we have, as many agencies do, have a higher 

level of attrition that is taking place right now with the older work 

force. This is a Government-wide issue but one we have felt particularly acutely. 

The combination of hiring to replace attrition and then adding 

new people for the over $200 million of enforcement initiatives we 

have means that we are about at the max of what we could take. 

It would be imprudent to throw more money at us in that regard, 

if you follow the concept. Just the ability to hire and train—

Chairman CONRAD. And I understand that absolutely. That is 

why I am asking you, we do not want to give you money that you 

cannot efficiently and effectively employ. 

Commissioner Everson. Yes. 

Chairman CONRAD. But you have been reduced from what the 

President concluded that you needed in enforcement, $100 million 

in 1 year. It seems to me clearly we ought to make that up to you. 

And then on the technology side, it looks to me like you could, 

just looking at the budget submission, knowing what I know about 

where you are, that you could use another $100 million or $150 

million there effectively. 

We know you are not asking for more. You have made that very, 

very clear. 

Commissioner Everson. You know, I cut a deal with the Administration. We work hard to get to a number that everybody can be 

happy with. 

Chairman CONRAD. I know how that works and I respect it and 

I respect that you are a good soldier. But we have an obligation 

here, too. Frankly, Congress took this $100 million out of enforcement. I am asking if we gave you that $100 million back, could you 

effectively and efficiently employ that? 

Commissioner Everson. We would take a look at that issue. 

Again, it comes down to the hiring. And on the infrastructure it 

397

comes down to a whole series of things we would have to look at. 

If you ask us, we will look at it. 

Chairman CONRAD. If we were to give you another $100 million 

or $150 million on the information technology side, could you effectively and efficiently employ that? 

Commissioner Everson. That is somewhat less sensitive to the 

issue of absorption, but not totally insensitive to that issue. So 

again, you would have to be very careful as to where you spent 

that money. 

Chairman CONRAD. Let us go back to the question, and I have 

gone past my time here. 

When you previously testified, you indicated that we could—if all 

of the things were done that you were suggesting, that we could 

raise $50 billion to $100 billion a year without having a significant 

impact on the relationship between taxpayers and the taxing authority. 

Commissioner Everson. Sure. This comes down to what Senator 

Gregg was referring to. If we look here, this chart shows the 

change in enforcement revenues that the IRS brings in over a period of time. The blue tube is the collections: money that people 

recognize they owe, but they have not paid, and that we get over 

a period of time.

The yellow strip, that is our document matching activities. That 

process is when we send you a notice saying we have seen more 

dividends reported by the brokers than you have actually shown on 

the return. 

And the green strip, which has shown quite a bit of growth, is 

audit results. 


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If you take the difference between 2001 and 2006—and 2001 coincides with when we did the studies that came up with the $345 

billion and the $290 billion—the delta is about, I think, plus or 

minus $15 billion. 

Now if we go to the next chart, the people who have studied this 

would say those moneys are just the direct impact. That is when 

we audit Kent Conrad and we know you are clean as a whistle—

but it might influence your colleague, Senator Gregg, to be maybe 

a little less aggressive. That is the indirect effect.

Chairman CONRAD. He is clean as a whistle, too. 

Commissioner Everson. Is he? Good. 

Senator GREGG. You can take that to the bank. 

Commissioner Everson. But the people who study this would tell 

you that, depending on the nature of the enforcement activity, 

there is an indirect compliance effect of four or five, sometimes 10, 

to one. What we have done here is said, even if you assume a very 

conservative indirect effect of three to one, that would indicate if 

you have a direct impact of somewhere around $15 billion, you 

might have already recovered $60 billion or so. 

So I think that probably just by bringing up the enforcement—

I do not want to be precise here. I would caution everybody to not 

try and get too exact here. I think we are probably somewhere 

around the lower end of that bracket. 

Now what the Administration has done is put in some more 

money for service. You could argue about whether we ought to put 

in a little bit more. We believe that will get us additional moneys 

in, both directly and indirectly. And then we have put together a 

basket of these 16 proposals and that will get us some more as 

well. So I think we will get into this zone. 

Now there has been conversation, I know my boss was here last 

week and also testified at Finance and elsewhere, with some people 

saying ‘‘jeez, you have to go further, this is a modest set of proVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00846 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH

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posals.’’ I think these proposals are quite significant in the sense 

that we have already got people screaming about the credit card reporting. That is, I think, the most important proposal. We are asking that for small businesses, which really very significantly understate their revenues, that we get the gross receipts once a year 

from the credit card issuers about a dry cleaning business or a restaurant or a car dealership. We think that will have a big impact. 

But already we are into arguments where people are screaming 

about how much burden and how unfair some of these steps will 

be. What I would say to the committee is I am satisfied with the 

basket of proposals we have, just like I am satisfied with the budget. I think if we do these two things together we will get more 

squarely into this zone, this range. 

You asked me that question last year, Senator, and that is when I offered a guess, $50 billion to $100 billion. But I think we will 

approach the middle of that range if we do these things that we 

have proposed. 

Chairman CONRAD. All right. Senator Gregg. 

Senator GREGG. Thank you. Picking up on that point, if I read 

these charts correctly what you are really saying here is that because you have ramped up enforcement significantly since 2001 

and you have generated the $17 billion in real gain and enforcement, and then the $68 billion in what you think is enforcement 

that comes because people see somebody else being audited and 

they say well, I better get my act together, that really the increment that you are talking about that may still be available as low 

hanging fruit, so to say, would be between $68 billion and say $100 

billion, somewhere in that range. So the increment on top of this 

probably is $30 billion or $20 billion, not $100 billion; is that correct? 

Commissioner Everson. I think that is right. This gets harder 

with each additional step. Senator Grassley, of course, can comment on the struggles in Finance to get anything through to close 

some of these loopholes; it gets harder. 

Senator GREGG. What I am trying to get to is a quantifiable 

number. 

Commissioner Everson. Yes. 

Senator GREGG. It looks to me, looking at your charts here, that 

what you are essentially saying is that over a 5-year period—and 

remember I presume you would again only ramp up—that by the 

fifth year you might be able to generate another $20 billion to $30 

billion? 

Commissioner Everson. I think if we got everything here, meaning the budget and the proposals. I think the proposals have been 

scored conservatively by the Treasury Department economists, and 

will been looked at by the Joint Committee economists conservatively, as well. And there are valid reasons for that, because oftentimes you will pass something into law and the IRS will not fully 

implement it because, for example, we will not get the money to 

do the document matching that we are now allowed to do from the 

third-party reporting. 

But if everything works together, I think we will get that kick, 

that lift. I would not want to speculate that it would get as high 

as $30 billion. But when I think of the basket and compare it to 

400

2006 where we say maybe haveten at the low end of that range, 

$20 billion would be a reasonable ballpark 4 years out. 

Senator GREGG. If we were thinking about how we would score 

this budget-wise, assuming we could even get OMB to score it at 

all, which they probably would not, you would have to ramp up to 

that $20 billion. So over a 5-year period you are probably talking, 

because these regulations would go into—assuming you could even 

get these regulations passed—they would go in over a period of 

time. And certainly, for example, reporting capital gains basis 

would take a long lead-in. 

Commissioner Everson. Yes, sir, that definitely ramps up overtime. 

Senator GREGG. So we are probably talking a ramp up to say $25 

billion or somewhere between $20 billion and $30 billion, which 

would mean over the 5-year period you might be able to score say 

$35 billion total, something like that. 

Commissioner Everson. I do not want to promise a particular 

number, but you are looking at it conceptually correctly. 

Senator GREGG. Conceptually and in a range. 

Commissioner Everson. Yes. 

Senator GREGG. So when you talk about these proposals, you 

have given us these 16 proposals. We are not the authorizing committee, obviously Senator Grassley is the former chairman and 

ranking member of that committee. 

But I asked you if you could rate these on a—if you could give 

me the top four. And just for the public record, you told me the top 

four were—the first one you have already mentioned, which is getting gross receipts from merchants’ credit cards. 

Commissioner Everson. Yes. 

Senator GREGG. The second one would be a felony for failure to 

file. 

Commissioner Everson. Yes, sir. 

Senator GREGG. The third one would be basis reporting on security sales. 

And the fourth one would be failure to file electronically for businesses. Those would be the top four that you think would be the 

most—

Commissioner Everson. The last one is actually lowering the 

threshold where you make it mandatory to file electronically. 

Senator GREGG. Which is a specific assessable penalty. No, it 

says establish specific assessable penalty for failure to file, so I 

may have misunderstood. 

Commissioner Everson. That is actually a slightly different type 

of—

Senator GREGG. You are talking about expanding electronic filing. 

Commissioner Everson. Yes, lowering the threshold for when you 

are required to electronically file. 

Senator GREGG. So those would be the top four and then the rest, 

obviously the other 12 you would also like on top of those. 

Commissioner Everson. What I would like to emphasize to the 

committee is these all work together. What happens is preparers 

and others respond to the overall change in the climate, and to the 

fact that the IRS and Congress are doing more. So, I am not trying 

401

to say it is an all or nothing proposal. But the more you do, the 

bigger this indirect effect, I believe, becomes. 

Senator GREGG. I think that is just human nature and unfortunately OMB refuses to score—or CBO refuses to score obvious 

human nature, such as if you cut capital gains rates people free up 

capital and sell and generate more capital gains, things like that 

that are obvious are not obvious to some. But your point is obvious 

to me. 

Thank you. 

Commissioner Everson. We try to be practical at the IRS. We are 

not as smart as the economists. 

Chairman CONRAD. Let me just say that I think you are being 

you too modest. If the tax gap net is about $300 billion a year 

times five, that is $1.5 trillion. And as I have heard your answer 

to Senator Gregg, it sounds to me like you are talking about recovering $30 billion to $50 billion of that. That would be, on the low 

side, one–500th of it, and on the high side one–300th. 

Senator GREGG. He is saying—

Chairman CONRAD. What he has done is he has put a multiplier 

effect on a number that is hard. The multiplier is soft. If you put 

a multiplier on the tax gap that was identified by the Revenue 

Service back in 2001, $290 billion, if you put that same multiplier 

on it as he has put on collections, you would have a tax gap that 

was $1 trillion. 

Senator GREGG. That is apples and oranges. 

Chairman CONRAD. No, it really is not apples and oranges because he is saying that compliance has a ripple effect. Certainly 

noncompliance would have a ripple effect, too. 

Commissioner Everson. I do not think that is fair, Mr. Chairman, 

because what we did our best to do in the NRP study was to measure at a point in time, and to come up with a real estimate of total 

noncompliance. 

Chairman CONRAD. But isn’t it the case that that point in time 

is 2001? 

Commissioner Everson. Absolutely, that is correct. 

Chairman CONRAD. But we do not know what happened between 

2001 and later. 

Commissioner Everson. That is why I am trying to be very gen- eral and not be precise when we get into, ‘‘is it $60 billion or $50 

billion?’’ I am just trying to say I think we were already somewhere 

around the lower end of the bracket that you and I discussed last 

year. 

Chairman CONRAD. I have a hard time believing that, I honestly 

do, because I know what happened. I have many contacts, as you 

know, and as you do, in the taxing profession and the accounting 

profession. They tell me the culture has changed dramatically and 

people have gone to a far more aggressive approach to how they approach paying their taxes. 

Again, I would just say to you if the tax gap was $300 billion a year, 5 years, that is $1.5 trillion. What I hear you talking about 

here is it may be $50 billion. That is one–300th, according to my 

math. We have to do better than that. 

Senator WHITEHOUSE. 

Senator WHITEHOUSE. Thank you, Mr. Chairman. 

402

I want to, first of all, make clear to people who are watching that 

as we are talking about the potential for increased enforcement, 

the average American taxpayer, who feels a chill down his or her 

spine when he hears that phrase, is not really the focus of what 

we are getting at. We are getting at relatively complex schemes to 

dodge taxes; is that correct? 

Commissioner Everson. Senator, on the first point, we say that 

we want to provide services to taxpayers because it helps them understand their obligation and facilitate their participation in the 

system. We enforce the law because average Americans, the vast 

majority, pay honestly and accurately. And they have every right 

to believe that when they do so, neighbors and competitors are 

doing the same. 

But while you are correct that there is a lot of money in the highend and the complicated shelters which we have been pursuing—

my first priority over these last 4 years is to increase our penetration in high-income individuals and corporations. And we have 

done that. The majority of the tax gap is in under-reported income 

by individuals. 

And the biggest single piece of this under-reported income is by 

individuals who are actually operating as a small business but unincorporated. This is the understatement of revenues, principally. 

The difference is what I would say is—

Senator WHITEHOUSE. But it is pretty hard to deploy the limited 

resources that you have effectively on a case-by-case basis to make 

a case against an individual private owner. 

Commissioner Everson. Yes, sir. 

Senator WHITEHOUSE. Those are the people who feel the effects 

of it and get the message and comply. But the actual enforcement 

would presumably be directed against high income, high networth, 

and corporate entities. 

Commissioner Everson. It would be a combination of things. 

What you are getting at is one reason why we are putting in the 

third-party reporting proposals. 

Let me give you one example. The last time there was significant 

change in this area was in 1986, when there was major tax reform, 

as you may remember. That year we added a requirement to the 

1040 for the Social Security numbers of dependents. The next year, 

even though the IRS did no matching with Social Security—it took 

us a year to get that going—five million dependents vanished. That 

is a lot and that is a lot of money. 

Senator WHITEHOUSE. Well, let me give you a counter-example. 

This is a story from the Wall Street Journal that does not involve 

Federal taxes, it involves State taxes. But it is pretty remarkable. 

It talks about Wal-Mart, and I will read just a few selections. ‘‘As 

the world’s biggest retailer, Wal-Mart Stores Incorporated pays billions of dollars a year in rent for its stores. Luckily for Wal-Mart, 

in about 25 states it has been paying most of that rent to itself—

and then deducting that amount from its state taxes. 

The strategy is complex but the bottom line is simple: It has 

saved Wal-Mart from paying several hundred million dollars in 

taxes, according to court records and a person familiar with the 

matter. 

403

‘‘The arrangement takes advantage of a tax loophole that the 

Federal Government plugged decades ago, but which many States 

have been slower to catch. Here is how it works: One Wal-Mart 

subsidiary pays the rent to a real estate investment trust, or REIT, 

which is entitled to a tax break if it pays its profits out in dividends. The REIT is 99 percent owned by another Wal-Mart subsidiary, which receives the REIT’s dividends tax-free. And WalMart then gets to deduct the rent from State taxes as a business 

expense, even though the money has stayed within the company... 

The so-called captive REIT strategy alone cut Wal-Mart State 

taxes by about 20 percent over one 4 year period...’’

‘‘The structure Wal-Mart is using’’—this is the part I love—‘‘features some unusual elements. Because REITs must have at least 

100 shareholders to gain tax benefits, roughly 100 Wal-Mart executives were enlisted to own a combined total of around 1 percent of 

the REIT shares,’’ all nonvoting. So they went and rounded up 100 

executives and said guess what, you are a shareholder to make this 

thing work. 

‘‘A single Wal-Mart real estate official, Tony Fuller, represented 

the company both as tenant and landlords in its leases with itself. 

Ernst and Young, the accounting firm that sold the strategy to 

Wal-Mart, also is the company’s outside auditor.’’

Now that is a ton of effort to go through just to beat one State’s 

taxes. So I have to believe that if one of the biggest corporations, 

a proud American corporation, is willing to create what looks to me 

an awful lot like a dummy corporation, set up with its own executives as the shareholders, just to dodge it, there is a lot of dodging 

going on out there. And the poor regular taxpayer who owns his 

own little business or just is getting a salary, nobody can compete 

with that kind of cleverness. 

Commissioner Everson. Senator, we set out and we started in 

this enforcement build-up to work on high-income individuals with 

the shelters and the corporations. And we have brought up the enforcement quite significantly in both of those areas. I agree with 

your assessment. I spoke 2 years ago in January to the New York 

State Bar Association taxation section. There were 98 tables of 10, 

and these people are not representing EITC taxpayers. 

You are entirely correct, there is a lot of energy around complying and then making sure that you are absolutely minimizing 

tax, if not altogether getting out of tax. 

We work hard on this. This budget requests more moneys for 

going after the high-income individuals who are engaged in these 

shelters. Our audit rate is now over 6 percent for individuals who 

are earning $1 million. That is a very high audit rate. We have $26 

million more in here for the corporate arena and something like 

$70 million or $80 million to work in the small business and highincome individual areas. So we agree with you that is where you 

go. 

I do want you to understand, though, that the big piece of the 

tax gap is in the individuals and small business area, which is not 

all high income people, just plain under-reporting income. We do 

not want to enforce our way out of this. What do want to get some 

help on the reporting.

404

Senator WHITEHOUSE. Thank you, Mr. Chairman. 

Chairman CONRAD. Senator Grassley. 

Senator GRASSLEY. Thank you very much. 

I am going to put a statement in the record that was leading up 

to my questions, so I can go immediately to the questions. 

[The prepared statement of Senator Grassley follows:]


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The second question I was going to ask has been pretty thoroughly handled by Senator Gregg. But I want to emphasize there, 

if I can, and ask you to shake your head without taking too much 

time because I want to get to the other four questions. 

I think the bottom line of what you and Senator Gregg were 

speaking about it that the $50 billion to $100 billion figure of the 

tax gap, a lot of that is already in the baseline? 

Commissioner Everson. That is right, sir. We have already 

achieved, probably, toward the lower end of that range. 


34649.367
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Senator GRASSLEY. So then I want to interpret what Senator 

Gregg was saying about getting a quantifiable number. I do not 

know why Senator Gregg wanted to get a quantifiable number, but 

the reason I want to get a quantifiable number is because regardless of the fact that the Joint Committee on Taxation and CBO do 

not score revenue from changes in enforcement, a quantifiable 

number and a pretty hard number is pretty important. Because 

there is a lot of people over the next month or month-and-a-half, 

when we are having budget debates in the committee and on the 

floor, they are going to look at the tax gap as a pot of gold. And 

it is a legitimate question. 

I have been working with Senator Baucus, he has been working 

with me. We are going to try to get all the money we can. But I 

want to make sure that we are talking about real money and not 

blue smoke. And there is a lot of people who are going to be counting blue smoke because they want it as offsets. 

Commissioner Everson. I agree. 

Senator GRASSLEY. They want it as offsets. So that is why it is 

very important for you to help us get as definitive figures as you 

can of quantifiable numbers, so we do not get a lot of this blue 

smoke involved in this offset game. 

Commissioner Everson. Yes, sir. 

Senator GRASSLEY. I am going to go through these other questions quickly because you are supposed to have some idea what I 

was going to ask. 

How would the IRS have to change its enforcement practices to 

actually close the tax gap? How much more intrusive would the 

IRS be in the lives of taxpayers? And what kind of timeframe 

should Congress expect for the resulting revenues to come into the 

Treasury? 

The fourth question, the President’s budget contains proposals 

that would expand information reporting from credit card transactions, broker transactions, payments to corporations, and cost 

basis for security transactions. 

Some members, and principally those on the other side of the 

aisle, have criticized these proposals as not going far enough because they only bring in about 1 percent of the tax gap. 

So how could these proposals be strengthened? And what other 

types of income should be considered for expanded information reporting and withholding? 

Fifth, in your view what role should tax reform and simplification play in this? 

And the last question, these last two will be a little—let me go 

to the sixth one. 

The role of the private debt collection program in going after the 

tax gap is how big of a factor? Would you answer those, which 

would be basically three, four, five and six? 

Commissioner Everson. Let me sort of group the first two. What 

I would say is this gets back to this question of burden and balance, and when do you get to be too intrusive? The packet of proposals we have made, with the credit card reporting and others, we 

think, are significant; they already are generating a lot of squawking. 

407

Other ideas that have surfaced. The taxpayer Advocate has 

talked about withholding, more withholding, on payments to independent contractors. I have opposed that, saying that I do not 

think that is something prudent to do now. 

But there are any number of things that you can add to this 

package. You just get to the very difficult tradeoffs and add more 

burden for the people that Senator Whitehouse was concerned 

about a few minutes ago. That is the nub of this. That is where, 

if you really want to get big money, you have to go. But you are 

going to get a firestorm. 

And I have to say again, just as the budget has not been passed, 

we had five of these proposals up here last year, as you know, and 

we got one through. So let’s get these done before we talk about 

going any further. 

Tax reform. We favor tax reform. I testified before the Tax Reform Panel, saying that simplification is a good thing. What I always say is that complexity obscures understanding. The fellow 

who wants to be compliant can throw up his hands and say, ‘‘hey, 

why bother? It is just too tough.’’ Then the others, the fellows doing 

business—or purporting to do business-out of that house or building that you have shown, they use complexity and technology and 

all of the different subsidiaries that are mentioned in that article 

to obscure our understanding and make it tougher to catch them. 

So we want simplification. We really do. I support that. 

The last point, and I am glad you raised this, on the private debt 

collection. This relates to the issue that we talked about before, 

adding enforcement personnel. As we have brought up our enforcement capacities that, in turn, generates more collection work because we provide more assessments. We do an audit and then we 

have to collect that money. So our collection activities are growing, 

as well. 

Add to all of this the churning of our own people. And then we 

add people through this initiative. I can tell you that this private 

debt collection is critical to supplement what we are doing, because 

we would not be working these cases. We have already started this 

program successfully, got in some millions of dollars already. These 

are cases we would not be working in the next several years in any 

event, just because of capacity issues in terms of how quickly you 

can grow your work force. 

So I am pleased with the program. We are monitoring it very, 

very closely to make sure we get the right quality, sir. And I think 

so far, so good. 

Senator GRASSLEY. Thank you. 

Chairman CONRAD. Senator Wyden. 

Senator WYDEN. Thank you, Mr. Chairman. 

Mr. Commissioner, in your view, would tax simplification and tax 

reform be a significant help in closing the tax gap? 

Commissioner Everson. I believe tax simplification will help. 

What is important, and I said it in my testimony before that Tax 

Panel a couple of years ago, you cannot compare a perfect theoretical system with an imperfect real system. You have to make an 

apples to apples comparison, though. 

Because people talk, as you know, you have raised reform proposals yourself. People talk about VAT and other systems. WhatVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00855 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
408

ever system you choose, there are compliance issues with that system. That is what I ask people to consider. The other thing I ask 

people to remember is, whatever you do, if you did real simplification or real change, you would have a transition period that would 

run for some years. It takes us a long time to unwind what has 

happened in a given point in the year. So you just need to be attentive to those two factors, sir. 

Senator WYDEN. We will be back at you on this topic. Chairman 

Conrad has put together a group here on the committee that is 

going to look at these issues. We will have some more to discuss 

with you in that regard shortly. 

Let me ask you about a very troubling report that involves senior 

agents in the IRS complaining. This is the people with decades of 

experience complaining in the large corporate auditing unit that 

deadlines have been set by some of the political appointees that 

close the audits early. 

The reason I find this troubling is that some of these employees 

have been in the IRS for decades. There is a fellow in Colorado who 

has been one of your auditors for three decades and he is speaking 

out publicly. He got asked to be transferred, and the like. 

And so you hear his comments and you square it with what you 

have told us, which I have always thought was laudable, that you 

wanted to put a bigger focus on it. What is going on here? Are 

these agents just wrong? Because apparently there are a substantial number of them that are very outspoken and they are also describing specifically the techniques by which the agency is involved 

in some of these strategies that limit our ability to close the tax 

gap. 

Commissioner Everson. I am glad you raised this issue, and I get 

the opportunity set the record straight on this. Let me make a couple of points. 

First, there are only two political appointees in the IRS. I am one 

and the Chief Counsel is another. Two out of 100,000. We play it 

straight down the middle. I make decisions every day that favor 

the Administration or disfavor the Administration. And they are 

made without regard to politics. 

I believe I do my job best by calling it down the middle. That 

serves the country, and I think it serves the President as well, because we all know there is a bad record when you try to reach into 

the IRS from the White House or anywhere else. So the first point 

I want to make is there is no politics in here. 

The second point comes down to cycle time. I believe that one of 

the biggest problems we have in the system is the long period of 

time it takes to resolve tax matters. You will come up with an idea, 

and it will go into law, and it is not clear what the ramifications 

of that law is for up to 20 years. That is because the IRS takes several years to issue guidance on what you really meant. Then it 

takes us five or 10 years to get to an audit on a large corporation. 

We make an assessment. Then they go into the appeals process. 

And then it goes into the courts and it takes 5 years. It can take 

10 or 20 years. 

In today’s world, that long cycle time is a detriment to compliance because the world is changing rapidly. Corporations need 

some stability to plan. And I would say to you, as a general prinVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00856 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ciple, uncertainty is a bad thing for the compliant taxpayer and the 

length of cycle time is bad for us in terms of getting after problems. 

Senator WYDEN. Let me, if I might, because I am running out of 

time. I think those are all valid points. 

Commissioner Everson. I have some specific statistics I would 

like to show you, but I wanted to make that point. 

Senator WYDEN. Good. 

Commissioner Everson. Can I show those to you? 

Senator WYDEN. Sure. 

Commissioner Everson. Corporate audits, let us go to the audit 

numbers. The corporate audits on the biggest corporations, which 

were the subject of these discussions, reached a low point in 2003. 

That is the year I got there.

The audits are now higher—these are the biggest companies that 

he was writing about—than at any time in recent years. What we 

have done is brought up the penetration in the companies with between $10 million and $250 million in assets, where we were doing 

very little.


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Now dollars recommended, which is what gets into, ultimately, 

the enforcement revenue. In 2003, when I got here, on these big 

companies we recommended $12 billion. That has more than doubled. Last year it was $30 billion and $25 billion in 2006. 

I would be concerned if these agents were saying that they were 

being sent home to work on training or something and they were 

not doing work. But the truth is we are doing more audits. We 

have gone from 7,000 total audits to 10,000 total audits. And we 

have recommended more money. We have gone from $13 billion to 

$26 billion. 

The final point I would make on this is that corporate tax receipts as a percentage of the GDP have gone to the highest level 

in 18 years. They have recovered to the highest level. They mirror 

profits. We put in the cycle time initiative and I would be very concerned if either what we were setting up was going down or not 

recovering. When I look at it in the big picture, I think it is OK.


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The last thing I will say is individual managers may make a mistake in saying to employees, ‘‘you have to close this out and move 

on to something else.’’ That is a difficult discussion. I am sure we 

are not perfect there. But I look at the big picture, Senator, and 

I think what we have done is responsible and correct. 

Senator WYDEN. The only thing I would say, Mr. Commissioner, 

and I want to ask one other question, with the Chair’s indulgence, 

is I have seen your numbers. I have heard you speak about this. 

And yet I read these reports about policies, coming from these senior people that are troubling. I would just like you to look into 

them and get back to me. 

For example, apparently these senior auditors are saying they 

were told to limit questioning only to those specific issues that the 

IRS and the companies had agreed in advance to examine. So they 

get into the audit, they see other things, and apparently these people say they are not allowed to go further. 

Would you get back to me on that? 

Commissioner Everson. I certainly will and I appreciate your 

raising the question. 

Senator WYDEN. Great. One last question, and I appreciate the 

Chairman’s indulgence on this. 

As both Chairman Conrad and Senator Grassley know—Senator 

Whitehouse has not gone through it—we have gone through a long 

debate about the question of Internet taxation. And what I and others have tried to do, and it is awfully arcane kind of stuff, is to say 

what we want to do is make sure that what applies off-line applies 

online. In other words, we would have neutrality. Nobody gets any 

breaks. Everybody is treated the same. 

You all have been thrashing through this whole question of the 

auctions and brokers and the like. And there are some parts of the 

President’s budget that raise questions in my mind with respect to 

making sure that there still is this nondiscrimination approach, as 

it relates to the technology companies. 


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The President’s proposal, for example, requires reporting by brokers to the IRS. That strikes me as a constructive idea, as it will 

help in preventing tax cheats from getting away with their cheating and in closing the gap. 

However, I am concerned that even though they are a broker 

under what is now the definition of a broker, the Joint Tax definition, that some may be trying to change the definition of a broker 

that could impact a variety of our technology companies. 

Can you tell us your desires in this area? And particularly, I 

know it is hard to go through all of the details in a short exchange 

like this, your commitment to try to keep technological neutrality. 

We should not be favoring the on-line world. We should not be 

hurting the off-line world. What we have been trying to do is keep 

it in balance. Your thoughts. 

Commissioner Everson. I am happy to get back to you in more 

detail on that, but my understanding of that proposal is that it 

does just what you have said, sir, which is it is neutral. The idea 

here is to sweep in brokers who hit a certain volume of activity. 

We do not want to burden somebody who is running a business—

it could be a physical business or otherwise—where it is not even 

a business, let’s say. 

But if you are doing a real business and that is how you make 

your money, we want some reporting on it after you reach a certain 

trip line of volumes. The physical versus Internet piece is not, as 

I understand, a determining factor at all. So I think we are in the 

same place. 

Senator WYDEN. Mr. Chairman, thank you for the extra time. 

Chairman CONRAD. I want to go back over. 

Senator GRASSLEY. Mr. Chairman, would I be able to get 5 minutes before 11:30? 

Chairman CONRAD. Sure. 

Senator GRASSLEY. Thank you. 

Chairman CONRAD. Last year you testified before this committee—and Senator Gregg asked you this question: Let us say we 

were to take this number, $137 million, the President has asked for 

and double it. Could we presume that our return on that would be 

five times, 10 times? I mean, how would we—what, in other words, 

if we were going to offset that with receipts that we would score 

in our baseline, what would the number be that we would be considering putting in as a result? And when do we get to a diminishing return event? 

Your answer: I do not 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 billion or $100 billion without changing the way the government interacts with its citizenry. And you had indicated that that was $50 billion to $100 billion 

a year. 

Now you tell us, a year later, that all of a sudden, as I heard you say it, the most you could get is $30 billion a year. 

Commissioner Everson. I think that if there is a disconnect here, 

it is that we were always talking about this 2001 starting point, 

which is where the latest research was. And I probably, to be clearer, should have drawn out all of the stuff that we were doing. You 

413

are right, I did not make that point as to what we were already 

doing. But I was looking at the reference point, as I do now, of the 

research in we did 2001. And then you get into that zone, as I have 

indicated. 

I probably was not as clear as I could have been, Senator. Because that is where the number came from. The number came from 

2001 and the work we did based on that point in time. 

Chairman CONRAD. By 2001, we have two moving pieces here. 

We have 2001. If that is your base, is it your conclusion that the 

tax gap did not grow between 2001 and 2006? 

Commissioner Everson. I believe we have made progress on the 

tax gap but obviously the tax gap—if all else was held equal, there 

were no changes—the tax gap would grow simply because the economy grew and the revenues grew. Whether you do it in real or 

nominal dollars, that is a different discussion. 

But obviously, it changes. It also changes, sir, because of the 

change in the—you have different compliance rates on different 

revenue streams, as you can appreciate, as well. 

Chairman CONRAD. I do. 

It still leaves me baffled. Honestly, your testimony baffles me. I 

do not know how it can be that last year we could recover $50 billion to $100 billion a year from the tax gap. And now, as I hear 

your testimony, somehow magically that has been reduced to onethird of that. 

When I look at the record on collections between 2005 and 2006 

from enforcement, it has gone up by $1.4 billion. It went from $47.3 

billion to $48.7 billion, a $1.4 billion increase. And all of a sudden 

your testimony of last year that was very strong, $50 billion to 

$100 billion, you said you can clearly reduce it by $50 billion or 

$100 billion. 

And now your testimony this year is, as I hear you say it, $30 

billion. How can that possibly be the case? 

Commissioner Everson. Again, we are now talking about a high- er number than I actually gave. Senator Gregg picked $30 billion. 

I did not pick $30 billion. 

But again, it depends on your starting point, sir. I think that if 

you take a look at this, you talked about the revenue recovery since 

2003. We have had this discussion, revenues have increased by 

over $600 billion. I think tax administration has played a part in 

that and stronger enforcement has contributed to that increase. 

I do not want to try to be overly precise, but I do not think we 

are just starting from ground zero today. 

Chairman CONRAD. I know but this is testimony—Mr. Everson, 

this is testimony you gave this committee last year. 

Commissioner Everson. Yes, and I did not say starting from 

today. Perhaps I failed to be clear. I was always looking at the context of 2001. And I am sorry if that was not clear or I did not fully 

get that out. We have not been just sitting here. We have done 

quite a bit, as you know. 

Chairman CONRAD. That is not my point. 

Commissioner Everson. I understand. It is a different expectation. I understand. 

Chairman CONRAD. My point is last year you testified very clearly before this committee and you said you can clearly—your 

414

words—you can clearly reduce it by $50 billion or $100 billion a 

year. 

And now 1 year later, after a very modest increase in enforcement, actual collections, now you are all of a sudden at less than 

one-third. 

Commissioner Everson. I do not think that is what I am saying 

at all. I am saying we are getting well over that. And if we did the 

research, we are going to start doing our research now. 

Chairman CONRAD. All I can say is that is the most magical 1-

year performance in history of tax administration. 

Commissioner Everson. I did not say what the tax gap was. I 

never said what the tax gap was, sitting here a year ago. We are 

talking about 2001, sir. 

Chairman CONRAD. Well, what you told us was—I do not know 

any other way to interpret your testimony, sir. Last year you told 

us very clearly—in fact your words—you can clearly reduce it by 

$50 billion or $100 billion a year. 

Commissioner Everson. And I think we will have done that. 

When we next do the measurement, we will have seen that. 

Chairman CONRAD. Based on 1 year of increasing collections by 

$1 billion? 

Commissioner Everson. What we talked about before, all of what 

has been done since 2001. 

Chairman CONRAD. I will tell you, it is not credible with me. I 

am a tax administrator. We have a tax gap, I believe, conservatively $300 billion a year, I believe conservatively. Because that 

is based on 2001. There is no way the tax gap has not gotten bigger 

given the aggressive nature of accounting today and given the 

growth of the economy. There is no way that it is not more than 

$300 billion. 

Commissioner Everson. Let me say this, too. 

Chairman CONRAD. And to say we can only collect $30 billion of 

that? 

Commissioner Everson. Let me be clear, too. I do not want a 

fixed point so that if we are here a year from now we have a similar conversation. The tax gap will, again absent these mixed factors, if you just take the gap as a percentage of the overall revenue 

stream, that will continue to grow. 

What we are talking about—and you have that baked into your 

budget projections anyway. That is baked into your budget projections, the continuing growth in the tax gap. What I am talking about with the $50 billion or the $100 billion, 

was at any point bringing that down relative to where it would otherwise have been. So you have to consider all of those factors, the 

growth and then the onset, which is real progress as a percentage 

of the total revenue stream. 

Chairman CONRAD. Are you saying to us that you can only recover 10 percent of the tax gap in a year? 

Commissioner Everson. I do not think that is what we have said, 

at all. I think that what we said—

Chairman CONRAD. What percentage—let me ask you that way. 

What percentage of the tax gap over time, if Congress goes along 

with your proposals, can you close? What percentage of it? 

Commissioner Everson. Starting from here. 

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Chairman CONRAD. Yes. 

Commissioner Everson. Starting from here—

Chairman CONRAD. And what do you think the tax gap is starting from here? 

Commissioner Everson. I do not have a precise number now. 

What I have said to you is if you look, coming back from that starting point, the $345 billion, we have done two things. We have made 

improvement through the recoveries, which is the extra $15 billion 

in direct moneys since 2001. And that recovery also has an indirect 

impact. So I am hopeful that if you measured today, did the same 

work, you would see some improvement in there. I think it gets toward—and again, I caution against real precision here. That was 

a pretty wide range—I think it gets toward the lower end of that 

range that we talked about last year. 

If you now look going forward and you look at three things: the 

direct impact from the enforcement and the indirect impact that 

you are talking about in the budget; the legislative proposals; and 

the other point that Senator Gregg made that I did not draw out 

as precisely as I could have, the normal growth in our 

enforcementactivities. 

Let us say if you take that at just 2 percent a year, you would 

expect, running a business, to get more productivity out of the business even with just a steady investment stream. If you just hold 

us to 2 percent a year there, then the impact of that is growth in 

that direct enforcement number as well. 

So all of those things together, they mix up and they get to a 

number somewhere near what Senator Gregg was talking about. 

Chairman CONRAD. So let me ask you, what is your testimony 

today? Last year you told us $50 billion to $100 billion a year. 

What is your testimony today? 

Commissioner Everson. I will try to be as clear as I can and not 

over-promise the committee, because if I did that last year, if I was 

not clear enough saying looking at where we were in 2001, I apologize for that. 

I think that if you look at these three things that I am mentioning—giving us the more money on both the infrastructure and 

the enforcement side, that basket of proposals, and the normal 

growth—I think that you are going to get a pop up by 2010 that 

might be somewhere around $20 billion, something like that. That 

is how I would bracket these things. 

The numbers you have in the detailed budget submissions, they 

will tell you that we get $700 million on the enforcement initiatives 

and it would tell you that by 2010 you get $3.5 billion on the legislative proposals, if you do all of them. And I would say if you take 

the indirect effect of the productivity and the growth and the enforcement initiatives, that would account for the bulk that would 

get you toward—somewhere toward over $20 billion. 

But again, these things all work together. I want to say, if we 

sit here next year or Senator Baucus is quizzing me, as Senator 

Grassley knows, ‘‘where is that money?’’ But you have not given us 

legislative proposals or you cut the budget or you say spend the 

money differently, you get to a very different answer. 

416

Chairman CONRAD. Let me just tell you, my conclusion from your 

testimony is that you are talking about recovering maybe one in 

every $30 that is in the tax gap in a year. 

Commissioner Everson. I do not read it that way, 70 out of—if 

you take—

Chairman CONRAD. But the problem is you are talking about dollars compared to a 2001 base. That is what you did apparently last 

year, your testimony this year, which I find baffling. 

The tax gap is growing. There is no question in my mind the tax gap is growing. If it was $290 billion in 2001, what is it going to 

be in 2010? It would not be unreasonable to expect it to be double 

that amount. That would be $600 billion. $600 billion and you are 

going to collect $20 billion of it, that is one-thirtieth. That is 3 percent. That is pretty tepid. 

Commissioner Everson. I do not think you are recognizing the 

progress we have already made. 

Chairman CONRAD. You have made progress. What I do not buy 

is the notion that this tax gap, even with your increased efforts, is 

not growing. The economy is growing and tax avoidance is growing. 

And anybody that is in your business that does not know or does 

not testify before this committee that there is aggressive tax avoidance going on out there is not being straight with this committee, 

in my judgment. 

Commissioner Everson. Senator, I have to take exception to that 

because that implies that I do not strongly combat aggressive tax 

avoidance. 

Chairman CONRAD. No, sir, that is not what I said. In fact, if you 

listened carefully, I commended you for what you have done. 

Commissioner Everson. I know you did. 

Chairman CONRAD. But let’s deal with reality. The reality is that 

the economy is growing. 

Commissioner Everson. I agree. 

Chairman CONRAD. The reality is global economy is growing. The 

reality is you talk to any accounting firm off the record, and you 

know it and I know it, and they will tell you that tax avoidance 

is growing and it is growing dramatically. 

When we have 12,000 companies doing business out of a fivestory building in the Cayman Islands and they all say they are 

doing business down there look, I know better. I have been a tax 

administrator. I have audited the books and records. And I have 

talked to people who I trust in the accounting profession. This kind 

of scam is doing nothing but growing. 

That is not a comment on you, it is a comment on reality. 

Commissioner Everson. Let me take one final pass at this and 

then I will retreat. 

As Senator Grassley knows—he had a hearing last June—some 

of the issues get beyond what would be, Senator, in the tax gap 

itself. There is a lot of aggressive tax planning and what we called 

tax arbitrage. That is not captured in this tax gap. That is the use 

by sophisticated players to generate excess foreign tax credits or to 

take advantage of the difference between debt and equity, the 

treatment under the law between different countries. 

That is not captured in the tax gap. But it can be at variance—

and I stated my real concern about it—with the intent of what you 

417

pass in Congress. You can end up in a situation where a big company will end up paying tax neither here nor in the United Kingdom, as an example. 

We are aggressively working on that. But it is a very tough line 

between what is legal and what is not. 

Chairman CONRAD. Let me just say, we have had testimony before this committee on just that area. And people who are experts 

in this area sat at that table and testified that that area is burgeoning with the global economy. 

Commissioner Everson. I agree with that. 

Chairman CONRAD. And that is not even captured—

Commissioner Everson. It is not captured. 

Chairman CONRAD [continuing]. In the tax gap. But I will tell 

you, that is not an area that I think involves hundreds of billions 

of dollars, hundreds of billions of dollars that is—not in a single 

year, but that is being avoided and evaded. 

I have personally audited the books and records of large multinationals. I mean, I have followed them offshore. I have seen their 

books and records. I have seen what they were doing to dodge what 

they legitimately owe. 

And the notion that we can only do $20 billion a year more in 

collection leaves me cold. I will tell you that. 

Senator GRASSLEY. Senator GRASSLEY. Thank you very much. 

I think that the Chairman has brought up, in regard to that 

international economy, a good point. I think it is something that 

he and I been working on trying to change the law, to some extent, 

to close those. We have a long ways to go. But we have done some 

of that in the case of the shell corporations, as an example, in Bermuda. We have even some of it for ex-patriots in our small business tax bill on the minimum wage bill. 

This first question is only because of the discussion you had with 

Senator Conrad, and it is not to combat anything Senator Conrad 

said. But when you come to estimating tax gap, isn’t it true that 

like any other estimate it is a guide for us as policymakers? 

Would you say that the estimate is as precise as what Joint Tax 

Committee might have for a specific legislative proposal? It surely 

cannot be as precise. So when you are talking about a tax gap, and 

there is a lot of taxes that are not being paid, but it could be $10 

billion plus or minus, or it could be $50 billion plus or minus, could 

it not? 

Commissioner Everson. You are entirely correct. We use the research for directional purposes and, when we get down to the level 

of specificity, to update our audit models. 

The other thing though, Senator, as you know, is we try to run 

a balanced system. If you only made decisions based on just what 

is easiest or maybe most profitable, you would beat the bejesus out 

of the middle class and go after some things like more document 

matching. 

Senator GRASSLEY. I think that the Chairman might be right in 

trying to pin you down on what you can get from enforcement. But 

the biggest part of what we are after in the tax gap is going to take 

place in these changes in the laws, of which you suggested and the 

Administration is suggesting is five. They suggested X number last 

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time and we did not do anything about it. So it is not your fault, 

it is Congress’s fault, if we are going to close the tax cap as much 

as we should. 

Now those are things that Senator Conrad and I have to work 

on.

My third point would be just a comment on where I left off with 

you on the sixth question, where you spoke very positively about 

the need for private debt collection. Because we have this anomaly 

now. You are trying to institute something we told you to institute 

and you see it as being, at least initially, as a good thing. 

For instance, we hear about creating good jobs in rural America. 

There is a company in my State that is doing one of these and it 

has good paying jobs. 

They are also, it seems to me, trying to help us close the tax gap. 

It is part of it. And you have this ironic situation where people are 

complaining about not having enough good paying jobs in the private sector and about closing the tax gap. And then they want to 

shut down these private debt collection agencies. So I am going to 

keep making that point as people move forward to do this. 

I do not think you have backed off any that these are very helpful toward closing the tax gap. 

Commissioner Everson. We appreciate your support of that program and I have been clear on this—Congress asked us to do this. 

It is not a question, in my view, of whether it would be cheaper 

if the Government did it. First of all, we cannot, as I indicated, do 

it in the next several years unless we had a lot more personnel. 

It is a question of getting money that we would not otherwise 

get. So that is correct, Senator. 

Senator GRASSLEY. Then, following up on the reference to the 

culture of tax compliance, and Senator Conrad made a good point. 

I would like to raise a couple of points for you to comment on. 

One, I would agree that in the late 1990’s and early part of the 

decade, this decade, there was an out-of-control culture of noncompliance. However, due to the bipartisan anti-tax shelter legislation that we have done through the Finance Committee and 

through enforcement, we have changed that culture. Now there is 

a lot more, of course, we can do. We have proposals in the Senate 

version of the minimum wage bill that I have already made reference to. 

Do you see any reason for delaying action on these compliance 

measures? 

Commissioner Everson. Senator, I do not want to comment on 

the pending legislation. 

Senator GRASSLEY. Could you comment just on the compliance 

measures, not on the process—

Commissioner Everson. The compliance measures are always important. We do want the Congress to act on tax administration 

issues as a general matter. I really do not want to go further than 

that. 

But can I respond to one thing you just said though, it gets back 

to Senator Conrad? I do want to say that I believe—and Senator 

Conrad I would draw out this point, because I do not think I responded to your observation about the change in culture that SenVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00866 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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ator Grassley is talking about now—I do believe that while there 

are these challenges, particularly in the area of international and 

globalization and tax arbitrage, that the companies, the bigger 

companies have pulled back considerably from the blatant noncompliance which we have drifted to. It is not just the IRS, it is 

largely Sarbanes-Oxley and a series of other things. 

So I agree with you, Senator Grassley, it is a whole series of 

things, in part what the Congress has done. 

Senator GRASSLEY. You just brought up Sarbanes-Oxley. Would 

you agree that that has somewhat changed the culture in large corporations and there is probably more we can do in that area, particularly in the economic substance area as well, because there is 

uncertainty and inconsistency in how the courts apply the substance doctrine to a greater extent. 

In fact I think there was a case that was just decided in the District Court level that the IRS won on some economic substance 

grounds, but lost on the penalty issues. 

Commissioner Everson. Yes, in Texas, I believe. 

Senator GRASSLEY. We have a responsibility to clarify it. But you 

know, it is very difficult to get some of that stuff through. Maybe 

the changed climate here would do it. But Sarbanes-Oxley has 

probably helped that to some extent? 

Commissioner Everson. I think Sarbanes-Oxley has had a positive impact on the corporate tax compliance. 

Senator GRASSLEY. Mr. Chairman, that is the end of my questioning. 

Chairman CONRAD. Thank you, Senator Grassley. 

I want to go back at this because honestly your testimony here 

today is among the most baffling I have ever confronted. It really 

baffles me. Last year you testify to this committee—let’s put that 

up. Let’s put up the quote. This is what you told us. You can clearly reduce the tax gap by $50 billion or $100 billion without changing the way the Government interacts with its citizenry. Now this year your testimony is you are down to $20 billion. 

I look at your chart. I look at—we do not have 2007 data obviously, but we have hard numbers from you that your direct enforcement revenue from 2005 to 2006 went up by $1.4 billion. You 

say on this indirect compliance effect, which is a multiplier on what 

you are actually doing, I do not know what you have to back up 

this multiplier. I have never seen such a thing applied, frankly. I 

have always looked at direct dollars. 

How much did you increase, dollars in the door, by enforcement? 

Your chart shows 2005, $13.5 billion; 2006 $14.9 billion. That is a 

$1.4 billion increase. That is about a 10 percent increase year over 

year. 

And yet last year you testified before the committee, as I have 

indicated, that we could recover $50 billion to $100 billion a year. 

Now it is $20 billion. How can that be? How do you reconcile that? 

Commissioner Everson. Again, I think we talked past each other 

and I clearly was not as precise as I should have been, saying we 

were starting at that gap in 2001. And the next time you measure 

that—

Chairman CONRAD. But that makes no sense. 

Commissioner Everson. It may make no sense and perhaps—

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Chairman CONRAD. 2001 is the last time you have data for what 

the tax gap is. 

Commissioner Everson. I am sorry? That is the last time, yes. 

Chairman CONRAD. The only relevance of 2001 is that your agency’s estimate of the tax gap was based on 2001 data. That is the 

only relevance of 2001. You were not testifying last year on something other than where we were last year. Where we were last year 

was what you were doing in compliance, what you were doing in 

enforcement, and what could be recovered if we did a better job and 

if we gave you more resources and we did the other legislative proposals that were before us. 

So I honestly do not know how $50 billion to $100 billion turns 

into $20 billion with the only evidence of actual direct enforcement 

revenue increase is $1.4 billion. How is that possible? 

Commissioner Everson. Again, I think we are measuring from 

different starting points. Senator, the only way this will be resolved 

is, as we get, presumably, this money and do more research, we 

will see whether the compliance rate is better. And then you measure that against all of what we talked about, including the size of 

the economy. If you assumed a stable rate on all those streams, did 

we make that improvement? 

Chairman CONRAD. How much money do you collect a year in 

revenue? 

Commissioner Everson. $2.4 trillion is what we took in last year. 

Chairman CONRAD. $2.4 trillion? 

Commissioner Everson. Yes. 

Chairman CONRAD. In a future year you can do $20 billion more, 

that is what you are telling us? 

Commissioner Everson. Just in a couple of years from now. 

Chairman CONRAD. In a couple of years from now, when you will 

probably be collecting $2.5 trillion, you are going to collect $20 billion more? 

Commissioner Everson. Again, this goes back to several points. 

Chairman CONRAD. What is that as a percentage? 

Commissioner Everson. I guess that is right. This is maybe a better place to have the conversation, going forward, let us talk about 

that. I think, that is a better place to be. 

First, there is a limit, again, on how much we can add into this 

capacity of the service. 

Chairman CONRAD. Tell me how much is $20 billion of $2.5 trillion? 

Commissioner Everson. It’s about 1 percent, a little bit below 1 

percent. 

Chairman CONRAD. Less than 1 percent, about 0.8 percent. 

So you are telling me that the best that you can do is to increase 

this by 0.8 percent? 

Commissioner Everson. Well, 0.8 percent on total revenue is a 

pretty big move. Let’s assume, just for this argument, that you 

take my side for just a minute and you say all right, maybe—

Chairman CONRAD. I have been on your side. That is why I find 

this—

Commissioner Everson. I know you are. 

421

What we are trying to do here is positive. We are trying to set 

expectations. And I apologize for any part I have played resulting 

in higher expectations. But if you look at that—

Chairman CONRAD. I will tell you, without higher expectations 

we do not accomplish anything. 

Commissioner Everson. Fair enough. 

Chairman CONRAD. That is a problem with this town, nobody 

wants to go on the line to accomplish anything. It is unbelievable 

the way this town is about reducing expectations so they do not 

have to produce. 

Commissioner Everson. Let me say, though, that if you looked at 

this noncompliance rate before our recoveries, and that was based 

on the 2001 research of overall 16.3 percent, if you follow me. It 

was like 83.7 percent is the overall, if you look at the mix. And just 

take broad numbers. 

Let us assume $20 billion, more or less. That would be, if you 

add the $20 billion to the $50 billion. If you assume that I am directionally correct, you are more or less somewhere in that ballpark. That would be a 3 or 3.5 percent reduction of the 16 percent. 

That would be cutting that noncompliance rate by maybe 20 percent. That is a big move in a big complicated system. 

And I cannot tell you sitting here, with all of the factors like you 

have talked about and—

Chairman CONRAD. Let me just tell you what I do not believe. 

I do not believe the tax gap was static between 2001 and 2006. Do 

you? 

Commissioner Everson. I do not believe it was static. I agree that 

there were a lot of factors in there. That is why I do not want to 

be overly precise. But I believe that we have made some progress. 

Chairman CONRAD. Just notionally, did the tax gap grow between 2001 and 2006? 

Commissioner Everson. It clearly would have grown because of 

economic activity—

Chairman CONRAD. Not only because of economic activity but 

your own testimony shows compliance dropped. Yes, 2003 was a 

low point according to your charts. 

Commissioner Everson. Yes, and then it has recovered significantly, yes. 

Chairman CONRAD. Right. 

Commissioner Everson. If you compare 2001, look at the delta on 

these numbers here, the 2001 versus 2006. That is up $15 billion. 

That is not up the $1 billion you were talking about. It is up $15 

billion. And that is what I am talking about. 

Again, these are very fair points to debate. We believe there is 

an indirect impact. I believe that is real. I think that the problems 

that Senator Gregg was talking about before, of the economy with 

the recession and 9/11, I think those were compounded by the IRS 

drawing down its resources in that period. 

Chairman CONRAD. When you show—the $1 billion I am talking 

about is from your chart. 

Commissioner Everson. Yes, the difference in one—just 1 year—

that chart is derivative of that chart there. 

Chairman CONRAD. And that is direct enforcement revenue. 

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Commissioner Everson. That comes right off of that number 

there. 

Chairman CONRAD. So I am using your numbers when I talk 

about direct enforcement revenue went up from $13.5 billion to 

$14.9 billion. 

Commissioner Everson. Right. 

Chairman CONRAD. Let me ask you a broader question because 

we have this whole area that you have acknowledged is not captured in the tax gap at all. It is not in the tax gap calculations. 

And it is the amount of money that is flowing through these international entities to avoid taxes not only in this country but to avoid 

them up right around the world. 

And we see, I see, and when I talk to people in the accounting 

profession, they tell me this is exploding. And that is not captured 

in the tax gap at all; is that correct? 

Commissioner Everson. There is a lot in what you just said. And 

portions of it, I would suggest, are captured and portions are not. 

Let us go to the tax gap map. 

The first thing I would tell you is we did not update our research 

on corporations in the 2001 study. And that is a very clear soft 

spot. 

What I have said when questioned on this is that it would not 

have changed my resource allocation because we already have a 

very high audit rate on those companies, as I was talking about 

with Senator Wyden. 

But I believe undoubtedly that number there, the $30 billion on 

the C-Corps, was understated and significantly. But it would not 

change the relative parameters that the big piece of this gap is in 

the individuals.

Chairman CONRAD. But I am talking now about other things because tax gap is not illegal activity. 


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Commissioner Everson. That is right, and let me make a couple 

of points here. 

We have traditional areas that are very tough. Transfer pricing—

very, very tough to deal with. That would be, if you updated this—

and we are going to start to do some work on the corporations—

that would fall into this tax gap, if we assess an extra $500 million 

for a big company or something. 

The problem on updating this gets back to this long tail here. 

Just because our auditors set up $500 million, how do you say 

what the real noncompliance is? Because by the time you are done 

it has gone through an appeals process in the courts, it might be 

$200 million. So it takes a long time to be precise. 

Chairman CONRAD. Believe me, I know how all that works. 

Commissioner Everson. But let me give you the other piece because it is real. Arbitrage and all the other things that take this 

line as to whether it is in this complicated code or past it, that line 

is constantly challenged by all the intermediaries. 

Now I do not want to give the impression that we are not trying 

to address it. I testified to Senator Grassley about what the big 

issues are, one of them being this arbitrage. We are addressing it 

aggressively. 

We started something called the Joint International Tax Shelter 

Information Center. It is here in Washington. It is a partnership 

between the United States, the United Kingdom, Canada, and Australia. It is working on these kind of transactions. We have been 

too slow at working on complicated transactions. 

I chair an OECD group of tax administrators, and we had a 

forum in Seoul, a meeting of some three dozen countries. That 

group is concerned about this. We have commissioned a study—

Chairman CONRAD. Why was this group formed? 

Commissioner Everson. The OECD group of tax commissioners? 

To share information. And then we put a finer point—

Chairman CONRAD. But why to share information? What are you 

concerned about? 

Commissioner Everson. We are concerned about just what you 

are getting after. What are the best practices? What is happening 

in most countries? 

Chairman CONRAD. Most of this is not included in the tax gap 

calculation? 

Commissioner Everson. I am sorry? 

Chairman CONRAD. Most of this would not be included in the tax 

gap calculations? 

Commissioner Everson. Again, some would, but much would not. 

If you are dealing in the tax arbitrage area, much would not be. 

Chairman CONRAD. Let me ask you, why do you think—here is 

this building in the Cayman Islands, a nice-looking building, a fivestory building. Why do you think 12,000 companies call that building home? Do they just like the weather down there? Are they 

down there to golf? Why do you think they got—

Commissioner Everson. I have never been to the Cayman Islands, sir. 

Chairman CONRAD. What do you think 12,000 companies call 

that building home? Do you think it has anything to do with taxes? 

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Commissioner Everson. I am with you on this. The tax havens 

are a real problem. We do our best on this but this is an area that 

is an extremely difficult enforcement challenge for us. 

Chairman CONRAD. Is this captured in the tax gap? 

Commissioner Everson. A good bit of that would not be. We do 

include it if we do some high income audits and we pick something 

up on an individual and unravel something then you might be in 

there. But I would suggest a lot of it we are missing. 

Chairman CONRAD. I will tell you something, I was just down in 

the Bahamas a few months ago. Boy, it was very interesting to 

read the pitch that they were making to people who might invest 

there and live there, very interesting. The big pitch was on taxes. 

Commissioner Everson. Right. 

Chairman CONRAD. You know, one of the biggest creditors of the 

United States now are the so-called Caribbean Banking Centers. 

Did you know that? We owe the Caribbean Banking Centers, as a 

Nation, about $100 billion. They are places like the Cayman Islands, the Bahamas. 

How do they have all this money? I think we can probably figure 

out where some of it is coming from. But a lot of it is illegal activity. Drug dealers are funneling funds through these operations because they do not have to reveal anything or they reveal very little. 

And then you have operations like this, where you have thousands of companies claiming they are doing business out of this 

building. They are not doing any business out of this building. 

They are engaged in a tax dodge because the Cayman Islands has 

a very favorable tax structure. That is what is really going on. 

We need your help in how we go after this. So what do we do 

to go after this kind of thing? 

Commissioner Everson. I think, sir, that supporting the budget 

will help us because we will be bringing up the enforcement resources and the infrastructure. 

Let me say something that we did that does not get to these Caymans—I do not want to confuse the issues—but it really makes a 

big change. When we mandated the electronic filing for corporations, which I did at the end of 2004 for the biggest outfits, this 

is going to make a sea change in our ability to do analysis. A lot 

of this is that there is too much potential information and because 

of complexity and everything else how do you sift through it? 

Now what we are going to do with all of this stuff that is coming 

in online now, starting with the last few months, we are going to 

be able to do much more sophisticated analysis and risk assessment that will help the compliant taxpayer. I do want you to know 

I do not think there is lot legitimate tax planning in the international arena. Cooperation is very important to the growth of our 

economy. It is good for America. 

Chairman CONRAD. I do not dispute that but I am talking here 

about abusive—I am talking about—

Commissioner Everson. This is really tough to get at and we are 

working with other countries to try and have joint approaches. But 

some of this gets into, obviously, the conduct of tax haven countries 

and the laws they set up. And then our ability to understand what 

is going on over there is quite limited. 

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Chairman CONRAD. Let me just tell you, a case I was involved 

with when I was the tax commissioner and it involved the Cayman 

Islands. I found a major company that was reporting virtually no 

profits anywhere in the United States. But they got down to the 

Cayman Islands and they reported $20 million with one employee, 

$20 million in profits with one employee. 

And of course, they paid no taxes to the Caymans either. So they 

structured their business to report no profits in any of their subsidiaries in the United States. They get to the Cayman Islands, all 

of a sudden they make $20 million where conveniently there are 

no taxes. 

I know what is going on and there is a lot of this going on and 

we have to go after it. 

Commissioner Everson. Yes, I agree with you 100 percent. 

Chairman CONRAD. The question is let us say you collect $2.4 

trillion this year. By 2010 you will be $2.5 trillion, probably more 

than that. And you are telling us you can do better by $20 billion. 

That is 0.8 percent. We have to do better than that. And you have 

to help us understand how we could do better than that. 

What could we do to do better than that? 

Commissioner Everson. What I would suggest to you, Senator, 

and I know Secretary Paulson feels the same way, we will work 

and review ideas that the Congress puts forward on all of these 

areas. What we are asking you to do now, meager as you might 

characterize these representations—

Chairman CONRAD. I accept that. I have your message on that. 

Let us do that. But you have to tell us—

Commissioner Everson. Let us do those and then let us see what 

wlse we can stomach. Because for what is more intrusive on the 

reporting or the withholding, these get to things that will be difficult.

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Chairman CONRAD. And I understand that. I will tell you something, what is outrageous is the vast majority of Americans pay 

what they owe. The vast majority of companies pay what they owe. 

But we have a growing group that does not. And we cannot permit 

that. Obviously there is always going to be some tax gap. No system is going to be 100 percent. We understand that. 

But just so people who are listening to this understand, the difference between 0.8 percent on an improvement on collection and 

say going to 4 percent is the difference between $20 billion and 

$100 billion a year. It is the difference between all the rest of us 

who pay what we owe having to pay more to cover for those who 

are not. 

I will tell you this is one thing that outrages me. This kind of 

scam, this outrages me, 12,000 companies saying they are doing 

business out of this building. Excuse me? That is outrageous and 

unacceptable and they ought to know we are coming after them. 

Commissioner Everson. It does not even look like there is a 

McDonald’s or a retail business in there. 

Chairman CONRAD. No, I do not think—you know 12,748 companies, it is amazing how efficient that building is. It is probably the 

most efficient building in the world. Probably the most profitable 

building in the world, because they are scamming. And that just 

cannot be allowed to continue. 

We, again, appreciate your testimony and we will close the hearing. 

[Whereupon, at 11:54 a.m., the committee was adjourned.]


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ADDITIONAL MATERIALS SUBMITTED BY SENATOR 

WHITEHOUSE


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ANSWERS TO QUESTIONS SUBMITTED


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THE PRESIDENT’S DEFENSE BUDGET REQUEST FOR FISCAL YEAR 2008 AND WAR 

COSTS 

THURSDAY, MARCH 1, 2007

UNITED STATES SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

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

SD–608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of the committee, presiding. 

Present: Senators Conrad, Lautenberg, Nelson, Menendez, 

Gregg, and Allard. 

Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 

Staff Director for the Minority. 

OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

Chairman CONRAD. The committee will come to order. I would 

like to welcome everyone to today’s Budget Committee hearing on 

the President’s defense budget and requests for additional war 

funding. Our witnesses today are Gordon England, the Deputy Secretary of Defense; Admiral John Giambastiani—I hope I pronounced that right. 

Admiral GIAMBASTIANI. He did great, sir, thank you. 

Chairman CONRAD. OK. As I have told you, my wife is Italian, 

as well. 

Vice Chairman of the Joint Chiefs of Staff. Ms. Tina Jonas, the 

Under Secretary and Comptroller of the of the Department of Defense. We appreciate very much all of you being here. 

We all know that Secretary England serves as the Chief Operating Officer of the Department of Defense and was previously the 

Secretary of the Navy. 

Our witnesses today are all dedicated public servants and we 

very much appreciate not only their service to the country but their 

being here today. 

I wanted to be clear, the Budget Committee is disappointed that 

Secretary Gates was not able to testify here. We hope that he will 

testify before this committee later this year, and the committee 

feels strongly about that issue and we want to make certain that 

that is communicated. 

The defense budget represents the single largest area of discretionary spending. Secretary Gates has acknowledged the magnitude of the President’s defense request. He recently stated ‘‘The 

truth is they represent a staggering amount of money.’’ Certainly 

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that is the case. We also want to put in context, in terms of our 

overall budget, what these costs are as a share of our gross domestic product. We will get that momentarily.

To put the defense request in some historical perspective, we can 

see that under the President’s request defense spending for 2008 

will exceed the highest levels during the cold war. We will spend 

more then at the peak of the Vietnam War or the peak of the Korean War, even after adjusting for inflation. And defense spending 

has been rising rapidly as a share of GDP, from 3 percent in 2001 

to 4.2 percent in 2008.


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Now as a share of GDP, we are not at a historic peak or anywhere close to it. So I think it is very important to understand both 

points. On a dollar basis, inflation adjusted, we are at a peak compared to those previous time periods. But as a share of GDP, we 

are nowhere close to a peak. And I think it is important for people 

to understand both of those facts.


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The costs of the war in Iraq are the major factor driving our defense expenditures higher. It is worth noting that before the Iraq 

War began, the Bush Administration suggested that this war 

would not be this costly. Here is a transcript of an interview with 

the previous Secretary of Defense on This Week With George 

Stephanopoulos. 

Stephanopoulos asked ‘‘What should the public know right now 

about what a war with Iraq would look like and what the cost 

would be?’’


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Secretary RUMSFELD. ‘‘The Office of Management and Budget estimated it would be something under $50 billion.’’

Stephanopoulos: ‘‘Outside estimates say up to $300 billion.’’

The Secretary ‘‘BALONEY.’’ well, now we know that the $300 billion cost estimate was not baloney, it was actually too low. CBO 

now estimates the war cost is approaching $532 billion. That is 

what has already been appropriated and what has been requested. 

That is, of course, on top of the regular defense budget. That brings 

the total cost of the Iraq War close to what we spent in Vietnam 

over 12 years, even adjusting for inflation.


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And that is not going to be the end of these costs. The President’s 

budget includes a request for $145 billion for 2008, a partial plug 

as they call it of $50 billion for 2009, which we do not believe is 

realistic. 

While that is more realistic than previous Bush Administration 

budgets, it is still, we believe, underestimating the likely ongoing 

costs.


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Let me stress, this is not just with respect to the war in Iraq. 

This also involves the war in Afghanistan and the overall war on 

terror. I have found many times in the press reports, they collapse 

it all down to just be the war in Iraq. That is not the case. I think 

it is very important for people to understand. Even if the war in 

Iraq were to end relatively soon we would still, in all likelihood, 

have ongoing costs certainly in Afghanistan, I believe, and in the 

ongoing war on terror. 


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Let me get into another issue that has been of concern to the 

committee, and that is the estimate of the costs of the surge—or 

whatever one terms it—with respect to putting the additional 

troops into Iraq. The Administration indicated that the cost would 

be $5.6 billion but the Congressional Budget Office estimated that 

the surge could actually cost $9 billion to $27 billion because the 

Administration was not fully accounting for the cost of all the support troops. CBO says that achieving a surge of 20,000 combat 

troops will actually require 35,000 to 48,000 total additional personnel, once you count all the support troops that are required and 

support units.

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This committee held a hearing on the issue and we found CBO’s 

analysis to be quite compelling. We would be interested in exploring that after the testimony of our witnesses today. 

Let me close with one more important point, and Senator Gregg 

and I strongly agree on this. Until this year the Administration has 

not been financing the war through the regular budget process, but 

instead through a series of supplemental appropriations bills on an 

emergency basis. We strongly urged the White House to put these 

war costs in the regular budget process. And to their credit, and 


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I think actually very much to the credit of Senator Gregg, they did 

increase quite dramatically what they put in the budget. But it is 

still done on an emergency basis, and that troubles us, in terms of 

the regular order here and having the disciplined oversight that we 

think is critically important to making certain dollars are not wasted. When we are spending over $10 billion a month, we think it 

is critically important that Congress conduct responsible oversight 

and look at all of our fiscal obligations. 

With that, I would like to turn to the distinguished ranking 

member, Senator Gregg. 

OPENING STATEMENT OF SENATOR JUDD GREGG 

Senator GREGG. Thank you, Mr. Chairman, and we thank the 

panel for appearing today. Thank you, Admiral, and thank the Secretary and Comptroller Jonas for taking the time to go before the 

Budget Committee. 

Yesterday or the day before yesterday we had the Chairman of 

the Joint Chiefs and the Secretary of Defense before the Appropriations Committee. A lot of interesting issues were raised but I think 

there are points which need to be addressed here which I would 

like to highlight and then hopefully we can get into them in more 

specifics. 

The first I will pick up, not necessarily in order of priority, but 

first picking up on the last statement by the Chairman, is the continued financing of the war in a manner which is outside the budget process. Declaring the funding for the war to be an emergency 

is really no longer a defensible position, because clearly we know 

we have these costs and obligation in this war now, after 5 years. 

And we certainly understand that we are going to be engaged in 

it for some time to come. And these costs should be predictable to 

a large extent. To the extent they are not predictable, they would 

be at the margin and could come up in an emergency supplemental. But the vast majority of the costs are clearly predictable. 

So these should not come forward as an emergency supplemental. I do not have any problem with them coming forward in 

what I call a ‘‘sidecar’’, where they are essentially not folded into 

the base of the basic defense budget, the war costs, and I do not 

think they should be. Because hopefully two or three or 4 years 

from now, when we are disengaged completely, hopefully, from Iraq 

we do not want to have to sift these accounts out. But they should 

no longer be declared an emergency and, in my opinion, the emergency designation should be stripped from the supplemental. 

Also the supplemental process, the emergency supplemental 

process, is being used to shield spending which is clearly not part 

of the war effort, in my opinion, and is being used as a way, because money is fungible, to basically bump up the base budget and 

put accounts into the emergency exercise which should be properly 

reviewed as part of the basic defense budget. 

I would take, for example, in the supplemental we have pending 

before us, there is an Osprey proposed which is not part of this war 

effort, will not be on line in time for the war effort. There are five 

C–130Js, which again probably will not even get to the theater. 

There are eight E–18 Growlers. There is a permanent force structure increase which again, is not part of the war effort. It is part 

452

of reorganizing the core element of the Marines, clearly. And there 

are even two Joint Strike Fighters in this budget, in the supplemental. They will not even be completed until 2013. 

I suppose it is human nature, when you have a vehicle moving 

you know you are going to get through, to try to load it up. Regrettably, some of my colleagues are throwing baggage on this train 

which has nothing to do with the war effort or emergencies, also. 

But it is one of the problems of sending this up through an emergency process. 

Those programs that I just outlined should go through the authorizing process, should go through the authorizing committee and 

then come to the Appropriations Committee in the regular order. 

They should not be set outside the process. So that concerns me. 

Those are concerns of significance, but I think the bigger concern 

is where our costs of defense are going. There is no question that 

the first responsibility of a government, especially our government, 

is to defend our Nation. We have an obligation. But we are seeing 

an explosion of cost here in the core defense budget which is very 

significant, and that is not necessarily related to the war effort. Or 

if it is related to the war effort, then it is projecting the war effort 

to go on for a lot longer than I hope it will go on, relative to the 

Iraq situation. 

For example, the Select Acquisition Report, which basically reflects what the Defense Department needs to buy, in 2001 was projecting weapons systems that would cost us about $790 billion. The 

Select Acquisition Report for 2005 is projecting acquisition costs of 

$1.5 trillion. So it has more than doubled in 4 years. That is a big 

jump. One wonders whether we can afford that sort of pace of expansion in those types of accounts. 

There are other issues which concern me. In the statement from 

the Secretary today, the statement is made that Iran, North Korea, 

and China, in different ways, are currently the most worrisome 

concerns. In my opinion, al Qaeda is the most worrisome concern, 

and the threat of a terrorist attack on American soil using a weapon of mass distraction is our greatest threat. These other nations 

are obviously significant concerns, and certainly a nuclear Iran is 

a very significant concern. 

But it does seem to me that if the mentality of the defense structure is that we are basically focused, as our primary concern, on 

those three nations in the traditional war fighting balance of power 

structure, that we are missing the point that we are now engaged 

in an entirely different world where boots on the ground do not 

necessarily win the fight. Intelligence and the capacity to find the 

people before they attack us wins the fight. The people who want 

to attack us are not organized in nation-states, they are just very 

organized as religious fanatics. 

And so I am interested in knowing how the Department of Defense reviews the balance between those two issues of confronting 

nation-states and confronting a very orchestrated, very large, religiously fanatically—a group of religious fanatics who believe genuinely that they should destroy our Nation and our culture. 

These are just some questions I have and I look forward to hearing from the Secretary on these. But let me end my statement by 

saying that I greatly admire the service that you folks give our NaVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00900 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
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tion. I think we all do, obviously. We appreciate it. We know you 

are in difficult times and having tremendous stress on you, as individuals, and obviously on the people you serve with who are in 

harm’s way. And we thank you their service and your service. 

Chairman CONRAD. Thank you, Senator Gregg. 

Secretary England, why don’t you proceed with your testimony. 

STATEMENT OF HONORABLE GORDON ENGLAND, DEPUTY 

SECRETARY, DEPARTMENT OF DEFENSE, ACCOMPANIED BY 

ADMIRAL EDMUND P. GIAMBASTIANI, JR., VICE CHAIRMAN, 

JOINT CHIEFS OF STAFF, DEPARTMENT OF DEFENSE, AND 

TINA JONAS, UNDER SECRETARY OF DEFENSE (COMPTROLLER), DEPARTMENT OF DEFENSE 

Mr. ENGLAND. Mr. Chairman, thank you very much. Senator 

Gregg, thank you for the comments. 

We do have a written statement which has been turned in and 

I am just going to make a few comments because I would much 

rather discuss what is on your mind. 

Mr. Chairman, I am sorry the Secretary is not here. You sort of 

have the backup quarterback today. But hopefully I can provide 

some useful information for you that will help in your deliberations 

and certainly we will try to do so. 

I would comment, first, lots of views about America and our defense of America. But I do know this. Everybody knows that we 

need to protect and defend our freedoms and our liberty. So while 

people may have different views on how to do that, I am encouraged that everybody is debating the core about how is the best way 

to do that. And we do that to the very best we can. And we are 

blessed, as you said, to have these magnificent men and women 

who serve our Nation every day. 

My job and the job at the other people in the Department of Defense is to provide them the equipment and the training and everything they need to carry out that mission for America. 

I am pleased to have my good friends and coworkers with me, 

the Vice Chairman, Ed Giambastiani, Admiral Giambastiani; and 

also the Comptroller, Ms. Tina Jonas. We work together every day, 

so hopefully we can be helpful together in providing you some information today. 

The Secretary was absolutely right, it is a staggering amount of 

money. We understand that. The total request before the Congress 

is $716 billion and it is three pieces. It is the supplemental, it is 

the 2008 base budget, and then it is also that 2008 what we called 

GWOT, which is the Global War on Terror amount. 

I understand the comment about why is it a supplemental and 

not in the base budget. Of course, that is a decision, first, of OMB, 

not the Department of Defense. But this year we did turn in with 

the 2008 budget, at the request of Congress, our best estimate of 

what the war costs would be in 2008. And I will tell you—the dilemma we are always in, and we had this discussion last year. If 

we do a supplemental, it is very near term, in terms of the estimates are much better. If we look out further they become less predictable. 

So when we put the numbers together for 2008 we basically took 

a projection of 2007. So not knowing if it goes up and down, we just 

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took where we were in 2007 and pretty much straight-lined that 

in terms of the number of troops and the cost of war. And so the 

expectation will be, frankly, that that number will change as we 

get closer and know more about what is happening on the ground. 

And it could go up or down, depending on what the situation in 

Iraq is. But it was the best we could estimate for the 2008 period. 

The 2007 supplemental, of course, is more near-term to us, so 

hopefully it has a higher degree of fidelity. 

In terms of what is in the supplemental, we provide extensive detail, more than I think we have ever provided, and as much as we 

provide for the budget itself. So we provide all of the supporting 

detail, how many thousand pages? I mean, 30,000-some pages in 

support. So we have provided a lot of information in support of it. 

And obviously we are pleased to discuss that whatever detail members of the committee would like to discuss that. 

Mr. Gregg, we do try to limit this to war costs. Your comment 

about the airplanes, I mean here again is the issue we have with 

this: we look at what has been lost as a consequence of the war 

itself or what I will call the accelerated depreciation of assets. So 

if we are flying airplanes a lot during the war and the life is getting very short on those airplanes, just like any other enterprise, 

we try to recover that depreciated cost. 

And then we buy whatever it is that we are buying. So those airplanes, a lot of what is being lost is no longer in production or 

those models are no longer available. So we buy whatever is in production. And they may not show up immediately. But if we do not 

replace them, at some point we will be short those assets. 

So this is, frankly, recovering the cost of using the assets for the 

war, whether they are lost or just being used up, recovering that 

cost and then applying them to whatever it is that is already being 

bought at that point in time. If we do not do that, then we will be 

short in the future. The war costs will eventually just consume our 

assets. So frankly, I do not see that we have any choice in how we 

do that. 

But we do religiously go through this. Our analysis people go 

through all of the war data, all of the operational rates, all of the 

burn rates, et cetera. And we only include in the supplemental 

those things that we can directly relate to the war. 

So hopefully, that is some feedback in terms of how we got to 

where we are today. 

With that, I will stop. Because frankly I would much rather discuss what is on your mind this morning. You already have our 

written statement and obviously you are quite familiar with the 

budget we submitted. 

[The prepared statement of Mr. England follows:]

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Chairman CONRAD. Thank you, Mr. Secretary. 

Let me go right to it, if I could, and first discuss the difference 

between Administration estimates of the cost of the surge and what 

CBO testified before this committee. I referenced that in my opening remarks. I talked with you about this before the hearing, that 

this would be a question. And I think it naturally flows from what 

this committee has been told. 

The original estimate that we were given from the Administration was that the surge would cost $5.6 billion. And the CBO said 


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well, it would cost a multiple of that because of additional support 

personnel. Can you give us your best estimate at this time of what 

the surge will cost? 

Mr. ENGLAND. If we can, perhaps between all three of us here 

we can bring some clarity to that. First, one of the differences, Mr. 

Chairman, is that we have costed the search through this fiscal 

year. So there is no money past 1 October in our estimate because, 

as Secretary Gates has testified, in his view we will know sometime this summer the success of that program, of the surge program. So we funded basically what we knew in terms of those requirements. So there is a significant difference there. 

Also, my understanding is the Congressional Budget Office had 

a very, very large number of support troops. And we already have 

a large number of those support troops in-theater. So while the 

number we have estimated may vary somewhat, it is not at all 

going to be in that many orders of multiples that was estimated by 

CBO. 

So I think there is just a difference in terms of the troops that 

are already there in the support arena versus added troops that 

would have to be provided. 

Ed, you may add to that, and Tina. 

Admiral GIAMBASTIANI. I think the question or the comment, 

first of all, on the length of what we had estimated out through the 

end of fiscal year 2007, so in other words through the 30th of September, there is a difference. I believe CBO was out to 2009 sometime. 

In addition, the numbers of these combat service and service support or what we would call enablers also, there is a sizable difference. We have an established and well-established logistics base 

inside and outside of the area of Iraq. And therefore, we believe 

that we will need considerably less combat service and service support than was estimated there. 

I think their numbers would be good if, in fact, we were doing 

this from a cold start. 

Chairman CONRAD. Have we got the chart that has General 

Schoomaker, is it? General Schoomaker said, on February 16th in 

testimony, that the increase of 17,500 Army combat troops represents only the tip of the iceberg, and will potentially require 

thousands of additional support troops and trainers as well as 

equipment. 

Do you disagree with General Schoomaker’s assessment that this 

is the tip of the iceberg? 

Admiral GIAMBASTIANI. I do not in that it will require some numbers of thousands of support troops. But with regard to the readiness issue, it is important for us to remember what he was saying. 

You have to get below the water level on the iceberg here to make 

sure we all understand on the readiness issue. 

If we are training simply a force for counterinsurgency, then we 

lose some of the readiness that we might otherwise do for other 

types of conflicts. For example, if we have aircraft that are flying 

all the time and doing air-to-ground missions, they lose their airto-air proficiency. So those are the types of things we are talking 

about. 

464

But remember, this surge is 21,500 plus or minus some thousands here of support troops out of 2.4 million Americans in the active component and the Reserve component. 

We have done a risk assessment and we understand that we are 

ready to meet any crisis or contingency that, frankly, we think will 

be posed to us. And the Chairman of the Joint Chiefs has signed 

out a risk assessment to the Secretary and the Congress. It is 

available to all of the defense committees in a classified form. All 

of us Joint Chiefs, myself included, have worked on that. I do not 

think this additional plus-up will change, frankly, that overall assessment that we will be ready to do our job to meet any crisis. 

What will happen is there will be some added risk with regard 

to the time it takes us to be victorious or to win and potentially 

you will have some additional casualties. But let there be no mistake, we can get our job done if another crisis comes about. 

Chairman CONRAD. Let me ask you this question because our obligation to our colleagues on this committee is to try to give them—

we are not the policymakers with respect to how the war is conducted. That is not our job. Our job is to try to give our colleagues 

as accurate a reflection as possible of what things are really going 

to cost. That is the way I see our obligation. I know there are some, 

even on this committee, who want this to be the forum for debating 

the war posture and the war policy. I do not see that as that form. 

I see our obligation as to try to give our colleagues as accurate 

an assessment is possible of the cost. 

Can you tell me how many support troops have now been requested by commanders on the ground in Iraq to support the 

surge? 

Admiral GIAMBASTIANI. What I would tell you is that right now 

we have approved requests for forces of about 2,400. 

Chairman CONRAD. But that is not my question. I am asking how 

many have actually been asked for? I am told, from my own 

sources in the Pentagon, that more than 10,000 troops have been 

requested. Is that accurate? 

Admiral GIAMBASTIANI. No, sir, it is not. What I was going to do 

is finish this off. There are 2,400 approximately that have been approved to date. And in addition, there are some additional requests 

for, I would gather, in the order of—for combat service and combat 

service support, detainee operations, these types of things—somewhere in the order of about 4,000 additional, 3,000, 4,000 that are 

there. But once again, these numbers are much lower than what 

you have seen before. And we are, inside the Joint Chiefs of Staff, 

reviewing these requests right now. 

Chairman CONRAD. Can I say this to you, and I am going to stop 

here. My time is rapidly drawing to a close. 

We are going to have to write a budget here in the next few 

weeks. We have not been given absolute assurance when our time 

will come, but it looks like probably the third week of March we 

will be on the floor with a budget. Which means this committee has 

to mark up the week before that. 

Senator Gregg and I, through our staffs, are now talking about 

that kind of a schedule. It would be very helpful to this committee 

to have the most accurate assessment that we can get. 

465

I find it a little troubling that the assessment, the numbers that have been given us before of $5.6 billion is for such a limited time, 

only until October 1st, as you describe it. It strikes me as just unlikely that this commitment would be that limited or that the costs 

would be that restricted. 

Mr. ENGLAND. If I can comment, Mr. Conrad, I believe the Secretary’s view on this is that we would know sooner rather than 

later the success of this effort in Iraq, and that we would certainly 

by this summer, his view and I believe General Petraeus’ view, is 

by this summer we would have some pretty good measures in 

terms of where we are. As far as you probably know, the Secretary 

this afternoon is briefing on the measures and measures to the 

Congress. There is a briefing this afternoon on this whole subject. 

But by this summer we would have a much better indication in 

terms of the success of the program. And so at that time we would 

adjust however is appropriate to do so. 

And I believe that is the whole concept here, is cost it through, 

get a level of confidence, see what happens and then we will adjust 

depending on what the outcome of this effort is. 

The other comment I would make is I am pleased to hear of the 

schedule because the supplemental for us will be very important by 

like the middle of April. Last year it was very difficult for us because we had to start reprogramming. That caused great problems 

for as. 

Chairman CONRAD. On that point, they are talking about doing 

the supplemental the last week of March on the floor. So that 

would be timely in terms of your deadline. 

Mr. ENGLAND. Can I go back to the surge a minute, before you—

Chairman CONRAD. Yes, absolutely. 

Mr. ENGLAND. Because I want to make sure it is clear. There is 

a war going on. And when the commanders on the ground, I mean 

things are going to happen and people are going to request troops. 

And the way that happens is it comes into the Chairman of the 

Joint Chiefs and they work this. So I would expect over a period 

of time there is going to be variations up or down. 

That said, my judgment is that the budget we have should be 

adequate to handle whatever those variations will be. Obviously, 

the $5.6 billion is an estimate itself. All of the numbers are our 

best judgment. Some are slightly over, some slightly under. I mean, 

events change. But I do believe the budget. But if the changes, we 

will definitely get back with you quickly on this matter. 

I would hope, however, that however these numbers may change, 

that we can accommodate them. If we cannot, we will definitely be 

back and talk to you. 

Admiral GIAMBASTIANI. Mr. Chairman, if I could just emphasize 

the point the Deputy Secretary made about the fact that commanders come in all the time. We meet with the Secretary as a 

minimum once a week, the Chairman and our operations people, 

changing deployment and redeployment orders constantly with new 

requests in from the field, Afghanistan, Horn of Africa, Southern 

Command, all over the world, in addition to Iraq. 

I would just tell you that we have new commanders in the field 

today. You have a new Multinational Corps Commander in Lieutenant General Odierno. You have a new General, Dave Petraeus, 

466

as you well know. You have confirmed him here recently. And he 

has only been on the ground since essentially the 10th of February. 

So it will not surprise me if these commanders come up with different requests. So we are trying to give you the best information 

we have right now. 

Chairman CONRAD. Put me down as a skeptic on the $5.6 billion. 

Senator GREGG. Senator GREGG. Thank you, Mr. Chairman. I think it is obvious the $5.6 billion is a number that is not accurate. 

Independent of that, however, this supplemental request, and I 

understand your argument, Mr. Secretary, that these various items 

that I listed will basically be replacing items that are lost or are 

no longer functional or just go beyond useful life as a result of 

fighting a war on the ground in Iraq and Afghanistan. I think that 

can be debated, but it is a legitimate viewpoint. I give you credit 

for that. 

But what I find difficult to accept, and this is rhetorically, you 

do not have to answer this unless you feel comfortable answering 

it, that a supplemental which is coming up to fund soldiers who are 

in the field at war appears to be coming—starting to be used by 

Members of Congress as a vehicle to load up with hometown interests. 

We have the avocado growers in California throwing baggage on 

this train. We have the loggers in the Northwest throwing baggage 

on this train. We have the Gulf Coast states throwing baggage on 

this train. According to an AP report today, SCHIP is going to be 

included in this. 

It is just incredibly unseemly, when we are at war, to be using 

a vehicle that is supposed to be supporting the troops who are 

fighting that war as a vehicle for basically taking care of issues 

which are probably legitimate, may be legitimate, but clearly are 

not part of the war effort and are part of the traditional piling on 

effort around here in spending money. 

I suspect the Pentagon has no opinion on that, since you are just 

interested in making sure you get money for the war effort. But to 

me it is fiscally irresponsible and it is blatantly unseemly to be 

doing this, and inappropriate. We are supposed to be fighting this 

war, and paying for the troops, making sure they have what they 

need. We are not supposed to be paying for avocado growers in 

California and loggers in the Northwest. 

Independent of that, on the issue of how money is being spent, 

it is hard to get a handle on just how much money has been lost 

there in the reconstruction effort. Nobody really seems to know. I 

am afraid when we write the history books on this, it is going to 

turn out to be a multiple billion number, maybe a very large multiple billion number. 

But you have now set up these Commander Emergency Response 

Funds. Do you think these approaches, giving the commanders on 

the ground the flexibility to have the funds and spend the money, 

is probably producing a more efficient way of doing this reconstruction than what we started out with, which was to have an independent construction effort which was pretty much independent of 

the commander on the ground? 

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In other words, are we going to see less waste, fraud, abuse, lost 

money? 

Mr. ENGLAND. So two comments. I meet regularly with Stu 

Bowen, who is the Special IG for Iraq. He was in my office just before he went back the other week, we met again. I think we go over 

his reports and talked in detail, et cetera. Lately, there has been this discussion about $6 billion wasted. 

But yesterday, I mean literally I had one of the folks talk to Stu 

in Iraq about what is the basis of $6 billion. Frankly, there is no 

basis for this. I am not sure where—

Senator GREGG. You do not subscribe to the view that at the beginning of this effort there was flow into Iraq large sums of cash, 

multiple hundreds of millions, potentially billions, that is now not 

accounted for? 

Mr. ENGLAND. I actually do not know. I do not know that. 

I can only talk about reconstruction. And there were issues with 

reconstruction. There has been a lot of IG reports dealing with the 

reconstruction. And some of it was poor workmanship. 

My indications, about 75 percent is just like you would find anywhere else in America. About 25 percent had various degrees of 

problems. 

Senator GREGG. Well, if I can stop you there, there are specific 

instances involving health care reconstruction in Iraq that have 

been shown to be—it appears from reports—represented as non-existent but money was spent on them anyway. You are not aware 

of those issues? Or you see that as a State Department issue 

versus a Defense Department issue? 

Mr. ENGLAND. Mr. Gregg, I guess some of it is Iraqi issues, because some of it was Iraqi money doing their thing. I am not sure 

I can differentiate. 

Again, I can only tell you the IG’s view, and having looked at the 

reports. I think certainly there is always some issues. It is a difficult environment. 

Senator GREGG. Anyway, let us get to the essence of the question, which is the Commander’s Emergency Response Funds a more 

effective way to manage the money coming into the country for reconstruction than what we were doing before? 

Mr. ENGLAND. It is effective and, frankly, my judgment is and 

our judgment is it is crucial. The commanders do have good accountability of this money. They can put people to work. They can 

do things that are instantly beneficial to the people. 

As you know, this whole effort is not just military, it is also economic. It is political in-country, and they have to work together. So 

this is part of the economic dimension that gives the commander 

flexibility that, along with the military effort, they can do things 

that are economically important to the people and do it immediately, real-time, which is what counts. 

In the past, this has made a giant difference. Going forward it 

will be even a bigger difference. So this is very, very important 

money that was asked for. 

Senator GREGG. It seems logical. 

Mr. ENGLAND. It is logical and necessary. 

Admiral GIAMBASTIANI. If I could, just to add to this, the CERP 

program, the Commander’s Emergency Response Program, funding 

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is—we consider it a different form of ammunition. It is the type of 

short-term projects that we can do. These are generally shorter 

term and smaller projects than the large reconstruction pieces. 

Senator GREGG. You obviously did not run that phrase through 

a focus group, Admiral. 

Admiral GIAMBASTIANI. I have not. 

Senator GREGG. But I think it is an appropriate—

Admiral GIAMBASTIANI. It is a good way, I think, to talk about 

it. But we use it for such things as short-term, 60 to 90-day garbage cleanup, sewage disposal, those types of things, rehabilitating 

hospitals, fixing schools up, and those types of things. And we find 

that it gives the commander a way to talk to the local sheiks, to 

the local population. And that is why we think it is real ammunition for them. 

So thank you for your strong support of this. 

Senator GREGG. I think it makes sense and I think it is an adjustment which I wish we had made a few years earlier. 

My time is about up, but I would be interested. Do you think it 

is unseemly that we are going to be using a war supplemental to 

basically fund domestic activities here in the United States which 

basically could be characterized as pork? 

Mr. ENGLAND. As you said, Senator, we are anxious that we fund 

the United States military. And what the Congress decides to fund 

other than that is, frankly, up to the Congress. But I would hope 

that none of that detracts from the needs of our men and women 

in uniform. 

Senator GREGG. Thank you. 

Chairman CONRAD. That is a very good answer. 

There is a differing perspective on this. This is a supplemental 

appropriations bill. The vast majority of it is directed toward the 

war effort. There are urgent emergency situations that have to be 

addressed by the Congress. That is a reality. 

Senator GREGG. Even accepting that there may be issues that 

are emergencies, it is very clear that there is a lot being thrown 

on this train that does not even have a scent of emergency. 

Chairman CONRAD. Let me just say that I, behind the scenes I 

have joined you in that sentiment. And I have told colleagues that 

I do not believe anything should be put on here that is not a true 

emergency. Those things that are costs that were fully predictable 

have no business being in an emergency supplemental. I have the 

wounds to show the fight behind the scenes on that. 

And I can tell you we so far have stopped some things that I 

think would have been very egregious. Now I cannot, at this moment, tell you we have won all of the battles. I doubt it. But there 

been some things that were proposed that had nothing to do with 

emergency. 

And we still have ongoing fights on things that I do not consider 

emergency and I know you would not. 

But be that as it may, Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. 

I do want to touch briefly on the President’s new strategy in 

Iraq. The question that I would like to put forward to you is has 

there been an immediate impact of security, positive or negative, 

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in Baghdad since either the President’s plan went public or increased American forces have begun to arrive? 

Mr. ENGLAND. Senator, I would say speaking or just looking at 

the reports from the people on the ground, I think their assessment 

would be it is too early to draw any conclusions because this is still 

in the early stages. So there have been reports about less sectarian 

killings et cetera. But I think the assessments I have read is it is 

too early to draw any conclusions. 

So your conclusion is that it is early but anecdotal evidence early 

on indicates that there is a difference in a positive way that is happening? That would be another way of phrasing your response that 

would be acceptable? 

Mr. ENGLAND. I would say that is valid. Admiral, you are even 

closer to the military. I will let you comment. 

Senator ALLARD. Do you want to comment, Admiral? 

Admiral GIAMBASTIANI. Yes, sir. What I would say is, first of all, 

I would confirm exactly what the Deputy said. We do not like a 

week or two, if you will, just a week or two of statistics to indicate 

an overall trend because we have learned over long years of doing 

this—

Senator ALLARD. I can understand that. 

Admiral GIAMBASTIANI. However, we do see sectarian killings are 

down right now and that is substantial. We hope that that trend 

continues. But it is not really a trend yet. So these are the early 

anecdotal pieces, the statistics we are looking at. 

I talked to General Petraeus yesterday on this very issue, and he 

relayed that the sectarian killings are down. 

One other potential bright spot—potential, I might mention—is 

that the sectarian migration from Baghdad, for example, and 

throughout the country is also down. 

Senator ALLARD. That is encouraging. 

Admiral GIAMBASTIANI. So those two things are a little bit of a 

bright light. 

Senator ALLARD. Which means they are more comfortable at 

home. 

Admiral GIAMBASTIANI. Yes, sir, but too early to tell. 

Senator ALLARD. Yes, I understand. 

Another aspect of the renewed initiative is more flexibility for 

our troops when they are combating outside forces that provide advanced weaponry and training to our enemies in Iraq. What about 

those impacts? 

Admiral GIAMBASTIANI. I did not quite understand your question. 

Senator ALLARD. As I understand it, part of the President’s new 

plan includes flexibility on outside sources of weapons coming in. 

Those soldiers have more flexibility in addressing those individuals 

when they come in contact with them. Has this had an immediate—has this had, again anecdotally at least, has it provided any 

positive or negative impact as far as advanced weaponry or training? 

Admiral GIAMBASTIANI. What I would tell you is as far as what 

is coming in from outside, I think it is public that we have actually 

had some raids recently where we have picked up materials. But 

I do not think we can tell you what the overall effect is on the level 

of violence. 

470

I will tell you though, separate from what may be moving across 

the borders, we have, in fact, found a couple of the significant 

caches of improvised explosive device material here over the last 2 

weeks. Once again, General Petraeus was mentioning these to me. 

We are very pleased that these were bomb factories that were in 

and around the Baghdad area, and finding large caches of these 

types of things, particularly the more advanced ones, is very important to stopping violence and obviously causing casualties to not 

only coalition forces, United States forces, but also to the civilians 

there. 

Senator ALLARD. DOD’s Selective Acquisition Report, commonly 

referred to as SAR, is one of the tools—some say the best tool—

for understanding the future budget consequences of present and 

past decisions. Now SAR measures the total acquisition of costs of 

major weapons systems. 

In September of 2001, they come up with an aggregate cost. And 

then 4 years later in 2005 they come up with another aggregate 

cost. I have those coming up. And the cost doubled in the 4-year 

period there. 

Are we going to have some serious affordability problems when 

these developmental system such as future combat system, the 

Joint Strike Fighter and the DD–21 hit full production a few years 

from now? 

Mr. ENGLAND. Senator, I would tell you we have issues today. 

Frankly, most of our equipment we buy at very, very low rates. 

And we buy them at low rates because that is the rates we can afford. But when you buy them at low rates, they cost you more. 

We are in this cycle frankly, of—

Senator ALLARD. They cost you more because you extend out the 

program? Is that what you’re saying? 

Mr. ENGLAND. Yes. And obviously a car a year, if you built it, is 

not like if you built a million cars a year. So whenever the rate is 

low, the cost per unit is higher for us. 

So we are generally, across all of our equipment, we are at very 

low rates. And when we need to adjust, what we do is we stretch 

the program. So cost goes up but that year the cost goes down. 

Although we have managed to increase—since President Bush, 

we have gone from, I believe, $40 billion to $100 billion a year in 

procurement. This year it is $101 billion. But you know, for a long 

time, in the 1990’s, we did not buy much equipment. So a lot of 

that equipment hasten very old. So if you look at a lot of our assets 

now, particularly Air Force assets but also even some of our submarine fleet is 18 years old now. A lot of those assets are aging. 

Right now, for example, this year we have put out the tanker 

program RFPs, but our tankers are already well over 30 years old. 

And by the time we replace them, I mean some of them will be 50 

or 60 years old. 

So yes, it will be an issue in the future and it is an issue today, 

frankly. We keep trying to increase rates but costs go up about as 

fast as our budget. 

Senator ALLARD. And particularly the equipment that we have in 

the dry, sandy environment in Afghanistan and Iraq. That equipment wears out much quicker because of the hostile environment 

with the sand and everything it has to operate in. And when you 

471

put this off, it tends to snowball at the end. And that is some of 

the concern that I am trying to express here. 

Mr. ENGLAND. And I appreciate it, Senator, because it is very important. In our budget and in these supplementals, of course, we 

have reconstitution money to replace that equipment. That was 

part of the discussion we had even on the airplanes. It is hugely 

important that we have the funds to repair and replace all of this 

war equipment. Otherwise, when this is over, we would leave literally a hollow military. So it is an obligation, I believe, both of the 

people in the DOD and the Congress and the American people, to 

make sure at the end of this war we did not have a hollow force. 

So each year we put money in the budget to repair and replace 

the equipment that is being worn out, damaged or destroyed as we 

pursue this global war on terror. 

Senator ALLARD. Ms. Jonas, do you have any comments in that 

regard? I noticed you were kind of nodding your head there. 

Ms. JONAS. Well of course, as the Deputy said, on the reset piece 

we have about $13.9 billion in the supplemental for resetting and 

reconstituting. And in the GWOT request that we have in for 2008 

we have another $37 billion. So that is very important to the Department. 

Senator ALLARD. Mr. Chairman, I see my time is expired. Do you 

want me to continue? No, go ahead. 

[Laughter.] 

Chairman CONRAD. If I could go to a separate question, we are 

considering, we have not yet reached conclusion, but I would like 

to have your thoughts on this. And I know that you are here as 

representatives of the Administration and so you have to support 

the Administration’s budget request just as it is through the 5-

years. I am not asking you to contradict any of that. 

We are considering using a CBO score on war cost. 

Let me back up and say, first of all, we are thinking of putting 

in as a defense request the money the President has requested of 

the basic defense request. Then in terms of the war cost request, 

we are considering using a Congressional Budget Office estimate 

that over the 5-years is actually $85 billion roughly over and above 

what the President has requested because, as you know, the President has no request past 2009. 

But as part of that, the CBO estimate for the next year is slightly under, I think about $20 billion less than the President. The 

next year it is $25 billion more. The next year it is somewhere in 

that range, $25 billion more. So overall through the 5-years, it is 

actually $85 billion above what the President has requested. 

Senator ALLARD. Mr. Chairman, so the first year here in 2008, 

there is actually a reduction of $20 billion? And then you pick that 

difference up? 

Chairman CONRAD. The next year you have $25 billion more. The 

next year you have some $25 billion more. And the next year—

Senator ALLARD. But isn’t the first year of the budget the most 

crucial aspect of the 5-year budget? I mean, that is the one that 

really speaks to what actual spending is going to be. And then the 

out years after that, that is just a matter of moving the figures 

around. 

472

Chairman CONRAD. Well, you know, it is a 5-year budget. So 

every year the President has estimates of what the costs are. We 

have estimates. Over the time—and we will be scored for the whole 

expenditure. We will be scored as spending $85 billion more than 

the President. When they draw the lines, they will say we are $25 

billion more. 

We are in a situation where you have to have some basis for 

making these estimates. You get an estimate from the Department 

and the Administration. You get an estimate from CBO. We are 

trying to use some objective third party so that there is some merit 

to the number. 

Would you have any comment on that? 

Mr. ENGLAND. Mr. Chairman, first, I have not seen the CBO estimate. But again, even for fiscal year 2008, we literally took an extension of 2007 because we did not know if 2008 is up or down. 

And if you do not know if it is up or down the safest thing to do 

is to just straight-line it. So that is what we did for 2008. 

Chairman CONRAD. I understand how you arrived at it. That is 

why CBO has looked at your analysis and they have come up with 

a marginally different conclusion. 

Mr. ENGLAND. But when they look out to 2009 and all that, I do 

not have any idea how they would project that because we do not 

know how to project it even a year ahead because it is a war and 

you do not know—

Chairman CONRAD. But Mr. Secretary, to estimate that it is 

nothing, I mean that is what the President’s budget is telling us, 

there is no cost. We are talking now about Iraq and Afghanistan. 

Saying there is no cost just strains credulity, frankly. 

Mr. ENGLAND. I would expect certainly there is going to be some 

tail cost to all of this. When the war is over, we know there is a 

reconstitution cost, for example, which we have testified that even 

when the war is over there is equipment at the end that will have 

to be refurbished. So I am not sure what that rationale is. 

I am not sure how you estimate it. It is not zero but I do not 

know what that number is, Senator. 

Chairman CONRAD. I appreciate that. We do not know either. We 

are searching here for something that is credible and defensible 

and we have not reached conclusion on these matters. But we are 

trying to find some objective measure that has—at least appears to 

have some credibility attached to it. 

Senator GREGG. Can I pick up on that point? 

Chairman CONRAD. Sure. 

Senator GREGG. If you assume that you are going to the answer 

to whether the surge worked or not by the middle of the summer, 

which was your statement, or a pretty good feel for what is going 

on, is it reasonable to assume that next year’s supplemental war 

costs can be reduced by the amount of the surge costs because that 

number would be no longer needed? 

Mr. ENGLAND. I would say, Mr. Gregg, by this summer, depending on what the situation is and what the projection is, at the time 

we would certainly update the estimates going forward for 2008. At 

this point, I do not know if that is up or down. But we would certainly know more. I think that is the general consensus, that by 

the middle of the summer we will know more. 

473

Senator GREGG. What the chairman is saying is that they are re- ducing your straight-line projection by $20 billion for the year 

2008. I do not know where they are taking that money and what 

they are doing with it. But my question would be of that $20 billion, if the surge cost is $5.6 billion, that is your estimate—even though I not it is rather 

low—is it reasonable to assume that at least that amount could be 

reduced from the straight-line projection? 

Mr. ENGLAND. Again, if the surge continues past 1 October, then 

there would be costs added for the surge because there is no surge 

cost past 1 October. So again, it would depend on what the circumstances are this summer. So it could go up or down. 

Senator GREGG. Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you. 

Senator NELSON. 

Senator NELSON. Thank you, Mr. Chairman. 

First of all, you have my commitment to support you and Senator 

Gregg as you all are trying to get your arms around this overall 

spending. If I may, since we have such esteemed leaders of our Defense establishment here, I would like to get into a couple of specific programs with your permission, Mr. Chairman. 

Chairman CONRAD. Absolutely. 

Senator NELSON. I feel compelled, on the basis of the commitment I made to the Marines in Western Iraq, to bring back and articulate on behalf of them their need to shift from a flat-bottomed 

vehicle to the V-bottom vehicle, what is called the MRAP vehicle. 

Do you all have any direct knowledge that we are going to increase the production of these vehicles so that the Marines will be 

able to have them instead of the flat-bottomed vehicle? 

And the Army seems to have a lack of interest in this V-bottom 

vehicle. Why? 

Mr. ENGLAND. I do not think they have a lack of interest, probably not the same need. Now we have some V-bottom vehicles in 

Iraq today. We do have Buffalos, we have different vehicles. 

The Army is typically in heavier vehicles than the Marine Corps. 

So with their Strykers and their tanks and everything else they 

have, I believe they have more protection today than the Marines. 

So going forward, they do not have the same number. But they 

do have needs and they have articulated quantities of these vehicles, also. I do not have the exact number. They also have a need, 

but it is not as high as the Marine Corps just because the Marine 

Corps, it is a lighter vehicle in the past. So they have more of a 

need for this vehicle going forward, Senator. 

Senator NELSON. Does the Army have everything other than the 

up-armored Humvee? 

Admiral GIAMBASTIANI. Again, what the Deputy said is very important. If you take an Armored Cavalry Regiment, for example, if 

you take an armored unit there are very heavy on Bradley fighting 

vehicles, they are very heavy on M1 tanks. Our best armored vehicle out there is an M1 tank. 

We also have now a series of three going to a larger number of 

Stryker Brigade Combat teams. These are very effective, much 

more effective than up-armored Humvee vehicles. The problem 

with the Marine Corps is they only have one tank battalion for the 

474

entire Marine Corps. So they normally move in either one, 

Humvees; or two, they will move in amphibious assault vehicles. So 

their need for these types of, if you will, armored vehicles is greater 

than the Army’s is. 

The Army actually started the work on these and brought them 

in in their route clearance teams and populated their explosive ordnance disposal combat engineers. So there is a tremendous interest 

on both the Army and the Marine Corps part. The difference is 

that the Marines want to replace essentially most of their 

Humvees, which the Army does not transport by to the degree the 

Marine Corps does, percentage wise. 

Senator NELSON. Right, but the Army does transport with up-armored Humvees? 

Admiral GIAMBASTIANI. Yes, sir, they do. 

Senator NELSON. So why wouldn’t they want to move like the 

Marines do? 

Admiral GIAMBASTIANI. They do want to and, in fact, we have a 

sizable request, as a matter of fact, in for these V-shaped hulls for 

both Army and Marine Corps in the current budget submission and 

supplementals. You will see those in there now. 

Senator NELSON. On another subject, you all have been reading 

the daily chronicles of the Washington Post with this stuff that is 

going on out at Walter Reed. This is not the first time that I have 

heard of this, because I have heard of the lack of attention of medical care to our troops. 

It was extraordinary the other day when the winner of the Congressional Medal of Honor, Senator Danny Inouye, told what it was 

like after World War II or during World War II, in his case when 

he lost his arm, that the military would not release them from active duty military until they had had all of the rehabilitation and 

all of the counseling and so forth so that they could cope with their 

wounds. 

And that seems to be the opposite of what we are doing. We are 

releasing them and letting them fend for themselves, not even to 

speak of what the Washington Post is talking about in the deficiencies out at Walter Reed. 

Your comments, Mr. Secretary? 

Mr. ENGLAND. Senator, I guess it is sort of multifaceted here. 

First, there is an independent review group that the Secretary of 

Defense has put together to look at all aspects of this. And so that 

group is being stood up so we get an independent look at it. 

Personally, I go out to Walter Reed regularly, and I think probably a lot of people in this room do. I meet a lot of the wounded 

people at ball games we take them to, and soccer games, and dinners almost every Friday night. Frankly, the people I meet, we ask 

every single person how are you doing? How about the parents? 

How is your spouse? How are the kids? And if we hear about a 

problem, we fix it for them. 

Look, I do not believe this is widespread. The people that I talk 

to specifically, and they are pretty straightforward because they 

come to tell me—I ask them. And I can fix things for them, so they 

are pretty forthright about it. 

I believe we give the best treatment in the world to our men and 

women in uniform. But frankly, it sounds like some have fallen 

475

through the cracks. We will know more with this independent review team. 

I can tell you, it is the full intent and the dedication of every single person in the Department of Defense to provide them the very 

best care we can. I know that goes for the VA also. And we work 

extraordinarily hard to do that. 

The Secretary of Defense has also said that he holds people accountable because we do have a standard of care for people who 

serve in our military. So he has a standard of accountability. And 

I can tell you, this is very serious for us because it underlines, I 

mean the people we serve knowing that we care for them is fundamental to everything. 

Senator NELSON . Do we muster them out and then turn them 

over to the VA, unlike what Senator Inouye said in World War II, 

that they would not release them until they had rehabilitated 

them? 

Mr. ENGLAND. I think a lot of people—just about everybody there 

are still active military. Occasionally, I will have someone that will 

come to me asking for a special—can we look into maybe keeping 

them a few more months for some reason. But a lot of these folks 

are with us for a couple of years after their injuries. 

Of course, a lot of them we keep back in the military. They come 

back and serve because we have roles in the military they can continue to serve. Some of these great Americans—I was just with 

someone last Friday night back in jump school who lost his leg 

back in jump school. We have a number of people like that who lost 

limbs and are still serving. 

So my view is the vast, vast majority of people we treat extraordinarily well because we work at it very hard. But it is pretty obvious that it has not worked 100 percent of the time. We are going 

to understand why. We have a review group to look into that. And 

we will do whatever and anything it takes to make this absolutely 

perfect. 

Senator ALLARD. Senator Nelson, may I followup on your line of 

questioning if it’s OK with the Chairman? 

Chairman CONRAD. It is really on Senator Menendez. 

Senator ALLARD. I do not plan on taking much time. 

Are we expanding Bethesda Medical Complex out there to begin 

to take the soldiers and everything that were going to Walter 

Reed? 

Mr. ENGLAND. Yes, Senator. As part of BRAC we decided rather 

than having two separate medical facilities in the Washington, 

D.C. area, we would have one literally world class facility and that 

would be Bethesda-Walter Reed. 

Senator ALLARD. Because I saw that a lot of infrastructure at 

Walter Reed looked like they were in pretty bad shape. But we are 

building a new facility then? 

Mr. ENGLAND. Yes, we are. We will have a whole new facility 

at—we will have the current facility plus other facilities expanded, 

our medical school. It is right there. The National Institutes of 

Health is right nearby. So the whole plan was to have a complex 

new, modern, with our very best capability at one place, rather 

than dividing it between the two locations. 

Chairman CONRAD. Senator Menendez. 

476

Senator MENENDEZ. Thank you, Mr. Chairman. 

Mr. Secretary, I want to go—I understood there was some discussion here before. But I want to return to the costs of the escalation 

of the war, where the Administration has asked for $5.6 billion. 

If the Chairman were to put you under oath, would you say that 

that is the total cost of the escalation? 

Mr. ENGLAND. Yes, I would. I would have one proviso. I would 

say that it is a war we are in. So things are going to change on 

the ground. 

Earlier, we said the commanders have asked for some additional 

support personnel and things, and that is being evaluated by the 

Chairman’s office today. So there will constantly be some variation 

in this. But that is very close. That was the best estimate at the 

time. 

Senator MENENDEZ. How is it that the CBO comes here before 

the committee and says that they have a really different sense of 

what you need in support troops, based upon your own standards? 

And we are being told, I understand your earlier testimony here is 

that you only need a couple of thousand. What is the total amount 

of support troops that you are going to need for the escalation? 

Mr. ENGLAND. The Admiral testified just earlier that if you were 

doing this from scratch, you would need more support troops. But 

we are not doing it from scratch. We have a lot of support troops 

already in-country, deployed in-country. So there is a benefit, in a 

sense, of having already deployed forces—

Senator MENENDEZ. My question is how many will you need in 

addition to, for purposes of this escalation? What is the total number? 

Mr. ENGLAND. It is going to be in the several thousands category, 

so we have some estimated. The Secretary said 10 to 15 percent 

added to the 21,000. 

There has also been requests now—

Senator MENENDEZ. So are you talking about 3,000? Are you 

talking about 5,000? What are we talking about? 

How do you ask us to budget in the blind? How do you ask us 

to provide moneys you in the blind? You must have some sense of 

what the support troops that you will need to backup your escalation. 

Mr. ENGLAND. So the answer, Senator, is 10 to 15 percent is 

what the Secretary of Defense has estimated of the 21,000, so that 

is somewhere around 3,000. 

Senator MENENDEZ. That is the total amount of support troops 

you think you are going to need for this escalation? 

Mr. ENGLAND. And in addition, General Petraeus on the ground 

has identified some additional needs, in terms of people. That, I believe, is on the order of 3,000 to 4,000. And that is currently being 

evaluated by the Chairman’s office. 

Senator MENENDEZ. So if that were to be accepted, then we are 

talking about anywhere between 6,000 and 7,000? 

Mr. ENGLAND. That is correct. 

Senator MENENDEZ. In your request to the Congress for the $5.6 

billion, do you include the 6,000 to 7,000 additional support personnel? 

477

Mr. ENGLAND. In terms of the funding, our judgment is that that 

will fit within the funding we have requested. Our funding is not 

just $5.6 billion. It is our defense budget to conduct the war. So we 

conduct the work. We do not tag people to fit $5.6 billion. We conduct the war. That is a delta cost of the war. 

So within the total costs—I mean, obviously some things change. 

Some things are plus, some things are minus. Within this cost estimate, our best judgment is we can handle whatever those costs are 

for whatever the support costs are—

Senator MENENDEZ. You mean within your overall request, beyond the escalation? 

Mr. ENGLAND. Again, because this is a war cost—I mean, we do 

not differentiate the dollars. 

Senator MENENDEZ. I know, Mr. Secretary, it is a war cost. But 

the reality is you do not have a blank check from us. I hope you 

do not expect a blank check from us. It is tough enough to look at 

the budget and try to figure out what you want to moneys for. I 

know money is fungible, but at some point you just cannot have an 

endless pot without justification. 

Mr. ENGLAND. We provide you, Senator, 35,000 pages of backup 

for our request. 

Senator MENENDEZ. That is why the CBO said that they had to 

go through extraordinary efforts just to determine what, in fact, 

you were asking for, what purposes. Let me just say, I do not believe, for the life of me, that $5.6 billion is going to be enough. Are you going to come back for a supplemental? 

Mr. ENGLAND. A supplemental? 

Senator MENENDEZ. Yes. Are you going to come back for a supplemental in 2008? In addition to your overall request, not only for 

the escalation but all your other requests. You are going to come 

back for a supplemental? 

Mr. ENGLAND. In 2008 there is a GWOT request in now, in addi- tion to the base budget. So there is $141 billion, as I recall, which 

is the GWOT costs, our best estimate of what the 2008 cost of the 

war will be based on our 2007 expenditures. So there is already submitted to the Congress a $141 billion request for fiscal year 2008 that is not part of the base budget—this 

is a discussion we had earlier—which is a supplemental. 

Senator MENENDEZ. Mr. Chairman, I do not know if you are having a second round or if I can pursue this. I see my time is—I am 

sorry—

Mr. Chairman, I do not know if we are having a second round 

or if I can just pursue a little longer? 

Chairman CONRAD. No, you can go. We have allowed others to 

go further. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Mr. Secretary, let me just get one more thing on this. So now you 

have support troops in the field, but they are supporting present 

missions. Are you saying that your standards—maybe the Admiral 

can respond to this—that the same standards that the Department 

of Defense has about the X number of personnel to support active 

combat personnel is going to be diminished? That you are going to 

have less than your normal standards? 

478

Admiral GIAMBASTIANI. If I could help to answer that for you, 

Senator, first of all with regard to the support personnel necessary. 

One of the comments I had made earlier, before your entry, was 

that we are operating on an established series of logistics bases, 

and in particular, around the Baghdad area where the plus-up is 

going. So we already have a substantial logistics combat service 

and service support establishment there. 

So when we bring in additional troops we can accommodate some 

level of them with the already existing support troops, which is 

why when CBO would estimate—I did not look at their estimate. 

But I believe they did it using the standard metrics for an 

unestablished or a new base of operations, where you would need 

a substantial number of support troops. Which is why our estimates are lower. 

The second thing is that they estimated through fiscal year 2009. 

We have only estimated the cost through the end of this fiscal year, 

which I know you know. That is that $5.6 billion. 

Senator MENENDEZ. So then if one is to believe that the escalation continues beyond, your cost will be greater, obviously. 

Admiral GIAMBASTIANI. I think one would have to say yes. 

Senator MENENDEZ. Let me just turn to one other question and 

then I will stop. 

Mr. Secretary, I met with the Special Inspector General for Iraq 

Reconstruction. The Administration comes before the Congress and 

asks for all this money. I have a real problem when the Special Inspector has told Congress that 15 percent of all of the money that 

the United States has spent on Iraq Reconstruction has been wasted, and that they are investigating cases of potential criminal activity. I have a real concern when we spend $43 million for a residential 

camp for police training personnel that is never used, when we 

spend $4 million on 20 VIP trailers and an Olympic-sized pool not 

authorized by us. I have a real problem when the Inspector General found that the government may have spent $36 million on 

weapons and equipment that they cannot account for. I have a real 

problem when we take $4 billion into Baghdad on giant pallets 

aboard military planes and cannot account for a good amount of it. 

How do you expect us to continue to give you an open check with 

such incredible waste, fraud and abuse? 

Mr. ENGLAND. Senator, I also meet with Stu Bowen regularly. 

Senator MENENDEZ. Do you hear the same things that I hear 

from him? 

Mr. ENGLAND. No, I do not. 

Senator MENENDEZ. You do not? 

Mr. ENGLAND. I read all the reports. I have read all of the reports, Senator. I have actually read all the—seen all of the pictures, talk to him regularly. 

I do not think he said it was 15 percent. I think he said he did 

not know what it was. But without doing an analysis, if he just had 

to guess, he would guess it would be 10 to 15 percent. But he actually did not know. 

But there is obviously some level, I mean it is a war. So there 

are some things that obviously do not work out. I mean, some of 

the buildings—

479

Senator MENENDEZ. Mr. Secretary, I hate to interrupt you, but 

is that an excuse for everything? 

Mr. ENGLAND. It is not an excuse at all. 

Senator MENENDEZ. I understand war has its exigencies and unexpected circumstances. But that is also not an excuse. Every time 

we ask the Administration, the answer is we are in a wary. But 

even some things are clearly definable. There are control mechanisms to be had to make sure that we do not have waste, fraud and 

abuse. 

Saying that we are simply in a war is not acceptable. 

Mr. ENGLAND. He is part of the control mechanism, so that is 

part of what the IG does is uncover issues so we can go fix them. 

We work at those. And so whenever we find a problem, we do work 

those problems. It is not an excuse. It is a just a fact of the environment where they are. 

Where there is waste or fraud, we obviously work that. There are 

people who do egregious things, just like they do in the civilian 

world. There are people who take advantage of circumstances. And 

fortunately a number of them have been caught and convicted, and 

I applaud that. That is exactly what should happen. 

So we do not have perfect people, like no other organization does. 

But we do have systems in place like the IG. That is the purpose 

is to uncover those problems so they can be fixed. So we work closely with the IG. 

Senator MENENDEZ. My final comment, and then I will cease. It 

is not whether we have perfect people, Mr. Secretary. We know we 

do not have perfect people in the world. It is not whether—the IG 

should not be the vehicle by which we—that is the after fact. 

It is the Department of Defense that needs to have control mechanisms to ensure that the taxpayers’ money that we give to you is 

ultimately spent in the most efficient way, both for our people who 

serve us in protecting them and meeting their mission, and also in 

terms of these other elements that the administration has asked 

for. 

To say that the Inspector General is part of that control mechanism, that is the after fact. He finds out what went wrong. The 

question is what mechanisms does the Department have. And I 

think the Department does not seem to feel that they need to have 

mechanisms. 

Mr. ENGLAND. Last year we conducted 35,000 audits, Senator. So 

we have a lot of controls in place. But again, not everything is perfect and we appreciate the efforts of the IG. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you, Senator. I feel the need to set the 

record straight on a couple of things. 

In terms of the CBO estimates, the CBO estimates were based 

on experience in Iraq, not just in other places but in Iraq, and specifically on the surge in 2005. And when we look at total troops, 

ground forces in-theater, and the number of combat brigades and 

the number of troops per combat brigade, the lowest number of 

troops per combat brigade was back on December 31st of 2004. 

That was the lowest since 2003, and it was 8,300. 

480

That would equate to a total of over 40,000 troops for the surge. 

This is the basis for CBO’s estimate. It is based on previous experience in Iraq. 

Let me go to the Washington Post story and Walter Reed, because I watched the Secretary. I thought his response was exactly 

right. I thought he was personally angered and offended by what 

was occurring there. And he is right to be. 

I think we have to differentiate. What is happening in combat is 

the best medical care in the history of warfare. That is the record. 

It is remarkable what an exceptional job the American military is 

doing of providing medical care in combat. So that needs to be laid 

out there and stated, because it is a fact. 

Second, when they come home and they are going through medical treatment directly at Walter Reed and Bethesda, that is excellent care. Many Members of Congress get their care from those 

same caregivers. And I think all of us would acknowledge their excellence and their incredible dedication. 

We also know as a fact that there are serious problems with 

those who are outpatients especially, and those who have need for 

specialty care and delays in getting appointments. 

The Washington Post story, let me just refer to it. You have all 

read it. Ever member of this panel has read it. They talk about 

how the wounded can wait for weeks with no help from staff to arrange treatment. 

Now these are typically people who are either outpatient or who 

are in these auxiliary facilities. 

Recuperating soldiers are asked to manage and guard other soldiers. Caseworkers are untrained and there are not enough of 

them. Lost paperwork and bureaucratic delays are common. 

Look, I have had a fair number of soldiers wounded from my 

home State. We have found a lot of bureaucratic delays, a lot of 

things that should not happen. And that has to be addressed. 

Can you tell us, Mr. Secretary, what is being done to address 

that? 

Mr. ENGLAND. Senator, first of all, there are a lot of things being 

done immediately on-scene. But I believe the most important thing 

is this independent review team that the Secretary has put together to report back to him, to look broadly at this whole issue, 

to make sure that we are doing it right. We actually want people 

from the outside, but with some familiarity, to come in and critique 

the system. So we have asked people to do that. I believe that is 

the most valuable thing, so that we can fix whatever the systemic 

problems are. 

Frankly, it is not difficult to go fix a room or whatever that is 

not right. All those things are being done. I think more attention 

immediately is being taken at Walter Reed. 

But the question is do we have a systemic issue? And so this 

independent review team will examine that. 

I will tell you the Secretary, as you rightly observed, is pretty 

much outraged, as we all are. So we take this extraordinarily serious. I mean, these soldiers are part of the family. These are people 

who we dearly love who serve in our military. They are family 

members for us and many of us know them as family members. So 

481

we are going to take whatever action we need to do. And that is 

anything we need to do. This is the most important job we have. 

So whatever those issues are, they will be addressed systemically 

and fixed. 

Chairman CONRAD. This is a story from this morning ‘‘Hospital 

Officials Knew of Neglect: Complaints About Walter Reed Were 

Voiced For Years.’’

This is one of the most disturbing stories that I have read actually, out of this whole sad episode. I would hope that people who 

knew that there were very serious problems and did not act or did 

not sound a warning, that those people be held accountable. 

Mr. ENGLAND. They absolutely will. The Secretary said that. This 

is a failure of leadership. And appropriate people will be held accountable. So that will definitely happen, Senator. 

Chairman CONRAD. I appreciate that. It is important that it be 

done. 

Senator LAUTENBERG. 

Senator GREGG. Mr. Chairman, can I just ask, just as a technical 

point, the Chairman has now had 2 second rounds and I have not 

had a second round yet. And we have gone back to your side three 

times, prior to coming back to our side. 

Chairman CONRAD. We would be happy to go to the Senator. 

Senator GREGG. I know it is the minority being difficult again. 

Chairman CONRAD. No, no. 

Senator GREGG. Senator GREGG. I am sorry. 

Chairman CONRAD. I was trying to give people who have not had 

any rounds a round. 

Senator GREGG. You are correct, and I appreciate that. 

Senator LAUTENBERG. I want to defer. 

Senator GREGG. No, I just wanted to make my point and then I 

will defer to the good Senator from New Jersey because he has not 

been here, and let him make his points. 

Chairman CONRAD. You know, the way it works, and I know it 

worked this way when the ranking member was Chairman, when 

additional members come that have not had a round, we give them 

their round. 

Senator LAUTENBERG. Senator GREGG. I agree. We should have stopped your round. He 

was complaining as soon as he came. 

[Laughter.] 

Chairman CONRAD. Senator Lautenberg. 

Senator LAUTENBERG. If it is urgent—

Senator GREGG. No, please proceed. 

Senator LAUTENBERG. I think mine are, not to make light of the 

subject here today at all. 

There is so much heavy weight over the country and over the 

citizens in the country and we see it not just in the polls, but if 

you get out in the field and you talk to people. I do not care where 

you meet them or what their profession or what their economic 

standing is, they are worried about this war. They really are. 

The last couple of nights we have seen the Woodruff experience—

I do not know what the title of it is. But it demonstrates, more 

than one can imagine, the pain of war. 

482

I served in World War II during the active war in Europe and 

I take pride in my service as a veteran. It was not heroic but it 

was steady, in terms of my work. 

And so when I look, Admiral Giambastiani—[continuing in 

Italian.] 

I wanted to ask about recruiting. What is the situation? What 

has it been like for the last couple of years, Admiral? 

Admiral GIAMBASTIANI. With regard to recruiting across all of 

the services, frankly about 3 years ago we wound up having a problem inside the United States Army. This is just as we were increasing the overall levels within the Army, increasing through the supplemental by 30,000. So we had an in-strength for the Army of 

482,400. We increased that, Congress allowed us to go up to an additional 30,000 at the request of the Administration. 

During that time, over 3 years ago, when we first started moving 

up, we had difficulty meeting our new goals in the Army. However, 

I can tell you that for about the last year and a half all services 

have continued to meet their goals. 

This month, for example, and the Army has continuously met 

their goals—I will take a look at it in just a second but I think it 

is about 15 or 16 months in a row. They were over 100 percent. 

The Navy is over 100 percent on the active component. The Air 

Force is over 100 percent and the Marine Corps is. So all of the 

services are meeting their goals. 

Now that does not mean it is not a tough recruiting environment, 

but we project that we will meet our goals throughout the rest of 

this fiscal year also, even though we have additional in-strength 

and additional recruiting coming on. We have authorized the Department, and the Secretary has authorized and requested an additional 5,000 Marines and an additional 7,000 soldiers for the Army 

per year. 

Senator LAUTENBERG. Is the same true of the Reserve Corps? 

Admiral GIAMBASTIANI. Now, on the Reserve component side, we 

had some difficulty also meeting our National Guard in-strengths 

however, and I am going to pull out my figures here while we are 

talking, we did make Army National Guard goals. Let me just get 

these numbers here and I will tell you exactly. 

Army National Guard recruiting was 113 percent. Army Reserve, 

however, was just under, at 94 percent. United States Navy Reserve, but by request of the CNO, was a little under 90 percent. 

And then the other services made the Reserve components. 

Senator LAUTENBERG. Thanks very much, Admiral. What did we 

have to do to meet those goals? Did we change our standards? 

Admiral GIAMBASTIANI. I would tell you no, sir, we did not fundamentally change our standards. What we did is the first thing 

we did is put many more recruiters in the field, particularly in the 

Army and the Marine Corps. The Army had to put a lot more. 

Have we changed and allowed some additional folks to come in? 

The answer is yes, but not in large numbers. Not in large numbers. 

Senator LAUTENBERG. The time is short, so unfortunately I have 

to leave that subject. I am concerned about that. 

Madam Secretary, is there any thought to increasing pay for hazardous or combat duty for our troops serving in Iraq and Afghanistan? I particularly look to those who are called up from the ReVerDate 0ct 09 2002 14:12 Oct 26, 2007 Jkt 000000 PO 00000 Frm 00930 Fmt 6601 Sfmt 6601 C:\DOCS\34649.TXT SBUD1 PsN: TISH
483

serve units, be it the Guard or the regular Reserves, where families 

left behind do not have the advantage of a base facility for medical 

or health care, and their tours of duty are much longer than ever, 

ever anticipated. 

So is there any thought to making life a little bit easier for those 

who are serving in the combat theater, to pay extra bonuses for 

their service? 

Ms. JONAS. Mr. Lautenberg, we appreciate the question. 

The budget that we have before the Congress right now includes 

a substantial amount on both topics for recruiting and retention, 

about $4.3 billion. There is a specific consideration for providing—

I believe it is $1,000—for Reservists who are extended beyond the 

time that they are supposed to serve. So that is a piece of it. 

We are constantly working with the personnel and readiness 

community to make sure that we have appropriate bonuses and 

support for the families. 

Senator LAUTENBERG. Mr. Chairman, can I have another—

Chairman CONRAD. Yes, sir. 

Senator LAUTENBERG. I really appreciate it. 

The question that comes to my mind as we look to escalate and 

expand the number of people there, it is a shocking thing to look 

at. I was the first legislator to go to the Gulf War I theater and 

we had 540,000 troops there. And now to be doing the job that our 

people are being asked to do—and they are doing it heroically and 

bravely and often at a disadvantage because of equipment delays. 

I just wonder, if we do succeed despite greatly opposing opinion 

here and in the world outside of here, do we guarantee that the 

people that we are going to send there will have the latest in the 

equipment, everything that they need? Will the vehicles be armored sufficiently? Will the flak vests or body armor be the latest 

that is available? Will it be there at the moment of their arrival? 

Admiral GIAMBASTIANI. Senator, I can assure you that anyone we 

send into combat to do any of this work will have the appropriate 

equipment, both body armor, armored vehicles, ammunition, food 

supplies, whatever it is. 

Senator LAUTENBERG. That has not been our experience, Admiral, in all due respect. 

Admiral GIAMBASTIANI. No, sir. I just want to come back to you 

for a second here. We will never have enough of everything as we 

change something new. Let me give you an example. 

We have changed our body armor many times. But anybody who 

goes outside of what we call the wire, moves outside of our bases, 

and goes on operations, we give the front-line armor to, the frontline armored vehicles. 

Now inside forward operating bases, for example, in Afghanistan 

and Iraq, we have unarmored vehicles, we have slightly armored 

vehicles, and they will operate on those. I have just been to Baghdad a couple of weeks ago. I was driving around in a Suburban. 

I did not wear my armor most of the time, and neither did any of 

the troops with me. But as soon as we went outside of the base, 

when we were flying in helicopters and the rest—and this is the 

same standard we apply to our troops across the board in the theater. As a member of the Joint Chiefs, I can assure you we do not 

484

let our folks go out and operate without the front-line equipment, 

period. 

When I say there is not enough, there is not enough to equip 

every single individual with every single piece of whatever it is. 

And I suspect there never will be. 

Mr. ENGLAND. If I can comment, Senator, I mean part of what 

we do is to keep upgrading. We keep adjusting to the threats. So, 

for example, we started this war we had 700 armored vehicles. We 

have built 43,000. But now we have another new model which is 

better. 

So if you go to Iraq today there are handfuls of the latest vehicle. 

Everybody does not have those because obviously it takes some 

lead time to build them up. And finally we will build all those up. 

But I expect they will be replaced at some point. 

So we have this constant turnover of the ‘‘latest’’ equipment. So 

at any given point in time, ‘‘nobody’’ has all the latest equipment 

because it is in manufacture because we are always going to the 

next, better model. 

Admiral GIAMBASTIANI. And these budget submissions that we 

have made include many of these pieces of equipment and vehicles 

to upgrade so that we can continue to upgrade and supply our 

troops. 

Senator LAUTENBERG. The Iraqi government sits on billions of 

dollars that it owns, however it got there. Why should we give any 

more money to their reconstruction when we have lots of requirements here that are some of them urgent, bridges obsolete and perhaps can collapse. 

Why should we be giving those in Iraq more money for reconstruction when the Iraqi government is sitting on a fairly significant reserve? 

Mr. ENGLAND. Senator, my understanding is they have somewhere between $12 billion and $15 billion in terms of their own reserves. But they are spending those reserves. They are spending 

them first to train their own forces and also to equip them and also 

to develop their oil and electricity and all of that. So there is just 

a lot of large needs in Iraq. And the dollars we spend there are 

very important. 

Part of this whole effort, as you know, is not just military. It is 

economic and also political. But there is an economic side of this 

that is equally very important that we accomplish in conjunction 

with the military operation. 

So we do augment Iraqi funds in this regard. So we do augment 

those funds, but they also spend their own funds for these—

Senator LAUTENBERG. Has there been any diminution of their—

I will call it that treasury or that reserve fund? Those reserve 

funds that they have? 

Mr. ENGLAND. Their budget has been going up each year. I do 

know that. I am not sure of all of their income, et cetera. But they 

have, indeed, been spending more. I do not know if their reserves 

have changed or not, Senator. I will have to get back with you on 

that. 

Senator LAUTENBERG. Admiral, and I will close with this, Mr. 

Chairman. 

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I am upset by the lack of knowledge. I mean here we have had 

this expose in newspapers across the country and television about 

the disregard for information that the leadership had. And to see 

these people being put in these humiliating, degrading facilities I 

think adds insult to injury. Admiral, for a long time now, it has 

been against the rules to permit photographs of caskets returned, 

flag covered in every instance, to be widely distributed, disseminated. 

Now in front of my office, I am proud to say, that we have easels 

with lots of the pictures of those who have perished. It is up to date 

as quickly as we can get the pictures. And it has those who have 

fallen from every State in the country. And we have a journal that 

people write comments. They are touching. I read them all of the 

time. 

That picture there brings pride to everybody who sees it. And I 

cannot, for the life of me, understand why when a coffin is there 

and it is another one of our bravest, why we cannot permit the photography of that occasion and that flag that says your country 

loved you and we regret so much that you have paid the price but 

we honor your sacrifice. 

We all have seen it. When Nancy Reagan got the flag from President Ronald Reagan’s coffin, she held it like a newborn child. I 

have seen that with mothers at the burials, wherever they took 

place, whether it is here or at home. 

Can you explain that policy? 

Admiral GIAMBASTIANI. I do not know the exact policy but let me 

just say to you, I do not think there is any issue with ever taking 

photography at funeral services, presentations of flags. 

Senator LAUTENBERG. They cannot stop those, Admiral. 

Admiral GIAMBASTIANI. I have seen many of those and I just see 

nothing. 

I think the only restriction that I know of is a restriction when 

a military aircraft flies in a large number of coffins together, because we bring lots of troops back, dignitaries, other folks, and we 

put all kinds of cargo on them. Those are the only ones I know of 

when those coffins are being taken off. 

But I will be happy to look into it. 

Senator LAUTENBERG. I would appreciate it. 

Admiral GIAMBASTIANI. I will just tell you that I grew up, like 

you, at the Naval Academy during Vietnam looking at pictures of 

every single one of the fallen and looking at their biographies, 

which classes they were in. I see this constantly in the military. I 

look at those tolls personally every single day. And we mourn every 

single loss of those folks and every single one of the wounded. 

But I will look into it. I do not know, Gordon, if you had anything 

you wanted to add to that. 

Mr. ENGLAND. I do not. 

Senator LAUTENBERG. Thank you, very much. 

Thank you, Mr. Chairman. 

Chairman CONRAD. Thank you, Senator. 

Senator GREGG. Senator GREGG. I just wanted to pursue this one issue which I 

am not sure you are in a position to answer. But this question of 

how you rank the threat and what we should be developing in the 

486

military to address as a threat. In your statement, as I mentioned 

in my opening statement, you pointed to North Korea, Iran and 

China potentially in different ways as being the priority that we 

need to worry about. 

My reaction was where is al Qaeda and where is the threat of 

a terrorist attack, a weapon of mass destruction, whether it was a 

nuclear or a biological weapon. 

Physical military response to a terrorist event is maybe not the 

priority to stopping that event. The priority is to have intelligence 

on the event’s potential occurrence and then being able to interdict 

the event before it occurs. 

And how is the Defense Department approaching that? And are 

we thinking in those terms? Or are we truly thinking in the terms 

of nation-state opposition? 

Mr. ENGLAND. Senator, if I could just try, first of all, we do try 

obviously to deter future adversaries, whoever they may be. So we 

do maintain a core capability, United States military and our Air 

Force and our Navy and in all of our forces, because it is obviously 

a lot cheaper to deter in terms of both lives and suffering and the 

Nation’s wealth than it is to fight the war. 

So we do invest in deterring, and that is a significant part of our 

procurement every year, and also of our training. 

When it comes to al Qaeda and terrorists, obviously we have a 

significant cost of literally fighting them every day as part of this 

global war on terror. 

But then here in the United States we do have Northern Command, which we stood up as a new combatant commander, Northern Command, who works hand-in-glove with the Department of 

Homeland Security. So that is the direct military support combatant commander here in the United States for combating terrorism. 

So we have an entire combatant commander dedicated to this function here in the United States of America. 

And as you know, we obviously invest in our intel assets and our 

human—that is all a growing part, our Special Forces are all a 

growing part of our force as part of our global war on terrorism. 

A lot of that is in our base budget. 

The QDR last year, we spent an entire year on this whole subject 

of making sure we had the right assets, the right sort of training, 

the right mix of forces. And we made significant changes across the 

entire United States military and Department of Defense. 

So the QDR really outlines the analysis and the strategic approach going forward, including with our coalition partners and 

friends. Because there is a recognition in this war on terror that 

no single nation can prevail. This is about friends and allies because a lot of this is taking place obviously in other people’s territory. So it does require this constant attention of the world community and that is a large part of the trust we had in our QDR. 

So I believe that we have taken a balanced approach and a 

thoughtful approach in terms of how do we do this in the Department of Defense. 

Admiral GIAMBASTIANI. If I could add to what the Deputy has 

said, your question is a very appropriate one. As Gordon said, we 

tried to address this in the Quadrennial Defense Review and we 

have written quite a bit about it. 

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Operating against nation-states and operating against these terrorist entities is a very different ball game. As you well know, they 

do not operate by United Nations conventions, Security Council 

resolutions, the Geneva Convention, or those types of things that 

nation-states recognize. 

For example, just a simple thing, I carry an identification card 

that says it is a Geneva Convention ID card. None of these folks 

do. I wear a uniform, and the 2.4 million Americans who are members of the armed forces wear uniforms. These folks do not. 

We have designated this as irregular warfare which is why, as 

the Deputy mentioned, we are increasing, for example, the size of 

our Special Operations forces. Just in the budgets we have submitted to you there is about 6,000 Special Forces and Special Operations forces that are included in this. 

Also, between nation-states there is varying degrees of transparency. We put out public budgets. Other people do not. Al Qaeda 

does not, for example, and many of these other outfits. So this is 

a very different world we are moving into, operating with these 

very shadowy groups that operate across borders, that do not recognize those types of conventions. 

Senator GREGG. I appreciate that answer and it is really a topic 

for a much broader discussion. But I guess my concern is the emphasis and whether we are effectively—I see this threat as being 

the most present and immediate threat, the use of a weapon to 

mass destruction on American soil by a terrorist group, which is 

probably Islamic fundamentalist driven. 

Mr. ENGLAND. Senator, we do prioritize in the Department, what 

we call war plans. Obviously, I cannot go into detail. But I will tell 

you the No. 1 priority in the Department of Defense is combating 

terrorism, al Qaeda and other groups like al Qaeda. So that is the 

No. 1 priority. And we fund those efforts. Those funding requests 

have priority within the Department of Defense. 

We do not deny funding or anything for areas where its focused 

on the global war in terror. That is our No. 1 funding priority in 

the Department of Defense. 

Senator GREGG. I appreciate all of the time you have given us 

this morning. 

Thank you again for your service. 

Chairman CONRAD. Would you like another round? 

Senator GREGG. I think I am owed three or four. Put them on 

account. 

[Laughter.] 

Chairman CONRAD. First of all, thank you very much for being 

here. We appreciate it. We appreciate all of your service for the 

country. 

You know, one of the great things about a democracy is we can 

disagree without, I hope, having to be disagreeable. On a question 

of disagreement, I hope you will take back this committee is not 

buying the estimate on the surge. We thought the CBO testimony 

was very credible. No estimate is going to be exactly right. We understand that. It is especially difficult in a war. We understand 

that. 

488

Our obligation, I hope you understand, is to try to give the best 

possible estimate to our colleagues. It is extremely difficult over an 

extended period. And we are just trying to do a credible job. 

I can tell you, whether we are on the defense budget, we are 

going to provide in the resolution that I present to our colleagues, 

we are going to provide every dime that is in the President’s defense budget. We are going to provide, on the question of funding 

of the war, we are going to provide actually more funding because 

we think the President’s budget has understated the war cost over 

the 5-year period. 

And we await tomorrow’s re-estimate from the Congressional 

Budget Office before we finalize our budget. That is the last step 

before we make final determinations. 

So with that, again, we thank you for coming and we appreciate 

your service. 

Mr. ENGLAND. Mr. Chairman, thank you for your professionalism. Thank you especially for recognizing this need for the 

supplemental. Moving that along is hugely important to our men 

and women in uniform and I appreciate your personal efforts there. 

Chairman CONRAD. We will get that job done. 

Thank you. 

[Whereupon, at 11:54 a.m., the committee was adjourned.]

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