S. HRG. 109–114

CONCURRENT RESOLUTION ON THE

BUDGET FOR FISCAL YEAR 2006

HEARINGS

BEFORE THE

COMMITTEE ON THE BUDGET 

UNITED STATES SENATE

ONE HUNDRED NINETH CONGRESS

FIRST SESSION

February 1, 2005—THE CBO BUDGET AND ECONOMIC OUTLOOK

February 8, 2005—REEXAMINING THE FEDERAL BUDGET FOR THE 

21ST CENTURY

February 9, 10, 2005—THE PRESIDENT’S FISCAL YEAR 2006 BUDGET 

PROPOSAL

February 16, 2005—TRANSPARENCY OF BUDGET MEASURES

February 17, 2005—MEDICARE AND MEDICAID: RISING HEALTH CARE 

COSTS AND THE IMPACT ON FUTURE GENERATIONS

March 1, 2005—THE PRESIDENT’S FISCAL YEAR 2006 DEFENSE 

BUDGET

(

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CONCURRENT RESOLUTION ON THE BUDGET FOR FISCAL YEAR 2006

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21–173pdf 2005

S. HRG. 109–114

CONCURRENT RESOLUTION ON THE

BUDGET FOR FISCAL YEAR 2006

HEARINGS

BEFORE THE

COMMITTEE ON THE BUDGET 

UNITED STATES SENATE

ONE HUNDRED NINETH CONGRESS

FIRST SESSION

February 1, 2005—THE CBO BUDGET AND ECONOMIC OUTLOOK

February 8, 2005—REEXAMINING THE FEDERAL BUDGET FOR THE 

21ST CENTURY

February 9, 10, 2005—THE PRESIDENT’S FISCAL YEAR 2006 BUDGET 

PROPOSAL

February 16, 2005—TRANSPARENCY OF BUDGET MEASURES

February 17, 2005—MEDICARE AND MEDICAID: RISING HEALTH CARE 

COSTS AND THE IMPACT ON FUTURE GENERATIONS

March 1, 2005—THE PRESIDENT’S FISCAL YEAR 2006 DEFENSE 

BUDGET

(

ii

COMMITTEE ON THE BUDGET 

JUDD GREGG, New Hampshire, Chairman 

PETE V. DOMENICI, New Mexico 

CHARLES E. GRASSLEY, Iowa 

WAYNE ALLARD, Colorado 

MICHAEL ENZI, Wyoming 

JEFF SESSIONS, Alabama 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

JOHN ENSIGN, Nevada 

JOHN CORNYN, Texas 

LAMAR ALEXANDER, Tennessee 

LINDSEY O. GRAHAM, South Carolina 

KENT CONRAD, North Dakota 

PAUL S. SARBANES, Maryland 

PATTY MURRAY, Washington 

RON WYDEN, Oregon 

RUSSELL D. FEINGOLD, Wisconsin 

TIM JOHNSON, South Dakota 

ROBERT C. BYRD, West Virginia 

BILL NELSON, Florida 

DEBBIE STABENOW, Michigan 

JON S. CORIZINE, New Jersey 

SCOTT GUDES, Majority Staff Director 

MARY NAYLOR, Staff Director 

iii

C O N T E N T S 

HEARINGS 

Page 

February 1, 2005—The CBO Budget and Economic Outlook .............................. 1

February 8, 2005—Reexamining the Federal Budget for the 21st Century ....... 85

February 9, 10, 2005—The President’s Fiscal Year 2006 Budget Proposal ........ 165

February 16, 2005—Transparency of Budget Measures ...................................... 277

February 17, 2005—Medicare and Medicaid: Rising Health Care Costs and 

the Impact on Future Generations ..................................................................... 395

March 1, 2005—The President’s Fiscal Year 2006 Defense Budget .................... 459

STATEMENTS BY COMMITTEE MEMBERS 

Chairman Gregg ........................................................................ 1, 85, 165, 277, 395, 459

Senator Conrad.................................................................. 2, 85, 166, 277, 350, 396, 460

Senator Feingold .................................................................................................... 69, 251

Senator Johnson ...................................................................................................... 248

Senator Stabenow .................................................................................................... 67

Senator Crapo .......................................................................................................... 74

Senator Bunning ............................................................................................ 66, 295, 486

Senator Allard .......................................................................................................... 349

Senator Enzi ............................................................................................................. 328

WITNESSES 

Bolten, Joshua, Hon., Director, Office of Management and Budget ................ 179, 242

Brown, Jeffrey, PhD., Assistant Professor of Finance, University of Illinois 

at Urbana-Champaign...................................................................................... 417, 420

Holtz-Eakin, Douglas, Director, Congressional Budget Office............. 17, 58, 356, 380

Jonas, Tina, Undersecretary of Defense/Comptroller, Department of Defense ..

Pace, Peter, General, Vice Chairman of the Joint Chiefs of Staff, Department 

of Defense .............................................................................................................

Quam, Lois, E., Chief Executive Officer, Ovations, A UnitedHealth Group 

Company............................................................................................................ 429, 432

Saving, Thomas R., Director, Private Enterprise Research Center................. 402, 407

Snow, John, Hon., Secretary, Department of the Treasury.............................. 279, 323

Walker, David M., Hon., Comptroller General of the United States Government Accountability Office................................................................................. 96, 132

Wolfowitz, Paul, Deputy Secretary, Department of Defense ............................... 501

ADDITIONAL MATERIALS AND CHARTS SUBMITTED 

Questions and Answers 

Questions and Answers ................................................. 79, 218, 230, 254, 330, 511

(1)

THE CBO BUDGET AND ECONOMIC OUTLOOK 

TUESDAY, FEBRUARY 1, 2005

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

The committee met, pursuant to notice, at 9:55 a.m., in room 

SD–608 Dirksen Senate Office Building, Hon. Judd Gregg presiding. 

Present: Senators Gregg, Domenici, Allard, Enzi, Bunning, 

Crapo, Alexander, Graham, Conrad, Sarbanes, Murray, Johnson, 

Byrd, Nelson, Stabenow, and Corzine. 

Staff present: Scott B. Gudes, Majority Staff Director; and Dan 

Brandt. 

Mary Ann Naylor, Staff Director; Sue Nelson and Jim Esquea. 

OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

Chairman GREGG. We are fortunate enough to have the director 

of CBO here, and Senator Conrad has been kind enough to be here 

early, which is, I expect, a North Dakota habit anyway, and so, 

now that we have everybody here, we can get started, even though 

it is a little early, and as other members arrive, we will be happy 

to have them participate. 

The purpose of this hearing is to hear from the director on the 

baseline. This is a traditional hearing of the Budget Committee 

and an important one. It is my first hearing as chairman, and I 

want to begin by thanking the staff of both Republican and the 

Democratic side for being so courteous to me and in my assuming 

this position, being so helpful. 

I want to thank Senator Conrad for his very kind and generous 

courtesy as we have sort of settled into this new role. We have 

served together a long time a time and have great respect for each 

other, and I especially want to express consideration and appreciation for all the work that Senator Nickles did as my predecessor. 

He was an excellent chairman and set a very high standard of fairness and objectivity and transparency, which I hope to carry on, obviously. 

This is an important committee for a lot of various reasons, but 

I consider it important because it sets the memo that controls the 

meeting; essentially, the budget drives the process around here, 

and we have an obligation to put out a budget that will effectively 

drive that process. The purpose of this memo over the coming year, 

I hope, will be to take control of the fiscal house of the Federal 

Government, move us back toward a position of balancing our 

budgets, reaching a goal of reducing the deficit in half in 4 years, 

2

that is my goal, and having effective enforcement mechanisms so 

that Members of Congress who feel they want to assert their rights 

to exercise fiscal discipline will have tools to do that, and it is my 

goal to produce such a budget, and hopefully, we can do that in a 

way that is, if not necessarily totally bipartisan, at least perceived 

as fair and honest in its approach. 

We obviously will hear from the President as to his budget at the 

beginning of next week, I believe, and that will set the tone as we 

move forward. But the initial step is to figure out where we are 

today, and that goes to the baseline. These are the figures off 

which we function. We need to have a fair number that everybody 

agrees on is what we are working off of. There are obviously some 

issues with any baseline, but it is critical that we do have a baseline, because otherwise, we are never going to be able to figure out 

what we are talking about relative to each other. 

So this is a critical issue for us, what the baseline is, and we 

very much appreciate the Director’s coming by today to give us his 

thoughts and to set such a baseline for us, and at this time, I 

would yield to Senator Conrad. 

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD 

Senator CONRAD. Thank you, Mr. Chairman. 

Thank you first of all for the many courtesies that you have extended to our side of the aisle during the transition. We appreciate 

very much the way you and your staff have accommodated us as 

these changes were made. It is certainly a very good start to a relationship, and I want to thank the Chairman. I also want to welcome him to his new responsibility and to indicate that I very 

much look forward to working with him. 

We have a long relationship, having served for many years together in the Senate. We have areas where we very much agree. 

I think both of us believe that deficits do matter and that these 

budget deficits that we have now are too large, and they need to 

be reduced, and that we have a role with our colleagues, a responsibility in trying to put forward plans to get these deficits under 

control. 

I want to thank Mr. Holtz-Eakin for his appearance today and 

for the hard work of his organization. They help us judge where we 

are and where we are headed. 

If I could, I would like to start off with just a few charts with 

respect to our current condition and look ahead to what we see 

coming if we do not take action. This first chart shows what has 

happened over the last several years. Back in 2001, we had a budget surplus of $128 billion. Every year since then, the deficit has 

grown larger: record deficits of $377 billion in 2003; $412 billion 

last year; and now, the administration is projecting a deficit this 

year of $427 billion, a new record.

3

The great concern that I have is not just the next 4 years or 5 

years. The President has set a goal of reducing the deficit, cutting 

it in half in the next 5 years. My great concern is what happens 

outside the budget window. The President has proposed making 

the tax cuts permanent. This dotted line shows the effect for the 

next 5 years of the budget window. But look at what happens after 

the 5-years of the budget window to the cost of the proposed tax 

cuts: they absolutely explode beyond the 5-year budget window. 

Let us go to the next chart. That is not only true of the tax cuts 

proposed by the President. That same pattern pertains to fixing the 

alternative minimum tax, the old millionaires’ tax that is now becoming a middle class tax trap; 3 million people affected now. Ten 

years from now, there will be 40 million people caught up in the 


21173.001
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alternative minimum tax if we fail to take action; the cost, over 

$770 billion to address that. That is not in any of the budget numbers; that is not in the CBO report today. I am not faulting CBO. 

It is not their fault that it is not there. It is the rules that they 

*COM007*are governed by.

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Let us go to the next chart. I think maybe we should make clear 

that CBO is required to do their estimates based on current law, 

and so, when the President proposes additional tax cuts, they are 

not in the CBO estimate. When we have a challenge of the alternative minimum tax, that is not in their estimates. We see the 

same pattern with respect to the cost of the war. There is the $80 

billion that the President has just requested, but the long-term outlook over the next 10 years is $426 billion of additional spending 

for residual war costs.

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When put all those things back in, what we see over the next 10 

years is red ink as far as the eye can see. We see massive deficits 

not only this year but every year going forward over the next 10 

years with very little improvement during this period. 

Let us go to the next chart. If, as some are proposing, we fund 

the transition cost of changing Social Security, moving some part 

of Social Security into private accounts, that would make the deficit situation even more dire. We would go from an ocean of red ink 

to an expanding ocean of red ink so that by the end of the 10-year 

period, we would be approaching a shortfall of $800 billion a year.

10


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Let us go to the next chart. If we put all those things back in 

the calculation that CBO does not include because they are not allowed to under the rules that govern them, we see that the publicly 

held debt of the United States explodes to $11 trillion by 2015. And 

this money is being borrowed not only from ourselves, but from 

around the world. We have now borrowed over $700 billion from 

Japan; over $190 billion from China. We have even borrowed more 

than $69 billion from South Korea. Some of us are alarmed by this 

dramatic increase in our external debt. Our external debt has increased 82 percent in just the last 3 years.

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Let us go to the final chart. This is why it matters: the Financial 

Times ran this headline last week: Central Banks Shun U.S. Assets. And the point that they are making in this article is that increasingly, foreign banks are concerned about the debt of the 

United States, both the trade deficit and the budget deficit and the 

extraordinary borrowing that are required by both.

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That sums up the additional comments I wanted to make, Mr. 

Chairman, as we head into a review by Mr. Holtz-Eakin of their 

long-term outlook. I thank you. 

Chairman GREGG. Thank you, Senator. 

Chairman GREGG. And as the tradition with this Committee, the 

Chairman and the Ranking Member make an opening statement, 

and then, we turn to our witness. So, Director, we would love to 

hear your thoughts on where we are going with the baseline. 

STATEMENT OF DOUGLAS HOLTZ-EAKIN, DIRECTOR, 

CONGRESSIONAL BUDGET OFFICE 

Mr. HOLTZ-EAKIN. Well, Mr. Chairman, Senator Conrad, thank 

you for the chance to appear today. You have our written testimony 

and our larger report, which I think is a tribute to the CBO staff 

and I hope a service to the Congress. I thought I would spend a 

few minutes hitting some of the main points and then would be 

happy to answer your questions. 

As you know, the Federal budget ran a deficit of $412 billion in 

fiscal year 2004. Under the baseline projections, the deficit in 2005 

will be $368 billion, including a reasonable allowance for the costs 

of operations in Iraq and Afghanistan, the fiscal year 2005 deficit 

is likely to be about $400 billion. This is a modest improvement. 

It is an improvement both in absolute terms and as a share of our 

national income, down from 3.6 percent of GDP to 3.3 percent. 

Nevertheless, the likely path in the future depends heavily on 

policies chosen by Congress and the administration. Clearly, the 

baseline, because of the conventions involved, does not include the 

cost of ongoing operations in Iraq and Afghanistan or other appropriations as necessary in the global war on terrorism, and that will 

likely cause spending to be higher. 

The baseline includes a tax policy that has taxes rising in 2009, 

with the expiration of rates on capital gains and dividends, and 

sharp rises in 2011 with the expiration of the EGTRRA and 

JGTRRA tax provisions. We have heard much talk of taxes not 

going up, instead staying at their current levels or even being reformed, and the baseline importantly includes a path of mandatory 

spending that will not only accelerate during the course of the 10-

year budget horizon but increasingly become larger thereafter. 

So it is important, I think, to look at changes in the recent budget situation since last summer, where they are modestly worse 

when done on an apples-to-apples comparison, and then, to think 

about the path going forward as largely dictated by policy choices 

of the Congress and the administration. 

We are building on a firm foundation. The U.S. economy is in the 

midst of a solid, private-sector led economic recovery, moving back 

toward its potential. It has experienced solid, long-term productivity growth, which is a great hope for the future, and as a result, 

it is best to think of the economy as not contributing to the budget 

deficit, that is a minor contribution, but rather, the policies chosen 

being built upon a stronger economy that will allow us to address 

these issues. Nevertheless, I think even given very strong growth, 

it is a bad bet to think that we will simply grow out of the current 

budget situation. 

18

And finally, in thinking about policy choices, I will close at the 

end by emphasizing again that mandatory spending represents the 

largest share of the Federal budget and the most rapid source of 

growth. 

So let me walk through those points in a little more detail and 

then take your questions. The graph indicates the CBO baseline 

budget projection. It is, as Senator Conrad noted at the outset, a 

current law projection. It represents the path of the Federal budget 

on essentially fiscal autopilot. If we were to simply track all discretionary spending that was on the books at the close of 2005 and 

raise it at the rate of inflation, if we were to allow all mandatory 

spending programs to execute as they are currently written in law, 

and if the tax code proceeds as currently written in law, we will 

see steadily diminishing budget deficits over the next several years, 

down from $368 billion or 3 percent of GDP; by 2010, it will be 

$189 billion, 1.2 percent of GDP, and thereafter, a return toward 

surplus and a total over the 10 years of $855 billion or half a percent of our GDP in budget deficits. 

Now, this baseline has changed somewhat since last September, 

and those changes are a bit hard to discern, largely because of two 

important differences. The first and the largest is that in September, when we did our baseline projections, there were $115 billion in appropriations on the books, mostly for operations in Iraq 

and Afghanistan. Baseline conventions say include $115 billions on 

the books every year; assume policy is unchanged, and raise it at 

the rate of inflation. Doing so, 10 years of $115 billion, inflation, 

debt service, contributes to $1.4 trillion of 10-year spending from 

those appropriations alone. 

At the moment, we have no supplemental appropriations for Iraq 

and Afghanistan, so we follow the same conventions. We put zero 

in for 10 years, raise it at the rate of inflation; we get zero. It is 

an apparently large swing in the fiscal outlook, but it has to do 

with the baseline conventions and nothing real. 

This chart shows that if you put it on an apples-to-apples basis, 

indeed, the 10-year budget outlook has worsened modestly. About 

three-quarters of that is legislation and a quarter economic and 

technical revisions. 

We turn next to the economy and the likely outlook. The most 

important feature of the CBO forecast is the outlook for productivity growth. It certainly, as everyone knows, figures into the longterm standards of living in the United States. Accordingly, it figures heavily into the long-term capacity to fund both private-sector 

needs and wants as well as the Government budget. A one-tenth 

of a percentage point increase in a sustained way in the level of 

productivity contributes about $250 billion to 10-year budget deficit 

reduction. So swings in productivity are very important over the 

long-term. 

Over the near term, the assessment of productivity is simultaneously an assessment of the capacity of the economy to absorb 

this cyclical recovery without generating capacity constraints and 

inflationary pressures. At the moment, assessing future productivity is particularly difficult. As is widely known, post-1995, the 

United States has experienced an acceleration in productivity that 

has been a great boon to our economic fortunes. 

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Most surprisingly, during the most recent recession and recovery, 

in contrast to the typical pattern of slower productivity growth and 

then a pickup as the economy comes out, we have seen an even 

more sharp increase in productivity in the United States. This 

leaves us with the difficult question of assessing whether to take 

the extrapolation of that sharp increase or to remain with a projection that looks like the post-1995 experience of the United States. 

Given the propensity for productivity to be revised and the value 

as a result of being patient before we certify something as permanent, we have adopted a middle course, where we assume that 

there is a greater level of productivity, a greater capacity for production and income in the U.S., but we are going to assume the 

post-1995 growth rate for productivity. It is an important issue 

that is probably the most important wild card in our outlook and 

one we are constantly reviewing. 

Other risks to the outlook that are worth just mentioning are, in 

no particular order, first, oil prices. Oil prices remain difficult to 

gauge in the current international environment. They are a bit 

higher at present than they were when we put the forecast to bed, 

about $4 a barrel likely in 2005, $2 a barrel in 2006; those will 

have small impacts on economic performance. $10 a barrel of oil is 

worth about two-tenths of a percent in GDP growth. Nevertheless, 

it is something we will watch closely. 

And more generally, it is the case that a wide variety of economic 

uncertainties exist. The most prominent is the economic consequences of a terrorist act, followed by concerns on international 

trade and international finance, the pace of world economic recovery, the potential for housing prices to moderate their growth 

somewhat in the United States or households to save more. All of 

those figure into the kinds of uncertainties that we have experienced in the past and are likely to revisit again in the future in 

mapping the course of the economy into the budget outlook. 

Let me turn now to the spending and the receipt side of the 

budget. Most of the attention recently has focused on discretionary 

spending, and it has been particularly difficult to judge the pace of 

spending growth, given the path of supplemental appropriations. 

This chart summarizes some of what we know. If we exclude supplemental defense spending between 2004 and 2005, appropriations 

for that area rose by 6.7 percent; in the non-defense, non-homeland 

section, 2.6 percent; homeland security appropriations rose by over 

14 percent, with the net result that overall, appropriations grew 

5.1 percent between 1904 and 1905, exclusive of all supplementals. 

Going forward, the baseline outlook that you saw assumes that 

outlays for discretionary spending will grow at a much slower rate. 

They will grow only at the rate of inflation, and as a result, there 

is a mismatch between the most recent experience and the projections that we have put before you in the baseline. 

However, the real dollars in the Federal budget are on the mandatory side. Mandatory programs now constitute over half of Federal spending; the three that are most notable in their size and 

growth are Social Security, currently the single largest Government program, $500 billion, which is growing at present about 4.5 

percent per year but which will by the end of the budget window 

be growing at over 6 percent per year. 

20

Medicare and Medicaid, currently behind Social Security, will 

overtake the outlays for Social Security during the 10-year budget 

window. They will grow at 9 percent from Medicare, a bit under 

8 percent for Medicaid, and the net result will be that those three 

programs will constitute over one-half of Federal spending by 2015 

in the baseline. 

This rapid growth in Federal spending is on the other side of the 

ledger confronted with fairly rapid growth in Federal receipts, on 

average, about 6.5 percent. Most of that is in the rapid growth of 

individual income tax receipts. The good news is that we have seen 

that receipts have begun to rise again this year as opposed to the 

past several years when they fell. We anticipate that individual income tax rates will rise about 8.5 percent per year over the 10 

years, with the result that total Federal receipts will climb from 

about 16.8 percent of our national income, nearly 17 cents on the 

national dollar, below the historic average of 18 percent in the post 

war, to about 19.6 percent of our national income by 2015. 

That rise in the Federal effective tax rate comes in two pieces. 

One piece is legislation, where about 1.5 percent of that rise is due 

to the sunset of tax provisions. The remainder is due to real economic growth and higher personal incomes and a bit from the cashout of IRAs and 401(k)’s as the baby boom moves toward retirement and finally, a bit more from the alternative minimum tax 

that Senator Conrad mentioned at the outset. 

Given the importance of policies for the ultimate fiscal outlook 

going forward, we included in our reports some illustrative alternatives on the discretionary side and on the tax side. I leave those 

for you to read and simply note in closing that we did not include 

any illustrative scenarios for mandatory programs. They obviously 

presented themselves as central to the policy debate, but it is the 

case that over the longer term, the combined spending on Medicare 

and Medicaid and Social Security will place increasingly large demands on the Federal budget, and that left at historic rates, the 

growth in these health programs especially will likely outstrip our 

ability to finance them and place our fiscal policy on an 

unsustainable course. 

With that cheery close, I thank you for the chance to be here 

today and look forward to answering your questions. 

Chairman GREGG. Do you know Senator Conrad? 

[Laughter.] 

Chairman GREGG. Cheeriness. 

Just to return to the issue which you ended up on, and we are 

going to stick to the 5-minute rule; we have a lot of members, 

which is great. Willie Sutton used to say you rob banks because 

that is where the money was. And if you are looking at the longterm fiscal solvency of the Nation and how we address the deficit, 

it is fairly obvious from your numbers that it is in the entitlement 

accounts that we have to show the most management; is that correct? 

Mr. HOLTZ-EAKIN. Yes. 

Chairman GREGG. And within those accounts, the ones that are 

driving the largest amount of increase, as you said, Social Security 

would be overtaken by health care, the health care accounts, primarily Medicare and Medicaid; is that correct? 

21

Mr. HOLTZ-EAKIN. That is correct. 

Chairman GREGG. Now, we have just put on the books a new 

Medicare benefit, which is the drug benefit. Do you have any estimates as to where that drug benefit is going and how much it will 

cost and how it is rising in relationship to what the original estimates were, which that it would be $400 billion over 10 years? 

Mr. HOLTZ-EAKIN. We do not track the subsequent cost of legislation that has been passed. To the extent that we can do an applesto-apples comparison, we can look at the baseline outlays for the 

Part D benefit under Medicare; about $1.1 trillion over the 10-year 

budget window. That is in line with the original cost estimate. 

The cost estimate, as it was in the bill, included some impacts 

on other Federal programs that we do not pull out and track separately in the baseline. So to the best of our knowledge thus far, the 

cost of the drug bill is essentially unchanged. It has crept up by 

about $5 billion compared to the $400 billion on the pieces that we 

can compare. Drug spending is growing more rapidly than health 

care spending as a whole, but it still represents a relatively small 

share, 10 percent of the kinds of outlays we face. 

Chairman GREGG. Do you have the capacity to break those numbers out? 

Mr. HOLTZ-EAKIN. Once the bill is passed and put into the various baselines, Medicare, Medicaid, FEHBP, and all those other 

things, we cannot track the exact configuration that was in the bill 

as it was passed. We can show you and are happy to the pieces 

that we track separately and their comparison to the original cost, 

and there, they are up only modestly, about $5 billion. 

Chairman GREGG. So you cannot do a Part D estimate. 

Mr. HOLTZ-EAKIN. We cannot do the MMA reestimate circa 2005. 

We can just look at the Part D as it appears in our baseline and 

that part of the MMA as it appeared in the original cost estimate. 

Chairman GREGG. And in the area of Medicaid, what are you 

projecting there in relationship to the baseline? 

Mr. HOLTZ-EAKIN. Medicaid spending is growing a bit under 8 

percent per year. It grows more slowly than Medicare, in part due 

to legislation. The expiration of the extra Medicaid match that was 

in the JGTRRA provision makes growth a little slower, and the 

MMA moved the responsibility for prescription drugs from Medicaid to Medicare for those who are eligible for both programs, and 

that makes the 10-year growth a bit slower. 

Over the longer term, the core source of growth is rising health 

care costs in the United States, the underlying cost pressures, not 

the particular structures of these programs. 

Chairman GREGG. Looking at the discretionary accounts, if you 

take out the cost of fighting the war, it appears that the discretionary accounts were relatively flat in their rate of growth; is that 

correct? 

Mr. HOLTZ-EAKIN. If one takes out the appropriations, you see 

the most recent year as I displayed on the chart, total growth at 

about 5 percent. 

Chairman GREGG. And what are you projecting for the next 5 

years in those accounts? 

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Mr. HOLTZ-EAKIN. Past the appropriations each year, we simply 

assume growth at the rate of inflation. Our inflation rate is going 

a bit above 2 percent per year over the budget window. 

Chairman GREGG. And I notice that you are projecting that the 

revenues of the Federal Government are going to go up by approximately 6 percent, did you say? 

Mr. HOLTZ-EAKIN. They are going to grow fairly rapidly, under 

9 percent per year. 

Chairman GREGG. And that is, in the first period, before the extension issue comes into play, what are you projecting revenue 

growth to be? 

Mr. HOLTZ-EAKIN. Over the first 5 years, total revenue growth 

will grow at 8.7 percent per year on average. 

Chairman GREGG. So even with the tax cuts, you are talking 

about revenues going up significantly. 

Mr. HOLTZ-EAKIN. Yes; over the 5 years, there is a bit of legislation that comes into play with dividends and capital gains, but we 

are getting some from recovery in the economy and some from a 

resumption of capital gains revenues closer to normal. 

Chairman GREGG. You are probably getting some from the dynamic fact that people with more income are more productive. 

Mr. HOLTZ-EAKIN. We hope that our baseline incorporates the incentives that come with current law fiscal policy; they are constructed to do so. 

Chairman GREGG. Your baseline seems to be fairly constrained 

in that you always assume that spending programs go on forever, 

even if their authorizations terminate, but you assume that the tax 

liability of the American citizenry will go up if the tax law is not 

extended. Why would we make those seemingly inconsistent assumptions? 

Mr. HOLTZ-EAKIN. Well, we would be happy to work with the 

Budget Committee if there is an alternative set of assumptions 

that you would like to pursue for preparing baselines. The intent 

is to provide a neutral benchmark against which you can measure 

changes from current policy. 

Chairman GREGG. Well, I guess my point is I understand you are 

constrained. 

Mr. HOLTZ-EAKIN. Yes. 

Chairman GREGG. And that is not your fault. But it does seem 

to me to be inconsistent in its constraining efforts. I mean, let us 

assume that if an authorization is sunsetted, why not assume that 

the program ends if you are going to say that when a tax rate sunsets, it is going to go up? I mean, you are handling one one way 

and another one another way; it just seems to me that it is not appropriate to getting a level playing field for reviewing the two. 

My time is about up; I will yield to Senator Conrad. 

Senator CONRAD. Thank you, Mr. Chairman. 

What is the 75-year shortfall in Social Security? 

Mr. HOLTZ-EAKIN. CBO’s estimate of the 75-year shortfall as a 

fraction of GDP is about 0.4. 

Senator CONRAD. Expressed in dollar terms, present-day dollar 

terms, what would the shortfall in Social Security be? 

Mr. HOLTZ-EAKIN. Over the infinite horizon, it is $6.7 trillion. 

Senator CONRAD. Over the 75-year. 

23

Mr. HOLTZ-EAKIN. I do not seem to have that number in front 

of me. 

Senator CONRAD. I think it is $3.7 trillion. 

Mr. HOLTZ-EAKIN. It would be similar to the Social Security Administration, a bit smaller. 

Senator CONRAD. Does $3.7 trillion sound about right as the 75-

year shortfall? 

Mr. HOLTZ-EAKIN. That is the Trustees’ number. Ours would be 

a bit lower. We assume higher interest rates. 

Senator CONRAD. Yours would be somewhat lower. What is the 

75-year shortfall in Medicare? 

Mr. HOLTZ-EAKIN. That number, I do not know how to calculate, 

quite frankly. Given historic rates of growth of Medicare and Medicaid, health care in general, 2.5 percent faster than income per 

capita. It is not obvious how to do that calculation without assuming something grows slower in the future, and so, the range of possible answers is enormous. I could essentially make up any number 

by assuming a future slowdown in costs. 

Senator CONRAD. Well, let me ask you this: do you think that it 

is safe to assume that the 75-year shortfall in Medicare dwarfs the 

75-year shortfall in Social Security? 

Mr. HOLTZ-EAKIN. Absolutely. 

Senator CONRAD. Do you have any estimate of what the 75-year 

cost of making the tax cuts permanent would be? 

Mr. HOLTZ-EAKIN. We have never done such an estimate. The report contains an alternative to the baseline that says that the impact in 2015 is about 2 percent of GDP, it is a bit under. There 

is no reason to think that that fraction of the economy would be 

dramatically different going forward. 

Senator CONRAD. I have an estimate that the 75-year cost of 

making the tax cuts permanent is $11.6 trillion. I would ask you 

to do an analysis of that. I would like to see what your numbers 

are, but that is in the range of the 75-year shortfall in Medicare 

and substantially more than the 75-year shortfall in Social Security. When you calculate the long-term imbalances in Social Security, what growth rate are you assuming? 

Mr. HOLTZ-EAKIN. In our analysis of Social Security, we assume 

that long run real wage growth, which is the reflection of productivity growth in the United States, is 1.3 percent per year; the 

other factor that figures into overall economic growth is how many 

bodies will be available to take advantage of that, and there, we 

are going to have labor force growth that is on the order of a half 

a percent per year. It depends——

Senator CONRAD. So to come up with this calculation of long-term 

shortfall in Social Security you would be estimating an economic 

growth rate of about 1.8 percent; is that correct? 

Mr. HOLTZ-EAKIN. Thereabouts; we can get the exact number. 

Senator CONRAD. And what was the economic growth rate last 

year? 

Mr. HOLTZ-EAKIN. Last year, we had a very good year. We do not 

know the final number for the fourth quarter yet, but it looks to 

be in the neighborhood of 4 percent. 

Senator CONRAD. Four percent. And over the last 10 years, what 

has the economic growth rate been? 

24

Mr. HOLTZ-EAKIN. I do not know off the top of my head but well 

below four. 

Senator CONRAD. And one of the things I would be interested in. 

If the economic growth rate was 2.5 percent instead of 1.8 percent, 

what would that do to the estimates of long-term Social Security 

solvency? 

Mr. HOLTZ-EAKIN. Productivity growth is not a panacea for Social Security. To the extent that we experience higher or lower productivity growth, it is reflected in real wages. Those real wages do 

provide higher payroll taxes into the Federal budget, but they also 

give the recipients higher benefit awards out of the Federal budget. 

Over the long-term, it is essentially neutral with respect to productivity. 

Senator CONRAD. And what about economic growth? 

Mr. HOLTZ-EAKIN. That is the key source of long-term economic 

growth. One could imagine a shift in the demographics, which raise 

the total growth rate because there was a larger growth in the 

labor force. There, I think the key uncertainty would be the path 

of future immigration, which is, I think, central. The native-born 

population at the moment is not replacing itself. The fertility rates 

are below replacement. 

So all future population growth is ultimately derivative of immigration and immigration policy, and that will be the key uncertainty going forward. 

Senator CONRAD. You know, I would imagine somebody listening 

to this at home must be utterly confused. I think it is hard to get 

your mind around the concept that economic growth is a product 

of productivity growth and the growth of the population. That is 

what you are saying to us this morning. And one of the key elements in population growth is how much immigration we have. 

What I hear you saying is that if there is more immigration, that 

would actually extend the solvency of Social Security. 

Mr. HOLTZ-EAKIN. It certainly would be an important part of 

long-term economic growth. As I said at the outset, I think it is important to recognize that we are unlikely to grow our way out of 

this problem. We did a long-term budget outlook in December of 

2003. Nothing has fundamentally changed since we produced that 

document. It suggests that between now and 2050, if we repeat in 

the future what we have experienced historically, Medicare, Medicaid and Social Security will be about 26 percent of GDP; the current Federal Government is about 20 percent, and economic growth 

will not dramatically alter that picture. 

Senator CONRAD. Very good; thank you for that testimony. 

Chairman GREGG. You have raised a huge issue, which is whether you can immigrate your way out of Social Security problems. 

Senator ALEXANDER. 

Senator ALEXANDER. Do you count illegal immigrants when you 

consider the number of people in the work force? 

Mr. HOLTZ-EAKIN. We use for our projections the information 

provided by the Census, which we have from 2001 as the jumping 

off point. That would include both legal and illegal immigrants, and 

we then do our best to project over the next 10 years based on what 

we know from the Bureau of Labor Statistics and the Census anVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00030 Fmt 6633 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
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nual data, so they are in there in an approximate fashion. I will 

not pretend to have great precision. 

Over the longer term, we use the Trustees’ assumptions regarding the demographics in the United States. 

Senator ALEXANDER. Do you have any—do you know how many 

illegal people are working, have jobs here? 

Mr. HOLTZ-EAKIN. At this point in time, no. It is very difficult 

to know even legal immigration on a real time basis. Undocumented workers would be even harder. 

Senator ALEXANDER. Your report says that the labor force participation rate has declined from its peak of 67 percent in 2000 to 

66 percent today, which you said means that we have 2.2 million 

fewer workers, and in your conversation a moment ago, the suggestion was that, we have more contributions to the economy. 

Bear Stearns has a report that came out this month that estimates there may be up to 20 million illegal immigrants in the 

United States, more than double the 9 million people estimated by 

the Census Bureau, and that illegal immigrants are gaining a larger share of the job market, so says Bear Stearns, and hold approximately 12 to 15 million jobs in the United States, 8 percent of the 

people working. 

Now, if Bear Stearns is right, that would make a massive difference, would it not, in your figures about the number of people 

working? A 1-percent change in the work force is 2.2 million workers, according to your report. So if there are 5 percent more illegal 

immigrants here than we think, we could have a significantly larger contribution to the work force. 

So let me ask the question this way: there is a good deal of talk 

and the President has suggested very strongly that in order to live 

by the rule of law which we preach in this country that we need 

to create a guest worker status for people who work in this country. If we were to do that, how might that affect your budget projections? 

Mr. HOLTZ-EAKIN. Well, there are really two impacts to think 

about: one is the starting point, and the second is future growth. 

With respect to the starting point, to the extent that workers, legal 

or otherwise, are employed and show up in the employment survey, 

they are counted in terms of employment. To the extent that they 

produce output, and it is measured in the standard accounts, we 

have already got them. 

If it is the case that a new policy toward immigration altered the 

growth of the labor force going forward, that would be a greater increase in the economic resources available in the economy. Labor 

is a central input and would allow us to grow faster, other things 

equal. 

Senator ALEXANDER. I would encourage you to explore how we 

count people who are illegally here working. I have had some conversations about it with Mr. Greenspan, and it seems to me unlikely that the employer survey, which surveys employers, is going 

to turn up an accurate count of people that they illegally hire. And 

if there are as many as 20 million people here, we need to get a 

better grasp on that, both for our budget debates and our debates 

about the rule of law and about immigration policy and about tax 

policy, and some part of our Government needs to help us underVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00031 Fmt 6633 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
26

stand the number of people who are here and are not legally here 

and who have jobs. 

Mr. HOLTZ-EAKIN. Well, Senator, I look forward to working with 

you on that. We are undertaking some work on immigration at the 

CBO and its impact on the budget and the economy more generally. I look forward to that. 

Senator ALEXANDER. Thank you, Mr. Chairman. 

Chairman GREGG. Thank you. 

Senator STABENOW. Senator STABENOW. Good morning. 

Mr. HOLTZ-EAKIN. Good morning. 

Senator STABENOW. And welcome, Mr. Chairman, to the Budget 

Committee. I look forward to working with you. 

You have spoken about policy choices, and that is really our responsibility, working together to look at the values and priorities 

of the country and how they are reflected through the budget, just 

as we do that in our own checkbook when we look at where we 

spend our dollars. 

I want to speak about that for a moment, because it is my understanding that we are going to see from the administration cuts in 

investments in education, cuts in veterans’ health care; at the same 

time, a supplemental that will be about $80 billion for Iraq, and 

I have supported those, the funding for Iraq. But the 1-year funding, the $80 billion equals, in fact, surpasses the 1-year funding of 

the Department of Education and the Department of Veterans Affairs. So I raise that just to say this is always about choices, values 

and priorities. 

I want to speak specifically about Social Security with you today, 

though. In speaking about Social Security, when you are talking 

about entitlements and the spending of the Federal Government, I 

think it is important for us to remember and to say Social Security 

is privately funded, is it not? We pay into it. We pay through payroll taxes into that system. It is privately funded. It is an insurance 

policy. It is the way we decide, just like you buy car insurance or 

home insurance, we pay into an economic insurance policy that insures us at retirement that we will not be in poverty or that if we 

are disabled, we will have an insurance policy, or if we have minor 

children, and heaven forbid, something happens to us, that they 

will have a life insurance policy. 

So it is an insurance system paid into privately, and it is about 

choices when we look at whether that is a good program for the future or whether we do other things. And I wanted just to return 

to what Senator Conrad had said: there are various numbers, but 

it appears that the 75-year shortfall in Social Security is around 

$3.7 trillion; some have actually said it is actually less, $2 trillion, 

but we will take the higher number of $3.7 trillion. 

When we look at making the tax cuts permanent over 75 years, 

we are looking at roughly $11.6 trillion. So what we doing is saying 

that those who have done well, have been blessed in our country 

will be receiving more than three times in the tax cut what the entire shortfall of Social Security is over 75 years. 

And one of the things that I want to put forward in the Committee in the debate is the proposition that we would say to those 

most blessed, who have worked hard, obviously, I am sure, but who 

27

breathe the air and drink the water and are secured by our troops 

in Iraq and around the world and drive on our roads and benefit 

from all of the blessings of the United States that they take 70 percent of the tax cut over the next 75 years, 70 percent, and we could 

secure Social Security for the next 75 years. I think that is an important value statement. It is an important priority. 

And now, to questions: let me just say is it not according to your 

estimates, the CBO budget outlook, Social Security will, in fact, 

take in more than it pays out in each of the next 10 years; is that 

correct? 

Mr. HOLTZ-EAKIN. Our most recent estimates are that the surplus in Social Security, taxes above benefits paid out, will remain 

positive until 2020. 

Senator STABENOW. OK; and so over the next 10-year budget 

window, Social Security will take in about $2.6 trillion more than 

it pays out, roughly. Is that what you are looking at? So it does 

face long-term challenges, we understand, after the 2052 that you 

have estimated. It can pay about 80 percent of its benefits; is 

that——

Mr. HOLTZ-EAKIN. We would expect that upon Trust Fund exhaustion, current estimate is 2052, not a lot of precision there, I 

would admit. 

Senator STABENOW. Right. 

Mr. HOLTZ-EAKIN. But there would be about a 22 percent across 

the board reduction necessary to balance. 

Senator STABENOW. So, 22 percent, so 78 percent roughly. So we 

do have a challenge that we do need to fix working together longterm. 

My question would be, though, is not the rising cost of health 

care more of a challenge for us right now, not just Medicare and 

Medicaid, but large and small businesses in my State have had 

over an average 11 percent increase in their health care costs, and 

is that not a tremendous challenge and drain on the economy right 

now, and is health care not much more of a real crisis that we 

ought to be focused on? 

Mr. HOLTZ-EAKIN. I think that the central domestic policy challenge that is evident at the moment is the rising cost of health 

care. It has a public sector evidence in the rising cost of Medicare 

and Medicaid. It has private sector implications for insurance and 

for the composition of wages versus fringe benefits. It is a very important issue. It will evolve in the same budgetary context as Social Security will over the next decades. 

Senator STABENOW. Thank you, Mr. Chairman. 

Chairman GREGG. Thank you, Senator. 

Senator ENZI. 

Senator ENZI. I want to congratulate you for your assumption of 

the chairmanship, Mr. Chairman. 

Chairman GREGG. I am sure you do. 

[Laughter.] 

Senator ENZI. I also want to thank Director Holtz-Eakin for 

being here today, too, and for the insightful information he has provided both verbally and in the more extensive testimony. 

We’ve talked about balancing the budget. Recently, I looked to 

see how we balanced it before. I wanted to see what kinds of cuts 

28

we had made in the budget in order to balance the budget in the 

late 1990’s. I noticed we had not reduced the budget in any one of 

those years; that we grew the budget every single time. It appeared 

to me that the difference was we took in more revenue, which allowed us to spend more revenue. 

I noticed last year in the budget and again in appropriations that 

the President found 65 different programs that had failed their 

own evaluation based on their own criteria. Under the Government 

Performance and Results Act, they had listed what their goals were 

going to be, and then, in their evaluation of whether they had 

achieved those goals, they failed; 65 programs. 

We suggested those programs be eliminated, and there was not 

a one of them eliminated, not a one. Of course, the comment I 

heard was that the cut was only $5 billion. Now, anybody around 

here who says only $5 billion may have been here too long. That 

sounds like a lot of money to me. Yet, if we cannot start with eliminating $5 billion, we certainly are not going to be able to eliminate 

$500 billion. 

But after looking at it, it looks like growing the economy has 

been the key to balnacing the budget, not what we did with programs. Is that a correct assumption based on when we had a balanced budget? 

Mr. HOLTZ-EAKIN. The swing from deficit to ultimately surplus 

in the late 1990’s was the net effect of slow discretionary spending 

growth and, in particular, a very large investment boom that was 

reflected in large amounts of equity-based compensation and ultimately tax receipts in the United States. 

Senator ENZI. When we did the tax cuts, part of those tax cuts 

were business incentives. If those business incentives run out, how 

would that affect the productivity? Have you made any estimates 

on that? 

Mr. HOLTZ-EAKIN. Which particular tax provisions are—the 

2001, 2003 or earlier? 

Senator ENZI. The more recent ones. 

Mr. HOLTZ-EAKIN. We have looked fairly carefully at the impact 

of the partial expensing provision that was in the JGTRRA act, the 

Job Creation and Worker Assistance Act and then expanded. It appears that it has a modest stimulative effect on business investment, and we have been looking fairly carefully to see if its expiration at the end of 2004 would affect the timing of investment, 

though so far, there does not appear to be a dramatic amount of 

evidence that it really significantly pushed investment into 2004 at 

the expense of 2005. 

Senator ENZI. Thank you. There is also some confusion or interest in the difference between the payroll and the household survey 

on the amount of employment. Which survey do you think more accurately measures job creation, and what is your opinion of why 

there has been a sustained gap between these figures? 

Mr. HOLTZ-EAKIN. Both surveys have their virtues, and any projection that used one to the exclusion of the others is probably unwise. We rely heavily on the employment survey. It is a broader 

survey. It has historically been very successful at tracking employment. The household survey has known advantages in picking up 

29

startups and in many other sorts of transitions into business. We 

look at both in the course of putting together our estimates. 

Senator ENZI. Thank you. 

Thank you, Mr. Chairman. 

Chairman GREGG. Thank you, Senator. 

Senator NELSON. Senator NELSON. Thank you, Mr. Chairman. 

Good morning, Mr. Director. Would you mind holding up your 

chart right there? Yes, please. In your statement, it is my understanding that you clearly acknowledge that that chart does not reflect the cost of the war. 

Mr. HOLTZ-EAKIN. That is right. There is no accommodation for 

appropriations in Iraq and Afghanistan from 1905 and thereafter. 

Senator NELSON. And that would not, that chart would not reflect the reflection of if the President’s proposal on Social Security, 

on privatization, and a transfer of those costs, that is not reflected 

in that chart. 

Mr. HOLTZ-EAKIN. No, it is a baseline, has only current law. 

Senator NELSON. And would not reflect if we do the alternate 

minimum tax reform. That is not reflected in that chart either. 

Mr. HOLTZ-EAKIN. No, this is current law on the AMT. 

Senator NELSON. And that would not reflect the additional debt 

service that would go along with those additional expenditures as 

well. 

Mr. HOLTZ-EAKIN. No. 

Senator NELSON. All right; then, that being the case, may I—all 

right; if you would show the other chart, the question is are we 

going to do the President’s plan on Social Security privatization, 

which would cost about $1.9 trillion over 10 years; the cost of making the tax cuts permanent, which is about $1.6 trillion; the ongoing funding for the war, which obviously, we are going to appropriate $426 billion; the defense buildup as indicated by the administration, another $230 billion; AMT, alternate minimum tax, 

which certainly, there is going to have to be relief there, and therefore, reforming it is a very expensive item, $642 billion, and the 

debt service on all of that in excess of a half a trillion over a 10-

year period. 

If that is what happens, is that not more of an accurate reflection 

of what happens to the deficit over the next 10 years? 

Mr. HOLTZ-EAKIN. Well, certainly under an alternative policy 

projection, something like that might transpire. To be perfectly 

honest, I do not know what Social Security would look like, and an 

alternative minimum tax reform, again, I do not know exactly what 

that would look like, but qualitatively, that would be the kinds of 

implications you would have. 

Senator NELSON. Mr. Chairman, and our Ranking Member, I 

merely raise this point: yesterday, I had the privilege of speaking 

to what is known as the Forum Club. It is a bipartisan group that 

comes together in this case in Palm Beach County, in West Palm 

Beach, and we were talking about the question of the deficit. 

And there are so many figures flowing around, as you pointed 

out, Senator Conrad. And when you see a chart like that, it does 

not reflect the actual realities that we have to face, and so, as we 

judge the question of what we are going to do with Social Security, 

30

we have to be more realistic. There is not one of us here who is 

not going to support, with every dollar needed, our troops in the 

war, because it is in the interest, clearly, of the United States that 

we stabilize Iraq; otherwise, a vacuum would be filled by chaos and 

by terrorists. 

And so, as we do these projections, I would encourage us to look 

realistically at what we are looking at and then see the actual deficit figures, what they are going to be, and see the fact of how we 

are going to finance those figures. And the shocking thing is that 

of the debt that we went out and borrowed last year, almost all of 

it was borrowed from foreign sources. And the two biggest sources 

that we are borrowing from are banks in Japan and China, and 

this is just simply not a good position for us from a defense posture 

to be in. 

So thank you, Mr. Chairman, for the time to make this point. 

Chairman GREGG. Thank you, Senator. 

Senator ALLARD. 

Senator ALLARD. Mr. Chairman, I would also like to congratulate 

you on your chairmanship, and I do not have the conflict of interest 

that my esteemed colleague did here in Wyoming, but I do think 

you will do a great job for us. I am looking forward to working with 

you. 

You know, the $3.7 trillion that we saw put up on the charts 

here that goes out for 75 years, and I think 75 years is a ridiculous 

kind of—I mean, if what we are looking at here on your chart is 

apt to be wrong, 75 years out is certainly likely to be wrong. And 

the question I want to know, does that figure incorporate current 

law? 

Mr. HOLTZ-EAKIN. Yes. 

Senator ALLARD. So in 2042, when we have a 30 percent cut in 

Social Security, that is incorporated in those figures? 

Mr. HOLTZ-EAKIN. The gap that is reflected in those figures, and 

those are not ours; those are from the Social Security Administration——

Senator ALLARD. Yes. 

Mr. HOLTZ-EAKIN [continuing]. But ours would be qualitatively 

similar is the gap between benefits as scheduled under current law, 

and they stay above revenues, as scheduled under current law, as 

far as the eye can see, and so, the question is how do you add up 

that gap over different horizons? 

Senator ALLARD. But the point that I am getting to is that 2042, 

I think, is what the Social Security Administration——

Mr. HOLTZ-EAKIN. Right. 

Senator ALLARD [continuing]. Has said that the Trust Fund will 

be spent out. I mean, all of the money in the Trust Fund of Social 

Security will be spent in 2042; that is their figures. Now, what current law provides for, as I understand it, is that then, money that 

goes in is expended out, so you are no longer relying on those Trust 

Funds that have been borrowed from the General Fund to sustain 

those payments. 

So the assumption is that there is a 30 percent, when the Social 

Security—all of the debt that has been paid out of Social Security 

has been paid in, paid out to the beneficiaries, you have a third cut 

31

in benefits to Social Security. That is current law. And what they 

are figuring, what I see putting in these charts, they put that cut. 

So I am assuming that everybody on that side thinks that cutting Social Security in 2042 is a good idea, because that is the figures they are using, and that is what they are using to somehow 

or the other discredit these tax cuts that have been proposed by the 

President, and many of us have supported. I just do not think in 

the real world that there is going to be a one-third cut in Social 

Security benefits to Social Security beneficiaries in 2042. And I 

think if we project out without that one-third cut, I think that what 

we will find is that Social Security will actually spend more than 

what the tax cuts have, and I would like to see some figures where 

we actually take Social Security, Medicare and Medicaid and combine them and look at their growth 75 years down the road, and 

I think when we are finished, we will find that is a lot more expensive than any of the tax cuts. Would you agree with that? 

Mr. HOLTZ-EAKIN. I can give you the numbers, and you can decide for yourself. Between now and 2050, Social Security will rise 

from about 4 percent of GDP up to about 6.5 percent of GDP, so 

2.5 percentage points of GDP. 

Senator ALLARD. Which includes the one-third cuts in benefits in 

Social Security. 

Mr. HOLTZ-EAKIN. That is prior to the cut. 

Senator ALLARD. That is current law. 

Mr. HOLTZ-EAKIN. That is prior to the cut. 

Senator ALLARD. Yes. 

Mr. HOLTZ-EAKIN. It will then proceed along in excess of receipts 

until Trust Fund exhaustion and the cut. 

Senator ALLARD. Sure. 

Mr. HOLTZ-EAKIN. Medicare and Medicaid over the same horizon 

could rise anywhere from 4 percent of GDP to either 12 or maybe 

even 20 percent of GDP, given the growth of health care costs. And 

these are numbers that we have outlined in our 2003 report. There 

is a large growth on the outlay side that will have to somehow be 

addressed, because it is unlikely that especially if the health care 

programs grow that large that we could ever finance them. 

Senator ALLARD. Do you think in your own mind that it is likely 

that the one-third cut proposed in Social Security in 2042 under 

current law is going to sustain? 

Mr. HOLTZ-EAKIN. That is a policy call, as you know. It is current 

law that if that is——

Senator ALLARD. But historically, those kinds of cuts in entitlement spending have not occurred, have they? 

Mr. HOLTZ-EAKIN. The fact that that is the current law projection, and that is how the program can sustain forever, the crucial 

policy issue will be that the rising benefits above dedicated payrolls 

will occur simultaneously in the budget with rising demands for resources from the health care programs especially and then others 

as well, and that what ultimately will have to prevail will be some 

sort of adjudication of the demands for spending with the financing 

that is put in place. It will happen in all programs. 

Senator ALLARD. So if benefits were to sustain themselves at 

what is projected, and, you know, if you were not to have that cut; 

it was projected out over time, you would have to have increases 

32

in taxes and increases and cuts in spending in other programs to 

sustain that. 

Mr. HOLTZ-EAKIN. Our projections show that——

Senator ALLARD. Or cuts in benefits, I guess, to the——

Mr. HOLTZ-EAKIN. Scheduled benefits under current law remain 

2 percentage points above scheduled taxes and receipts under current law for the Social Security program out at the end of our 100-

year horizon. So that is the mismatch in scheduled benefits and 

scheduled revenues. 

Senator ALLARD. I think to try and extrapolate something out for 

75 years is just insane. 

Senator DOMENICI. Senator, would you yield just for a clarification? 

Senator ALLARD. My time is up, but go ahead. 

Senator DOMENICI. I ask unanimous consent for——

Chairman GREGG. Yes. 

Senator DOMENICI. What is 1 percent of GDP, so everybody that 

listens to——

Mr. HOLTZ-EAKIN. Currently, this is about $120 billion. 

Senator DOMENICI. Every time you mention that $120 billion. 

Mr. HOLTZ-EAKIN. Yes, and you can think of, thus, you can think 

of any future number in terms of currently having to come up with 

$120 billion per percent of GDP. 

Senator DOMENICI. Thank you very much. 

Chairman GREGG. Senator Corzine. 

Senator CORZINE. Thank you, Mr. Chairman, and I look forward 

to your leadership of the Committee and working with you in very 

difficult circumstances. As a matter of fact, some of the issues we 

talk about here I hope actually have a constructive impact on my 

future life, particularly Medicaid and some of the other issues that 

are so important on the agenda of our budget efforts here. 

I am curious here: you are very clear about the structure of Social Security. You talk about rising to 6.2 percent of the overall 

budget, but when we get to these Medicaid and Medicare costs, it 

is a little foggier in judgment, and I like the line of questioning of 

the Chairman and Ranking Member. Is it possible that we can sort 

through some of these discussions? You are saying that you did 

come up with a number of roughly 25 or 26 percent of the budget, 

did I hear you say, for mandatory spending or entitlement 

spendings? 

Mr. HOLTZ-EAKIN. Mandatory spending is over half of Federal 

spending right now. 

Senator CORZINE. But these entitlements, Medicaid. 

Mr. HOLTZ-EAKIN. Those three, Medicare, Medicaid, and Social 

Security, will rise to be over half by 2015 and then will continue 

to grow. 

Senator CORZINE. Right; and Social Security is what percentage 

of that 50 percent or——

Mr. HOLTZ-EAKIN. Currently, it is $500 billion, and Medicaid and 

Medicare are a bit below it, so it is a bit above half, but in the next 

10 years, Medicare and Medicaid are projected to exceed it. I do not 

know the exact percentage. 

Senator CORZINE. And their pace of growth is at a higher trajectory than what Social Security projections are. 

33

Mr. HOLTZ-EAKIN. Yes; all the programs grow, because, as the 

baby boom retires, there are more beneficiaries. It is also the case 

that health care costs per person have grown much faster than income per person over the long-term, and that is an additional 

source of growth in those programs. 

Senator CORZINE. And if I am not mistaken, last year, we added 

Part D to this program. 

Mr. HOLTZ-EAKIN. Yes. 

Senator CORZINE. It is hard for me to quite understand how we 

believe that Social Security—I do not expect you to opine on this, 

but how we think Social Security is in such a crisis when it is becoming a diminishing proportion of the overall mandatory social 

safety net programs that we have that are protected. Particularly 

in the context that we as a Congress just decided that we wanted 

to put a Medicare prescription drug plan down that is going to increase those elements. I would just, if you wanted to opine on 

which was in crisis, I would ask you, but I can understand——

Mr. HOLTZ-EAKIN. I think CBO directors are allergic to words 

like crisis. 

Senator CORZINE. Right; I think that one has to put these in the 

overall context of what is actually going to be driving expenditures 

as we go through time. It certainly looks like Social Security is one 

that has options that are relatively certain. You know, we talk 

about not ever having reduced benefits. I think we extended—the 

Greenspan Commission extended the time when retirees would receive benefits, which, you know, call it whatever you want, those 

people who are missing it for a year or two versus when they were 

was a discretionary judgment that Congress came to. 

So if Senator Nelson’s projections are, you know, rough justice 

true, do I have this right that we will be running cumulative deficits—I think he had something like $5.4 trillion? That would add 

to this $855 billion that you would say is a cumulative deficit over 

the next 10 years. 

Mr. HOLTZ-EAKIN. Yes, if those proposals——

Senator CORZINE. If those projections are right. 

What implications would that have, in your view, on the cost of 

money and the country’s ability to manage its current account deficit, and what kinds of economic implications does our borrowing 

$6.5 trillion versus $855 billion have? What would be the kinds of 

things you would expect from that kind of change in——

Mr. HOLTZ-EAKIN. Let me do it in two steps. First, if one looks 

at the trajectory exclusive of a Social Security proposal, deficits on 

average move the country’s economic activity away from saving and 

toward consumption, and that, over the long haul, lowers our accumulation of wealth, of capital, of technologies, of education, and 

slows economic growth. 

Senator CORZINE. That lowers that productivity curve, I presume, 

if we are to do that. 

Mr. HOLTZ-EAKIN. Yes, and there may be, you know, capital market manifestations of that in terms of higher interest rates, lower 

exchange rates; the exact combination is not clear. But the core 

economic impact is to save and accumulate less for the future. 

The Social Security piece is harder, because without knowing the 

details, there are two pieces. One is what is done to the underlying 

34

program, the mismatch between benefits up here and dedicated receipts below it, and then, what is done in any Commission Plan 

Two-style individual accounts. 

And if one just looks at borrowing money and putting it in individual accounts, the economic ramifications are a bit different, because that is from a national perspective a wash initially, and any 

economic ramifications would come from changes in individuals’ 

perceptions of the future, and that would probably hinge on what 

was done in the underlying program. So it is not easy to spell out 

what would happen to the economy there. 

Chairman GREGG. Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. 

Just as a comment on Senator Nelson’s chart, that chart assumed that the Congress of the United States would do nothing, 

change no laws, change no tax law, change no Social Security law, 

change nothing, and that would be the result if we did nothing. 

Mr. HOLTZ-EAKIN. I will let the Senator speak for his own chart, 

but I do not think that is what he showed. He showed something 

which had a proactive change in the alternative minimum tax; a 

proactive change in Social Security law, and I forget the exact list. 

Chairman GREGG. If the Senator would yield, it also had a $2.9 

trillion number in there for Social Security borrowing. 

Senator BUNNING. Oh, yes. 

Chairman GREGG. And that would be new policy, plus, he doublecounted it, because first, he counted it as a direct—he directed that 

borrowing to the bottom line of the deficit, which is sort of ironic, 

because it is borrowing, and then, he counted the interest on top 

of that to the bottom line of the deficit, so the numbers themselves 

were a little confusing. 

Senator BUNNING. There were many changes that we had not 

made. 

Chairman GREGG. Yes. 

Senator CONRAD. Mr. Chairman, if I might just intercede——

Senator BUNNING. May I finish and then go ahead, Kent? After 

I get finished, you can do whatever you want as vice-chairman of 

this Committee. 

Yes; I just am amazed that 2080 is 75 years from today; 2080, 

there is not going to be too many people in this room still on this 

side of the Earth. And now, we are trying to project, because we 

have a law that says we must project, solvency for the Social Security for 75 years, solvency, not a 30 percent reduction in the year 

2042 or 2043; not in 13 years going from a positive inflow to a negative inflow in the amount of money coming in; yes, I know in 

2018, there is an inflow that starts downward, and then, our supposedly, bonds will pay the taxes well enough to pay full benefits 

into 2042 or 2043. 

And then, that chart also showed that—or did not show that 

there would be about a 30 percent reduction starting in that year 

on Social Security benefits if current law were left like it is. I want 

the American people to understand, we do not want to do that. 

That is doing nothing about Social Security. We want the people 

now collecting it to collect the full amount, and I want my 35 

grandkids and my nine children and their spouses to be able to collect the full amount that they expect. 

35

And if we do not do something, and we do not do it shortly, 13 

years maybe; why not do it before the 13 years? It is a lot easier 

to do it up front. We are going to be short, big time short, depending on who adds up the numbers, whether it is $4 trillion, whether 

it is $10 trillion. As an economist, would you comment on the likelihood, economics and behavioral effect of Congress not extending 

the tax cuts, including individual tax rates and capital gains and 

dividend tax rates currently set to expire within the budget window? 

What effect would such a large tax increase have on economic 

growth? How would it physically or potentially affect the Social Security solvency? 

Mr. HOLTZ-EAKIN. Two different questions. The first is the impact of letting those tax cuts go away as under current law would 

depend on what people are expecting. If people expect dividends 

and capital gains rates to remain at their current level past 2009, 

the rise would raise the cost of capital; it would serve in the longterm to diminish their spendable income, and they would presumably choose, as a result, to consume less and save more. 

Similar impacts could be expected in 2011. If they expect those 

to be made permanent, and they are not, that would be a surprise 

increase in taxes; they would feel worse off. They would save more 

to make up for it, and it would impact incentives to save, invest 

and supply labor. 

Senator BUNNING. And Social Security? 

Mr. HOLTZ-EAKIN. Social Security is narrowly financed by a payroll tax, and the formula is determined by the growth in real 

wages. Only the impacts on real wages and payroll tax base would 

show up in Social Security. 

Senator BUNNING. Would you call 12.5 percent narrowly? That is 

the payroll tax. 

Mr. HOLTZ-EAKIN. I do not understand the question. 

Senator BUNNING. If you say 6.25 from the individual and 6.25 

from the corporate side, is that a narrow-based tax? 

Mr. HOLTZ-EAKIN. I may not understand the question. I do not 

know of any changes in the payroll tax under current law, so if the 

question is if we changed one——

Senator BUNNING. Well, there is none proposed. 

Mr. HOLTZ-EAKIN. If we changed it, it would have big economic 

impacts, yes. 

Senator BUNNING. Thank you very much. 

Chairman GREGG. Thank you. 

Senator BYRD. 

Senator BYRD. Thank you, Mr. Chairman. 

I congratulate you on winning the election——

Chairman GREGG. Thank you. 

Senator BYRD [continuing]. Which made you the Chairman. And 

I am going to look forward to working with you. I have found our 

past relations to be very cordial, and they will remain that way. 

Mr. Director, I am not one of those who believes that Social Security can continue to pay benefits without changes 50 years into the 

future. A significant problem exists, and while it may not be on our 

doorstep, it certainly is on the horizon. The Congress has the reVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00041 Fmt 6633 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
36

sponsibility to make the relevant facts known to the American public. 

At a recent event hosted by the New America Foundation, you 

referenced the, quote, important details, close quote, that you 

hoped would emerge from a, quote, high-level discussion, close 

quote, about Social Security reform. When you say high level discussion, are you referring to conversations behind closed doors at 

the White House, or do you mean to encourage an open, public discussion in which all of the details of Social Security reform emerge? 

Mr. HOLTZ-EAKIN. That was intended to convey the benefits I 

would receive from a vigorous public discussion that looked at all 

of the policy issues from an economic, from a budgetary, and from 

a programmatic perspective. 

Senator BYRD. You might want to consider a point that I made 

in my letter to President Bush: what important details should the 

Congress know before it makes changes to Social Security? 

Mr. HOLTZ-EAKIN. I think there are many dimensions to a Social 

Security proposal that will matter. It is well-established that the 

current program will, in fact, automatically come into balance, in 

our projections, in 2053. The question is is there a better way to 

bring the underlying program into balance, and what would that 

entail in the way of benefit changes and tax changes? In addition, 

there is a threshold question that has been discussed about the desirability of moving from a fully pay-as-you-go to a system that is 

at least in part prefunded. That is a threshold policy question, and 

one would need to understand both the nature of the transition at 

the beginning and how it would be financed and then also the 

interaction of any ultimate private investments and the traditional 

program as modified at the end. 

There is an enormous number of details that are central to evaluating that from an economic policy point of view; certainly, its 

budgetary implications and then for the objectives of the program 

narrowly defined. 

Senator BYRD. The people pay for Social Security. Before we 

make any changes in the program, the people have a right to know 

all of the details. I have written to the President and ask that he 

explain the full costs of his Social Security plan and its effect on 

workers’ benefits. What else should we ensure that our constituencies know? 

Mr. HOLTZ-EAKIN. I think the range of information is enormous. 

The distribution of benefits and taxes, both prior to and after any 

alteration of legislation; the range of options that would be involved 

in any new elements of the Social Security program, the interaction 

of the disability program with the retirement program; the list 

could go on and on. 

Senator BYRD. What facts should the Congress require of the administration in order to make an informed decision about individual accounts? 

Mr. HOLTZ-EAKIN. The Congress will probably decide in its own 

wisdom what facts it needs. I think that the legislative details of 

any proposal, individual accounts or otherwise, will have a very 

large impact, and knowing those details is central, at least in 

CBO’s eyes, to giving an accurate assessment of the economic, 

budgetary and Social Security impacts. 

37

Senator BYRD. In discussing investment accounts at the New 

America Foundation, you were asked about the Federal Government providing a financial guarantee that is comparable to the 

guarantee afforded under the current Social Security system. Assuming that the Government guarantees a minimum benefit from 

individual investment accounts, how much of a cost would that impose on the Federal budget? 

Mr. HOLTZ-EAKIN. It is not possible to calculate a dollar amount 

of that cost without knowing the nature of any individual investments and also the size of the guarantee, the minimum benefit. It 

is just my observation that with the presence of market risk that 

market risk can be transferred to the Government and ultimately 

to the taxpayer, but it cannot be made to go away, and that accurately assessing such an investment strategy would involve accurately assessing the cost of risk. 

Senator BYRD. Mr. Chairman, is my time up? 

Chairman GREGG. I am afraid so, Senator. 

Senator BYRD. I thank the Chairman. 

I thank you, Mr. Director. 

Chairman GREGG. Senator Domenici, the former chairman. 

Senator DOMENICI. Thank you, Mr. Chairman. 

First of all, let me not only congratulate you but say that I have 

wished for many things since I was a Senator, but I certainly do 

not wish to be in your place. 

[Laughter.] 

Chairman GREGG. Congratulations is faint praise. 

Senator DOMENICI. But when I was working on budgets, and 

there were deficits comparable to this, people were saying the same 

thing: they did not want my job. 

But let me suggest to all of you and Mr. Director to you also that 

the first chart you put up, put it up there again about where the 

deficit has been. See, that is a pretty good indication that the deficit changes rather dramatically. Do you see where it peaked out 

up there? That is a higher percent of GDP than we are now, substantially higher. So is the percent of GDP that accompanies a deficit an important number in terms of the American economy and 

what our people might expect in terms of their lifestyle? 

Mr. HOLTZ-EAKIN. Yes, I think it is much more accurate to measure the deficit as a fraction of national income than just the dollar 

terms. 

Senator DOMENICI. So it is important that that be as low as you 

can get during good times. 

Mr. HOLTZ-EAKIN. One would expect that you, as a Federal Government, decide what programs you want to have and how much 

they will cost, and then, you put in a financing plan that supports 

it. 

Senator DOMENICI. I am not sure I should ask you that question, 

because that is a sort of a policy thing. We should not be asking 

you those, but I think that is sort of well-understood. Now, look at 

it, and everybody look at it. Look how quickly it came down. You 

see, at the bottom end, it was balanced, right? Follow that green 

line. It was balanced for 2 years there. I might say to everybody 

I was privileged to be there when that happened. 

[Laughter.] 

38

Chairman GREGG. You did a great job. 

Senator DOMENICI. Yes; that made up for all the pain. 

[Laughter.] 

Senator DOMENICI. I am not sure how long it will last if this 

other one keeps going up, but Mr. Director, did I hear you say that 

there is nothing on the horizon that would indicate that that deficit 

might not come down precipitously like it did in the years up there, 

part of the Clinton years and part of the Reagan years; did you say 

that? 

Mr. HOLTZ-EAKIN. I cannot rule that out. As a matter of science, 

I cannot. The uncertainty is too large. I think that as a matter of 

the odds, it is unlikely that we will simply grow our way out of this 

deficit using current policy, but I certainly could not stipulate that 

it could not happen. 

Senator DOMENICI. But we did grow our way out of that one. 

Mr. HOLTZ-EAKIN. The growth in the late nineties, the big investment boom and the receipts that came with it were extraordinary, 

and I guess the sentiment I am conveying is it is unlikely to bet 

on that again. 

Senator DOMENICI. That is the era when we have a lot of arguments as to what caused it. If you were on President Clinton’s side, 

you would say his tax increases caused it. Some people say that. 

If you are on my side, I would say that is ludicrous; it was a lot 

of other things that caused it but not that. 

In any event, to me, the most important thing is the economy 

and what happens to it and that there be sustained economic 

growth, not just for a few years but that we are not doing things 

that will hurt the economy in the out years. Everything we do 

ought to be measured against sustained economic growth, because 

the American people should know that those are fancy words, but 

that essentially means jobs; it means the potential for wages to go 

up and for more people to be employed. 

Now, we do not have to have a balanced budget to have a good 

economy, do we? 

Mr. HOLTZ-EAKIN. No. 

Senator DOMENICI. And America, an economy as powerful and as 

strong as ours, can sustain and live with deficits; is that not right? 

We have. 

Mr. HOLTZ-EAKIN. It is an issue of magnitude, sir. To the extent 

that there are enormously large deficits that reduce national saving, then, ultimately, growth will be impacted. But it is certainly 

the case that we have had good economic growth coexist with deficits. 

Senator DOMENICI. Now, we should be concerned about getting 

the deficit down, because we have had a very large accumulation 

of deficits, which means that debt is getting very large. Is that a 

fair statement? Concerned about it; I did not ask how quick or how, 

but we should be concerned about it, right? 

Mr. HOLTZ-EAKIN. I think that certainly, going forward, fiscal 

policy is central to the U.S. economic outlook. I would say that the 

years past this chart are as important as any. 

Senator DOMENICI. Mr. Chairman, I do want to make one point. 

All this testimony, you know, we are listening to it, but so are a 

lot of people. And we use words that many people do not underVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00044 Fmt 6633 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
39

stand. You know, he made a statement, if this happens, the cost 

of capital will go up. What does the average American know? What 

does that mean? 

Chairman GREGG. Nobody understands that. 

Senator DOMENICI. That means interest rates will go up; is that 

correct? 

Mr. HOLTZ-EAKIN. It means interest rates will go up, and businesses will find it harder to finance their investments. 

Senator DOMENICI. So, that is bad, right? I mean, for the economy, for jobs, for people. 

Mr. HOLTZ-EAKIN. Yes. 

Senator DOMENICI. My second question on that line—am I out of 

time? OK; will we get another round? 

Chairman GREGG. Yes. 

Senator DOMENICI. I will stay. 

Chairman GREGG. Senator Murray. 

Senator MURRAY. Mr. Chairman, thank you. I join with my colleagues in welcoming you to this new position. You take it at a 

very difficult time with all of the challenges that we certainly face 

in the country today. 

I think we are the only two members of this Committee that are 

on this Committee, the HELP Committee and Appropriations, so 

we will be seeing a lot of the outfall of the decisions. 

[Laughter.] 

Senator MURRAY. Mr. Director, it is good to have you here as 

well. We all depend on your objective, unbiased outlook and assumptions; may not always agree with everything you say, but 

really do appreciate the work that you do, so we welcome you here 

today. 

Mr. HOLTZ-EAKIN. Thank you. 

Senator MURRAY. Mr. Director, the CBO’s most recent economic 

outlook assumes an fiscal year 2005 deficit of $368 billion. You 

have acknowledged that that does not include any supplemental 

funding for Iraq or Afghanistan, any changes to the AMT or revenue changes from making the tax cuts permanent. If we simply 

include the additional supplemental spending, we are, I believe, 

looking at a deficit for 2005 of at least $420 billion, which is another historic high. 

Now, I have heard the President say that he hopes to cut the deficit in half over the next 5 years, and excluding any funding for 

DOD or Homeland Security or revenue changes from extending the 

tax cuts, if we just look at the supplemental, what kind of cuts will 

we have to enact to Medicare and Medicaid and other mandatory 

programs in order to cut that deficit in half? 

Mr. HOLTZ-EAKIN. Let me begin first with the fiscal year 1905 

number. Our estimate would be that the outlays, the additional 

outlays in 1905 for Iraq and Afghanistan would total about $30 billion. Our estimate of the deficit would be about $400 billion. The 

administration estimated something close to $430 billion. That is 

consistent with our recent experience that on baseline, outlays that 

are about $20 billion higher than us, and spending on 

supplementals, they are a bit above us. So we put the number closer to $400 billion. That is the one I 

would be comfortable with. 

40

Senator MURRAY. Fine. 

Mr. HOLTZ-EAKIN. Cutting it in half over the——

Senator MURRAY. Five years? 

Mr. HOLTZ-EAKIN [continuing]. Next 5 years, I guess I would ask you starting from what point? Starting from $400 billion, you 

would have to get down to $200 billion. The arithmetic is pretty 

simple: you would have to take out $200 billion. If you did it as 

a fraction of GDP, it would be a bit less. Right now, $100 billion 

is about 42 percent of Medicare spending; Medicaid, it is a bit larger as a fraction of Medicaid, and those are mechanically the kinds 

of reductions in spending you would need to meet that kind of target. 

Senator MURRAY. Including in education and transportation and 

veterans’ health care and housing, and all of those programs would 

all have to take a cut of about 2 percent, correct? 

Mr. HOLTZ-EAKIN. That is if we just did $100 billion in Medicare 

and Medicaid; the broader thing, you would have a wider base. It 

would be lower. We can get an estimate for you if you would like. 

Senator MURRAY. But there would definitely have to be some significant cuts in mandatory programs and other programs as well. 

Mr. HOLTZ-EAKIN. There would certainly have to be some reductions. 

Senator MURRAY. I listened carefully to my friend from New 

Mexico, who chaired this Committee for a long time, and agree 

with him that the sustained economic outlook is critical to us getting our budget in control, but we also know that to keep jobs out 

there, we have to have education and training and transportation 

infrastructure in order to create and sustain those new jobs. So I 

am very concerned that enacting major cuts will have a bigger increase on the deficit and make it very hard for us to reach that deficit reduction if we are making big cuts in programs that actually 

help sustain and create jobs plus health care. 

Mr. Director, you did point out that increases in Medicare and 

Medicaid reflect some of the overall increases in health care, and 

this administration has been arguing that caps on noneconomic 

damages on medical malpractice will slow increases in health care. 

Would caps on damages significantly reduce the Medicare and 

Medicaid costs that we are looking at? 

Mr. HOLTZ-EAKIN. To the extent that we know the link between 

caps on damage awards and various costs in health care, our 

knowledge is pretty limited, but we did do some work that suggested that caps would reduce malpractice premiums significantly, 

by about 22 percent, but those are a small fraction of overall health 

care spending, and the impact on the broad spending basket would 

be under 1 percent. 

So that is the extent of a statistical link between caps and health 

spending that we found so far. It is an area we continue to work 

in and are interested in learning more about. 

Senator MURRAY. It is not going to save our way out of this? 

Mr. HOLTZ-EAKIN. Not on what we know so far. 

Senator MURRAY. It was not that long ago that this Committee 

was looking at a fairly large surplus, and here we are with historic 

highs in deficit spending. We have heard a lot about the war on 

terrorism, recession, increased spending on domestic programs all 

41

contributing to this, but there is not a lot of talk about the impact 

of the tax cuts from 2001 and whether or not they have contributed 

to this deficit. 

What role did the President’s tax cuts play in our rapid escalation in annual deficits? 

Mr. HOLTZ-EAKIN. There are two answers to that. The first is 

that mechanically, if one does the arithmetic and looks at the 

CBO’s projection of the budget surplus for this year and now the 

reality of a deficit for this year and does a decomposition of the 

swing from surplus to deficit, about 35, 36 percent of that is economic impacts, economics and technicals; a comparable size, 35, 36, 

is on the spending side, and the remainder would be on the receipts side. 

More generally, the swing from surplus to deficit on both tax and 

spending during the course of the early 2000 period, when the 

economy was very weak, on balance did support a very weak economy, and that, other things equal, was an economic benefit. It is 

just now the case that the economy has recovered. Going forward, 

we have a private sector-led economy, and those kinds of sustained 

budget deficits have a very big and different impact going forward 

than they do looking back. 

Chairman GREGG. Thank you, Senator. 

Senator MURRAY. Well, thank you, Mr. Chairman. I just would 

say that I am very concerned about the deficit spending. We are 

looking at the war in Iraq, continuing costs, supplementals, a lot 

of talk about Social Security. I believe our generation has the responsibility to look at this budget from an honest perspective and 

say what we are spending; we should not be passing these costs on 

the next generation. 

Chairman GREGG. Senator Graham. 

Senator GRAHAM. Thank you, Mr. Chairman. Congratulations. I 

am honored to be part of the Committee. 

I asked you some questions before the hearing, and I do not 

know if you got the information or not, but if the Congress decided 

to make the tax cuts permanent, and we borrowed the transition 

costs of a personal investment account bill like I proposed, which 

is, I think, $1.2 trillion, did you find how that would affect the deficit? 

Mr. HOLTZ-EAKIN. We took the policy that your staff conveyed 

and consisted of the taxes and AMT, Social Security. That would 

lead in 2015 to a deficit on the order of $650 billion and a total 

over the 10 years of about $5 trillion. 

Senator GRAHAM. So to make sure we understand that, if you 

made the tax cuts permanent, and you borrowed the transition 

costs of personal investment accounts as described by my bill, one 

of the more modest ones, you would have a $650 billion deficit in 

2015; is that correct? 

Mr. HOLTZ-EAKIN. Yes. 

Senator GRAHAM. All right; if you tried to make Social Security 

solvent just by putting new money without any other reform to 

2075, how much money would you have to come up with in today’s 

dollars? 

Mr. HOLTZ-EAKIN. If the question is, you know, what would you 

need to solve the actuarial imbalance——

42

Senator GRAHAM. Right. 

Mr. HOLTZ-EAKIN [continuing]. Then, that is a number that is on the order of $3.5 trillion, and the difference, of course, is in the timing, the gap between benefits and taxes. 

Senator GRAHAM. OK; to avoid any benefit cuts between now and 2075, you would need $3.5 trillion in today’s dollars right now. 

Mr. HOLTZ-EAKIN. You would have to dedicate to Social Security 

those resources and find a way in the budget and the economy to 

get them. 

Senator GRAHAM. OK; if you tried to solve the Social Security dilemma of reduced benefits coming over time, just by changing the 

age eligibility, how old would you have to be to meet that goal before you drew your first check? 

Mr. HOLTZ-EAKIN. It is easiest for me to frame the long-term 

problem as the fact that benefits are about 7 percent of GDP; taxes 

are about 5 percent of GDP, so there is a gap out there for as far 

as the eye can see between promised benefits and taxes. 

Raising the normal retirement age above 70, even to the 

midseventies, seems unlikely to close that gap. 

Senator GRAHAM. So if you went up to 75 before you got your 

first check just by raising the age limit, it would not close the gap, 

you do not believe. 

Mr. HOLTZ-EAKIN. We do not have a firm estimate, but it would 

take a substantial increase. 

Senator GRAHAM. OK; there is a big issue going on debate in the 

country: is Social Security really a problem or not? Do we have a 

problem with the system? Whether it is 2042 or 2052, you are firm 

on the idea that we start paying more money out than we collect 

around 2020. 

Mr. HOLTZ-EAKIN. I do not know what constitutes a problem, but 

I know the future. And the future is that at the moment, Social Security brings in more in payroll taxes than it pays out in benefits. 

Between now and roughly 2020, that would diminish and go to 

zero. Those funds would no longer be available to the remainder of 

the budget and cushion it, and thereafter, it will switch. 

Senator GRAHAM. Well, if I started paying out—if I spent more 

than I took in, would I eventually have a problem? 

Mr. HOLTZ-EAKIN. Yes, sir. 

Senator GRAHAM. I would probably go to jail, because I would 

start writing bad checks, but that is not going to happen here. 

So the bottom line is by 2020, in that timeframe, the country has 

to deal with a phenomenon that we are paying more in benefits 

than we are collecting in Social Security taxes. Are you sure about 

that? 

Mr. HOLTZ-EAKIN. It is the case that this will evolve in a budgetary framework, and to the extent that——

Senator GRAHAM. Did you just say yes or no? 

Mr. HOLTZ-EAKIN. No. 

[Laughter.] 

Mr. HOLTZ-EAKIN. It is the case that you could, you could, sir, 

as a matter of principle decide not to touch Social Security. But if 

you do that, you have to simultaneously address a larger budget 

problem everywhere else. 

Senator GRAHAM. Right. 

43

Mr. HOLTZ-EAKIN. And so, that is a policy problem. 

Senator GRAHAM. That is not my question. My question is a very 

simple question: we have 12.4 percent payroll taxes coming into the 

system. We are going to pay benefits, and they have already been 

scheduled. There comes a point in time where the 12.4 percent does 

not equal the amount you are paying out. 

Mr. HOLTZ-EAKIN. Yes, absolutely. 

Senator GRAHAM. OK; and once that happens, bad things follow. 

Mr. HOLTZ-EAKIN. Once that happens, you must find the way to 

honor those benefits which will be statutorily due from somewhere 

in the Federal budget. 

Senator GRAHAM. OK; when do you believe Social Security really 

becomes stressed? Is it 2020, or does it happen before then? 

Mr. HOLTZ-EAKIN. I believe that when viewed from a budgetary 

perspective, it will be the case that shortly after the baby boom begins to retire in 2008, that the cushion that the program is currently providing to the Federal budget will begin to diminish. That 

will be noticeable to members of the Budget Committee and Congress as a whole, and thereafter, it will not only diminish; it will 

switch, and funds to honor benefits payable under current law will 

have to be found by either cutting other spending programs, raising 

taxes, or borrowing more. 

Senator GRAHAM. And one last comment. I have gone over my 

time my first appearance; I apologize. The basic problem is that in 

the future, we are going to have a lot more people come into the 

system as retirees than are workers; is that correct? 

Mr. HOLTZ-EAKIN. That is right. There is a sharp ramp-up with 

the retirement of the baby boom generation. 

Senator GRAHAM. Thank you. 

Chairman GREGG. Senator Sarbanes. 

I notice that nobody has turned their mike on when they welcome me to the Committee. 

[Laughter.] 

Senator SARBANES. Actually, now that the mike is on, I was 

going to repeat the welcome. 

[Laughter.] 

Senator SARBANES. I join my colleagues in welcoming you to the 

Committee, and we look forward to working closely with you, and 

I want, as always, to acknowledge the chairmanship of Senator 

Domenici for many, many years. 

Senator DOMENICI. Thank you very much. 

Senator SARBANES. I want to talk a bit about our international 

situation, but before I do that, I just want to be clear on this Social 

Security question. When you use these various projections, whose 

assumptions are you using with respect to growth of the economy? 

Mr. HOLTZ-EAKIN. CBO’s projections are built off of the 10-year 

baseline projections, so we use the same economic assumptions in 

our Social Security as we do for the budget outlook that you saw 

today. 

Senator SARBANES. That is for 10 years. 

Mr. HOLTZ-EAKIN. Yes, beyond that——

Senator SARBANES. Beyond that, are you using the Social Security system’s projections? 

44

Mr. HOLTZ-EAKIN. We will use the Trustees’ assumptions for fertility, mortality, immigration, disability. We use CBO’s economic 

assumptions for the entire period. 

Senator SARBANES. I see. Now, the Trustees’ assumptions generally, on the figures I have seen used, are really the most conservative path, are they not? Is that one of the reasons that you project 

that the Trust Fund will still have something in it in 2052 as opposed to their 2042? 

Mr. HOLTZ-EAKIN. There are really two big differences that contribute to that. The first is we assume that real interest rates will 

be higher, 3.3 percent as opposed to 3 percent for the Trustees. Mechanically, that allows higher interest on bonds in the Trust Fund, 

and they last longer, and then, we have a bit lower in the way of 

male benefits paid, and so, there is less going out, and that tends 

to extend the Trust Fund. 

Senator SARBANES. Now, on your projections, as I understand it, 

the system, including the Trust Fund balances, which have been 

built up for the purpose of paying the benefits, would be able to 

handle that at a 100 percent level until 2052; is that correct? 

Mr. HOLTZ-EAKIN. Our indications are that the Trust Fund accounting would keep benefits fully payable until 2052. 

Senator SARBANES. 2052. 

Mr. HOLTZ-EAKIN. Yes. 

Senator SARBANES. In other words, 47 years from now. 

Mr. HOLTZ-EAKIN. Yes. 

Senator SARBANES. Now, at that point, if all of these assumptions 

work out, and of course, we are assuming a lot of things, because 

we are talking about half a century in terms of what is going to 

happen, but at that point, assuming all these assumptions work 

out, there will not be any balances in the Trust Fund to help pay 

the benefits; is that correct? 

Mr. HOLTZ-EAKIN. At that point, under current law, there would 

not be the legal authority to pay full benefits, and you could only 

pay payroll taxes coming in. 

Senator SARBANES. Right; now, am I correct in understanding 

that payroll taxes coming in would still be sufficient to pay 75 to 

80 percent of the benefits? 

Mr. HOLTZ-EAKIN. Yes; our projection has it 78, but as you well 

know, there is enormous uncertainty over all these numbers. It is 

the trajectories that really matter. 

Senator SARBANES. Yes; of course, the uncertainties run in both 

directions. 

Mr. HOLTZ-EAKIN. Yes. 

Senator SARBANES First of all, I would just make the comment 

that that does not sound to me as if the system is broke or insolvent. There is a shortfall which we need to address, and I recognize 

the sooner you address it, the smaller the adjustments you have to 

make; the longer you wait, the greater the adjustments you have 

to make. But even in 2052, if nothing else is done—and no one is 

operating on that premise—this inflow into the system would cover 

75 to 80 percent of the benefits; is that correct? 

Mr. HOLTZ-EAKIN. Yes. 

Senator SARBANES. OK; now, I want to ask you about our international situation and the growing imbalances which exist interVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00050 Fmt 6633 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
45

nationally. It is my understanding that we are now running the 

largest trade deficit in our history. 

Mr. HOLTZ-EAKIN. Yes. 

Senator SARBANES. Now, that means, of course, that we are 

building up our external debt, does it not? 

Mr. HOLTZ-EAKIN. Yes. 

Chairman GREGG. Senator, your time is up, but if you want to 

continue this for a minute or so, because we are going to do another round. 

Senator SARBANES. Oh, we are? 

Chairman GREGG. I will give you a couple more minutes here, 

and then, we will start off on the other round. 

Senator SARBANES. I will wait until the next round then; I will 

pursue that subject on that round. I do not want to impose on my 

colleagues. 

Chairman GREGG. Thank you. 

Just to followup on the line of thought that Senator Sarbanes 

has pursued here as to what really is the solvency of the Social Security fund, first, remember that this Committee’s role in Social Security is prescribed by the statute, but all of us on this Committee 

have spent a lot of time working on the issue. But the point is this: 

the real issue that we confront is what Senator Graham points out, 

which is that we have a demographic adjustment in our nation 

coming at us, which is that historically, the genius of Social Security was that it was a pyramid. 

There were always going to be many more working people paying 

into the system than people who took out of the system; originally, 

in 1950, there were 12 people paying in for every one person taking 

out; today, there are 3.5 for every one. By the year 2019, where 

there will be two people paying in for every one person taking out, 

we go from a pyramid to essentially a rectangle, and there are just 

simply too few people working to support the tax burden to support 

the people who are retired. 

And the concept that there is a fund somewhere that is going to 

be redeemed that is going to be able to pay for the benefits is really 

a bit illusory, because what the fund is, is it is a put to the American taxpayer or a call to the American taxpayer, the working 

American, the American who is 20, 30 years old, the American, our 

children, our grandchildren who are coming into the work force 

saying you shall pay taxes to redeem these bonds to support these 

people who are retired. 

And that tax burden has to go up to the point to support the benefit. So what we are basically saying is we are going to significantly 

increase the tax burden on those working Americans because there 

are so many fewer of them working to support the number of people retired; is that not correct? 

Mr. HOLTZ-EAKIN. It is the case that there are no economic resources in the Trust Fund, and in order to avoid defaulting on the 

bonds in the Trust Fund, it will be the case that the Treasury will 

have to come up with funds from some source. There will be higher 

taxes or lower spending on other programs, or the Treasury will 

borrow from the public as a whole. 

Chairman GREGG. So essentially, what is happening here is that 

you have a generation that is so large that it is going to end up 

46

putting a tremendous burden on the younger working generation 

when it retires, and that was not conceived when the Social Security system was structured; it was always conceived that there 

would be a much larger working group, which is why we got into 

the immigration issue earlier on in this discussion, but I think it 

is important that people understand that, that there really is not 

some fund out there that people are going to be able to suddenly 

jump onto. 

That must be my wife saying I am not smiling. 

[Laughter.] 

Mr. HOLTZ-EAKIN. I am not wearing the tie my wife bought me 

so——

Senator DOMENICI. I have a wife like that, too. 

[Laughter.] 

Chairman GREGG. I do think that point is critical to this whole 

debate of how we address Social Security. 

I am not going to take any more time here, because I know that 

you have been very generous with your time, Mr. Director, and I 

have my wife calling me. 

[Laughter.] 

Chairman GREGG. So I will yield my time to Senator Domenici, 

I know, had some followup point, and then, we will go back and 

forth. 

Senator DOMENICI. Thank you very much. 

I want to tell you all one about wives calling. I was on the floor 

one night debating with Senator Kennedy, and, you know, we both 

have a tendency to yell. 

[Laughter.] 

Senator SARBANES. I have never noticed it. 

[Laughter.] 

Senator DOMENICI. And somehow, we both think that the louder 

and more red we get, the more effective we are. 

Senator DOMENICI. And one night, my wife called and left a note 

and said please, the fact that you are getting louder and more red 

does not mean you are any more effective. In my opinion, you are 

getting worse. 

So I went back, and when I got the floor, I changed it, and I said 

Senator Kennedy, my wife called and said that you and I were both 

yelling too much and getting too red——

[Laughter.] 

Senator DOMENICI [continuing]. And she suggested that you tone 

it down. 

[Laughter.] 

Senator DOMENICI. When I got back home, my wife was really fit 

to be tied. 

[Laughter.] 

Senator DOMENICI. She said if you ever do that again, you know, 

she did not say what would happen, but probably something bad. 

[Laughter.] 

Senator DOMENICI. Just two or three questions: one, I need you 

to check on the budgetary impact of parity for the mentally ill 

statutorily as it applies to the insurance companies of America, 

group policies. Would you do that for me? 

Mr. HOLTZ-EAKIN. Certainly. 

47

Senator DOMENICI. I am saying that, looking at what you all 

have done in the past, I cannot understand why you estimate such 

a large budgetary impact, but I would like you to tell me that. 

Mr. HOLTZ-EAKIN. Certainly. 

Senator DOMENICI. This balance of trade accounts that Senator 

Sarbanes was going to talk about, how much of that is attributable 

to our having to purchase oil overseas? 

Mr. HOLTZ-EAKIN. I do not know the number off the top of my 

head, but oil imports are a substantial part of the net trade situation. 

Senator DOMENICI. Would you get the number and——

Mr. HOLTZ-EAKIN. Yes. 

Senator DOMENICI [continuing]. The percent and submit it to the 

Chairman? Maybe somebody there knows. 

Mr. HOLTZ-EAKIN. It is about $180 billion. We have a $600 billion—so it is not quite a third. 

Senator DOMENICI. Not quite a third. 

Mr. HOLTZ-EAKIN. Of the deficit. 

Senator DOMENICI. So that is a very large amount that would be 

dramatically reduced if we did not have to buy oil overseas, right? 

Mr. HOLTZ-EAKIN. Other things equal, yes. 

Senator DOMENICI. That is arithmetic. 

Mr. HOLTZ-EAKIN. That arithmetic, yes. 

Senator DOMENICI. In your opinion, how risky is it that the Chinese are buying a significant portion of our debt, the Chinese, the 

Japanese——

Mr. HOLTZ-EAKIN. There are two levels to the question. One is 

purely economic, and it is not our central forecast that it is a problem; it is certainly a risk that there may be a shift in the desire 

of foreign investors to hold U.S. securities and, in particular, U.S. 

Treasuries. So it is a concern. We are looking at it. 

And the second is whether it is past economics and that there 

would be more strategic motives involved in foreign governments’ 

purchases or sales, and on that, we are really not qualified to say, 

but it is something we watch, and it is out there. 

Senator DOMENICI. But the point of it is that there are not very 

many places they can put their money that is as secure as ours. 

Mr. HOLTZ-EAKIN. No, it is unlikely we are going to see a big 

problem, because the U.S. remains a good investment environment; 

it remains, you know, a reserve currency. At the moment, a fraction of U.S. international liabilities, whether in total or Government, held by foreign governments is smaller than it was 10 years 

ago, smaller than it was 20 years ago, but it is certainly something 

that merits watching, and we do so with each forecast. 

Senator DOMENICI. My last question has to do with immigration. 

The fact that we, as the Chairman said, we do not have as many 

people working per Social Security recipient is part of the big, overall problem, but we also need an economy that needs more workers. 

You cannot just say we need more immigration; we need more immigration if the American economy can assimilate more employees. 

Is that an automatic thing, or is that related to the growth in 

the American economy and how we are doing versus competition in 

the world? 

48

Mr. HOLTZ-EAKIN. The benefits of immigration are broadly the 

same as the benefits of being open in trade in goods, capital and 

also in skills and labor. The flows of immigration are determined 

by our performance economically and performance elsewhere in the 

globe and also on the policies toward immigration. I mean, there 

are clearly important considerations that go into this. So it is a 

broad, you know, set of influences. 

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

Chairman GREGG. Senator Conrad. 

Senator CONRAD. Thank you, Mr. Chairman. 

Mr. Holtz-Eakin, I do not know if you had a chance to read the 

New York Times this morning. 

Mr. HOLTZ-EAKIN. I did. 

Senator CONRAD. There was an opinion piece by Mr. Krugman, 

noted economist, talking about the growth of the economy over the 

last 75 years compared with your projections of the growth of the 

economy over the next 75 years and this question of Social Security 

solvency. He makes an interesting observation that the growth has 

been, over the last 75 years, 3.4 percent. You told us this morning 

you are projecting growth over the next 75 years of 1.8 percent. 

His point is that if we are going to have that kind of slowdown 

in economic growth, how can we expect the same rate of equity 

growth that we experienced over the previous period? Did you have 

the chance to read that? 

Mr. HOLTZ-EAKIN. I will not pretend to have studied it in any 

great detail. I think that there are, you know, two issues raised by 

it that I saw right away. The first is whether it is possible to have 

a rate of return on corporate equities in real terms, inflation-adjusted of, say, 6.8 percent, our assumption, that is above the longterm growth rate of the economy. And the answer to that, I think, 

has to be yes, because historically, it has happened. We have seen 

the 6.8 percent happen as a matter of history. As you note, his article says that the economy grew much slower than that in total. 

The second issue is whether——

Senator CONRAD. Can I just stop you on that? 

Mr. HOLTZ-EAKIN. Yes; that is just the facts. 

Senator CONRAD. Let me just stop you on that point, because if 

we had a growth of 6.5 or 6.8 percent in stocks over the previous 

period——

Mr. HOLTZ-EAKIN. Rate of return. 

Senator CONRAD. A rate of return, but that was in an environment in which the economy was growing 3.4 percent——

Mr. HOLTZ-EAKIN. Yes. 

Senator CONRAD [continuing]. Would it not be fair to assume that 

if economic growth slowed to 1.8 percent, that equity rate of return 

might also slow? 

Mr. HOLTZ-EAKIN. The second point is what would be the future 

in the face of faster or slower economic growth, either as a matter 

of other stuff, like immigration, or policies, and there, you would 

want to look and see the extent to which national saving changed 

and the things that would determine long-run economic growth 

were going to alter future rates of return. That is certainly part of 

a comprehensive assessment of the future of Social Security. 

49

Senator CONRAD. Well I had never thought of this point, frankly, 

but it raises an interesting question about how our equity growth 

is tied to economic growth? Is there a relationship? I assume there 

is. If we are going to have slower economic growth than we have 

had over the previous 75 years, does that mean we should expect 

slower equity growth? And how does that affect all of our calculations? 

And it goes back to the question of the economic growth that you 

project over the next 75 years. Are there things that we could do 

that would get stronger economic growth? What would be the factors that would contribute to stronger economic growth in terms of 

Government policy? 

Mr. HOLTZ-EAKIN. Economists organize the sources of growth 

into nice little bundles, and the bundles are accumulation of capital, a term that encompasses all of the things that you do when 

you do not eat something today, and you save it for tomorrow, you 

put it into——

Senator CONRAD. That has to do with savings. 

Mr. HOLTZ-EAKIN. So any policy toward savings. Then, the labor 

inputs, the number of bodies, how many people are around to work, 

what skills they bring to work: education, training, those kinds of 

policies are there. The third bundle is technology, and the technologies are driven by policies toward R&D, intellectual property 

rights, all the incentives to innovate and claim the returns to that 

innovation. And then, there is the rest, which is the large unexplained portion that comes from managerial efficiencies and smarter ways of doing business. 

Senator CONRAD. All right; Senator Enzi, and I am sorry that he 

is not still here, talked about how we got back on fiscal track before, and basically, he suggested it was all on the revenue side. I 

do not agree with that, and I do not think the facts show that. This 

shows, going back to 1980, the relationship between spending, that 

is the red line, and the green line, which is revenue. This is all as 

a share of gross domestic product, so we are using the measure 

which you said was most appropriate.

50


21173.010
51

And what we see is, in fact, outlays did come down markedly 

during the 1990’s. Outlays came down markedly. Revenue went up 

markedly during the nineties as a percentage of GDP. That is what 

produced budget surpluses. It was a combination of spending restraint and increased revenue, partly as a result of tax increases; 

partly as a result of strong economic growth. 

Now, we can see what has happened to take us back into deficit. 

We have had a tick up in spending, although spending is still far 

below where it was in the eighties; the tick up is almost entirely 

homeland security and national defense. Ninety-one percent of the 

increase is just in those two categories. But the revenue has fallen 

out on us. We have the lowest revenue last year since the late 

1950’s. 

So just as a factual matter, this is what I believe the facts are. 

This is what occurred. This is what occurred in terms of bringing 

down expenditures as a share of our national income, raising revenue as a share of our national income, and it shows us where we 

are now. It tells me that if we are going to solve this problem, we 

have to work both sides of the equation. We have to work the 

spending side of the equation and the revenue side. 

I thank you. 

Chairman GREGG. Thank you. 

Senator ALLARD. Senator ALLARD. Thank you, Mr. Chairman. 

I come from a State where we do a lot of dynamic scoring in our 

budgeting process, and I want to make sure that I understand to 

what extent you use dynamic scoring with the CBO. And my understanding is that what might be referred to as dynamic, in 

quotes, that you actually take behavioral changes into effect, but 

that everything else is pretty much statics, particularly as it applies to the macroeconomic feedback effects. 

Has the Congressional Budget Office studied ways to account for 

the macroeconomic feedback effects in its budget estimates? 

Mr. HOLTZ-EAKIN. Why do I not tell you how we put these numbers together that you saw today, and you can decide what labels 

are appropriate. 

A baseline projection takes into account current law and the economic incentives provided by current law. In particular, in this 

baseline projection, we have the difficult problem of assessing what 

happens in 2009, when dividend and capital gains rates go up; 

what happens in 2011, when marginal tax rates go up and all the 

provisions in EGTRRA and JGTRRA sunset. 

We build into not just the evolution of taxable incomes but the 

macroeconomic performance feedbacks from that current law, from 

that current law. The hard part is actual economic performance depends on what people expect, and we do not know what the private 

sector expects about the permanence of the current tax rates. 

So we take, as a matter of internal consistency, the assumption 

that people believe current law will execute as written: that the 

rates will go up in 2009 and 2011. We build that into our macro 

and our micro behavior. And whether that is fully dynamic or not, 

I do not know, but that is how the budget projections are done. 

Senator ALLARD. So the CBO has moved—you are saying that 

the CBO has moved more toward, historically here in the last decVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00057 Fmt 6633 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
52

ade, has moved more toward using dynamic scoring, but as it applies to the macroeconomic effects, your policy has stayed pretty 

much the same. 

Mr. HOLTZ-EAKIN. Baseline projections have always tried to incorporate whatever the fiscal policies are, and so, that, I believe, 

is a virtue, because it is the right way to do it, and it has always 

been done that way, to my knowledge. The biggest change has been 

in analyzing the President’s budget, where we have, at the request 

of the budget committees, done an analysis that includes the macroeconomic impacts of the President’s budgetary proposals. 

Senator ALLARD. Yes. 

Mr. HOLTZ-EAKIN. We have done that for 2 years now, and we 

hope that it is useful to the Committee. 

Senator ALLARD. OK; so you are doing that now, where you had 

not done it in the past. 

Mr. HOLTZ-EAKIN. Yes. 

Senator ALLARD. And you plan on continuing to do more of that 

in the future? 

Mr. HOLTZ-EAKIN. Absolutely; we would provide anything the 

Budget Committee would find useful in doing that analysis. 

Senator ALLARD. It is kind of interesting to look at how States, 

and I want to talk a little bit about Medicaid here, that States will 

allocate in order to make up their share of the Medicaid, will take 

and overallocate the amount of dollars they send to their hospitals, 

and they get that rebated at the end, and the net effect is that 

probably, they have overleveraged Federal dollars. Would you comment on that problem some? 

Mr. HOLTZ-EAKIN. We are unsure of the magnitude of these 

intergovernmental transfers and how they are affecting the Feds’ 

share going to the States. We know that CMS is looking at them; 

that this is an important issue, and we are working with them and 

trying to learn from their investigations to see how many dollars 

are on the table. We are really not sure at the moment. 

Senator ALLARD. So you cannot give us an estimate of how many 

States might be doing this? 

Mr. HOLTZ-EAKIN. We do not know at the moment. It is something that we are looking at now. 

Senator ALLARD. That would be a part of your investigation at 

the time? 

Mr. HOLTZ-EAKIN. Yes. 

Senator ALLARD. Thank you. 

Chairman GREGG. Senator Sarbanes. 

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

As recently as the 1980’s, the U.S. was a creditor nation. U.S. investment abroad exceeded foreign-owned assets here by more than 

10 percent of GDP. In today’s economy, if that were still the case, 

it would be $1 trillion in a positive position. Regrettably, today, the 

U.S. is the world’s, largest debtor. Our external debt in 2003 was 

$2.4 trillion, or nearly a quarter of our GDP, and we continue to 

run enormous trade and current account deficits. They are projected to be over $600 billion in 2004, which would mean that our 

external debt would then be over $3 trillion. 

Just a few weeks ago, the President of the Federal Reserve Bank 

of New York, Timothy Geithner, noted in a speech: the size and 

53

concentration of external imbalances in the system are at an unprecedented scale, between 5 to 6 percent of GDP in the case of the 

U.S. current account deficit. The counterpart of this deficit is a 

large inflow of capital from elsewhere in the world. The expected 

trajectory for this imbalance produces a dramatic deterioration in 

our net international position and cannot be sustained indefinitely. 

And Geithner concluded: what is new is that we are significantly 

more dependent today on the confidence of the rest of the world in 

U.S. economic policy and the safety and stability of our financial 

markets. 

And the Financial Times, in an editorial earlier in the year, said: 

like Tennessee Williams’ ill-fated character, Blanche DuBois, the 

United States has long been dependent on the kindness of strangers. And that is the issue I want to examine with you here this 

morning. 

Now, first of all, given some questions that were asked, which of 

our trading partners hold substantial dollar reserves, in other 

words, have these claims against the U.S.? 

Mr. HOLTZ-EAKIN. The largest outstanding are Japan, in most recent years, the largest increase has been in China. 

Senator SARBANES. And then, would Korea and Taiwan come in 

behind them? 

Mr. HOLTZ-EAKIN. I could check. I think that is right. 

Senator SARBANES. Do we import oil from any of those countries? 

Mr. HOLTZ-EAKIN. I do not know. 

Senator SARBANES. I do not think so. 

Mr. HOLTZ-EAKIN. If I say no, I am probably wrong, but I do not 

think they are substantial. 

Senator SARBANES. Well, I do not think so, just to clear that off 

the deck. 

Now, you say in your report, the trade deficit has widened by an 

estimated $230 billion in nominal terms or about 2 percent of GDP, 

but then, you say you expect a decline or a reverse in the near future, and by 2006, the growth of exports is likely to outpace that 

of imports. 

Now, OECD projects that for 2005, the trade imbalance is going to go up to about $700 billion negative, and you are saying that by 

2006, namely, in the next year, that the growth of exports will outpace that of imports. It is a shift in the trajectory; is that what you 

are telling me? 

Mr. HOLTZ-EAKIN. Broadly; what we have underneath our projections is an improvement eventually in the U.S. current account position. 

Senator SARBANES. Yes, but I want to know how fast. What are 

you projecting for 1906? 

Mr. HOLTZ-EAKIN. We expect a turnaround after 2 years. 

Senator SARBANES. In other words, then, instead of being $700 

billion, it will be $675 billion or some figure like that; is that what 

you are telling me? 

Mr. HOLTZ-EAKIN. I do not know what the number is for 1905, 

but what we expect is for 1905, it will continue to worsen; 1906, 

we will begin to see a turn. That is the mechanics of the projection. 

Senator SARBANES. When are you projecting that we will be back 

in balance? 

54

Mr. HOLTZ-EAKIN. I do not think we have a projection of that. 

Senator SARBANES. You cannot glimpse it on the horizon, can 

you? 

Mr. HOLTZ-EAKIN. No. 

Senator SARBANES. No; now, even in this projection you are making, the projected trend in the trade balance largely reflects the expected decline of the dollar relative to the currencies of the U.S. 

trading partners, especially those of Asian economies. What makes 

you think that is going to happen? What has happened in the depreciation of the dollar over the past 3 years has been relative to 

the euro and other non-Asian currencies, has it not? 

Mr. HOLTZ-EAKIN. The trade-weighted dollar has depreciated in 

nominal terms, and that is the core of both the history and our projection, and the questions then become how quickly does that 

change prices of imports relative to exports? 

Senator SARBANES. How is it going to change if the Chinese are 

pegging the value of their currency? John Snow tells them, they 

should go to flexible rates. Now, they are not going to go to flexible 

rates. Everybody knows that, because it invites a banking crisis in 

China, at least that is what everyone tells us. And Snow has not 

asked them to repeg, so if they stay at the peg, how are you going 

to correct the Chinese imbalance? 

Chairman GREGG. Senator, we are going to have to move on 

here, but we are going to have Secretary Snow here next week, and 

that is a good question for him. 

Senator SARBANES. Yes, but this guy is pretty good. 

[Laughter.] 

Chairman GREGG. Well, why do you not go ahead and answer his 

question, Mr. Director? 

Mr. HOLTZ-EAKIN. I am flattered. 

Senator SARBANES. What I meant by that is I regard you as a 

straight shooter and not a spin artist. I think that is important. 

Mr. HOLTZ-EAKIN. The Chinese peg, let us just assume it stays. 

China is not our only trading partner, and the current account is 

the net effect of all trade transactions with all of our trading partners. So our forecast does not assume that the Chinese change 

their peg a bit. It assumes that relative to all of our trading partners, the dollar does, in fact, continue to decline somewhat. 

But that is not the only mechanism by which the current account 

reverses. To some extent, we count on oil prices moderating a 

touch. It is the case that world economic growth has been very slow 

relative to the U.S., and part of the forecast, both for the United 

States and more generally is for world economic growth to improve. 

So that will help. 

Senator SARBANES. No, I want to go specifically on what you said 

in the report. 

Chairman GREGG. Could we move on, and——

Senator SARBANES. Could I just ask this one question? 

Chairman GREGG. OK. 

Mr. HOLTZ-EAKIN. I hope we said that in the report. I believe——

Senator SARBANES. Let me quote from the report: ‘‘The projected 

improving trend in the trade balance largely reflects the expected 

decline of the dollar relative to the currencies of the United States’ 

trading partners, especially those of Asian economies.’’ How do you 

55

expect there to be a decline of the dollar—let me be very specific—

relative to the currency of China, if they continue to do the peg? 

Mr. HOLTZ-EAKIN. Again, we do not have a projection that relies 

on bilateral exchange rates with particular countries. It is the 

broad trade-weighted one, and we can do it by Asian or non-Asian 

countries, if you would like. We would be happy to work with you 

on this. 

Senator SARBANES. Well, that is not what this statement says. 

Chairman GREGG. Senator Bunning. 

Senator BUNNING. I am the last one here, I guess. Thank you, 

Mr. Chairman. 

You know, I once heard that budget forecasting was referred to 

as being about as accurate as forecasting earthquakes. As an economist, could you please comment on the historical accuracy of longterm projections of the Federal budget deficit by CBO, by OMB, by 

others who might get into the forecasting business? 

Mr. HOLTZ-EAKIN. We can not only comment on it; we try to display it in the report. We show the uncertainty around our baseline 

projections in a fan chart. The fan chart tells you, for example, that 

under the baseline, take all its flaws at the moment, but under the 

baseline, the deficit is 1.2 percent of GDP 5 years from now. Based 

on historical uncertainty in the economic performance and in technical relationships between the budget and the economy, there is 

a 5 percent chance that that number could be 6 percent of GDP or 

greater. There is a 35 percent chance that it could be in balance 

or better. 

Senator BUNNING. OK. 

Mr. HOLTZ-EAKIN. There is an enormous range of uncertainty 

that should be acknowledged and should be used in evaluating policies. 

Senator BUNNING. If you have a $2.5 trillion economy, and you 

are off by 5 percent, what is that in dollars? 

Mr. HOLTZ-EAKIN. We have a $2.5 trillion budget; 10 percent of 

that is $250 billion; 5 percent is $125 billion. 

Senator BUNNING. $250 billion——

Mr. HOLTZ-EAKIN. Five percent would be $125 billion; no, that is 

not right. 

Senator BUNNING. Uh-oh. 

Mr. HOLTZ-EAKIN. Of the budget, yes. 

Senator BUNNING. OK; and I wanted to get to what Senator Sarbanes has been talking about, because we would like for you, Senator Sarbanes, to join Senator Schumer and myself in trying to get 

China to unpeg their currency from the dollar. We have a bill in 

to do just that. Would you like to comment on the impact, if any, 

the weak dollar has had both on the assumptions behind your analysis and the conclusions of your report? 

Mr. HOLTZ-EAKIN. The dollar narrowly, the international situation more broadly, are all part of the forecast for the U.S. economy 

in terms of its cyclical recovery, where we anticipate better net export performance over the next 2 years, and as a result, they feed 

into the budgetary outlook. And so, it is the case that the budget 

projections and the economic projections are an internally consistent whole, and the economic projections in particular add up. 

56

We take into account international conditions and domestic conditions and make sure that it is an internally consistent forecast. 

So we are, in fact, cognizant of the dollar and the future path of 

the dollar as part of our forecast. 

Senator BUNNING. Has CBO always done that? I mean, have 

they used that projection in their past? I have been on budget committees for 8 years, both the House and the Senate Budget Committee, and it seems to me that the accuracy in forecasting the 

deficits, the surpluses, the growth in the economy, the growth in 

the CPI, have been so skewed by CBO over the last 8 years that 

I have been on budget committees that it has just been unbelievable to try to get a handle on the current budget. Is that an incorrect assumption? 

Mr. HOLTZ-EAKIN. I think that CBO’s forecasts of the budget and 

of the economy are comparable in quality to anyone. You and I 

could have a discussion about whether the economics profession as 

a whole has progressed to the point where they provide forecasts 

that you are happy with, but the CBO projections are of equally 

high quality to those of the OMB, the private sector, and many. 

Senator BUNNING. Is it true that if I brought 10 economists in 

here, not one of them would have the same projection given the 

same numbers? 

Mr. HOLTZ-EAKIN. It would be true that it would be unlikely that 

you would get exactly the same projections, but given the range of 

movements, I think our projection is qualitatively very similar to 

the blue chip consensus, for example. It is in the report, the comparisons, and other forecasters. 

We do display on our Website our forecasting record. You can go 

check for yourself. And we are always looking to improve it. We are 

cognizant of the gap between what happens in fact and what we 

project, and everywhere we can close that gap, we have attempted 

to do so over the years. 

Senator BUNNING. Thank you, Mr. Chairman. 

Chairman GREGG. Thank you. You have been courteous with 

your time, Mr. Director. I know Senator Sarbanes had just a couple 

of followup questions. 

Mr. HOLTZ-EAKIN. Sure. 

Chairman GREGG. And then, we will give you a break. 

Senator SARBANES. Well, thank you very much, Mr. Chairman. 

I know this hearing has been going on for quite some time, and you 

wish to draw it to a close. 

I just have a couple of questions I want to pursue. Do you regard 

the dollar being the world’s reserve currency as an important economic or financial factor or asset for the United States? 

Mr. HOLTZ-EAKIN. It represents another source of demand for 

dollars and dollar-denominated assets and fits in the constellation 

of reasons why you would not expect a precipitous shift away in 

international portfolios. So it is one feature. 

Senator SARBANES. Do you think that the U.S. would have lost 

something of import and value if the dollar ceased to be the world’s 

reserve currency? 

Mr. HOLTZ-EAKIN. Again, other things equal, if people have less 

of a standing desire to hold dollars in their portfolios and do so 

strictly on other considerations, risk, return and the others, then, 

57

that represents a diminished appetite for dollar-denominated assets. 

Senator SARBANES. What are the implications of that for us? 

Mr. HOLTZ-EAKIN. Qualitatively, I think more sensitivity in dollar demand, in the demand for dollar-denominated assets to prices, 

but I do not know numerically how large that would be. 

Senator SARBANES. The Financial Times a week ago yesterday 

said ‘‘central banks are shifting reserves away from U.S. assets and 

toward the euro zone in a move that looks set to deepen the Bush 

administration’s difficulties in financing its ballooning current account deficit. In actions likely undermine the dollar’s value on currency markets, seventy percent of central bank reserve managers 

said they had increased their exposure to the euro over the past 

2 years. The majority thought euro zone money and debt markets 

were as attractive a destination for investment as the United 

States.’’

That has serious implications for us, does it not? 

Mr. HOLTZ-EAKIN. As the Senator knows, the current account reflects the desire to make capital investments, both in a portfolio 

and in actual factories in the United States, and to the extent that 

that desire diminishes, it will have negative implications as to financing. 

Senator SARBANES. Some of that is not investment. Some of that 

is buying our Treasuries, in order to impact the value of the currency to gain a trade advantage. Otherwise, why are the central 

banks of China and Japan building up such large dollar reserves? 

Mr. HOLTZ-EAKIN. There is no question that central banks intervene to manage currencies. 

Senator SARBANES. To manage currencies. 

Mr. HOLTZ-EAKIN. To manage currencies, no question. 

Senator SARBANES. And that is clearly going on. 

Mr. HOLTZ-EAKIN. And that is part of the overall determination. 

Senator SARBANES. Mr. Chairman, I think this is an important 

issue. I am just trying to help the President out. He seems to be 

searching around for a crisis on which to focus his attention, and 

I want to suggest and will continue to suggest that, between the 

internal deficit, which Senator Conrad talked about, and this external situation, we have a crisis at hand. 

Thank you very much. 

Chairman GREGG. I appreciate your thoughts, Senator, and we 

certainly thank the Director for his courtesy and the time he has 

granted us this morning, and we look forward to continuing to 

work with him and his excellent staff, who do such a good job for 

us. 

Thank you very much. 

Mr. HOLTZ-EAKIN. Thank you, Mr. Chairman. 

[The prepared statement of Mr. Holtz-Eakin follows:]

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Chairman GREGG. The next hearing will be on February 8, and 

the Comptroller General is going to be participating. 

[Whereupon, at 12:15 p.m., the hearing was adjourned.]

STATEMENT OF SENATOR BUNNING 

SENATE COMMITTEE ON THE BUDGET 

CBO’S BUDGET AND ECONOMIC OUTLOOK

Thank you, Mr. Chairman. 

I was concerned, as I’m sure were most members of this committee, to read new 

CBO estimates of a $368 billion budget deficit for fiscal 2005. 

This number brings into stark reality the magnitude of the job before us in this 

committee and in the Congress. Certaninly, we need to see spending reigned in.I11I 

was please with recent statments from the Administration regarding the President’s 

commitment to control spending. We, as a country, have faced difficult challenges 

over the past few years and we will continue to face them. Protecting our citizens 

does not come cheap, but it must be our highest priority. 

However, we must be disciplined in all areas of the budget we are about to 

produce in this committee. We must make difficult decisions and we must lead the 

Senate in sticking to them. 

My review of the recent CBO report shows that freezing discretionary spending 

during the 10-year window would reduce the deficit by about $3 trillion compared 

to letting discretionary spending grow at the rate of GDP. 

While a true freeze on discretionary spending may be difficult, we must at least 

work toward reigning in the rate of spending growth. 

Additionally, and maybe even more importantly, we must examine mandatory 

spending. Our chairman has mad clear that he is willing to look at this often-ignored part of the budget and I support his plan to put these entitlement items on 

the table and examine them. 

Congress must also take a hard look at our Social Security System and make 

some reforms. In only 13 years, Social Security will begin paying out more in benefits than it collects in revenue. By the year 2042, the program will be insolvent. 

Without any reforms, the current system has an unfunded liability of over ten trillion dolloars. We owe it to our children and grandchildren to have an honest debate 

on this issue and put this program on a financially sound path. 

I thank Dr. Holtz-Eakin for the hard work and dedication of his office and for his 

willingness to appear before us today to explain the most recent analysis in detail. 

Thank you.

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Testimony inserts in response to Questions from Mr. Crapo

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Testimony insert in response to economic growth rate questions 

posed by Senator Byrd from 2/1/05 Senate Budget Committee hearing entitled ‘‘The CBO Budget and Economic Outlook’’

Q1. For your projections of the Social Security long-term deficit, 

what is the assumed average annual growth rate in the economy? 

Answer: The average assumed real growth for the 204-2079 period is 2.0%

Q2. What was the annual average growth rate for the last 75 

years? 

Answer: The actual real growth rate over the last seventy-five 

years (1929-2004) was 3.4%

Q3. What was the average annual growth rate over the last 10 

years? 

Answer: The actual real growth over the last ten years (1994-

2004) was 3.3%

(85)

REEXAMINING THE FEDERAL BUDGET FOR 

THE 21ST CENTURY 

TUESDAY, FEBRUARY 8, 2005

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

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

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

Present: Senators Gregg, Domenici, Allard, Sessions, Cornyn, Alexander, Graham, Conrad, Nelson, Stabenow, and Corzine. 

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

Hearn, analyst. 

Staff present: Mary Ann Naylor, Staff Director; and John Righter, analyst. 

OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

Chairman GREGG. We are fortunate to have with us today the 

Comptroller General of the Government, David Walker, who does 

a superb job, and he has some very interesting ideas and thoughts 

that he wants to share with us, I know, especially about the outyear impact of contingent liabilities of the Federal Government, 

which I am extremely concerned about. In fact, one of my goals in 

this budget, although the Budget has done it in the past well, but 

I hope we can do it even better, is to have a very clear and transparent statement of what the liabilities are of this Government not 

only for the 5-year and 10-year period, but 20- and 30-year period 

to the extent we can project them accurately not only in the area 

of Medicare and Social Security, which are obviously big numbers, 

Medicaid, but also in the areas such as PBGC, student loans, 

things that are out there and maybe either somewhat sleeping or 

completely sleeping, but we know they are going to come back and 

hit us in the back of the head here with fairly high costs. 

I know that the Comptroller has done a lot of work in this area, 

and we look forward to his presentation, which we have had a little 

bit of a preview of, and thank him for taking the time to come and 

testify. 

Senator Conrad. 

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

Senator CONRAD. Well, I, too, want to welcome you, Mr. Walker, 

to this committee. Your work has been very valuable. And I want 

to just go through a couple of slides, if I could, to put this in some 

86

perspective, at least from my perspective, and then I look very 

much forward to your testimony. 

You said, on February 2nd, to the National Press Club, ‘‘The 

American people need to realize that the fiscal choices being made 

in Washington today have profound consequences for the future of 

our country and our children. In a nutshell, these fiscal choices will 

directly affect our future national security, economic vitality and 

quality of life.’’ I think you summed it up very well. These decisions, if I were to sum up your statement, really matter. They matter to our economic security. They matter to our children.

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As I look at the President’s budget, I believe it continues to push 

us toward bigger and bigger deficits and more and more debt. I 

look back to before he took office—we actually were in surplus. In 

fact, for 2 years, we did not use Social Security funds for other purposes. And since the President took office, we have plunged back 

into the red. And the President says the deficit is going to significantly improve over the next 5 years, but he only gets there by 

leaving out things. He leaves out war costs past September 30th 

of this year. He leaves out fixing the alternative minimum tax all 

together, which is becoming a middle-class tax trap. He leaves out 

the second 5 years of his tax cut, which is when the cost of it explodes. He leaves out item after item. When you put them back in, 

what you see is quite a different pattern than what the President 

is telling the Nation. And, of course, he leaves out the cost of his 

Social Security privatization plan. 

All those things are left out. When you put them back in, here 

is what we see happening: A deepening of the deficit, additional 

debt and all at the worst possible time, before the baby boomers 

retire. 

Let us go to the next chart.

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As we look at this turnaround, dramatic turnaround, from surplus to deficit, 74 percent of the reduction in our fiscal condition 

is a result of changes on the revenue side of the equation. Now, not 

all of this is tax cuts. About half is tax cuts. About half is other 

things. Twenty-six percent is an increase in spending. Virtually, all 

of the increases in spending have been for national defense and 

homeland security, and, of course, the big change in entitlements, 

the prescription drug bill that we passed, which apparently is exploding in cost as well. As Senator Gregg was concerned about, he 

is being proved to be correct, that the cost of that program is dramatically increasing beyond what we were told at the time. 

Let us go to the next.

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This chart I think is very important to keep in mind because it 

looks at spending—that is the red line, and the green line is revenue—and this goes back to 1980. We can see spending, even now, 

even after the increase—largely due to defense and homeland security, and rebuilding New York—we can see this spending level is 

still well below what it was throughout the 1980’s and into the 

1990’s. Revenue’s have had tremendous changes, and the last several years they have dramatically fallen. So we have a problem on 

both sides of the equation here, longer term on spending and also 

on revenues, and this gap is the reason for the deficit. 

Let us go to the next.

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The President says to us we have a deficit problem, and then he 

increases spending this year, 2004 to 2005, spending is increasing 

8 percent. Next year, according to our calculations, they will go up 

another 5 percent. But the President is also saying make the tax 

cuts permanent. And when you overlay that against what is happening to the trust funds of Medicare and Social Security, what you 

see is the tax cuts explode just as the trust fund cash surpluses become deficits. The combined effect is to drive us deeper and deeper 

into deficits and debt. 

Let us go to the last one.

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This looks at the shortfall in Social Security over 75 years, $3.7 

trillion. I, also, asked my staff to do an analysis of what the tax 

cuts, what is the 75-year cost of the tax cuts that the President has 

proposed, and that is $11.6 trillion. Now, the tax cuts are three 

times the 75-year shortfall in Social Security. Let me just say I do 

not conclude from that we do not have to do anything about Social 

Security. I believe we do. I believe we have to address the Social 

Security shortfall. I believe we have an even more urgent need to 

address the Medicare shortfall because Mr. Walker, as you have indicated, the shortfall there is eight times the shortfall in Social Security. 

And so I believe we should be working on both of those problems, 

as well as the revenue base of the country, and I look forward to 

your remarks. I want to thank you for sounding the alarm that we 

are on a fiscal course that simply is not sustainable. 

Chairman GREGG. Thank you, Senator. 

Mr. Walker, we look forward to hearing your thoughts. 

STATEMENT OF THE HON. DAVID M. WALKER, COMPTROLLER 

GENERAL OF THE UNITED STATES GOVERNMENT ACCOUNTABILITY OFFICE 

Mr. WALKER. Thank you, Mr. Chairman and Senator Conrad. It 

is a pleasure to be back before the Senate Budget Committee 

again, and with your approval, I would respectfully request that 

my entire statement be entered into the record. 

Chairman GREGG. Of course. 

Mr. WALKER. Thank you. I will now move to summarize it, with 

assistance from Ty Mitchell. 

I appreciate the opportunity to be before you to talk about the 

Nation’s long-term fiscal outlook and the challenge that it poses for 

our country, our children, and our grandchildren. I realize that 

most people are focused on the President’s budget for fiscal 2006, 

which was just unveiled yesterday, and that is obviously a very important document. At the same point in time, I believe it is important that we think about tomorrow in order to be able to put the 

issues that are in that document in context, which will be debated 

within this body and your sister body over the coming year. 

This first chart, which also is in my written statement, represents the result of GAO’s latest long-range budget simulation, 

which we do twice a year. Our long-range budget simulation, is 

based upon CBO’s baseline and other longer-range assumptions, 

based on input from CBO and others. What it shows is this is what 

our fiscal future looks like based on three key assumptions, which 

CBO is required to make, which I would respectfully suggest are 

not very realistic. 

No. 1, no new laws will be passed. You can bet on that, but I 

would not bet anything on it:

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Second, discretionary spending grows by the rate of inflation 

after 2015. Discretionary spending includes national security, 

homeland security, education, our judicial system, transportation, 

et cetera; 

And, third, that all tax cuts sunset. 

Those are three key assumptions that underlie this and with it 

you can see that we start to have serious problems starting out 

after 2015 that grow with the passage of time, but I would respectfully suggest you need to have alternative scenarios to look at because there are unrealistic assumptions and conditions backing 

this one. 

The next simulation only changes two assumptions, and I am not 

saying this is good, bad or indifferent. I am just trying to give you 

the facts. The only difference between this scenario and the last is 

that, A, discretionary spending grows by the rate of the economy 

rather than the rate of inflation during the first 10 years and, B, 

all tax cuts are made permanent. Under this scenario, the only 

thing the Federal Government can do in 2040 is pay interest on the 

massive debt that has accumulated over that period of time. 

The bottom line, Senators, is that we face a large and growing 

structural deficit due primarily to known demographic trends and 

rising health care costs. There are other factors that are contributing, clearly, including the fact that revenues, as a percentage of 

GDP, are at the low end of the range that they have been over a 

number of decades. They will come up somewhat as the economy 

grows, but we have a structural imbalance that is going to require 

very tough decisions. 

I believe, Mr. Chairman, it is going to require us to do nothing 

less than engage in a fundamental baseline review of entitlement 

programs and other mandatory spending, of discretionary spending, as well as tax policies and related enforcement programs. The 

gap is too great to simply grow your way out of the problem. You 

cannot solve it just by looking at discretionary spending. You cannot solve it just looking at other mandatory spending and without 

looking at the entitlement programs. We also have to recognize 

that the Government spends hundreds of billions of dollars a year 

in tax expenditures through tax preferences, which are largely off 

the radar screen, that may or may not be achieving the desired 

outcomes and may or may not be affordable and sustainable in the 

years ahead. 

Next, chart please.

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Let me give you the bottom line on this chart, Mr. Chairman and 

other Senators, because there are a lot of numbers here, and these 

numbers, by the way, are in billions, which is a big number, in and 

of itself, with nine zeroes. 

The bottom line here is, according to the latest financial statements of the U.S. Government for the year ended September 30, 

2004, if you add up all of our liabilities, if you end up considering, 

also, the commitments that we have made for such programs as Social Security, Medicare, veterans health care, et cetera, and if you 

were to accumulate all our liabilities and commitments that existed 

as of September 30, 2004, and if you offset the dedicated revenues 

that have been earmarked for those programs, such as payroll 

taxes for Social Security and Medicare, premiums for certain Part 

B and Part D, and you only consider the portion that the taxpayers 

will have to fund, then our accumulated liabilities and commitments exceeded $43 trillion as of September 30, 2004. That is 

about $350,000 per full-time worker, and it is a big number, and 

it is growing every day, due primarily to demographic trends. 

Next, chart please. And one of the problems that we have is, is 

that these numbers are largely off the radar screen, and Congress 

does not have access to this type of information as part of the normal budgetary process and as part of legislative deliberations, as 

evidenced by the fact, Mr. Chairman, that you talked about the 

Medicare prescription drug bill. There was a great debate last year 

about whether the cost was $395 billion or $534 billion, depending 

upon who you asked and when. The real number came out about 

3 months after the bill was passed, according to the annual report 

of the Medicare trustees and their actuaries—$8.1 trillion. That is 

the estimated current dollar cost of the Medicare prescription drug 

benefits. That is how much money we would have to have today invested at Treasury rates to deliver on the unfunded promise for the 

next 75 years alone, and it is going up every day. That is more 

than the entire debt of the United States outstanding since the beginning of the republic, which is about $7.6 trillion, I believe.

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So one of the things I know you are interested in, Mr. Chairman, 

and other members of the committee, is what can be done to try 

and help provide more transparency and to provide more safeguards with regard to considering not only the short-term costs, 

but the long-term affordability and sustainability of decisions that 

you have to make on an ongoing basis as a member of the U.S. 

Senate. 

My written statement has a lot of details. I will touch on three 

high-level points: 

First, there clearly is a need for more transparency. There is 

clearly a need to provide supplemental information as part of the 

budget process as to the number nature and magnitude of the existing unfunded commitments that we already have; 

Second, there is clearly the need to consider additional mechanisms, through the legislative process, whether it be points of 

order, triggers or otherwise, whereby this body and your sister 

body would have the opportunity, if not be required, to discuss and 

debate the cost not only in the short term, but the long term cost, 

of various legislative proposals; 

And, third, there is a need to consider, for certain types of items, 

whether or not we ought to move more toward an accrual-based approach for things like insurance, or Federal employee pension and 

health obligations, where accrual-based concepts have clearly existed for many years in the private sector and, some, State and 

local Governments, I might add. So, therefore, we might want to 

consider whether or not there is additional transparency that is 

necessary there, either through an accrual-based approach or, if 

not an accrual-based approach, further supplemental disclosures. 

Next chart, please.

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The other thing I want to bring to the Senators’ attention is the 

fact that, as you know, every 2 years we update our strategic plan 

for serving the Congress, and we do that through outreaching to 

members and key staff on both sides of the aisle and, both ends of 

the Hill, to try to help us do a better job in serving you, and you 

do a better job in serving your constituents. These are the latest 

themes in our strategic plan, which were validated by the members. These are trends and challenges that have no geopolitical 

boundaries, domestically and internationally, and that serve to 

frame the work that we do for the Congress and, hopefully, improve its value and contextual sophistication. 

They are pretty much self-explanatory. But the first one, which 

overrides everything, is our long-range fiscal challenge because it 

overrides everything that we are doing or thinking about doing 

today and for tomorrow. The others speak for themselves, so I will 

not go through them, but I think they are fairly compelling. 

Next chart, please.

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One of the things that we are going to be doing, Mr. Chairman, 

that we plan to unveil on February 16th is a new product to try 

to help the Congress by providing input for its consideration as it 

deems appropriate in setting its oversight agenda and other types 

of activities. This report is based upon our years of work at GAO, 

90 percent plus of which, as you know, is done at the request of 

the Congress or mandated by Congress, as well as based upon my 

experience at having run three agencies in the Government, two in 

the executive branch, and one in the legislative branch. 

I would respectfully suggest a vast majority of the Federal Government, whether it be on the mandatory spending side, the discretionary spending side or the tax policy side is based upon an America that existed in the 1950’s and 1960’s. And a vast majority of 

the Government is based upon an accumulation and an amalgamation of programs, policies, functions and activities that have been 

aggregated over the years and have never been subject to fundamental review, reexamination, or reprioritization in light of the 

trends that I just mentioned and 21st century realities. 

Our gap is so great that we can afford to do nothing less than 

engage in that fundamental review and reexamination that will 

take as much as a generation to deal with. Obviously, the Congress 

has to decide what to do, when to do it, and how best to do it. But 

one of the things that will be included in our report, that is scheduled to be unveiled on February 16th, is a series of generic questions that should be asked about every major Federal program, policy, function and activity. These are just a few examples. There are 

a lot more. 

For example, what is the relevance, the purpose of the Federal 

role? When did we put this in place? Why did we put the program 

in place? What were the conditions that existed? What were we trying to accomplish? And have things changed since that point in 

time? 

Measuring success. How do we measure success? How do we 

know that we are making a difference on an outcome-based basis? 

Do the programs and the agencies have outcome-based measures? 

If not, why not? If they do, is the program successful based upon 

those measures? Same thing for tax policies. What were we trying 

to accomplish? How do we measure success? Are we successful 

based upon those measures? Targeting benefits. All too many times 

the decision is to try and do it for everybody, rather than base it 

on need, value and risk. And in a time of constrained resources, 

you may not be able to afford to do it for everybody or sustain it 

if you try to do so. 

Affordability and cost effectiveness. Are we using the most costeffective and beneficial approaches in trying to achieve the objective while employing best practices? If the program makes sense, 

is it still a priority. Does it have outcome-based measures? It is 

being successful based upon those outcome-based measures? Are 

they employing best practices in order to accomplish their mission 

as economically, efficiently and effectively as possible? 

Next chart, please.

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This document will also divide the Government into 12 areas. 

Based on our strategic plan, which was developed in conjunction 

with the Congress and to serve the Congress. It is going to take 

these areas, which span all of Government, on the spending side 

and the tax side, and it is going to raise a series of illustrative 

questions that we would respectfully suggest that the Congress 

may wish to consider, as it deems appropriate, in looking at the 

base of Government. 

Next chart, please.

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21173.053
112

Let me give you four examples, if I can: 

There will be many questions presented, and they will be balanced. And, by the way, we will not give answers because we are 

not elected officials. You are elected officials. We do, however, 

stand ready to assist the Congress in getting additional facts, come 

up with options and identify pros and cons, if you so desire. However, we think that our future fiscal gap is so great that the time 

has come that we need to help the Congress try to be able to at 

least raise some of the questions that it might wish to consider, but 

only you can decide whether, when and how best to proceed. 

Defense. How should the historical allocation of resources across 

the services and programs be changed to reflect the results of a forward-looking, comprehensive threat and risk assessment and a capabilities-based approach to determining defense needs? Bottom 

line, we are talking about the need to look at credible threats and 

risks, what capabilities are necessary to address those threats and 

risks, and how you allocate resources to the different services and 

other entities that are part of the Department of Defense in order 

to maximize the impact and mitigate risk? That is not being done 

right now. A vast majority of the resources of the Defense Department are allocated based on methodologies that have been used for 

decades. 

Health care. How can industry standards for acceptable care be 

established and payment reforms be designed to bring about reductions in unwarranted medical practices, as well as related liability 

concerns? What can or should the Federal Government do to promote uniform standards of practice for selected procedures and illnesses? Now, there are many, many questions under health care. 

This is but one that is designed to address quality, cost, litigation 

access and other issues. 

Retirement and disability. Believe it or not, our definitions of disability have not been updated for decades. In the case of the Defense Department, the last time it was updated was 1945. Things 

have changed a little bit since 1945. 

The tax system. What tax incentives need to be reconsidered because they may not be achieving the intended objectives? For example, the largest tax incentive in the Internal Revenue Code 

today is for health care. Individuals never pay income tax on employer-provided and paid health care or payroll tax irrespective of 

how much money is involved and what percentage of their compensation is being represented by health care. That is an area I 

think you need to look at, how much money is involved, what type 

of incentives is it creating and what type of impact is it having 

with regard to our ability to control health care costs. 

In summary, Mr. Chairman, the Congress, obviously, is focused 

on what to do with the budget that is being proposed, and that is 

important, but it is also important to be able to consider the size, 

the nature, the extent, the magnitude, and the driving forces behind our large and growing long-range fiscal imbalance. Addressing 

this imbalance is going to require a considerable effort over many 

years. It is going to have to involve discretionary spending, as well 

as mandatory spending, including entitlement programs, as well as 

tax policy, including tax preferences and enforcement efforts. It is 

going to have to involve all three because the numbers are simply 

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too great, and realistically there is no way, we are going to grow 

our way out of our fiscal imbalance. The math just does not work, 

and the sooner we get started, the better. 

Thank you, Mr. Chairman and Senators. 

Chairman GREGG. Thank you, Comptroller. That is a sobering 

presentation, an appropriate presentation and an important presentation. Obviously, the numbers which you cite, relative to the 

outyear issues, are hopefully going to cause us to reflect on what 

the best way is to address them—this $43-trillion number that you 

have cited as being basically the contingent liability of the Government, which is already in place. Other Congresses may come and 

add more to it, but that is in place. It is a staggering number. 

I was interested in the point you made, which is an undeniable 

point, which is that this is driven primarily by a demographic shift 

in our society and the cost of health care as it relates to that demographic shift. I mean, the baby boom generation is alive, and it is 

headed toward retirement, and it is the bubble that has moved 

through the system ever since it, in the 1950’s, caused the country 

to have to buy a whole lot more cribs and create a whole lot more 

kindergartens. 

So we cannot deny it, and we cannot avoid it, and we need to 

get ready for it. That is your message, and the way you are putting 

it, the context of the way you are putting it is excellent because you 

are setting out the parameters of the problem and asking us the 

hard questions to resolve them. I hope we have the courage to step 

up on this. 

On a couple of issues, to help you with transparency, what do 

you think the budget—the budget is a 5-year budget or it can be 

a 10-year budget, but it is going to be a 5-year budget I presume 

this year—the problem is a 30-year problem, a 40-year problem, 

but if we do not get to it now the problem becomes huge for us. 

What can we do in the budget to make the budget document a 

more transparent, action-oriented document that, when people look 

at it, they will say, wow, we have a problem here; we have to address it; this is the issue? Do you have recommendations in that 

area? 

Also, in that context, you mentioned mechanisms to empower 

Members of Congress who want to raise the fiscal issues and capacities to do that. Can you go through some of those and how they 

would relate to a budget document that was authored this year. 

Mr. WALKER. Mr. Chairman, some of it has to do with the budget 

document and some of it has to do with what happens as a result 

of the legislative process that flows from the budget document. In 

my written testimony, I have some details, but a few examples I 

would give are: 

First, I think it is important, as part of the budget document, 

that there be more transparency about where our existing commitments are: 

Second——

Chairman GREGG. How do you suggest we do that? 

Mr. WALKER. Well, that could be a supplemental schedule that 

is provided as part of the budget document. 

Chairman GREGG. Nobody looks at schedules. Give me another 

idea. Can we go to neon lights? I mean, is there——

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[Laughter.] 

Mr. WALKER. We might need a burden clock or something, but 

we can come back to that, Mr. Chairman, if you want. 

As you know, the budget document sets the President’s priorities. 

It has a number of proposals in it. One of the things that has to 

be considered as part of that budget document, is what are the 

long-range costs, affordability and sustainability, of those proposals 

that are being made through the budget document. 

I also think it is important, whether they be made through the 

budget document or not, that, when Congress is considering legislation, it needs to consider the long-range cost, affordability and sustainability of those proposals before it actually acts on legislation. 

The example that I gave of Medicare prescription drugs I think is 

a perfect example. 

Chairman GREGG. Well, if I can stop you there because my time 

is——

Mr. WALKER. Yes, Mr. Chairman. 

Chairman GREGG. The problem is it is not the new programs—

well, it was the new program when they put prescription drugs 

on—but it is the programs that are on the book. So how do we get 

back to those? Are there mechanisms, besides reconciliation, that 

you are recommending that get us back to those? 

Mr. WALKER. What I am suggesting with regard to the base of 

Government, that is the accumulation and amalgamation of policies, programs, functions and activities that are there that do not 

get a whole lot of attention each year because the attention is what 

are you plussing up and what are you proposing to cut, with the 

assumption that the base is OK. The base is not OK. 

What I am suggesting, Mr. Chairman, is that Congress needs to 

engage in a fundamental review and reexamination effort of the 

base of Government. In some cases, it is through oversight, in some 

cases, it may have to involve commissions. In the document that 

will be coming out on the 16th, we are going to give specific examples of how the Congress has addressed these types of issues in the 

past and potential vehicles that it may wish to use in addressing 

them in the future, but it is not a one-size-fits-all approach. Depending upon what the nature and extent of the challenge is, 

whether or not there is recognition that there is a problem that 

needs to get solved, whether you have enough facts, the maturity 

of the issue, you are going to use different approaches. 

Chairman GREGG. You suggested accrual-based accounting for 

some of our accounts. Do you have a specific proposal on that that 

we could look at as a committee and possibly incorporate? 

Mr. WALKER. We have made some recommendations in the past. 

I would be happy to get something up for you and the Committee’s 

consideration. I do think it is important to note this. Accrual budgeting is not a panacea. There are some areas where accrual budgeting may make sense. On the other thing, what is critical is that 

even if you do not go to accrual budgeting, that you consider the 

long-term cost, affordability and sustainability of items on the front 

end. That is critical. And right now that, does not get done. 

Chairman GREGG. And you suggested outcomes-based approaches. Can you give me a little more thought on how we would 

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take a program that is presently on the book and analyze it on an 

outcomes-based approach within a budget context. 

Mr. WALKER. Well, one of the things that the President has tried 

to do, to the administration’s credit, is to try to start looking at the 

results of programs, has its initiative called the Program Assessment Rating Tool. It is not perfect, by any means, but, conceptually, recognizing the need, we need to start looking at Federal 

programs and start asking what kind of results are they delivering 

with the resources and authorities that they have. 

And if agencies cannot even tell you, that is a problem. And if 

they have not defined what type of outcomes are desired or if the 

Congress has not helped them to define that, that is a problem. 

And so I think that is a good first step, but I think it has to be 

expanded far beyond discretionary spending. You are not going to 

be able to solve the problem just looking at discretionary spending. 

You are going to have to look at entitlement programs and other 

mandatory spending as well as tax policies. 

Chairman GREGG. Thank you. 

Senator Conrad. 

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

Walker. 

You talked here about $43 trillion of unfunded liabilities. Over 

what period is that? 

Mr. WALKER. The $43 trillion? That is how much money we 

would have to have today to be able to deliver on promises that 

have already been made for up to 75 years. 

Senator CONRAD. For the next 75 years. How much has that 

number increased in the last 4 years? 

Mr. WALKER. In the last year, it increased by over $13 trillion. 

Fiscal 2004 was not a good year, from a financial and fiscal standpoint, and that resulted in an emphasis paragraph in our audit report. 

Senator CONRAD. So just in 2004, that increased $13 trillion. 

Mr. WALKER. That is correct, most of which related to Medicare, 

and most of the Medicare increase related to Medicare prescription 

drugs. 

Senator CONRAD. Now, does that figure capture the proposed tax 

cuts? 

Mr. WALKER. This is on the commitment side, the liability and 

commitment side. So, no, it does not capture that. That is on the 

revenue side. 

Senator CONRAD. And what is the growth estimate that you have 

behind these numbers. I know that CBO and the Social Security 

Administration, for the next 75 years, are looking at a growth estimate between 1.8 and 1.9 percent, even though growth over the 

last 75 years has averaged 3.4 percent. What are the growth estimates behind these projections? 

Mr. WALKER. The main drivers, Senator, are entitlement programs, Medicare being No. 1, and Social Security being another 

major entitlement program. What we use for assumptions on those 

programs are the assumptions that have been adopted by the Medicare and Social Security trustees, their so-called best-estimate assumptions. As you know, every year, they make three projections: 

low cost, high cost and intermediate or best estimate. And we are 

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using the intermediate or best estimate, so it would be their assumptions. 

Senator CONRAD. So that would be an estimate of economic 

growth of about 1.8 percent. 

Mr. WALKER. Senator, candidly, I do not know what assumptions 

they use. I can provide it for the record, if you would like. 

Senator CONRAD. That is the testimony they have given in another committee, in the Finance Committee, specifically, just the 

other day, that their long-term economic growth estimate is 1.8 

percent, even though the last 75 years, the economy has grown at 

3.4 percent. 

Now, when quizzed as to what appears to be a pretty conservative outlook with respect to growth, fairly pessimistic outlook in 

terms of growth, they say the major driver is a lack of new entrants to the work force; that is, that economic growth is a result 

of two factors—increases in productivity and new entrants to the 

work force. Do you agree with that basic understanding? 

Mr. WALKER. Yes. It is my understanding that the primary reason that they are being more conservative with regard to future 

economic growth is because we will have had a dramatic decline in 

the rate of growth in the work force and a flattening out is going 

to occur. 

Senator CONRAD. So, if we could have stronger economic growth, 

that would help address all of these problems, would it not? 

Mr. WALKER. No question about it. 

Senator CONRAD. And so part of our strategy has to be taking 

those steps that give us the biggest bang for the buck in terms of 

economic growth. 

Mr. WALKER. Clearly, additional economic growth will help, but 

I would respectfully suggest, when you do the math, you are not 

going to get there through economic growth alone. There is still 

going to be a huge gap. 

Senator CONRAD. I want to make very clear that while I believe 

we have to be aggressive at measures to increase economic growth 

because that helps deal with this, there is no conceivable scenario 

that I have seen that allows you to grow out of it. The structural 

imbalance is here now, which is the reference you are making. Can I just go very quickly to the point of the $43 trillion. What makes up, in broad categories, the $43 trillion? I believe the other 

day you told me that Medicare is more than $20 trillion of that $43 

trillion; is that correct? Did I hear you correctly? 

Mr. WALKER. It is over $27 trillion. 

Senator CONRAD. Medicare alone is over $27 trillion of the $43 

trillion of unfunded liabilities. 

Mr. WALKER. That is correct, Senator. 

Senator CONRAD. And how much would Social Security be? 

Mr. WALKER. About $3.7 trillion. 

Senator CONRAD. About $3.7 trillion. So, just doing quick math, 

the Medicare problem, in terms of an underfunding, is eight times 

the shortfall in Social Security; is that correct? 

Mr. WALKER. That is correct. 

Senator CONRAD. That would tell me that our top priority ought 

to be looking at Medicare, and obviously we need to deal with Social Security as well. My own view is we ought to be dealing with 

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both of them because the Medicare problem is so enormous, and 

the cost escalation that you are estimating is so significant. 

My time is up, Mr. Chairman. 

Mr. WALKER. Mr. Chairman, if I may real quick, I agree with you 

that we need to be dealing with both, but I think we have to be 

cautious. The last time Medicare legislation was acted on by the 

Congress, it increased the fiscal imbalance by $8.1 trillion. 

I do, however, think that it is possible to reform Social Security 

and exceed the expectations of every generation of Americans. And 

if you can do that—and I think you can—then, that would send a 

positive signal to the markets as to the ability of Congress to be 

able to address challenges before it has to and also would send a 

positive signal to the public that the Congress is concerned about 

this long-range imbalance that threatens our future. 

Senator CONRAD. Could I just say, in conclusion, Mr. Chairman? 

Chairman GREGG. Of course. 

Senator CONRAD. Could I just say that I believe in Medicare the 

biggest opportunity is that 5 percent of the beneficiaries use 50 

percent of the budget, the chronically ill, and we ought to focus like 

a laser on that population, better coordinate their care. The things 

that we have done so far by way of pilot programs show that if you 

do that, you better coordinate their care, you save big amounts of 

money, and you get better health care outcomes. 

Chairman GREGG. Thank you, Senator. 

Senator Alexander? 

Senator ALEXANDER. Thank you, Mr. Chairman, Mr. Walker. 

A Comptroller General’s forum I guess month, that one of the 

participants, according to the report, suggested biennial budgeting 

might be one approach at making more oversight possible again. 

I’ve been looking at Congress from outside Congress for a long 

time, and I have always thought that. And now that I am here, I 

see that making the budget pushes the appropriations to a late 

process, leaves very little time for oversight, and then we end up 

with this big omnibus appropriations bill, and it is all a big mumbo 

jumbo. 

Do you have any recommendations for us about the pros and 

cons of a 2-year budget which might be adjusted in the second 

year, if there emergencies? But would that not leave us a lot more 

time for structured oversight of the kind you are suggesting? 

Mr. WALKER. Senator, candidly, several factors are relevant. 

No. 1, that if you went to biennial budgeting, that would, theoretically, give you more time to do more things. Hopefully, one of 

the things that the Congress would do would be more oversight and 

engaging in a much-needed and long overdue baseline review of 

Government. I do not know that there is a guarantee that that 

would happen, but that would be my hope. But you need more time 

to be able to do it. There is no question. 

Second, there are States, as you know, that have biennial budgeting. And the other thing that I would note is that we have been 

having supplementals every year now, and it is likely that there 

are going to be supplementals for several more years. They are a 

vehicle that could be used to adjust things if you went to biennial 

budgeting. So there are pros and cons, but, again, how would the 

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Senate and the House actually use their time if you went to biennial budgeting is a real question. 

Senator ALEXANDER. Disciplining a legislative body is always difficult, but that has always appealed to me as a possibility. 

Another thing, and again maybe this naive, but I have looked at 

Washington mostly from outside as a Governor, has there been any 

serious consideration, in this report you are coming up with, is 

there any consideration in separating the budget back into component parts? We now have a unified budget, but of course in the 

States we have a different approach. We take capital items, and we 

put them over here because those are investments for the future. 

And then in our State, at least, we pay them back in an aggressive 

way, and we see what that debt is for, and it helps us keep it under 

control. Then, we have an operating budget. And borrowing for the 

operating budget is very, very limited. And then I would guess on 

the Federal level, and in the States, you might have a pension 

budget. 

Why do we not have a capital budget, an operating budget, and 

a pension budget? Would that not provide more transparency and 

would it not permit us, also, while we are in the midst of this deficit, not to squeeze out necessary investments we need to make 

that we might need to do for our future in higher education research development, for example? 

Mr. WALKER. Well, Senator, we have done work in the past in 

a number of these areas, including capital budgeting. I would be 

happy to provide some of that information for you. I do think that 

we need to disaggregate more, and we need enhanced transparency. You talk about capital budgeting, which is one element. 

The other thing that you touch on is the so-called operating budget 

versus other types of programs. 

We, clearly, need to be able to disaggregate, provide more transparency on these numbers, and try to be able to make more informed judgments as to what we should be investing in and what 

is generating a rate of return. Although I am sure that you can appreciate, Senator, that one person’s investment might not be another person’s investment, and being able to demonstrate that, in 

fact, there is a rate of return that we are getting on that investment is very important. It is easier for capital items than it is for 

other types of items. 

Senator ALEXANDER. Well that is true. But if the States are the 

laboratories of democracy, and some of them are pretty big, and 

some of them have done this way for a long time, that is at least 

one place we can look to see how we might learn. 

You have described to us a fiscal challenge that is new in its severity, and maybe that is a spur to these ideas. 

Thank you very much. 

Mr. WALKER. Thank you, Senator. One other thing I would note 

is the Federal Government, obviously, has a responsibility for overall fiscal policy, and what it does has a direct impact on the economy as a whole. And so that is why, while we need to look at some 

of these disaggregated numbers, we cannot lose sight of the unified 

budget because the unified budget does have economic impact. 

Senator ALEXANDER. You could have, I suppose, a unified policy 

and a disaggregated budget. 

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Mr. WALKER. We should have a strategic and integrated approach to everything you do. It is just a matter of how you show 

the information and some additional disaggregation would be appropriate. 

Senator ALEXANDER. Thank you, Mr. Chairman. 

Chairman GREGG. Senator Stabenow. 

Senator STABENOW. Thank you, Mr. Chairman. 

I appreciate Senator Alexander’s questioning in terms of how we 

look at investments in capital improvements and so on. I think we 

really should be looking at that in terms of what our values and 

priorities are and how we are evaluating that. I think that makes 

a lot of sense to take a look at that. 

Thank you, Mr. Walker, for coming in. 

There are a number of things I would love to ask you about as 

it relates to this because we really do need to be evaluating what 

we are doing, in terms of revenue, as well as expenditures, as well 

as interest payments for the long haul. And on this committee, Mr. 

Chairman, we really are the folks that lay out what the priorities 

and the values are for American families, and that is how I see this 

committee. 

It is, also, I think, important to recognize that even though we 

include Social Security in the bottom line, certain streams of revenue coming in, those are dollars paid in by individuals. There is 

not general fund money involved in this. So we are including those 

dollars as it relates to what our debt is. Essentially, some would 

argue to mask the debt because we have it in a unified budget, but 

Social Security is something that has been a program where folks 

pay in, and then they receive a benefit out based on basically an 

insurance policy. So it is important we look at these numbers to 

say that as part of it. 

But, Mr. Chairman, I find it really interesting when we look at 

these numbers that we have received. To put it in context, the 

President is proposing a nondefense, none homeland security budget, domestic budget—education, research, the environment, health 

care and so on—of $389 billion for next year—$389-. The deficit for 

next year is projected at $390-. So you literally could wipe out 

every penny of nondefense, nonhomeland security dollars in order 

to be able to wipe out the debt next year. I think that is very important for us to remember as we talk about what I view as sort 

of tinkering around the edges on this, in terms of how much we put 

into education or research and development, which I believe do 

spur economic activity and investments in the future. And if we are 

not paying attention to those things, we are going to be left behind 

by other countries like China and so on who are. 

But I, also, wanted to put in perspective something else. If you 

take out Social Security, you are saying that our interest payments 

will be $213 billion next year, interest. It would be $415- if we included Social Security. So, if we take that out, $213 billion that 

does not educate a child, does not provide health care, does not 

build a road. It is interest. And the cost of the tax policy that we 

passed, the cost for 2006, is $252 billion. So we are paying more 

on that tax policy than the interest. And when you put that all together, I just hope that we will have a real honest debate about 

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what all of this looks like and what our priorities are in terms of 

the overall budget. 

Now, my question. When we look at Social Security, and the fact 

that we are seeing Social Security is growing at a certain level and 

Medicare is growing at a certain level, and you have indicated that 

Federal health care costs will go from 4.2 percent of GDP to 11.5 

percent in 2030. At the same time Social Security will go from 4.3 

percent of GDP to 6 percent. 

Are we not avoiding, as they would say, the ‘‘gorilla in the middle 

of the living room’’ here by not focusing on health care? There is 

a lot of effort going in to talking about Social Security, plans that 

will not even strengthen Social Security, privatizing, which I would 

argue do not add a day to the length of the solvency of the trust 

fund, but yet we are avoiding the big issue, which is the explosion 

in health care costs. 

Mr. WALKER. I would come back to what Senator Conrad said. 

I think you need to work on both. I think you need to work on 

health care, and you need to work on Social Security. The fundamental difference is, in the case of health care, the problem is 

much more complex, there are huge expectation gaps. We are not 

only going to have to reform Medicare and Medicaid, we are going 

to have to reform the entire health care system in installments. It 

is going to be very heavy lifting. It is going to take many years. 

And, whereas with Social Security it is possible, with or without individual accounts to reform Social Security to make it solvent, sustainable, and secure for current and future generations and for 

every generation will get more than they think they are going to 

get. 

And I think if you can achieve that, there are a lot of positive 

reasons why that is desirable to do, with or without individual accounts. It is going to take many years to deal with the health care 

problem and that is going to be very heavy lifting. So, yes, work 

on both, but recognize that one is a lot more solvable a lot quicker 

than the other one is. 

Senator STABENOW. Just in conclusion, and I would agree with 

you that there are small changes we can make now, I would argue, 

instead of privatizing, but there are small changes we can make 

now with big impacts 5 decades from now. But, Mr. Chairman, I 

hope we will have a real discussion on health care. There is not a 

business person in Michigan I talk to, there is not a worker, there 

is not an older person, there is not a younger person going off of 

their parents’ insurance that is not concerned about health care as 

the top priority. And there are things we can do. Allowing Medicare 

to negotiate for group prices would bring down the cost of the 

Medicare bill, and I would hope that we would aggressively begin 

now because it is not going to go away. It is only going to get worse 

and, today, I would argue it is a bigger crisis in terms of health 

care than it is on most other issues. 

Thank you, Mr. Chairman. 

Chairman GREGG. Senator Cornyn. 

Senator CORNYN. Thank you, Mr. Chairman. It is good to be back 

on the committee this year and under your leadership. We certainly have a tough job set out for us, and it is always a pleasure 

121

to be back on the committee with Senator Conrad and see what 

kind of new charts he has to show. 

[Laughter.] 

Senator CORNYN. I think, Mr. Walker, what you have said and 

what we have already heard discussed here so far is powerful refutation of those who have said that we really do not have any problem in Social Security. We really do not have a problem in Medicare, in Medicaid, and entitlement programs because plainly we do. 

I know there are those who would like to point to the tax cuts 

as a source of all of our fiscal woes, but the fact is last year we 

grew about 2.5 million jobs in the country. 

I believe in no small part to the economic stimulus provided by 

reduced taxes, which are a powerful incentive for people to work 

a little harder, and earn more money, and be able to keep more of 

what they earn. But I have two specific questions that I would like 

to ask today. One has to do with collections—tax collections—and 

the other has to do with information technology. 

I understand several of IRS studies suggest that increasing enforcement will lead to additional revenue. One, in particular, suggests that doubling the examination rate would increase assessments and collections by $16.7 billion. But my question is not so 

much about that, but estimates that we have currently working in 

the United States now, about six million undocumented immigrants who work in a cash economy, maybe do, maybe do not pay 

taxes. I know, in Mexico alone, they estimate that the value of remittances from the United States back to Mexico, by Mexicans 

working in the United States, is about $14.5 billion a year, Central 

America and other places similarly. 

Do you know whether anyone in the U.S. Government has calculated the increase in revenue that might be gleaned from providing some sort of legal way, legal framework, for undocumented 

immigrants, that 6 million who are currently working in the economy, to work and pay taxes? 

Mr. WALKER. Senator, I am not aware of any study that has been 

done on that. I can check with my staff and see if they are aware 

of anything, and if we can come up with anything I would be happy 

to provide it to you. 

Senator CORNYN. That would be great. I would appreciate that 

very much. 

My second question has to do with information technology, and 

I will give you a quick background. When I was in State Government—attorney general—we had a broken computer system that 

basically monitored child support payments, and it was a disaster. 

It was a huge, complex project, but we ultimately got those problems worked out. 

When I see that the FBI, for example, is going to throw away $100 million of taxpayer money because of a poorly conceived, poorly executed computer upgrade, I just wonder how much of that is 

happening out of our sight and how much waste of taxpayer money 

and poor execution on the part of Government agencies because 

they do not have the technology in place that provide better services to the American taxpayer. Can you give us any insight or any 

thoughts about what we can do, what we should be doing to address that waste and lack of poor services? 

122

Mr. WALKER. Senator, GAO issued its latest update of its highrisk list the last week of January, and on that high-risk list there 

are several examples of different departments and agencies that 

have serious problems in this regard. You mentioned the FBI’s latest problem. Probably the biggest problem that exists right now is 

at the Defense Department. The Defense Department has 14 of 25 

high-risk areas. They added two more this year. Many of them 

have been on the list for years. If you take information technology 

as an example, they have over 4,000 legacy information systems 

that are not integrated, and that is the latest count. Every time I 

go over there, it goes up. 

And so part of it is getting control of what we have and then creating a more positive future and making sure that we streamline 

our processes, define what our standards need to be and to make 

sure that we do not just turn it over to contractors. We have to 

have enough people to manage cost, quality and performance in 

any type of contracting activity. We have many different recommendations and I would be happy the talk to you about it separately if you want. 

Chairman GREGG. Senator Corzine. 

Senator CORZINE. Thank you, Mr. Chairman. Welcome, Mr. 

Walker. 

Let me try to frame this a little bit, and I am going to back into 

a question that deals with shifting costs to the States. You have 

identified big programs that are going to drive the future expenditures, entitlement programs, if you will, at the Federal level. We 

are operating at something like 16.5, 16.7 percent of GDP in revenues to the Federal Government, and the average over——

Senator DOMENICI. Would the Senator yield on that? How much 

did you say? 

Senator CORZINE. I think it is something like 16.5, 16.7. Memory 

does not serve me for the last digit, but the average is slightly over 

18 percent, and the end of the 1990’s was something slightly north 

of 20 percent. 

As the Federal Government has decreased the amount of revenues it has taken, and we have not changed the mandates to 

States and we have not changed the entitlement policies, have we 

not just shifted tax burden to our State and local governments? At 

least in the place I come from people have been looking at compounded rates of 7 percent increase in property taxes year over 

year. And we have mandates from the Federal Government on education and a whole host of issues that we have to deal with; such 

as environmental protection. 

If we no longer continue, particularly in the Medicaid program—

and Medicare has some of the same implications—aren’t the solutions we are talking about here only just transferring exposures 

and responsibilities to our State and local governments? So that we 

take it out of one pocket, or we give it out of one pocket and get 

it taken out of in another pocket. I would love to hear your comments on it because it seems to be a pattern that is happening over 

and over. I happen to be a little more sensitive to it today than 

maybe I was 6 months ago, but it certainly is an analysis that absolutely, I think, needs to be raised in this context. 

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We can make ourselves feel good here under certain circumstances, but all we are doing is offloading this on other poor, 

unwilling folks that have to meet mandates. I wonder if you could 

comment. 

Mr. WALKER. Senator, I think it is important to consider the ripple effects of whatever decisions are made at the Federal level, because to the extent that the Federal Government decides that 

something needs to get done, but it may or may not want to fund 

it itself, or it may only want to fund part of the cost, then the question is, who is going to end up making up the difference? 

As you know, the fastest growing cost at the State level is Medicaid. In fact, Medicaid is among the largest budget item in my 

States budget. So that brings me back to the issue of health care. 

It is not just Medicare. It is Medicaid. It is the entire health care 

system, not just for the Government but for employers, that we 

have to look at. 

So it is facts and circumstances. It depends upon the area that 

you are talking about. I know that there are going to be proposals 

with regard to Medicaid, GAO itself has found instances where 

States, have used the rules in a way to try to get more of a reimbursement than arguably they should have. We have made related 

recommendations to the executive branch. 

I also know of examples where the formulas for transportation 

spending should be changed. So I think it is facts and circumstances. But you are exactly correct in saying that a number 

of instances where the Federal Government does less and yet it 

still wants to see national progress, that can put additional pressure on the States and one needs to consider that, hopefully, in 

your deliberations. 

Senator CORZINE. Just changing subjects. I think I have a split 

second here. Do you have a view on PAYGO rules, two-way PAYGO 

rules with respect to revenues as well as spending? 

Mr. WALKER. Senator, I am a bottom line person. The bottom 

line means, whether it is red or whether it is black, and how big 

it is on the bottom line. Obviously, red being a deficit and black 

being a surplus, which we probably will not see any time soon. I 

believe it is important that you consider both sides of the ledger. 

You should consider both the tax side and the spending side when 

you adopt PAYGO rules and when you should consider the long 

term cost, affordability and sustainability of legislative proposals. 

Now reasonable people can and will debate that, and obviously, 

to the extent that you have certain tax actions that could be stimulative, that should be considered. But not all tax cuts are stimulative, and not all spending is necessary. But I think exempting onehalf of the ledger from the analysis will help our bottom line, or 

help us deal with our long range fiscal imbalance. 

Chairman GREGG. Senator Domenici. 

Senator DOMENICI. Mr. Chairman, thank you very much. First, 

I want to thank you for today’s testimony, in particular for the constructive ideas that you have given us. I am going to try to do two 

or three and see if you will answer them. That might permit me 

to cheat on the time. I am not sure. Maybe your answer will take 

all 5 minutes plus some more. 

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First, we gave you a job once that we called a trade-in trade-out 

assessment, and that had to do with looking at Federal programs 

to see how many programs did the same thing. The goal was for 

us to try up here, when we start a new program, to trade a new 

one in for trading out some old ones. You did a series of studies 

on that. I wonder if you would give us that again, and then take 

what the President has suggested as terminations and do an analysis of those in the same way. If he is eliminating something, what 

other programs are there that do the same thing? 

I am trying to figure out a budget way to push that. Right now, 

Committee members and the Chairman, as I told him yesterday, 

we know that a budget resolution does not do that. It just plugs 

in the numbers, but then there is nothing that requires that you 

do that. Say you got rid of 15 programs, they may never show up 

in appropriations bills and we may never get an authorizing bill to 

do it because you cannot pass it. 

So if you would do that, it would help us. I am thinking about 

a reverse reserve where you would set up the reserve and get a 

bonus if you cut a program, and lose the bonus if you did not, as 

part of a budget resolution. But I will work on that, and give it to 

the Chairman and ranking member myself. You can talk about 

that in a minute. 

Second, you mentioned in answer to the ranking member that 

growth was dependent upon entrants to the marketplace, workers 

entering the marketplace, and productivity. And he said, if we had 

more growth we would be able to hire more people. But which 

comes first? What if we had 5 million more immigrants—do not say 

that out loud, but what if we did, would that help the economy? 

If not, why not? 

And my last question has to do with outyear obligations. We 

keep mentioning outyear deficits or outyear obligations, and that 

we need to do something about them. You keep mentioning that obviously we have to reform Medicare. Doesn’t reform mean that we 

cannot afford the size of the program? Why do we call it reform? 

Why shouldn’t we say restrain it? Why shouldn’t we say cut it? 

My own observation—this is not an answer to the question—but 

the ranking member said, it looks like we ought to take on Medicare before Social Security because it is bigger. The problem is, it 

would be the same argument if you took on Medicare. It is almost 

the third rail. If it is not the third rail, it is 2.9 to one rail. So if 

you started doing it, it would be the same argument, you are hurting the old people; you are cutting. 

So I do not know which comes first. I think which comes first is 

that which you can do. In that regard, you mentioned you can do 

Social Security reform and create more for the pensioners rather 

than less. I assume that means some kind of savings account, but 

would you tell us what that means, please? 

Mr. WALKER. Thank you, Senator. Four things. First on the 

trade-in, trade-out I do recall that. I believe that was very early in 

my tenure. As you know, I have been in office about six and-a-half 

years, only eight and-a-half left. I would be happy to take a look 

at that and see how that compares with what the President is putting forward. 

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One of the things that we are encouraging the Administration to 

do is to focus on the base. The Administration has developed the 

Program Assessment Rating Tool (PART). They tend to look at 

each program and you look vertically within that department or 

agency. The other thing that we are encouraging the Administration to do is to look horizontally. Look at different types of activities or different types of programs where they exist in many different departments and agencies, for example, food safety. A recent 

one that I became aware of is financial literacy. We have over 20 

Federal agencies involved in financial literacy. We do not need 20 

Federal agencies, and I doubt very seriously they are even saying 

the same thing. 

Second, more people. It depends on a number of things, including 

the skills and knowledge of the people. We are now in a knowledgebased economy. We need to compete based upon innovation, quality 

and productivity. We cannot compete on wages. So it depends to a 

great extent on the skills and knowledge of those people and what 

would they be doing and what value they would be adding. 

Third, with regard to Medicare, there is no way we are going to 

deliver on all the Medicare promises that have been made. No way. 

So I think we need to recognize that reality, and I think that Medicare needs to be restructured as part of a broader restructuring of 

our overall health care system. I think we need to answer basically 

two fundamental questions which we have never answered. 

First, what are broad-based societal needs in health care that irrespective of your income, irrespective of your geographic location, 

irrespective of a variety of other facts that from a societal standpoint there is a need that we ought to try to make sure that it is 

addressed? I did not say by whom. I said that it is addressed. 

Versus individual wants. Because individual wants are absolutely 

unlimited, and if there is one thing that could bankrupt the country it is health care. 

Second, what is an appropriate division of responsibility between 

employers, individuals and the Government for addressing health 

care? That is going to take fundamental change in Medicare, Medicaid, employer-provided arrangements, and it needs to be done. 

And we are going to have to do it in installments. It is just too 

heavy a lift to do all at once. 

Then last, Social Security. What I meant by Social Security, and 

as you probably recall, Senator, I have been a trustee of both Social 

Security and Medicare. I was a trustee of Social Security and Medicare from 1990 to 1995 so I am pretty deep in these two programs. 

I previously said that you have an opportunity to reform Social Security and exceed the expectations of every generation of Americans. Let me give you my family as an example of that. 

My father is retired. You are not going to touch his Social Security benefits. I am a baby-boomer under 55. Most people of my generation are discounting what they think they are going to get from 

Social Security. I have a daughter 31, and a son 28, they are discounting it big time. They do not have confidence that Government 

is going to be able to deal with the issue. I am not saying it is right 

or wrong. That is the situation. 

You therefore have the opportunity to restructure the program, 

making progressively greater changes the younger the person is, 

126

with or without individual accounts, and structure it in a way that 

current retirees and near-term retirees will not be affected at all. 

They will get exactly what they have been promised and therefore 

they should not worry. Baby-boomers, Generation X and Generation Y will get more than they think they are going to get. You may 

decide that you want to have individual accounts for younger people as part of the equation. They may want it. 

But my point is this, you can restructure it and everybody gets 

more than they think they are going to get. I call that a win. You 

do not have a prayer doing that in health care. 

Senator DOMENICI. Thank you. 

Chairman GREGG. Thank you. Excellent answer. 

Senator SESSIONS. 

Senator SESSIONS. Thank you, Mr. Chairman. Here we go again. 

You, Mr. Walker, have given us some serious matters to think 

about. We thank you for that. We thank you for your agency and 

what it does. I would join with those who discussed this question 

of productivity and our projections for the future. I noticed that 

United States’ growth this past year exceeded the other industrialized nations according to the economists and their poll expects us 

to outgrow every one of those nations next year, or this year that 

we are in. Some of that is indeed a result of our placing less burden 

on the private sector. 

We can do several things. I think one is remember that the private sector is what drives us. It is what lifts our boats. Also, we 

can make the public sector more efficient and productive, saving 

money. Too often when we do save it though, we spend it, what we 

save. It is not as if we save it and then pay it down on debt. When 

we improve efficiency in one or more agencies it goes back in some 

other spending program that may or may not be efficient. So, I did 

want to make that point. 

I know Senator Domenici just left but he is a champion of nuclear power. He believes that has a potential to increase our productivity. We have talked about all kinds of visions for the future 

there that when you get out 75 years I think we do not need to 

make ourselves too depressed because I believe something else will 

help us meet this challenge if we continue to invest in creativity. 

You have worked on a number of things that deal with systemic 

problems in Government. One that I have thought about recently 

is concern over the nature and procedures and effectiveness of Government contracting. We contract out more now than we have done 

before. Sometimes those contracts are, I believe, poorly drawn and 

leave us less able to enforce them effectively. We had the FBI problem, as has been mentioned earlier. You have looked at that. Mr. 

Mueller is one of the finest FBI leaders that we have ever had, but 

I am sure he is not a thorough expert in how to put in a computer 

system. He called on GSA and they were supposed to help. But 

somehow we end up with a system that is not working. 

The same has happened in defense. I have been impressed with 

the idea that some of the FEMA contracting after disasters is not 

effective, and it appears one reason is that the contractor themselves are required to evaluate their own performance, and that 

this has left a lack of evaluation there. 

127

Do you think we can do a better job of contracting, and could 

that amount to real dollars? 

Mr. WALKER. Senator, there is absolutely no question that interagency contracting is a new Government-wide high risk area, and 

there are a number of items with regard to contracting dealing 

with specific departments and agencies, DOD, DOE, NASA where 

contracting is also on the high risk list. So we are continuing to 

work to try to help people have the right type of controls in place, 

the right type of people that have the skills and knowledge necessary to manage cost, quality and performance. You can contract 

out the responsibility but you cannot wash your hands of it. That 

all too frequently is what happens. It is as if, we have hired a contractor and they are going to take care of it. No, you have to have 

people who can manage cost, quality and performance. 

You also have to decide certain things up front in computer systems. You have to reengineer your processes. You have to decide 

what you need to accomplish versus what you want to accomplish, 

because everybody has got a dream about the computer system in 

the sky that can do everything and that is where you end up getting nightmares because you try to build things that you do not 

need and the specifications keep on changing. So, yes, we are on 

the case. 

Last thing. Let me mention, you are correct in saying that we 

have the strongest economic growth of any major, industrialized 

nation. We are projected to continue to have it. But it will not be 

strong enough, because if you just do simple math on these numbers, on that second scenario it would take double-digit real GDP 

growth every year for decades to close that gap. It has never happened in the history of this country. It is not going to happen. So 

we need to get serious. Yes, we need to encourage economic growth. 

The other thing is, even if you look in the short term, at last 

year’s unified deficit which offsets the Social Security surplus—an 

amount equal to less than 25 percent of the FY2004 deficit had 

anything to do with Iraq, Afghanistan, or incremental homeland security costs. And we have not been in a recession since November 

2001 and we had the strongest economic growth of any major industrialized nation. What is the other 75 percent and what are we 

doing about it? 

Senator SESSIONS. I would just note that I will ask you also 

about some of the laws and rules we impose on our agencies and 

departments that interfere with their ability to do their job. I know 

that is a concern that you have and I think we can do better about 

that. 

Mr. Chairman, my time has expired. 

Mr. WALKER. We need to do a baseline review on those as well, 

Senator, because they have aggregated up over the years. We need 

to do a baseline review of those too. 

Chairman GREGG. Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. 

The information that I am getting is that Medicare is the one 

that is carrying the huge future liability out there, larger than any 

other program. What aspects of Medicare is driving those future 

obligations most? 

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Mr. WALKER. It is a variety of factors. One is just demographics, 

that we have more and more people that are becoming eligible for 

the program. It is known that it, on average, costs more money to 

insure senior citizens than it does younger people. Senator Conrad 

also mentioned the fact that a very, very high percentage of the 

cost for Medicare is used by a fairly small percentage of the population covered by Medicare. So there are a number of contributing 

factors. 

Plus, health care cost increases continue to far outpace economic 

growth. I think one of the reasons it does is because for any system 

to work you really have to have three things in place: incentives 

for people to do the right thing, transparency to provide reasonable 

assurance they will because somebody is looking, and accountability mechanisms if people do not do the right thing. I would respectfully suggest, we do not have any one of the three in health 

care. 

Senator ALLARD. How would we do that? How would you accomplish those three objectives? Is it performance standards we need 

to put in there? Or what is it that we do to accomplish it? Do we 

reduce eligibility requirements? What is it that we do? 

Mr. WALKER. Senator, I honestly believe in the case of Medicare, 

for example, you are going to need to look at eligibility requirements. You are going to need to look at standards of practice. You 

are going to need to relook at prescription drug coverage. One of 

the things that was just announced in the new Medicare prescription drug benefits. It was just announced that under Part D you 

are going to be able to get Viagra. I do not know how that affects 

extending life. 

Senator ALLARD. So if you are 65 years of age or older you can 

qualify for Viagra? 

Mr. WALKER. Under the new Medicare prescription drug bill, 

that was announced within the last week. Now as you know, that 

program does not kick in for several years yet. 

Senator I am happy to speak with you. I will tell you this, that 

in the document that is going to be issued on February 16 we raise 

a number of very thought provoking questions in this area and others that are a starting point. And the Congress may wish to ask 

us to do additional work to come up with specific options and the 

related pros and cons, which we are happy to do if you want us to 

do it. But we have a lot of recommendations out there already. 

Senator ALLARD. I think it would be interesting to get some of 

that. I do not know how the other members of the Committee, 

maybe other committees haveten some of it. But I would be interested in it personally. 

Last year is when I paid more attention to GPRA. That is how 

we did the performance and results, and it was put in the President’s budget that he submitted to the Congress. I felt that helpful 

on a number of things. I have not have a chance to go clear 

through the budget but I assume those kind of proposals or provisions or ratings are in the budget again this year. Do you feel that 

that is helpful? 

Mr. WALKER. There is absolutely no question that we need to understand what type of results are being achieved by various programs with the resources, the responsibilities and authorities that 

129

they have. That is fundamental. But I would also respectfully suggest that it is not just with regard to spending. We should also do 

it with regard to tax policies as well. 

For example, the tax incentives of health care. It is the No. 1 tax 

preference in the Internal Revenue Code and growing very rapidly. 

Is it achieving the desired objective or are we spending a lot of 

money there that may be fueling the health care cost increase rather than helping? 

By that I mean, 80 percent-plus costs are paid for by a third 

party. The individuals who end up receiving the service do not necessarily even see what is being billed for. Individuals never pay income tax on the value of employer-provided and paid health care 

benefits, no matter how lucrative. They never pay payroll tax on 

it either. It is not on your W–2. It is not on your tax return. People 

do not really have any idea that health care costs are out of control. And to the extent that they are concerned about it, which they 

are, the relative burden of bearing the health care cost has changed 

dramatically over the last 40 years. Much more is being borne by 

Government. Much more is being borne by corporations than individuals, and yet corporations have to compete in a global economy. 

Senator ALLARD. I see that my time is about ready to expire. 

Thank you, Mr. Chairman. 

Chairman GREGG. Thank you. 

Mr. Walker, you have raised a whole lot of very interesting to 

issues, but I think if you sugar it all off we do come back to how 

we address the issue of health care in the outyears as being probably, along with Social Security, the core issue of fiscal responsibility. You have also pointed out tax expenditures, which I hope 

will be taken up in this tax reform initiative that is being promoted 

by the President and which I strongly encourage. But if you have 

specific proposals on how Medicare you think should become more 

transparent and more responsible as to usage, we would be very interested in them. 

The President in his request did not address Medicare relative 

to addressing the programmatic activity. In fact in the budget it is 

projected Medicare will jump by about 17 percent, which is the 

largest item by far in this proposed budget. A lot of that is a function of the drug benefit. The drug benefit has not even started yet 

and it is already out of control as far as I can see. So if you have 

some thoughts there we would be interested in them. We can 

maybe pass them on to some of the Finance Committee members 

who are members of this committee. 

I will turn to Senator Conrad. 

Senator CONRAD. Thank you, Mr. Chairman. 

Mr. Walker, a couple of things were said by the former chairman 

referencing me that I want to make very clear. He said that I have 

suggested more workers mean more economic growth. This is not 

my formulation. The head of the Congressional Budget Office and 

the head of the Social Security Administration in determining their 

projections for economic growth, say economic growth results from 

two things: growth in productivity and new entrants to the work 

force. That is the way they make their determination and projection on future economic growth. It is not my formulation. It is the 

economists’ formulation. 

130

The second thing he referenced was Medicare, suggesting that I 

say, do Medicare before you do Social Security. That is not my position. I believe we have to do both. And there is a inreference here 

that it is hard to do. Yes, it is hard to do, but if you are right, if 

the shortfall in Medicare is eight times the shortfall in Social Security, to delay beginning to address that imbalance is just a mistake, 

because the sooner we get at it, the better. 

I have laid out very specifically here today something that I 

think should be pursued aggressively by this committee and the 

other committees of jurisdiction, and that is to focus like a laser on 

the 5 percent of the eligibles in Medicare who use 50 percent of the 

money. Five percent use 50 percent. Those are the chronically ill. 

We did a pilot project with 22,000 patients in which we more 

closely coordinated their care. What we found is that you could reduce hospitalizations dramatically. They reduced hospitalization 20 

percent. They reduced costs 40 percent, and they got better health 

care outcomes. The Senator indicated, he said, why not just call it 

a cut? I do not consider that a cut. You are spending less money 

but I do not consider it a cut because you are getting better health 

care outcomes. 

What we have found is that nobody is coordinating these chronically ill people’s care. Now that is not true in every case certainly, 

but by and large it is the case. What do we mean by that? People 

have a doctor, if they live in Washington they have a doctor here. 

They have a doctor at the beach. They have a heart specialist. They 

have a lung specialist. There is a lack of coordination of all these 

health care providers. As a result there are duplicate tests that 

waste a lot of money and are a drain on the patient. There are people with too many prescription drugs. 

Just to be personal about it, we have found this with my own father-in-law. We went down and spread out all his prescription 

drugs on the table. He was taking 16 different prescription drugs. 

I got on the phone to his primary care doctor and I started reading 

through the list of the prescriptions he was taking. He said, oh, my 

God, he should not be taking that. That was two and-a-half years 

ago. He should not be taking that any more. Get to the next one; 

he should not be taking that along with this other drug. Those 

drugs interact adversely. That could send him to the hospital. 

Now the problem is, the way our health care system works is you 

have all these different people that patients are going to. Nobody 

is on top of managing the overall case. I really believe this is something we have to aggressively address—this Medicare problem, this 

$27 trillion unfunded liability. Now that is real money, even in 

Washington, $27 trillion. It is by far the lion’s share of our long 

term obligations. I really believe we have an obligation to start 

now, and everybody come up with their best ideas on what we 

could do, and maybe we would make real progress. 

I thank the chair. 

Mr. Walker, I want to again thank you as well. I think you have 

been a real leader for the country in firing the warning shot about 

where this is all headed, and that we have to work on all sides of 

this. It has got to be on the spending side, discretionary and mandatory—including entitlements. It has got to be on the revenue side 

of the equation as well. All of these things have to be on the table. 

131

We have an obligation to avoid the long term serious adverse consequences of piling up deficits and debt. 

Chairman GREGG. I join you in that. I join Senator Conrad in expression of appreciation. Senator Allard, one followup and then we 

will let the Comptroller go back to trying to straighten these things 

out. He has only mentioned about 200 things we need to straighten 

out. He may have a busy day today. 

Mr. WALKER. That probably will take many years, Mr. Chairman. 

Senator ALLARD. Mr. Chairman, and my colleague from North 

Dakota, Senator Conrad, had talked about a gatekeeper approach. 

I have a feeling that some of that is being done at the State level. 

I think the State of Colorado, for example, we do have a primary 

care physician as a gatekeeper approach before they provide any 

benefits, and you have to go through the primary care physician 

and he is supposed to do that. If this is being done on a State by 

State basis we might already have the information out there where 

we can look at the way one State is doing it and another State is 

doing it and see if there is anything that can be reflected, bringing 

some efficiencies to the program. That is the only other comment 

that I would make. I think if we look at some of the States as to 

what they have been doing on that perhaps something can be extrapolated out of what they are doing. 

Mr. WALKER. Yes, I think that is important, Senator. We not 

only look at States, we look at the private sector, and frankly, we 

look at other governments around the world because we lead in 

many things but we do not lead in everything, so we can learn. 

Thank you. 

Chairman GREGG. I think you hear a general consensus from this 

committee that we would like to get your ideas that are specific, 

especially relative to health care and Medicare, and be able to 

maybe use them as a committee or at least pass them on to the 

committee of jurisdiction, which is the Finance Committee, of primary jurisdiction. 

So thank you. Thank you for, as Senator Conrad said, putting a 

warning shot across the bow. Hopefully notice will be taken of it. 

That was the purpose of this hearing. We look forward to your report coming out on the 16th. It should be something that will be 

very informative and very useful for us as a Government and hopefully for people generally, and we will do whatever we can to draw 

attention to it. Thank you for the good work. 

Mr. WALKER. Thank you, Senators. 

[The prepared statement of Mr. Walker follows:]

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Chairman GREGG. The Committee is adjourned. 

[Whereupon, at 11:33 a.m., the Committee was adjourned.] 

(165)

THE PRESIDENT’S FISCAL YEAR 2006 BUDGET 

PROPOSAL 

WEDNESDAY, FEBRUARY 9, 2005

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

The committee met, pursuant to notice, at 10 a.m., in room SD–

608, Dirksen Senate Office Building, Hon. Judd Gregg, chairman 

of the committee, presiding. 

Present: Senators Gregg, Domenici, Allard, Sessions, Bunning, 

Crapo, Ensign, Cornyn, Alexander, Conrad, Sarbanes, Murray, 

Wyden, Feingold, Stabenow, and Corzine. 

Staff present: Scott B. Gudes, Majority Staff Director; and David 

Pappone. 

Mary Ann Naylor, Staff Director; and Sue Nelson. 

OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

Chairman GREGG. We will get started. It is 10 o’clock. 

We very much appreciate the Director of the Office of Management and Budget for participating here for this hearing today, 

which is a hearing on the President’s proposed budget, which becomes, as I describe it, the memo that controls the meeting, so to 

say. Actually, I should footnote that. That was Henry Kissinger’s 

term. 

In any event, the administration has sent us a budget which I 

believe sets out some fairly aggressive and appropriate fiscal initiatives in the area of trying to control our deficits. We all know that 

the deficit is too high and that we need to have action on the deficit. We also know that this divides into two issues: the short-term 

deficit and the long-term structural problems of our Government. 

The short-term deficit, of course, is the fact that we are running 

very large numbers in deficit right now, and the President’s budget 

has suggested ways we can reduce that in half over the next 4 to 

5 years. And that is a very positive step, and he has done that 

through basically, as I have called it, goring everybody’s ox. Everybody sort of takes a hit in this budget, which has not made anybody happy, which is probably a sign that it is a good budget. 

The second issue of the structural deficit involves the fact that 

we have this demographic shift in our society which we cannot 

deny, as we all exist, and which is going to put huge pressures on 

our society as the baby-boom generation retires. Essentially, my 

generation, the baby-boom generation, is going to end up requiring 

of our children and our children’s children significant support, 

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late into a reduction of their quality of lifestyle, unless we address 

the retirement benefit structure for my generation so that it is affordable for our children and effective in the way that it covers people who are retired, especially low-income and middle-income seniors. 

The President has stepped forward on that issue, both in his suggestion that we address the issue of Social Security and in the 

budget itself and his suggestions on Medicaid, which is one of the 

big items in the issue of long-term structural concern for the Government. 

I have said all along that you cannot get to where we need to 

go in getting the deficit under control unless you address entitlement spending. This administration, with the exception of one 

item, which I am sure there will be some discussion about, has 

stepped forward on the entitlement accounts and made very strong 

proposals, proposals which I believe are appropriate and timely in 

Medicaid, in agriculture, and in a variety of other entitlement accounts. 

So as a general statement, I congratulate the administration’s 

initiative here. It is a document that the Congress is obviously 

going to work over because that is why we are here, as the administration knows. But in the end I hope that we can conclude that 

we will agree to the basic goals here, which are to control discretionary spending aggressively, especially nondefense discretionary, 

to pay for the war, but to also make sure that we do it in a responsible way that does not allow the defense base to overwhelm us, 

and to look at the entitlement accounts and make sure that we are 

fiscally responsible there—all of which will lead us toward reducing 

this deficit in half over the next 4 years, and in the out-years addressing the long-term concerns we have with entitlement spending. 

So I thank the Director for being here. I thank him for his document, which is a well-prepared and well-thought-out and aggressive approach toward fiscal responsibility, and I yield to the Ranking Member, Senator Conrad. 

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

Senator CONRAD. I thank the chairman. I do not think it will 

come as a surprise to you that I have a somewhat different take 

on this budget. 

First of all, let me say I welcome you, Mr. Director. I enjoyed our 

conversation the other day. I want to stipulate right at the beginning that I think you are a fine public servant. In many ways, the 

country is fortunate to have people of your quality who are willing 

to step forward in public service. 

With that said, I think this budget——

Chairman GREGG. Is that the end of the kindness? Is that all the 

love we are going to feel here? 

[Laughter.] 

Senator CONRAD. It is kind of a wind-up. You know these baseball metaphors, Mr. Chairman. 

Seriously, I say to you I have been here 19 years, and I think 

this budget is completely off track. I believe that very genuinely. 

I have to say to you I think this is not so much a budget, it really 

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strikes me more as camouflage, because I think it is hiding the 

true fiscal condition of the country from the American people and 

even from Congress. Maybe this administration is even fooling 

themselves. 

Let me go directly to some slides to make my point. You have 

a budget here that shows progress on the deficit, but as I see it, 

the only way it makes progress is it just leaves out things. It leaves 

out the funding for the ongoing war costs beyond September 30th 

of this year. 

Now, the President says he has no timetable for withdrawal, but 

this budget provides a timetable. It says they are not going to 

spend anything on Iraq past September 30th of this year. Now, 

that is not credible. 

It says that there is no cost to the President’s privatization plans 

for Social Security. We all know that is not true. There is a massive cost, over $700 billion the first 10 years, according to the administration’s estimates, but you cannot find that anywhere in this 

budget.

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Alternative minimum tax reform. Last year they at least provided funding for 1 year. The old millionaire’s tax that is rapidly 

becoming a middle-class tax trap costs $700 billion to fix over 10 

years. There is not a dime in the President’s budget. 

And then on the spending side of the ledger, you provide only details for 2006, no details for future years. I think there is a reason 

for that, because it gets really ugly after this year, and in some accounts it gets ugly this year. 

So as I look at this budget, I do not see a real fiscal plan for the 

country or something that really reveals the fiscal condition of the 

country. Instead, I see something that hides what I believe to be 

the true fiscal condition. 

Let me go to the next chart.

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The President reveals the effect of his budget proposal for just 

the first 5 years. But look what happens just beyond the budget 

window. The costs of the President’s tax proposals explode. It is not 

surprising that you have gone from 10-year budgeting to 5-year 

budgeting, because you do not want Congress to see this and you 

do not want the American people to see this. But this is what happens. It is also the case with the alternative minimum tax where 

you have provided no funding in your budget. The Congressional 

Budget Office tells us this is the cost to deal with the alternative 

minimum tax, over $700 billion over the 10-year period. You cannot 

find it in the President’s budget.

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And why is that important? It is important because 3 million 

people are affected today. It is going to be 30 million people 10 

years from now. Some are saying it may be 40 million people. The 

middle class is going to be in for a big surprise when they find 

themselves caught up in the alternative minimum tax. 

For the war, there is $81 billion in the budget, but there is nothing for it past September 30th. And I heard your testimony in 

other venues where you have said it is hard to estimate. That is 

what you told us last year. It is hard to estimate. The one thing 

we know for sure though is that the right answer is not zero. That 

is for sure not the right answer. The Congressional Budget Office 

says another $383 billion needs to be included in the budget to give 

a real reflection of the ongoing war cost. 

On Social Security, the President has included nothing in terms 

of a cost for his privatization plan, but we know from the administration’s own estimates that from 2006 to 2015, it costs $754 billion. The 20-year cost is a staggering $4.5 trillion. Now, you know, 

that is real money and it is not in the budget. 

Let’s go to the next.

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When we put back all of the things you have left out, here is 

what we see. This black line is the administration’s claim that the 

deficit is going to be improving. This red box represents the administration’s claim about improvement in the deficit. When we add 

back the things that are left out, here is what we see. We see a 

very modest improvement in the coming few years, but then things 

get much worse. I think an honest reflection of this budget would 

tell the American people that the fiscal condition gets much worse, 

if the President’s plans are adopted and at the worst possible time, 

right before the baby boomers retire. 

Finally, the President has said that Social Security is in crisis. 

But if you look at his budget, he is taking $2.6 trillion from Social 

Security over the next 10 years to pay for other things. If it is in 

crisis, why is he taking money raised by payroll taxes, designed to 

strengthen Social Security, by either paying down the debt or prepaying the liability? The President takes every dime of surplus Social Security money and uses it to pay for other things. 

There is some disconnect between his language that there is a 

crisis in Social Security and his budget that takes all of the money 

that is available in Social Security that could be used to prepay the 

liability or pay down debt. He is taking $2.6 trillion over the next 

10 years to pay for other things. 

Finally, the Washington Post this morning now that says the 

drug benefit, instead of costing $400 billion, could cost as much as 

$1.3 trillion over the next 10 years. Now, in this story, I think in 

fairness, the Medicare chief, Mr. McClellan, said that there are 

various offsets and savings that will reduce the bottom-line costs 

to $724 billion. But we were told by this administration that was 

going to cost $400 billion. Now the administration is saying, oops, 

it is not $400 billion, it is not the $534 billion that we were told 

right after it passed, but instead $724 billion, and in gross terms 

potentially $1.2 trillion.

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Let me just say that this new information damages the credibility of this administration in a very serious way with respect to 

the rest of their budget proposal because there is a pattern here. 

There is a pattern of concealing, the true fiscal condition of the 

country from the Congress and from the American people. 

I thank the Chair. 

Chairman GREGG. Thank you. We are going to subscribe to the 

5-minute rule here. Unfortunately, the Director has to go over to 

the House and testify after he comes here, which is an unfortunate 

experience for you. But we do want to give people the opportunity 

to speak to you and ask you questions. 

Let’s start with this Medicare number, the drug number, which 

has become the cause du jour. And I would be interested in your 

thoughts on the story in the Washington Post, which says it is a 

$1.2 trillion number over the next 10 years as versus what I would 

guess would be a $720 billion number if we were talking apples to 

apples in the 10 years comparing the—in other words, the $400 billion number was for 2 years’ startup, 2004 to 2014. This number 

of 1.2, I guess is from 2006 to 2015. If you compare 2006 to 2015 

under the projected numbers, I presume the number we are dealing 

with is 700-something. 

What is the actual increase in the drug benefit cost over the 

original estimate? is the question. 

STATEMENT OF HON. JOSHUA B. BOLTEN, DIRECTOR, OFFICE 

OF MANAGEMENT AND BUDGET 

Mr. BOLTEN. Mr. Chairman, thank you, and thank you for the 

nice welcome, and Senator Conrad as well, other members. 

Mr. Chairman, I have a compelling opening statement that I 

would like to have included in the record. 

Chairman GREGG. I apologize for skipping your opening statement. 

[Laughter.] 

Chairman GREGG. This issue interests me so much, I wanted to 

get to it. 

Mr. BOLTEN. All right, sir. 

Chairman GREGG. So let me withdraw my question, save it for 

you, know that you will answer it in your opening statement, and 

allow you to make your opening statement. 

Mr. BOLTEN. Mr. Chairman, if you prefer, I will skip the opening 

statement. 

Chairman GREGG. No. I think you should make it because I 

think that you have a good case, and I think the Senator from 

North Dakota has made a case, I have made a case, and we would 

like to hear your case. So we definitely want to hear your opening 

statement. 

Mr. BOLTEN. I hope you will find it compelling, Mr. Chairman, 

and thank you, Senator Conrad and other members of the committee, for your welcome. 

The President’s budget, which was transmitted on Monday to the 

Congress, meets the priorities of the Nation and builds on the 

progress of the last 4 years. 

We are funding our efforts to defend the homeland from attack. 

We are transforming our military and supporting our troops as 

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they fight and win the global war on terror. We are helping to 

spread freedom throughout the world. We are promoting the progrowth policies that have helped produce millions of new jobs and 

restore confidence in the economy. 

Over the past 4 years, the President and Congress rose to meet 

historic challenges: a collapsing stock market, a recession, the revelation of corporate scandals, and, of course, the terrorist attacks 

of September 11th. 

To meet the economy’s significant challenges, in each year of the 

first term Congress and the President enacted major tax relief that 

fueled recovery, business investment, and job creation. 

The strong economic growth unleashed by tax relief is reflected 

in this chart. Since the recession year of 2001, economic growth has 

increased in each of the following 3 years. A primary goal of the 

budget that we have just sent up is to assure that our economic 

growth continues.

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Now we can take the next chart. A strengthening economy produces rising tax revenues. Last year, after declining 3 years in a 

row, Federal revenues grew by nearly $100 billion. Reflecting 

strong continued growth, we project that Federal revenues will 

grow by an even larger figure this year.

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The President and Congress have also devoted significant resources to rebuild and transform our military and to protect our 

homeland. In the first term, the defense budget grew by more than 

a third, the largest increase since the Reagan administration, can 

we see the next chart. To make our homeland safer, the President 

worked with Congress to create the Department of Homeland Security and nearly tripled funding for homeland security governmentwide.

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While committing these necessary resources to protecting America, the President and Congress have focused on spending restraint 

elsewhere in the budget. Working together, we have succeeded in 

bringing down the rate of growth in non-security discretionary 

spending each year of the President’s first term. In the last budget 

year of the previous administration, non-security discretionary 

spending grew by 15 percent as represented by the green bar. In 

2005, such spending will rise by about only 1 percent. Because of 

this increased spending restraint, deficits are below what they otherwise would have been. 

In order to sustain our economic expansion, we must exercise 

even greater spending restraint than in the past. When the Federal 

Government focuses on its priorities and limits the resources it 

takes from the private sector, the result is a stronger, more productive economy. 

The President’s 2006 budget proposals build on that enhanced restraint. As you can see from this chart, the 2006 budget proposes 

a reduction in the non-security discretionary spending category of 

the budget. This is the first proposed cut in the non-security spending category since the Reagan administration.

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The budget proposes more than 150 reductions, reforms, and 

eliminations in nondefense discretionary programs, which save 

about $20 billion in 2006 alone. 

As a result of this enhanced restraint, overall discretionary 

spending, even after significant increases in defense and homeland 

security, will grow by only 2.1 percent. That is less than the projected rate of inflation of about 2.3 percent. In other words, under 

the President’s 2006 budget, overall discretionary spending will see 

a reduction in real terms. 

The budget also proposes savings from an additional set of re- forms in mandatory programs, which save about $137 billion over 

the next 10 years. 

As this committee well knows, both mandatory and discretionary 

categories of spending are inherently difficult to control, but mandatory programs are especially difficult because of their auto-pilot 

feature. The administration looks forward to working with this 

committee and the rest of the Congress on a package of mandatory 

savings. 

We will also work with Congress on budget process reforms. Last 

year, I transmitted to Congress, on behalf of the administration, 

proposed legislation to establish statutory budget enforcement controls. We will have similar proposals this year. 

In addition, the administration proposes other enforcement and 

budget process reforms, such as the line-item veto, a Results Commission, and a Sunset Commission. These reforms would put in 

place the tools we need to enforce spending restraint and would 

bring greater accountability and transparency to the budgeting 

process. 

The budget restrains spending in a responsible way by focusing 

on priorities, principles, and performance. We were guided by three 

major criteria in evaluating programs: 

First, does the program meet the Nation’s priorities? 

Second, does the program meet the President’s principles for the 

use of taxpayer resources? 

Third, does the program produce the intended results? 

The Bush administration is comprehensively measuring the effectiveness of the Government’s programs, and the results are helping us make budgeting decisions. As part of the President’s Management Agenda, the Program Assessment Rating Tool, or PART, 

for those who are cognoscenti of these management tools, was developed to measure the performance of Federal programs. Roughly 

60 percent of all Federal programs have undergone the PART, and 

those scores figured into our budgeting process. 

By holding Government spending to these accountability standards, by focusing on our priorities, and by maintaining pro-growth 

economic policies, we are making progress in bringing down the 

size of the deficit in 2006 and beyond. 

Last year’s budget initially projected a deficit of 4.5 percent of 

GDP in 2004, or $521 billion. The President set out to cut this deficit in half by 2009. Largely because economic growth generated 

stronger revenues than originally estimated, and because the Congress delivered the spending restraint called for by the President, 

the 2004 deficit came in $109 billion lower than originally estimated. 

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At 3.6 percent of GDP—that is the figure in the far dark-blue column on the left—the actual 2004 deficit, while still too large, was 

well within historical range and smaller than the deficits in 9 of 

the last 25 years. 

We project the 2005 deficit to come in at 3.5 percent of GDP or 

$427 billion. If we maintain the policies of economic growth and 

spending restraint reflected in this budget, the deficit is expected 

to decline in 2006 and each of the next 4 years. In 2006, we project 

the budget deficit to decline to 3.0 percent of GDP. In 2007, the 

deficit is projected to fall further to 2.3 percent of GDP. 

By 2009, the deficit is projected to be cut by more than half from 

its originally estimated 2004 peak, to just 1.5 percent of GDP, 

which is well below the 40-year historical average deficit of 2.3 percent of GDP, and lower than the deficit level in all but 7 of the last 

25 years. 

The administration intends to submit shortly a supplemental appropriations request of approximately $81 billion, primarily to support operations in Iraq and Afghanistan for the remainder of the 

fiscal year. The 2006 budget spending and deficit projections fully 

reflect the outlay effects of this supplemental request, as well as 

the prior $25 billion supplemental bill already enacted by the Congress. However, the budget does not reflect the effect of undetermined but anticipated supplemental requests for ongoing operations in Iraq and Afghanistan beyond 2006. 

The published version of the 2006 budget also does not reflect 

the effects of transition financing associated with the President’s 

proposals to create personal retirement accounts as part of a comprehensive plan to fix Social Security. As the administration announced last week, the type of personal accounts the President is 

proposing will require approximately $664 billion in transition financing over the next 10 years, with an additional $90 billion in 

related debt service. This transition financing would result in a deficit in 2009 and 2010 of 1.7 percent of GDP. Let’s see that on the 

chart. Those levels are still consistent with the President’s goal to 

cut the deficit in half by 2009 and still well below the 40-year historical average deficit.

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It is important to remember that this transition financing does 

not have the same impact on national savings, and thus on the 

economy, as does traditional borrowing. Every dollar the Government borrows to fund the transition to personal accounts is fully 

offset by an increase in savings represented by the accounts themselves. In addition, the transition financing of retirement benefits 

does not represent new debt. These are obligations that the Government already owes in the form of future benefits. 

Perhaps most important, comprehensive Social Security reform 

that includes personal accounts can eliminate the system’s current 

$10.4 trillion in unfunded obligations. 

Senator SARBANES. Mr. Bolten, could you pull that microphone 

closer to you? I think it would be helpful. If you keep it too far 

away, we do not pick up your voice. 

Mr. BOLTEN. Am I doing better now? 

Senator SARBANES. That is better. 

Mr. BOLTEN. Those of us who devote our time to thinking about 

fiscal policy all share a common interest in averting this danger. 

There is no task as vital to fiscal policymakers this year than removing these unfunded obligations by enacting comprehensive Social Security reform. 

Confronting these long-term obligations, combined with our nearterm deficit reduction efforts, will help assure a strong economy 

both now and in the future. 

I look forward to working with the committee and Congress on 

this budget, which meets the priorities of the Nation in a fiscally 

responsible way. 

Thank you, Mr. Chairman. 

Chairman GREGG. Thank you, Mr. Director, and I apologize 

again for skipping over that. It was a good point, and a couple 

points which I would just pick up on is that to the extent that we 

reflect these transition costs, the deficit will still be going down by 

half, and the issue of Social Security. But the most important point 

is that if we reform Social Security, in the out-years we will have 

a $10 trillion essentially correction occurring in the fiscal situation 

of the Federal Government in that we will be able to, instead of 

facing massive deficits in the out-years in Social Security, actually 

have a fund that is solvent. 

Unfortunately, the budget process by definition does not really 

structure itself to address Social Security, and that is why we are 

out of the process, because we are a 5-year budget, and Social Security is a lifetime-of-earning issue, which is a 30-, 40-year experience. And so if you are going to adequately reflect Social Security 

and if you make changes in Social Security, you really need to see 

what the 30-year impact is, not put it in a 5-year window because 

that really perverts the answer, which is an excellent point that 

you have made. 

Let me put two questions on the table. The first is the question 

which was raised by Senator Conrad, which is the question of what 

is the number for the drug benefit in relationship to the number 

that was estimated? How much higher it? Is this $1.2 trillion number an accurate apples-to-apples comparison? And what is in that 

number, if you know? 

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Second—well, why don’t we answer that question first, and then 

I will get into my second question. 

Mr. BOLTEN. Mr. Chairman, thank you. It is not an accurate apples-to-apples comparison. This has come up just recently, so I 

would like to have the opportunity to submit something more detailed, perhaps from Dr. McClellan, for the record. But your description was exactly right, which is that our estimates, I think, remain in exactly the same range that they have been. In fact, I 

think our estimates in this budget for Medicare costs may have 

come down slightly from the estimates we put out 6 months ago.

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The reason it is not an apples-to-apples comparison is that when 

you were considering the Medicare bill, there were a wide variety 

of offsets that were not considered. I have a list of some of them 

here: that States are now contributing to the cost of the benefit, 

that is about $134 billion; beneficiary premiums are adding about 

$145 billion. The number that was cited in the newspaper does not 

take into account that the Federal Government is saving almost 

$200 billion on Medicaid now because seniors are receiving their 

coverage through Medicare. 

So all of those offsets bring the number down to the one that I think Dr. McClellan cited in the low $700 billion figure, and then 

a true apples-to-apples comparison would be over the same time 

period. When you were looking at the Medicare bill, the years covered were, I think, 2004 to 2013. That was the relevant 10-year period. Now the 10-year period is 2006 to 2015, as you identified. And 

when we make that shift of just 2 years in the 10-year period, what 

we are adding at the back end are years in which the drug benefit 

is fully phased in. So naturally those costs are going to be higher. 

And what we are dropping off are the early years of the 10-year 

Medicare plan in which the drug benefit was not fully phased in. 

We have had a drug card and so on, but the full Medicare benefit 

arises in 2006. 

So if I may, I would like to submit something detailed for the 

record, responding on the numbers, but the short answer is that I 

think the numbers that are reflected in this budget are completely 

consistent with the numbers that the administration has produced 

before for the costs of the Medicare system. 

Chairman GREGG. As you know, I am not a great defender of the drug benefit because it is scored to be about an $8 trillion unfunded liability over the next—over the actuarial life, which is 75 

years, and I do think we are going to have to go back and readdress it. But I do think these numbers are misleading as they 

have been reported, and I think by saying that I might have more 

credibility than others because I would be the first to be aggressive 

were they not. 

As I see it, basically what the 1.2 is, it has not netted out the 

income that will come in, which would be about $300 billion. So 

you are back down to about 900. And then it has not netted out 

the fact that you are moving $200 billion out of Medicaid over to 

Medicare, so that gets you down to the $700 billion. And as you 

mentioned, the out-years, as we hit the out-years, we are into full 

participation and your annual cost is about $138 billion a year as 

versus the 56 that it starts out at. 

So that is where the numbers come from, as I see them, but I 

am still very suspect of this program as to its cost, and I certainly 

want to know what the real numbers are, and so we will look forward to getting more specifics. 

What I would like to do is go on, though, to the other entitlement 

issues. In your budget submission, you propose a fair number of entitlement accounts which you wish to slow the rate of growth of, 

you do not cut any. And then there are a number of other issues 

where you actually create new entitlement accounts. 

Could you give us a general statement of what accounts you are 

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mately, and then the accounts that you are adding and what the 

5-year or 10-year number is? 

Mr. BOLTEN. Mr. Chairman, again, I would like to submit something formal for the record that will put precise numbers on it. But 

we are proposing to slow the growth in the rate of Medicaid spending from about 7.4 percent per year to about 7.2 percent per year 

out over the next 10 years. The net savings in the Medicaid system 

would be about $45 billion over 10 years, and we are hoping to 

achieve that through program integrity measures. More importantly—and without reducing the actual service that we can provide to the lowest-income folks who depend on Medicaid.

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The more important thing is that we are also proposing a comprehensive reform of the Medicaid system, which is very tied up 

and has a lot of structures in it to prevent Governors from using 

the funds appropriately. We can go into more detail on that. We 

are proposing a reduction in farm programs and farm subsidies of 

about $5.4 billion. I do not recall exactly what percentage decrease 

that is. I will ask my staff to help me out. 

It is in the low single digits as a percentage of total projected 

farm spending that we are proposing to reduce—3.8 percent. 

We are also proposing to increase—to capture some savings from 

power marketing authorities by asking them to charge a market 

rate for the electricity. Those are some of the largest elements. And 

then in addition, we are proposing to capture savings in the student loan programs by making it possible for the government to deliver some of the benefits, without the middleman in the process 

collecting quite as large a fee. 

Chairman GREGG. And the new programs, new entitlement programs? 

Mr. BOLTEN. We are continuing to carry a health credit in the 

budget, that is, a credit for the uninsured to purchase health insurance on their own. This is not new. This has been in our budgets 

in the past. But in terms of new entitlement spending, I think it 

is very restrained. 

On the Medicaid side, we are proposing a program to sign up 

more kids for S-CHIP, which has been a relatively effective program, and there is about $1 billion of spending over the next 2 

years to get more, more of the eligible kids signed up. But there 

is also an associated cost with that within the S-CHIP program, because as we sign up more eligible children, there will be more burden on the Federal budget, and we are carrying those costs as well 

in our budget. 

Chairman GREGG. Senator Conrad. 

Senator CONRAD. Thank you, Mr. Chairman. 

Just to go back to the Medicare estimates. Mr. Foster, who was 

Medicare’s chief actuary for nearly a decade, said that administration officials threatened to fire him if he disclosed his belief in 2003 

that the drug package would cost $500 to $600 billion. 

That is why there is a credibility problem here. We were told as 

we were dealing with the legislation that the cost would be $400 

billion. Then after it was passed, they let it be known that, oops, 

that was wrong, the real cost is over $530 billion. And now we are 

talking about a 10-year cost of $724 billion, accepting your offsets, 

which I do accept, $724 billion. 

Now, this is the pattern as I see it. In 2001, the President told 

us we can proceed with tax relief without fear of budget deficits. 

That was clearly wrong. Then he told us in 2002, our budget will 

run a deficit that will be small and short-term. Obviously that was 

wrong because these are record deficits and they are for as far as 

the eye can see. In 2003, he told us that the current deficit is not 

large by historical standards and is manageable. I would submit to 

you that, correctly considered, these deficits are not small by historical standards either. The way he gets there is he just leaves out 

things. 

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In fact, I would like you to put up that chart, if you would again, 

showing the deficit reduction as a percentage of GDP, because I 

have to tell you, I think this hurts your credibility again because 

I think it misrepresents the true state of our fiscal condition.

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That is the that I want. Let me just say this to you: First of all, 

that chart leaves our war costs past September 30th of this year. 

That is No. 1. 

Senator SARBANES. Is that correct? 

Mr. BOLTEN. That is correct, and I would——

Senator SARBANES. Leaves out war costs after September 30th? 

Mr. BOLTEN. It leaves out any supplemental spending after September 30th, and I think I was clear about that in my testimony, 

and it is clear in the budget documents as well. 

Senator CONRAD. No. 2, what that chart leaves out most significantly is the money that you are taking from Social Security to pay 

for other things. 

If you go back, because you are making a comparison back to the 

1980’s, back in the 1980’s there was virtually no Social Security 

surplus. So if you look at this on an operating basis, you get quite 

a different picture. If you look at this on an operating basis, you 

know, no private sector company could take the retirement funds 

of its employees and use those to pay operating expenses. That is 

a violation of Federal law. 

But in your budget, in the President’s budget, he takes $2.6 trillion of Social Security money over the next 10 years to pay other 

operating costs. That is nowhere in these figures. 

By the way, you do not have alternative minimum tax in there. 

Last year, at least you had it in for 1 year. This year you do not 

have it in at all. It costs over $700 billion to fix. It is not there. 

So this is not a budget. This is a political document. It is a talking point. It fundamentally misleads people as to our fiscal condition. Even more serious is if you just go beyond the 5-year window, 

many of the costs of the President’s policies explode, for example, 

the cost of making the tax cuts permanent. You only have the first 

5 years there. You know and I know what happens after the first 

5 years. The costs of those tax cuts in lost revenue to the Treasury 

absolutely explode. 

So you have a chart here that does not reflect reality. It is not 

what is going to happen, and it is part of a pattern. 

You know, I do not even know what to say to you in terms of 

how seriously I believe this misleads the American people. We are 

not on a course to substantially reduce deficits. We are on a course 

to a train wreck. We had the Comptroller General of the United 

States here yesterday. Boy, what a difference his testimony was 

from the testimony we are hearing today. He talked about $43 trillion of unfunded liabilities, $28 trillion of it in Medicare alone, and 

there is nothing in this plan that deals with that. 

My time has expired, but I would just say that you have a presentation here that I do not think reflects reality. 

Chairman GREGG. Thank you. That was a good question. 

Senator Alexander. 

Senator ALEXANDER. Thank you, Mr. Chairman. 

I have some questions about Medicaid and then an observation 

about higher education. You said that you would reduce the growth 

in Medicaid spending from 7.4 to 7.2 percent. Do you know about 

what the rate of growth annually for Medicaid spending has been 

in the Federal Government and the State governments over the 

last 4 or 5 years? 

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Mr. BOLTEN. We will give that to you for the record, but I think 

it has been at about that level. 

Answer: Average, annual Federal Medicaid growth was 9.8 percent from FY 2001 through FY 2005. 

Senator ALEXANDER. State spending might have been higher. 

Mr. BOLTEN. States, in fact, probably are experiencing a slightly 

higher rate of growth in their costs than even the Federal Government’s 7-percent rate. 

Senator ALEXANDER. What I would like to drive at here is a question really of federalism. You have a predecessor of yours who is 

now Governor of a State. You have a former Governor, Chairman 

of the Governors, who is the head of Health and Human Services. 

And if I am putting myself back into—if I were the Governor of 

Tennessee today, I would be looking at a State budget that might 

have, for example, approximately $10 billion of Federal funds that 

I manage and about $10 billion of State-collected tax dollars. And 

of the $10 billion of State-collected tax dollars, that would be most 

of the funding for kindergarten through the 12th grade, for colleges 

and universities, for parks and police, when you add in the local 

spending—in other words, many of the things that people really 

rely on for Government and that have to do with our future. To 

keep our competitiveness in the world marketplace, we need brain 

power, and that comes from improving our early education, our 

schools, and our universities. A lot of that is State funding. 

So what is happening in Tennessee, as an example, is when I left 

the Governor’s office 15 years ago, we were spending 51 cents of 

every dollar on education; today it is 40 cents. The reason is because 15 years ago it was 16 cents on Medicaid and today it is 26 

cents, going up. 

So if we are to continue to have quality universities and schools 

funded by State and local governments, we have to make sure that 

whatever we do here does not have the unintended consequence of 

tying the hands of Governors and Mayors who are trying to allocate funds so they all do not get eaten up by health care. 

So what I want to urge you to do is to—and you said you would, 

but I just want to urge you to listen to the Governors as you restrain Medicaid spending. Because if I am sitting down there with 

$10 billion and that situation of health spending going up, there 

are two people who get in my way: one is the Federal Government, 

and one is the Federal courts. Because you say here is a cap, and 

then other agencies of the Federal Government say, ‘‘But you have 

to spend money on this person instead of third grade or this person 

instead of the community college.’’ And then the Federal courts 

come in. 

So that is just a general comment. I am working on some legislation that will make it easier for State and local governments to 

amend and adjust Federal consent decrees, which might help with 

that. But what is your attitude toward giving maximum flexibility 

to Governors and legislators as you seek to restrain the growth of 

Medicaid spending? 

Mr. BOLTEN. Senator, that is precisely the direction we are trying to take the system because the restrictions that Governors face 

in the rules often make it very difficult for them to provide the care 

that is needed to the people who need it most and is eating an ever 

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larger portion of State budgets. So we are headed toward proposals 

of exactly the kind of flexibility you are talking about. Governor 

Leavitt understands that, I think, as you do because he is a former 

Governor. He made an excellent speech last week, which I commend to you—and we will gladly provide you a copy of it—outlining 

the principles that we are going to be pursuing in Medicaid reform, 

and I think you will find them entirely consistent with what you 

have just said.

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Senator ALEXANDER. I have one observation I would like to 

make, and if there is time for you to comment, fine. When I left 

the former President Bush’s Cabinet as Education Secretary in 

1993, when the voters ushered us out of office, there was one regret 

I had and it was that I had not volunteered to be the point person 

for higher education, because as I have looked through all of Government, it was all over the place. It was in the Defense Department. it was in NSF. It was in the National Institutes of Health. 

It was in Pell grants. It was in a variety of places. And about half 

our economic growth since World War II has come as a result of 

our investments in science and technologies, the national laboratories, the research that we do. 

I think administrations need a point person on all that we spend 

and all that we do in science and technology and higher education, 

especially now that competitiveness is such a major issue and other 

countries are keeping their better students home, building up their 

universities, trying to compete with our national laboratories. And 

I just offer that to you since management is another part of your 

responsibility, and it is something that I would like to suggest that 

the administration consider. 

Mr. BOLTEN. Thank you, Senator. 

Chairman GREGG. Senator Murray. 

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

Mr. Director, appreciate your being here today. I listened to the 

President’s State of the Union Address last week, and he told us 

he was going to send the budget and would focus on essential priorities, so I was looking forward to seeing it. I guess I was really disappointed to find out what was not essential priorities, things like 

veterans and students and securing our ports and borders and affordable health care and nuclear waste cleanup, and I think that 

sends a very bad message to our country right now. I do not know 

how we can maintain a strong defense if we are going to cut veterans’ access to health care or how we can make sure we have 

strong homeland security if we are eliminating funding for our port 

security grants, and I do not believe we can strengthen our economy if we are going to reduce our investments in education and job 

training and infrastructure at a time when everyone is asking how 

can we be secure. I think this budget really undermines that security, and I echo the comments of Senator Conrad on what this 

budget really is, how real it is and masking it. 

But let me for this time, since my time is short, focus on a very 

parochial issue. Actually, it is not real parochial. It is the Pacific 

Northwest which you should know is up in arms over your proposal 

to force our power marketing administration to charge marketbased rates for electricity. I think there are eight Senators on this 

committee alone who are going to be affected by that, and I want 

you to know that our region does not want to see this budget balanced on the back of our rate payers. 

But that is not the only legislative proposal in your budget that 

is going to undercut Bonneville Power Administration. You also 

propose to hold certain financial transactions, such as third-party 

financing, against BPA’s borrowing authority. I have to tell you 

that is really rich with irony because for 2 years OMB opposed our 

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essary investments in transmission and other capital projects that 

were needed. And in 2003 OMB finally supported half of BPA’s 

needed borrowing authority but said that they should use other financing means like third party financing to meet the remainder of 

its investment needs. So here we are a couple of years later, and 

you are proposing to undercut the ability of BPA to use third party 

financing by holding these and other types of transactions against 

their borrowing authority limit. These kinds of proposals are going 

to cripple BPA’s ability to meet their investment needs. 

Mr. Bolten, President Bush came out to my home State, Washington State, in July 1999, and he came out again in 2003, and 

stood at Ice Harbor Dam, and he promised to save the dams. I cannot believe that this budget is making two different proposals that 

is going to severely undermine the value of those very dams that 

he promised he was going to save. 

My question to you this morning is, is it the intention of President Bush to privatize BPA and other PMAs? 

Mr. BOLTEN. No, that is not reflected in these proposals, and I 

do not think these proposals in any respect undermine the value 

of the dams out there. All that we are asking in these proposals 

is that the power marketing authorities charge their customers a 

reasonable market rate, not a subsidized rate for which the rest of 

the taxpayers in this country are paying, but a——

Senator MURRAY. The rest of the taxpayers are not subsidizing 

Bonneville. We pay the rates. 

Mr. BOLTEN. I think we have a disagreement on facts on that, 

and CBO has found that most of the PMAs in fact do receive a subsidy from the Federal Government. But even beyond that, when 

the Government is engaged in a commercial venture, I think using 

assets created with Federal taxpayers’ dollars, especially in these 

times of deficit, it is reasonable to expect that those commercial 

ventures charge their customers a reasonable market rate. That is 

all we are asking, and I think particularly the customers of BPA 

will find that we are talking about a very modest increase in the 

subsidized rates that they now——

Senator MURRAY. 20 percent increase in our cost of heating our 

homes, providing electricity to many businesses who rely on it is 

going to cripple the economy in the Pacific Northwest. We are just 

beginning to drag out of the economic damages from the last 4 

years which started with an electricity crisis which I will not go 

into, that had to do with Enron. I believe there are a number of 

other members on this committee who share that viewpoint with 

me, but we cannot cripple the Pacific Northwest. These are not 

subsidized rates. We pay the rates for our electricity out there. I 

will tell you what, the Northwest is not going to stand there and 

take this, we are going to fight back. 

Mr. Chairman, I know I am out of time. I have a number of other 

questions for you including the proposed cuts to Hanford Nuclear 

Reservation Cleanup, and you will be hearing more from me on 

that on the next round. 

Thank you, Mr. Chairman. 

Chairman GREGG. Thank you, Senator. 

Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. 

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I just want to understand what has happened in Social Security 

since its very inception. It seems that every President has used the 

surplus coming in from the Social Security money, the FICA tax, 

and spent it because we have bought bonds, put the bonds in the 

trust fund, and spent the money that we got from those bonds for 

other government functions. Is that a fact? 

Mr. BOLTEN. That is true. 

Senator BUNNING. Since the inception of Social Security? 

Mr. BOLTEN. I believe that is true, yes. 

Senator BUNNING. It is true. In 13 years, 2018, is it also true 

that Social Security will then be paying out in actual dollars more 

than they take in in actual dollars? 

Mr. BOLTEN. That is the currently projected date that Social Security will go into cash deficit. 

Senator BUNNING. If we do nothing, if we do nothing in that respect, then eventually if we deem every bond that is in the trust 

fund, and we pay all the interest due on that bond, there is a difference of opinion between CBO and the trustees when eventually 

we run out of money, and if we do not change the current law 

which says you cannot pay out more than you take in, somewhere 

around 2042, between 2042, 2052, there will be a reduction of 

about 25 percent in benefits if we do not change the law. Is that 

correct? 

Mr. BOLTEN. That is correct, Senator. That is the Social Security 

actuaries estimate is 2042, and I believe they expect——

Senator BUNNING. CBO’s was 2052. 

Mr. BOLTEN. On some different assumptions. 

Senator BUNNING. We will give them a 10-year leeway, and 

maybe in the middle. 

Mr. BOLTEN. Yes. And I think their estimate was that thereafter 

the system would be able to pay only slightly more than 70 percent 

of the promised benefits. 

Senator BUNNING. There is a difference of opinion there too, from 

72 to 78 percent, but somewhere under 80 percent. That is the law 

as it is now written. 

Mr. BOLTEN. Correct. 

Senator BUNNING. So if we do not change the law, the Social Security law, we are not going to be able to pay my grandkids their 

benefits, the ones that would retire after 2042 or 2052? 

Mr. BOLTEN. Correct. 

Senator BUNNING. So it is not unusual to use that money, but 

perfectly normal? 

Mr. BOLTEN. Well, that has been the practice in Government. 

And the way we have accounted for it has been the consistent practice. 

Senator BUNNING. In the Department of Energy’s budget the administration has proposed to cancel funding for the Clean Coal 

Technology Program, which researches advanced clean coal based 

technologies, and instead redirect the funds to FutureGen, which 

researches creating hydrogen power from coal. Why is the administration focusing more on the FutureGen than on other types of 

technologies to burn coal cleaner to produce electricity? 

Mr. BOLTEN. Senator, I will ask to come back to you on the 

record for that. But my understanding is that we are continuing to 

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fund a variety of clean coal technologies, that FutureGen holds a 

lot or promise and——

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Senator BUNNING. Yes, but that is not a huge expenditure, but 

it is transferring out of what we had proposed in the last bill, energy bill that did not quite get through. But the fact is we need 

to develop every technology possible so that when we are producing 

52 percent of our electricity from coal generation, we ought to at 

least try to do the best job we can in America, in the United States 

at least to clean up. I know if we do nothing China will suffocate 

us all with the amount of coal-based non-clean technology that they 

are burning and producing power from, but I think it is very important that we develop all the clean coal technologies that we can, 

and I will work hard to alter some of the things that have been 

put in this budget. 

Thank you. 

Chairman GREGG. Senator Corzine. 

Senator CORZINE. Thank you, Mr. Chairman. 

Welcome, Mr. Bolten. I want to ask a question. I read something 

in the Post that said that you acknowledged yesterday in a House 

committee that private accounts and personal accounts do not in 

themselves solve the full Social Security problem. Is that correct? 

Mr. BOLTEN. The personal accounts that the President is proposing——

Senator CORZINE. Do not deal with the problem of solvency from 

2042 or 2052? 

Mr. BOLTEN. They do not in and of themselves solve that problem, but I believe they are an integral part of any reform program 

that does solve the permanent problem. 

Senator CORZINE. But it is really addressing an issue other than 

the solvency, part of promoting savings or some other objective 

other than dealing with the solvency? 

Mr. BOLTEN. The view I take is that the personal accounts are 

an integral part of a plan that fully addresses the permanent solvency of Social Security. 

Senator CORZINE. Could you explain to me how that is going to 

improve the solvency of the Social Security accounts? 

Mr. BOLTEN. The creation of personal accounts? 

Senator CORZINE. Yes. I mean it may be an integral part of something, but how is it dealing with the solvency question? 

Mr. BOLTEN. In and of themselves they do not address the solvency question, but they do provide the recipients of the personal 

accounts an opportunity to get a better return than they otherwise 

would——

Senator CORZINE. Given whatever the sort of efficient market 

would allow people to be able to do. I just wanted to make sure 

that I had read that there is a difference between how they impact 

in dealing with the issue of solvency in 2042, 2052. 

Let me a second—and I will not go through this issue of credibility with regard to what I would call two sets of books if I were 

seeing budgets like this back in the world that I used to live in, 

and you left out revenue flows or expenses that were broad and 

deep into what people would want to see on getting to a bottom 

line, whether it is this Medicare issue, Social Security transition, 

AMT full implementation, war costs. I think it is very troubling because I do not know how any of us can go sit with our constituents 

and tell them that we have a budget, when we know that is not 

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reflective of the challenges we have to take on. So I certainly identify with the articulate analysis that Senator Conrad brought forward, and I think it hurts our ability to deal with some of the other 

tough issues because we do have entitlement problems in this country. But if we are not fair and square about what it is that the 

costs are of both sides of the ledger, whether it is revenue raising 

from taxes or how we are going to spend money, I do not know how 

we can sit down and ask the American people to make clear 

choices. We are leaving out so much here, that I think we leave 

that in a very failed position. 

I also want to take a follow-on to what Senator Alexander said 

or talked about. If State Homeland Security grants are cut 30 percent, if my favorite railroad, Amtrak, was cut from $1.2 billion to 

$360 million for operating basis, if Medicaid at $100 million was 

cut to States, COPS programs, Fire Acts, Perkins Vocational Technical Education grants, what do we think would be the result to 

State budgets, and after school and day care, community development block grants, what is the end result when we push this off 

the budget? Are we going to say that our poverty levels are going 

to go down, that health care coverage is going to go up in the country? Is that the conclusion that these kinds of cuts, that educational levels are going to improve? What are our State and local 

governments going to do when they have mandates and the Federal portion of support does not happen? 

What is the expectation on the end results with regard to people’s lives, with regard to poverty, with regard to health care, with 

regard to quality education if the money does not flow and shared 

by the Federal Government? 

Mr. BOLTEN. Senator, let me come back first to your concerns 

about what is not reflected in the budget. I believe that the presentation I have made, the charts that I have put up here are an accurate reflection of what our budget picture looks like. I have said explicitly in my testimony, and it is explicit in this budget, that war 

costs beyond those that are contained in the 2005 supplemental are 

not included. So we do have to expect that there will be an addition 

there. 

Senator CORZINE. Respectfully, do you—and I mean that in all 

sincerity—respectfully, aren’t we going to deal with AMT in this 

country sometime in the next, one, two, three, 4 years? 

Mr. BOLTEN. I hope we will deal with AMT, but the President 

has asked the Secretary of Treasury to deal with that in the context of revenue neutral, overall fundamental tax reform. So we 

have not carried a patch, and it seems to me it is inappropriate to 

carry a patch year after year for a system that is as broken and 

complex and unfair as the AMT is. It seems to me that AMT is a 

proper subject to be considered in fundamental tax reform that the 

President has also called for. 

Chairman GREGG. Senator, we are going to have to move on, unfortunately. 

Senator CRAPO. 

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

Director Bolten, I am going to make a couple of statements first 

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ple of things, and then talk to you about some questions I would 

like you to answer. 

The first thing I would like to commend you on in the budget, 

is the Administration’s commitment to nuclear power. You and I 

have had several meetings on this issue and I appreciate the fact 

that you heard and responded well to the concerns that we have 

raised about the importance of making sure that this budget supports our movement in our energy policy in this country toward a 

strong nuclear power program. I just wanted to, first of all, commend you and thank you on that. 

On the other side of the ledger, I have to say that I agree with 

those who say you have it wrong on the Bonneville Power Administration. There is no subsidy there and I believe that when we get 

into the details of that you will see the distinction that we are 

making. 

I want to, in my questions, I wanted to go back to the question 

that you answered from Senator Corzine about the solvency issue 

with regard to Social Security, because, frankly, I understand it a 

little different and I want to get this straight. I clearly understand 

that initiating a system of personal accounts will not impact the 

short term solvency issues because, frankly, it takes a number of 

years for investment in accounts and for the buildup in those accounts to take place before you can start having the growth that 

we want to see develop. 

However, in terms of the outyears of Social Security where we 

are seeing the big problems, it is my understanding that all these 

transition costs that we are talking about are, in reality, the costs 

that we are going to try to incur up front now for debt obligations 

of the Social Security system that will be present in the outyears. 

Is that not correct? 

Mr. BOLTEN. That’s correct. 

Senator CRAPO. If we are utilizing a personal account system to 

create a better investment opportunity with a greater return to 

handle outyear debt, how can that not have an impact on the ultimate solvency of Social Security in the outyears as we have a much 

stronger fiscal position in those years as the obligations of the system then come due? 

Mr. BOLTEN. I think you have given a clearer explanation than 

I was able to give earlier, and you are absolutely right. As we create personal accounts, all we are doing is taking an obligation that 

the Government will owe in the form of future benefits to a beneficiary and letting them keep that money earlier on and earn a 

higher return on it than the Social Security system can possibly 

promise to pay. So in that respect, it is largely neutral to the Government. It is a cost that we are just moving forward. 

In the context of an overall, comprehensive reform plan that allows people to keep more of their money earlier on and increase the 

amount of benefit they can get from that, that is part of the whole 

plan of bringing the whole social security system into solvency. 

Senator CRAPO. Thank you. In the time that I have left I want 

to shift gears yet once again. That is, it is my understanding that 

you have introduced a proposal in this budget that I guess we could 

basically call it administrative PAYGO, in terms of a proposal to 

have the administrative actions that any agency may take which 

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could increase the cost of an entitlement program, to be subject to 

a PAYGO principle or equal reductions would have to be kept in 

place so that the net cost would not be driven up in entitlement 

programs by agency actions. 

Could you explain that a little better? I think it is a tremendous 

idea but I would like to know exactly how that works. 

Mr. BOLTEN. You described it accurately. It is still in gestation. 

It is a new idea for us, but we have found that a lot of the growth 

in costs in our entitlement programs is not just the result of the 

automatic pilot feature of legislation. It is administrative decisions 

made by individual agencies. As a way of helping us at OMB and 

elsewhere in the Government get control of costs that might just 

be growing without any particular action having been taken, we 

are going to be asking agencies, as they make proposals for administrative changes for changes in regulations, when we assess that 

those proposals are going to result in an increase in the cost of 

those programs, we are going to ask the agencies to come forward 

at the same time with an offsetting decrease in cost. So we are 

going to ask them to do the same kind of PAYGO exercise that we 

are asking you to go through as you consider mandatory legislation. 

Senator CRAPO. Are you going to do that through some type of 

executive order, or would this be something better done by legislative action? 

Mr. BOLTEN. We were planning to do it through administrative 

action internal in the Administration, but we would be happy to 

work with you on appropriate legislation if that is of interest to 

you. 

Senator CRAPO. Thank you very much. 

Chairman GREGG. Senator Stabenow. 

Senator STABENOW. Thank you, Mr. Chairman. 

Good morning. Thank you for being here. It is hard to know 

where to begin there are so many questions that I would like to 

ask. I am drawn to your opening statement when you indicated 

that you presented a budget on behalf of the President that meets 

the priorities of the Nation. I think it is important to look at what 

those priorities are and then I want to ask a question about Social 

Security. 

Some veterans under your budget will be greeted with a new 

$250 prescription drug coverage enrollment fee and a doubling of 

their copayments. Are you suggesting that meets the priorities of 

the Nation? 

Mr. BOLTEN. Senator, we have proposed these additional fees in 

the past. They are for category seven and eight veterans. What we 

are asking those veterans to do is pay an enrollment fee of $250 

to be part of the VA medical care system, and to pay a copay on 

their drugs that would rise from $7 to $15. I think most people who 

are operating under good health plans would not consider a $15 

copay to be something out of range. 

But here is the reason we are doing it. While we are expanding 

the expenditure on veterans health care, which by the way has 

grown by almost 50 percent over the course of this Administration, 

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ministration, which is to take care especially of those who have 

service-related disabilities and similar categories, the higher up 

categories. When we ask those in the lower down categories to pay 

some higher fees, the purpose of that is to capture some extra revenue to be spending it on those higher priorities, which we are 

doing. 

Senator STABENOW. I understand that. So some veterans are 

going to be greeted with a new $250 prescription drug coverage enrollment fee and a doubling of their copays. I would just remind 

you that we have certainly been spending more on veterans health 

care but still have long lines of folks waiting to see doctors. We are 

creating more veterans also every day because of our brave men 

and women. I had an opportunity to spend time with some in the 

Upper Peninsula of Michigan on Sunday to thank them for their 

service. They expect to come home to a fully funded veterans 

health care system that does not continue to fund the system by 

asking additional dollars from them. 

But another question, on first responders. Very important to us 

certainly in Michigan and around the country. The budget cuts 

overall first responder funding by 38 percent, the formula funding 

by 26 percent below current levels. Firefighter grants, which have 

been critical to us in Michigan are being cut 30 percent below last 

year’s levels and below homeland security levels. A 96 percent cut 

in the COPS program, which has put over 3,500 new officers on the 

streets in Michigan. I could go on. 

I would just suggest to you, that does not meet the priorities of 

the Nation. 

The final thing I would say is that we look at a number of areas 

of research and development, the manufacturing extension partnership for small and medium-sized manufacturers which gives them 

the technology and the support to be able to compete in the global 

economy; dramatically cutting that back. It is about jobs. It is 

about loss of profit. It is about inability to compete. It is pennywise and pound-foolish, and I would suggest does not meet the priorities of the Nation. 

One question though on Social Security. There is a lot of confusion about what has been called the clawback provision; a very 

lovely title. The clawback provision basically really goes to the 

question of what happens when people put money into the 

privatized accounts. We frequently hear about, it is your money 

and it is your money whether it is payment into an insurance system in Social Security, 100 percent funded by all of us working, or 

whether it is the privatized accounts. 

But is it not true that at this point from what we are hearing 

from briefings, from reports and so on, that workers who choose 

privatized accounts would have to pay a portion of those accounts 

back in terms of their retirement? In other words, get less in traditional benefits. Some estimate that this provision, which is also 

being called a retirement tax, could be between 70 and 100 percent 

of the value of the person’s privatized account. 

For example, if someone set up a private account and it grew 

only 3 percent above inflation, the net effect would be that all of 

his or her privatized account earnings would be taken away in benefit cuts. Is that not correct? 

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Mr. BOLTEN. I do not believe so, Senator, but I think you have 

to look at whatever the Social Security plan is in its totality. What 

I do know about the personal accounts that the President has 

talked about is that his intention is that people be able to keep all 

of what they invest in those accounts and realize all of the returns 

which, over any historical measure, are likely to be far better than 

what they can get in the public sector. 

But may I take a moment on your point on priorities? Because 

you listed a lot of programs, and you listed a lot of tough cuts. But 

that is what this budgeting is about. If we are going to get control 

of our spending situation, we do have to set some priorities and 

take down the numbers in a lot of programs that are very popular 

all over the country, and that includes some of the grants that you 

talked about. What we need to focus on is making sure that our 

grants go toward actually improving homeland security. It would 

be——

Senator STABENOW. Mr Bolten, since my time is up I am going 

to just ask—I apologize for cutting you off because I assume I am 

going to be cutoff here in a moment to move on to other colleagues. 

I want to talk to you more about what the reality of these 

privatized accounts is at some later point, but let me just suggest 

this. 

We all know that we could eliminate the entire non-defense, nonhomeland security, domestic budget and not solve this year’s deficit. We are talking about focusing on small investments with huge 

impacts in terms of safety, and security, and education, and research, and supporting our veterans, and yet we have no discussion 

of the larger issues that have been raised by my colleagues in 

terms of the tax plan and where revenues go versus what we are 

asking of our veterans to pay for prescription drugs, or what we invest to keep people safe. I would just suggest that this does not reflect our priorities, nor does it reflect a true budget and I would 

hope that we could do better. 

Thank you. 

Chairman GREGG. Senator Sessions. 

Senator SESSIONS. Thank you, Mr. Chairman. 

I believe that first chart or two that you had there showed revenue coming into the Government. If you could find that and put 

that up, I would appreciate it. We have had an increase in revenue 

and one reason I believe, Mr. Bolten, is that we have created a tax 

system that really focuses on the affluent. The income tax is heavily skewed to the affluent, and it seems to me that it is a reality 

all of us need to consider that when the economy goes down and 

the affluent, who have been making high incomes and paying 35, 

39 percent tax on that, do not pay it. If the stock market goes down 

and they sell stocks, they take losses instead of gains, and maybe 

their investments do not pan out as well and they just do not pay 

as much in taxes. 

That shows to me a little bit of a confirmation of that thought 

I have had for some time. Are you concerned that that is a problem 

for us in the way we collect taxes in terms of our ability to predict 

each year what the revenue will be? 

Mr. BOLTEN. I certainly agree with the description of the problem 

which is that we had surpluses, or we thought we had surpluses 

225

at the end of the last decade because the Federal Government was 

receiving huge revenues in large part from a stock market bubble. 

When that bubble burst and wealthy people, instead of paying 

large capital gains, had capital losses, revenue dropped off a cliff 

for this Government. I think what you see reflected up here is that 

in the first 3 years of this Administration, as a result largely of 

that situation that the President encountered on entering office of 

a burst stock market bubble, a recession, then the 9/11 attacks, for 

the first time since the 1920’s the Federal Government experienced 

actually declining revenues for three straight years in a row. 

Now you and the President put in place some very effective tax 

cuts that helped restore economic growth——

Senator SESSIONS. Those tax cuts, according to conventional liberal wisdom would result in reduced revenue to the Government, 

would it not? We cut taxes. Why don’t revenues go down? 

Mr. BOLTEN. What this reflects is that revenues are coming back 

strongly. After this 3-year actual decline in revenues, we now have 

revenues coming back strongly, $100 billion last year; and we 

project more than that for this year. It is because we have a strongly growing economy. That is the most important fiscal tool we have. 

There is nothing else in the toolbox that comes close to a vigorously 

growing economy to determine whether we are in a good fiscal situation. 

Senator SESSIONS. I do not mean to totally argue with my colleagues here, but I do think that growth in the economy has resulted in increased revenue even though we have a lower tax rate. 

With regard to how we got into some of this and the spending 

that we incurred. I remember the last year of the Clinton Administration, the increase in appropriations that year was 15 percent. I 

do not know how that all happened, but it happened, and I think 

a lot of us regret that we participated in such a large growth rate. 

If we contain spending I think we have a way to work through this. 

I am concerned, as several have expressed, the prescription drug 

bill. We went from zero on prescription drugs under Medicare basically to a very substantial commitment to increase that. We did 

not, I do not believe, any of us think that we were doing an openended program that would grow completely out of control. I think 

we may need legislation. I think we may need tough regulations 

from the Administration. But I believe there is a commitment here 

to contain Medicare prescription drug spending to the $400 billion 

over the first 10 years, as you noted. We all knew it was going to 

go up over years two through 12; it would be higher. But not that 

much higher. 

So do we have any interest on the part of the Administration in 

trying to be faithful to the basic commitment that we had when we 

passed this bill to see that this prescription drug program not get 

out of control? 

Mr. BOLTEN. Sure we do, Senator, and we would be glad to work 

with you on whatever cost control measures you are interested in 

pursuing. 

Senator SESSION. I would just ask, Mr. Chairman, that I submit 

a written question about Medicaid and the impact on the States. 

I am very concerned about that. 

Chairman GREGG. Thank you. 

226

Senator SARBANES. 

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

Senator DOMENICI. Senator Sarbanes, I wonder if you would 

yield for an observation. 

Senator SARBANES. Not out of my time, but otherwise, yes. 

Senator DOMENICI. I want to say, Mr. Chairman, as chairman of 

the Energy and Natural Resources Committee I have a markup of 

10 or 15 bills for Senators that have to be voted out. It takes a very 

little bit of time, and I do want to come back, if I can. If you are 

finished, then you are finished. But could I just say, first I would 

compliment you——

Senator SARBANES. Mr. Chairman, I will yield my time to Senator Domenici. He can get his questioning in and then go to the 

markup and he will not have that problem. 

Chairman GREGG. That is very generous of you, Senator Sarbanes. Then we will come back to you. 

Senator DOMENICI. That is very good. Thank you, Senator. 

Chairman GREGG. Very nice of you, Senator Sarbanes. Thank 

you. 

Senator DOMENICI. First, let me say I congratulate you on your 

efforts. Considering the things that nobody wants to touch around 

here, which are entitlements, and in particular, health care, which 

sooner or later we are going to have to realize we cannot afford 

what we are trying to do in health care. I do not ask you to comment. I do not want you to commit to that terrible proposition. But 

it is obvious we cannot pay for the entitlements that we have over 

time if we want a growing economy and low inflation, which are 

the really cornerstones of America’s prosperity. That is my absolute 

conviction. I do not think we have done much about that. 

But for those who say we should, it is very interesting. You are 

trying to do something with Social Security. They suggest you 

should do Medicare. If you had tried Medicare they would all be 

saying, why don’t you do Social Security? Or, we cannot cut Medicare. So at least you took one of them on and you are going try. 

I have two observations for you and I really urge you to think 

about it and urge that you tell the President about it. You have 

some things in this budget that say we ought to make changes. We 

ought to get rid of some programs. There is no question, threequarters of those programs that you want to cut are just not needed. They are duplicative. There are four or five of them doing the 

same thing. But you know what happens? We do not do them because we do not have an easy way. We cannot do them. There is 

no way to authorize their death, so it is all up to appropriators. 

I submit that you have to do more to see, and force, and insist 

that Congress do what you have asked for. Now that is not easy. 

I never hear the Administration say, this appropriation bill did not 

cut the 10 programs that we asked for. Have you ever done that 

as a budget director? I do not think so. How are we going to get 

them? It is your program. So I urge that you do that. 

My last one has to do with energy. I note the President’s speech 

to the Detroit Growth Club, or whatever it is, on energy. I also 

want to tell you, again, that he got the greatest applause, according 

to the report, when he said we have to do something about nuclear 

227

power. Thank you and thank him for proceeding with it. We are 

going to try. I hope you help us. 

My last question is ANWR. Now there is some rumbling around 

that the Administration may not be for pushing ANWR to the maximum. It is in your budget by way of expected revenues, right? 

Mr. BOLTEN. Yes, it is. 

Senator DOMENICI. Now you intend for us to try to do that, do 

you not? 

Mr. BOLTEN. Yes, we do, Senator. 

Senator DOMENICI. So you support doing whatever we can do 

that is legitimate up here and consistent with our processes to get 

ANWR done, right? 

Mr. BOLTEN. Only legitimate activity, yes, sir. 

Senator DOMENICI. Of course. I do not mean illegitimate in that 

sense, but that are consistent with our rules. 

Mr. BOLTEN. Yes, sir. 

Senator DOMENICI. Whatever we can do you would ask us to do. 

You would have no objection if we put ANWR in our budget as an 

item that we should mandate, do you? 

Mr. BOLTEN. I do not expect we would, Senator. 

Senator DOMENICI. Now my last point is way, way out in left 

field. Would you support, as a reform measure, 2-year budgeting 

and 2-year appropriating? I look around here and I do not know 

how you can get your agenda down because we cannot get our work 

done. It seems to me we ought to try to do something different. 

What do you think about that? 

Mr. BOLTEN. It is an interesting concept. The President actually 

talked about that in the 2000 campaign and we have carried it before in our budgets. It did not attract a lot of interest up here in 

the Congress, but I would be interested in opening the dialog on 

it because I think it would provide an opportunity for us to focus 

1 year on the numbers and the appropriating and another year on 

the implementation. 

Senator DOMENICI. Now my last issue has to do—I have been 

watching people who either do not like the President—it seems 

there is a large group of people that even though he has been elected seem to want to get on and express their extreme dislike for 

him, and when it gets to the budget they do that, and they really 

criticize you for not putting the 1-year appropriation supplemental 

for defense in this budget. Could you just tell us, since there are 

a few people watching, in very simple language, why shouldn’t you 

put that in the budget in terms of this 5-year budget? 

Mr. BOLTEN. As a budget director, it is very important to me that 

we not include one-time, extraordinary war costs in a budget because if you put it in the basic budget it ends up in the base and 

you never get rid of it. It just grows from there. 

So we are restoring our underlying military strength through 

progressive increases in the base defense budget. But when we 

have an extraordinary episode, like a war, we need to fund that 

separately. We try to show those costs as transparently as we possibly can, including the supplemental request that you will be receiving shortly. But I think as a budgeting matter it is very important that we not let these things float into the base because then 

228

I think we will have been fiscally irresponsible in not preventing 

those costs from being permanently in the defense base. 

Senator DOMENICI. So a way of saying it is if you put these costs 

in the budget and they are supposed to be one time expenditures, 

Congress could in fact expect them to be in beyond that time and 

plan their spending, to include the spending as if it were in there 

permanently, so you keep it out. 

Mr. BOLTEN. Senator, I fear that not just Congress but a lot of 

other people who are interested would assume that we would be 

doing that spending in perpetuity. 

Senator DOMENICI. Thank you, Mr. Chairman. 

Chairman GREGG. Thank you, Senator Domenici. And thank you, 

Senator Sarbanes, for allowing Senator Domenici to go. Which 

means that after Senator Sarbanes, Senator Wyden would be next. 

Senator SARBANES. Mr. Bolten, I have been listening to you with 

great interest this morning and I was really struck by the feeling 

that the qualities that are needed nowadays to be a good OMB director, at least as you all are doing the business, are those of a magician. I just want to put that out at the outset. 

Now let me ask you a couple of questions. You said earlier, as 

I understood it, that it has always been the case that the Social Security surplus has been used to pay for other programs; is that correct? 

Mr. BOLTEN. I believe it has, but there have been periods when 

the surplus has actually been paid down. So I think there was a 

brief period in the 1990’s when the money went the other way, 

when the Government was actually in surplus. 

Senator SARBANES. That was not your answer. That is an elaboration on your answer. That was not how I understood it at the 

time. You said it was always the case, and I would just refer you 

to your own budget document which shows that in both 1999 and 

2000 we had an on-budget surplus. 

Mr. BOLTEN. Correct. 

Senator SARBANES. So we were not using the Social Security surplus to pay for other programs, correct? 

Mr. BOLTEN. Yes, that is correct, in those years when the Government was running a surplus. 

Senator SARBANES. I just want to get things clarified and I want 

to make sure we at least try to see if we cannot get some agreement on what the facts are. 

Second, you just talked about a 2-year budget, but I understand 

that in the budget you have just submitted there is a major departure in that with respect to projections of discretionary domestic 

spending you provided only 1 year; is that correct? In the past we 

haveten either five or 10-year projections, depending on whether 

we were getting a five or 10-year budget; is that correct? 

Mr. BOLTEN. We have now, for the last couple of years and for 

many years before that, been doing 5-year budget projections. But 

I think what you are referring to is that we are, providing less detailed account by account information in future year discretionary 

expected expenditures. 

Senator SARBANES. There was a departure in the budget you submitted this year from past practice, so you are not giving us the 

projections out beyond just this year, correct? 

229

Mr. BOLTEN. We are giving the projections in broader categories 

than we have in the past, and if you will give me a moment to explain why. 

Senator SARBANES. Would you say it is fair to say it is substantially different from the past? 

Mr. BOLTEN. It is different, and the reason why——

Senator SARBANES. That is all I want to know. 

Now let me ask the next question. What is the 10-year cost of 

making the President’s tax cuts permanent? 

Mr. BOLTEN. I do not have that figure off the top of my head. 

Senator SARBANES. Let me try to help you. I have a wonderful 

chart here of Senator Conrad’s. 

If you do your 5-year budget, which you are now doing, this is 

what you show on the cost of the tax cuts. But if we do a 10-year 

projection of the cost of the tax cuts, look what happens. I think 

the word up there is ‘‘explodes.’’ You get a 1.6 trillion dollar 10-year 

cost of the Bush tax cuts. Do you quarrel with that figure? 

Mr. BOLTEN. I think I do, although I am told that what we are 

carrying in the budget is $1.1 trillion. But what I would point out 

is——

Senator SARBANES. Let us do 1.1 trillion. Take that point and 

proceed on that one. There is a 1.1 trillion dollar cost for the tax 

cuts, you say? 

Mr. BOLTEN. Correct, the extension of the President’s, of the existing tax cuts above the current baseline. 

Senator SARBANES. Does that include the interest cost on the 

debt from those tax cuts? 

Mr. BOLTEN. It does not. 

Senator SARBANES. No. It would be $1.4 trillion roughly if that 

were included? 

Mr. BOLTEN. I do not know, but that would be a substantial increment. 

Senator SARBANES. Why do you not submit that for the record? 

Mr. BOLTEN. Be glad to.

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Senator SARBANES. Let me ask you this question. I gather you have cut first responders in this budget by about $1.6 billion from 

the 2005 level, correct? That is fire and police, first responders. 

Mr. BOLTEN. There are reductions in a number of first responder 

grants, but what we are also increasing on the other side many of 

the grants that do not just go out by formula to a lot of first responders but are focused on the highest priority homeland security 

needs. This is what I was trying to get at with Senator Stabenow, 

which is that we have tough choices to make in the budget, and 

that is one of the things that we are trying to do with the allocation——

Senator SARBANES. You do indeed have tough choices, and that 

is the next point I want to make. This is what we figure the cut 

is to the first responders, 1.6 billion dollars. Now, this big column 

over here is the cost of the Bush tax cut in 2006 for those making 

over a million dollars, just the millionaires. The cost of the tax cut 

they received, $32 billion. What that tells me is if you would just 

reclaim 5 percent of that wonderful tax cut, 5 percent only, you 

could fund the first responders. Now, that is priorities. You just 

said to Senator Stabenow, this is all about priorities, and you have 

just told me the same thing. It is certainly all about priorities, and 

there they are. There are the priorities, this excessive tax cut for 

people making over a million, and we are cutting the first responders, the fire fighters and the police all across the country. 

I welcome the formulation because I think it is important to 

focus on the priorities question, and the priorities question encompasses, in my view, the tax cuts that have been given and who benefits from them, compared with who is impacted and hurt by the 

spending cuts you are making in this budget. 

Thank you very much, Mr. Chairman. 

Chairman GREGG. Thank you, Senator. 

Senator Wyden. 

Senator WYDEN. Thank you. Mr. Chairman, I have always enjoyed working with Mr. Bolten, and he has always been interested 

in bipartisan approaches and that is what I want to ask about 

today as it relates to containing the cost in the Medicare prescription drug benefit. 

I think people look at this program, and at a time when Senators 

on both sides of the aisle are up in arms about the costs of the program. People look at the program and are just mystified as to why 

Medicare is not using the cost containment strategies that are used 

in the private sector of our country. I have talked with Chairman 

Gregg about this in the past, but I think it is fair to say, colleagues, that what Medicare is doing as it relates to prescription 

drugs, is essentially the equivalent of a guy standing in the Price 

Club and buying one roll of toilet paper at a time. The program is 

not using the common sense cost containment strategies that are 

used every day at Goldman Sachs, at timber companies, auto companies and the like. 

Now, there is a bipartisan bill that will let us change this, and 

this is something I want to talk with Chairman Gregg and Senator 

Conrad about because I have introduced this with Senator Snowe, 

Senator McCain, and Senator Feingold, my colleague on this committee. It is bipartisan, and allows us to say, at a time when the 

232

costs of this program are going through the stratosphere, that we 

are going to use not some cost control regime run out of Washington, but private sector bargaining power to control the costs of 

the program. I mean I do not know of anybody on the planet, 

Josh—I am going to call you that, we have been known each other 

a long time—who, when they are buying something in volume and 

they are going to buy some more of it in volume, does not say, 

‘‘Hey, pal, how about a discount? Let us negotiate.’’

So I would like to work with you on it. We have senior Republicans on the Finance Committee, Senator Snowe, Senator McCain, 

not on the committee but very influential in the health debate, myself, Senator Feingold, my seat mate here. Can we not, at a time 

when the costs of this program are going through the stratosphere, 

instead of spending our time wrangling about the numbers—I 

mean I happen to share Senator Conrad’s view about it and Senator Sarbanes—but here we have a chance to do something bipartisan that we can do now to rein in the costs. It is not just the program. We have seen that already the last few days. I mean Lipitor 

has gone up 5 percent just in the last few weeks, the big cholesterol-fighting drug. Would it not make sense—the number of the 

bill, in case you want to send us an endorsement letter quickly, is 

S. 239, Snowe, Wyden, McCain, Feingold and the like. Can we not 

work together on something like that, to start reining in these 

costs? 

Mr. BOLTEN. Senator, you know I am all about cost containment, 

so we are glad to talk with you about any proposals that you have. 

I know Secretary Leavitt will be interested in engaging with you. 

Senator WYDEN. So you are open then, Mr. Bolten, to the idea 

of lifting the restriction? Right now there is in the law a statutory 

ban that prohibits the kind of cost containment strategy that goes 

on every day, Goldman Sachs, Weyerhauser, goes on every day in 

America. I have talked to the chairman about this. It just defies 

common sense when everybody else in America sits down to buy 

something they try to get a bargain, they try to get something for 

it. I would be satisfied today if you would say that you are willing 

to look at lifting the ban that is now in the law so as to allow us 

to have private sector cost containment strategies. 

Mr. BOLTEN. I am going to leave it, Senator, to Secretary Leavitt 

to do the actual negotiating with you on this. I do know that the 

administration has looked at what I think you are referring to, and 

has relied on CBO and some other estimates that have concluded 

that the price negotiations would not produce substantial savings 

to the system, but as the Budget Director, if there are any savings 

to be captured, I of course do not want to preclude ever having that 

conversation. My telephone line is always open as you know. 

Senator WYDEN. First of all, they actually sent us a revision of 

that original one and pointed out a situation in particular, sole 

source drugs, were cost savings, but this is just common sense. I 

mean, again, it would be one thing if somebody was talking about 

price controls and having a one-size-fits-all, run from Washington, 

D.C. kind of program. 

I will give you an example. 

Chairman GREGG. Senator, we are going to have to——

Senator WYDEN. Can I just finish my thought on this? 

233

Chairman GREGG. Of course, yes. 

Senator WYDEN. I appreciate it because we represent a lot of 

rural communities. In a lot of rural communities there is going to 

be a fall-back plan, so we will have maybe 1,000 seniors in rural 

Oregon or New Hampshire, for example, that will have no bargaining power whatsoever to control the costs down. So what Senator Snowe and I want to do is let those seniors in those communities where there is absolutely no leverage whatsoever to hold 

down the cost of medicine, to be able to pool their power, which everybody does in the marketplace. S. 239, hope we can work together on it. 

Thank you for the extra time, Mr. Chairman. 

Chairman GREGG. Senator Ensign? 

Senator ENSIGN. Thank you, Mr. Chairman. I want to comment 

quickly on the first responders, and tell you shame on your for trying to eliminate pork. In a lot of these cases, in parts of my State, 

in parts of States all over this country, that is exactly what a lot 

of these grants have become. They are not related to terrorism. 

They are not related to homeland security. Every little community 

wants something, they want a new fire truck, they want a new this 

and that. They may be meritorious but they are certainly not related to national security. So I applaud you for that and I think 

that that needed to be pointed out. 

Mr. BOLTEN. Thank you, Senator. 

Senator ENSIGN. There are a couple other things that I want to 

mention about the budget. First of all, you had to provide details 

to make sure that the number, the top line number that you have 

is legitimate. That is the reason that you have to put in details. 

We will disagree sometimes on policy, and you know some of my 

disagreements with you. We may disagree on specifics but I think 

the bottom line is that we all agree that we have to get deficits 

under control. 

The major disappointment that I have with this budget is that 

I do not think it goes far enough on controlling some of the entitlements. I would have liked to have seen a much bolder proposal on 

health care reforms from the administration. I know the administration does not want to re-open up debates on the new prescription drug program yet. We are going to work with the new Medicare reform law, but I think that there are serious problems. I 

thought there were serious problems with the bill. I thought there 

were some really good things in it but there were no real cost controls, especially for lower-income seniors. The copays I believe were 

too low, and that is going to have to be reviewed. You just raised 

copays for some veterans and it is something that I think we are 

going to have to look at, for Medicaid, for Medicare and the like. 

But an overall bold health care proposal, some of the things that 

Senator Enzi and others of us are working on, can save not only 

Medicare and Medicaid but the whole health insurance system by 

bringing down costs. Obviously, medical liability reform is very important. Putting in the electronic medical records and going to best 

practices are as well. The reason it is important for Medicare and 

Medicaid to adopt these measures is because the insurance industry and the companies that are out there financing health care, will 

follow Medicare and Medicaid’s lead. We will have significant savVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00239 Fmt 6601 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
234

ings if we adopt some of these reforms. That does not even go to 

preventative medicine, which I believe in the long run is going to 

save us a lot of money as well. 

Just disappointment there, but I understand you are not a policymaker in that regard. I wish the administration would have 

been a little bolder in some of the things that they did with respect 

to health care. I believe this long-term liability is a bigger problem, 

for our country than even Social Security. Which takes me to my 

next point: Social Security. 

First of all, Senator Stabenow mentioned private accounts. Let 

us get it straight once and for all, these are not private accounts. 

This is not privatizing Social Security. They are similar to what we 

have in the Thrift Savings Plan. All Federal employees including 

Members of Congress and Senators, can participate in the Thrift 

Savings Plan. The plan is tightly regulated by the Government. It 

is not just my own personal Charles Schwab account that I can go 

out and do with whatever I want. It is very tightly regulated. 

I was just talking with someone who was down in Chile when 

they did this back in 1980. Chile transitioned much faster than we 

are talking about transitioning. Of all of the index funds that they 

have, not a single one of them since 1980 has ever lost money. 

They get a better rate of return. Even if you look at the public employee retirement systems that we have for our State employees 

across this country, they get a better rate of return. In my State 

of Nevada, since its inception, FERS has averaged an 11 percent 

return on their money over a 25-year period of time. That is not 

too shabby. Even if you take conservative numbers, 5 or 6 percent, 

that is a lot better than what a younger worker will get back under 

Social Security. Younger workers can expect a negative return on 

their money under Social Security. Even if you are optimistic and 

give them a 1.6 percent return it is nowhere near 5 percent. 

So looking at the long-term liabilities, and I think that Senator 

Crapo addressed this with you, that long-term liability offsetting, 

should be the bottom line. Let us ask what does the individual get? 

If the individual is getting more money, they are not getting cut. 

Whether it is from a private account or the traditional way that we 

pay out Social Security benefits. The bottom line is if the money 

is there, they are getting more money for it, that is a pretty good 

deal for the younger workers. That is why younger people in the 

United States are really excited about this. We protect older workers, put it in there, and I think that it can be a very good thing. 

Would you care to address any of those things that I mentioned? 

I just wanted to make some of these comments. You can feel free 

to comment on any of the things I just mentioned. 

Mr. BOLTEN. Thank you, Senator. I cannot improve on any of 

that. 

[Laughter.] 

Senator ENSIGN. Thank you. 

Chairman GREGG. Excellent questions. 

[Laughter.] 

Senator ENSIGN. I would like to find out more about one of the 

things that the Director talked about at the beginning. I think 

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235

ing or not. I would like to find out how that works. So if you could 

get us that and the type of metrics that you are using. I do not 

think that Congress is using very good metrics in a lot of the 

things that we are doing. If a program is not measuring up, we 

need to find out. To do that we need to find out how we are measuring, and not just the number of people going through. For example with a jobs program, are people just going through the program 

or are they actually getting jobs? I would appreciate the opportunity to learn more. 

Mr. BOLTEN. We would be grateful for a chance to brief you in 

detail and appreciate your interest in it, Senator. Thank you. 

Chairman GREGG. Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. I was sort of 

amused by Senator Sarbanes’ chart up there. I do not think it is 

entirely accurate. But I think what it does point out is that if we 

let these temporary taxes expire it will result in the largest tax increase in the history of this country. I just bring up the tax issue, 

and it seems to me that it has had a positive impact on the economy. We have heard millionaires sort of referred to, but you know, 

the small business sector, a lot of them have their value, farmers 

and ranchers have value that puts them over in the millionaire 

bracket, and they are the producers, but certainly they are the 

drivers of this economy, and I would like to have you just comment 

a little bit about what you have seen happen with the tax cuts and 

how it has motivated Americans to produce and how it has helped 

to sustain our economy. 

Mr. BOLTEN. Senator, the Council of Economic Advisers at the 

White House and the Treasury Department did a study about the 

effects of the tax cut, and they concluded that we today, or last 

year rather, had 3 million more jobs and 3–1/2 percentage points 

higher gross domestic product than we otherwise would have without those tax cuts. The first charts I put up during my presentation 

were charts about economic growth in this country and Federal 

revenues, which is my preoccupation, and I do not believe we would 

have had that strong economic growth in this country, and I certainly do not believe we would have had the resurgence of Federal 

revenues absent the strong economic growth that I believe is in 

large part a product of those very effective tax cuts. 

Senator ALLARD. How would you attribute Government spending 

to economic growth, think that helps any? 

Mr. BOLTEN. Most economists will tell you that Government 

spending, and particularly Government borrowing, is not as useful 

as money in the private sector, that when we borrow to spend 

more, that tends to be a net dissavings nationally for the economy. 

If I can just detour for a second into Social Security and point out 

one of the things I mentioned in my statement that we have not 

discussed much here, is that the creation of personal accounts, 

while it may require some additional Federal borrowing in the 

short run, does not have that same dissavings effect. It is neutral 

with respect to national savings because the money is being borrowed by the Federal Government to go into personal accounts 

which are savings. 

So it is very important that we restrain our Federal spending appetite to promote economic growth, but if people are concerned 

236

about the economic effect of creating these personal accounts, that 

is very different from additional borrowing to spend. The borrowing 

to create the personal accounts I think is in the long run actually 

a very good thing for this economy. 

Senator ALLARD. My time is starting to run out. One thing I did 

want to bring up is this, I think you have referred to it as PART. 

That is Program Assessment Rating and Priority Tool, and you use 

what we refer to as the GPRA, Government Procedures and Results Act to come up with a test. Can you kind of lay out a little 

bit how you used this assessment tool to decide which programs 

are performing and which re not, and maybe use some specific examples if you are prepared to do that? 

Mr. BOLTEN. Sure. The Program Assessment Rating Tool asks 

about 25 different questions. What we are trying to do is assess 

whether the programs on which we are spending money have clear 

goals, are they real Federal priorities, is the program being properly managed, and do we have metrics that make it possible for us 

to assess whether that program is actually performing. Then we do 

a review, using metrics, to ask, is the program actually performing? 

So we try to bring all those questions together in a relatively comprehensive and consistent way so we can compare programs, many 

of which have the same purpose, but do not necessarily have the 

same effect or the same kind of PART rating. As we put the budget 

together, one question we have asked consistently and are asking 

more and more as we put the budget together is, what is the PART 

rating on the program? Those ratings are and will be available to 

you as you make your own budgeting decisions, and you will see 

that many of the programs that the administration is proposing for 

reduction or elimination are programs with very poor PART ratings. 

Senator ALLARD. Are those ratings in the budget that was sent 

up to the Hill here? 

Mr. BOLTEN. I am not sure exactly which document the PART 

ratings appear in. It is in the document called Analytical Perspectives that you will see the actual PART ratings of the programs, 

but we are glad to provide additional detail on all of the programs 

that we have proposed for reduction or elimination, and you will 

see that many of them are based on poor PART ratings for those 

programs. 

Senator ALLARD. Thank you. 

Mr. BOLTEN. Thank you, Senator. 

Chairman GREGG. We appreciate your time, Director. There are 

only three of us left here, and I suspect that Senator Conrad and 

Senator Sarbanes may have a followup question. Am I right? 

[Laughter.] 

Chairman GREGG. But we are going to have a vote here, so we 

will limit those followup questions to 5 minutes too, and essentially 

the members here, those are the members who will ask the questions, and I will begin. 

I want to get back to this issue of tax policy because I look at 

these suggestions from the other side of the aisle, and basically 

what they are saying is, ‘‘Well, we just have to raise taxes to address the deficit.’’ Of course they also suggest spending money with 

the taxes they raise. And in fact, I had a chance to study some of 

237

the proposals of the nominee of the Democratic Party on this point, 

and he suggested that all you had to do was raise the taxes on the 

top 2 percent of American wage earners or top 10 percent of American wage earners, income brackets, not wage earners. And as a result, you would raise X billions of dollars. Then his proposals came 

forward, and he spent that plus another trillion dollars. So the debt 

would have actually increased by about a trillion dollars under the 

net effect of his proposals. So I guess we await the other side’s 

budget and we will look forward to their proposals and tax increases and their belief that the American taxpayer is under taxed. 

But there is also the economic impact. We were confronted with 

two rather serious events when this President became President. 

First was a recession which came out of the largest bubble in 

American history, probably the largest bubble in world history, 

even bigger than the South Seas Bubble or the Tulip Bubble for all 

intents and purposes. But we could have expected as a result of 

that bubble that we would have had an extremely severe recession, 

but we did not. One of the primary reasons we did not, I believe, 

was because we cut taxes at the beginning of the recession, which 

is classic economic reaction to recession, reduce taxes, give people 

more money to spend, create more economic activity, create more 

productivity in the marketplace, and it translated into a shallowing 

out of the recession, which is in turn, as we are now seeing, generating more revenue. You had a very interesting chart there that 

showed our revenues are now going up rather dramatically, projected to be 9.2 percent this year, 6.5 percent next year, 7 percent 

projected for the next year. Those are huge increases and jumps in 

revenue. We are headed back to what is basically the historical revenue of the Federal Government, which will be about 17.9 percent 

of gross national product with the present tax structure. 

So I guess my question to you is if you were to throw a new tax 

increase on top of this fledgling economy that is growing, this fledgling recovery that we are in, which is becoming fairly robust, would 

you not expect that that would have a fairly significant dampening 

effect on our economy, create job loss, probably in the end reduce 

revenues because you would see reduced economic activity potentially, or certainly slow the rate of growth of revenues? 

Mr. BOLTEN. Senator, I am in complete agreement. Our economists believe that a tax increase at this point would be very detrimental to the strong and stable growth that we are projecting out 

into the future. For our fiscal position, for the positive movement 

in our deficit picture, the most important thing, the most important 

element for ensuring that we continue to bring that deficit down 

is that we realize those relatively strong and stable growth numbers in gross domestic product the you see projected in our budget. 

We are projecting growth in the mid 3 to low 3 percent range out 

over the next 5 years, which is entirely consistent with blue chip 

expectations. We would not be able to project that growth if in fact 

we had a substantial tax increase which our economists believe 

would dig heavily into the economic growth, and as a result, dig 

heavily into the kinds of revenues we could expect to receive in the 

Federal Treasury. 

Chairman GREGG. I do not want to cut you short but I am running out of time here. The one major tax that needs to be extended, 

238

or one of the major taxes, but the one with the biggest number in 

this 5-year window—and I accept the argument that when you get 

outside the 5-years you have the rate issue and you have the death 

tax issue, but that does not have to be addressed this year. The tax 

that probably has to be addressed this year is the capital gains and 

dividends extension. Am I not right, but did not Microsoft just pay 

out a massive dividend of something like $32 billion, which actually 

increased Americans incomes significantly. It was a staggering 

event. Was that not almost purely a function of the fact that we 

cut the dividend rate back to 15 percent? 

Mr. BOLTEN. I believe it was, Senator, and there was an associated increase in gross domestic product as a result of that one-time 

event. I think it was .1 or .2 percent of GDP that was associated 

with Microsoft paying that one dividend which I believe was substantially the product of the dividend tax cut that you put into the 

law a couple of years ago. 

Chairman GREGG. So we do need to extend that. 

Mr. BOLTEN. I think we do need to extend it. It expires in 2008, 

so within this budget window, and the cost of extending that is 

fully reflected in our budget proposals. 

Chairman GREGG. Senator Conrad. 

Senator CONRAD. Thank you, Mr. Chairman. I am really glad you 

started this debate on economics, basic economics. This is where we 

really do have a disagreement about history and what happened. 

This is what CBO told us was the range of possible outcomes for 

deficits back in 2001 when the administration came in and had a 

projection of budget surpluses of 5.6 trillion dollars. CBO said this 

was the possible range of outcomes of budget deficits. Yes, pre-9/

11, this was the range of possible outcomes. You know, the CBO 

and the administration took the midline. That is what led them to 

believe there were going to be all these surpluses. I warned at the 

time betting on this was most unwise. 

Look at where we came out in terms of the deficits. I tell you, 

my colleagues on the other side of the aisle, let us revisit history. 

They told me at the time, ‘‘Kent, you are way too conservative. It 

is not going to be the midline because that does not take account 

of the tax cuts we are going to put in. The tax cuts are going to 

unleash this massive increase in revenue. The deficits are not 

going to be there at all.’’ I had colleague after colleague on this side 

of the aisle tell me, ‘‘Kent, there is going to be way more money.’’

Well, look what happened in the real world. Not a lot more 

money, a lot less money, the biggest deficits we have ever seen. 

Let us have a history lesson what happened with economics in 

the real world, not in some ivory tower world, in the real world. 

Back in the 1990’s President Clinton came into office. Here is 

where outlays were as a percentage of national income. Here is 

where the revenue was, had an enormous gap, had record budget 

deficits then, only eclipsed by the deficits we have now. And we put 

in a plan that reduced the outlays each and every year of the 5-

year plan, raised revenue, which according to what you have just 

said should have tanked the economy. What happened in the real 

world? Did the economy tank? No. 

We had the longest period of economic growth in our Nation’s 

history. We had the lowest inflation in 30 years. We had the lowest 

239

unemployment in 30 years. We had the highest period of business 

investment in the Nation’s history. That is with reducing spending 

and increasing revenues and eliminating deficits and eliminating 

the growth of debt, and stopping, which you acknowledged yourself 

earlier in your testimony, stopping for 2 years the raiding of Social 

Security Trust Funds to pay for other things, which would have 

meant, if that pattern had been continued, we could really have 

strengthened Social Security by prepaying the liability or paying 

down the debt. 

But those are not the choices that have been made now. Instead 

here is what happened to spending. We had a tick up, still well 

below the levels of the 1980’s and 1990’s. We had a tick up for 

three primary reasons: defense, homeland security, rebuilding New 

York, 91 percent of the increase. 

Look what happened to the revenue. The revenue collapsed. And 

you never mentioned the effect of the tax cuts on the revenue collapsing. That is half the reason for this collapse. The other is the 

economic weakness. 

But look where we are. Even with your forecast of where things 

head in the future with pretty strong economic growth, we have an 

enormous gap between the spending you advocate and the revenue 

you advocate. You have deficits that go on forever. Some of us believe that puts our economic strength at risk, that that hurts us, 

that that will inevitably threaten the United States’ position of economic strength in the world. You cannot borrow your way to 

strength. 

One other point I would want to make, I have a few seconds 

here. Our colleague from Nevada—I wish he was still here—said 

something that really struck me. He said you never lose money in 

these TSP like accounts. Whoa. I tell you, I have a lot of people 

on my staff are going to be surprised by that, because if they started in 2000 they have not made money. I tell you, I lost a lot of 

money in the TSP account, a lot of money, and so have a lot of 

other people. 

When he said this is all pork that is being cut, look, we have to 

have cuts, but this is a matter of choices. When you cut the COPS 

program 96 percent, you are cutting a lot more than pork. That put 

100,000 police on the street. When you cut the firefighters 30 percent, that is more than pork. I had the Republican Attorney General of my State come to me, Republican Attorney General, on the 

question of Byrne grants for law enforcement. I said to him, ‘‘You 

know, the claim will be it is pork. Is it pork?’’ He said, ‘‘Absolutely 

not. Those Byrne grants are essential to our war on illegal drug 

use, especially methamphetamines.’’

Well, I have exceeded my time, Mr. Chairman. 

Chairman GREGG. Thank you. 

Senator Sarbanes, for the last 5 minutes. 

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

Director Bolten, do you think that the increase in defense spending and the increase in homeland security spending contributed to 

the increase in economic growth in terms of stimulating the economy? 

240

Mr. BOLTEN. I suppose they may have, but money spent in the 

private sector, most economists agree, is a more effective stimulus 

to the economy. 

Senator SARBANES. That all depends. When yo do a tax cut, people are going to hold on to some of it. They do not spend it all so 

you do not get 100 percent infusion of that into the economy. On 

the defense and homeland security spending, just to take those two 

examples, you do get 100 percent infusion in the first round and 

then you get the multiplier effect thereafter. 

But in any event, even if I want to concede a little bit to your 

point, the difference is not very great. In other words, if I take 

someone who is making more than $1 million—and this is income, 

not wealth, as one of my colleagues said—it is good to hang around 

here so you can keep clearing up the misconceptions. Let us say I 

put a surtax on people making more than $1 million in order to 

fully fund the COPS and the FIRE grant programs, which were established before 9/11. They were not a response to 9/11. They were 

an earlier response to upgrade our police and fire fighters all across 

the country, and most observers think they have worked pretty 

well. I do not know the situation in my colleague’s State when he 

labels it pork, but I know the situation in my own State pretty well 

and that money has been put to very good use. 

If I take some of this money that the millionaires have and fund 

the police and the fire fighters, in a macroeconomic sense, I am still 

putting money into the economy, am I not? 

Mr. BOLTEN. Most economists would say not nearly as effectively 

as if you allowed people in the private sector to keep the money 

on their own, especially if the Federal Government is borrowing 

that money in order to make expenditures. 

Senator SARBANES. Of course you are borrowing it in order to do 

the tax cuts. Let us address that right now. You are borrowing in 

order to do the tax cuts. So there is no difference on that point. You 

say you are borrowing in order to do the spending. You are borrowing in order to do the tax cuts. Let us be clear about that. So 

the choice becomes, in terms of priorities, what is more important. 

And second, I would argue that in terms of the macroeconomic impact on the economy there is not much difference. 

Do you think paying unemployment insurance has a macroeconomic effect? 

Mr. BOLTEN. I am sure it does, Senator. But I think almost——

Senator SARBANES. Do you support it? 

Mr. BOLTEN. Sure. But I think almost all economists would agree 

that Government spending and Government tax cuts are not equal 

with respect to their effect on the economy. There is a much more 

stimulative effect to the economy from tax cuts. 

Senator SARBANES. I think they would also ask what are you 

spending the Government money on. 

How about Government spending for research and development, 

what do you think about that as an impetus to the economy? 

Mr. BOLTEN. It can be very positive. 

Senator SARBANES. It is very important, is it not, for the future? 

What about Government spending on education? 

Mr. BOLTEN. It can also be very positive. 

241

Senator SARBANES. The age cohort in this country that is most 

in poverty is our youth. That is a sad commentary if you are thinking about the future strength of the Nation. If you look at what 

other countries are doing that we are engaged with in global competition, they are putting a lot of resources into developing their 

human resources, the skilled labor force, which our people are 

going to have to compete with. 

So I think we need to strip away from this, first of all, the argument that, in terms of the overall impact on the economy, you do 

not get that both on the tax side and the spending side. Then you 

have to make the judgment, which is the better priority? What is 

your sense of priorities? What does the society need? 

I am frank to tell you, I would put as a higher priority educating 

our children or strengthening our fire and police forces ahead of 

giving large tax breaks to very wealthy people. That is what has 

happened. You gave these large tax breaks and you got a deficit 

out of it. 

Thank you. 

Chairman GREGG. Do you wish to comment on that, Director? 

Mr. BOLTEN. Mr. Chairman——

Chairman GREGG. Or would you rather leave? Which I can understand. You have been very generous with your time. 

Senator CONRAD. We do have more questions, Mr. Director. 

Chairman GREGG. You have been very generous with your time, 

and obviously there was a bit of rhetorical——

Mr. BOLTEN. I am always honored to have an opportunity to engage in dialog with the members. 

Chairman GREGG. We thank you for your time. We thank your 

staff for its cooperation with our staff. They have also been very 

generous with their time. 

Tomorrow we will convene here to hear Secretary Snow. 

Senator CONRAD. Mr. Chairman, might I just add a final word 

as well to the director and thank him for his courtesies? We have 

very real differences and it is important that we debate. Hopefully 

it never becomes personal, and it certainly has not. I have high regard for you as an individual and for your background. I just wish 

that you came with a different budget plan for the future. 

Mr. BOLTEN. Senator, I appreciate your courtesy and I know we 

are seeking the same objective if different paths. 

Thank you, Mr. Chairman. 

[The prepared statement of Mr. Bolton follows:]

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Chairman GREGG. Thank you. The hearing is adjourned. 

[Whereupon, at 12:10 p.m., the committee was adjourned.]

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(277)

THE PRESIDENT’S FISCAL YEAR 2006 BUDGET 

PROPOSAL 

THURSDAY, FEBRUARY 10, 2005

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

The committee met, pursuant to notice, at 10:04 a.m., in room 

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

Present: Senators Gregg, Domenici, Allard, Enzi, Bunning, Alexander, Conrad, Sarbanes, Murray, Stabenow, and Corzine. 

Staff present: Scott B. Gudes, Majority Staff Director; and Cheri 

Reidy. 

Staff present: Mary Ann Naylor, Staff Director; and Steve Bailey. 

OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

Chairman GREGG. We will convene the hearing. We appreciate 

the Secretary of the Treasury joining us today for a hearing on the 

President’s budget, and he is going to give us some insight on tax 

policy within the budget, and I suspect tax policy outside the budget, and maybe a little insight on the value of the dollar and a few 

other issues that may be of interest to the committee. 

My understanding is that the Senator from North Dakota has recovered from his recent slight illness, so we can also look forward 

to a wonderful presentation from the Senator, and we shall turn 

to his opening comments and then hear from the Secretary. 

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

Senator CONRAD. I thank the chairman. Mr. Chairman, I want 

to take just a moment and go back over some history I reviewed 

yesterday because I keep hearing things that I think are mistaken 

in terms of our economic history. 

This is the chart I wanted to refer to that shows the relationship 

between our spending and our revenue since 1980, and the red line 

are the outlays, the green line is the revenues. The last time we 

had a huge gap, major budget deficits, was in the previous Bush 

administration. You can see outlays were running 22, 23 percent 

of gross domestic product. Revenues were varying between 17 and 

19 percent, so we had that gap, and that gap is what created the 

deficit and increases in the debt. 

Then in 1992 President Clinton was elected and a 5-year plan 

was passed that reduced outlays as a percentage of gross domestic 

product, as a share of our national income, and increased revenue. 

Some of our colleagues, in fact on the other side most of our colVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00283 Fmt 6601 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
278

leagues said at the time this set of policies would crater the economy. It still rings in my ears, Senator Dole’s final speech, that increasing taxes is going to crater the economy. We can go back 

down, check the record and see what in fact happened. It did not 

crater the economy. It set off the longest economic expansion in our 

Nation’s history, the lowest unemployment in 30 years, the lowest 

inflation in 30 years, the strongest business investment expansion 

in our history. 

How can that be? How can it be if you are reducing spending and 

raising taxes that the economy strengthens? One key reason is the 

other part of policy that affects the economy. That is monetary policy under the control of the Federal Reserve Board. Because the 

Congress and the President were being responsible on fiscal policy, 

the Federal Reserve was more accommodative on monetary policy, 

and that helped us grow. We even had 2 years where we were not 

only in balance, but we stopped using Social Security Trust Fund 

money for other purposes. 

Then we ran into 2001, the recession, and of course the horrible 

attack, and the response was a plan of tax reductions and of course 

spending increases mostly for defense and homeland security. You 

can see the increase in spending, the reduction in revenue. About 

half of the reduction was tax cuts, about half of the reduction was 

because of economic slowdown and other factors. 

Tax cuts, without question, were an important thing to do. Now, 

we had a great difference about how big the tax cut should be, who 

it should go to. We had great disagreements about that. We also 

had disagreements about how long lasting they should be in light 

of our long-term fiscal imbalances. But I want to make clear I proposed almost a trillion dollars of tax relief at the time to give a lift 

to the economy. 

The problem that I see with the President’s policy is there is no 

closing of this gap going forward. The spending line remains well 

above the revenue line under the President’s projections, under 

CBO’s projections, under the blue chip forecasters’ projections, and 

I do not see any plan by the administration to close this gap. What 

strikes me as most dangerous about this is this gap which constitutes a deficit, which means the debt is growing because it is 

happening at the worst possible time. It is happening right before 

the baby boomers retire, and that is going to dramatically increase 

pressure on the Government. 

So my own reading of this history is that we have to work on 

closing this gap, and we have to work on the spending side of the 

equation, you also have to work on the revenue side of the equation, and I do not see any proposal from the President, none, to 

deal with the revenue side of this equation. 

I hope, Mr. Secretary, we can address this as we get into your 

remarks. 

I thank the chair. I look forward to the testimony of the Secretary and we welcome you to the committee. 

Secretary SNOW. Thank you. 

Chairman GREGG. Thank you. 

Senator DOMENICI. Mr. Chairman, could I just ask you a question? 

Chairman GREGG. Certainly. 

279

Senator DOMENICI. I am not going to ask him a question. That 

is your job. Is there any way to answer that or do you want to wait 

until my turn? 

Chairman GREGG. Why do we not wait? I know the Senator from 

North Dakota tends to get juices fired on our side, but we did come 

to hear the Secretary of the Treasury. I am sure he will have some 

ideas on what the Senator from North Dakota said. He always 

manages to get us thinking, usually with enthusiasm. 

[Laughter.] 

Senator DOMENICI. Mr. Chairman, I am enthused. The reason I 

will not push you is that I just wanted to make sure that there was 

continuity. He presented one side, and there is a hole on the other 

side, and I did not want it to get away. 

Chairman GREGG. We are going to let the Secretary talk about 

that, and I am sure in our questions, to the extent we feel that the 

Senator from North Dakota needs response, we will do that too. 

Senator DOMENICI. Thank you. 

Chairman GREGG. Mr. Secretary, thank you for coming, and 

thank you for your presentation today. 

STATEMENT OF HON. JOHN SNOW, SECRETARY, DEPARTMENT 

OF THE TREASURY 

Secretary SNOW. Thank you very much, Mr. Chairman, Senator 

Conrad, members of the Budget Committee. It is always a pleasure 

to be up here with the Senate Budget Committee, engage on a dialog with you on these critically important issues that come before 

the committee. 

Let me say that this year I am pleased that the American economy is doing a lot better than it was a year ago at this time. We 

just got the news this morning that the U.S. jobless claims fell to 

a 4-year low. That is good news, 303,000, lowest in 4 years. Of 

course that is on top of the good news about the GDP coming in 

at 4.4 percent for the year; the 2.7 million additional jobs; productivity remaining strong; exports getting stronger—we need to close 

that gap—but exports are getting stronger; home ownership at an 

all time high; net worth of American families, household wealth at 

the highest in history; unemployment rates fallen down to 5.2 percent. 

Mr. Chairman, we have made a lot of progress with the American economy, and I think it is undeniable that lower tax cuts that 

the Congress made available through the Jobs and Growth Bill lie 

at the center here of this good recovery we are enjoying. It is a recovery I would note that we are enjoying without inflation. We still 

continue to have a very benign inflation environment with mortgage rates low, with interest rates low, and of course interest rates 

tend to follow inflation. The low interest rates reflect I think the 

competition that is in the American economy and the high productivity that is in the American economy, conditions we want to make 

sure continue. 

The President’s budget also recognizes the need for fiscal discipline. It is a budget that calls for continuing focus on reducing 

the deficit, and calls for cutting the deficit in half over the budget 

window, taking it down to well below 2 percent. As Senator Conrad 

knows, as an expert on those numbers, the historic average of the 

280

deficit is about 2.2, 2.3 percent of GDP. The plan we have is to 

bring it down to well below 2 percent, so low by historical averages. 

I would agree with the Senator the real issue is those outyear 

numbers that are driven by unfunded mandates, by Medicare, Medicaid and Social Security, which is why the President has put Social Security front and center, proposed that we make it a legislative priority for this year, as he said in the State of the Union message. The system is unsustainable. The sooner we get to it, the 

sooner we address it, the easier the answers will be and the better 

the retirement outlook will be for younger people. Remember, we 

are reducing a huge overhang liability on the American economy, 

the 10.4 trillion dollars that the actuary of the Social Security system has identified as the unfunded obligation there, an unfunded 

obligation that grows according to the actuary at about 600 billion 

a year. So I agree with Senator Conrad. We need to be thinking 

about these longer-term deficits. They are driven by the unfunded 

mandates, by Social Security and by Medicaid and Medicare. Those 

are the really big issues for the future of our country. I have seen 

comments you have made, Mr. Chairman, on that subject as well, 

with which I want to be identified. We clearly need to find answers 

to those problems. 

In the course of today’s hearing I hope to offer some thoughts on 

that in response to your questions. We know that deficits matter. 

We know that the current deficit levels and the projected deficit 

levels are too high. There are really only two ways to deal with 

deficits. One is grow the revenues, the receipts of the U.S. Government. To do that we have to keep the economy growing and expanding. That is where a low tax environment I think is very helpful. We see now that revenues are coming up. So far this year they 

are up about 10 percent over last year year-to-date receipts. That 

is a direct reflection of the fact the economy is growing, expanding, 

jobs are being created, businesses are more profitable, because 

when that happens of course the Government gets a bigger take, 

they get more receipts. But I will agree with all of you that that 

alone is not enough. Growth will not get us out of this problem. We 

also have to focus on spending. 

The President has sent up a disciplined budget to the Congress, 

one that constrains spending. Yes, the budget increases in the military area, and yes, it increases in homeland security. Those are national priorities that need to be funded. Outside of those areas you 

will see that the President’s budget is very, very tight, many will 

say too tight. They said that last year. In fact, I recall last year 

testifying up here. The comments, not from the committee, but the 

comments in the media were: this budget is dead on arrival. Well, 

you did not adopt every line item of the President’s budget, but 

Congress came out with a number that was right in line with the 

President’s number, and I commend you for that. We do not expect 

every line item in this year’s budget to be adopted either as sent 

up. You have your work to do in the Senate and in the House, but 

we would hope that you could stay in line with those overall numbers. That is what happened last year, and of course we came in 

with numbers last year that were well below the projections. I 

would hope that might even be, might be able to do that again this 

year. 

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But in any event, growing the economy, sustaining high rates of 

growth, and that is where low tax environment counts, and discipline on the spending side are the critical components of finding 

the answer, Senator Conrad, to the gap between those lines that 

you showed on that chart. 

Mr. Chairman, I thank you very much for the opportunity to be 

here, and look forward to responding to your questions. 

Chairman GREGG. Thank you, Mr. Secretary, and I appreciate 

the points you have made, and I think they are good and they 

should be reinforced. The main point of course is that this administration is addressing and has been willing to step forward on the 

long-term structural problems which we face as a society, which is 

the entitlement spending issue. 

The President has, you may not agree with his positions or the 

colleagues on the other side may not agree with it, but he has 

stepped forward and put Social Security on the table for discussion. 

I regret that our colleagues across the aisle—and I am not speaking here about the Senator from North Dakota because he has been 

an exception—but that the leadership from across the aisle, especially the House leadership, has said there is no problem and that 

they are not going to address the Social Security issue because 

there is no problem. 

The President has also been willing to step forward on the entitlement questions with a Medicaid proposal. I will be interested to 

see how many colleagues from the other side of the aisle decide 

that they are willing to address that huge health care question, 

which is how we pay for health care in the outyears and next year 

in the Medicaid area. It is a big question that needs to be addressed. The President has also taken on the sacred cow of agriculture subsidies. So the President has stepped forward on the entitlement side, which is critical. I am hopeful that we will also review Medicare at some point, but I can understand that the administration wants to allow its Medicare proposal to run a little bit 

here, at least startup before we get back to that issue. 

On the discretionary side again the administration deserves to be 

congratulated because you have made the tough decisions. You 

have sent up a budget which is stringent, which gores everybody’s 

ox, including the defense base, and we are hearing of course from 

defense contractors across the country about their concerns about 

defense spending. The budget is very responsible on the spending 

side of the ledger. 

On the tax side of the ledger, I guess my questions would be, 

since you are the Secretary of Treasury, what would be the practical implications in this fledgling recovery, which is now getting to 

be fairly robust of increasing taxes? Was the fairly severe recession 

alot less severe because of the tax cuts? 

Secretary SNOW. Absolutely, Senator, absolutely. 

Chairman GREGG. What would be the effect of putting in place 

a major tax increase on small business in this country today, and 

especially small businesses which generally create jobs? 

Secretary SNOW. Senator, I will not surprise you by my response. 

I think it would be a terrible mistake. The lower tax rates the 

small businesses are enjoying through the expensing provisions 

and through the lower marginal tax rates, because so many of 

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them pay their taxes through the ordinary income tax system as 

subpart S organizations. You would raise their tax rates significantly, and if you raise the tax rates of small businesses, they are 

going to be far less inclined to expand and to grow and to hire, and 

of course they do an awful lot of the hiring in the United States. 

Two out of three new jobs come from small businesses. I think it 

would be a terrible mistake. 

Chairman GREGG. So when our colleagues from the other side of 

the aisle subscribe to the policies of Senator Kerry, who during his 

Presidential campaign suggested that the way you solve our budget 

problem is to significantly increase taxes on high-income Americans, as he described them, which are for the most part small businesses in those top brackets that are practicing as subchapter S 

corporations, and then of course he put in place another trillion 

dollars of spending on top of whatever he would have raised in revenue, so he would haveten a negative number anyway. But independent of the negative number that his proposals would have created in the deficit situation, the tax policy of dramatically increasing taxes on small businesses through a increase of marginal rates 

aimed at the top two quadrants of the marginal rates would have, 

in your opinion, a negative impact on economic growth and therefore cost jobs and reduce revenues probably in the long run? 

Secretary SNOW. Yes, Senator, absolutely. I think it would be a 

wrongheaded decision. It would surely reduce small businesses’ 

ability to invest in their businesses, and what creates jobs is small 

businesses investing in growing. Behind every job is some investment that somebody has undertaken. Roughly, it is $100,000 of investment behind every job. Small business will only invest when 

they see good returns, and lower tax rates mean higher returns for 

those investments. 

Chairman GREGG. We will look forward to the other side putting 

forward their budget with that type of a tax increase, and then we 

can have that debate. 

The one tax increase which clearly will occur if we do not take 

action in this 5-year window is the 15 percent dividend rate and 

the 15 percent capital gain rate will jump back up. I guess I would 

like to get your thoughts on that specifically in relation to an event 

which happened I guess about 3 weeks ago, where Microsoft paid 

out the largest dividend in the history of the country, I think something like $32 billion, which yesterday I believe Director Bolten 

said created more than a 0.1 percent jump in the GDP of the country, and meant that literally hundreds of thousands if not millions 

of Americans, who have investments, who work on the line at the 

UAW and have their UAW funds invested in Microsoft, or who 

work at a small restaurant and have their 401(k) invested in 

Microsoft, millions of Americans saw their income jump as a result 

of that dividend distribution, which was done as a proximate result 

of the reduction of the rate to 15 percent, which put Microsoft in 

a position where they felt that sort of dividend was appropriate. 

I would be interested in knowing what your feeling is about first 

what happened as a result of the dividend cut to 15 percent, and 

then also the capital gain cut. How much have we seen revenues 

jump as a result of that cut? And then what will happen if we do 

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not extend those two tax cuts, which clearly the other side of the 

aisle appears to be resistant to? 

Secretary SNOW. Senator, I think the evidence here is pretty 

clear even if it is hard to quantify fully. Both the reduction in the 

dividend rate and the reduction in the capital gains rates have affected behaviors. We see that in the fact that not only Microsoft but 

many more companies are now paying higher dividends than was 

the case before. As a former CEO who wrestled with the question 

of the amount of dividends to pay out and whether to raise dividends or reduce dividends, the question always was: is this a tax 

efficient way to reward shareholders? When shareholders had 39.6 

percent marginal tax rates, paying them a dividend at that tax 

level always met resistance from the finance people in the company 

and from others, even stock analysts, saying that is a very tax inefficient way——

Chairman GREGG. If you could explain that for a second because 

I think it is important to the extent—I know everybody at this 

table understands it, but the fact that dividends when they are distributed have already been taxed once, and maybe you could explain that just so people understand it. 

Secretary SNOW. Sure, Senator. The argument behind the President’s initial proposal was that it is appropriate to tax income once, 

but once is enough. As an investor in a company you are looking 

for dividends. You are looking for appreciation too, but one form of 

income you would like is dividends. Before the company can pay 

you a dividend it has to pay a tax on its corporate income, and then 

the dividend is paid out of the after tax corporate income of the 

company. So by the time you get your dividend it has already been 

taxed at the corporate level. 

The proposal that the President sent to the Congress last year 

you will recall was once is enough, let us not have that second tax 

on the dividend. If it has been taxed at the corporate level, then 

it should not be taxed at your level. While that did not carry the 

Congress, what did carry the Congress was I think a very thoughtful proposal to reduce the dividend rate to 15 percent. Many people 

were paying 25 percent, 30 percent, 35, 39 percent tax rates on 

their dividends. If you were paying 35 percent tax rate, personal 

tax rate, you got the dividend after the company had paid their 35 

percent, you can see that ends up being a very high marginal tax 

rate, 35 at the company, 35 at the individual, 70 percent tax rate 

on the dividend, which is why I say in the old tax environment 

prior to the Jobs and Growth Bill, executives would, in response to 

shareholders’ requests for more dividends, would often say: Mr. 

Shareholder or Mrs. Shareholder, that is a very tax inefficient way 

for us to distribute the earnings of this company to you. 

Today, because of the action of the Congress, it is far less tax inefficient. That is the basic point. 

And the same with capital gains. It should come as no surprise 

to anybody that the stock market did a nice pickup in 2003 subsequent to the time it became clear the dividend tax and the corporate gains reductions would be part of that legislation because 

the earnings of companies are now worth more in the marketplace 

since they are not taxed as highly. They are not discounted as 

much by taxes as once was the case. So the market puts a higher 

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multiple on the outlook for the company, and that takes the marketplace up. We saw I think in 2003 roughly a 30 percent increase 

in equity values, and last year about a 10 percent increase in equity values. 

Senator I would assert that there is a direct relationship between 

the improvement in equity values and the market performance and 

the lower tax rates on corporate earnings through the dividend and 

capital gains that you made available. 

Chairman GREGG. Thank you, Mr. Secretary. 

Senator Conrad. 

Senator CONRAD. Mr. Secretary, should we cut taxes another 25 

percent in your judgment? 

Secretary SNOW. I would not recommend that at this point. 

Senator CONRAD. Why not? 

Secretary SNOW. Because I think at current tax rates we are on 

a path, as your charts show, to bring the revenue stream back up 

to its traditional roughly 18 percent. It seems to me we should be 

able to fund this Government with a revenue stream of about 18 

percent of GDP which is the historic average. 

Senator CONRAD. Mr. Secretary, you mentioned in your opening 

statement that the deficit is going to get cut in half under the 

President’s plan. Is that correct? 

Secretary SNOW. Yes. The plan is to reduce it to about 1.7 percent of GDP by the end of the President’s term, which would be 

more than cutting it in half. 

Senator CONRAD. Of course that gets into a question of what the 

goal is, and is it in dollar terms or percentage GDP. But without 

getting into that, let me just tell you why I think that misses the 

mark. When I looked at 2009 here is what I see. The President is 

saying in his budget he is going to reduce the deficit to $233 billion. But he leaves out the money he is taking from Social Security 

itself. In that year alone he is going to take $242 billion of payroll 

tax money that was meant to strengthen Social Security and he is 

going to use it to pay for other things. 

Back in the 1980’s there was virtually no Social Security surplus 

to use in that way, so these historical comparisons have a big disconnect, and the big disconnect is in the 1980’s a Social Security 

surplus in any 1 year was not in the billions, it was in the hundreds of millions. Now the Social Security payroll taxes were increased to prepare for the retirement of the baby boom generation, 

the Social Security surplus in that year is going to be $242 billion. 

Under the President’s plan he is going to take all of it, not going 

to use it to strengthen Social Security, he is going to use it to pay 

for other things. CBO tells us the residual war cost in that year 

is going to be $55 billion, so that is not counted. Costs, according 

to CBO, to fix the alternative minimum tax, the old millionaire’s 

tax that is rapidly becoming a middle class tax trap, is $54 billion 

in that year, and none of that is in the President’s budget. 

So what is going to get added to the debt that year? And it is 

interesting how the focus has been on deficits. There has been almost no focus on what is happening to the debt. The debt is going 

to increase that year, not by the $233 billion of deficit that the 

President is asserting, but the debt is going to increase by $584 billion. When we are running massive budget deficits and having 

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masses increases in the debt, and at the same time we have huge 

increases in our trade deficits, those twin deficits are requiring us 

to borrow staggering amounts of money and from all around the 

world. 

Let me ask you this. In your judgment, does this increase in foreign borrowing, which by the way, just during this administration 

has increased 91 percent, increase in foreign borrowing has increased 91 percent, does that concern you at all? Here is the increase. We had four holdings of U.S. debt in January 2001, just 

about a trillion dollars. It has gone up to almost 2 trillion in just 

these few years. 

Secretary SNOW. No, Senator. Those are the numbers. There is 

no arguing with them. What those numbers reflect, of course, is the 

fact that the American economy has been doing well relative to 

other economies, and as a result, we are importing more from those 

other economies, because we are developing more disposable income than they are relatively, and we recognize the issue there. I 

think the answer though is three things basically. One, we have to 

reduce our own dissavings through attacking the deficit problem 

you are putting on the table and the chairman is putting on the 

table and all of you are putting on the table, because our dissavings contribute to that problem. We need to improve national 

savings. 

Second, it sure would be helpful if Europe and Japan and our 

trading partners would grow faster because if they would grow 

faster they would create more disposable income and be able to buy 

more from us. We are working with them on suggesting what they 

might be able to do, encouraging them to adopt growth policies. 

The third piece of the answer I think is getting the Chinese to 

move toward—and this is a matter I have discussed with a number 

of you privately—the Chinese to move to greater flexibility in their 

currency, so that their currency reflects market values rather than 

some arbitrary determination on what the exchange rate would be. 

We are pushing all of those initiatives, Senator, but of course that 

is a matter we continue to monitor and monitor very closely, the 

current account deficit. 

Chairman GREGG. Senator Domenici. 

Senator DOMENICI. First, thank you, Mr. Chairman, and also I 

want to thank you for your analysis of the President’s budget and 

the situation right now. 

Just two observations before I ask a couple of questions. I do not 

have time to give the counter arguments to what the distinguished 

ranking minority member suggests has happened in the last 7 or 

8 years or 10 years, including the Clinton administration’s growth. 

Suffice it to say that there is an indication on the part of Democrats that this big era of growth that occurred that yielded the increase in tax revenues that he showed came because they increased 

taxes and from increasing the tax under the IRS. I think neither 

are true. I do not think very many people believe the tax increase 

caused the great growth. I think it was going to happen, and it had 

already started, and maybe it pushed it a little just because it affected the attitude of the investing community. Certainly tax increases do not account for what happened. Something else caused 

it to happen. In any event that is one observation. 

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Second, the big growth during that period that brought in all the 

revenue. I was there. That is how we balanced the budget, Senator, 

we had a big tax growth, unexpected revenue to the Treasury. That 

happened for two or three reasons. It happened because of capital 

gains that were occurring because of this huge stock market bubble. There is no question about that, and all the actions surrounding it brought these incredible revenue surges. Those revenue 

surges were not singly because of the growth, they were because 

of this very different set of economic facts regarding securities, regarding equity. I do not know if we will ever have that again so 

we are not going to get the benefit of that situation. 

Second, my analysis is that looking at the long term, the biggest 

problem we have is that we are kidding ourselves if we think we 

can afford the cost of health care. Everything else pales as you look 

at the outyears, the future of America. When you look at the expected medical benefits that the American people perceive, they are 

almost so big when added to the private sector expenditures for 

health care, that most of our productivity will go to taking care of 

ourselves. I have been thinking that the time will come when you 

walk down the street, Senator Alexander, and you can say ‘‘Hello,’’ 

and every third person you can say, ‘‘Thank you for taking care of 

my health,’’ because that is how big the cost will be. 

I am very concerned because our colleagues on the other side 

criticize the President while they know that their position is that 

we should not do Social Security and we should do Medicare. 

Maybe they ought to do Medicare. I have not seen any plan to reduce health care costs coming from the other side. Second, very 

simply, if they think we ought to increase taxes to take care of this, 

that is a simple proposition. They do not have to wait for us to do 

it. We are going to mark up a budget. Why do they not propose increasing taxes to show us that that will fix the budget? I would like 

to see the proposal and I would like to see how much it is. It would 

be very interesting to analyze its effect on America’s growth. 

Having said that, I want to ask you if you have done any studying about energy and energy prices and America’s energy problems 

as it relates to our economic growth? I guess specifically, would you 

tell the committee what you project prices to be for major energy 

components during the next 5 years? Do you have that estimate as 

part of your Treasury analysis? 

Secretary SNOW. Senator, we do not do those projections. To the 

extent they are done, they would be done by the Energy Department. The new Secretary there, Sam Bodman, comes from Treasury. 

Senator DOMENICI. I understand. 

Secretary SNOW. He had been the Deputy. But I defer to Secretary Bodman and the Energy Department on those projections. 

I would say though that one of the striking things about the 

American economy, its flexibility and its dynamic qualities is how 

we have come through the energy shocks of the last year. If anybody had told you we would be living with $50 a year oil, you 

would not have forecasted 4.4 percent growth rates, and clearly 

those high energy prices have taken a toll on the growth rates, and 

yet we have plowed right through it. That is a testimony to the inVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00292 Fmt 6601 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
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herent strength of this economy, its flexibility, its adaptability, and 

I think again, for the low tax rates. 

Senator DOMENICI. Mr. Secretary, we understand that, but that 

is almost stopped. That occurred because the changing nature of 

what caused productivity gains here. We used new equipment and 

the like which used less energy. I do not know if that is going to 

continue, but could you supply us, wherever you get it, with the 5- 

and 10-year projections on what you assume in the budget on energy. Will you answer in that what you assume energy, the condition of the energy market, what impact it will have on the American economy? Could that be an answer, would it have a drag, and 

if you can find out how much of a drag, we would like to know that. 

Secretary SNOW. We do know that higher energy prices are a 

drag. They act like a tax. 

Senator DOMENICI. Would you put that together with the other 

information? 

Secretary SNOW. We will, absolutely. 

Senator DOMENICI. Thank you, Mr. Chairman. 

Secretary SNOW. Senator, if I could just make a comment on your 

earlier observations, because I think you helped frame the 1990’s 

well. Most economists were surprised by the growth rates in the 

1990’s, and it was a nice time to be Treasury Secretary or in that 

case President of the United States, because there was this surge 

of revenues that had not been anticipated. It came from technology. 

It came from productivity increases associated with technology that 

drove equity markets and created a stream of revenue that could 

not have been anticipated. It is unrealistic to think that we are 

going to have a 21.6 percent revenue receipts level and sustain 

that. 

So I would agree completely with you it was an unrealistic number, it was an unforeseen number, and it was an unsustainable 

number due entirely to the fact that we had the bubble. The bubble 

created a huge amount of capital gains and options returns, returns on options that raised the Federal income stream. That is not 

a sustainable situation. 

Senator DOMENICI. Mr. Chairman, I understand your properly 

presenting the growth in tax receipts, as you have shown, that is 

correct. All I am saying is that if you look at the years we balanced 

the budget, that was not 10 percent growth in taxes like you described, it is much, much more, and I was trying to say that did 

not come from tax increases. It came from something phenomenal 

happening in the economy that you are not going to have while you 

are chairman, because there is a different ambience out there. 

Chairman GREGG. Senator Stabenow. 

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

Snow, welcome. 

Mr. Chairman, I would hope that we might have an opportunity 

at the Budget Committee just to really talk about economics and 

what grows the economy. I think there is an honest and serious 

discussion that we can have about supply side economics versus 

supply and demand, and I think there is a very big—there is just 

a philosophical difference between one side of the aisle and others 

in terms of whether it is supply side, everything is focused on the 

top and it trickles down, or whether you need a balanced economy 

288

with supply and demand. Personally, I think to bring us back to—

and I do have a question for you, Secretary Snow—but to bring it 

back to where we were, 2001, the highest budget surplus in the 

history of the country, 4.6 trillion projected, now the highest budget 

deficit in the history of the country using predominantly a strategy 

of a supply side tax cut for the majority of that, understanding 

there were other costs. I think that pretty much basically starts 

with speaking for itself about where we are. 

I had a gentleman, an investment banker, very wealthy, in the 

country, say to me yesterday he wanted to convey, to please convey 

to my colleagues that while he appreciated the huge tax cut he received, he knows he is going to pay for the deficit plus interest as 

well as the other investments in education and science that will be 

eliminated that we need to grow the economy, and he said thank 

you very much, please do not do that, let us have a more balanced 

strategic approach about how we do this. 

When we talk about how we address jobs, I would just say a couple of things. One, a transportation bill like we passed on an overwhelming bipartisan basis a year ago in the Senate would create 

more jobs immediately than anything else we could do. 99,000 jobs 

are created for every one billion dollars spent. So I hope you will 

look at that. That is the demand side. Money in the pocket, good 

paying jobs for people who are customers of the businesses we all 

want to succeed. 

Second, the No. 1 issue I am hearing from businesses is health 

care, which I do not know how in the world we address with these 

huge deficits we have. If my businesses had one request of us, 

whether it is the Big Three auto makers or whether it is small 

businesses, or seniors, or workers for that matter, it would be lower 

my health care cost. 

And second, I am pleased to hear you talk about China and what 

is happening in terms of manipulating their currency because the 

second thing my businesses, particularly small and medium size 

businesses say to me, is level the playing field, enforce the rules 

on trade, and stop China from what they are doing. 

Move to Social Security where my question is, and I would love 

for us to have a chance to really debate what I think are on the 

economy, serious and honest differences about how to approach economic growth. 

Chairman GREGG. I think that is called when the budget hits the 

floor. 

Senator STABENOW. Yes. Well, even in the committee though, I 

think that would be a good thing to do. 

On Social Security, a couple of things. One, I feel compelled to 

go back. You were talking about unfunded mandates in passing 

Medicare, Medicaid. Just to remind all of us, Social Security is not 

an unfunded mandate. I pay in, you pay in, everybody pays in to 

an insurance plan that they expect to be there at retirement. The 

baby boomers have paid in more on purpose so there would be a 

surplus there. This is something people pay into and they own, it 

is not general fund dollars. And they expect it to be there, and that 

is our job, to make sure it is there, working together. 

When we look at privatization, and most people today, many people would agree that privatized accounts do not do anything to 

289

lengthen the trust fund. It is a philosophical difference but it does 

not do anything to meet the gap in 2042 or 2052. When we talk 

about how those would work, I think it is important to have a discussion even though we know all the details are not there. And I 

would ask you to followup on a comment that you made in response 

to a question in the House Ways and Means Committee earlier this 

week concerning what has been called the clawback or the privatization tax, as we would call it, where you indicated that that exists, that this clawback or payback exists. And you said if retirees 

earned less than 3 percent on their privatized account, they would 

do worse, but that is very unlikely. 

So in fact this process is being talked about in terms of people 

not getting the full value of what has been put into the account, 

and in fact we are being told that what is being looked at is that 

a retiree would have to earn 3 percent plus inflation, which is 

about 5.7 percent, before they actually would see any benefit to the 

account. I would, in simple lay person’s terms say, that is like giving my daughter, who is 25, $1000 for retirement; she moves forward and invests it. At retirement I say, ‘‘I want the $1,000 back 

plus 5.7 percent of your investment earnings. You get everything 

on top of that.’’ Is that a good deal? 

Secretary SNOW. Senator, let me address your question here. 

First of all, the Social Security system is not on a path where it 

can pay your daughter the benefits that it has promised. 

Senator STABENOW. I would only interject, with all due respect, 

it is also not going bankrupt, and the differences we certainly on 

a bipartisan basis want to work to fix. 

Secretary SNOW. I appreciate that and we should. But it is going 

bankrupt in the sense that a company goes bankrupt if it has obligations that it cannot cover. In that sense, which is the meaning 

of bankruptcy under Chapter 11 of the U.S. Code, or Chapter 7, it 

is going bankrupt because it cannot meet the future obligations. 

The idea of fixing it now is we can restructure it, we can modernize, we can put it on a sound financial footing at a lower cost 

than if we wait for what President Clinton called ‘‘this looming crisis’’ comes in on us. 

Senator STABENOW. Secretary Snow, there is no disagreement 

with anybody on this. We have good faith discussions going on 

about how we make small changes now that have big impacts 40 

or 50 years from now. It was certainly done in the 1980’s when it 

was more imminent. I think the real question is, overwhelmingly 

we hear evidence that the privatized accounts are really about a 

philosophical change. It really does not—you are mixing the two together. It really has nothing to do with what do we do about the 

gap. It is about wanting to change to a privatized system. And my 

question to you would be, why is that a better deal for people, 

when (A) it puts an individual’s dollars more at risk, requires them 

more to administer the accounts. They may not be better off. And 

essentially it begins to dismantle an insurance system. In a way it 

is kind of like if I put in a proposal say with my car insurance, instead of having the insurance company get the full premium I pay, 

I want to take two-thirds of it and put it in a private account. If 

I never have an auto accident, I am going to keep it. I do not think 

the insurance company would appreciate that. 

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Chairman GREGG. Senator, why do we not let the Secretary answer that question. Then I am going to have to move on. 

Senator STABENOW. Thank you. 

Secretary SNOW. Senator, what I can say I think without any 

fear of contradiction is that under a system of properly constructed 

personal accounts, the beneficiary will do better than they will 

under the current Social Security system. Your daughter will do 

better by being able to take some part of her payroll taxes and put 

it into these personal investment accounts, and use her working 

years to see those accounts grow. No less than the General Accounting Office rendered the judgment here that across cohorts, 

and I am just going to quote them, ‘‘Across cohorts,’’ meaning the 

various age groups retiring, ‘‘median monthly benefits of those 

choosing accounts are always higher despite the benefit offset than 

for those that do not make the choice.’’ And the gap, the difference, 

grows over time. Over any period of time these investments will do 

well and do better than the return you could get on the moneys 

going into Social Security. 

I appreciate your comments. We really do want to work with you 

and your colleagues to find some answers here, and I appreciate 

your sentiments that something needs to be done. 

Senator STABENOW. I would just say—and I know my time is up, 

Mr. Chairman—just that in looking at the numbers being used for 

people to be able to benefit from private accounts, it actually raises 

enough money that ironically the Social Security fund, where if we 

were growing at that rate, there would not even be a gap. So there 

are a number of questions we need to address. Thank you. 

Chairman GREGG. I think it is also important to stress that the 

personal accounts the President is proposing are optional. 

Secretary SNOW. Entirely optional. 

Chairman GREGG. And voluntary. 

Secretary SNOW. Entirely voluntary. 

Chairman GREGG. Senator Alexander. 

Senator ALEXANDER. Thank you, Mr. Chairman. 

Mr. Secretary, thank you for coming this morning. I would like 

to step back a little bit and ask you about competitiveness, how we 

keep our jobs in the world marketplace and how this budget affects 

that because my sense is if there is a point person in the administration on competitiveness, it might be you. I would like to approach it this way. If I had to think of what the great challenges 

that face us are, one would be terrorism, one would be competitiveness and one might be preserving our common culture. When we 

talk about competitiveness, we have talked a lot about taxes here, 

and I am big for low taxes. Our State had the lowest taxes, and 

I voted for tax cuts. And I will vote for them again. 

But if all we had done since World War II is cut taxes, we would 

not have a third of all the money in the world today for 5 or 6 percent of the people. We did a lot of other things. We created a telecommunications system, an interstate highway system, and perhaps the most important think we did was focus on brain power. 

We created the 50 greatest research universities, 20 Federal laboratories, this remarkable system where 60 percent of our students 

have grants and loans to help them go to college. And the President has a pretty good record on that, the President and the last 

291

two Congresses I mean. Pell grants are up 50 percent. There has 

been a doubling of funding for research for NIH. 

But my question is this: we have a real challenge here just as 

we did on terrorism, and on terrorism we looked around the Government and we saw that intelligence was spread all over the Government and not coordinated very well, so we created a Director of 

National Intelligence to make sure the President got advice. I am 

wondering if we should not be thinking about that for competitiveness, because we have $132 billion of research and development in 

this budget, but it is in agriculture, energy, defense, NASA, health 

and human services, commerce, transportation, interior, et cetera. 

It is as spread out as intelligence was. I wonder whose job it is to 

go to the President and says, ‘‘Hey, Mr. President, the Oak Ridge 

Laboratory researchers who went up to Canada for a conference 

could not get back for 6 months because of their visa,’’ or ‘‘States 

are not properly funding universities and the quality is going to go 

down,’’ or ‘‘We need to double the funding in physical sciences if we 

really want to create jobs.’’ I mean the National Academy of 

Sciences says that half of our new jobs since World War II came 

from science and technology. 

So I am not suggesting we need to have a budget of more than 

2.5 trillion, and I admire what the President has already done, and 

I like tax cuts. But I am wondering whether if terrorism is one big 

challenge and competitiveness is another, if you or someone in the 

administration ought not to be the point person for competitiveness 

and can keep our focus on this. 

Just one last thought. The rest of the world is focused. You know 

that because you are in the rest of the world. China and India are 

keeping their best students home now. Germany and England are 

improving their universities because they see a big outsourcing of 

brains to the United States. While we talk about outsourcing of 

jobs, they are worried about outsourcing of brains. 

So what can you tell me about your role as the point person for 

competitiveness and whether this administration in the next 4 

years might organize itself in a different way, as we have with intelligence, to make sure we meet this challenge in the same way 

we have met terrorism? 

Secretary SNOW. Senator, that is a very thoughtful question. I remember talking about a year ago to one of your successors, Secretary of Education, Rodney Paige, a very able person as you know, 

who was asking me about the economy. I was talking to him about 

the economy and the outlook and jobs coming back and so on. And 

all of a sudden it dawned on me that he really was going to have 

a lot more to do with the jobs of the future than I was. I said to 

him, ‘‘Rodney, Mr. Secretary, interesting you would ask me about 

that, but the fact is more hangs in the balance with respect to the 

quality of our education in the future than anything I am working 

on right now at Treasury. I am the spokesman for the economy, but 

you are driving the economy because the quality of the products 

that come out of our education system determine the jobs of the future and the productivity of the American economy for the future.’’

Your point is very well taken. So is your point on the visas, a 

subject that I have talked to Secretary Powell about a number of 

times when he held that post, because clearly things like visa polVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00297 Fmt 6601 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
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icy affect the performance of the American economy and our ability 

to sustain our high growth rates. 

From the Treasury point of view let me say we are trying to 

work on things like tax policy and making the tax code simpler, 

fairer, more growth-oriented. It seems to me Government’s role on 

the economy, which is really your question, how to keep America 

competitive, essentially has to do with putting in place the foundations or the framework so that the dynamic qualities of the American people in this great economic system of ours can be unleashed. 

But part of that is investing in the right things, technology, research, our great universities and so on. So let me think about that 

and come back to you for a more detailed question. But clearly, 

clearly we have to keep our eye on that question, what drives 

American competitiveness? 

One thing it does is keeping the free enterprise system working, 

keeping our education system capable of turning out educated people because educated people are productive people, and productive 

people drive GDP, and they also, productive people lead to the innovations that allow us to have those higher standards of living in 

the future. So let me come back to you with a fuller answer to that 

excellent question. 

Senator ALEXANDER. Thank you, Mr. Chairman. 

Chairman GREGG. Senator Murray. 

Senator MURRAY. Thank you, Mr. Chairman. 

Thank you, Mr. Secretary, for being here today. I listened to your 

exchange with Senator Stabenow about her daughter and how she 

would be better off. I think you said you guaranteed she would be 

better off with the private personal account than she would today. 

I just wanted to go back through that because I was surprised to 

hear you say that. Perhaps she would be. 

But according to Peter Orszag, who is a former economic adviser 

to the White House under the Clinton administration, walked us 

through this, and he said under current law a 25-year-old worker 

is scheduled to receive a monthly benefit of $1,708 in today’s dollars. If there is absolutely no changes in the law, that that worker, 

that is what they would get today, but if we do nothing they will 

get $1,642, which is $66 less. So if we do not do anything, they will 

get $66 less than they are expected today. 

But under the President’s plan, the Commission Model 2, his calculations are that that person would receive only, $1,192, which is 

$516 less than what they are scheduled to get today. So there are 

disputes about that. 

But let me be more specific because you are assuming that Senator Stabenow’s daughter does really well, nothing wrong, nothing 

happens in her life. Well, if horrible happened and she became disabled in her 40’s, she would not be better off because under today’s 

current Social Security system she would get full benefits. If she 

only pays in to private accounts for 8, 10, 7, 20 years, would get 

much less, and so you cannot guarantee that she is going to be better off. 

Another thing that could happen, which happens to many 

women, is that when she retires she buys the annuity, she lives to 

be 85. Under current law today Social Security has a COLA so that 

if you are on Social Security for 20 years you are not expected to 

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live at the same amount of income the you would get throughout 

that 20 years. You would be able, as hopefully we all can, to be 

able to have a COLA so that you will have an increased amount. 

So I would say Senator Stabenow’s daughter, if something happens unfortunately to her, would do worse, or if she does what 

many women do today and lives to be over 80, she would do worse. 

Or if you go by Peter Orszag’s model, she would do worse. So I do 

not think there is any guarantee that anybody is going to do any 

better, and in fact I think the facts show that it is highly unlikely 

that she would. 

So if you want to comment on that, you can. 

Secretary SNOW. I would like to. 

Senator MURRAY. And I have another question. 

Secretary SNOW. Let me reply very quickly then. 

Senator MURRAY. Well, my other question is, as I hear about this 

clawback provision I think very few people understand that the 

money that you take out to put into private accounts is not yours 

to keep, you pay back the Government, and I would like you to explain that clawback provisions so we all understand that. 

Secretary SNOW. OK. I have not seen Professor Orszag’s numbers, but I think the facts are pretty clear on this, that in 2042 

there will be, when the system reaches the point where it can no 

longer pay the benefits, the money is not in the account, in the 

trust fund——

Senator MURRAY. And the President is saying private accounts 

will fix that? 

Secretary SNOW. No. Let me just finish. Your daughter will receive, or a young person today who retires then will receive a big 

reduction in their Social Security benefits. That is the course we 

are on. The system is only capable of paying about 72 cents on the 

dollar of the promised benefits. 

What I am saying is, with the personal accounts, the young person today who retires post-2042 will be able, with the personal accounts, to do better than they would otherwise be able to do. 

Senator MURRAY. Should nothing bad happen to them. 

Secretary SNOW. Pardon me? 

Senator MURRAY. Should nothing bad happen to them. 

Secretary SNOW. Now, on the disability issue, let me say the 

President’s principles include sustaining the benefits of the disabled, so that anybody who is disabled, the President’s proposal, 

his principles—he has four or five big principles. One is nobody 

over 55 is adversely affected. The system should be fixed permanently. Another one is the disabled provisions should be continued 

in a way that people get good protection for disability. 

And on the dying, living a long time, which we hope everybody 

does, our proposal would be that people could take out an annuity 

and that annuity would then carry them through a long life. 

Senator MURRAY. But I do not know of any annuities today that 

have a cost of living built in. 

Secretary SNOW. Well, the——

Senator MURRAY. Social Security does. 

Secretary SNOW. Yes, Social Security has a cost of living, but remember, you built up over your long working career an amount of 

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money which is much larger than anything Social Security could 

deliver to you. 

Senator MURRAY. Except go back to the clawback provision, 

which means that you will not buildup that huge annuity. 

Secretary SNOW. I think there is a misunderstanding on the 

clawback. That is a word that is ascribed to what we are proposing, 

but it is not what we are proposing. There simply is no clawback. 

Let me describe what we are proposing and then respond further. 

The idea here is that people are today contributing money to Social 

Security. They would be allowed to take some part of that, and put 

it into these personal accounts. The money withdrawn from Social 

Security would, as it goes into the personal accounts, would result 

in an equivalent, present value equivalent reduction in the longterm liabilities of Social Security. That is, as you take the money 

out, you are not contributing that money to it, your future claim 

on Social Security would be reduced by an equivalent amount. But 

that is all it calls for is reduction in future claims on Social Security equivalent to the amount of money that you are taking out, 

which seems only fair. 

Chairman GREGG. And which makes a lot of sense if you are honest about the way you set up a personal account. 

Senator Bunning? 

Senator BUNNING. Thank you, Mr. Chairman. I would like a 

statement that I have prepared to be put into the record. 

Chairman GREGG. Of course. 

Senator BUNNING. Thank you. 

[The prepared statement of Senator Bunning follows:]

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Thank you, Mr. Chairman. 

Welcome to the committee today Secretary Snow. I look forward 

to a meaningful discussion of the provisions contained in the President’s budget proposal. 

As I have reviewed the many revenue proposals released this 

week, I have been pleased to see the attention paid by the Administration to so many important areas—making health care more affordable, simplifying the tax laws, encouraging savings, as well as 

extending many expiring provisions. 

Of utmost importance, of course, is that we do no allow our economy to face the largest tax increase in history. I support the President’s call to make permanent the tax cuts that have contributed 

to the 11 consecutive quarters of economic growth that we have experienced recently. 

I was also pleased to see that, in this year in which we plan to 

finally take a serious look at the Nation’s Social Security System, 

the Administration is also taking a serious look at private retirement savings and employer-supported retirement plans.

Senator BUNNING. Secretary Snow, thank you for showing up. 

There are an awful lot of things I would like to ask you about, but 

I was pleased to see that the administration is finally looking at 

all aspects of retirement financing in addition to important Social 

Security changes. In particular, with regards to employer provided 

pension plans, I have long been concerned that our current funding 

rules, however well-intentioned, can have the effect of worsening 

the lows of the business cycle. Those rules can act to require large 

pension contributions from sponsoring companies just when those 

companies are facing a downturn in their business. I understand 

that the administration is proposing some changes to allow plan 

sponsors to contribute additional funds during good economic times 

when they have the money available. I have long thought this was 

a very sensible idea. I am hoping that you will comment on these 

proposed changes to the funding rules and how you think the 

changes will impact employer sponsored pension programs. 

Secretary SNOW. Senator, thank you very much. Yes, this is a 

major initiative of the administration. We took the better part of 

the last couple years to think about the problems affecting the defined benefit pension plans, and the sponsors, and the Pension 

Guarantee Board, and have concluded that the system needs a 

major overhaul for some of the reasons you are talking about. 

One of the biggest changes we are proposing is to allow employers, as you are suggesting there, to put moneys into those pension 

plans during the good years, put more money in, and to take the 

deduction that would go with it. The problem was always about the 

deduction and could they take the deduction. The rules would be 

changed to allow a deduction to accompany those higher levels of 

contributions in the good years. We think that will encourage employers in good times to put more money in, and thus help sustain 

the viability of those pension plans. There are a whole number of 

other rules as well that I think will help improve the financial status of the defined benefit plans, which will help both the employees, the employers, and ultimately the taxpayers. 

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Senator BUNNING. One of the rules must be that they cannot in 

the good years put it in and then the bad years take it out and use 

it for other purposes. 

Secretary SNOW. You are absolutely right, absolutely right. 

Senator BUNNING. OK. Congress has previously enacted many 

types of incentive programs, such as Renewal Communities and 

Empowerment Zones in order to jump start local economies in distressed areas. I am very interested in the Renewal Community Program as part of Eastern Kentucky participates in it. In fact, I included a provision in the Jobs bill last year addressing this program, an issue I worked with Chuck Schumer on. Can you address 

for me how the Opportunity Zones that are proposed in the President’s budget exceed the capabilities of existing programs? What do 

you envision happening to participants in the existing programs, 

specifically Renewal Communities, and do you see them applying 

and being accepted as Opportunity Zones? 

Secretary SNOW. Senator, as I understand these programs—and 

I am not an expert on them—the President’s proposal is designed 

to be in addition to accompany the sort of program you are talking 

about, not in lieu of. 

Senator BUNNING. In other words, an add on? 

Secretary SNOW. Yes, yes. It is complementary to it. It does not 

withdraw it. It adds onto it. But I will have to——

Senator BUNNING. In other words, from what my quick—and it 

is quick when you get books about that thick—there is no cuts or 

no reduction in the funding for those other programs? 

Secretary SNOW. I think the funding remains. The proposal 

would call for the establishment of a number of new zones, 28 

urban, 12 rural, to be designated by the Commerce Department, 

who would select the zones through an application process designed, as you say, for distressed areas, focusing on what I think 

the words of art are, communities in transition. The idea is some 

communities have been hard hit by changes in the economy, and 

these economies in transition who had a steel plant or a textile mill 

or something——

Senator BUNNING. Under the current—I do not want to get into 

a confrontation—but under the current set up, Renewal Communities give tax breaks to companies to move there. 

Secretary SNOW. Right. 

Senator BUNNING. Are you saying that those things that you 

talked about would do likewise? In other words, the new zones you 

are talking about? 

Secretary SNOW. Yes. There is a provision for income tax exclusion inside these—tax advantages inside the zones for enterprises 

inside the zones, but I will give you a full layout on it once I understand it better myself. 

Senator BUNNING. Thank you, Mr. Chairman. 

Chairman GREGG. Thank you, Senator Bunning. 

Senator Sarbanes. 

Senator SARBANES. Mr. Secretary, I know you all are looking for 

a crisis and you seem to think you have found it with the Social 

Security system because you project, and I think you use the earliest date of the estimates, that in 2042 the amount of money going 

out will be greater than the amount coming in, and at that point 

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it will be able to pay about 75 percent of the benefit levels. You 

all are using 2042; CBO says 2052. So that is about 45 years away. 

I want to submit for your thoughtful consideration some other 

crises that seem to me to be looming right in front of us. One is 

the internal budget deficit crisis. The deficit now is, in nominal 

terms, the largest it has ever been, if I am not mistaken. Is that 

correct? 

Secretary SNOW. In nominal but not real terms, yes. 

Senator SARBANES. When you say real terms you are talking 

about percent of GDP? 

Secretary SNOW. No. Even, I am talking about real dollars, inflation adjusted dollars. 

Senator SARBANES. I noticed the Budget Director yesterday, 

when he talked about cutting the deficit in half, used percent of 

GDP. He did not refer to the dollar figure. Is that how the administration is now treating the budget deficit when they make these 

statements? 

Secretary SNOW. I think the reason the Budget Director is using 

that formulation is probably the most authoritative way to look at 

it, the best way to look at it, because it is the way you would look 

at the mortgage on your house, it is relative to your income. 

Senator SARBANES. Is that the formulation you use now? Has the 

administration in a sense shifted over, and is now using that formulation to talk about the budget deficit? 

Secretary SNOW. Senator, I think we are talking about in both 

nominal terms, those dollars terms, and as a percent of GDP. 

Senator SARBANES. Do you regard the budget deficit as a serious 

problem? 

Secretary SNOW. Yes, I think the deficit is a serious problem and 

one that needs to be addressed. 

Senator SARBANES. Is it serious enough to be categorized as a crisis? 

Secretary SNOW. No, not the deficit inside the window because 

we are bringing it down to a level that is low by historical standards, but long term, the deficit reflected in Senator Conrad’s charts 

is certainly something that seems to me to be a looming crisis anyway, to use President Clinton’s phraseology on it. 

Senator SARBANES. That trend line takes off in 5 years. 

Let me shift to the other crisis. I am concerned about these figures. This is the U.S. current account deficit. In the early 1980’s 

we had a positive situation and then we started moving this way. 

But look at what has happened to our current account deficit over 

the last five or 6 years. It is incredible. We are now over $600 billion in the current account deficit, which of course reflects in large 

part what has happened with this rapidly deteriorating U.S. trade 

deficit. So we are now here. The figures are at record levels. Am 

I right in asserting that, that the figures on the trade deficit and 

the current account deficit are at record levels?

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Secretary SNOW. Yes. 

Senator SARBANES. Far beyond anything we have experienced in 

the past. Would that be a fair statement? 

Secretary SNOW. Yes, Senator, as is our GDP. 

Senator SARBANES. What am I to conclude from that? 

Secretary SNOW. That there are a number of things that are 

growing. 

Senator SARBANES. Including the deterioration in our net international investment position. Look at this chart. This is for 2003. 

It does not reflect 2004. 2004 is going to add another 600 billion 

to that. It is going to take us over $3 trillion into a negative net 

international investment position. This is claims that people 

abroad, or governments abroad, are holding against us, correct?

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Secretary SNOW. Certainly. 

Senator SARBANES. In fact, have not the purchases of dollar assets in recent times been made primarily by the central banks in 

China and Japan? 

Secretary SNOW. Yes, they have made substantial purchases of 

our debts. 

Senator SARBANES. Do you think they are doing that in order to 

influence or impact the currency valuations and therefore to gain 

a trade advantage? 

Secretary SNOW. No. I think they view the U.S. market as a good 

place to make investments. 

Senator SARBANES. But not the private sector. There has been a 

shift from the private sector to the public sector, so these investment decisions now are being made by central bankers in China 

and Japan, correct? 

Secretary SNOW. Certainly they have increased their holdings of 

U.S. treasuries. 

Chairman GREGG. Senator, I do not want to interfere with your 

line of questioning, but you are a bit over your time. 

Senator SARBANES. All right. I will close, Mr. Chairman. 

Let me just make this point to you. I think they are manipulating the currency. You tell the Chinese to go to flexible exchange 

rates. All the experts tell us they cannot really do that right now 

without a serious banking crisis, and I cannot for the life of me understand why you do not shift your objective to getting them to 

reset the peg at least, which they could do without precipitating a 

banking crisis. You say flexible rates. All the experts say, ‘‘Well, 

the Chinese cannot do that. They will have a banking crisis.’’ But 

they can repeg and not have a banking crisis, and it seems to me 

that at least ought to be one administration objective. 

Chairman GREGG. Could you answer that question? 

Senator SARBANES. Thank you, Mr. Chairman. 

Secretary SNOW. Yes, Senator. We are in close and intense discussions with the Chinese. It is probably not best if I go into any 

detail about the nature of those discussions. I am encouraged by 

them even as I would like to see them move quicker. They are 

making progress on their financial institutions. They have indicated their commitment to move to greater flexibility, that is, a 

mean total flexibility, greater flexibility, which I think would accomplish the objective you are suggesting there. 

Chairman GREGG. Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. I would like to 

change the focus of some of the discussion here a little bit, and talk 

a little bit about your efforts to increase collections of those who 

are not supposedly paying their taxes. I have served in State legislature where proposals came in that said, ‘‘We are going to improve 

our enforcement,’’ and it never quite measures up. I have been here 

in the Congress where they said, ‘‘Well, we are going to improve 

our enforcement,’’ and never quite measures up. 

My question on the figures that you are giving us, where they can collect $255.2 billion less than what the taxpayer owes, I would 

like to know how you are figuring this out. Sometimes I think what 

they give us is a gross figure. They do not figure in the cost of collection. Lots of times you have to take it to court or whatever, you 

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have to pay attorney fees, and take time and everything from your 

staff. You got to hire sometimes new employees and they do not get 

figured in. Can you shed a little bit of light on how you arrived at 

that figure? 

Secretary SNOW. Senator, the figure you are talking about is this 

so-called tax gap figure? 

Senator ALLARD. Yes. You are estimating that you collect, the 

IRS collects $255 billion less than taxpayers owe. 

Secretary SNOW. Right. Senator, I do not put a lot of confidence 

in these tax cap numbers. We know there is a big number out 

there. We know that we can do better, but I must say that the tax 

cap numbers are not intellectually very satisfying to me, as I look 

at them. 

Senator ALLARD. I am glad to hear you say that because I am 

having the same problems. 

Secretary SNOW. I have talked about this with the IRS Commissioner, and there really is not, to be frank about it, any reliable estimate of the tax cap. We know it is big, we know it is sizable. It 

could be bigger, it could be smaller. I do not know. I am looking 

forward to getting the current study which is under way, updating 

this data, which I think is 17-, 18-years-old. We really need better 

data, and I know Senator Conrad has an interest in that, the chairman does, you do, and as soon as we get this updated study I want 

to give it to you and make sure that it is available. But right now 

I think we are in a state of ignorance, frankly. 

Senator ALLARD. They are asking for more money to carry this 

out, and as I think as policymakers we need to make sure that 

there is some validity. I am glad to hear that you are going to try 

and update your figures, at least your methods of trying to do that. 

Secretary SNOW. Right. 

Senator ALLARD. On tax simplification, you know there is a level 

there where it just does not pay to fuss with the taxpayer because 

the cost of collection is more than what it I worth. I have had constituents come to me and say, ‘‘You know I had $45 I owed the IRS, 

and I paid it. Then they billed me again, and I paid it, then they 

billed me again and I paid it, because I did not figure it was worth 

messing around for 45 bucks.’’ But in a way it is not fair to the 

taxpayer. Do they make any kind of assumptions that, well, you 

know, ‘‘If it is a low amount we will just keep hassling them until 

they finally break in. We do not care whether they are innocent or 

guilty.’’ Would you respond to that? 

Secretary SNOW. I think as with all laws—and laws need to be 

enforced—there is also a need to enforce them with a good deal of 

common sense, and one of our objectives for the IRS is that they 

enforce the law fairly and effectively, they go after real tax cheats, 

but they do so with a well-developed sense of good common sense 

as well, so that taxpayers are not harassed. 

Senator ALLARD. It seems to me that any proposal we have on 

tax simplification, we might look at simplification of enforcement, 

and kind of bring up some common sense proposal into it. 

I see I have some more time, so I want to talk to you a little bit 

about, or listen to you about what you are thinking about tax simplification. I would hope that does not include tax increases. I 

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would hope that it is truly simplification. I want to hear from you 

what you think is most practical in today’s environment. 

Secretary SNOW. This was a subject of conversation with two of 

your form colleagues, the two Senators, who will be Connie Mack, 

who is the chairman, and John Breaux, who is the Vice Chairman 

of this panel. They have been asked by the President to look at this 

issue of simplification and fairness and growth. When you get to 

simplification, Senator, as you know, somebody who has lived in 

this world of taxes, simplification means getting at the things that 

create complexity and the things that create complexity are credits, 

preferences and deductions. And Senator Mack and Senator 

Breaux, and Congressman Frenzel, who is also on this panel, as 

well as the other panel members, but those particularly, understand the give and take of simplification because one person’s simplification is the removal of somebody else’s equity. But they have 

pledged to come forward with their best efforts to give me and ultimately the President the best thinking they can come up with on 

what a sensible simplification would look like. 

Beyond that I do not think I should try and foreshadow what 

they might do. 

Senator ALLARD. Thank you for your comment. I see my time has 

expired. 

Chairman GREGG. Thank you, Senator. 

Senator Corzine. 

Senator CORZINE. Thank you, Mr. Chairman. 

Welcome, Mr. Secretary. First of all I want to identify with a 

number of the remarks that Senator Sarbanes made, but with regard to the negotiations on adjustment of the currency, those numbers are serious and at some point cumulatively create huge risks 

in our financial markets, and at least my experience would say if 

we do not start seeing some change in our position, trade position 

and current account position, there will be tough times at some 

point that tend to happen in short bursts as opposed to something 

that you can see over a period of time. 

I actually want to ask some questions that are sort of definitional, and then I would like, if I have time, to get to will somebody 

be better off under Social Security reform as propositioned by the 

President? 

First of all, I do not think companies go bankrupt—I was watching the hearing—when they have unfunded liabilities or health 

benefits. They have a period of time to adjusts. Is that not correct, 

Mr. Secretary? 

Secretary SNOW. Yes, Senator, but I was not talking about pension plans. I was saying that Social Security is going bankrupt in 

the same sense that a private company goes bankrupt when it cannot meet its obligations. That is the sense of the word I am using. 

Senator CORZINE. But it is in the same context as there are obligations that are contractually put in place for pensions and health 

benefits, and we have it with regard to our entitlement projects, 

and that by one estimate 2042, and the other 2052. I think it is 

very confusing if not misleading to say that Social Security is bankrupt, and by any comparison with any other standard. And then 

when you tie it to Chapter 7 and 11, there is no comparison since 

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we can meet all our financial obligations up until 2042, just from 

a standpoint of definitions. 

Secretary SNOW. I understand, Senator, but it is in 2042, call it 

what you want, the system can no longer meet its heretofore promised obligations. 

Senator CORZINE. Unless we do something. 

Secretary SNOW. Right. We need to do something. 

Senator CORZINE. I think we all agree we need to do something. 

So bankrupt I think is a term that probably does not fit this current situation. 

On valuations of stock I heard a very interesting conversation 

about what drives stock markets. I do not know. Last time I took 

a finance course somebody told me discounted earnings flows over 

a long period of time are what people look at as what drives stock 

values as opposed to dividends and capital gains because it is a 

combination of all those things, and the earning power that people 

think. Have you seen the studies out that show that since we have 

cut the dividend rate that stocks that pay dividends have done 

more poorly than companies that have retained earnings? If you 

have not, I would be happy——

Secretary SNOW. No, I have not. 

Senator CORZINE. I would be happy to just—this is under Davis 

Research, and I think actually there are a number of places. I 

would like to put in the record a Monday, January 31st Wall Street 

Journal article that would point out that companies that have been 

paying dividends, increased their dividends, have done less well 

than companies that have retained earnings. I think there are 

some—all of us are going to talk about what is correlated to the 

power of earnings, but I think we have had 10 percent growth in 

earnings in the last couple of years, and it probably has something 

to do with what marginal comeback we have had in the stock market. 

[The article follows:]

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Senator CORZINE. Another question I have, Mr. Secretary, over 

and over I hear about how small businesses have benefited from 

rate cuts, and I really think we ought to get the facts on the table 

because there is so much assertion that small businesses are the 

ones that are benefiting. According to the work that a number of 

analysts have done, and I think they have done this very specifically, only 436,000 of the tax filers with small business income, 

that is 1.3 percent of 32.8 million filers, actually were operating at 

the top tax rate. I suspect you will then translate that into who 

created jobs, is it those 1.3 or is it the 32.8 million filers. But do 

you believe that the top tax rate is driving the job creation in small 

business? 

Secretary SNOW. Yes. I think the tax cuts overall, including the 

expensing, taken cumulatively and in the aggregate have certainly 

helped job creation. And small businesses, what do they do? They 

create 7 jobs out of 10 or something. 

Senator CORZINE. 32.8 million of filers are not operating at the 

top tax rate, and actually the numbers are not so impressive even 

at the second rate. I think the question was framed in the context 

of if you were dealing with a top tax rate relative to choices we had 

to make on strategic investments in education or strategic investments in research and development. I see the red light. 

Chairman GREGG. OK. You can continue that line of questioning. 

Secretary SNOW. Senator, if you are asking me whether I think 

we should fail to make the tax cuts permanent, my answer is no. 

I think we should sustain the tax reductions because by doing so 

we avoid a tax increase, and tax increases I think would be not 

consistent with sustaining the sort of growth in the economy we 

want to see. Right now, as Senator Conrad and I discussed earlier, 

we are seeing the revenue line of the U.S. Government, the top line 

of the U.S. Government with the tax increases rise and improve, 

and revenues this year so far are up about 10 percent for the Federal Government, and I think the lower tax rates are helping get 

the economy stronger with more jobs, more profits, which is leading 

to higher tax revenues for the Government. 

Senator CORZINE. Maybe Microsoft had something to do with 

that dividend and the repatriation of profits from overseas, but it 

is worth an analysis. 

I do have the request that I would love to see the Treasury put 

together numbers so that we could once and for all analyze whether the top tax rate is really applying to small business. And I know 

it has to include S-corps and all the other elements of it, but we 

hear that argument so much that it would be worthwhile having 

some definitive objective research on that made available. 

Thank you. 

Chairman GREGG. Thank you, Senator. Are there Senators who—

did you have some second questions? 

Senator DOMENICI. Yes. 

Chairman GREGG. Why do you not go? 

Senator DOMENICI. After we finish with me we are done? 

Chairman GREGG. After we finish with you, we are going back 

to Senator Conrad and then if Senator Corzine wants to go again, 

we will do it. 

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Senator DOMENICI. Mr. Secretary, I just want to spend my time 

on Social Security. If you do not mind, can we talk together about 

it? We are using this data, 2042, and some people use the word 

bankrupt and others say it is not bankrupt. What happens in 2042 

if we do nothing, and assuming some reasonable path of growth 

and all the other things we say? 

Secretary SNOW. Senator, in 2042, if nothing is done in the interim, according to the actuary of the Social Security system, the 

trust fund will have insufficient revenues to pay out the prior level 

of benefits and will only be able to pay out benefits at about 72 percent of the former level, 72 cents on the dollar of the former benefits that had been paid. 

Senator DOMENICI. So are we saying that if we do nothing, at 

that point in time everybody that is getting a check from Social Security will get reduced by 28 percent, and those who are waiting 

in line and not yet there, their expectation is rather bleak as to 

what their benefit is going to look like. Is that correct? 

Secretary SNOW. Yes, they will take a big haircut on their benefits. That is right. 

Senator DOMENICI. Now, when we use the 2018 to 2020 number, 

what are we talking about? 

Secretary SNOW. Senator, the 2018 number, which is a very important year, is the first year that the withdrawals from Social Security, the payments out are greater than the payments in, the inflow. The outflow exceeds the inflow for the first time, and that will 

continue in every year thereafter. 

Senator DOMENICI. OK. Now, Mr. Secretary, whatever you call 

it—bankrupt or the 2018 phenomenon—those are dates when Social Security, the program, there are signals of serious trouble, and 

then in 2042 there is big trouble because the checks are going to 

be dramatically reduced. Is that correct? 

Secretary SNOW. Precisely. That is exactly what happens. 

Senator DOMENICI. Now, the question is: Should we try to fix it 

later or sooner? My question to you is: Will it be easier to fix it now 

for our seniors, or will it be easier to fix it later? 

Secretary SNOW. Senator, I can quantify that. It is much easier 

to fix it now. If we look at just the arithmetic, fixing it now 

through—say you wanted to fix it through a benefit cut, or you 

wanted to fix it through a tax increase—I am not recommending 

either, but I am just giving you the arithmetic. Today it could be 

fixed with about a 3.5-percent change in either. If we wait out in 

the future there, 2042, it is double that. It takes a 6.5- or 6.6-percent change to fix it. So you would be adding a 6.5-percent tax in 

2042 to fix it to the 6.4 that you pay today—the 6.2 that you pay 

today. So you would be doubling the tax on the individual in 2042. 

Senator DOMENICI. Let’s just stay with that. What we are saying 

is if we just wait around and the crisis occurs, the people paying 

in—that is our grandchildren and young workers—they will have 

to pay almost twice what we are taking out of their payroll checks 

now to make this fund solvent. 

Secretary SNOW. That is right, Senator. 

Senator DOMENICI. So out there in America, for the young people, 

they can expect that they will not get their checks in toto, they will 

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be dramatically reduced, or they will take out of their paychecks 

twice what is being taken out now. 

Secretary SNOW. That is right. They will have a huge tax increase. 

Senator DOMENICI. I assume that is what the young people understand. I have seen young people who get a payroll check for the 

first time, and they say—they come home, two of my daughters, 

and say, ‘‘I thought I was in a low bracket. Look at how much they 

took out of my check.’’ Well, it was the Social Security they were 

looking at. So that would be double what it is now, more or less. 

Secretary SNOW. That is right, Senator. That is right. 

Senator DOMENICI. Now, when we speak of repairing this system 

sooner rather than later, we are talking about in the case of the 

President’s notional fix, notional repair, taking a piece of that 

money that is going to into the fund and investing it. And let’s just 

look at that by itself, just that. You are investing it. Can you give 

us, in some way that we would understand, how much more is generated that goes into these personal accounts than if the money 

was invested as it is now in Social Security, compounded? Do you 

have a chart showing that or can you give us that? 

Secretary SNOW. Yes, Senator, I will be happy to supply that. I 

can give it to you sort of rough and ready. If you are an average 

wage earner born in 1985, 20 years old, you would be retiring in 

2050. If the system could pay out to you in 2050 what it promises, 

you would get $20,000. You would get almost $21,000. Unfortunately, the system can only afford to pay you $15,000. So that is 

that haircut I talked about. 

If that individual now took advantage, that 20-year-old took advantage of the opportunity to withdraw some of their money and 

put it into these personal accounts, by our estimate they would—

and this is earning just the average sort of market return of a mixture of debt and equity—they would end up with $17,000. So rather than the $15,000 that the system could pay, they would get 

$17,000. And that comparison gets better with every cohort going 

out because the system becomes less and less and less capable of 

paying benefits over time. 

Chairman GREGG. Thank you, Senator. 

Senator Conrad. 

Senator CONRAD. Thank you, Mr. Chairman. 

Mr. Secretary, what are the estimates of economic growth that 

underlie the forecast that Social Security will not be able to meet 

its payments in 2042, according to the Social Security Administration, or 2052, according to CBO? 

Secretary SNOW. Senator, I think the growth rates for GDP are 

something like 1.8, 1.9, something on that order. 

Senator CONRAD. Yes, that is correct. 

Secretary SNOW. Going forward. 

Senator CONRAD. And what has been the economic growth rate 

over the last 75 years? 

Secretary SNOW. It has been considerably higher than that because of the combination of productivity and population growth for 

the last 50 years. Population growth, demographic growth, has 

been much higher than the actuary sees for the next 40 years. 

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Senator CONRAD. Let me just say that Senator Domenici has 

commented in the past on productivity growth. Something is happening with productivity growth that we do not fully understand. 

We have had much higher rates of productivity growth than were 

anticipated by anyone, I think it is fair to say. 

So one of the concerns I have about these projections in Social 

Security, first of all, they are 75 years. Second of all, they are really very pessimistic, 1.8-percent economic growth when we have had 

3.4-percent economic growth in the previous 75 years. That is the 

first, I think, important fact to know. 

Second, Senator Domenici had suggested that some of us do not 

think you need to do Social Security, do Medicare first. I want to 

make clear my own position is I think we need to do both. I think 

we need to do both. The fact is the head of the General Accounting 

Office told us the shortfall in Medicare is 8 times the shortfall in 

Social Security. So I urge the President to deal with Social Security 

and Medicare. 

Senator Domenici said, well, he has not heard any proposals on 

Medicare. I will give you four quick proposals on Medicare. No. 1, 

5 percent of the people use 50 percent of the money. We ought to 

focus like a laser on that 5 percent by better coordinating their 

care. In the pilot projects we have run to do that, we have saved 

dramatically in expenses, we have reduced hospitalization substantially, and we haveten better health care outcomes. So that would 

be No. 1. 

No. 2, I think we ought to go back and look at the $10 billion 

slush fund we provided the Secretary of HHS to sweeten the pot 

for private accounts. Third, I think we ought to look at the $40 billion we are giving 

private accounts over and above what traditional Medicare pays. 

Fourth, I think we ought to look at reimportation from Canada. 

Fifth, I think we ought to allow Medicare to negotiate lower drug 

prices. They are specifically precluded under the law from doing 

that. 

So if we want suggestions, I think it is—I welcome the Senator’s 

call for that. I think that is exactly what we need. I think we need 

to have everybody come with their best ideas, and we need to work 

on Social Security and Medicare, and I think tax reform, too. There 

was a question about the tax gap. The tax gap that your IRS agency has developed, 2001, $300 billion tax gap, the difference between 

what is owed and what is paid. Unfortunately, that is based on a 

modeling of economic behavior that is 17 or 18 years old, updated 

for 2001 figures. I think it badly understates the tax gaps. As a 

former tax administrator and the former chairman of the MultiState Tax Commission, I have spent a good deal of time analyzing 

those numbers—with your people, by the way, Mr. Secretary—and 

I believe we will find in the new analysis that the tax gap is really 

much larger. 

And so when I say we need to bring revenue to the table—and 

I know some of my colleagues immediately assume that is a tax increase—that is not necessarily the case, is it? 

Secretary SNOW. No. I agree. 

Senator CONRAD. If we could find a way to effectively capture 

part of that tax gap—and, by the way, that is why I think tax reVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00324 Fmt 6601 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
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form has got to be on the table here as well, because I do not think 

you are going to capture as much as we need to just by jiggering 

with the current system. The current system is a horse-and-buggy 

system that was devised largely in the 1930’s, and we have to go 

back and do a much better job of improving the efficiency of the 

system. 

Secretary SNOW. Senator, I think your former colleagues who are 

chairing this panel, the tax panel, share those sentiments entirely. 

Senator CONRAD. Let me just conclude with—let me show that. 

This is where I have a profound disagreement on where you say 

this is all headed. This is your assertion of what is going to happen 

to the deficit in the coming 5 years, but you get there by leaving 

out a lot of things. It is sort of like a family having a budget and 

they say, gee, things are really going well, if we just leave out our 

mortgage payment and our car payment. But that is not the way 

it works with a family, and that is not the way it works with the 

U.S. Government. And you all have just left out a lot of things, like 

the war costs past September 30th of this year, like the need to fix 

the alternative minimum tax, a whole series of things that have 

just been left out. 

When we put those things back in, here is what we see as the 

pattern, somewhat of an improvement, but then when we get past 

the 5-year budget window and the full cost of the President’s tax 

cuts come in, the situation further deteriorates. And, you know, in 

a way this does not even capture what is happening. 

So I would just say to my colleagues, I do not think I see anything that is very serious about dealing with this deficit. And for 

those who now say deficits do not matter, I think that is a preposterous position. Do you believe deficits matter, Secretary Snow? 

Secretary SNOW. Absolutely, Senator. I think you and I have 

talked about that. They do matter. They make a big difference. Financial markets are watching this. We have to make sure that 

black line never materializes, and there would be serious consequences to pay if it did. So the administration knows, the President knows that these deficits are too large, that they matter, and 

we have to reduce them. 

Could I just offer one thought, though, on your observations on 

GDP growth and productivity growth and Social Security? Social 

Security is really not driven by GDP growth, I mean the problem 

there, because higher GDP growth translates into higher wages, 

and given the benefit formula, that translates into higher obligations, so you cannot grow your way of out the Social Security deficit 

problem given the formula or given the current rules of the road. 

Senator CONRAD. Mr. Secretary, you and I would agree on that. 

That is why I do believe Social Security has got to be addressed 

as well as Medicare, as well as tax reform. It would help—I mean, 

obviously if you have higher rates of economic growth, that helps 

all of our challenges of meeting our long-term budget obligations. 

And it is really those long-term budget obligations that are our central problem. I think you and I would agree on that. 

Secretary SNOW. Absolutely. 

Senator CONRAD. The real problem we are going to have, as the 

chairman has said, is how are you going to redeem those bonds. 

The Social Security Administration holds these bonds. They are 

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backed by the full faith and credit of the United States. They are 

going to get paid. But how are they going to get paid? That really 

is the challenge before us. 

Secretary SNOW. Exactly. 

Senator CONRAD. Thank you. 

Chairman GREGG. Thank you. 

Do you have any additional questions, Senator Corzine? 

Senator CORZINE. I will be very quick. Mr. Secretary, does the 

privatization formulation address that 30-percent gap? Does it provide for solvency 2042 and out? 

Secretary SNOW. Senator, we call them personal accounts rather 

than private accounts because we really do not view what we are 

doing as privatizing Social Security. But the personal accounts, 

while not alone addressing the gap, are, I think, part of an overall 

solution. They are an integral——

Senator CORZINE. Just dealing with the solvency issue, do personal accounts accommodate the language? Do they deal with the 

solvency issue? 

Secretary SNOW. The underlying purpose, as I understand it, of 

Social Security is the retirement security of the individuals who are 

in the system. And if that is the overall objective, which I think 

it has to be, then the personal accounts play a critical role in 

achieving the underlying objectives of Social Security. 

Senator CORZINE. Financially? 

Secretary SNOW. But alone they do not deal with the financial 

problem. They have to do it in concert with other things. 

Senator CORZINE. What is the real rate of return and then the 

nominal rate of return that you use to get to this $3,000 discount 

from the benefits that were talked about? 

Secretary SNOW. I think it is a 3-percent real rate of return. 

Senator CORZINE. A 3-percent real rate of return, if I have done 

my numbers right, will give you a bigger discount than $17,000 for 

your individual. But I would like to know specifically what it is, the 

rate of return that is built into——

Secretary SNOW. I am sorry. 

Senator CORZINE. Both the break-even——

Secretary SNOW. The 3-percent is break-even; 4.5, I think, or 4.6 

gives you the $17,000 I talked about. Three is the break-even. 

Senator CORZINE. That is the 7.5 percent that you are using that 

is the average nominal yield over the extended period of time. 

Secretary SNOW. Yes. 

Senator CORZINE. To get back to the $20,000 mark, what would 

be the rate of return, the nominal rate of return that would be required? 

Secretary SNOW. I think you need an equity rate of return, 6.7 

or something. 

Senator CORZINE. Above the base. 

Secretary SNOW. Yes, real. 

Senator CORZINE. Something in the 11-percent——

Secretary SNOW. Nominal, yes. 

Senator CORZINE. Right. I think these kinds of questions—and, 

you know, I wish I could guarantee myself I was going to make 11-

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pounded. That is presuming that you would make that in this 50-

year timeframe that you are talking about. 

Secretary SNOW. Yes. The——

Senator CORZINE. Regardless of pattern or when you retire 

or——

Secretary SNOW. It is the average, yes, over the period. 

Senator CORZINE. The question that I think is fair to ask is: 

Looking at different points in history, what is the probability of 

those kinds of returns, whether it is the 7.5 or 11, applying to any 

cohort set of retirees? And any way you look at it, there is some 

risk factor that you have to assign to whether that is at all probable. You know, I think we all talk in certain terms. Those of us 

who are not particularly thrilled with personal accounts would say 

we are not—we are probably focusing too much on one element of 

risk. I think there is an ignoring of risk with regard to those kinds 

of returns actually coming to pass. 

Secretary SNOW. Senator, the returns we are citing are the 40-

year averages for blended—you know this better than I do, but 

blended stocks and equities and a full equity and various ratios. 

But I think the 4.5, 4.6, with a fund over 50 years or 40 years of 

bonds at 40 percent and equities at 60 percent produces that 4.6. 

Senator CORZINE. If you go back and look at any given starting 

point, though, you get different patterns for each cohort that started work and then retired. It is just—I think too often we talk in 

certainties, and, frankly, I was surprised to hear you say, you 

know, you are going to come up $3,000 short relative to what you 

would get under Social Security if we did some of that tinkering 

around that Senator Domenici was talking with you about, you 

know, got another Greenspanian commission to sit down behind 

closed doors and come out and give us the ability to say, well, let’s 

tinker with this variable or that variable and get this resolved, 

which I think most people——

Secretary SNOW. I do not think tinkering—the problem, though, 

is that tinkering will not solve it. As I say, if today the system is 

out of kilter by 3.5 percent on benefits or taxes, it is out by 6.5 percent in 2042. Those are the actuary’s numbers. That is a doubling 

of the taxes on individuals. 

Senator CORZINE. If you wait—and I think all of us agree, from 

whatever perspective, that doing something now is a heck of a lot 

easier to solve this problem. Even your own example does that. 

Secretary SNOW. Right. Senator, I think there is more to agree 

on here than disagree on. I think there is a sense that there is a 

real problem, that the sooner you act, the better. I think President 

Clinton—I like his formulation of the issue. It is ‘‘a looming crisis.’’ 

He said that in 1998. So it is coming in a little closer on us. If it 

was looming then, it is looming-plus right now. 

Senator CORZINE. Thank you, Mr. Secretary. 

Chairman GREGG. I just do have to comment on this because I 

spent so much time on this issue and was there with President 

Clinton when he called this ‘‘a looming crisis,’’ and I had a bipartisan bill which did address this issue, and we did adjust benefits. 

We adjusted tax rates, and we created personal accounts. But the 

point, of course, here—and I think you, Mr. Secretary, put it in numerical terms, but I think it is important to put it in personal 

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terms, which is that if you were to guarantee the benefit of Social 

Security as it exists today to a person who retires in the year 2042, 

that benefit, the $20,000 you are talking about in today’s dollars, 

would cost the working American, our children and our grandchildren, a doubling of their tax burden, which would mean that 

their lifestyle would be radically reduced. Their ability to send kids 

to college, their ability to buy a house, their ability to buy a car, 

their ability to live a good lifestyle would be radically reduced by 

the need to support my generation which would be retired. And 

that is what this is about. 

Secretary SNOW. That is right. 

Chairman GREGG. We as a generation, because we are the babyboom generation which is so disproportionately larger than every 

other generation in the history of this country, have an obligation 

to fix the Social Security system before we hit it and put that burden on our children where they live a lower quality of life because 

they have to support us. And that is what this administration 

stepped up to the table on. I regret that members on the other side, 

especially in the House, are saying there is no problem, because 

there is a problem. Whether you call it ‘‘looming,’’ whether you call 

it ‘‘crisis,’’ whether you call it ‘‘bankruptcy,’’ our children are going 

to face the largest intergenerational tax increase since the drug 

plan, which was an inexcusable act, if we do not fix this situation 

for them. 

And so I at least congratulate the administration for stepping up 

to the issue. I hope we can reach consensus on it, and one legitimate way to do it is to use personal accounts to assure that at least 

our children have some asset which they own, which they will actually retire with, or which, should they unfortunately get hit by a 

truck before they retire, can pass to their children. 

So I congratulate you on creativity. Thank you for your time. You 

have been very generous with it. 

Secretary SNOW. Thank you very much, Mr. Chairman. 

Chairman GREGG. We appreciate it. 

[The prepared statement of Secretary Snow follows:]

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Chairman GREGG. The hearing is adjourned. 

[Whereupon, at 11:59 a.m., the committee was adjourned.]

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(349)

TRANSPARENCY OF BUDGET MEASURES 

WEDNESDAY, FEBRUARY 16, 2005

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. Wayne Allard, presiding. 

Present: Senators Allard, Domenici, Ensign, Conrad, and Nelson. 

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

Hearn. 

Staff present: Mary Ann Naylor, Staff Director; and John Righter. 

OPENING STATEMENT OF ACTING CHAIRMAN SENATOR 

WAYNE ALLARD 

Senator ALLARD. I am going to go ahead and call the Budget 

Committee to order. We will have other members, I am sure, that 

will be attending this morning. We have some pretty stiff competition as far as testimony in front of the other committees, but I 

think we have the real expert here before us. 

Dr. Holtz-Eakin, I look forward to hearing your comments. And 

despite some of the competition, this does remain a very, very important hearing. We are going to be examining some of the fiscal 

demands of Government in the short term, and probably even more 

importantly in the long term, as they evolve over a number of decades, weighing the costs and the benefits of every dollar taxed and 

spent. And I think that is the role of this committee. 

I do not think we can underestimate the value of understanding 

the Nation’s fiscal exposure, particularly when we look at such programs such as Medicare, which I think is very obvious. We have 

the other two big programs out there that we share concern with, 

that is, things like Medicaid and Social Security. But I anticipate 

we will focus most of our time on Medicare. But we also have other 

long-term liabilities out there that I am concerned about, and I 

think other members are concerned about, for example, the Pension 

Benefit Guaranty Corporation, and things like AFDIC and FDIC 

and other programs that I do not think some Members of Congress 

have thought too much about our future obligations, but potentially 

there are future exposures out there, and we need to at least give 

them some thought. 

I think each one of these trust funds—or programs, or trust 

funds in some cases, where we have these significant challenges 

and demands, I think we need to spend some time to study them, 

350

and I think that is what the chairman of the Budget Committee, 

Senator Gregg, had in mind when he set up this hearing. So we 

will try and focus on that, and I want to thank in advance Senator 

Conrad for his help in conducting this hearing with us this morning. This is a bipartisan effort this morning. 

With that, let me call on Senator Conrad for a few comments. 

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

Senator CONRAD. First of all, I thank Senator Allard, who is acting as chairman for us this morning. I agree with you. I think this 

is very, very important because we are starting to talk now about 

our long-term obligations and the shortfall that we are experiencing in those long-term obligations. 

Let me just put this up. This was recently in Business Week. 

This is what they said: ‘‘There are no good reasons for hiding the 

cost of all these endeavors or denying their consequences. New private retirement accounts could cost $1.5 trillion from 2011 to 2015 

and add $100 billion a year to the budget deficit for 20 years. Making tax cuts permanent could cost $2 trillion. Fixing the alternative 

minimum tax could cost an additional $500 billion. These are real 

numbers that should be included in any real budget. If President 

Bush believes the policies proposed are best for the Nation, then 

he should lead an honest dialog about how we should pay for 

them.’’

Mr. Chairman and Director Holtz-Eakin, I agree with that. I 

think we have a runaway train on our hands, not just in the short 

term, but more seriously, I think, in the long term.

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Let’s go to the next chart. As I look at the budget and I see what 

is left out—full 10-year numbers are left out. We all know what 

that means because the tax cuts go up dramatically in cost the second five years. There is no funding included for the Iraq war beyond this next fiscal year; alternative minimum tax reform; Social 

Security privatization transition costs. I am told now that the cost 

of Social Security privatization costs over 20 years is approaching 

$5 trillion. And we have no discretionary spending policy details 

past fiscal year 2006. Highly unusual.

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Let me go to the next chart. When we put all these things back 

in, here is what we see. The President’s budget shows the deficit 

improving, but when we put all the things back in that have been 

left out, we see the deficit improving slightly over the next 4 or 5 

years, but then going back in the wrong direction. And all of this 

kind of hides our real long-term situation. 

The Comptroller General was here the other day and testified we 

have $43 trillion of obligations that have not been covered, of unfunded obligations, $43 trillion, most of that is for Medicare, $27 

trillion for Medicare. Social Security was about one-eighth that 

amount.

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My own conclusion is we have to be addressing all of these 

things. We have to be addressing the imbalances in Medicare and 

Medicaid and Social Security. We have to address the budget deficits. All of that I think is going to require not only spending discipline, but fundamental tax reform. 

One other comment I would like to make because I think this is 

also critical to our understanding of the problem. The long-term 

economic growth assumptions of the Social Security Administration 

are 1.8 percent a year. That is what they are forecasting the economic growth will be over the next 75 years. If we look at the previous 75 years, growth has averaged, as I understand it, about 3.4 

percent. Now, the major difference is we have a dramatic reduction 

in new entrants to the work force. But that is really a very pessimistic outlook. 

I asked the Social Security Administration to tell us what would 

happen if productivity growth was 2.6 percent instead of 1.6 percent. They told me that Social Security’s funding shortfall would 

decline by more than half, from 1.8 percent of payroll to 0.82 percent of taxable payroll. If average productivity growth doubled to 

3.2 percent, then Social Security’s funding shortfall would decline 

90 percent—90 percent. 

So these estimates really matter, and it does strike me that they 

are extraordinarily pessimistic. It is one of the things I would like 

to talk to Dr. Holtz-Eakin about today. 

Notwithstanding any of that, we have still got a problem. We 

have still got a problem. The problem is the baby-boom generation 

that is going to dramatically increase the number of people eligible 

for these programs. As I have indicated, the Social Security problem of whatever dimension needs to be addressed. A far bigger 

problem is Medicare and, frankly, Medicaid is eating the States 

alive. 

So I am delighted we are having this hearing today, and I look 

forward to the testimony of Dr. Holtz-Eakin. 

Senator ALLARD. With that, Dr. Holtz-Eakin, welcome and we 

look forward to your comments. 

STATEMENT OF DOUGLAS HOLTZ-EAKIN, DIRECTOR, 

CONGRESSIONAL BUDGET OFFICE 

Mr. HOLTZ-EAKIN. Thank you for the chance for the Congressional Budget Office to be here today. Mr. Chairman, Senator 

Conrad, we have some written testimony which I would like to submit for the record. It makes a few points, and it says that the Congress creates programs for their benefits, and it constructs budgets 

to reflect their costs. The focus of that testimony is that the key 

decision is to spend money and that that spending can be in many 

different forms. It can be in the form of mandatory programs, 

which last for a long time and which are currently the big numbers 

that attract everyone’s attention. It can take the form of spending 

only under certain circumstances, as would be the case for a loan 

guarantee or an insurance program. Or it could be something that 

looks like a short duration but quite certain, such as annual appropriations. 

In each case, spending is a good measure of the cost of that program, and the spending should be presented as close as possible to 

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its true economic cost, to level the playing field both across budgetary items and also between the public and the private sector so 

that a fair comparison of benefits and costs is possible in evaluating programs. I leave it to you to go through that testimony. I 

would be happy to answer any questions on it. 

Given the title of today’s hearing, the transparency of budget 

measures, I wanted to focus my remarks on a slightly different 

topic, and that is, recently there has been, I think, a fair amount 

of well placed concern and attention placed on transparency in private sector accounting. In the private sector corporate accounting, 

there has been a lot of attention on better disclosure and presentation of the exact status of affairs. And in light of that, there is 

a temptation, I believe, to import into discussions of Federal Government finance the private sector model wholesale and in what I 

hope is—and in what I fear is a not—well thought out fashion. And 

my concerns come in two forms. The first is on principle. I think 

one should be cautious about importing this because there is no 

private firm that has the power to print money. Neither is there 

a private firm that has the power to tax. The Federal Government 

is a very different entity, and its most powerful asset is the sovereign power to tax. And thinking about presentation of budgets 

from a private sector standpoint can send you down to the wrong 

place. 

One of the pieces where I think that shows up the most is the 

notion of an unfunded liability. Let me spend a couple minutes 

talking about my reservations on this concept taken at face value. 

The first is, just so we are on the same page, how these are calculated. If you would take Medicare, for example, one would count 

up all the spending that is promised under Medicare where you 

count future years less than present years, discount them, and 

count them at less than dollar for dollar. But you add up all this 

spending over some horizon. You add up all the dedicated revenues 

over some horizon. And you look at the difference and label that 

an unfunded liability. 

What are the problems with that? Well, first, as I mentioned, is 

that at conceptual levels nothing is unfunded at the Federal level. 

There is always the power to raise taxes and fill that gap right up 

to the point of economic irrationality, at which point the taxes are 

so detrimental that you actually harm yourself. So I think it is unlike the private sector where an unfunded liability requires the infusion of new resources because the commitment is made and the 

funds are not in place. Here funds can be brought into place in a 

much different fashion.

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No. 2, I think we have to be careful with the word ‘‘liability.’’ I 

noticed you used ‘‘obligation.’’ I think that is sensible. The firm liability of the U.S. Government is outstanding Treasury securities, 

backed by the full faith and credit of the United States. There is 

an enormous continuum of obligations, commitments, and promises 

to pay resources out in Federal programs, and some rise to a level 

of firmness that they should properly appear in the budget, and 

others do not, where it might be more appropriate to know about 

them, have some information, but not actually place them on the 

budget. One can think of areas such as implicit guarantees for future disasters where you would not want to actually put that on 

the budget, but you would want to be cognizant of the size versus 

very firm commitments where once they are made, a contract for 

a student loan, a contract for a long guarantee, it would be appropriate to put the recognition on the budget itself. So the notion of 

liability I think is slipperier than a lot of discussions make it seem. 

Then there are some practical difficulties, and I think the Medicare example is an important one for thinking about this in the 

Federal context. The first practical difficulty from a budget standpoint is that you lose some information in going to these unfunded 

liability kinds of measures. In the chart that I have distributed and 

that we have here, we have on the left side a replication of some 

work we did in 2003 on the long-term budget outlook. It shows the 

future spending under Medicare as a fraction of GDP between now 

and 2050, depending on how fast health care costs grow. The top 

line is growing at 2.5 percent faster than income per capita; the 

bottom line is 1 percent faster. So those are the numbers that we 

have in our long-term budget outlook. 

Senator CONRAD. Mr. Chairman, might I just ask him to repeat 

that? Could you repeat, the 2.5 percent relates to what? 

Mr. HOLTZ-EAKIN. We have historically had this, what I think of 

as a horse race between costs and resources—costs, spending per 

beneficiary, and resources, income per capita, GDP per capita. Historically, in the past three decades, costs have risen 2.5 percent 

faster per year than has income per capita. That gets the label ‘‘excess cost growth,’’ and the blue line shows the future of Medicare 

if one simply extrapolates that historical pattern with the new demography of getting older, and something which shows a sharp rise 

from a bit above 2 percent of GDP now to just under 16 percent. 

The green line assumes a future where costs grow more slowly, 

1 percent faster than income per capita, an assumption used by the 

Medicare trustees. The left panel shows two alternative futures. 

The right panel shows a series of present value calculations of the 

type that would be in an unfunded liability notion. 

Consistent with what I said earlier, I left out the taxes. It’s the 

spending that matters. These are present values of spending. Blue 

bars on the right correspond to the fast cost growth on the left; 

green bars, the slower cost growth. 

From this, I think you can draw a couple of lessons. The first lesson is the bars on the right tell you nothing about how fast this 

problem hits, and so by definition, when you add things up over the 

future and you present them now, you give up the timing, which 

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tance of problems at different points in time. The left diagram 

gives you some timing. 

The second lesson that one could draw is these computations are 

very sensitive to discount rates. The middle bar in each pair is the 

3.3 real interest rate that CBO uses for its long-term projections 

at the moment. The actuaries use 3.0 for Social Security. I would 

argue by the standards of science those are the same number. We 

simply do not know. But you can see that there is a very big difference in the height of those bars. A slight change in the discount 

rate either down, to the left, or up, to the right, moves the numerical value tremendously. 

It is not the case that by bringing these numbers to the present 

there is a truth revealed. It is not about truth. It is, again, an estimate of the current cost of the obligation that has been incurred 

by this program. And they suffer the uncertainty that one would 

put in in any projection. 

Then, finally, if you just had those numbers, I do not think you 

would be able to discern readily whether you had the 2.5 percent 

fast growth or the slower growth. So it would not necessarily be the 

case that by moving to this kind of a system one would increase 

transparency. Indeed, it might be harder to figure out what is behind the numbers. Looking at the left, you can see which grows 

fast and which grows slow. 

I think those are practical difficulties in moving wholesale toward this kind of a presentation for Federal budgeting and reasons 

why, given that Medicare, Medicaid, health programs are the big 

numbers that face us in the Federal budget, one would want to 

move cautiously in adopting this model for a whole variety of reasons. 

Then I will close by saying that I think it is obvious that more 

information about the future and the scope of the Federal budget 

is important, and more information is something that the CBO and 

many others would be happy to provide. The real issue is how to 

incorporate it into the formal budget process. You can imagine a 

range of possibilities where at the request of the Budget Committee 

we could provide a longer-term estimate or some alternative presentation. You could automatically provide such a presentation for 

mandatory programs, for example, build it into the process in that 

way so the information becomes available, but the current Federal 

budget process is unchanged. Or you could move a little more toward a formal incorporation by raising points of order, having some 

threshold for, ‘‘Whoa, that is big,’’ that would trigger a point of 

order and cause an automatic discussion of the size of a particular 

bill. 

Finally, one could—and I emphasize the trepidation with which 

I personally would go there—One could incorporate these kinds of 

numbers into the budget process in a formal and numerical fashion. I think given the practical difficulties of doing so, that would 

be a step that the Congress should only take with a great deal of 

caution and study. 

We are happy to be here today, and I look forward to answering 

your questions. 

Senator ALLARD. Well, thank you for your testimony. 

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You know, this is one of the debates we have, the Members of 

Congress, is how far out should you project your estimates. I think 

generally the term applies, the further out you go, the more variables that get kicked in that are unpredictable, and how can you 

bring any kind of certainty to that process. I think sometimes we 

have a difficult time just figuring out what is going to happen within the same Congress, the first session to the second session. 

What kind of tools would you think we could use in trying to 

make some long-term projections? 

Mr. HOLTZ-EAKIN. Well, the tools that we are using at the moment are to take current law programs, extrapolate them, and examine the sensitivity of those projections to alternative assumptions that are important. As Senator Conrad mentioned in his 

opening remarks, key uncertainties in the future of the Social Security program would include fertility, disability, mortality, and immigration on the demography side. And on the economics, what is 

the future of real wage growth as driven by productivity? 

So the tools that one can provide are both the best point estimate 

that an analyst can provide, but also some rough sensitivity analysis, in some cases formal sensitivity analysis that shows the bands 

of uncertainty from those sources. That would allow the Congress 

to see which solutions were robust to the uncertainties and which 

were not. And since we cannot know the future exactly, that is the 

kind of thing that you can bring to the decisionmaking. 

Senator ALLARD. One of the things that we have to struggle with 

is that this committee and your budget office have limited resources. And as we try and look at all these long-term obligations, 

it strikes me that it is going to outstrip our resources that we have, 

and perhaps maybe you can help us begin to set some priorities. 

What programs do you think we ought to be looking at now, what 

programs in the intermediate future and some that could be put 

out a little bit longer when we look at some of our long-term obligations? 

Mr. HOLTZ-EAKIN. I think that you can divide, as our written 

statement did, the challenges into two rough areas. The first are 

the long-term costs of current programs, particularly in Medicare, 

Medicaid and Social Security, where regardless of the precise numbers, we know the shape of the future driven by demography in 

large part, and the spending lines point north to a degree that is 

unlikely to be sustainable. 

And then a second group of programs that merit attention but 

which are quite likely to be smaller in nature are those things that 

are associated with contingencies and uncertainty, things like the 

PBGC, where we do not—we know that the magnitude will not be 

comparable in scope to Medicare, but when it will arrive is very uncertain. And prudently knowing that it could arrive is an important 

part of the budget process. 

Senator ALLARD. So your suggestion then is that we look at those 

where we are looking at larger future obligations first, and I am 

gathering from your comments—I am just trying to simplify this—

that because they are huger obligations, the sooner we begin to address those, then the easier it is going to be to solve those that are 

such huge ones; that if we put them off, then they almost get to 

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be at the point where they are unsolvable. That is basically what 

you are saying. 

Mr. HOLTZ-EAKIN. As a policy matter, the big mandatory programs are a key place for focus. As a budget presentation matter, 

we can work on all—I mean, I am happy to volunteer the staff to 

work on everything simultaneously. 

[Laughter.] 

Senator ALLARD. OK. We will move ahead. I call on Senator 

Conrad. 

Senator CONRAD. Thank you, Mr. Chairman. Again, thank you, 

Director Holtz-Eakin, for being here. Thank you for that very 

thoughtful presentation. I learned something here this morning. 

Actually, I learned quite a bit. So that was important testimony. 

Explain for me, as you look ahead—let’s remove ourselves from 

the language of whether it constitutes an unfunded liability or an 

unfunded obligation. To me the most important thing are the trend 

lines, where this is all headed. 

If you were to characterize, as you look—and not based on the 

rules that are put on you formally, because you can only do projections based on current law. That is the requirement that is put on 

you. But based on your judgment of—your analysis these numbers. 

You spend a lot of time doing it, as do the members of this committee. You look at the trend lines on Medicare. You look at the 

trend lines on Social Security. You look at the revenue situation. 

You know the demographics of the baby-boom generation. 

If you were to characterize our current circumstances in a budget 

sense—we have already got very large deficits; we have large demands on spending coming up; we have the President asking for 

substantial additional tax cuts—how would you characterize our 

long-term budget situation? 

Mr. HOLTZ-EAKIN. I think our long-term budget situation is likely unsustainable. There is a long-term mismatch between the 

spending promised and the resources present to finance it, and the 

long-term spending promise could, in fact, be so large that one 

would not want to finance it as a matter of economic policy. 

Senator CONRAD. Let’s go to that statement, that the long-term 

commitments that are being made by our Government are 

unsustainable, in your judgment, and as a matter of economics 

might be unwise to keep. Why? 

Mr. HOLTZ-EAKIN. Again, nothing is for sure, but if one thinks 

of the upper end of the risks, Medicare and Medicaid over the next 

50 years rising to 21.3 percent of GDP, Social Security rising to 6.3 

percent, we are at 27.6 percent; whatever the needs in defense 

might be; and we have not touched many of the things that most 

people consider the Federal Government budget—education, highways, welfare——

Senator CONRAD. Let me stop you there and put that in perspective for people, because we have people listening and this percentage of GDP probably gets lost on them. What is typically the total 

spending by the Federal Government as a share of GDP? 

Mr. HOLTZ-EAKIN. Twenty percent has been the post-war average, so the——

Senator CONRAD. About 20 percent. 

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Mr. HOLTZ-EAKIN. The numbers I mentioned, Medicare and Medicaid, take up all of that. And then you are layering on top of it 

additional spending that would take us above the post-war average 

to somewhere in the vicinity of 30 percent. The post-war average 

on the tax side has been 18 percent of GDP. That strikes me as—

it is certainly not a guarantee, but it is something that one would 

not want to sail into casually. 

Senator CONRAD. Can we just repeat this? Because I think, you 

know, people listening, it is very important that they understand. 

Right now typically the Federal Government spends about 20 percent of gross domestic product. 

Mr. HOLTZ-EAKIN. That is the post-war average. 

Senator CONRAD. That is the post-war average. And what you 

are telling us here today is that there is a potential for Medicare 

and Medicaid alone to spend 20 percent of gross domestic product. 

Is that correct? 

Mr. HOLTZ-EAKIN. That is a straight-line extrapolation of history. 

So something has to change in order for that not to occur. 

Senator CONRAD. We are in a circumstance in which Medicare 

and Medicaid alone could consume what has typically been all of 

Federal spending. That would be no money for Social Security. 

That would be no money for national defense. That would be no 

money for parks or education or all of the other priorities of Government. 

Mr. HOLTZ-EAKIN. That is right. 

Senator CONRAD. And Social Security on that same trend line 

would be 6.5 percent of gross domestic product. Is that true? 

Mr. HOLTZ-EAKIN. Yes. 

Senator CONRAD. So just those, Medicare, Medicaid, Social Security, 26.6 percent of gross domestic product being consumed by the 

Federal Government when the post-war average is 20 percent. 

Mr. HOLTZ-EAKIN. Those are the numbers, and that is the risk 

that we face. 

Senator CONRAD. Well, it again speaks to, to me, the need to address all of these things collectively. 

Senator ENSIGN. Senator, would you yield so I can ask a follow 

up question. 

Senator ALLARD. His time is just about up. 

Senator ENSIGN. Just to clarify and to add an additional number. 

What is the historical average of the rest of the budget as a percentage of GDP? In other words, you have Social Security which 

you just said in the future would account for about 30 percent, 

what would the total budget be as a percentage of GDP? You have 

just given us 26.5 percent just with Medicare, Medicare, and Social 

Security. Has historically everything else been 3.5 percent? 

Mr. HOLTZ-EAKIN. Well, the history is less clean there because 

we have had this big shift over the post-war period. It used to be 

about two-thirds discretionary, one-third mandatory. Now we are 

at the other end of the spectrum. And so it is these big mandatory 

programs that we are talking about. 

How big can you let the discretionary programs get is, you know, 

much more controlled on an annual basis, but if you took a third 

of the budget, you are looking at 6 percent of GDP, roughly. That 

is right now. 

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Senator ALLARD. I want to go back and give Senator Conrad an 

opportunity. You have 20 seconds left on your time, so if there is 

something you want to summarize? 

Senator CONRAD. Thank you very much, Mr. Chairman, and 

thank you for the question, because I was going there myself, how 

does that all add up. And I think it just becomes very clear it does 

not add up. 

What I wanted to take you back to is the economic question. Why 

would it be harmful to the economy for the Federal Government to 

be consuming 30 percent of gross domestic product? What would be 

the adverse effect? 

Mr. HOLTZ-EAKIN. It is hard to imagine that we could maintain 

some of the key broad pillars, I mean, not details but the big picture, pieces of the U.S. economic success have been broadly a reliance on private markets and small contained Government financed 

by relatively low and efficient taxes. We would have a much larger 

Government. It would take over a greater fraction of the economy. 

It would necessarily have to have higher taxes, and to the extent 

that they were levied in an inefficient fashion, that would have an 

economic cost. That is well documented. And it may be the case 

that in those circumstances there would be a temptation—and this 

is an unknowable part of the future—to accomplish policy goals in 

other ways, using regulations and mandates, and that interferes 

with the flexibility of the economy. 

So it is a future in which the overall scope of things becomes so 

large that it is hard to maintain the historic patterns that have 

been successful in the United States. 

Senator ALLARD. Thank you. 

Senator ENSIGN. 

Senator ENSIGN. Thank you, Mr. Chairman. That was a great 

line of questioning. I want to followup with it because I think that 

the importance of this cannot be overstated. What Senator Conrad 

and Senator Allard talked about underscores that, if we do not 

make changes sooner rather than later we will find ourselves in a 

difficult position. I mean, if we were at the point where our budget 

consensus, say 30, 33 percent of our gross domestic product, we 

would have to have the revenues to equal that. Historically that’s 

obviously difficult when we have been around 18, 19 percent historically as far as a percentage of GDP for purposes of taxes. If we 

had to finance that, the tax rate would be outrageously high in this 

country. But if you just continue on the current course, there is no 

way you change it. It goes back to studying the historical truth of 

democratically elected governments collapse? They collapse because 

people realize that they can vote people into office who will give 

them what they want. We are at that critical breaking point, I 

think, and the longer we wait, the less chance there is of truly fixing the system. 

I want to talk about a couple of programs. Lets compare Social 

Security to Medicare and Medicaid. Social Security has unfunded 

liability that is small compared to Medicare and Medicaid. If we do 

not make changes to the new Medicare prescription drug benefit 

Part D right now, from what I understand, over the lifetime, we 

have huge unfunded liabilities. Do you know the number of the unVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00370 Fmt 6601 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
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funded liability on just the prescription drug benefit over an equivalent timeframe? 

Mr. HOLTZ-EAKIN. Given my reservations about these numbers, 

I want to just put big bracket——

Senator ENSIGN. Just so we can compare apples with apples. You 

know, the numbers are what they are, but just so we can compare 

apples with apples. 

Mr. HOLTZ-EAKIN. Drug spending is rising at about 8 percent per 

year at the end of our 10-year projection. The discount rate that 

one would apply to these kinds of calculations to do the unfunded 

is about 5–1/2 percent, treasuries plus inflation. That means that 

if you go over a long enough horizon, literally out to infinity, the 

cost of that bill is infinite because the costs are rising faster than 

the discount rate. 

So to give you a number I would have to make an arbitrary assumption about when drug costs would begin to slow down and 

how much. I would have to get them down to under 5–1/2 percent 

in order to give you a number, and I would have to pick a date. 

One of the reasons I am nervous about embedding numbers like 

this in the Federal budget is they are really arbitrary. I am terribly 

aware of how difficult some of these estimates are, but they are far 

less arbitrary than something like that. 

So it is a big number, I assure you. We could decide on how big 

a one you want. 

[Laughter.] 

Senator ENSIGN. I do not want a big one. 

[Laughter.] 

Senator ENSIGN. Just to further illustrate this, lets just go back 

to Social Security. We hear the year 2018 tossed out there, which 

is when the trust fund starts running into the red. As far as I am 

concerned, trust funds are phony and they are an accounting procedure. It is not like what most people really think of when they 

think about a trust fund where they actually have money in a savings account. We all know the kind of games that are played up 

here. 

If we do not do anything, and it has continued to grow—let us 

go out to 2018 and we have not touched Social Security, we have 

not made any changes to the system, we have not cut benefits, we 

have not done anything because the chances of cutting benefits, 

well let’s jsut say we know the politics of this, so we have not increased the rate of return or anything like that. Lets go right to 

where the trust fund starts turning upside down. 

At that point, if we have not made any changes, what happens 

to the rest of the budget, Medicare, Medicaid, all of the discretionary spending? What happens to the rest of the budget at that 

point? 

Mr. HOLTZ-EAKIN. First of all, the rest of the budget is growing 

rapidly, Medicaid and Medicare, and to honor the promises of Social Security you will have to find those resources in the rest of the 

budget. You will have to raise taxes. You will have to cut spending 

in the rest of the budget. You will have to go borrow more. 

In Social Security in isolation you might feasibly imagine that, 

but for the budgetary picture as a whole it is hard to imagine you 

could borrow that kind of money. 

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Senator ENSIGN. At what point, how many years from now does 

that actually start becoming a reality? I gave you the 2018. 

Mr. HOLTZ-EAKIN. 2010. 

Senator ENSIGN. 2010 is when that——

Mr. HOLTZ-EAKIN. 2010 the Social Security surplus peeks in our 

estimates, but somewhere around there, and then it begins to diminish and pressure in the unified budget will begin to become 

more apparent. And people have different dates at which it becomes a problem, but that is the starting point for the diminishing 

cash surplus into the remainder of the budget. 

Senator ENSIGN. Based on your experience on watching us up 

here on Capitol Hill and the proclivity to spending up here and not 

cutting spending, what is your best guess on what would happen 

to the rest of those programs? It would be borrowing, correct? 

Mr. HOLTZ-EAKIN. An economist can give you two answers to 

anything, so the answers are as follows. One, people do things because of preferences, political or otherwise, and they do things because there are constraints. Even the United States cannot borrow 

infinitely large amounts of money every year and at some point the 

constraints will bind even if the Congress does not choose to 

change programs. 

Senator ENSIGN. Bottom line is we are in trouble in the future 

if we do not make changes? 

Mr. HOLTZ-EAKIN. Yes. 

Senator ENSIGN. Thank you. 

Senator ALLARD. Let me call on Senator Nelson. 

Senator NELSON. Thank you, Mr. Chairman. 

Hello again, doctor. 

Mr. HOLTZ-EAKIN. Good morning. 

Senator NELSON. Several times. I am just going to ask a simple 

question. Years ago I came to the House of Representatives, elected 

in 1978, shortly after the Budget Act was put in place. And it was 

put in place for the purpose of basically bringing the deficit under 

control. At first there was some success in the late 1980’s. I believe 

that the deficit was brought to somewhere close to 20 or 25 billion 

dollars. Then in the decade of the 1980’s it ballooned and we had 

a different situation. Of course you know the history in the 1990’s. 

It was brought under control so that by the end of the decade of 

the 1990’s the Federal budget achieved what we had been trying 

to achieve for 20 years, which was the budget came into balance, 

and then lo and behold, for a couple of years running we had a surplus. 

I guess my concern is that the budgetary process does not mean 

anything any more if we do not come forth with the subject of this 

hearing, the transparency, the adequate numbers. You can deal 

only with the numbers that you are given, but looking at one of 

Senator Conrad’s charts here, that if all of these things are not included—and of course we are getting ready to vote on this right 

now, and it is going to pass overwhelmingly because who is not 

going to support to money to support our troops—and if all these 

other things are not in the budget, and I am asking you I think 

a philosophical question, why are we going through this exercise if 

what is in front of us really is not a reflection of the reality? Would 

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you philosophize for us, make me feel any better about the budgetary process?

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Mr. HOLTZ-EAKIN. People rarely come to the Budget Director to 

feel better. 

[Laughter.] 

Senator CONRAD. Or this committee. 

[Laughter.] 

Mr. HOLTZ-EAKIN. And to ask an economist to philosophize is a 

really dangerous business. 

The purpose of the hearing I think is to ask the question, what 

should be in a congressional budget, how should it be entered, and 

how do you reflect the operations of the Federal Government? 

When there is a firm enough commitment it should be entered 

in the budget, there is no doubt about that. And budgets, I believe, 

should best be thought of in their plain vanilla English sense. They 

are planning documents. You budget for things. And you should 

plan for the things that are most important. 

Right now it is a different situation than it was 10 years ago. 10 

years ago the hard work of the Congress put controls on discretionary spending. The peace dividend made it easier to do in the 

area of defense, and a revenue boom was a great bonus on top of 

it. We are 10 years way from that. We are 10 years closer to the 

retirement of the baby boom. We are unlikely to have a peace dividend in the near future, and the money in the Federal budget is 

not in the discretionary side. 

So to the extent that business needs to be done differently going 

forward, I think it essentially has to involve finding a way to budget for the mandatory programs that are the biggest part of the Federal budget, that are the rapidly growing threats to the future, and 

I do not have a magic presentation or panacea. I have some reservations about some things that I see people talking about. I 

would be happy to work with this committee, certainly, who are the 

people most cognizant of these issues in my experience. 

I do not know if that is good philosophy or not. I was not great 

at philosophy. 

Senator NELSON. Senator Conrad, you are so eloquent in all of 

this. Would you make me feel better? 

Senator CONRAD. I wish I could. You know, I really think we are 

on a long-term course which the Director describes as 

unsustainable, and these things are real. There is no question 

about it. Alternative minimum tax is quickly becoming a middle 

class tax trap, 3 million people affected now. It is going to be 30 

to 40 million people affected. We are going to have to deal with it, 

and it costs money to do. It is not in the budget. 

The war costs past September 30th of this year, the Congressional Budget Office tells us it is very substantial but it is not in 

the budget. 

The cost of going to Social Security individual accounts or personal accounts, whatever one wants to call them, private accounts, 

has an enormous cost, and it is not in the budget. 

I mean when we put the things back in the budget that the 

President is proposing it just further takes us into a swamp of red 

ink, and at the worst possible time, before the baby boomers start 

to retire. We know what is going to happen. We know that the 

number of people in this baby boom generation are going to double 

in very short order the number of people eligible for Social Security 

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and Medicare, and we know that Medicare costs are going up before we even consider the new numbers. The costs of medical treatment are going up far in excess of inflation. Is that not the case, 

Director Holtz-Eakin? 

Mr. HOLTZ-EAKIN. Yes. 

Senator CONRAD. So we are on a collision course. The more I 

come here the more I feel like I am in a sort of detached-from-reality state in the Congress and in working with the administration, 

because we know these things. It is not even a close call. We know 

that none of this adds up, and yet we act as though nothing is happening and really nothing needs to be done. 

My own view is the work that we would have to do to put the 

country in a more secure position for the future is really quite 

stunning. To take on the challenge of the shortfalls in Medicare 

and Social Security and the existing budget deficits, coupled with 

the President’s plan for even more tax cuts—none of it adds up. It 

does not even come close to adding up. And you know, I guess my 

most fervent wish would be that all of us, that the President say, 

OK, time out. Let us get everybody to bring forward their best 

ideas on how we deal with Medicare and Social Security and tax 

reform, because I think that has to be a piece of it, and I say that 

not as code words for a tax increase, I say to my colleagues. I say 

that because I truly believe our current tax system is hemorrhaging hundreds of billions of dollars a year that is owed that 

is not being paid. 

I used to be a tax administrator. I see the estimates of the IRS 

that say $300 billion in 2001 was the tax gap. I do not think they 

are anywhere close to how big the tax gap is. I think it is much 

bigger. They are working on studies now that I think will reveal 

that. I do not think just jiggering around with the current tax system is going to fix a significant proportion of that. We have tried. 

We have tried to do that before. Senator Allard has been a part of 

those efforts. I have been part of those efforts. 

But I think the agenda is really very, very significant, and yet 

we kind of are dealing with the edges of it, and the sooner we get 

on this much more ambitious agenda, the better for the country. 

Senator ALLARD. Your time is expiring here. I would like to keep 

it rotating around. We will have another time to speak. We allowed 

you to go over almost 4 minutes, so I would just like to keep it rotating around. 

Senator NELSON. May I make a concluding statement? 

Senator ALLARD. You may, as long as it does not go over a few 

seconds. 

[Laughter.] 

Senator NELSON. It seems to me that what I thought of as you 

were speaking is that we just cannot solve this problem in this era, 

this atmosphere of highly partisan charged, ‘‘got ya’’ politics, that 

it is just like Social Security. You cannot solve that in this atmosphere. And it has got to be a coming together, and the only thing 

that I can think is from my own experience when Ronald Reagan 

and Tip O’Neill got together in the early 1980’s and said, ‘‘We are 

going to do something about Social Security.’’ And they had 6 

months that they had to get it done because Social Security was 

going to run out of money for its payments, and they did it. And 

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they did it with a bipartisan commission that said ‘‘We are not 

going to play partisan politics.’’ And they did it. I do not know how 

else we are going to solve this budgetary crisis until we get that 

kind of bipartisan atmosphere. 

Thank you. 

Senator ALLARD. Thank you. 

I would like to assume some of my time now on this. We talk 

about resources that are available, and in your preparation I think 

you had taken great pains and effort to distinguish between obligations and unfunded obligations. When you use the term 

‘‘unsustainable,’’ are you not in a way talking about unfunded obligations? 

Mr. HOLTZ-EAKIN. I use that term because I do not believe that 

if we attempted to fund them going to what is the ultimate resource, the U.S. economy, that we could do that by higher taxes 

without damaging that economy, that it would be a losing battle. 

Senator ALLARD. Another source out there that we have not 

talked about in this discussion, and maybe you want to take a little 

time to do that, is one thing we can do is restructure some of the 

programs in order that you do not incur the future cost. Would you 

care to mention how that resource may be used in trying to cut 

down on some of our future obligations? 

Mr. HOLTZ-EAKIN. I think in the end it will be the prerogative 

of the Congress to decide how to restructure the programs, but I 

think the numbers——

Senator ALLARD. Give us some ideas on some of the big ones. 

Mr. HOLTZ-EAKIN. The numbers give you places to start. We 

know the big ones, Medicare and Medicaid. They are also the hardest of the mandatory programs because the underlying source of 

the increase is rising health care costs in the United States, not 

necessarily the structure of the programs alone, and that is not as 

well diagnosed as many other phenomenon. As a result, it is very 

difficult to pretend there is a list of solutions out there that one 

could pick off the menu and hand to the Congress. There I think 

progress will be incremental and involve lots of experimentation 

because necessarily we might spend more on health but we do not 

want to overspend. 

Social Security next in line in terms of magnitude, very different, 

a program that is well understood, a program that in the end involves raising money in one part of the economy, delivering it to 

another, perhaps at a different point in time. There is a large menu 

of potential solutions to the financing and the policy objectives, a 

place the Congress is discussing right now. Moving down the line, 

there is the whole list of policy options in the areas of defense and 

other defense policy, annual appropriations, and then smaller mandatory programs, whether they be insurance, where I think the important thing is to recognize that when the Federal Government 

engages in the large number of financial transactions that it does 

it transfers but does not eliminate risk, and when it carries that 

risk on the Federal budget, it is implicitly carrying it on behalf of 

the taxpayers who are ultimately going to have to foot that bill, 

making conscious budgetary recognition of all the risks that the 

Federal Government has collected and is holding for the taxpayer. 

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It would be a step toward identifying which places were large and 

would be a way to go forward. 

In the work we have done for the Budget Committees, as an example of that, we have looked at the America West loan guarantee, 

which under current budgetary treatment appears to be a profit 

center for the Federal Government because it ignores the market 

risk, but if you put the risk in there appropriately the way markets 

recognize it, it swings from being a $45 million profit center to a 

$25 million loss. Things like that I think will be useful in letting 

the budget reflect the relative magnitude so that the policy decisions can be made better. 

Senator ALLARD. And I agree with our colleague from Florida, 

maybe some of this ought to be a bipartisan effort, but I think it 

serves reminding ourselves at this point in time that a third of this 

round figures is discretionary spending, which tends not to be as 

political as with the mandatory program which is two-thirds, and 

there is where we talk about the political part of it. And if we 

would take a position on spending on some of those programs, then 

the responsibility falls to the authorizing committee, not the appropriators to come up with some solutions as to how we can move 

these programs in a way in which our future obligations may not 

be quite as great, and that is a real challenge I think for the Congress. 

The only way that I see something like that happen is it does 

have to be a bipartisan effort because you have to have more than 

a majority to move forward on most of this, and so you have to rely 

on some support coming out of the minority party to get that accomplished. My hope is that we can come on these really important 

mandatory spending, or entitlements, in a way that we can look at 

it. I know that some members in the Senate, more so out of the 

Democrat side than Republican side, have said, Look, you know, 

there is not any problem with Social Security. But I hear my colleague here, and I certainly believe, and I think most of the American people believe that there is truly a problem with Social Security and that the sooner we deal with that problem the easier it 

is going to be to resolve it in a satisfactory way. As you had commented earlier, the longer you put that off it almost gets to a point 

where it is impossible to solve. 

Let me just kind of move on to another area, which I think has 

some potential sizable obligations on our Federal budget, but perhaps even more, it has some impact even on the marketplace, and 

that is what we call our Government sponsored enterprises. I serve 

on Banking Committee, for example, where we are looking at 

Fannie Mae and Freddie Mac, and those we see huge obligations, 

potential obligations out here, and that they are carrying a pretty 

sizable debt. I think somewhere around 1.6 trillion, 1.7 trillion is 

the figure that gets tossed out there. 

What can we do legislatively to resolve this issue of implied obligation? We have not made a direct obligation to them, but everybody assumes that if something happens to Fannie Mae or Freddie 

Mac that that is going to be an obligation that the Government is 

going to pick up. What can we do legislatively to make it clear that 

those types of funds—and we can pick out several other examples, 

but I will just use those—what can we do legislatively to make sure 

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that it is understood out there that it is not necessarily going to 

be—that it is not a Federal future obligation? 

Mr. HOLTZ-EAKIN. The implicit subsidy to the housing GSEs derives from an array of different features of the way they operate, 

the Presidential appointment of directors, the exemption from SEC 

registration requirements, the ability of banks to hold greater fractions of their securities as if the were treasuries, a line of credit 

at the U.S. Treasury. So there is a long list of things which contributes to this implicit subsidy. A process has begun and legislation 

could accelerate peeling back different aspects of those special and 

preferential treatments toward, and in the continuum of that, you 

get to a point where they are treated like any other private entity 

with comparable capital requirements, comparable registration requirements. That would sever it completely. Any movement in that 

direction would lessen this implicit guarantee. 

Senator ALLARD. You fall into almost kind of this concept ‘‘too big 

to fail,’’ and it seems to me that perhaps maybe on those kind of 

things if the more competition you got in there so that your entities 

are not quite so large, that perhaps maybe that could be part of 

our solution. I wonder if you might address that thought. 

Mr. HOLTZ-EAKIN. ‘‘Too big to fail’’ is a market perception. 

Senator ALLARD. It is. 

Mr. HOLTZ-EAKIN. So you cannot control that directly. Indirectly 

you control it by more firmly putting in the same kind of regulatory 

environment that is meant to prevent failure, capital requirements, 

disclosure requirements, registration, all those things, so that the 

nature of the failure is one which is comparable in risk to other private entities, and then making sure that you are happy with the 

overall nature of the risks out there in the capital markets. 

Senator ALLARD. My time has expired. I will now recognize Senator Ensign—I am sorry—Senator Conrad, you had some time. 

Senator CONRAD. Let me just, on the Government sponsored enterprise, signal this note of warning because I remember very well 

when I was doing in my younger days real estate projects, and 

North Dakota and many parts of the country did not have access 

to national credit markets. And the advent of Fannie Mae and 

Freddie Mac made a dramatic difference in the credit available for 

real estate development, both housing and apartments and commercial. It is very important we not throw out the baby with the 

bath water here because I can tell you the difference in interest 

rates because of access to a national market versus being locked 

into local and regional markets is very dramatic. It has had a very 

beneficial effect. 

Let me go to Medicare if I could because we have really identified that as the big enchilada in terms of our long-term obligations 

here. I just want to say for my colleagues, I really do think we need 

to have some kind of situation where we come together and everybody bring their best ideas. 

Let me give four that I would advocate to my colleagues, and ask 

them to ask their staffs to be thinking about these things. First of 

all on Medicare, 5 percent of the people use 50 percent of the 

money, 5 percent use 50 percent. Is that roughly right, Dr. HoltzEakin? 

Mr. HOLTZ-EAKIN. Yes. 

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Senator CONRAD. I think we ought to focus on that 5 percent like 

a laser, and we ought to better coordinate their care because we 

could, I believe, achieve substantial savings as well as get better 

health care outcomes if we put a case manager on every one of 

their cases, and here is why. We did a pilot study with 22,000 patients. We put a case manager, a nurse on each one of their cases 

to better coordinate their care, and we reduced hospitalization 20 

percent, achieved 40 percent savings and got better health care 

outcomes. 

Now, why is that such a powerful idea? Because what is happening in modern life is people have multiple doctors, they are 

going to multiple health care providers. They have a doctor at their 

home place, they have a doctor down at the lake or at the beach, 

they have a lung doctor, they have a heart doctor, and they are getting medicine at the pharmacy and they are getting medicine out 

of town, and they are getting medicine in mail order. The problem 

is there is no central point of coordination for many of these cases. 

The result is they are taking too many prescriptions, they are getting duplicate tests, and many of these things actually harm the 

patient. 

I’ll just share a personal experience with my father-in-law, who 

passed away. We went down and spread out his prescription drugs, 

taking 16 different prescription drugs. I got on the line with the 

doctor, and I started reading him the drugs he was taking. He said, 

‘‘Oh, my God, he shouldn’t have been taking that for the last 3 

years. He should not be taking that drug. That adversely interacts 

with the third drug you mentioned.’’ And on and on it went. We 

found out 8 of the 16 drugs he was taking he should not have been 

taking. 

I say that because that is exactly what they found with the 

22,000 patients. They found that many of them were taking 15 to 

16 prescription drugs, and half of them they should not have been 

taking. That led to all kinds of adverse interaction. It led to all 

kinds of hospitalization. In fact, that alone accounted for 20 percent 

of the hospitalization at enormous cost to Medicare and Medicaid. 

The second idea I would offer is negotiating lower drug prices in 

Medicare. We do it in the Veterans Administration. I think we 

have to seriously revisit that. 

The third idea I would offer is the $10 billion slush fund that the 

Health and Human Services Secretary has to sweeten the pot for 

private funds, private plans. 

The fourth idea I would offer is the amount that private plans 

are costing over and above traditional Medicare, that is $40 billion. 

I just do not think we can afford these things. I think on the prescription drug plan that we ought to go revisit it. I voted for it. I 

sided with the administration, to some consternation of some of my 

best friends. But honestly, when it is up to $720 billion, Mr. Chairman, I think it deserves us going back in and see where we could 

save money. I think we ought to be doing that everywhere. We 

have to revisit everything we are doing. 

Senator ALLARD. I thank you for your comments. I just want to 

take this up. I think it is more complicated than just having a case 

manager, frankly. I mean the State of Colorado from which I come, 

we have used case management as far as Medicaid is concerned. 

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But those costs continue to grow. The real problem is that 5 percent that utilize 50 percent of the resources in Medicaid, for example, those are all at the end of the life cycle decisions that are very, 

very difficult for any kind of Government agency to make, and 

those almost comes back in onto the family and the provider to 

come and do that. And where we have in Colorado said we have 

case managers in those cases, this is being monitored, there still 

is some duplication of drugs, even though you have that oversight. 

It helps, but I think that the savings from that gets oversold, and 

there are some real tough decisions on how you manage a medical 

case toward the end of the life cycle, which, you know, I would hate 

to see Government involved in, and I do not think you want to get 

involved in it. The Governor of Colorado has tried to get involved 

in those discussions to a huge political detriment. 

So I think that we need to figure out some ways in which we can 

put the family and the family practitioner more in control of their 

own decisionmaking processes. 

My view sometimes is the fear of lawsuits and taken to court because somebody makes this kind of decision. Somebody who feels 

like they do not have any flexibility in their decisionmaking process 

really does not add an awful lot to that. 

Let me go ahead and call on Senator Ensign. 

Senator ENSIGN. Thank you, Mr. Chairman. 

I think, Senator Conrad, you are exactly right though, and I said 

this about Medicare and Medicaid when Josh Bolten was here testifying, that I was disappointed that the administration did not 

propose more reform in its budget. I guess they are suggesting 

some reforms to Medicaid, but Medicare really is, between the two 

of those, a much bigger threat than Social Security. Social Security 

is a threat also. There is no question. There is a huge unfunded 

liability out there, but health care costs really, dwarf the Social Security problem that is looming out there in the future. I believe solutions have to be in a bipartisan fashion. 

There are some things that really are noncontroversial and 

which do not go to philosophy, pretty simple things. Requiring 

Medicare and Medicaid to move to best practices. The reason you 

need to start with those is because all insurance companies and everybody else follows what Medicare and Medicaid do. Each one of 

the specialties right now, have identified various disease types and 

what the best practices are to follow. What the best drugs are. 

What the best tests to run are. How exactly to follow up. Requiring 

best practices can result in fairly substantial savings. The estimates are up to 20 to 35 percent of health care costs with that single reform. 

Obviously, we disagree on tort reform. I have seen it right in my 

own State. Being right next door to California, which has had a 

very good medical liability reform law for a long time, and the difference between the liability costs in Las Vegas versus Los Angeles 

is just huge. A lot of our good doctors from Nevada are moving to 

California while, everybody else from California is moving to Nevada. The exception though is our doctors who are moving back to 

California because they can better afford to practice medicine 

there. We are losing a lot of really good specialists. We cannot get 

neurologists to take calls. There are all kinds of problems and the 

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costs are skyrocketing. So I believe any kind of a system in the future, in order to get costs contained, needs medical liability reform. 

We also have to eliminate medical errors. 

Fundamentally, the other huge part of all of this is we have to 

devise a system where the patient is brought back into the accountability loop and understands cost. When you talked about case 

managers, today what has happened because of managed care and 

costs running out of control? Businesses said, hey, we need managed care. We need somebody to come in and control our costs. 

Managed care was originally supposed to be about managing care, 

now it is more about managing cost. The primary care physician 

used to be that case manager. They do not have time any more. It 

is about volume now. They have to try to see as many cases—Medicare’s reimbursement is so pathetic, and because of the chances of 

being sued by the very low reimbursement, a lot of doctors are just 

saying, forget it. I am not going to even deal with those cases. 

We do not allow doctors to charge, on Medicare, wealthy people 

more, to allow doctors to spend more time with them. If we could 

have health savings accounts, a lot of administrative costs. There 

is so much money spent in administration today. HSA’s puts a person back into the accountability loop. The money is actually being 

spent from their account and the patient sees their balance. The 

doctor could spend more time with them. Patients could negotiate 

prices. We could do those types things. There are lots of ideas like 

that that I believe in the future that we could all come together 

on. 

The question I wanted to ask, Dr. Holtz-Eakin, of you, has to do 

with the PBGC and the problems that are looming out there with 

so many pension plans. You know the ideas that have been put forward in Congress. Can you describe the problem to us? In the last 

year Congress passed a bill, and I was one of the few people who 

voted against it, that addressed pension under funding. Did that 

bill last year make the problem with the PBGC better or worse? 

Mr. HOLTZ-EAKIN. The problem got worse because of the lower 

funding requirements for a couple of years. The problem comes in 

two pieces. One piece is the financial status, which is defined benefit pension plans are underfunded, broadly defined, and in some 

cases quite dramatically so. That is the broad underfunding issue. 

The PBGC’s problem, as the guarantor of these is that you can 

divide the underfunding into some legacy problems which steel 

companies fit into that, and there is not much you can do about 

that, and there are a variety of plans that look like that, versus 

those which going forward could be funded adequately and which, 

given the right incentives, would provide an option for people to 

have a DB plan in the private sector. 

So the policy design issue is: can you segregate those policies 

aimed at the legacy and those which provide good incentives for DB 

plans going forward to fund themselves adequately? And if you 

raise, for example, a premium too high to cover the overall funding 

hole, you might make a DB plan so unattractive on a going forward 

basis that people would simply switch to defined contribution 

plans. 

It is one of these issues where you have to distinguish between 

the past and the future and it is hard to do. 

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Senator ENSIGN. I mean I think most companies realize defined 

benefit plans are almost unsustainable into the long term. The 

rates of return are not what a lot of people have sold them. 

But I think that one of the points to make here, obviously is that 

the taxpayer is going to end up holding the bill on a lot of these. 

Mr. HOLTZ-EAKIN. The narrow liability of the PBGC is quite 

clear, but the concern of course in the broader scope is if there was 

a larger than expected event which caused lots of plans to show up 

at the PBGC, that Congress would feel compelled to pick up more 

of the tab. 

Senator ENSIGN. Just a quick followup, and this is just clarification of this because I am now aware of this. Are the public employee pensions, are they guaranteed or backed up by PBGC? I do 

not know. 

Mr. HOLTZ-EAKIN. No. 

Senator ENSIGN. OK. I just did not know. Thank you. 

Senator ALLARD. We are going to get ready to kind of wrap this 

up. I might check with Senator Conrad here on my right and see 

if he has any wrap up comments, then I will close the committee. 

Senator CONRAD. First of all, I want to thank again Director 

Holtz-Eakin for being here, and thank Chairman Allard for filling 

in today and for conducting this hearing in a way that I think we 

had one of the best discussions we have had. I really do believe 

that this idea—and I would say to Senator Ensign, we have talked 

about more ideas here this morning about how to rein in some of 

these expenditures, than we have had a chance to talk about all 

year. I honestly believe if members had a chance to get together, 

bring their best ideas on saving money and improving care, it is 

amazing how many good ideas we would have. 

I think some of my colleagues would be surprised. They think, 

well, you are against tort reform. I am not against tort reform if 

it is done in a way that I think is fair. In fact I think it is going 

to be an essential component of this whole package. But I have 

heard more good ideas here this morning than I have had a chance 

to hear at any of our previous sessions. 

I very much hope that somehow we find a way to give a chance 

to every one of our colleagues to bring their best ideas and then 

implement them. I think we could make dramatic progress. 

I thank the Chair. 

Senator ALLARD. Thank you, Senator Conrad, for your comments 

and whatnot. 

I would also like to thank you, Dr. Holtz-Eakin, for making here 

to share your expertise with us. We appreciate your good work. I 

personally think that we are going to have plenty of opportunity in 

the future to have some more discussion on these because these are 

very, very difficult issues that we are coming to struggle with. It 

has taken some leadership. I think it has taken the President to 

bring up these issues so that they come before the Congress, and 

I think now that discussion opened, we are finding more and more 

members saying, look, let us look at the total package and let us 

look at all of these issues. I think that it is members like Senator 

Conrad, who is thoughtful and keeps coming up with some novel 

problems that we have out there, novel solutions, and participation 

from members on this committee. 

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Hopefully, if we can get these out and begin to get them discussed, we can begin to address some of these solutions, which are 

not going to be easy, but they are important that we recognize 

them early on and begin to address them. 

With that I would like to thank my colleagues for participating 

this morning. I would like to thank the witness, and those who 

have been following this debate. Thank you very much. 

One other thing before I do adjourn the committee. We give to 

the end of the day for members to submit any additional questions 

that they may have to the staff, and then the staff will go ahead 

and process their responses. So I just ask the witness that if you 

get these additional questions, that you process them as fast as you 

possibly can, get them to the staff, and then we will be able to 

write up a full record on the committee proceedings. 

[The prepared statement of Mr. Holtz-Eakin follows:]

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Senator ALLARD. With that, I want to go ahead and call the committee closed. 

[Whereupon, at 11:12 a.m., the committee was adjourned.] 

(395)

MEDICARE AND MEDICAID: RISING HEALTH 

CARE COSTS AND THE IMPACT ON FUTURE 

GENERATIONS 

THURSDAY, FEBRUARY 17, 2005

U.S. SENATE, 

COMMITTEE ON THE BUDGET, 

Washington, DC. 

The committee met, pursuant to notice, at 10 a.m., in room SD–

608, Dirksen Senate Office Building, Hon. Judd Gregg, chairman 

of the committee, presiding. 

Present: Senators Gregg, Bunning, Ensign, Alexander, Conrad, 

Nelson, Stabenow, and Corzine. 

Staff present: Scott B. Gudes, Majority Staff Director; and Don 

Dempsey and Dave Fisher. 

Staff present: Mary Ann Naylor, Staff Director; and Sue Nelson. 

OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

Chairman GREGG. We will start the hearing. We very much appreciate our witnesses joining us today. 

A lot of the testimony that we have heard so far in this committee about the issue of the fiscal solvency of our Nation and specifically our Government and how we address responsible management of our fiscal house has been tied to the question of health 

care. I think there is no debate any longer about the fact that 

health care is the single biggest driver of Federal expenditures for 

the foreseeable future. It is probably also the biggest driver of the 

costs of day-to-day life in this country as we head into the future. 

We have this aging generation, the baby-boom generation, which 

a lot of discussion has been focused on, and their needs in health 

care are going to increase exponentially as they head into the retirement years. 

We had Comptroller Walker testify that there is a huge amount of unfunded liability in this country, about $43 trillion worth over 

the actuarial life of the various programs, of which the majority, 

about $27 trillion, is directly tied to health care costs. 

The President has begun to address this issue both from a policy 

standpoint and from a budget standpoint, and in the budget he has 

made proposals in the area of trying to address Medicaid costs. 

And this committee will hopefully also address those issues. 

But the big elephant in the room is Medicare and how we address the cost of Medicare and make health care available for seniors but also make it affordable for the young people who are working who have to pay the costs of the HI insurance. 

396

So we have asked the panel to join us today. The panel is made 

up of experts in the area of health care who have had a lot of experience with the Social Security funds and the management of the 

health care/Medicare system. And we look forward to getting their 

input on ideas that we as a Government could address to try to 

start to manage the health care issue not only from a standpoint 

of cost because cost is really the tail. The dog is delivery of service 

and how you make it—continue to deliver quality but make it affordable. 

And so we are joined by Dr. Thomas Saving, who is a professor 

of economics at Texas A&M. He is a member of the Board of Directors of the Social Security and Medicare Trust Funds and has been 

instrumental in the development and the use of the infinite horizon 

to detail the financial difficulties facing Social Security and Medicare. 

We are also joined by Dr. Jeffrey Brown, who is assistant professor of finance at the University of Illinois on the Urbana-Champaign campus. Dr. Brown is assistant professor, as I mentioned, 

and he was a senior economist at the White House from 2001 to 

2002, and I believe he has just been nominated to be a member of 

the Board of Trustees of the Social Security Trust Fund. 

And Lois Quam, who is the CEO of Ovations, a business unit of 

the UnitedHealth Group which provides health services to Americans age 50 and older, including insurance products for AARP and 

care options including Medicare supplement and hospital health insurance and plans, prescription drugs and discount programs. 

So it is a high-quality panel who I know are going to have a lot 

of good ideas to give us as we move forward in the budget and 

move forward in addressing this very critical issue of public policy. 

Senator Conrad. 

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD 

Senator CONRAD. Thank you, Mr. Chairman. We missed you yesterday. 

Chairman GREGG. Sorry I was not able to be here. 

Senator CONRAD. Senator Allard carried on in exemplary fashion, 

and I thought we had really an outstanding session yesterday. I 

think we had more ideas on how we might save money for Medicare yesterday than almost any session that I have been at. And 

it just tells me that if we had an opportunity for everybody to come 

forward with their best ideas, we might make real progress. 

Yesterday, the testimony from the Director of the Congressional 

Budget office noted that in 2050, if nothing changes, and if we see 

the same trend lines hold, over 20 percent of the gross domestic 

product of the United States will be spent on just two items: Medicare and Medicaid. It is pretty stunning when you just extrapolate 

out from where we are now and look at the increases that are projected as the baby-boomers retire, more people are eligible for these 

programs, and health care costs continue to explode. 

Just to put it in some context, Federal spending since World War 

II has been at about 20 percent of gross domestic product. So to 

have just two items consume 21 percent of gross domestic product 

obviously is an unsustainable course. 

397

Let me put up this chart. In recent days, we have learned that 

the prescription drug benefit that was passed in 2003 is exploding 

in cost. When we passed it, we were told it would cost $400 billion. 

That estimate was later revised for the same period to be $534 billion. And now we are being told that for a different 10-year period 

it is going to cost $724 billion. So we have exploding costs with the 

most recent legislation that was passed for the Medicare program.

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Yesterday, Mr. Chairman, I said I really do think it is time for 

all of us to come forward with our best ideas on how to save money 

in Medicare. I have put up five ideas that I think could help us 

make a difference:

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Better coordinate care. Yesterday, I indicated 5 percent of the 

population uses 50 percent of the money. The most recent statistic 

is 6 percent use 51 percent of the money. I think we ought to focus 

like a laser on that population, and we will hear more about that 

in today’s testimony. 

I think we ought to consider eliminating the $10 billion slush 

fund provided to the Health and Human Services Secretary to 

sweeten the pot for private plans. 

I think we ought to cut the $30 to $50 billion of expenditure that 

is the amount private plans are costing over and above traditional 

Medicare. 

I think we ought to allow the Health and Human Services Secretary to negotiate lower drug prices, just as the Veterans Administration is able to do very successfully. 

And I think we ought to allow the reimportation of prescription 

drugs. In Canada, my State borders Canada—drug prices are dramatically lower. There is no reason not to reimport those drugs 

manufactured in the United States that have gone to Canada, and 

have much lower prices. Let’s bring them back and at least at some 

point be importing something that helps the economy. 

Those are ideas, Mr. Chairman, that I would like to put some 

focus on in the hearing today. I hope others will stress other ideas, 

because clearly we are on a course that is not sustainable. 

I thank the Chair. 

Chairman GREGG. Can I ask the Senator a question? 

Senator CONRAD. Absolutely. 

Chairman GREGG. Because I am intrigued by his five proposals. 

I think it is constructive that he is willing to bring forward specific 

proposals. Can you explain the slush fund? 

Senator CONRAD. You know, in the Medicare prescription drug 

bill——

Chairman GREGG. Oh, this is Medicare? That is the money that 

was set aside in the Medicare fund. OK. I understand. You are 

talking about the drug fund then? 

Senator CONRAD. Yes, right. 

Chairman GREGG. I thought it was the overall Medicare. 

Senator CONRAD. No. And, you know, this was set aside to allow 

the Secretary of Health and Human Services to sweeten the pot for 

certain private plans. 

Chairman GREGG. Right, to keep their plans. 

Senator CONRAD. No, that is another element of the legislation, 

to allow private sector businesses to keep their existing plans. I am 

talking now about the money that was given to the Secretary, 

money at his discretion to use to sweeten the pot for other private 

sector plans because they were concerned about regional differences. 

Chairman GREGG. Is that a 10-year number? 

Senator CONRAD. Yes, and the $30 to $50 billion is a 10-year 

number. 

Chairman GREGG. Thank you. 

Well, we will start with you, Dr. Saving. We would like to hear 

your thoughts, and then we will go down the line. 

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STATEMENT OF THOMAS R. SAVING, DIRECTOR, PRIVATE 

ENTERPRISE RESEARCH CENTER 

Mr. SAVING. Mr. Chairman, thank you for having me here, and 

I am really going to concentrate my discussion here on the longrun costs of Medicare, and we can deal with questions later on. 

Chairman GREGG. Can you pull the microphone a little closer to 

you and make sure it is on? 

Mr. SAVING. A little closer? All right. And maybe get the height 

of it adjusted to my lower center of gravity. 

Today, Medicare is the second largest entitlement, program behind Social Security. In 2004, Medicare accounted for 13 percent of 

the Federal budget, 2.6 percent of gross domestic product and required general revenue transfers equal to 10.7 percent of Federal 

income tax revenues. The program provides health care and insurance for the retired and disabled population, the same population 

served by Social Security. The 2003 Medicare Modernization Act 

made Medicare’s health insurance coverage more comprehensive, 

with the addition of a prescription drug benefit. It did other things 

also to general Medicare, but that is beside the point here. Making 

the coverage more comprehensive has also made the program more 

costly. By 2024, total Medicare spending is expected to exceed Social Security spending, and the differential will continue to escalate 

thereafter. 

Here I want to discuss several ways to address the current and 

future status of Medicare as it pertains to the Federal budget. So 

I am going to concentrate a lot on the Federal budget. As a trustee 

of the Social Security and Medicare Trust Funds, I will highlight 

a few of the measures I believe shed light on Medicare’s financial 

position. 

Before getting to the estimates of the total cost of Medicare, I 

want to review a couple of the characteristics of Medicare that will 

cause it to become larger than Social Security in just 20 years and 

become 50 percent larger by the middle of this century. And while 

both Social Security and Medicare share the same demographics, 

the similarity ends there. 

Social Security’s revenue and expenses, without consideration of 

the demographic issues, rise at roughly the same pace as the Nation’s gross domestic product. Its future deficits are the result of 

two—or three things, actually: the baby-boom generation’s retirement, falling fertility rates, and increasing life span. 

Medicare faces these same demographic issues, plus the fact that 

the population’s demand for health care, something that you alluded to already, Mr. Chairman, is growing faster than the Nation’s gross domestic product and has been for a century, so that 

nothing has changed there. Since 1960, per capita health care expenditures have grown 3 percentage points faster than per capita 

gross domestic product. But Medicare Part A Hospital Insurance 

tax revenues rise only as fast as gross domestic product. This 

means that even if there were no demographic issues at all, Medicare would face future deficits. Other components of the Medicare 

program face a similar fiscal situation. Supplementary Medical Insurance, SMI, comprised of Parts B and D, prescription drugs, are 

financed through premium payments. They provide approximately 

25 percent of the program. The rest of it, 75 percent, are general 

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revenue transfers. The premium payments are expected to rise 

about 25 percent of expenditures, so they are going to grow as fast 

as expenditures and, thus, they are actually going to grow faster 

than gross domestic product. But because 75 percent of these expenditures are financed by general revenue transfers, an ever larger proportion of general Government revenue will be required to 

fund SMI, that is, Parts B and D of Medicare. 

Because the revenue for Part A is not linked to GDP growth, the 

day will come when premium payments for SMI—that is, both prescription drugs and what used to be physician things—will actually 

exceed the tax revenues for Part A. In 2003, the tax revenues were 

more than 5 times total Medicare premiums. In 2005, when the 

prescription drug benefit becomes fully operational, the HI tax revenues will still be 3.5 times premium revenues. But by 2055, the 

premium revenues will exceed the HI tax revenues. 

Now, in producing the Trustees Report estimates of future expenditures, we assume that by 2029 Medicare expenditure growth 

will have fallen from its current level of approximately 2 percentage points faster than per capita gross domestic product to 1 percentage point faster. And then when we end the 75-year horizon, 

we gradually let the growth of health care fall to exactly the same 

as the growth of gross domestic product. Both of these assumptions 

may be conservative as there appears to be little evidence that 

health care expenditures will not continue to grow at more than 

our ultimate assumed rate of 1 percentage point above per capita 

gross domestic product. 

Now, Medicare’s financial status can be summarized in two 

ways: one of them in terms of the present value of future unfunded 

liabilities, which people are familiar with, often the 75-year horizon, sometimes a longer horizon; and, second, in the past of future 

budget transfer required to cover future shortfalls. And I think that 

may be more appropriate in regard to this committee, but I am 

going to address both of those. 

The first of these represents how much the system owes, and the 

second represents how much the general tax revenue must be 

tapped to meet these obligations. Medicare is fundamentally a generation transfer system; current taxpayers pay for the benefits of 

current retirees. And the fundamental economics of such a system 

is that the debt that we owe the current generation is going to 

have to be paid by the future generation. And I want to separate 

that debt, the way we do it in the Trustees Report, into the three 

principal programs of Medicare. Part A, Hospital Insurance, the 

debt owed to the current generation, that is, everybody who is 

working now and currently retired, if we pay them the benefits 

that are in the bill at the moment and we only charge them the 

tax rate, which is the HI tax rate, the unfunded liability for the 

current generation is $14.2 trillion. 

Now, in a system that worked, that is, in a system that was in 

equilibrium, the next generation would pay—would have a surplus 

because they would enter the system—they will start working tomorrow. They will pay taxes for 45 years before they ever collect 

any benefits, so they should contribute something to paying off this 

debt? Rather than contributing anything, what are they going to 

do? They are actually going to generate $7.8 trillion more in debt. 

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So that the total unfunded liability for just the Hospital Insurance 

part of Medicare is $22.1 trillion. 

Now let’s move to Medicare Part B, which, along with the prescription drug benefit, Part D, of course, comprises Supplementary 

medical Insurance. Unlike Part A, which is meant to be financed 

with HI taxes, Part B is set up to be financed with general revenue 

transfers of 75 percent. And we know that that is going to make 

for a rising cost. So the difference between the premium income 

that we expect to accrue over the whole period and expenditures 

for the current generation is $8.8 trillion. Now, the next generation is going to cost us another $14.4 trillion, so the unfunded liability, the present value of the unfunded 

liability for Medicare Part B is $23.3 trillion, and this comes right 

out of last year’s 2004 Trustees Report. 

Now, let’s consider the newest addition to Medicare, Part D, prescription drug benefits. Again, this operates exactly the way SMI 

does. It has premium payments, which are roughly going to cover 

25 percent of expenditures. The unfunded liability for Part D for 

the current generation is $6.2 trillion. The next generation, rather 

than contributing anything to paying that off, is going to add another $10.3 trillion to it. So the total unfunded Part D liability is 

$16.6 trillion. 

All three of these together, we owe the current generation $29.2 trillion. Now, David Walker talked about $27 trillion, which is the 

75-year unfunded liability, and this is the current generation’s unfunded liability. The two numbers are similar, but they have a different meaning. The future generation is going to add $32.5 trillion 

to this obligation. The total Medicare unfunded liability as it now 

stands is $61.6 trillion. 

I am going to put it in perspective for you. Assuming that Federal income tax revenues were to remain at the 50-year average of 

10.9 percent, roughly, of gross domestic product—now, they were 

lower this year; they were only like 8.7 percent because we are still 

coming out of the recession. But if they were to do that, the present 

value of all future Federal income tax revenues is $99.3 trillion. 

The unfunded liability here is $61.6 trillion. It is 62 percent of all 

future Federal income tax revenues. 

If you pass legislation today binding on all future Congresses 

that set aside 62 percent of all Federal income tax revenues, starting tomorrow to eternity, that is what it would take to cover this 

liability. You would have to give up almost two-thirds of all Federal 

income tax revenues. This year you spent 10 percent on Medicare, 

so that means roughly 50 percent additional of all Federal income 

tax revenues would have to be set aside from now to eternity to 

cover the debt. So the funds have—that means that—and what I 

would really like to say, again, bear in mind that you cannot just 

spend the money and send us some bonds, send CMS some bonds 

that we will later on cash. I mean, this means you really would invest the 62 percent of Federal income tax revenues in real resources in the economy because that is what would in the future 

generate the revenue and the resources and the output that it 

would take to provide these benefits that we are promising. 

As a final note—and this comes back to the 75-year horizon, the 

numbers that David Walker talked about—that number is $27.7 

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trillion, but that is only the 75-year number. And even erasing that 

would take for the next 75 years your setting aside 43 percent of 

all Federal income tax revenues. And then at the end of the 75 

years, you would have these huge debts that you would still have 

to pay off. So these are very significant numbers. 

Now, another way of understanding these future funding problems is just look at the cash-flows. They can be denominated in a 

number of different ways. I like to denominate them in terms of 

Federal income tax revenues, again, because I think that is meaningful. I am not convinced that the way we do it in the Trustees 

Report where we denominate these things in terms of gross domestic product is very meaningful to most people. They do not understand what gross domestic product is, and it is clear from a budget 

perspective that Federal income tax revenues are a clear budget 

item, income, and what you want to know is how much of that income do we have to transfer to these programs. 

They may seem like a manageable amount. We are going to show 

a deficit—the Hospital Insurance portion showed for the first time 

in many years a deficit last year, in 2004, and that is going to grow 

at an accelerating pace over the next 25 years. Part D, prescription 

drug benefit, will begin in earnest next year and will rapidly grow 

in its requirements on the budget. The transfers required to pay 

the current law benefits given current law taxes and premiums will 

grow from their current level to almost 19 percent of Federal income taxes in 2015. Now, remember, they were 10 percent this last 

year, in 2004. They are going to double by 2015. They are going 

to triple by 2025 to a third of all Federal income tax revenues. And 

they are going to require over 90 percent of Federal income tax revenues by 2075. It is hard to imagine transfers of this magnitude 

being made, but the only real alternative is for individual members 

of society to ultimately provide more of the funding for their own 

retirement health care. How we are going to do that and, second, 

somehow make markets so that people care about what it costs—

and one of our fundamental problems is they do not. 

As I pointed out above, the trustees have adopted the assumption 

that health care costs per capita will grow at a rate equal to GDP 

per capita growth plus 1 percentage point. And that implies alone 

that health care expenditures will rise from the current level of 15 

percent of gross domestic product to 38 percent by 2075. But, actually, of course, they have been historically growing much more rapidly than that. And if they were to grow plus 1.5 or 2 percentage 

points, then they are going to account for 55 or 79 percent of GDP, 

and they are going to account for huge proportions, if we are paying for them the way we are now. Federal income tax rates would 

have to be way over 50, 60 percent, rather than 11 percent of gross 

domestic product. 

Now, numerous factors contribute to health care growing faster 

than the rest of consumption. Regardless of the cause, it seems reforms are inevitable given that 45 percent of all health care spending today is paid for by taxpayers through Federal, State, and local 

government funds. Now, that same 45 percent sounds like a number that we have to report to you, but that is State and local. I will 

get to that number right now. 

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Beginning with the 2005 Medicare Trustees Report, as you know, 

the Medicare Modernization Act requires the Board of Trustees to 

test whether the difference between program outlays and dedicated 

financing sources, consisting of payroll taxes, share of income 

taxes, and premium payments, reach 45 percent of total Medicare 

expenditures. If this critical level is expected to be attained within 

7 years of the projection, then we have to say there is excess general funding and we have to let the White House know that, and 

they have to come to Congress with something. In the 2004 Trustees Report, we reported that the critical difference is expected to 

reach the 45-percent level in 2012. That is just 1 year short of the 

7-year requirement. If our 2005 Trustees Report for which we do 

not have the final numbers at this time—is consistent with that, 

that means that this year when we issue the report, we would be 

issuing an excess general funding warning to the executive branch. 

To conclude, since I am past my time here, as my fellow trustee 

John Palmer and I have noted several years in the summary of the 

combined Medicare and Social Security reports, Medicare’s financing problems occur sooner than Social Security’s, and the solutions 

to its problems are more difficult. The more difficult part is important. This past year Part A, Hospital Insurance, spending was in 

excess of tax revenues. The others will be increasing general revenue transfers with each passing year. The pace of this increase 

will accelerate when the full Part D prescription drug benefit takes 

effect. The demands Medicare places on the rest of the Federal 

budget will force Congress to consider some difficult choices of who 

should bear the burden of retirement health care spending. As the 

debate over Social Security has highlighted the generational consequence of financing elderly entitlements, the generational burden 

represented by Medicare amplifies the need for serious consideration of reform. 

Thank you. 

[The prepared statement of Mr. Saving follows:]

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Chairman GREGG. I would like to say thank you, Doctor, but to 

tell you the truth, you just made me sort of sick. 

[Laughter.] 

Chairman GREGG. Thank you. Those were startling and sobering 

numbers, to say the least. 

Dr. Brown? 

STATEMENT OF JEFFREY R. BROWN, PH.D., ASSISTANT PROFESSOR OF FINANCE, UNIVERSITY OF ILLINOIS AT URBANACHAMPAIGN 

Mr. BROWN. Chairman Gregg, Ranking Member Conrad, and 

members of the committee, thank you for the opportunity to speak 

before you today about the implications of an aging population for 

the Medicaid program. 

As you know, in just 3 years the leading edge of the baby-boom 

generation is going to start claiming Social Security benefits. In 

just 6 years, they are going to start claiming Medicare. In the years 

to follow, millions of them will find that, due to declining health, 

they are in need of long-term care services, including nursing 

homes. As a result of the substantial costs of paying for long-term 

care, many of them will end up relying on Medicaid to finance their 

own care after their own financial resources have been exhausted. 

While my written testimony focuses primarily on Medicaid, I do 

want to take just a moment to put Medicaid’s cost growth into this 

broader context which Dr. Saving has just told us about, which is 

the context of overall growth in entitlement spending. 

Today, spending on Social Security, Medicare, and Medicaid combined is about 8.5 percent of GDP. Just 25 years from now, about 

the time that I am looking to retire, these three programs alone 

will be close to 16 percent of GDP. The farther into the future that 

one looks, the larger these programs become. 

As Senator Conrad already mentioned, total spending today by 

the entire Federal Government is about 20 percent of the economy. 

Looking ahead about 75 years, absent significant change to the 

structure of these programs, Social Security, Medicare, and Medicaid alone will account for 25 percent of this Nation’s output. 

Now, this is obviously before we have set aside a single penny 

to support national defense, homeland security, environmental protection, or educating our children. It is also before any State and 

local government has raised money to support programs at their 

level. And then, of course, one must also keep in mind the obvious 

fact that future generations are still going to need money to live 

on, to start careers, to buy homes, to educate their children, and 

save for their own retirement. 

So to sustain these entitlement programs strictly on a pay-asyou-go basis in the future decades will require substantial increases in tax burdens. And, unfortunately, large tax increases can 

in turn basically serve as a drag on future economic growth, which 

can, therefore, exacerbate the problem. 

So it is clear, as all of you know, that the time to begin thinking 

about the long-term prospects for these programs is now because 

the sooner that we begin to face these issues, the more choices we 

have available to us. 

418

I would like to specifically turn to Medicaid now. As you know, 

Medicaid is a very important source of health care financing for 

about 46 million individuals today. This includes children, pregnant women, individuals with disabilities or who are blind, as well 

as the elderly. And obviously this program plays a very important 

role in the lives of its beneficiaries, providing health care to people 

who otherwise might not be able to receive the care they need. 

Unfortunately, the financial burden of Medicaid, which is shared 

by both the Federal and the State governments, is large and it is 

growing. This year, for example, it is expected that the Federal 

Government will spend approximately $190 billion on Medicaid. If 

you include both Federal and State spending on Medicaid, it is well 

north of $300 billion. 

As large as this level of spending is, it is the trend in spending 

that is perhaps even more noteworthy. Over the last 10 years, at 

a time when the economy grew by about 60 percent, Medicaid expenditures more than doubled. CBO and OMB projections are both 

that Medicaid expenditures are going to continue to grow faster 

than the economy for the foreseeable future, and the role that 

aging of the population plays in this is relatively straightforward. 

It is attributable to three basic facts: first, America is growing 

older; second, older Americans spend disproportionately more on 

health care, particularly long-term care services such as nursing 

homes; and, third, because Medicaid today is the single largest 

source of payment for nursing home and other long-term care expenditures in the U.S. It currently covers about 40 percent of nursing home expenditures. And, therefore, Medicaid expenditures are 

anticipated to rise. 

Under reasonable assumptions, by the time today’s kindergartners reach age 65, Medicaid spending at both the Federal and 

State level will consume about $5 out of every $100 produced by 

the economy. 

Now, to better understand these trends, I want to focus just a 

bit on the interplay between long-term care and Medicaid in the 

United States. As I already mentioned, Medicaid covers a wide 

range of beneficiaries, but from the perspective of a budget and the 

perspective of the economic impact, not all Medicaid beneficiaries 

are created equal. What I mean by that is roughly one-half of Medicaid beneficiaries today are children, and yet children only account 

for about $1 out of every $8 of Medicaid spending. 

In contrast, the aged currently represent just a little over 10 percent of Medicaid enrollees, but account for over one-quarter of all 

expenditures. And long-term care is a major reason for this. 

Medicare, which Dr. Saving referred to, pays the lion’s share of 

acute medical spending for the elderly, but it has very limited coverage of long-term care. In addition, there is very little private insurance coverage in the U.S. for long-term care. Last year, it was 

estimated that only about 4 percent of total long-term care expenditures were covered by private insurance. This is in very sharp contrast to the market for acute care. And also in contrast is the fact 

that the Medicaid program, as I mentioned, is the single largest 

source of financing for long-term care. It is about 40 percent of 

nursing homes, 35 percent of all long-term care. 

419

It is also worth noting, by the way, that this leaves about onethird of long-term care expenditures currently paid for out of pocket by individuals. 

But in regards to Medicaid, this suggests that, absent significant 

policy changes in the way we finance long-term care, rising longterm care expenditures in the aging population will certainly lead 

to rapidly rising Medicaid outlays in the years to come. 

In my written testimony, I go into more depth about some of the 

other factors that influence this process, in particular, changes in 

life expectancy, changes in the disability rates among the elderly, 

as well as factors like changes in family structure that influence 

the degree to which there are informal substitutes available for formal care. While these issues are complex and, therefore, make it 

difficult to pin down a very precise estimate of future costs, nearly 

every plausible scenario suggests that Medicaid expenditures are 

going to continue to grow faster than the economy in the coming 

decades. 

Looking into the future, one interesting question is to what extent some of the future costs of paying for long-term care can essentially be off-loaded onto the private sector through encouraging 

private long-term care insurance markets. I discuss this issue in 

more depth in my written testimony and would be happy to take 

questions. But, in particular, I focus on the fact that among the 

many possible explanations for why the private market is so small, 

the Medicaid program itself turns out to be one that is quite relevant. Specifically, Medicaid serves as a disincentive for people to 

purchase private insurance policies for reasons that I am happy to 

go into during the questions and answers. And as a result, it is unlikely, absent some sort of significant reform to the way we think 

about Medicaid, that private insurance markets are going to save 

the day for us. 

So just to conclude, let me just say that we all know that Americans are living longer. This is great news for each of us as individuals. But we have to recognize that the existing financial structure 

of the entitlement programs in the U.S., particularly those that are 

serving the elderly, are going to place an ever increasing burden 

on future generations. 

If we continue to try to finance all of these programs on a payas-you-go basis, we are not going to have many good alternatives. 

We can either impose an ever increasing tax burden on future generations; we can start scaling back benefits for the elderly; or we 

can basically reduce or even eliminate all non-entitlement spending. The best and possibly the only alternative to those scenarios 

are to try to find ways today to increase national savings. By increasing national savings, essentially what we are doing is reducing our current consumption in order to set aside resources to invest in the economy, to grow the economy, and hopefully provide 

the resources for the future from which to pay these rising costs. 

I would be happy to take questions. Thank you for the opportunity to speak to you. 

[The prepared statement of Mr. Brown follows:]

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Chairman GREGG. Thank you, Dr. Brown. 

Ms. Quam. 

STATEMENT OF LOIS E. QUAM, CHIEF EXECUTIVE OFFICER, 

OVATIONS, A UNITEDHEALTH GROUP COMPANY 

Ms. QUAM. Chairman Gregg, Senator Conrad, and distinguished 

members of the committee, thank you for the opportunity to appear 

before you today. I am Lois Quam. I am chief executive of Ovations, which is the largest company providing services to the Medicare program. We are headquartered in Minnesota, and we are 

unique in that we participate in the Medicare program nationally, 

operating in both urban and rural areas, and we participate in the 

traditional fee-for-service program as well as Medicare Advantage 

and programs for the chronically ill. 

The discontent about the growth and costs, which my fellow 

panel members have so eloquently spoken of, is igniting today’s discussion and can and must be addressed. As the chairman indicated, 

it is not only an issue for Government, but it an issue for all of us. 

Our discussions about solutions have followed predictable but 

somewhat frustrating patterns: calls for increased public subsidies, 

calls for cuts to public programs. As for the first, we cannot spend 

our way through this because cost increases outstrip our economic 

capacity. As for the second, cuts in this arena simply shift costs to 

others—families, providers, State taxpayers—rather than actually 

cutting or eliminating services. 

So as business people, our job is to try to find practical and sustainable solutions. I wanted to offer the committee four ways that 

we may be able to do something else, and that is to powerfully shift 

to a strategy of not cutting our spending, but a strategy of using 

our current resources more successfully. 

The first idea I would like to put before you is to improve services to those who are chronically ill. As Senator Conrad indicated 

in his opening remarks, people who are chronically ill use most of 

the Medicare budget and Medicaid budget. Five percent use slightly over half of those budgets. These are very sick people, and despite the immense amount of resources we put forward to care for 

them, they still suffer greatly. 

We need to expand effective ways to care for them and invent 

new ways to improve their care and maintain their health because 

that also reduces our use of resources. 

We, through our Evercare program, have been providing services 

in this area to the Federal Government since 1987, to many States, 

and to the British National Health Service since 2002. This sophisticated set of tools that we bring really comes down to a straightforward approach to do three things: 

The first is we try to keep this very sick group of people as 

healthy as possible so they do not need to go to the hospital. 

Second, we try to prevent those crises, like a broken hip or a case 

of the flu, that send them to the hospital for long stays. 

And, third, when they become sick, we move heaven and earth 

to try to treat them where they live versus having to send them 

to the hospital. 

Our results have been good. The independent Federal evaluation 

of Evercare found that we reduced hospitalizations by half while 

430

achieving a 97-percent satisfaction rate among patients and their 

families, and a 20-percent reduction in the use of medication. In 

one Texas county, from 2000 to 2002, we saved $123 million 

through this approach. 

The MMA provided some important expansions in this area in 

the special needs plans and in the chronic care improvement program, but there is great potential to do more, and I wanted to suggest three things: 

The first is moving these chronic care programs from the edge of 

Medicare to its center, to focusing in this area. 

The second, to focus on patients’ burden of illness, not simply on 

discrete diagnoses. 

And the third, to focus on the dual-eligible population, those people who have both Medicare and Medicaid coverage. They often get 

lost between those two programs, and there is an opportunity to 

improve their lives and save resources by focusing on them solely. 

Second, I wanted to suggest that we look more diligently for 

ways to increase the productivity in American health care. If American health care productivity were simply on par with the rest of 

the American economy, we would not be having this discussion 

today. We would have the resources that we need to meet the challenges of Medicare and Medicaid. So how can productivity be improved? In our experience, it can be improved by improving the 

way that work and patient care is organized. We have seen dramatic increases in productivity by changing the way that we ask 

our work force and our caregivers to work. 

Second, by using technologies to support better ways of working. 

We have invested over a billion and a half dollars in new technologies to make these changes in ways of working stick. 

Third, we can use rapid learning models to get better results. In 

essence, learning quickly from things that don’t work well. In 

Evercare, after every patient ends up in the hospital, we have a 

case conference where we don’t say, ‘‘the flu is going through and 

it is inevitable that this is going to happen.’’ We say, ‘‘what could 

we have done differently to prevent it from happening?’’ And what 

does that tell us about how we need to change the way we work? 

And then how can we instill that in our practice? 

While productivity cannot be legislated, legislation can establish 

a framework for productivity: reward structures tied to preferred 

outcomes, incentives to invest in productivity tools like technology, 

and improved regulatory processes and standards. 

I want to make clear that technology is not an end in and of 

itself but simply a tool. And, in fact, if the underlying ways of 

working are not improved, technology can, in fact, increase spending and productivity. It is a tool to institute and make stick better 

ways of working. Surely American health care, where so many of 

our best and brightest go to work, can be on par in productivity 

with the rest of our economy. 

Third, we should look at ways of developing a national focus on 

evidence-based health insurance packages. This would encourage 

that best treatments are covered and that damaging or ineffective 

treatments are not covered. It would use science as its base. We 

need to invest in more research, and the MMA took an important 

step to do that. But lots of research is available which is not used. 

431

And we would support an empowered, independent entity akin to 

the IOM that could develop evidence-based benefit packages that 

public purchasers and private purchasers such as ourselves could 

use. There may also be an interesting role for tax incentives here. 

Finally, I would urge us all to look at ways to apply both the 

strengths of both the private sector and government to this important problem. So often the health care debate is counterproductive, 

focused on whether government or companies can do a better job. 

As chief executive of one of the nation’s largest health care companies, I would be the first to acknowledge the importance and benefits of government. This debate does not need to be an either/or, 

but it can be effectively a debate about how to get the best out of 

both sectors. Each have strengths, each have weaknesses, which 

makes them complementary. Government does a great job of offering consistent programs nationally, providing security over time, 

concentrating resources on vulnerable populations, providing standard operating rules, to name a few. 

Companies do a great job of adapting services locally, innovating 

rapidly, quickly deploying skilled staff, and inventing new ways of 

working, to name but a few. 

I would urge a shift from the debate between the two to take on 

the real challenge of bringing about the best in each. 

We have reached a state in health care where a new approach 

truly is required. Cost increases outstrip our ability to afford them, 

not only in the Federal budget but in State capitals and boardrooms and at dinner tables. It is time now to focus on a way to better use the existing resources that we have. There are ways to do 

that: improving care for the chronically ill, investing in productivity 

tools, translating research into practice, and using the practical 

and immense skills of both Government and companies to do that. 

These efforts in a way have been at the periphery of our efforts 

in Medicare and Medicaid. They need to become its focus. 

Thank you very much. 

[The prepared statement of Ms. Quam follows:]

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Chairman GREGG. Thank you, Ms. Quam, and I thank the entire 

panel for a truly excellent presentation, which gives us a lot to 

think about. What I appreciate is it gives us some substantive 

ideas to pursue. 

Just to quickly summarize, as I understand it, what Dr. Saving 

is saying is that we are heading toward one heck of a train wreck, 

but that there are things that we could do that would slow the potential there, and the area of making people more cost-sensitive in 

their purchasing was one item I heard him suggest. And then Dr. 

Brown was talking about maybe creating incentives for savings 

which pre-fund some of this liability. And then Ms. Quam has outlined a number of interesting initiatives which would be sort the 

hands-on, how-to-do-it-better answers. 

This committee deals in the big numbers. Finance deals in the 

specifics, usually, on this. And I hope that we can get your specifics 

over to Finance. But dealing with the big-number question, I guess 

I would like to start with the Medicaid issue because the President 

has addressed that in his budget. He did not address Medicare in 

his budget. I happen to think we should address Medicare, but I 

may be a voice in the wilderness on that one. And I have to 

produce a budget. So I am looking for votes. 

So to get to the point of Medicaid, Dr. Brown, maybe you could 

talk about this a little bit. What the President, as I understand it, 

is basically suggesting is that we try to slow the rate of growth of 

Medicaid from about 41 percent over 5 years down to about 34 percent over 5 years. The way he suggested that it be done is that we 

address a number of different elements: first, the issue of better 

handling the spend-down problem; second, the issue of giving 

States much more flexibility with the dollars they receive; and, 

third, the issue of making sure that Medicaid is spent on health 

care versus on general fund operations within the States. 

The first year of his proposal, as I understand it, basically represents a reduction in rate of growth of about—well, about half a 

billion dollars, $500 million, on a spending base of over $190 billion. So it would seem to me to be—those types of restraints would 

seem to me to be attainable. Do you think that they are attainable? 

Mr. BROWN. I think the specific cost savings that are built into 

the President’s budget are achievable. It is important, though, to 

distinguish between policy changes that lower the level of spending, a one-time reduction in the level of spending that then might 

last forever, versus things that actually change the rate of growth. 

Chairman GREGG. Which, of course, goes to your second point. I 

would be interested in your second point. But you feel on the first 

point that we could make those types of numbers? 

Mr. BROWN. I do not have any reason to believe that we cannot. 

I will put it that way. 

Chairman GREGG. So on your second point, what are the systemic issues which we should put in place to pre-fund the liability, 

as you mentioned earlier, and other ideas you have in that area? 

Mr. BROWN. Sure. Let me address the issue of pre-funding specifically, and this is something that is an issue that cuts across any 

number of entitlement programs, be they Social Security, Medicare, 

or Medicaid. When I am thinking about pre-funding in a Medicaid 

context, there is a sense in which that is most appropriate for some 

442

of the longer-term sort of long-term care type of issues that directly 

affect the elderly. 

There is a sense in which it is more difficult to think about prefunding that piece of Medicaid which is specific to, say, providing 

acute health care for children and so forth. But in the context of 

thinking about the elderly, which is the part of the program which 

I am most familiar with, one of the things that distinguishes longterm care is that almost anyone in this country has a risk of needing long-term care services in their lifetime and they tend to happen late in life. If you look at a group of 65-year-old individuals 

alive today, for example, roughly a third to even 40 percent of them 

can expect to spend some time in long-term care during their lifetime, women more so than men. And the average age of entry into, 

say, a nursing home is in their early 80’s. So this is a type of cost 

which is a substantial, large risk, and is for most young people 

today far off into the future. In that sense, it is the perfect type 

of program to be thinking about how do we get people to set aside 

money today in a way that pre-funds their future expenditures. 

Achieving this is, unfortunately, difficult. I am happy to go into 

more detail if you want. The rules of the existing Medicaid program 

that require that people spend down their resources means that 

Medicaid is not necessarily a very good insurance policy for people 

in the sense that it does not allow them to protect their wealth. 

But, on the other hand, it is sufficient to sort of crowd out most 

of the income distribution from wanting to buy private long-term 

care insurance policies today. And so it is a little bit of a catch–

22 from a policy standpoint in that we are providing a publicly provided means-tested program for people who do not have the resources to pay for care themselves. It might not be a great form 

of insurance, and yet it is enough to crowd out what might arguably be better forms of insurance. 

That is a tough problem, that is a very tough problem to deal 

with. But I think in general what we need to be thinking about, 

not only with regard to Medicaid but with all of these programs, 

is how do we set up a system so that rather than continuing to pay 

for these on a pay-as-you-go basis, we find ways of encouraging national savings more broadly. 

Let me just say one other thing, and then I will take followup 

questions if you would like. 

When we think about the role of national savings, it is not necessarily important that that national savings be earmarked for any 

one particular use. If you think about it, the real trust fund in this 

economy is the economy itself. And the role of national savings is 

to provide resources that the economy can invest, grows the economy even larger, so that hopefully economic growth can try to keep 

up or possibly outpace some of the growth in expenditures. And as 

long as we do additional saving today—and that can be done 

through Social Security, through the pension system, through some 

of these programs that have been proposed to encourage savings 

among children, things like that. That helps grow the economy and 

provide the resources that we can then draw on in the future to 

help pay for some of these costs. 

443

Chairman GREGG. Thank you. I have a lot of followup thoughts 

and questions, but my time has expired, so I will turn to Senator 

Conrad. 

Senator CONRAD. Thank you, Mr. Chairman. 

Dr. Saving, what are the economic growth estimates that underlie the projections that you gave us? 

Mr. SAVING. Well, really we are assuming productivity growth, 

but they have actually very little to do with this because if you 

think about the growth in gross domestic product and if health care 

has been consistently growing faster than gross domestic product, 

increasing the rate of growth of gross domestic product is not going 

to help you because health care is simply going to grow that much 

faster. So you cannot—in a sense, to the extent that the amount 

of health care that people want to consume is related to their income, and if we give them more income, if they want to consume 

even more health care, then we actually worsen this deficit that we 

are talking about. 

Senator CONRAD. But, understand, we are the Budget Committee, and on the Budget Committee economic growth matters a 

lot. 

Mr. SAVING. Oh, yes. No question about it. 

Senator CONRAD. Economic growth determines how big the pool 

of resources are that we are going to have to draw from to sustain 

all of these programs. So this is a relevant question, and I assume 

that the underlying forecast that you are using is what the Social 

Security Administration is using, what the Congressional Budget 

Office is using, which is about 1.8 percent a year. 

That is their estimate for the next 75 years, 1.8 percent a year. 

I contrast that with what has happened over the previous 75 years, 

which is roughly 3.4 percent, and it seems to be a very pessimistic 

outlook for economic growth. 

Now, the reason for that pessinism is they see new entrants to 

the work force combined with productivity as the underlying factors that determine economic growth, and they see a dramatic reduction in new entrants to the work force with productivity basically humming along at 1.6 percent. 

But one of the things I want to caution my colleagues about is 

the notion of solving Social Security for all time. Most plans have 

been focused on 75 years, and I tell you, I have grave doubts about 

these projections. The truth is we were told 4 years ago that we 

were going to have $5.6 trillion of surpluses over the next 10 years. 

That proved to be wrong. That proved to be totally off the mark. 

So I want to just enter a note of caution, about these 75-year projections. I have grave doubts about them. They are very pessimistic 

forecasts. With that said, we still have a problem, and the problem 

is the size of the baby-boom generation. 

I would like to go to Ms. Quam for a moment, if I could. You laid 

out three very specific areas where we might make progress. Just 

for the record, I assume that each of these areas would also help 

us on the Medicaid side of the budget. 

Ms. QUAM. Yes, they are as powerful on the Medicaid side of the 

budget as they are on the Medicare side. 

Senator CONRAD. You talked at some length about the chronically ill and the fact that just a small percentage of the people are 

444

using most of the resources. It seems to me that tells us we ought 

to focus like a laser on the chronically ill. 

You also mentioned something about productivity in health care, 

and you made a statement that caught my attention. You indicated 

that if productivity in health care were the same as it is in other 

elements of the private sector, we would not have a shortage of resources. Could you just go a little further in describing what you 

meant by that? 

Ms. QUAM. Yes. When you look at the productivity of the American economy by sector, the health care portion of the economy has 

lagged in terms of productivity, that is, it has cost more to provide 

services. There have not been the gains in productivity in terms of 

output per worker or other ways that you can measure that as 

there have been in the rest of the economy. And that is part of the 

reason why we experience much higher costs. 

If we were able to get health care working on the level of productivity as the rest of the economy, we would have an enormous freeing of resources you which we could address these questions. You 

will find pockets within health care that function very productively, 

and they can provide us with best practices, clues about ways of 

spreading that across the whole. But, in fact, that is our challenge. 

And to me it says that that challenge is surmountable because 

surely it is not inherent that it has to operate in so much less productive a manner. 

Senator CONRAD. What are the key reasons that there is less productivity, in your judgment? Obviously, you have spent some time 

trying to understand this with respect to your own company. What 

is your assessment of why productivity has lagged? 

Ms. QUAM. Well, I think there are many. I think one relates 

right back to the discussion around the chronically ill. The focus 

has not been on those areas where we can make most of a difference. Since most of the spending is in this area, and since, in 

fact, despite this level of spending, this group has fairly poor outcomes, there is a huge opportunity to do better. 

Second, relating to my point around evidence-based benefit packages, we actually know a lot about what works in medicine and 

what does not. We need to know a lot more. We need much more 

research. But there is a vast amount of time between when a research finding comes out and when it is generally applied in practice. And during that period of time, we pay for lots of things that 

are ineffective or even harmful for people. So establishing frameworks and incentives to be able to make changes more quickly that 

are productive is at the heart of what we need to do to improve 

productivity. 

Senator CONRAD. Thank you. My time is up. 

Chairman GREGG. Senator Alexander. 

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

I have a question about Medicaid, and I want to ask for your 

help, the help of the panel. And trying to follow the example of 

Senator Conrad, I actually brought a chart to help. 

Let me try to put this into perspective. Twenty-five years ago, 

when I was Governor of Tennessee, I came to see President 

Reagan, and I asked him to make a swap. I said let’s swap Medicaid and elementary and secondary education. We States will take 

445

all the responsibility for K–12, you take Medicaid. And he liked the 

idea, but nobody else did. 

And then all during the time I was Governor—and we have a 

former Governor who is chairman—I had to work through the problem of trying to keep health care spending under control so we 

could fund universities such as the ones that two of you are associated with. 

Now, here is what happens with Medicaid. The Federal Government sets the eligibility rules, tells the States these are the core 

areas you must fund, and sends some money. And so what had traditionally happened is that State spending on such things as Texas 

A&M and the University of Illinois and the University of Tennessee goes up at the rate of 5.5 percent. That is the blue lines 

through here. But State spending on Medicaid goes up 15 percent. 

Now, there was a blip on that when the welfare law was passed 

in the mid-1990’s, but now we are back to the same thing. And so 

when I left the Governor’s office in 1987, we were spending 51 

cents out of every State tax dollar on education and 15 cents on 

health care. Today it is 40 cents on education and 31 cents on 

health care, and one of the results of that is we will not continue 

to have great research universities like Texas A&M and the University of Illinois if States cannot properly fund them. 

Here is my question: I support the idea of saying we have to reduce the amount that we increase, Federal spending on Medicaid. 

But when we send that problem back to the States, they are likely 

to have to increase spending on Medicaid, and it is already more 

than they are increasing spending on everything else. And why is 

that? It is because we set the eligibility requirements up here and 

they cannot change them, and the second thing that happens is the 

Federal courts get involved and they do not let the States make 

changes. 

In Tennessee, the Governor is trying to reduce an optional program, and a Federal judge just decided the Governor cannot do 

that. And the legislature may have to go into recess just to wait 

for the Federal judge to decide what to do. The same thing happened in Arkansas. The same thing happened in Mississippi. 

So my question is this, and I am really asking for help from the 

chairman and the ranking member: If we are going to tell the 

States that you must continue to spend more on Medicaid than 

every other thing based on these eligibility requirements we have 

set here, but we are going to cause you to have to make even greater reductions in growth, then how are we going to make sure they 

can do it? Can we write some language either into the reconciliation act or into other legislation that requires the Federal Government to give States more flexibility and makes it less likely that 

the courts will interfere with their decisions? That is my question. 

Mr. SAVING. I would respond first by saying that the issue that 

you raised, Senator Alexander, about flexibility is extremely important. The only way that you can get things to be better is for people 

to try experiments. Those experiments have to be done on a small 

scale. You are not going to have a national experiment, and I would 

take welfare reform as a case in point; that if it were not possible 

for individual states, like Wisconsin, to experiment with things and 

to show you that something worked, and the things that do not 

446

work, of course, will not be adopted, but they have to have flexibility. Without flexibility, with a national uniform program, you are 

not going to have change. And you want States to experiment. 

When programs do not work, we will abandon them because that 

is the way business operates. 

Senator ALEXANDER. But, Dr. Saving, just to hone in on my 

point, we have a Democratic Governor in Tennessee who has decided that if we keep growing Medicaid at the rate it is growing, 

we will not have a University of Tennessee or a K through 12 or 

a city park or anything else. And so he has decided that he wants 

to take 323,000 people off the rolls. These are optional programs. 

The Federal Government does not require that these people be 

served, and the Federal court is stopping him. The Federal court 

is stopping him. 

Now, how can the Federal Government, how can we blithely pass 

a law up here and say, ‘‘OK, you spend less money,’’ and then the 

State does not have the capacity to do that? What could we write 

into the law that would stop that and also encourage the Federal 

agencies that administer the program to give the Governors more 

flexibility? 

Mr. SAVING. I would like to be able to respond to that, but, unfortunately, that is outside my—that is your expertise, Senator. It is 

outside mine, I think, in terms of how you might keep the Federal 

courts out of, with the flexibility, but it is clear that we have given 

it in the welfare program. We gave variances so that States could 

try experiments. Now, that is an experiment that, clearly, we 

might allow a State to try because that, in a sense, is within the 

law, but I merely meant, within the current law, allowing States 

to deviate from those experimentally to see if there was a way to 

reduce expenditures that worked and that did not harm the participants, and that is what we are looking for here. 

It may be the case, of course, some of those will come under, as 

a lot of the welfare reform things in Wisconsin did, and have to get 

by those issues. And how you get that legislation that takes the 

courts out of it is beyond my expertise. 

Chairman GREGG. Senator Alexander’s time is up, but go ahead. 

Ms. QUAM. Thank you, Mr. Chairman. 

Senator Alexander, it surely is not in the national interests to 

have this situation where we cannot invest in education. And if 

Medicaid reduces spending, of course, in many ways, it gets shifted 

then to county levels or health care providers. So our challenge is 

to figure out how Medicaid can cost less, and I want to just offer 

you four ideas, if I could. 

The first is, is providing integrated programs for the dual eligibles. These folks, right now, get lost between Medicare and Medicaid. In Arizona, for example, for over a decade, we provided services for both Medicare and Medicaid. We have to have separate 

programs, separate administrations, separate everything to care for 

the same person, and it is not nearly as effective, and it is much 

more costly to do. 

Second, connected with that, if States could invest in areas 

where these dual eligibles that they are principally responsible for 

that gets savings to the Medicare program and gets that recognized, that would help. We often talk with States that are considVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00452 Fmt 6601 Sfmt 6601 C:\DOCS\21173.TXT TISH PsN: LAF
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ering investing in case management programs for these people. 

And the cost of those programs is borne by the State. The result 

of those programs are savings and reduced hospitalizations, and 

those savings and reduced hospitalizations go to the Federal Government. So, again, they are lost sort of between these programs. 

It is not an integrated view. 

Third, it would be possible to authorize waivers. The waiver process now is very time consuming and diminishes the flexibility 

States have to respond to these situations. There has been some 

Federal legislation that has preauthorized waivers under model circumstances. They have been very small. That could be done more 

broadly. 

And then, finally, I think there is an opportunity to recognize 

some benefits of an improved regulatory process. The regulatory 

process has both quite lengthy delays which do not correspond well 

to State budget pressures. And, second, it would be useful I think 

at times to consider whether all of the regulations are worth it in 

terms of the lost opportunities for savings. Sometimes, obviously, 

we need regulations, but sometimes those are not looked at together. And put to that test, it may be able to come to something 

more effective. 

Senator ALEXANDER. Thank you, Mr. Chairman. 

Thank you, Ms. Quam. 

Chairman GREGG. Thank you for those excellent thoughts. I wish 

this committee had legislative authority over Medicaid because I 

would like to institute those. But there are a number of Finance 

members on this committee. 

Senator Nelson. 

Senator NELSON. Continuing on Medicaid. Right now, in Florida, 

they are currently discussing a change that would require Medicaid 

beneficiaries to shop for private coverage. Now, I would like, Dr. 

Brown, your opinion. That has a certain appeal to it, but what is 

your opinion about how could such a system care for those with severe cognitive problems such as Alzheimer’s or mental illness? 

Mr. BROWN. I am not familiar with the details of what is being 

done in Florida, but, in general, I think it is certainly worth experimenting with ways of involving the private sector, but one needs 

to be very careful about what we economists call the issue of adverse selection or what might be called cream-skimming or cherrypicking have you, which is the notion that, if it is going to be done, 

it needs to be done in such a way to where the private sector is 

not just picking up the good risks and, essentially, leaving the 

more difficult, more expensive population sector because that is 

just going to sort of shift those costs around. 

As I said, I do not know the details of the Florida program, so 

I am not sure to what extent they have been successful at doing 

that. But as Dr. Saving said, one of the nice things about experimentation at the State level is that we can hopefully learn from 

those types of experiments, and hopefully only expand the ones 

that actually work. 

Senator NELSON. Going back to Senator Conrad’s chart, where he 

was pointing out the increasing cost of the Medicare prescription 

drug benefit, any one of you, what would be your opinion of the 

cost savings that would occur as a result of us changing the law 

448

where the Secretary of HHS would be allowed to negotiate on behalf of beneficiaries in order to arrive at a price for the prescription 

drugs through Medicare? 

Mr. SAVING. I am not a big fan of these negotiations, and I will 

say why, and I am not sure I can answer the question of what the 

savings will be. We have done an extensive study of what seniors 

paid for prescription drugs before the prescription drug bill came 

into effect. And the individuals who paid for the drugs entirely 

themselves actually got lower prices than any of the negotiated 

prices that we have seen, and we were using Medicare data for 

this. 

So the more you care about what it costs, the more you shop. 

When you shop, you get lower prices, and since these prices were 

lower than the negotiated prices, it comes back to the issue that 

to the extent that the bill covers prescription drugs and gives people co-pays, then they are not paying for it. And when they stop 

paying for it all, they stop shopping. And when they stop shopping—you know our strongest thing about finding out about prices 

and about overcharges is if individuals care what it costs because 

then they will shop. They will spend some of their time. 

As I like to say, when we were talking about up-coding and a big 

issue in Medicare, and we had to have investigators go into doctor’s 

offices, to find out if they are up-coding, I said, ‘‘There is a reason 

we do not have to do that in a grocery store. Nobody is looking at 

the counter because the customer is looking at every item that gets 

rung up to see if they are being up-coded.’’ We have to somehow 

make the individuals care what it costs to help us. 

Senator NELSON. My question was not about shopping. My question is about negotiating in bulk purchases just like the VA Administration. 

Mr. SAVING. Yes, I understand, and my point was that people 

who shop get lower prices. Our issue is how much will it help? And 

it may help. I do not know the answer to that question, though, because I have not investigated it. 

Senator NELSON. Well, do you have an opinion with regard to the 

VA? They negotiate in bulk purchases. Does that tell us anything 

that would apply to the Medicare model? 

Mr. SAVING. Well, you would expect that they should be able to 

negotiate similar prices. My point was that people who paid for the 

drugs themselves actually got lower prices, still lower prices by 

shopping. The problem with the bill is it relieves people from having to pay for it all. So then you are in a situation where they will 

wind up paying more, and then the VA program might well help. 

Senator NELSON. And comparing apples to apples, in the VA system, does your answer that you just said apply to the VA, that they 

go out and shop, and that is why they get lower prices? 

Mr. SAVING. They shop in bulk, yes, for these. They get bids, and 

individuals shop individually, but they wound up with lower prices 

than the VA did. 

Senator NELSON. Thank you, Mr. Chairman. 

Mr. SAVING. Sorry. 

Chairman GREGG. Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. 

449

First of all, I would like to put an opening statement in the 

record. 

[The prepared statement of Senator Bunning follows:] 

Senator BUNNING. There are a couple of things I would like anybody that knows the answer can come up with it. The President 

has proposed in his Medicaid proposal closing some loopholes that 

States use. The budget proposes curbing the use of intergovernmental transfers States have used to avoid the legal-determined 

match rate for Medicaid. Through several accounting measures, 

Government providers of health care, such as county-run nursing 

home or a municipal hospital, returns a portion of their Federal 

Medicaid dollars back to the States. The State then recycles these 

funds to draw down additional Federal dollars or for other purposes. The budget proposes to match only those funds kept by providers as payment for services. It says that there will be about a 

$5-billion savings over 5 years and about a $12-billion savings over 

10 years. 

Is this a problem in a lot of States or do you know that? 

Mr. BROWN. Again, my expertise in this is more in terms of the 

budgetary impacts of long-term care financing and so forth. So my 

knowledge of this sort of is——

Senator BUNNING. You do not know of any States——

Mr. BROWN [continuing]. Is limited to what I have seen the HHS 

Secretary——

Senator BUNNING. Ms. Quam? 

Ms. QUAM. Yes, Senator. As Senator Alexander referenced, many 

States have seen incredible pressure on their budget through Medicaid, and they have gone to great lengths to then try to find ways 

to get a larger Federal contribution. 

Senator BUNNING. So they are doing it, and it is a practice that 

might, if we could eliminate it, save some Federal dollars? We want 

to make sure that all the States are, if there is a share that they 

are getting and that is an actual share of cost, like Kentucky gets 

70 percent from the Federal Government and pays 30 percent of all 

programs under Medicaid. I just want to bring Kentucky in specifically because Senator Alexander brought up the fact that a Federal 

judge has ruled in a specific way. 

In Kentucky, there are currently 27 optional services provided 

under Medicaid. There are only 13 core programs that we must 

cover. According to the judge in Tennessee, those optional programs are not optional. In other words, they are challenging us and 

the judge is challenging Tennessee that they must cover what has 

been paid for because it was optionally paid for by Tennessee. 

Would the Federal Government be better off not having optional 

programs or letting the State decide what is optional and what is 

not? 

Ms. QUAM. Senator, I think the challenge we have now is that 

health care costs have gotten sort of too high for every part——

Senator BUNNING. That is true. 

Ms. QUAM [continuing]. The Federal budget, the State budgets, 

corporations, families. And so we are going to have to really put a 

great deal of focus on how we get more for the current money we 

spend. And shifting, in some ways, has become less of an option as 

the costs have gotten so high, that if costs shift from Federal to 

450

State, States have difficulty, and then if they shift to local, then 

the local areas have difficulty, that we really have reached something of a stage or a dilemma where we are going to have to look 

at how do we get more value out of the whole. 

Senator BUNNING. The productivity thing interests me because of 

all of the areas that we have in the economy, you would think that 

medicine would be one of the most susceptible to new productivity 

because of the technologies not only in the way we use it, but other 

things, as far as drug development and things like that. Is that——

Mr. BROWN. I just want to make a comment about the productivity point, which is productivity in health care is a very difficult 

thing to measure, and let me just give you an example. Suppose 

that a pharmaceutical company develops a new drug for treating 

cancer, to take an example. It may be the case that this actually 

increases overall health care spending in the U.S. The sense in 

which we get benefits from that is that people are living longer, 

have better quality of life after being diagnosed and things like 

that. 

And if you really want to think about health care productivity, 

you need to take into account those health benefits that people are 

receiving. So the question I often ask my students, when I am 

teaching in class, is would you rather have 2005 health care at 

2005 prices or would you rather have 1980 health care at 1980 

prices? Of course, the usual answer is, well, we want 2005 health 

care at 1980 prices. That is not an option on the table. 

But the point is, is that health care is better today than it was 

25 years ago. We are getting something for our money. The question that I think we need to ask, and it gets at the heart of this 

productivity question, but it is a very difficult thing to measure, is 

on each new drug, on each new investment, from a public standpoint, are we getting what we pay for? 

We know that there are incremental benefits. We know there are 

incremental costs, and the question is which is larger? 

In going back to Dr. Saving’s point, one of the difficulties about 

health care in the United States is because consumers, by and 

large, are not facing the full price of their decisions, private insurers or Medicare or whatever is picking up part of the costs——

Senator BUNNING. Third-party payers. 

Mr. BROWN. That is right. You know, I go to the doctor, and all 

I need to think about, when there is a prescription, is, is it worth 

$10 to me because that is my co-pay. And if I get $11 worth of benefits from that, I am going to do it, even if it costs society $100 to 

provide that prescription. 

There are two concepts here. One is I think we need to be careful 

about how we talk about productivity. I think some of the productivity gains may be greater than what traditional productivity 

measures have suggested. 

And, second, is I think it underscores the point that we need to 

find ways to get on the margin for people to have to think a little 

bit harder about whether the cost-benefit is worth it. 

Mr. SAVING. There is another issue here that affects the way we 

measure productivity. If you were a private firm developing in a 

private market a new knee replacement, you would be asking yourself what people would be willing to pay for this knee replacement. 

451

And if it were a $100,000-knee replacement, how many people 

would buy it, and what is it going to cost to produce it? And if not 

many people would buy it, but here you only say, if Medicare is 

willing to pay for it, it is free to everybody who takes it. And you 

have a whole different market. So the technologies that get developed in the private sector, you just would not have developed it because, in any other industry, it would not have worked. 

And that helps productivity in those industries look better. Now, 

that does not mean that someone like me, an old person whose 

parts are wearing out, is not much better off because everyone else 

is subsidizing the system to do things which do not enhance productivity in the way we usually measure it. And I think therein lies 

a problem, and when we try to deal with this, we are encouraging 

these kinds of technological change. And they do contribute greatly 

to the rate of growth of health care costs. 

Senator BUNNING. Thank you, Mr. Chairman. 

Chairman GREGG. Thank you. Thank you for those interesting 

responses. 

Senator Corzine. 

Senator CORZINE. Thank you, Mr. Chairman, and I appreciate 

you holding this hearing. I think this is focused on maybe one of 

the most important topics we have. It is certainly going to dominate our——

Chairman GREGG. Especially for those who might be Governor. 

Senator CORZINE. Yes. I am sort of trying to go to school on a 

few of you here. 

[Laughter.] 

Senator CORZINE. If I might be a little bit editorial before I get 

into a serious question. Dr. Saving, did I read in your remarks that 

you said Medicare’s financing problems occur sooner than Social 

Security and the solution to its problems is more difficult? 

Mr. SAVING. Well, to the extent that it is already in—you say HI 

is already in deficit last year. 

Senator CORZINE. Right. 

Mr. SAVING. So, in that sense, yes. 

Senator CORZINE. And did I hear you say that whatever the in- definite infinity unfunded cost is something like $62 trillion——

Mr. SAVING. Exactly, yes. 

Senator CORZINE [continuing]. Depending on, I presume, Social 

Security. We are having a debate about what crises and problems 

are, and I would just like to have that for background. And for a 

failed economic student at the University of Illinois, I am glad that 

Dr. Brown is here. 

I would want to argue——

Mr. SAVING. You are going to get revenge on him? 

[Laughter.] 

Senator CORZINE. I was going to suggest that since we take a 

survey of young people in the country or at least I hear somebody 

says anecdotally that they think the likelihood of them getting 

their Social Security payments is about as likely as seeing a UFO, 

do you really believe that people are thinking about spending down 

their assets so that they can get Medicaid for their long-term care? 

Do you think that that really is a decision that is going on when 

people are making savings decisions when they are 25 years old? 

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Mr. BROWN. I, actually, use that survey in my class, and my 

class confirms it, that they are somewhat pessimistic about getting 

Social Security in the future. 

Senator CORZINE. I guess they would be a little skeptical about 

getting Medicaid in the long term. 

Mr. BROWN. Yes, I think it is fair to say that young people today 

are not thinking a whole lot about long-term care needs. What is 

more troubling is that when you look at 65-year-olds today, who 

have a fair amount of information out there, for those who are interested in looking, about the probability of needing long-term care. 

They have had family members and acquaintances that need longterm care. Among those that buy long-term care insurance, the average age is around sixty-five. But even at that age, there does not 

seem to be a tremendous amount of activity on the part of seniors 

to save. 

Senator CORZINE. I think you and I probably have the same view, 

that there is a real savings problem in the country——

Mr. BROWN. Oh, absolutely. 

Senator CORZINE [continuing]. On a whole host of issues that underlie how we get to resolving some of these issues. It was interesting that Chairman Greenspan yesterday used the term ‘‘forced 

savings,’’ when he was talking about private accounts and Social 

Security. And somehow or another, on all of these various issues, 

we just do not have enough savings to take care of the demographic 

problem, whether it is through governmental programs or through 

a private program, so that there is a major shift of something that 

has to happen under any kind of category. 

Ms. Quams, you start on this discussion about capping Medicaid. 

We can hold down costs on Medicare, but the costs do not go away, 

I do not think. I think we create a feel-good situation here in 

Washington because we controlled our budgets, but the last time 

I checked, at a hospital in New Jersey, they have a responsibility 

to take in people who come in with no insurance, and then they 

give out the care, if I am not mistaken, and then it is just a big 

charity care. 

Can you walk us through? These problems do not go away just 

because we capped them or we say they do not exist. I do appreciate that there are specific challenges or specific steps. We can 

take on productivity and all of the other things. I think they are 

worthy of discussion. But we have a problem. There are sick people. 

And I was also curious why you did not talk about catastrophic 

insurance, all of you, since that 5 percent is dominating 50 percent 

of the cost. Are there not directions that we can go in that area 

that maybe help solve some of this problem in conjunction with the 

other issues? 

Ms. QUAM. Senator Corzine, you are correct. We have an overall 

problem. And where it all eventually gets shifted to is families. And 

as we have done some analysis and look at different family income 

and look at by county, so you look at average family income in a 

county, average housing costs, health care costs, other kinds of 

things, you see very quickly that this combination of costs, health 

care costs has increase in a dramatic way for families. That is very 

significant. 

453

And your point on local providers of health care is exactly right. 

Hospitals are required to care for these people if Medicaid does not 

pay. And I think it is interesting to note that Arizona was the last 

State that put a Medicaid program in place. They did it in the 

eighties. And what finally propelled them to do it was that the 

local health care system was collapsing under the weight of caring 

for patients for which they were not reimbursed. 

Medicaid pays for 40 percent of all deliveries in the United 

States. It is an essential part of what we do. So I think we have 

reached a point where, in some ways, there is not anyone to shift 

to that can bear it, that we have to seriously look at ways of controlling costs and, in particular, look at those people with these 

high expenditures because there is an opportunity to do better for 

them and to lower costs. 

Mr. BROWN. I just wanted to make one point that it is certainly 

true that for a given level of expenditure, if you just reduce Federal 

Medicaid spending, that has got to show up somewhere else. Somebody has to bear that cost. 

I think what we really need to be spending a lot of time speaking 

about is to what extent the structure of Medicare or the structure 

of Medicaid or the structure of how we pay for health care, in general, leads to additional increases in health care costs that might 

not be efficient from a social point of view. 

I am not about to make a policy recommendation on this, like in 

the future, one might need to ask really difficult questions like just 

because a particular new procedure or a new drug is approved by 

the FDA, does that mean it automatically ought to be something 

that the public sector pays for? 

There are all sorts of issues involved in terms of thinking about 

what is the proper role for what the Government ought to pay for 

using tax revenue, which we know has distorting effects on the 

economy, as opposed to things that ought to be left to the private 

sector. It is a big issue, a lot of research speaks to this, and it is 

broader than we can get in here today. But I think it is important 

not to forget that these programs can influence the level of spending and not just how it is divided up. 

Chairman GREGG. Thank you very much. 

Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. 

Chairman GREGG. I want to thank you for chairing yesterday. 

Senator ALLARD. Well, thank you. We had a good discussion I 

think yesterday, and we were talking the very same subject I think 

you are kind of talking about now. And my staff informs me that 

we continue to talk about the 5 percent that consumes 50 percent 

of the resources, and that is a very tough issue, and it is a difficult 

issue. And, bottom line, I think we have to rely on the patient-doctor relationship to come up with the right answers, in many cases. 

And somehow or the other, we haveto facilitate this so that the doctor and patient feels some responsibility in the decisionmaking 

process. 

You had just made a comment here about in Medicare, about the 

taxpayer should not be required to pay maybe for some procedures 

or some drugs. I believe we still have, in current law, and, Mr. 

Chairman, you are more knowledgeable on this, but I think we 

454

have in current law now a provision that a physician who is taking 

Medicare patients cannot take private pay in addition to that. And 

as a result of that, I think they feel really constrained, and it is 

difficult for them to say, well, you know, maybe there is a procedure out here, the Federal tax dollars should not pay for it, but if 

you are a wealthy individual, you can pay for it, and you can go 

ahead and do it. I do not think that option is there. 

Do you think that that provision creates some special problems 

as far as our health care policy is concerned and perhaps maybe 

it is something that ought to be looked at? 

Mr. BROWN. I think all of these issues need to be looked at, and 

it is tough. I mean, at some level, what we, as a country, just need 

to decide is how much health care do we want and how are we 

going to pay for it? 

The fact that health care expenditures are growing faster than 

the economy is not necessarily a bad thing if that is what we want 

to spend our money on. I think the issue that you are referring to 

is one which what people are concerned about is that we get into 

a situation where, if you are poor, here is the set of drugs you can 

buy, and if you are wealthy, here is the set of drugs you can buy, 

and there are concerns about equity and so forth. 

But what I was trying to get out more was the issue of, as Dr. 

Saving was referring to with his knee replacement example suppose there is already a perfectly good knee replacement technology 

out there, and then someone is trying to decide whether to develop 

one that is slightly better. When we think about the net social 

gains to having this new knee replacement, it may be relatively 

small, but positive. 

But because this is all paid for by public dollars, it is very much 

in that company’s interests to do it. It can be very profitable for 

them. Once we have all these third-party payers in here, it takes 

away a lot of the market forces that would typically serve as a control on those costs. And my point is, simply, and again I am not 

recommending this, I am just saying these are the types of issues 

we need to ask ourselves, is to what extent should new drugs or 

new procedures or new technologies be required to pass some sort 

of a social cost-benefit test before the public sector pays for them? 

These are difficult questions. I am not even sure how one would 

implement that, but, I mean, those are the types of things I think 

we are going to have to think about. 

Mr. SAVING. In that same vein, what are the incentives for I will 

say the need for someone to develop a cheaper knee replacement? 

And when there is no reason for them, the customers do not care 

what it costs, and what is the benefit of the cheaper—and that is 

the thing that, as productivity, Lois talked about productivity, productivity is better in the private sector because developing the 

cheaper way to do it is how you transfer the customers to yourself. 

As we know, as we look, and a member of my board is the chairman of Radiological Oncology at M.D. Anderson, one of the top cancer hospitals, and when I speak to her, I like to say, ‘‘I just dream 

of the day when I drive to Houston, and I see a big sign, but for 

M.D. Anderson, and the biggest thing on the sign is the price. And 

you are telling me come to M.D. Anderson. It is $99 a day, everything included.’’ I thought she was going to fall off her chair when 

455

I told her that. But that is what we see for LASIK surgery, that 

is what we see for plastic surgery. The notion of the price matters 

to people. 

And until we can make it matter to people, and the real issue 

is, as Jeff said, if you make it matter to people, do you take away 

the top tier, the Rolls-Royce of care, from everyone else? And do we 

have to have a system in which everyone is entitled to the RollsRoyce of care? And those are very tough questions. That is what 

makes Medicare reform so difficult. 

Senator ALLARD. I appreciate your comments, both of you, and I 

do think that we need to figure out ways of trying to make it more 

competitive out there. I agree with that approach. But the fact remains it is very obvious that we have a problem with Social Security that needs to be dealt with immediately. We have a big problem with Medicare that we need to think about at some point in 

the future. We have a big problem with Medicare, all of our entitlements, as a matter of fact, but particularly those three programs 

that we have to begin to deal with. And I think what we are struggling with and what we have to get some insight in is on solutions. 

Most problems in medicine, if you make the diagnosis, the treatment is easy. This is one of those problems in politics, where you 

make the diagnosis, the treatment gets very complex, and is not so 

easy. And I am looking forward to hearing from you in the future 

about any suggestions on what we may do to bring some efficiencies to the program to make it so that we can begin to reduce 

the huge exponential growth that is happening in all of the entitlement programs, as we go out into the future. 

Thank you, Mr. Chairman. 

Chairman GREGG. Thank you. 

Dr. Allard? 

[Laughter.] 

Senator ALLARD. A little veterinarian medicine thrown in. 

Mr. SAVING. Just send everybody to the vet, and we would have 

no problem at all. 

[Laughter.] 

Chairman GREGG. Senator Stabenow. 

Senator STABENOW. Well, thank you, Mr. Chairman. I would just, 

on that note, indicate if everyone went to their vet for their prescription drugs, they would get the same medicine at about half the 

price. So that is one way to—maybe we ought to do that. We ought 

to be doing it. 

Senator ALLARD. Well, we do not have as many lawsuits. 

[Laughter.] 

Senator STABENOW. Thank you all very much. This is such an 

important topic. And thank you, Mr. Chairman, for holding this 

hearing. I have many thoughts and comments. I think this is the 

most important issue, both from a moral standpoint and fiscal 

standpoint, that we have to deal with, as well as for businesses and 

family members. 

On a personal note, just to bring this back to a human factor, 

I think the reality to the question of how much health care do we 

want is we all want health care for our families, and we all want 

to make sure our families are taken care of, that we are taken care 

of, that we can afford medicine, that we can get what we need. And 

456

our challenge is to figure out how to do that in a cost-effective way 

without telling someone they cannot get what they need for their 

families. 

I have a question, but I first want to put this in context. Other 

countries, other industrialized countries, spend about 9 percent of 

GDP on health care. We spend 15. This goes to the point that Ms. 

Quam talked about, which I think is so critical at this point. It is 

not that we are not spending money, but it is a question of how 

effectively are we spending dollars and what way. And I would 

urge us to look at the context of looking at all of health care and 

not just Medicaid and Medicare, which are our immediate responsibilities, because, according to CBO, Medicare and Medicaid, average spending growth on a per-capita basis in the last 4 years was 

lower than the private insurance, was lower than private insurance. 

So we have to make sure we are looking at all of this so that we 

can address it and not just moving the deck chairs around on the 

Titanic. We need to be addressing it, as you said, Ms. Quam. And 

I would reinforce what Senator Conrad said. We have 5 percent of 

the public that is chronically ill, using 50 percent of the dollars. 

Evidence-based health care would say we should be focusing in 

that area, and there are a number of other issues that deal with 

evidence-based care that we need to address. 

I, also, would just make the point that if we cut Medicaid and 

Medicare, our business community now understands that that rolls 

over into uncompensated care, which rolls back onto them. So, in 

Michigan, last year, we had over a billion dollars in uncompensated 

care folks walking into the emergency room sicker than they should 

be or getting care they could have gotten in a doctor’s office or preventative care, if they are treated, as they should be, and then my 

private businesses see their health insurance rates go up. 

So it is all connected, and the question is how do we more effectively do this and deal with tough choices. And I would suggest 

there are a number of tough choices beyond whether or not we buy 

new equipment. We have prescription drug prices on the blockbuster drugs going up 10 times faster than the rate of inflation. A 

tough choice would be maybe we ought to do something about that, 

in terms of accountability. So there a number of choices. 

I would like to ask Dr. Saving, though, on the issue of prescription drugs and on pricing, you have indicated that the prescription 

drug benefit will ‘‘rapidly grow in its requirement on the budget.’’ 

I am assuming that your statistics are assuming current drug 

prices; is that your assumption? 

Mr. SAVING. Well, we are making assumptions about what is 

going to happen to pharmaceutical prices, so——

Senator STABENOW. You are assuming that they would be going 

up as a part of that? 

Mr. SAVING. Is that they are going to rise at historic rates, and 

we taper them down. So we make assumptions about what is going 

to happen to pharmaceutical prices. And one of the things that Jeff 

Brown mentioned, are things about levels and rates of change. A 

lot of the things we have discussed today have to do with the level 

of expenditures and do not really affect how fast they are growing. 

And those have very small effects in total because you only simply 

457

reduce something now, but it grows just as fast. The issue is a lot 

of this is about how fast these things are growing and not——

Senator STABENOW. Right, which, of course, they are exploding 

the prices. 

Mr. SAVING. That is the issue. That is right. 

Senator STABENOW. Yes. Let me just ask, though, when you talk 

about shopping around, one of the challenges I think for us in 

health care and in prescription drugs is that it is not like buying 

an automobile. I come from Michigan. We want everyone to buy 

one, and we want it to be made in Michigan. And it is not like buying a pair of tennis shoes or something else where you can say, 

‘‘You know, I would really like a new pair, but I will wait a year.’’

My sister-in-law was diagnosed last year with breast cancer. Her 

doctor gave her a prescription for medications. She could not say, 

‘‘I will wait until next year. I cannot afford this.’’

So we have a different way which we approach this because the 

marketplace is different. And so I would ask you, when we look at 

this, if we shop around, and if I am walking in by myself to a pharmacy right now without an insurance plan to negotiate for me, I 

pay the highest retail prices in the world, but if I have somebody 

who negotiates for me, I do not. 

We have the VA, as an example. Zocor right now, a veteran will 

pay 66 cents for a pill. If I walk in by myself or my relatives who 

are veterans walking by themselves, they will pay $3.77 for a pill. 

Why would we not want to give Medicare the ability to negotiate 

66 cents for a pill for others, rather than telling folks to go shop 

on their own, when it is something that they have to have? 

Mr. SAVING. Well, I am not here to suggest how you might 

change things, although I have suggestions for that, but that is not 

my role here. But the research that we did looked at what bulk 

buyer are paying and what individuals paid who are paying for it 

themselves. As a matter of fact, when I presented this on the Hill 

somewhere—I think it was over on the House side—there was a 

woman in the audience who had just had breast cancer, and she 

was taking Tamoxifen, and she was going to have to take it the 

rest of her life. And she said, You know what you are saying is exactly right. I searched—because she was going to pay for it herself—she searched, and the prices ranged from something like $140 

to $60, and so she went to the $60 pharmacy. Now, if she paid a 

$10 co-pay, she would have stopped at the first pharmacy she went 

to and taken the drug. It might have been the $140 one. And the 

difference is her shopping for the drugs, since she was paying for 

it. And it was as if I had had her in the audience. It was wonderful 

to have someone like that when you are giving a talk. I was not 

expecting her to be there, but she leapt up and said, ‘‘That is exactly right.’’

I am not suggesting that we give people the authority to do this. 

I am requiring it. For that to be the price, it may be some what 

difficult to make sure that everyone pays that price because it may 

be a higher price than some people would actually be able to get 

the drug for. So we have to be very careful of the——

Senator STABENOW. No question that folks should shop around. 

I am just suggesting it is a limited shopping if you do not have 

somebody negotiating for you, and that is why I have introduced 

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legislation that I hope my colleagues will support to allow, as our 

former Secretary Tommy Thompson said, he wished he had had the 

authority to be able to negotiate group prices, and I think that is 

a part of bringing prices down. But you raised one other point, and 

I know my time is up, but I am going to ask to pursue this just 

for a second on Tamoxifen as an example. 

Part of shopping around and getting the best price is to be able 

to do what we can do for any other product, which is go across the 

border and safely purchase Tamoxifen. Again, in Michigan, I can 

go to Windsor, across the bridge, it is $60; in Michigan, it is $360 

for a month’s supply. Have you looked at issues on reimportation. 

And if you are talking about shopping around and the ultimate 

competition to be able to bring prices down would be to give our 

pharmacists the same ability to shop for people that we have for 

other products. And we have a very strong bipartisan group advocating this right now, but that is certainly is a part of shopping 

around, and I wondered if you had looked at that. 

Mr. SAVING. No, we have not done research. I understand some 

of the economics of this issue and why the drug prices are different, 

meaning that certain foreign countries have suggested that if they 

do not get the price that they want to the pharmaceutical companies, they will allow other companies to simply make the product, 

and that has a longer-run issue, in terms of drug development. And 

this is a real issue that, say, you want to have the new exotic 

drugs, and if you were to control the prices of them, no one will 

develop again. 

So I am not taking a position on this in one way or the other. 

I am simply saying here are the arguments on both sides of the 

issue. 

Senator STABENOW. In Canada, for instance, they negotiate 

prices. 

Chairman GREGG. Senator——

Senator STABENOW. Thank you, Mr. Chairman. 

Chairman GREGG. Well, we want to thank the panel. You have 

certainly put on the table a lot of very interesting ideas and, obviously, some statistics which are fairly staggering and have significant implications for us as a society and for the Government, specifically. So we do thank you, and this concludes this hearing. 

We will have, on March 1st, the Deputy Secretary of Defense. It 

will be a first for this committee to have that opportunity to talk 

to the Defense Department about a fairly large budget that they 

have, something I know the ranking member has been interested 

in having. 

So we look forward to that testimony, but we very much appreciate your testimony. I am hopeful, quite honestly, that some of the 

ideas that you have put on the table, which have been very creative, will find resonance with the proper authorizing committee, 

and we will certainly try to energize that. 

Senator CONRAD. Thank you all. 

[Whereupon, at 11:43 a.m., the committee was adjourned.] 

(459)

THE PRESIDENT’S FISCAL YEAR 2006 

DEFENSE BUDGET 

TUESDAY, MARCH 1, 2005 

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

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

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

Present: Senators Gregg, Allard, Sessions, Bunning, Ensign, Alexander, Conrad, Feingold, and Stabenow. 

Staff present: Scott B. Gudes, Majority Staff Director; and Mike 

Lofgren. 

Staff present: Mary Ann Naylor, Staff Director; and Jamie 

Moran. 

OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

Chairman GREGG. We will begin this hearing. We are joined 

today by Dr. Wolfowitz and General Pace and Ms. Jonas, and we 

are very fortunate to have these three individuals join us today. 

They lead the Defense Department, along with Secretary Rumsfeld, 

and have done an extraordinary job there. I believe this is a new 

precedent in that we have not heard too often from the Defense Department at the Budget Committee, and we very much appreciate 

Secretary Wolfowitz taking the time to come here today and bring 

with him his senior team. 

This is important for us to have the Defense Department’s input 

onto the budget. Obviously, the Defense accounts represent the 

most significant item in discretionary spending. It represents in a 

$2.5 trillion budget approximately 20 percent of the entire budget 

of the United States, and one that is clearly critical to where we 

are going as a Nation and how we maintain our independence and 

strength as a Nation. 

I want to begin by thanking the men and women who serve this 

Nation and who work with you in the Defense Department. We 

have seen a display of extraordinary courage, ability, talent and intelligence in the way they have executed their duties in Iraq and 

Afghanistan and around the globe generally, but obviously in those 

two extremely intense environments. We are all very proud of them 

and we are very thankful for what they have done because it has 

been exceptional work. And their success is considerable. The elections in Iraq I think stunned the world because it showed that democracy could work and that there was a desire for it. And they 

came about because men and women on the ground in American 

460

uniforms made sure that they were able to pursue an election 

there. We should take great pride in that result. 

The recent actions in Syria and in Palestine also reflect that the 

awakening of the voices of democracy is occurring in the Middle 

East and it is in large part because of the commitment, the efforts 

of our soldiers in that region, making sure that people who seek 

freedom have the ability to pursue it without being stifled by radical terrorists or individuals who are despotic in their approach. So 

we admire what you have done, or I do, and I think I speak for 

most Americans, and we thank you. 

The budget of the Defense Department, as I mentioned, is significant, and it is one that needs to be addressed in an open forum like 

this. I know many of my colleagues will have a lot of questions. My 

questions primarily will focus on how we are going to sustain our 

commitment to the Defense initiative as we restructure the force 

structure in order to meet the new threat of terrorism or the threat 

which now unfortunately we are deep into fighting. It is not that 

new any longer. But what is it going to cost us in the outyears? 

We know what it is going to cost next year. We can project what 

it is going to cost for maybe 2 years, but what is the long-term cost 

and where should we be reallocating resources and how should we 

do that? And how do we treat the issues beyond the Defense Department, which the Defense Department is pursuing or being 

drawn into, such as public diplomacy and nation building, for lack 

of a better word, protecting democracies, fledgling democracies? 

How do we deal with that and what is the cost as we move forward? Where will we adjust in other areas, which obviously there 

has been a lot of discussion about, and there are some major reports coming forward. 

So we look forward to your testimony today. We thank you for 

taking the time to appear before us. We appreciate the courtesy 

you are showing us by being here today. 

With that, I will yield to the ranking member of the committee, 

Senator Conrad, for his thoughts. 

OPENING STATEMENT OF RANKING MEMBER KENT CONRAD 

Senator CONRAD. Thank you, Mr. Chairman. I want to join the 

chairman in first of all thanking you, Secretary Wolfowitz and General Pace and Ms. Jonas for being here today. It is very important 

for the deliberations of this committee to have a defense panel before us, and we appreciate very much your taking the time to come 

and make a presentation here. 

I also want to join the chairman in, through you, thanking the 

men and women in uniform. I think every American is intensely 

proud of how you have conducted yourselves at a time of great 

stress. I believe my State has the highest proportion of guard 

troops in Iraq. We are proud of each and every one of them, and 

we recognize their sacrifice and their service, and again through 

you, we want to express to them this Nation’s undying gratitude. 

Whether one agrees with every element of the policy of the United 

States really should not have a place with respect to how we regard 

the men and women who meet the call of this Nation. That is an 

extraordinary thing that people do to answer this Nation’s call at 

the time of need. 

461

I would just like to put a few things in perspective in my opening 

remarks, and then we will get to questions. And I want to thank 

the chairman as well for holding this hearing. 

I put up this chart just to put in perspective where we are in 

constant dollars terms, the Defense budget of the country over an 

extended period of time. What this chart shows is going back to 

1950, coming off of the Korean War and the peak of the time of 

the Vietnam War which was between four and five hundred billion 

in constant dollars. Then the Reagan defense buildup, which was 

just about 500 billion in constant dollars, and now this buildup 

which appears to be, if my eyesight is correct, the highest in real 

terms since the Korean War. So we have a trajectory here that I 

think we all understand. It is a result of the war in Iraq, the war 

in Afghanistan. It is a result of the war on terror. Those are the 

things that are pushing up this Defense budget. Defense is where 

most of the increase in discretionary spending has occurred. In fact, 

91 percent of the increase in discretionary spending is a result of 

the increases in Defense, Homeland Security and the other responses to September 11th, the rebuilding of New York, the airline 

bailout, et cetera. So the vast majority of the increase in spending 

that has occurred is in just those three areas.

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21173.218
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If we go to the next slide, I think the administration has been 

less than forthright with respect to what these costs would be. This 

is an interview with George Stephanopoulos in January of 2003 

with the Secretary of Defense. And the interviewer asked this question: ‘‘What should the public know right now about what a war 

with Iraq would look like and what the cost would be?’’ Secretary 

Rumsfeld: ‘‘The Office of Management and Budget estimated it to 

be something under $50 billion.’’ Interviewer: ‘‘Outside estimates 

say up to $300 billion.’’ The Secretary: ‘‘Baloney.’’

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Let us go to the next slide. These are just the supplementals that 

we have had since that time. The supplemental in 2003 was 79 billion. We had a total of supplementals in 2004 of 112 billion, and 

now this year $82 billion. You add that all up and we are approaching the $300 billion that was described as baloney.

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Whatever the description, the harsh reality is this has cost us a 

lot, and it is going to cost us a lot more. As I look at the budget, 

I do not see the President providing for these costs anywhere close 

to what most objective observers say the cost is going to be. We 

have the supplemental now of $82 billion. The Congressional Budget Office says that the expected cost is over $380 billion. If I were 

to fault the administration, I would fault them for not really sharing with us in a clear way what the costs are going to be. I know 

people say it is hard to estimate the cost. Well, that is what a 

budget is about, and it is like a family saying it is hard to estimate 

what our utility bill is going to be, so we just leave that out of the 

family budget, or it is hard to estimate how much we are going to 

eat out so we are going to leave that out of the budget.

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We know the right answer is not zero past September 30th of 

this year, and yet that is where we are with the budget. So I would 

urge the administration to put in the budget what they think the 

real costs are going to be. 

Let me go to the next slide. This is a quote again from the Secretary in February 12th of 2004 before the Defense Appropriations 

Committee, and he said, ‘‘We have instituted realistic budgeting so 

that the Department now looks to emergency supplementals for unknown costs of fighting wars and not to sustain readiness as had 

been the practice previously.’’

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But when we look at this budget, when we look at these 

supplementals, we see something other than that assertion. We see 

$5 billion for Army modular force restructuring, $2 billion for aid 

to foreign militaries, $100 million for a Jordan Special Operations 

Training Center, $300 million for recruiting and retention, and as 

much as $3 billion of core Army operations and maintenance costs. 

I would say to you, Mr. Secretary, and through you to the Secretary of Defense, from a budgetary standpoint I think it is critically important that we have these ongoing expenses included in 

the budget itself, not in supplementals, because that will lead us 

down a road that is even more unsustainable than our current 

course. 

With that I look very much forward to your testimony. Mr. Secretary, you reminded me this morning we first met in Indonesia almost 20 years ago, and I was very impressed by you then. As I 

have expressed to you before publicly, we appreciate all of those 

who come forward and serve this Nation, and I say that to General 

Pace as well. I have high regard for Ms. Jonas, thank you as well. 

Chairman GREGG. Thank you, Senator Conrad. 

Dr. Wolfowitz, we would be happy to hear your thoughts. 

STATEMENT OF PAUL WOLFOWITZ, DEPUTY SECRETARY, DEPARTMENT OF DEFENSE, ACCOMPANIED BY GENERAL 

PETER PACE, VICE CHAIRMAN OF THE JOINT CHIEFS OF 

STAFF, DEPARTMENT OF DEFENSE; AND TINA JONAS, 

UNDER SECRETARY OF DEFENSE/COMPTROLLER, DEPARTMENT OF DEFENSE 

Mr. WOLFOWITZ. Mr. Chairman, thank you. Senator Conrad, 

thank you. 

We understand the enormous responsibility this committee has 

to try to look at the overall financing of the Federal budget. We appreciate that we are a very big part of, as you said, of the discretionary part of that budget, and most importantly we appreciate 

that the incredible men and women who serve this country so nobly 

and so well, that both of you have praised appropriately. And I 

think we cannot praise them enough, could not do what they do 

without the support that comes from the U.S. Congress through the 

budgetary process. We know that we need that support and we are 

privileged to come here and be able to try to explain what we are 

doing to this important committee. Given the many difficult choices 

with which you are faced, I appreciate this opportunity. 

As both of you have referred to, we are a Nation at war. On September 11th, 2001, terrorists attacked the United States in a way 

that American territory had never been attacked before, claiming 

lives on a scale that could only be compared with the attack at 

Pearl Harbor 60 years earlier. Along with our national loss, September 11th revealed another stunning threat, the possibility of far 

more terrible attacks including those using weapons of mass destruction. Indeed, soon after September 11th the Congress itself 

was attacked with military grade anthrax. 

Given the nature of terrorist networks and the secrecy with 

which they operate, no one can say for certain why this country has 

not been attacked in the last 3 years. What we can say with confidence is that the reason we have not been attacked is not because 

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the terrorists have not been trying, we know that they have. But 

we can also say with confidence that many plots and attempted attacks, both here and abroad, have been thwarted through the continuing efforts of the United States and some 90 nations who are 

cooperating with us in the war on terror. The facets of this international cooperation are many and varied. They are not purely 

military. 

In fact, from our standpoint, this war involves all elements of 

American national power, including military force, but not solely or 

in most cases even primarily military force. Indeed the various instruments of our national power, including intelligence, law enforcement, diplomacy, and I would add particularly as we watch 

dramatic events unfolding in places like Lebanon, the power of the 

idea of freedom for which this country stands served to reinforce 

one another. But there is no question that the contribution of the 

U.S. military has been indispensable to much of the success that 

we have achieved so far. 

While our efforts are far from complete, we can point to certain 

significant milestones. For example, terrorists have lost their ability to train thousands of potential terrorists in camps that previously existed in Afghanistan and in northern Iraq. And while bin 

Laden and his top lieutenant, Ayman al-Zawahiri, are still on the 

loose, more than three-quarters of al Qaeda’s senior leaders have 

been detained, captured or killed, and thousands of lesser members 

of that organization since September 11th. Bin Laden’s access to 

resources and his ability to communicate with his confederates has 

been significantly constrained. And in the terror war which bin 

Laden Abu Musab al-Zarqawi is waging against democracy in Iraq, 

al Qaeda is losing badly. 

In just the last 3 years, in regions some people previously judged 

immune to the democratic spirit, there has been an extraordinary 

movement toward representative Government, what President 

Bush has rightly called the ultimate weapon against the terrorists’ 

bleak vision of death and despair. 

Thanks in no small part to the efforts and the sacrifices of American men and women in uniform, some 50 million people in Afghanistan and Iraq, almost all of the Muslims, are now themselves helping to advance the cause of freedom in the Muslim world. 

But Afghans and Iraqis are not alone. There seems to be a larger 

movement of democratic forces at work, and it has been due in 

great measure to the courage and commitment of brave and committed citizens of Muslim countries themselves, in many cases 

without any involvement of U.S. military force. 

Last September in the country where I first met Senator 

Conrad—it is hard to believe it was 20 years ago, Senator, you do 

not look that old; I hope I do not—Indonesia, the country with the 

largest Muslim population in the world, held it second successive 

free and fair election of a president, a milestone often considered 

a landmark on the road to democracy. 

In January the Palestinian Authority held an historic election 

that has produced new leadership that may finally deliver for the 

Palestinian people the state they have long deserved. 

In Lebanon tens of thousands of people have come out to demonstrate in the wake of the assassination of former Prime Minister 

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Rafiq Hariri. As we saw just yesterday, the Syrian-backed government in Lebanon resigned under popular pressure. 

And of course citizens were a powerful driving force for freedom 

in Afghanistan and in Iraq. 

While the U.S. military is not the only national instrument the 

has contributed to these important goals, its indispensable role is 

unquestionably the most expensive. It is expensive in terms of the 

resources that it demands of the American taxpayer, and it is expensive particularly in terms of the sacrifices that it demands of 

our men and women in uniform, including those who have made 

the ultimate sacrifice for our freedom and security. 

This Defense budget is first and foremost about them and about 

their future, and about ours as Americans. 

It is in this context, Mr. Chairman, that the President has requested $419.3 billion in discretionary budget authority for the Department of Defense, representing a 4.8 percent increase over fiscal 

year 2005. Combined with a supplemental, this request provides 

sufficient funding to sustain the President’s pledges to defeat global 

terrorism, to restructure America’s armed forces and global defense 

posture, to develop and field advanced war fighting capabilities, 

and most of all to provide for the personnel needs of our forces. 

Before I discuss the 2006 budget request, I would like to say a 

few words about the supplemental. The President has pledged that 

our troops will have what they need to fight and win this war. The 

President’s recent request for an additional $74.9 billion in fiscal 

year 2005 supplemental appropriations, on top of the $25 billion 

that was appropriated last August, keeps that solemn pledge. 

Of critical importance, this supplemental will provide significant 

resources to address wear and tear on our military equipment, to 

create a larger more combat-capable Army and Marine Corps, and 

to train and equip Iraqi and Afghan security forces to empower 

them to take the fight to the extremists and help them take control 

of their future. Let me briefly address each of those three topics. 

First, as far as resetting the force is concerned: a high operating 

tempo is causing significant wear and tear on some of our warfighting equipment. The supplemental includes $11.9 billion to 

reset or recapitalize the force, which is essential to ensuring military readiness. I think those are some of the costs that Senator 

Conrad referred to, and we believe they are war related costs. 

Our commitment is to keep military units at full combat 

strength, and provide them with the equipment they need to be 

ready when we need them. 

Second, very importantly, when it comes to restructuring ground 

forces, the Department has made a major commitment to restructuring the U.S. Army, adding $35 billion over the 7-years of the fiscal year 2005 to 2011 future years Defense plan, on top of $13 billion that was already in the Army baseline budget. 

Restructuring will increase the number of Army brigades and 

convert them into independent brigade combat teams that can conduct operations on their own. Let me take just a moment to explain 

in a bit more detail what we mean when we talk about that conversion. We use regularly the term ‘‘Army modularity.’’ We all think 

we know what it means, but it is a kind of obscure phrase that I 

think obscures the exciting implications of what’s going on. 

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Because what the Army is undertaking is actually a remarkable 

and fundamental transformation in the way that it organizes and 

thinks about deploying forces, and it will make a huge difference 

in the strain that is placed on forces and the strain that is placed 

on families through deployments. 

The Department has made a major commitment to this type of 

restructuring for its ground forces, which is designed to add more 

deployable units, create a larger rotational base, and increase flexibility, thus relieving the strain on the total force by creating more 

deployable units. 

The Active Army, for example, will expand from 33 maneuver 

brigades in fiscal year 2003 to 43 brigade combat teams in fiscal 

year 2007. The chart that has been put up actually shows you how 

that increase of 10 deployable brigade combat teams, if notional, 

for deployment of 15 active brigades, increases the amount of time 

that any individual brigade spends at home by 50 percent. That is 

a very big difference, has a very big impact on morale and on families. 

In addition the current Army plan would restructure the Army 

National Guard to reach 34 trained and ready brigade combat 

teams by fiscal year 2010, up from the current 15. The most significant consequence of these two expansions is that for any required 

level of overseas force deployment, active brigades will deploy much 

less often and reserve maneuver brigades will be mobilized much 

less frequently. 

Right now as we speak, the Army’s Third Infantry Division, the 

first to complete the transformation going from three brigades to 

four independently deployable units has just completed its redeployment to Iraq. It is putting this new concept into practice. The 

Third Infantry division relieved the First Calvary Division which 

will undergo the same transformation now when it returns to Fort 

Hood. The result of that change in the Third Infantry Division is 

that we needed one less National Guard brigade to fill what otherwise would have been a hole. 

The recent history of the Third Infantry Division explains why 

we are funding Army transformation in fiscal year 2005 and fiscal 

year 2006 from supplemental funds. As the Third Infantry Division 

redeployed from Iraq some 15 months ago, we simultaneously reset 

it from the wear and tear of combat and transformed it from three 

brigades to four. 

Let me emphasize beginning in fiscal year 2007 we will request 

funding for restructuring I the baseline Army budget. By then we 

expect both the rotational strain on our troops to be less, and our 

understanding of the costs of transformation to be more exact. 

But for this year and next year supplemental funding is critical 

because it addresses two urgent requirements. First it rapidly expands the operating size and combat power of the Army, making 

our forces more effective in the global war on terror and making 

their deployment more sustainable. And second, by creating a larger number of more capable brigades available for rotation, it significantly reduces the strain on our military units and troops. 

Third and very important, the supplemental also funds the vital 

strategic goal of training and equipping indigenous military and security forces in Iraq and Afghanistan. Building the capabilities of 

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these countries’ forces is essential to the long-term security and 

stability of both nations, and will enable them to become more selfsufficient and less reliant on U.S. and other coalition forces. I urge 

full funding of our request and creation of an Iraq Security Forces 

Fund and Afghanistan Security Forces Fund to provide the resources needed to train those forces so that they can take control 

of their own security needs and take the burden off of our troops. 

Members of Iraq’s security forces were critical participants in 

January’s choice for freedom. Several bravely gave their lives to 

shield Iraqi voters from suicide bombers and insurgents. Their performance on the January 30th election day is visible and tangible 

evidence of the returns we are getting from our substantial investment in those forces. 

In a recent call with General Casey, he told us that since the 

election Iraqi security forces have grown more confident, and volunteers have grown in numbers. The Iraqi people have become 

more confident of an Army made up of Iraqi patriots who are their 

husbands, their daughters and their sons, and some 1,400 Iraqi police and soldiers have died since Iraq’s liberation. 

Mr. Chairman, let me say a brief word also about the requesting 

in the supplemental for tsunami relief. Let me also emphasize that 

our ability to come to the aid of hundreds of thousands of people 

who were made homeless by that incredible disaster, that made it 

possible I think to save tens of thousands of lives, would not have 

been possible without the investment the American taxpayer has 

made over many years in those capabilities. We estimate conservatively just the equipment alone, the ships and the helicopters, represented a $28 billion investment in military equipment that no 

other country could have provided. It was an honor and a privilege 

to be able to do that, and I think it was not only a great humanitarian success, but I also think it has helped advance America’s position in many parts of that region. 

We have requested funds in the supplemental to cover those expenses. We have an enormous stake to make sure that the subsequent recovery efforts build on the success we have already 

achieved. The benefits of that assistance will focus principally on 

Indonesia, which, as I believe Senator Conrad pointed out, has the 

largest Muslim population of any country in the world, and it does 

so at a time when Indonesia is emerging as a democracy, seeking 

to join the community of free nations. 

A recent poll in that country indicates that strong positive 

change in public opinion after people saw how Americans, especially American military men and women, labored to bring life-saving water, food and other supplies. I was privileged to visit with 

young sailors on board the U.S.S. Lincoln, as did several Members 

of Congress. They were incredibly eager and enthusiastic volunteers whose tireless and selfless efforts were truly inspiring. 

We now have the opportunity—and the supplemental will enable 

that—to build on their wonderful work by helping Indonesia 

strengthen its democratic institutions and rebuild its vital infrastructure. It is certainly in our national interest to do so. 

Mr. Chairman, we have had to make some difficult choices in 

this budget, particularly to find the resources to fund Army 

modularity in fiscal year 2007 and beyond. We recognize that the 

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fiscal year 2006 budget is sizable by historical standards, but I believe it is a sustainable defense burden, especially in light of the 

stakes involved. Americans can be ensured, however, that we are 

balancing this budget request with some difficult choices among 

competing needs. We need Congress’s support of those tough 

choices. 

To get the best out of America’s investment in defense the budget 

reflects continuing work to restructure our forces, to restructure 

our global defense posture, and to restructure our basing here at 

home. We believe those are all smart choices that will help to 

achieve more combat power in the future without a commensurate 

increase in troops or funding. 

Beyond concepts like Army modularity, something equally remarkable is taking place in the way in which we base our forces. 

We are changing fundamentally the character of our global stationing, and at the same time we are going through a major effort 

to realign our basing posture here at home so that it supports the 

essentially expeditionary character of most of our forces. In addition we think this realignment of our base structure will support 

the new requirements for homeland defense. 

There are two key initiatives regarding base structure that I 

would like to mention. The President’s global posture restructuring 

will bring home 70,000 U.S. military personnel and approximately 

100,000 dependents back to the United States, and relocate those 

forces and equipment that remain overseas. Second, the 2005 Base 

Realignment and Closure Commission will take this return from 

overseas into account in deciding how to streamline and restructure the Department’s installations here in the United States. 

In addition, all of our services are taking efforts to rebalance the 

distribution of military specialties between the active and reserve 

components, so that for those military specialties that are in high 

demand, we will not constantly have to go to the reserves as we 

have had to for certain ones, particularly, notably, civil affairs. 

Mr. Chairman, the fiscal year 2006 budget funds a balance combination of programs to develop and field the capabilities most 

needed by America’s military. It provides for our most valuable 

asset, our people, by maintaining the President’s commitment to 

take care of our military men and women and their families. It includes a 3.1 percent increase in military base pay. It includes an 

increase in funding to ensure continuing good health care, and it 

will fund by fiscal year 2009 the elimination of all inadequate housing units worldwide. 

Mr. Chairman, American soldiers, sailors, airmen, Marines and 

Coast Guardsmen, as well as their civilian colleagues serving in 

the global war on terror have performed magnificently. They have 

done everything that has been asked of them and more. As of February 28th, more than 1,600 Americans have given their lives in 

Afghanistan and Iraq, and thousands more have been wounded to 

protect our freedom and encourage liberty’s advance for people once 

enslaved by brutal tyrannies. 

They could not have pursued this noble cause without the strong 

support of Congress. On behalf of those brave Americans who serve 

and have served us so well, I would like to thank the members of 

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this committee and the entire Congress for that continued bipartisan support. 

We can point to some truly significant gains, some of which I 

mentioned earlier, but we must not allow ourselves to become complacent just because this country had not been attacked in the last 

3 years. As I said earlier, we know that the terrorists are still actively plotting, and we must maintain strong pressure on them, 

and if possible, intensify it. 

As just one example, I would note that in the regions that straddle the Pakistan-Afghan border, as we speak here today Pakistani 

armed forces, supported by active American operations on the Afghan side of the border, are putting intense pressure on al Qaeda 

leadership, hiding in northwest Pakistan. 

But while capturing and killing terrorists is critically important, 

this struggle is not just about those activities alone. As the President said in his inaugural address, and I quote, ‘‘The best hope for 

peace in our world is the expansion of freedom in all the world.’’ 

That means reaching out to mainstream Muslims who want freedom and democracy and prosperity. That is what the terrorists 

fear. That is why they fight to impose on their fellow Muslims a 

medieval, intolerant, tyrannical way of life. 

That is the fear that prompted members of the Taliban to threaten voters in the Afghan elections. That is the fear of freedom and 

self-determination that caused Osama bin Laden to declare that 

Iraqis who voted in the elections would be infidels and apostates. 

But we know that despite those threat, the Iraqi people exercised 

their new-found freedom and voted anyway. It is a story of enormous courage by 8–1/2 million individual Iraqis, every one of whom 

knew they were taking a personal risk when they marked their finger with that bright purple ink, telling everyone including the terrorists where they stood. 

There are many stories of heroism from that day, including the 

stories of two separate Iraqi policemen who tackled suicide bombers and gave their lives to protect voters. But one of the ones that 

impressed me the most was one told to me the next day by Brigadier General Carter Ham, who commands our forces up in Mosul. 

He described a polling station in a Sunni-Arab neighborhood of 

that city, a city that suffered some of the most brutal intimidation 

in the last few months. Nobody had voted for the first 2 hours, but 

a crowd of several hundred people had gathered at a distance to 

watch. Finally, around 9 o’clock in the morning after the polls had 

been open, as I say, for 2 hours, one old woman in her late 60’s, 

early 70’s stepped forward and said, ‘‘I have waited all my life for 

this opportunity. I am not going to miss it.’’ She stepped into the 

polling place and the crowd followed her. The will to fight for freedom does not diminish with age or infirmity. 

It is difficult to imagine people anywhere in the world showing 

more courage and determination to vote in the face of intimidation. 

But as impressive as that result is, as impressive as the results 

in Afghanistan or some of the seeds of freedom that are sprouting 

elsewhere in the Middle East, Iraqis and everyone still face a difficult road to defeat the terrorist threat, to defeat tyrannical intimidation, and to achieve stability, much less freedom and democracy. 

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ginning to pay off, and it will continue to do so, especially as their 

growing capability translates into less stress on our troops, which 

is one of our key goals. 

Mr. Chairman, just to conclude, our investments in many fronts 

of the global war on terror have given us some important returns, 

but we must remain resolved and patient, for there is much yet to 

do. This problem of terrorism grew up over a period of 20 or 30 

years if not longer. It is not going to go away in two or three. We 

may recall how long we waged the cold war and how long it took 

to rebuild Western Europe, but in both cases we know how the 

story ended. We know that seemingly impossible challenges can be 

achieved when the American people and their allies are resolved to 

stand firm for freedom, and freedom is perhaps the most powerful 

force in the world. 

It has been the glue of the world’s strongest alliances. It has 

been the solvent that has dissolved tyrannical rule. The same values that held the western alliance together over four decades of 

often contentious debate during the cold war have brought some 40 

countries into the coalition effort in Afghanistan, more than 30 

countries with us into Iraq, and some 80 or 90 countries into the 

larger coalition against global terrorism. The longing for freedom 

that penetrated even the Iron Curtain brought about the peaceful 

end to the cold war, and that same universal desire for liberty 

among Muslims as well as non-Muslims will be our strongest weapon in fighting fanaticism today. 

Mr. Chairman, this budget addresses our country’s need to fight 

the war on terror, to support our men and women in uniform, and 

to meet the threats of the 21st century. It reflects difficult choices 

to ensure sufficient funding for our most pressing requirements. 

Those difficult choices and our proposed transformation of the business of defense underscores our resolve to be wise in spending taxpayer dollars. 

This committee has provided our country strong leadership in 

providing for the national defense, and ensuring the taxpayer dollars are wisely spent. We appreciate that support and we look forward to continuing our work with you to achieve both of those critical goals. 

Thank you very much. 

Chairman GREGG. Thank you, Mr. Secretary, for that very strong 

statement on purposes of our military and how it has brought freedom really to millions of people and allowed elections to occur in 

Afghanistan and Iraq, which have led, I believe, to the elections in 

Palestine being successful and the recent Lebanon situation, which 

has reflected a movement toward democracy. So I congratulate you. 

This committee deals with numbers, and although the philosophy 

you have presented is one I would love to pursue, because I think 

it needs to be echoed, let me stay with the purposes of this committee which is numbers. 

The ranking member, Senator Conrad, has mentioned the fact 

that the budget did not, as presented by the President, did not 

have in it any allocation for the expenditures which we might incur 

relative to the war in Iraq. It had in it a core defense budget, as 

you mentioned, of $419 billion as being the request. You have obviously presented a supplemental this year. There are prior 

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supplementals before this year. It is logical that next year we will 

need to expend money in Iraq and in Afghanistan, which will be 

above the core defense budget. It would be my expectation that as 

part of our budget process, we would put in place a reserve fund 

for the purposes of funding that. I expect it would be in the same 

range as we put in last year, although the budget did not pass last 

year, which was $50 billion. 

The reason I think it is important to pursue it in a reserve fund 

form and the reason I think you are correct in bringing up the 

issue of how you paid for the war in Iraq and Afghanistan through 

the supplemental process, as versus through the core process is 

that these are not expenditures which are going to go on forever. 

In fact, we hope that they are expenditures which will be shortened 

in their time horizon rather than infinite in their time horizon, and 

in fact, hopefully no more than two or three more years of significant expense, maybe even less if we are fortunate. 

Therefore, I do not believe that these dollars that we are expending in Iraq and Afghanistan should be built into the defense base, 

and I think it would be a major budgeting error to do that because 

it would inappropriately inflate the defense base. So they should 

come forward as supplementals, but I also think that our budget 

should reflect the fact that we expect that, and therefore, I do anticipate that we will put in, as I said, a reserve fund. I have spoken 

with people within the administration who I do not believe resist 

this idea. I think they probably think it is a reasonable approach, 

and I would be interested in whether you even have an opinion on 

this or whether you think it is our responsibility to just go forward 

and do what we think is right. 

Mr. WOLFOWITZ. Let me say we certainly want to work with you 

to provide as much clarity as we can about expenditures. I agree 

emphatically with what you have just said about why these emergency expenditures that are not predictable should not be built into 

the base budget. In fact I believe we made an effort to do exactly 

that in the first year of Operation Enduring Freedom, and I think 

the Congress turned it down on the ground that this would be an 

unallocated—in some people’s words—slush fund. 

I think when you have emergency expenditures of this kind that 

really are unpredictable, it is wise to do it through supplemental. 

At the same time we can absolutely predict there will be a supplemental budget request next year. I do not know what the size is. 

I hope as you do that it may turn out to be a lot smaller than what 

we need this year, but I would be a fool to predict that. I think, 

therefore, making some kind of a provision in your overall budgeting for the fact that there’s going to be a requirement for U.S. 

Fiscal resources over and above the $418 billion that we are requesting makes common sense. I think you did it last year or tried 

to do it last year. 

The one thing I would add in addition is the reason we came forward with a supplemental request for 2005 early in this process 

this year was precisely so that people would see—as you know, 

often there has been a tendency, for various reasons, to delay it 

and delay it. We are kind of happy as the Defense Department to 

get that number out there early, and I think the administration as 

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stands at this point what we estimate is going to be the full cost 

for fiscal year 2005, but we really cannot predict fiscal year 2006. 

Chairman GREGG. I expect we will set up a reserve fund and it 

will be approximately in the range of last year, and I take it from 

your answer that you do not have any great reservations about 

that approach. 

The number 419 is a significant number, but in the context of 

being at war it is probably not a significant number relative to the 

rest of the national budget, the national budget being a $2.5 trillion 

budget. We are at war. Senator Conrad put up some numbers 

which reflected this in real terms relative to the number in other 

periods in our history, but I suspect that if we went back historically the percentage of the budget that is being committed to fight 

this war is significantly less than percentage of the budget that 

was certainly committed to fight World War II when we were attacked at Pearl Harbor as we were attacked this time in New York 

and here in Washington. And I suspect that it is significantly less 

than when we were at war in Korea, and probably in Vietnam, and 

during the defense buildup of the Reagan years it may have even 

been less then when we were not in a formal war, though obviously 

our intention was to dismantle the Soviet Union by making it clear 

to them that they could not compete with a free society. 

So I would be interested in putting those numbers in a framework of what they represent rather relative to defense spending at 

a time of war if you have those numbers. 

Mr. WOLFOWITZ. Ms. Jonas may have more detail. I know roughly just in terms of the measure of percent of GDP, which—or defense burden, or what it represents for the average taxpayer, if 

there is such a thing as an average taxpayer. We are at about 3.3 

percent of GDP which I think is about half or less than half of the 

cold war peak. My impression—I guess I do not want to guess. 

What was it in World War II, Tina? Do you know? 

Ms. JONAS. I do not have that percentage, but I do have, in terms 

of Federal spending, we are 18 percent—this budget would make 

us 18 percent of Federal spending. But 1960 we were 51.4 percent 

of Federal spending so it has dropped a little bit. I have the number here. In 1960 DOD outlays were 8.2 percent of GDP, so we are 

down significantly. 

Mr. WOLFOWITZ. We will get you the full historical data, not for 

the record.

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Chairman GREGG. The point I was obviously trying to make was 

that, yes, we are spending a lot on defense, but we are at war, and 

in the context of other times that we have been at war, actually 

our defense spending is small compared to those periods. 

Senator CONRAD. Mr. WOLFOWITZ. One other point, Mr. Chairman, too. I think 

compared to the potential cost to this country if terrorism is successful—we had a inkling of that on September 11th—the potential 

expense of that. We are not doing this mainly to—most of all it is 

a matter of protecting lives and security, but just the monetary 

costs alone of terrorism are enormous. 

Chairman GREGG. Thank you. 

Senator CONRAD. 

Senator CONRAD. Thank you, Mr. Chairman. 

Let me say first of all the speaking for me, I intend to fully support the President’s request for Defense, as I have throughout this 

period. We are at war. I think it is very important that we stand 

shoulder to shoulder. I think it is very important that we signal 

our adversaries that we are united in support of our men and 

women in uniform, and I think that it is just critically important 

that we send that message. I can assure you that on our side of 

the aisle, we will fully support the resources the President has requested. 

I also told the President, when I had an opportunity to fly to 

North Dakota with him right after the speech on the state of the 

union, that I thought when he talked about the enduring values of 

this country, freedom, liberty, that is really the moral strength of 

America, and that is the signal that we should send the rest of the 

world. 

I think I mentioned to you, Mr. Secretary, that I graduated from 

high school from an American military base in Libya, old Wheelus 

Air Force Base. A family I lived with was the Vice President of 

Mobil Oil in Libya at the time. His name was Wendall Smith. So 

it was an interesting growing up. Sometime I would love to sit 

down with you and share perspectives on what is happening in 

that part of the world and the challenge that we face there. 

But we face a challenge on this committee of trying to make all 

this add up, and frankly, as I look at the overall budget, I do not 

see any of it adding up, and that is a big problem. We have record 

deficits. We are headed for the retirement of the baby boom generation. And the pressure on all of these spending priorities is going 

to be intense and only get more so. 

Let me just go to this. This struck me, this exchange with the 

Secretary of Defense on February 7th in a press briefing on the 

President’s budget. And let me just go over with you what was said 

in this briefing. The reporter asked the Secretary: ‘‘The budget 

shows that Army spending is going down by $300 million in the fiscal year.’’ The Secretary interrupted and said, ‘‘Which as you know 

is not the case.’’ The reporter said, ‘‘Well, that’s what I see.’’ The 

Secretary said, ‘‘Yeah, I should have mentioned that. The only way 

you can look at this budget is to look at the supplementals with 

it, and it would be a misunderstanding of the situation to come to 

the conclusion that you pretended you had come to, but of course 

you did not, being as knowledgeable as you are.’’ The reporter: 

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‘‘Well, are you hiding? Are they in fact hiding non-combat costs in 

the supplemental?’’ The Secretary: ‘‘No, of course not. No, that 

would be wrong’’—laughter—‘‘and we wouldn’t do that.’’

You know the problem that I see looking at this budget—and 

again I want to make clear I support the overall resources being 

requested—but I have to tell you I am very, very concerned about 

not having anything in the budget for past September 30th of this 

year for conducting this war. We all know that there are going to 

be expenses. To the extent we know them, we ought to budget for 

them. 

I applaud to chairman for indicating he is going to put up a reserve fund, because it is just a mistake, I believe, not to tell the 

American people, not to tell Congress the expenses that we anticipate associated with these conflicts. You know we can take—but we 

need you to make your best estimates, and I know it is hard, I 

know it is difficult to estimate, but it is impossible to put together 

a budget unless we make good faith estimates of what costs are 

going to be, and to say there are not going to be any costs, to suggest in a budget there are not going to be is just wrong. We know 

it is not the case. 

So I would ask you what your reflection is on this interchange 

with the Secretary and the reporter on whether or not the Army 

budget is being reduced. How would you have answered those questions? 

Mr. WOLFOWITZ. We know that the Army budget is going to—the 

Army resourcing in fiscal year 2006 is going to include a substantial amount for resetting the force and modularity, and I think I 

made that clear in my testimony. It covers expenditures that have 

I would say two characteristics to them. A lot, No. 1, they are unpredictable, and No. 2, a lot of them are combat related and we can 

get into how many angels dance on the head of a pin as to whether—certainly repairing equipment that has gone through extra 

wear and tear because of the very substantial increases in usage 

in Iraq is combat-related, but also the kind of resetting that we are 

doing in the Third Infantry Division on the schedule we are doing 

it is because we are at war. We could do it in a much more leisurely way if we were not. And these really are—that is the second 

point, Senator, these really are genuinely unpredictable. 

General Pace may be able to help me on this, but General Shoemaker and Acting Secretary Brownlee, they first came to the Secretary of Defense with this whole idea of Army modularity—when 

was it, Peter? Was it the fall of last year or a little earlier? 

General PACE. About that, sir, maybe just a little bit earlier. 

Mr. WOLFOWITZ. That was brand new. It was projected in the 

neighborhood of several billion dollars. I do not want to give an 

exact number because my memory will betray me here. That was 

a brand new expenditure that had not been anticipated that is, as 

I say, is related to making the Army more sustainable for the war. 

By the time we got around to putting together this year’s supplemental just a few months later, that Army estimate had nearly tripled for a variety of reasons. So we really are dealing with something that is unpredictable, but I can predict for you with confidence that there will be a substantial request to fund Army 

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485

priation. So if you want to take a realistic estimate of fiscal year 

2006 Army resources, that would have to be part of it. And we are 

not trying to hide that fact. We just cannot predict it. 

General PACE. If I might add, sir, when the Army thought bout 

how they would use the money that was coming to them to reset 

the force, had a choice of resetting to the old Army or moving forward to what was a new concept of modularity. Using the money 

then in a supplemental to buy the new Army, not the old one, and 

as a budget is laid out then, in fiscal year 2007 and beyond, the 

expenditure to reset the remaining part of the Army will in fact be 

on budget. But since this budget process had begun and the concept of how to modularize came up about midway through the 2006 

budget process, the perturbations that would have taken place 

seemed to make it prudent for the Army to use the supplemental 

money that was available for resetting to being modularization, 

and then to put the rest in budget beginning in fiscal year 2007. 

Mr. WOLFOWITZ. Let me just mention on the perturbations General Pace refers to, I mean we have gone through an enormous 

amount of reallocating budget priorities in fiscal year 2007 and beyond with in the Army and between the Army and other services, 

and it has led to decisions which I am sure you have read about, 

about scaling back procurement of aircraft, scaling back procurement of ships, efficiencies across the Department in various areas, 

and those involve a lot of painful decisions, a lot of moving pieces 

around. Trying to do that for this budget that we are presenting 

now with a dollar request for the Army that is uncertain, I think 

frankly would have thrown the whole budget process into chaos 

rather than help it. 

Senator CONRAD. Let me just say in conclusion, I appreciate all 

you say. Also, we have the same problem here. I mean we have got 

competition for scarce resources. And frankly, it is not acceptable, 

I think, to come here and say, well, it is hard to predict. All of the 

budgets are hard to predict. That is what budgeting is, is making 

a projection. The one thing we know for sure is not the right answer is zero, and so I just push back and say to you it would be 

very useful for this committee, very useful for the Congress, if you 

provide estimates that are as good as you can make them about 

what the costs are going to be. 

Chairman GREGG. I have to agree with Senator Conrad. If you 

can give us an approximation, we will budget it, because we are 

committed to making sure you have the resources you need, and 

it might actually be helpful to you folks in the end. 

Senator BUNNING. 

Senator BUNNING. Thank you, Mr. Chairman. I would like to put 

my opening statement into the record with your permission. 

Chairman GREGG. Absolutely. 

[The prepared statement of Senator Bunning follows:]

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Senator BUNNING. Secretary, I have before me your request for $81.9 billion in supplemental spending, and in it there is a section 

called International Affairs, $5.6 billion being spent. I want to 

know how you can justify that $200 million—I am just going the 

pick one out—in economic and military aid to Jordan, when Jordan 

was on the other side, fighting against us in the first Gulf War. My 

son happened to be in that war, and flying over Kuwait at the 

time, and we could not get Jordan’s cooperation to stop the supplies 

coming in from Jordan. Now I want to know why, not only that, 

but then there is $200 million in aid to Pakistani, or to the PLO, 

I would suggest, humanitarian aid. I can understand that one a little better. 

But these are items that are normally done in the appropriation 

process in Foreign Affairs. Why would they be in a supplemental? 

Mr. WOLFOWITZ. There are two different numbers that come out 

almost the same. That is why there is a certain confusion on our 

side. 

Senator some of this is State Department budget request, including things like construction of more secure embassies and so forth, 

and you would have to get a State Department witness here for 

that. But let me just say two things——

Senator BUNNING. The big number would be $658 million for construction of a U.S. embassy in Baghdad. That would normally come 

under normal funding in the State Department request. 

Mr. WOLFOWITZ. Well, I don’t think they anticipated when they 

put in their fiscal year 2005 budget request 12 months ago what 

the security needs would be for that embassy. But let me just say 

that there is one large number in there, and that was what caused 

the confusion. It is not the $5.6 billion you mentioned. There is 

$5.7 billion requested for training Iraqi and Afghan security forces, 

and——

Senator BUNNING. Well, I understand that. 

Mr. WOLFOWITZ. You understand that, OK. 

Senator BUNNING. I was there watching them being trained at 

the time when we thought there were 250,000 of them being 

trained. That is what we were told. And, unfortunately, they cut 

and ran during certain attacks, and we finally found out that there 

were about 125,000 or less that we could depend on. And I understand us trying to buildup that force. In fact, General Petraeus is 

a good friend. 

Mr. WOLFOWITZ. A constituent, I think. From a defense perspective, I would just like to comment on Jordan and Pakistan. You are 

right that Jordan was an unfriendly neutral during the first Gulf 

War in 1991. But things have changed enormously, and they really 

stood up and supported us at considerable risk to themselves because they are right on the border. There is a very large Iraqi—

there was a very large Saddam Hussein intelligence presence in 

Jordan, and yet they allowed us to base forces and many things 

that were helpful. 

And in the case of Pakistan, again, I am not about to defend everything that government does, but as I mentioned in my testimony, their cooperation in pushing into northwest Pakistan and 

putting pressure on al Qaeda leadership in northwest Pakistan I 

believe is helping us in the global fight on terrorism. And President 

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Musharraf has taken some enormous risks to be on our side. In 

fact, there have been two attempts on his life. I think support——

Senator BUNNING. I understand Pakistan better than I do some 

of the others. 

Mr. WOLFOWITZ. OK. I cannot go line by line with you, but——

Senator BUNNING. Well, that is what we have to do. 

Mr. WOLFOWITZ. I understand that, and I think for the State Department—I will do my best on the defense pieces, but——

Senator BUNNING. OK. I am going to do something that is usually done here a lot more. This is a parochial interest in Kentucky. 

You have withdrawn defense money for the construction and procurement of the destruction of chemical weapons at the Bluegrass 

Army Depot and at Pueblo, Colorado. Instead, $33 million is requested for further research. Do you know how long we have been 

researching the destruction of those weapons? We have a treaty to 

get rid of them by 2012, and even the money we appropriated in 

the last DOD budgets over the last 1, 2, 3 years, you want to use 

it for other purposes now. That is what you have requested in this 

year’s DOD budget. 

Now, go down to Richmond, Kentucky, and Lexington, Kentucky, 

and tell those people that those 50,000 rockets that have nerve gas, 

that are corroding, that you are not going to be able to get rid of 

them in time to meet the treaty obligations. Thirty-three million 

dollars is peanuts in a defense budget. 

Now, why would you do that? 

Mr. WOLFOWITZ. Senator, I don’t want to—on the why, we were 

confronted with, as I think you know, enormously escalating costs 

for this whole program. The budget does contain $1.4 billion for 

this fiscal year and $6.3 billion over the course of the defense program. I talked with a couple of your colleagues about that decision, 

and we are certainly prepared to look at whether changes can be 

made. We understand the priority that has to be put into getting 

rid of this stuff, but we also have a problem of costs that are just 

going through the roof. 

Senator BUNNING. I would invite you to come with me to the 

Bluegrass Army Depot and walk through it. 

Mr. WOLFOWITZ. I would be happy to do that, sir. 

Senator BUNNING. And you would understand how urgent it is to 

get rid of those things. 

Mr. WOLFOWITZ. OK. 

Senator BUNNING. Properly. 

Mr. WOLFOWITZ. Let’s do that. 

Senator BUNNING. Thank you. 

Chairman GREGG. Senator Stabenow. 

Senator STABENOW. Thank you, and welcome, Deputy Secretary. 

I appreciate your being here. And, General Pace and Ms. Jonas, 

thank you for your service as well. 

First, a comment, and then a couple of questions in a different 

direction. I would share, first of all, the sentiments of Senator 

Conrad speaking about the fact that we join together, Democrats 

and Republicans, in supporting our troops and making sure that 

they have the resources that they need. That will not be a debate, 

I do not believe, before this committee, and that is something that 

we all stand here ready to do. 

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The challenge for us goes to the question of funding the wars and 

whether or not it is in the budget or not in the budget, and as has 

been said, we know that proceeding it is not zero. And so I would 

just echo, Mr. Chairman, that we need to have, whether it is a reserve fund that is adequately addressed in terms of the dollars or 

whether it is in the regular budget. We know it is not zero. And 

it seems to me the supplemental should be used to make adjustments, not be a part of the regular budgeting process. So I hope 

in some way as a part of the Budget Committee that we will be 

addressing that so that this is a more real and a more honest reflection of the costs. 

We talk a lot about the sacrifice our men and women make in 

the military, and I certainly agree with all that has been said. Deputy Secretary, you said that our men and women have done everything that has been asked of them and more. I would like to speak 

about what we are doing for them. 

My husband and I have had an opportunity to visit the men and 

women at Walter Reed. He is former Air Force and International 

Guard, by the way. I am very proud of that. And I have also had 

the opportunity to have a number of men and women from the 

Guard and Reserve come here to the Hill and visit with me and 

so on, and we have worked with them. 

And I am very concerned right now that for the men and women 

that we have been visiting with that have received medical care for 

injuries while serving in the war on terrorism, that without exception—without exception—the Army has made mistakes in the proper allocation of their pay. And it has been extremely difficult for 

them to resolve these issues, and this is of great concern to me. 

And I am sure it is—hopefully it is with you as well, that we are 

asking them to serve, they are coming back, they have injuries, and 

then we are dealing with bureaucracy and the inability to be able 

to have them receive the pay that they have earned. 

Just this month, the Government Accounting Office released a 

report that I am sure you are aware of that found that the Army 

cannot ‘‘provide reasonable assurance that injured and ill reserve 

component soldiers receive the pay and benefits to which they are 

entitled without interruption.’’

This is just not acceptable, and I would hope that you would view 

it as not acceptable as well, that when we are asking men and 

women to serve, to fight for the freedoms that you have eloquently 

spoken about today, that they are not able to be assured that something as basic as their pay will be taken care of when they are injured in the line of duty. And I would like to know what funds are 

in the budget, this budget. What funds are you allocating to resolve 

these pay issues? And what plans do you have to fix this problem? 

Mr. WOLFOWITZ. Those are very important questions, and I appreciate your asking them, and let me make one aside before I go 

to the heart of it, because Senator Conrad said correctly—and I applaud him—that it is very important for our adversaries to understand that we are united. And I just wanted to add it is also very 

important for our men and women in uniform to understand that. 

I think I continue to be amazed, in many, many visits with our 

wounded troops, at the incredible spirit and morale they have in 

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lenges in life. And a huge part of what keeps them going is the 

knowledge that the country regards them as heroes. 

Now, I am about to talk about material issues, which are very 

important, but that spiritual morale issue is—it is pretty difficult 

to exaggerate how important that is. So I just wanted to mention 

that. 

I share very strongly your concern. I spend a lot of time with 

wounded soldiers, and I hear about some of these problems. And 

I cannot help saying that, you know, they get the absolute best, 

21st century medical care, and then they have to deal with a bureaucracy that is inherited from earlier times. 

Some of it is, I think, bureaucratic rules that probably date back 

to World War II when we had hundreds of thousands of severely 

injured soldiers for whom very little could be done, as opposed to 

now when the number is much smaller and the possibilities of reemployment and rehabilitation are incredible. In fact, on the goodnews side, there is an Air Force lieutenant colonel who has lost his 

leg above the knee, not a combat injury, but he spends a lot of time 

at Walter Reed himself. He is the first pilot in Air Force history 

to be requalified on jets after losing his above the knee. 

There are a lot of miracles even in the bureaucracy of that kind, 

but we need to do a lot better. That is the reason why we recently 

opened something called the Military Severely Injured Joint Support Operation Center. I think we need a shorter name for it, but 

this is a 24/7 family and wounded service member support center 

where people can call in 24 hours a day to get what we hope will 

be the right answers to what the rules permit, and also to alert us, 

if it looks as though the rules are not written the right way. 

Sometimes it is a matter, unfortunately, that they will go to 

someone who misinforms them about what their rights are and 

they don’t know where to go next or they accept that as the right 

answer, and that should not happen. So we want people who are 

absolutely the best trained, who know exactly what is possible, who 

also can alert us if what is possible is not good enough. 

One of the most concerning problems to me right now is the one 

you alluded to, that if someone is medically retired, there is an unfortunate and I think inexcusable gap between the time they go off 

active duty pay and go onto VA benefit pay. And, in fact, I have 

talked to Jim Nicholson personally about the fact that we need to 

get together between our two Departments and find a way so that 

that burden is not borne by the serviceman, that somehow we manage to deal with it between our two Departments. 

I wish I could put a deadline on when we solve it. As far as I 

am concerned, I wish we had solved it last month. But we are putting a lot of energy into it. 

I think the general principle here is that because of the nature 

of modern war, the burdens of war are not distributed evenly at all 

across the population. It is a much smaller number of people that 

go into combat, that bear the costs of combat. I think that puts a 

greater obligation on the rest of us to make sure that those who 

are wounded, the families who survive members who were killed, 

make sure that those people who bear the inordinate burden are 

adequately supported by the rest of us. 

491

I feel very strongly about it. I appreciate your interest. And I am 

quite certain that where money is needed to deal with that, the 

Congress will be supportive. I hope also where new legislation is 

required, I am sure the Congress will be supportive as well. 

I would make one last observation, and that is, we need to be a 

little bit careful I think sometimes about taking a benefit that we 

want to go to those people who have suffered in combat and extending it to the entire population of active and retired military 

personnel. You very quickly sort of price yourself out of the ability 

to do anything. I think the point I just made is that the exceptional 

burdens are borne by relatively few people, and that really should 

make it possible to make the resources that we need to meet those 

needs. 

Chairman GREGG. Thank you, Senator. 

Senator STABENOW. Well, thank you, and if I might just conclude 

and just indicate that my specific question regarding funds allocated to resolve the pay issues I would appreciate a followup on to 

know if there are specific dollars in here, and just say that we have 

got a lot of work to do on this front because we do have men and 

women with tremendous patriotism and love for this country who 

have, in fact, put their lives on the line and are coming back now. 

And when I look at the kinds of requests I have gotten in my office 

on just basic things in terms of pay, it is just not acceptable and 

it needs to be a very high priority. And I appreciate your comments 

about that. But this needs to be a high priority if we expect people 

to believe and trust what we are saying in terms of fulfilling our 

commitments when they are certainly fulfilling theirs. 

Mr. WOLFOWITZ. I agree with you, Senator. I take it very personally. I know General Pace does, too. Do you want to add to this, 

Peter. 

General PACE. I know the light is red, Mr. Chairman. Please forgive me. 

Chairman GREGG. Go ahead, General. 

General PACE. But I would be remiss if I did not add my sincere 

thanks on behalf of all of us who wear the uniform, not only from 

the funding standpoint but the fact that so many members of this 

committee and of Congress go out and visit the troops, that you 

visit the hospitals, that you have them in your offices, that you 

have them in your homes. That sends a huge message to all of us, 

especially those who are overseas serving right now, that this Congress cares. And, Senator, you are right. It is not acceptable that 

any of our service members have pay problems, and we owe them 

better than that, and we will work on that. 

Chairman GREGG. Senator Alexander. 

Senator ALEXANDER. Thank you, Mr. Chairman. 

Thanks to each of you for being here and thank you for your 

service. I would like to get an update about armor on vehicles in 

the combat zone in Iraq. One of our Tennessee guardsman from the 

278th Cavalry Division last December got pretty famous asking the 

question of the Secretary of Defense, and the question went along 

the lines of why was he and his colleagues having to scrounge 

through junkyards—I believe those were roughly the words—in 

order to properly arm their vehicles. 

492

That struck a chord with a lot of people in Tennessee. We prize 

and honor all of our service men and women, but the 278th is our 

largest National Guard unit. There are 3,000 of them. They had 

just arrived in Iraq. There are three deputy sheriffs from my home 

county and the school superintendent from Athens and the mayor 

of Lexington. So we know them all, and they are all in our community, and their lives have been interrupted for 18 months, which 

they are proud to do. 

You have been good about keeping me updated about the 

progress you have been making toward making sure that they have 

armor for those vehicles. So my specific question is this: I have 

been told that by 2005 June, June of this year, just a few months 

away, that all of the vehicles in the combat zone will have Level 

1 or 2 armor. And I wonder if we are still on that track and if you 

could describe for me what that means and tell me what I should 

be saying to families of those 3,000 guardsmen about the level of 

armor on vehicles in the combat zone in Iraq. 

General PACE. Senator, thank you. I can respond to that. And 

you are correct, by the summer of 2005 we will have all our vehicles with the Level 1, Level 2 armor. You have through funding allowed us to ramp up from building, for example, 35 up-armored 

Humvees per month to 450 per month now, going to 550 a month 

in about a month and a half from now. You have given us the 

money we need to give every single soldier, sailor, airman, marine, 

U.S. Government civilian complete SAPI-protected body armor. We 

were able to ramp up the focus on Level 3 armor, which, as you 

know, is armor which is produced here but put on over there, so 

that by the middle of February, February 15th, General Casey, the 

command on the ground over there, was able to announce that no 

vehicles would leave and travel throughout Iraq unless they were 

properly armored. So he had gotten to the point where he could ensure that he could put out that kind of an order. Of the 35,000 

wheeled vehicles that are in Iraq right now, 28,000 are currently 

protected by armor; the other 7,000 are being worked on. 

So the whole program and the billions of dollars that Congress 

has allocated and the focus of effort to include taking sailors who 

are welders on ships and getting them over to Kuwait to help put 

on this armor has had a tremendous impact. 

Senator ALEXANDER. General, that is a very good answer and an 

adequate answer for me. But if I were explaining in plain English 

to families in Tennessee what does Level 1 and Level 2 armor 

mean on a vehicle, what would you suggest I say? How do I explain 

that so they will understand it? 

General PACE. You can tell Mom Pace that her son, Peter, will 

be protected from rifle fire in the vehicle that he is traveling in and 

that some of the explosive devices, he will be protected from that 

as well. 

The difference between Level 1 and Level 2 is only where it is 

put on. Level 1 is made here in the United States, and it is made 

a part of the vehicle when it is being produced. Level 2 is the exact 

same armor shipped to the theater and then put on in-theater. It 

would be like putting a stereo in your car either bought in the factory when it is delivered to you or taking the same stereo and putting it in when you get the car. 

493

Senator ALEXANDER. And no Level 3, which was improvising, 

which was finding scrap metal and using it to make a vehicle that 

was not properly armored better armored. Is that correct? 

General PACE. Level 3 in the way it has been describes makes 

it sounds like the Beverly Hillbillies, which it is not. It was very 

good, protective armor, but, in fact, it was metal that was available 

in-theater that had been in-theater for other reasons and was used 

to properly armor vehicles to the metal protection of rifles. 

What was not part of Level 3 was ballistic glass protection that 

is part of Level 1 and Level 2. That is correct, sir. 

Senator ALEXANDER. Thank you, Mr. Chairman. 

Chairman GREGG. Thank you, Senator. 

Senator Feingold. 

Senator FEINGOLD. Thanks, Mr. Chairman. Mr. Secretary, good 

to see you again. 

There are Wisconsin Guard and Reserve units returning from 

Iraq without any of their equipment, including the Army Reserve 

652nd Engineer Company from Ellsworth, Wisconsin, and the Wisconsin Army National Guard’s 264th Engineer Group out of Chippewa Falls, Wisconsin. There is no way for these and many other 

Guard and Reserve units throughout the country in similar situations to train and maintain their readiness or be ready for state 

missions without their equipment. So this is also going to have a 

corrosive effect on morale and retention if we treat these brave citizen soldiers as second class. 

The supplemental includes $5.4 billion for refurbishing and replacing equipment, but there are estimates out there that it will 

take much more than that. How much of the regular fiscal year 

2006 budget and how much from the fiscal year 2005 supplemental 

is going directly to the National Guard and the Reserve for reset 

costs? And will that cover the need to make sure that readiness is 

maintained? 

Mr. WOLFOWITZ. In the budget, in the supplemental request, we 

include funding for returning Guard and Reserve units to be reset 

to war fighting standard, which I believe would cover the Guard 

units that you are describing, although I would want to check and 

give you an answer for the record to be sure about that. And I 

think—Tina, how much is that sum? 

Ms. JONAS. We have about $3.3 billion in the supplemental for 

reset activities. Also, the modularity piece in the baseline budget 

in the outyears, if the Army continues with their plan, would cover 

some of those units. 

Senator FEINGOLD. I would like to send a letter to you, if I could, 

a question to just kind of nail this down a little more specifically 

so I can give the kind of reassurance that you at least were beginning to give me here that this will be taken care of. 

General PACE. Senator, I may be able to help just a little bit, if 

I may; that is, part of the reason that they are coming home without their equipment is that to save taxpayer dollars, rather than 

have Unit A go over with the same gear that is there, Unit B is 

leaving their equipment behind. When they come back to the 

States, then we have to redistribute. That does not overcome the 

fact that as we started out into this with our Guard and Reserve, 

the plan for the Guard and Reserve had been to go as part of World 

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War III, so to speak, to be available to fight at month six or month 

nine, so the levels to which they had been provided equipment 

were lower than the rest of the Army. 

That clearly has changed in the way we are using our Guard and 

Reserve. They are fabulous soldiers. They are doing a great job. 

And we will get the exact number for you, but I know there is $16 

billion total in the supplemental for procurement and resetting the 

force, and the Army’s intention, I know for a fact, is that as they 

reset the active Army, they will reset the Reserve so that it will 

have 43 active brigades and 34 Guard and Reserve brigades that 

are ready to go to combat tomorrow for the country, sir. 

Senator FEINGOLD. I appreciate it, General. I will follow this 

closely, but I certainly sense your sincere desire to make sure there 

is no gap here. 

The Defense Appropriations Act for Fiscal Year 2005 included a 

sense of the Senate that said that ongoing costs for operations in 

Iraq and Afghanistan should be included in the President’s annual 

budget submission. Section 9012 of that same bill required the 

President to provide Congress by January 1 of this year with a detailed report on estimated costs for ongoing operations and reconstruction costs for Iraq and Afghanistan for fiscal year 2006 

through fiscal year 2011. 

Where is this report, Mr. Secretary? 

Mr. WOLFOWITZ. We are working now with OMB and with the 

NSC to try to find the correct way ahead on that report. It is still 

not possible to accurately estimate the cost for military operations 

in fiscal year 2006, much less over the following 5 years. So there 

is a challenge here. I mean, we can make guesses, but the guesses 

would be really unsubstantiated. 

We are working with NSC and OMB to try to answer that requirement. 

Senator FEINGOLD. When will we get the report? 

Mr. WOLFOWITZ. As soon as we can figure out how to answer it, 

sir. 

Senator FEINGOLD. Estimate, please? 

Mr. WOLFOWITZ. I don’t have one. I am sorry. 

Senator FEINGOLD. Weeks? 

Mr. WOLFOWITZ. I just don’t know. 

Senator FEINGOLD. Years? 

Mr. WOLFOWITZ. Obviously sooner than that. 

Senator FEINGOLD. It is a congressionally mandated report, I 

would note for the record. 

I am also concerned that the reliance on supplemental spending 

bills is forcing the services to raid accounts to cover the incremental costs of ongoing operations and, thus, hurting readiness. 

How much money has been reprogrammed already to cover costs 

in fiscal year 2005? 

Mr. WOLFOWITZ. Tina, do you know? 

Ms. JONAS. Sir, we could certainly provide the exact number of 

the record, but I would say that with our fiscal year 2006 budget, 

our operation and maintenance accounts are up $11 billion over the 

fiscal year 2005 enacted level. The readiness-related amounts are 

up $4 billion. So we understand the concerns of the Congress with 

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respect to readiness and agree that that is an important thing for 

the military. 

Senator FEINGOLD. Thank you, Mr. Chairman. Thank you, Mr. 

Secretary. 

General PACE. If I might add, sir, the bridge $25 billion that you 

made available to us made it possible to really reduce any O&M 

movement into the current year. So that was very, very helpful to 

have that going into this year, sir. 

Chairman GREGG. Thank you. 

Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. I for one want to 

take time right at the start here to compliment our men and 

women of the armed forces. I just think they are doing a tremendous job. I visited with them before they went over to Iraq and Afghanistan, visited them in those countries personally, and I have 

visited with them when they have come back. And I think we can 

be very proud of our young people who have stepped forward to 

meet the causes of freedom. And I realize that it is a stress on their 

families and their spouses as well, but I think we can be particularly proud of the whole unit—the family, the spouses, and the men 

and women who have served in the armed forces. 

I would also say this about this administration: I think you have 

been responsible. I have witnesses in previous conflicts and war 

where we have tried to run the war out of the Pentagon or you try 

and run a war based on politics. And I think this administration 

has tried to be very sensitive to the professional men and women 

in the military and listened to the commanders in the field. And 

I think that that is as responsible as you can be. 

Now, you cannot come up—I can understand why you cannot 

come up with a sound budget, you know, specific figures on a budget. You know, war is unpredictable. I think we all have to recognize 

that. And, you know, there has been some unpredictable things in 

this budget. But the important thing is that we have responded 

when those unpredictable things have occurred, and I think it has 

been through the professional advice of those people that are in the 

field. They have come back with recommendations. It is then 

worked through, and finally we have come up with a solution. 

So I do think that this has been a rather responsible budget in 

many ways. There are some areas obviously where we raise questions. But I don’t think the administration can take all the blame 

because I think in being responsible and consulting with the professionals, we have dealt with four amendments on the floor of the 

Senate, for example, and in the House from the other side that 

have said, well, you are not doing enough, we need more after 9/

11, we need more for our Reserves and National Guard, and we 

need more for our ground troops, we need more for our retirees, we 

need more for education after they graduate, we need more recruits, we need more intelligence, and more and more and more. 

But I think the bottom line is that you have been responsible. 

Now, I have a lot of concern like the chairman does about how 

we define emergency spending. I want to compliment the chairman 

for thinking about how you are going to put in a reserve fund. But 

even with the reserve fund, I don’t know how you meet all the 

unpredictabilities that will happen when you are in conflict. And 

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so my question, as we get to this budget, and particularly when you 

get to the supplemental, how much of this supplemental is a onetime expenditure? I think that is the key question. If it is not a 

one-time expenditure, then perhaps we ought to build this into the 

base so we can project for future expenses. But if it is a one-time 

expenditure, then I don’t think we want to unnecessarily build this 

into the base and obligate ourselves into an expanding base when 

it is a one-time expenditure. I would like to know—and maybe you 

cannot give that to me today, but I would like to know how much 

of this supplemental is a one-time expenditure. 

Mr. WOLFOWITZ. I think, if I understand the way you use the 

word, I think everything that we are putting in the supplemental 

and anticipating next year’s supplemental are one-time expenditures. I know precisely we want to avoid the phenomenon you describe where we artificially inflate the base, and then you spend a 

long time arguing that number down because people say, you are 

decreasing your budget from last year, and we try to say, no, that 

was a one-time expenditure; it needs to come out. I think it is important to identify these expenditures, which does not mean they 

will not be repeated. If we are still—at some point we may still 

have forces—we will certainly have forces in Iraq in fiscal year 

2006, for example. So spending some money this year for those 

forces I would consider a one-time expenditures, but we are going 

to have another one-time expenditure next year. 

It is when we get to the point where there is some stability and 

some predictability to it that then you can build it into your base 

budget. 

Senator ALLARD. Your hope is that what you are asking for in 

the supplemental, you may have to repeat a little bit of those requests in future years but at some point in time that is going to 

phaseout. If it does not phaseout, it is going to be built into the 

base. Have I got that right? 

Mr. WOLFOWITZ. That is right, and we certainly expect at some 

point, and it is an unpredictable point——

Senator ALLARD. I want to move on a little bit here, and I am 

sorry to interrupt you on this, but I also want to followup on some 

of the concerns that were expressed by Senator Bunning from Kentucky. He also alluded to the plant that we have in Colorado, the 

problems, and that has to do with the Department of Defense’s 

chemical weapons demilitarization program. Now the Department 

of Defense has decided to delay construction of disposal sites in 

Pueblo as well as Bluegrass in Kentucky. 

My question is, is the Department considering its decision to suspend all construction activities at the disposal sites in Colorado and 

Kentucky? Do you know that? 

Mr. WOLFOWITZ. We are taking another look at that whole decision to see whether there is maybe a different way, but there is no 

question that the costs, as I said, were going through the roof and 

we need to do something about that. 

Senator ALLARD. I think you need to review costs. But here is 

what has happened. The Army has gone and sat down, at least in 

Colorado, with the leaders of the community and said, here is some 

technology we think is reasonable that can be done, and now all 

of a sudden after working this out you have backed off, or the 

497

Army has backed off. So then this adds to the confusion of the 

project, adds to delays, and part of the delay is that you are asking 

for more studies. We have already done three studies on transportation issues out of there. 

I do not understand why you include part of your restudying 

transportation issues related to that when you have already done 

three studies on that. We have in fact passed legislation that says 

transportation is off the table. The legislation says that if it is 

going to go across State lines that it has to have the agreement of 

the Governor as well as the President—has to go to the Presidential level, and none of that has happened. So as far as I can tell 

it is off the table and yet we are still going ahead and have these 

included in the studies. 

So it seems to me that some of the costs that have gone here is 

because of the faults in the demilitarization program itself and it 

not being focused and moving forward like it should. I would hope 

that you would sit down, because Condoleezza Rice—I asked her 

this same question about how it was going to impact our relationship with other countries when we do not comply with demilitarization agreements. It is a chemical convention agreement treaty—

why we did not comply with that. 

Her response was, I think, very straightforward and unequivocal, 

that such a failure would damage our credibility overseas and 

hinder our efforts to hold other nations accountable when we do 

not meet our deadlines when we have eight sites and we are only 

meeting the deadline on six of them. So I do think that whole program needs to be reviewed. 

I also think that the people of Pueblo and Bluegrass have been 

misled, assuming that you have put everything together and then 

all of a sudden we are back to a study. I think that the whole program, something needs to be done and we need to move forward, 

and what is happening now is we are just having further delays, 

we are going to lose confidence with our allies and our friends overseas because we are not meeting deadlines, and we need to move 

forward in my view. I think some of the costs that we are experiencing is because we have had these delays. Maybe you would like 

to have some response, Doctor, or maybe Ms. Jonas, your staff person, would want to respond to that. 

Mr. WOLFOWITZ. Let me just say I think we do need to take a 

look at it. I think of the parameters that has to be in there though 

is how to contain costs, in addition to all the others. That is what 

led to the current budget proposal. I acknowledge there are some 

issues there that we really do need to look at, and would be happy 

to work with you and with Senator Bunning and other concerned 

members. 

Senator ALLARD. I hope that we can. We have been working with 

those that are underneath you. I hope they have been consulting 

with you. But we do need to get something moving here. I want to 

make that point. 

Thank you, Mr. Chairman. 

Mr. WOLFOWITZ. If I may, Mr. Chairman, I think it is important 

at least to say for the record that the costs we carry for the cost 

of the war to date, for Operation Noble Eagle, which is defense of 

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stan, and Operation Iraqi Freedom, all three put together to date 

is $172 billion. You can get to different numbers depending on 

whether you look at money that is spent or money that has been 

authorized. Of that $172 billion, $110 billion is for Operation Iraqi 

Freedom. 

I think those are, Senator Conrad, different from your numbers 

and I would be happy to talk with you and see whose numbers are 

right, or maybe there is a third set. But I thought it was important 

to put those in the record. 

Chairman GREGG. I think Senator Conrad’s numbers are accurate as a statement of what the supplemental requests have been 

over this period—a percentage of those supplementals went to 

items that are not included in the three wars, that we are pursuing. So that is where the differenence probably occurs. 

Mr. WOLFOWITZ. I think so. 

Chairman GREGG. Senator Ensign. 

Senator ENSIGN. Thank you, Mr. Chairman. 

Mr. Secretary, I would like to address, the recent supplemental 

submitted by the Administration. One of the reasons that some of 

us on this committee have had a problem with the way that this 

supplemental has been put together is because of our experience up 

here on the Hill. My question focuses on how Congress has used 

offsets in the past for supplementals. Sometimes you have offsets 

for regular appropriations bills. There are real offsets and then 

there are phony offsets. 

What I mean by a phony offset is this: DoD puts in a request for 

this year, including money that cannot be spent this year, or 

maybe even for next year. Then somebody on Capitol Hill decides, 

because that money is not going to be spent this year, we will rescind supplemental money and use that as an offset to make it look 

like regular appropriations bills are deficit neutral, when it really 

is not. So Congress can increase overall spending by using phony 

offsets. 

I can understand the 2005 and somewhat the 2006 numbers in 

the supplemental because of what Secretary Rumsfeld explained 

last week to the Armed Services Committee about the budgeting 

process. I understand the difficulty in the budgeting process because of how long it takes to put a budget together, and how long 

it takes to go through the whole process, and that the supplemental is much faster. So I understand that a supplemental request in the short term, 2005 maybe and even 2006 expenditures. 

Which amounts to about $62.5 billion of the total supplemental request. But after that the supplemental has $14 billion in 2007, almost $4 billion in 2008, $1.3 billion and it goes a little bit down each 

year from that. 

I guess the question is, why those are put into a supplemental. 

Supplementals are supposed to be for emergencies. That is why 

they are designated emergency as such. 

Ms. JONAS. Senator, I appreciate your concern with regard to the 

spending. The procurement funds are multi-year funds, but I am 

told that we expect that all the procurement funds would be on 

contract by the end of the fiscal year. The funds for the Iraqi security force, I believe, are multi-year, and that is to allow the military 

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to have some flexibility with their training. So I understand the 

concern there. But what I am told on the procurement funds, about 

$16.1 billion in the supplemental would be able to be on contract 

by the end of the year. 

Senator ENSIGN. But the money is still not spent. It is going to 

be out there. It is not an outlay. 

Mr. WOLFOWITZ. But it is a commitment you have to make in 

this fiscal year. Can we get back to you for the record if there is 

money that is not committed by the end of this fiscal year, which 

sounds like it may be——

Senator ENSIGN. Do you understand the fear that I have? It is 

that the unspent money will later be used by somebody to increase 

the overall budget number, to increase the deficit. They will say, 

‘‘but this money was put out there in the supplemental but now it 

really was not spent this year so we can use that number,’’ because 

even if it might be committed in contracts they will say, ‘‘Congress 

can now use that number since it was not an outlay.’’ And Congress will use that as an offset and we will have to later reappropriate that money. We spent it twice. 

Mr. WOLFOWITZ. I do understand your question. Let us give you 

a detailed answer for the record. The FY 2005 emergency supplement request for contingency operations is specifically for incremental costs above the baseline funding needed for the ongoing 

global war on terrorism. The supplemental request does not in any 

way add to the baseline funding requirement in a future year. Regarding multiyear funding, only items that are executable for obligation in FY 2005 were considered, and those must be able to 

produce deliveries prior to FY 2006 funded deliveries. Assuming 

approval of normal periods of availability for procurement appropriations, normal outlays will occur over the period of deliveries. In 

this respect, the supplemental funding request only supports items 

needed due to the emergency nature of ongoing operations, and 

there is no artificial expansion of a future year funding requirement base. 

Senator ENSIGN. Thank you. 

Thank you, Mr. Chairman. 

Chairman GREGG. Thank you. We appreciate your time, Mr. Secretary. Senator Conrad did have one final question and then we are 

going to let you go. 

Senator CONRAD. This goes to the question that was asked previously about the armoring of vehicles. General Pace, you gave a 

review there. I do not know what it related to; perhaps Humvees, 

other vehicles as well. 

But here is the question that I have. It relates to the medium 

and heavy trucks that are in Iraq. These are the oldest trucks in 

the inventory. We were advised there were 9,000 of the M–939 

class and the M–915 class in January in Iraq but that only 10 of 

them had level two armor. At that point the DoD had not even let 

a contract to design more robust kits, and the best that these 

trucks had were level three armor. I will tell you, my units that 

are in Iraq refer to level three armor as hillbilly armor. This is how 

they describe it in their e-mails to us. 

These older vehicles are concentrated in the Guard and Reserve. 

I have got a lot of my guys who are driving these trucks, and they 

500

are very concerned about the lack of armor. Can you tell me if 

those numbers that I have just used are correct, and if not, how 

they are not correct? We were told in January, 9,000 trucks in the 

theater, in Iraq specifically, and only 10 of them had level two 

armor. 

General PACE. Senator, I will get for you for the record a very 

detailed description of each vehicle, how many, and by when they 

will have what level of armor. For today, if I may, I will tell you 

that as of 15 February no vehicle traveling on the roads in Iraq is 

allowed to be out there without level one, two, or three armor, and 

that the difference between one and two is where the armor was 

put on. And the difference between one, two, and three is that one 

and two have ballistic protection for the windshields themselves. 

Senator CONRAD. But let me just be clear on what you have said 

here now because I hear that differently than what I heard before. 

What I hear you saying now is that as of February 15 no vehicles 

are on the road unless they have got one, two, or three. 

General PACE. That is correct. In answer to the Senators question, by June of this year, June, July of this year, it is projected 

that all vehicles will have one or two. But as of now, all those traveling on the roads have one, two or three. Of the 35,000 vehicles 

that are there, 28,000 have one, two or three, which leaves 7,000 

still to go. Then all those that have level three need to be replaced. 

Senator CONRAD. From what I hear, that would still leave the 

possibility that there are literally thousands of these trucks that do 

not have one or two. 

General PACE. Sir, I will get you the specific answer so we are 

not talking past each other. 

Senator CONRAD. That do not have one or two. I want to be very 

clear now. That there are thousands of these trucks that do not 

have one or two level armor. 

General PACE. I do not know that it is thousands. I do know that 

there are a number that have level three right now, and that by 

this summer all of those are to be replaced. I will get you the specifics. 

Senator CONRAD. If you can get me the disposition of these, because we have got, disproportionally, Guard and Reserve driving 

these trucks. I was told in January there were 9,000 in Iraq and 

only 10 of them had one or two level armor. 

General PACE. I will get you the details, sir. 

Senator CONRAD. Thank you. 

Chairman GREGG. Thank you. We want to thank you very much 

for participating in this hearing and making yourselves available 

to the Budget Committee. We appreciate it. We hope it will be a 

precedent that has been set that will continue. We appreciate your 

excellent presentation today. Thank you for your service to the 

country. 

Mr. WOLFOWITZ. Thank you again and all of your colleagues for 

the support you give to our military. Thank you. 

[The prepared statement of Mr. Wolfowitz follows:]

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Chairman GREGG. Thank you, Mr. Secretary. 

The meeting is adjourned. 

[Whereupon, at 11:47 a.m., the Committee was adjourned.]

Responses to Questions submitted by Senator Domenici to General 

Pace for the Record

Question: Can you discuss the current strategic approach pursued by the Department to address the persistent rocket, artillery and mortar threat that continues to 

kill and injure our troops in Iraq?

Answer: The Chief of Staff of the Army initiated a Countering Rockets, Artillerly 

and Motors (C-RAM) effort in May 2004. The Army is aggressively fielding 2 Intergrated Area Defense Intercept systems to 1 Point Defense, Sensing and Warning is 

based upon successful demonstration late last year. The demonstration system comprised the Ranger’s Lightweight Counter Mortar Radar with the Navy Close In 

Weapons System (CIWS is a 20 mm Phalanx gun system). The DepSecDef requested 

fielding acceleration options. Those options are in development.

Additionally, a Joint Staff directed, Army led Intergrated Air and Missile Defense 

Capabilities Assessment (IAMD CBA) currently underway includes C-RAM capabilities. The functional solutions analysis poortion of the IAMD CBA will examine all 

potential material approaches and provide an evaluation of the operational effectiveness, operational suitability and estimated costs of alternative systems to meet this 

mission capability.

Responses to Questions submitted by Senator Nelson to General 

Pace for the Record

Question: Section 153 of Title 10, US Code requires the Chairman of the Joint 

Chiefs of Staff to submit a ‘‘risk assessment’’ each year. If the Chairman’s assessment in any year is that a risk is ‘‘significant,’’ the Secretary must include a plan 

for mitigating that risk. Why has the Chairman’s risk assessment not cleared the 

Pentagon and arrived on the Hill as required?

Answer: Title 10 requires the Chairman’s annual risk assessment to be submitted 

through the Secretary of Defense. It was approved by Gen Myers on 4 March and 

is currently with OSD for development of mitigation options given the characterization of risk. Title 10 requires that the Secretary forward the Chairman’s risk assessment and the Secretary’s comments/mitigation plan with the Department’s budget 

justification materials, which OSD say will be in late March.

Question: Given the pace and scope of operations around the world; the extension, 

and arguably over-extension of our ground forces as they are currently configured; 

and the strategic uncertainty of conditions in many areas around the world like the 

North and Southwest Pacific, do you think it is strategically prudent to reduce our 

Nation’s aircraft carrier capability at this time?

Answer: Crisis response and deterrence through global presence are the prinicipal 

aspects of the carrier fleet’s contribution to our national defense strategy. Using innovative joint solutions such as global force management, global posture realignment initiatives and use of rotational expeditionary forces and the Navy Fleet Response Plan, risk associated with the reduction of our Nation’s aircraft carrier numbers can be mitigated.

With regard to the North and Southwest Pacific, current global posture realignment 

initiatives are examining ways to increase our ability to project military forces rapidly, at long ranges, by establishing a network of forward operating sites and cooperative security locations.

Determining the approriate size of the carrier force has long been a topic of debate 

in force-structure planning. As the strategic environment changes, DOD will continue to assess the force structure necessary to execute the missions of the National 

Military Strategy.

Question: The Navy has based its willingness to cut a carrier—in order to satisfy 

the Department’s late breaking requirement for a budget reduction—on initial results of experimentation with the ‘‘Fleet Response Plan.’’ I recall that the Air Force 

essentially experimented with the Aerospace Expeditionary Force concept for about 

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two years before deploying it throughout the force. In your judgment, is a single experiment with a new operating approach sufficient to base a reduction of this magnitude in our carrier force?

Answer: The Fleet Response Plan (FRP) was designed and implemented prior to 

the Service determination to reduce the carrier fleet by one. FRP realigns fleet 

maintenance and training cycles to increase the number of months a group is available and ready to deploy in support of global contingencies. FRP, by design, does 

not appreciably increase the Navy’s capability to provide routine forward deployed 

global Carrier Strike Group presence; however, the increased availability provided 

since the implementation of FRP has postured the Navy to rapidly respond to emergent world events with the deployment of up to eight Carrier Strike Groups (CSG). 

Reducing the carrier fleet by one will have a small incremental impact on the 

Navy’s ability to meet Global Naval Force Presence Policy and will slightly reduce 

the overall number of carriers available for contingency operations. However, FRP 

has shown great promise as a more effective way to manage our Naval Forces and 

will contribute to the mitigation of the risk associated with this carrier force reduction.

Question: All Atlantic Fleet nuclear aircraft carriers are currently stationed at one 

port in Norfolk. In your view, what is the strategic risk associated with vulnerable 

concentrartion of valuable ships in a single port? Would it be more prudent to have 

the flexibility to station our nuclear aircraft carriers at other locations on the East 

Coast? How would this impact stationing and construction decisions in the nearterm?

Answer: At a national level, it would be prudent to mitigate strategic risk associated with carrier stationing by having the ability to station carriers in multiple locations. The ongoing BRAC process will look specifically at the risks and costs of the 

current and future carrier basing plans and will develop recommendations on basing 

locations for all of our strategic assets.

Question: At presence there are two nuclear-ready carrier ports on the West Coast, 

but only one on the East Coast. All of our Atlantic Fleet nuclear carriers are 

homeported in one place. How does the strategic situation justify two ports on the 

West Coast and only one on the East Coast?

Answer: At a national level, it would be prudent to mitigate strategic risk associated with carrier stationing by having the ability to station carriers in multiple locations. The ongoing BRAC process will look specifically at the risks and costs of the 

current and future carrier basing plans and will develop recommendations on basing 

locations for all of our strategic assets.

Question: Admiral Clark told the Armed Services Committee recently that the Environmental Impact Statement process and MILCON necessary to make Naval Station Mayport CVN-ready will take up to 6 years. What is your assessment of the 

strategic risk of having only one carrier port on the East Coast through 2011?

Answer: At a national level, it would be prudent to mitigate strategic risk associated with carrier stationing by having the ability to station carriers in multiple locations. The ongoing BRAC process will look specifically at the risks and costs of the 

current and future carrier basing plans and will develop recommendations on basing 

locations for all of our strategic assets.

Question: General Pace, current Defense Department policy offsets the Survivor 

Benefit Plan (SBP) benefits purchased by 100 percent disabled retired Service member by DIC payments also due to the survivors of retirees and Service members 

killed on active duty. My staff and I could find no other purchased benefits program 

that is allowed to refuse to pay its benefits based on the receipt of another benefit. 

From my experience as Florida insurance commissioner I can tell you that this 

would be a breech of contract in the private sector. How do you justify this offset?

Answer: The Survivor Benefits Plan (SBP) is currently the law of the land. This 

is an excellent topic to be discussed with the Congress and with the Executive 

Branch.

Responses to Questions submitted by Senator Feingold to Dr. 

Wolfowitz for the Record

Question: The Defense Department had the unfortunate distinction of, once again, 

doinating the GAO’s list of high-risk areas open to waste, fraud, and mismanagement. Of particular concern to me since coming to the Senate in 1993 are the chronVerDate 0ct 09 2002 10:26 Nov 02, 2005 Jkt 000000 PO 00000 Frm 00518 Fmt 6601 Sfmt 6633 C:\DOCS\21173.TXT TISH PsN: LAF
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ic problems with DOD’s financial management system. The President’s FY06 Budget 

Request still rates the Pentagon’s financial management as poor. We are spending 

half a trillion dollars a year on defense yet the Department of Defense still cannot 

submit auditable financial records. Is it still your goal to obtain an opinion on 

DOD’s consolidated financial statements by FY2007? Is that a realistic goal? What 

are you doing to make sure you meet this goal? What are the top challenges you 

must overcome to meet your goal? If you intend to revise the FY2007 deadline, 

please provide details.

Answer: We have concluded that an unqualified audit opinion (clean audit opinion) 

on the DoD’s consolidated financial statements is not achievable by FY 2007, unless 

we spend an extraordinary amount of resources to achieve it through unsustainable 

methods. Hence, our goal is to create sustainable auditability without incurring extraordinary annual costs. We are making progress toward that goal by aligning our 

business transformation activities, thus creating more transparent material and financial processes in support of warfighter requirements.

However, the Department continues to make progress toward a clean audit opinion through both improved business processes and business systems modernization. 

Our progress includes:

Six unqualified and one qualified audit opinion on the Department’s subordinate 

FY2004 financial statements. 

BMMP is transitioning from an architecture phase to an implementation phase. 

Systems efforts are being prioritized to deliver measurable capabilites that will be 

affirmed by auditable financial statements. 

Instituting stronger program governance over the Business Management Modernization Program (BMMP) through the creation of a Defense Business Systems Management Committee chaired by the Deputy Secretary of Defense. 

Developing a plan to use the Marine Corps as a test case for achieving an unqualified audit opinion for an entire Service. Our focus on the Marine Corps audit, as 

an interim deliverable, is intended to help us better understand how to overcome 

the critical barriers to a clean opinion across the other Services without the duplicative costs that would result from learning those lessons simultaneously. We will use 

the lessons learned from this to build more predictable audit plans and expectations 

for the other Services.

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