[House Hearing, 110 Congress] [From the U.S. Government Publishing Office] FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR 2009 _______________________________________________________________________ HEARINGS BEFORE A SUBCOMMITTEE OF THE COMMITTEE ON APPROPRIATIONS HOUSE OF REPRESENTATIVES ONE HUNDRED TENTH CONGRESS SECOND SESSION ________ SUBCOMMITTEE ON FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS JOSE' E. SERRANO, New York, Chairman CAROLYN C. KILPATRICK, Michigan RALPH REGULA, Ohio C.A. ``DUTCH'' RUPPERSBERGER, Maryland MARK STEVEN KIRK, Illinois DEBBIE WASSERMAN SCHULTZ, Florida RODNEY ALEXANDER, Louisiana PETER J. VISCLOSKY, Indiana VIRGIL H. GOODE, Jr., Virginia ROBERT E. ``BUD'' CRAMER, Jr., Alabama JO BONNER, Alabama MAURICE D. HINCHEY, New York ADAM SCHIFF, California NOTE: Under Committee Rules, Mr. Obey, as Chairman of the Full Committee, and Mr. Lewis, as Ranking Minority Member of the Full Committee, are authorized to sit as Members of all Subcommittees. Dale Oak, Bob Bonner, Karyn Kendall, and Francisco Carrillo, Subcommittee Staff ________ PART 7 Page Department of the Treasury....................................... 1 Office of Management and Budget.................................. 55 Internal Revenue Service......................................... 127 Securities and Exchange Commission............................... 261________ U.S. GOVERNMENT PRINTING OFFICE 42-831 WASHINGTON : 2008 COMMITTEE ON APPROPRIATIONS DAVID R. OBEY, Wisconsin, Chairman JOHN P. MURTHA, Pennsylvania JERRY LEWIS, California NORMAN D. DICKS, Washington C. W. BILL YOUNG, Florida ALAN B. MOLLOHAN, West Virginia RALPH REGULA, Ohio MARCY KAPTUR, Ohio HAROLD ROGERS, Kentucky PETER J. VISCLOSKY, Indiana FRANK R. WOLF, Virginia NITA M. LOWEY, New York JAMES T. WALSH, New York0 JOSE'1 E. SERRANO, New York DAVID L. HOBSON, Ohio ROSA L. DeLAURO, Connecticut JOE KNOLLENBERG, Michigan JAMES P. MORAN, Virginia JACK KINGSTON, Georgia JOHN W. OLVER, Massachusetts RODNEY P. FRELINGHUYSEN, New Jersey ED PASTOR, Arizona TODD TIAHRT, Kansas DAVID E. PRICE, North Carolina ZACH WAMP, Tennessee CHET EDWARDS, Texas TOM LATHAM, Iowa ROBERT E. ``BUD'' CRAMER, Jr., Alabama ROBERT B. ADERHOLT, Alabama PATRICK J. KENNEDY, Rhode Island JO ANN EMERSON, Missouri MAURICE D. HINCHEY, New York KAY GRANGER, Texas LUCILLE ROYBAL-ALLARD, California JOHN E. PETERSON, Pennsylvania SAM FARR, California VIRGIL H. GOODE, Jr., Virginia JESSE L. JACKSON, Jr., Illinois RAY LaHOOD, Illinois CAROLYN C. KILPATRICK, Michigan DAVE WELDON, Florida ALLEN BOYD, Florida MICHAEL K. SIMPSON, Idaho CHAKA FATTAH, Pennsylvania JOHN ABNEY CULBERSON, Texas STEVEN R. ROTHMAN, New Jersey MARK STEVEN KIRK, Illinois SANFORD D. BISHOP, Jr., Georgia ANDER CRENSHAW, Florida MARION BERRY, Arkansas DENNIS R. REHBERG, Montana BARBARA LEE, California JOHN R. CARTER, Texas TOM UDALL, New Mexico RODNEY ALEXANDER, Louisiana ADAM SCHIFF, California KEN CALVERT, California MICHAEL HONDA, California JO BONNER, Alabama BETTY McCOLLUM, Minnesota STEVE ISRAEL, New York TIM RYAN, Ohio C.A. ``DUTCH'' RUPPERSBERGER, Maryland BEN CHANDLER, Kentucky DEBBIE WASSERMAN SCHULTZ, Florida CIRO RODRIGUEZ, Texas Rob Nabors, Clerk and Staff Director (ii) FINANCIAL SERVICES AND GENERAL GOVERNMENT APPROPRIATIONS FOR 2009 ---------- Wednesday, March 5, 2008. DEPARTMENT OF THE TREASURY WITNESS HON. HENRY M. PAULSON, JR., SECRETARY OF THE TREASURY Chairman Serrano's Opening Statement Mr. Serrano. Good morning. The subcommittee will now come to order. Today the subcommittee is pleased to welcome Henry Paulson, Secretary of the Treasury, for his annual appearance before our subcommittee. We all know that the Secretary of the Treasury occupies an important position in the Federal Government, serving as a policy advisor to the President on a broad range of domestic and international economic issues. In addition, the Secretary's responsibilities as Department head cover a range of important functions: administering the U.S. public debt, issuing Federal Government payments, collecting the vast majority of the Federal Government's revenue, working to prevent money laundering and many other important responsibilities. Some examples of the Secretary's recent work include helping to formulate and administer the economic stimulus package and working to counter the rise of foreclosures associated with the subprime mortgages. I look forward to discussing these issues today. The issue of subprime mortgages, which this subcommittee addressed at a hearing last week, is a huge concern not only in my particular district, but throughout the country. While subprime loans have in many cases allowed low- to moderate- income families to experience home ownership for the first time, it is also apparent that in a great many cases, borrowers were not fully informed about the terms of the loans. All consumers are at risk of being victimized by financial predators. However, it is often our most vulnerable populations who bear the brunt of these crimes. Each year, countless working-class parents who are struggling to achieve the American dream tragically have their hopes of upward mobility crushed by the practices of dishonest businesses. While their plight often goes unrecognized, the enduring housing crisis has opened the eyes of many Americans to their struggles and made us all aware of the devastating effects such exploitation can have on the strength of our economy. Hundreds of thousands of subprime loans have already reset to much higher interest rates, and approximately 2 million subprime loans will reset over the next 2 years. Foreclosures and late payments rose in January to the highest level on record and the medium price of a single family home fell in 2007 for the first time in at least 4 decades. The rise in foreclosures has had an impact not just on families who have lost their homes. Whole neighborhoods across the country have seen declines in property values and tax bases as a result of being near foreclosed homes. In New York City, my city, as I noted last week, 400,000 homes are experiencing or will experience devaluation as a result of being located near foreclosed homes. In addition, minority communities have been and will continue to be the hardest hit by the foreclosure crisis, since these communities receive a disproportionate share of subprime loans. In 2006, 52 percent of the home loans that went to African American families and 41 percent of the home loans that went to Latino families were subprime loans. As I expressed also last week, I am deeply concerned that many borrowers in these communities were steered specifically towards subprime loans even though the borrowers in many cases were fully qualified to receive conventional loans. The Treasury Department has begun to address the issue of foreclosures, most notably in the Hope Now Initiative. Under this voluntary initiative, participating mortgage loan companies are agreeing to institute a 5-year delay in interest rate resets for certain families faced with the prospect of foreclosure. While I truly appreciate the efforts, Mr. Secretary, that you and others in the Department have put into this initiative, I still have significant concerns, as I have pointed out before. Specifically I am concerned that, one, the proposal is still a voluntary initiative and, two, a great many borrowers who are facing foreclosure are not eligible. While any progress in preventing foreclosures is to be welcomed, I have concerns about just how many people will be helped compared to the number of families who will face the loss of their homes. Indeed, the Secretary himself has stated recently that we have not yet seen the worst of the foreclosure crisis. I hope that we can continue to work together to explore ways to minimize the number of foreclosures. We thank you, Mr. Secretary, for being here today. We assure you that this committee stands ready to support you in all the work that you do and we know that we probably will take a little more time than usual at this hearing with the issue of the mortgage issue, but it is the number one situation in this country which is really concerning and scaring a lot of folks very seriously. Mr. Serrano. So we welcome you, and I also welcome my partner and my friend, Congressman Regula. From Ohio, right? Mr. Regula. From Ohio. A rather significant State today. Mr. Serrano. Especially last night, yes. Mr. Regula. Even more so than Texas, which is not easy. Mr. Serrano. At least you had just one election. They had an election and a caucus. Mr. Regula. Yes. It takes them two times to do as much as we do in one. Mr. Serrano. Be nice to the Ranking Member. Mr. Regula's Opening Statement Mr. Regula. Well, Mr. Chairman, you have done an excellent job of outlining the challenges that confront the Secretary and I want to say, Mr. Secretary, that as a citizen of the United States, I appreciate the fact that you are willing to come to this city and accept the challenge of leading the Treasury Department. It is an extremely important responsibility in terms of the economic development of the country. I think sometimes we don't fully understand the role of Treasury. But when you look back in history, it was Alexander Hamilton who pushed the development of the Treasury Department. It is so vital to a nation's success to have a good financial system. And you are the leader of that and we thank you for taking on that responsibility. I look forward to your testimony. As the Chairman has said, we want to help in any way possible. You have some requested funding increase because of the IRS. You have a multiplicity of responsibilities: coinage, managing the Federal debt, which is a challenge. We appreciate what you have done by way of leadership in these responsibilities. So we welcome you here this morning. Mr. Serrano. Yes. And before we hear your testimony, Mr. Secretary, once again I want to thank you very much on your work on the stimulus package. I particularly want to thank you on your work to include the territories in the stimulus package, which we thought was something that was great. And last but not least, we thank you for the fact that you helped us so much in getting five more quarters, starting with the District of Columbia, which will be added to the program. Mr. Secretary, please. Secretary Paulson's Testimony Secretary Paulson. Is this on now? Okay. First of all, thank you for your gracious comments and thank you for all your leadership on the stimulus, and particularly as it relates to Puerto Rico and the territories where you were a real leader, and they should be very grateful. Now, let me say to you and to Congressman Regula and members of the committee, I very much appreciate the opportunity to discuss the Treasury Department's proposed 2009 budget. Our budget request reflects the Department's continued commitment to promoting a healthy U.S. economy, fiscal discipline and national security. The Department has broad responsibility in Federal cash management, tax administration, and plays an integral role in combating terrorist financing and advocating the integrity of the U.S. and global financial systems. Our spending priorities for the 2009 fiscal year fall into six main categories. I will briefly describe the priorities and then will have plenty of time for your questions. Treasury has an important role to play as steward of the U.S. economy, and our office provides technical analysis, economic forecasting and policy guidance on issues ranging from Federal financing to domestic and global financing systems. Those functions are especially critical now as the U.S. economy, through a combination of a significant housing correction, high energy prices, and capital market turmoil has slowed appreciably. Our long-term economic fundamentals are solid and I believe our economy will continue to grow this year, although not nearly as rapidly as in recent years. In response to economic signals early this year, the administration and Congress worked together to quickly pass on a bipartisan basis the Economic Stimulus Act of 2008, and I would like to thank this subcommittee for approving funds for the IRS and FMS to administer the stimulus check rebate program under that act, thank you. As you know, the stimulus payments to households and incentives to businesses in the act together are estimated to lead to the creation of half a million jobs by year end. This will provide timely and effective support for families and the economy, and it wouldn't be possible without your leadership. Treasury's Office of Terrorism and Financial Intelligence, TFI, uses financial intelligence, sanctions and regulatory authority to track and combat threats to our national security and safeguard the U.S. Government financial system from abuse by terrorists, proliferators of weapons of mass destruction, and other illicit actors. To continue to build on our efforts to combat these threats, we are requesting an $11 million increase for TFI, including $5\1/2\ million for the Financial Crimes Enforcement Network to ensure effective management of the Bank Secrecy Act. The budget request emphasizes infrastructure and technology investments to modernize business processes and improve efficiency throughout the Treasury Department. We will continue to make information technology management a priority and have taken several significant steps to strengthen our systems and oversight. Treasury is committed to managing the Nation's finances effectively, ensuring the most efficient use of taxpayer dollars in collecting the revenue due to the Federal Government. The Internal Revenue Service, of course, plays an integral role in this. The budget requests a 4.3 percent increase in IRS funding to expand IRS enforcement activities, improve compliance, enforce the tax gap, and continue improvements in taxpayer service. In addition, we are asking your colleagues on the State Foreign Operations Subcommittee to support funding for the multilateral development banks, noticeably new replenishment for the World Bank's International Development Association, IDA, and African Development Fund and a $400 million request for the first installment of a $2 billion clean technology fund that, with additional funding from other donors around the world, will help to finance clean energy products in the developing world and make strides towards addressing a global climate change. Overall, the budget request reflects a prudent and forward- leaning approach to fulfilling the Treasury Department's core responsibilities to support our economy, managing the government's finances and ensuring the financial system's security. I thank you for your past support and consideration of our work and look forward to working with you during your deliberations. Thank you and I welcome your questions. [The information follows:]
Mr. Serrano. Thank you, Mr. Secretary. STIMULUS CHECKS AND THE TERRITORIES I want to ask you first a question on the issue of the territories because as you well said, we worked long hours, the leadership of both parties and your office and my office, to make sure that territories were included. As you know, there is one difference. In the 50 States, checks will go directly to individuals. In the territories, a dollar amount is going to go to the central government, the territorial government, in the case of Puerto Rico the commonwealth government, which then will distribute dollars based on their tax rolls to the folks who will qualify, which is all the folks, a lot of the folks in the territories. The concern, the fear by some folks as expressed to me and expressed in the press is that the local government in the territories, because the money is coming in a lump sum, could either use the money to sit there for a while and look like they are balancing their local budgets and/or would take local tax liabilities. Let's say Mr. Rodriguez in San Juan owes $300 to the local tax department. From the $600 that he was supposed to get, he will only get $300 because $300 will be taken out for that. Two problems with that. First of all, that is not really the intent. The intent was to get dollars into people's pockets so they could spend it and stimulate the economy. And secondly, unlike if you do it here, where you take from the stimulus check, from the rebate check to pay for a tax liability, over there you would be taking Federal dollars to pay for a State debt, if you will, or a debt to the State that hasn't been approved by Congress. So what are the negotiations going like to make sure that the intent of this committee and this Congress for those dollars to go directly do take place? Secretary Paulson. Mr. Chairman, first of all, I appreciate your strong interest and your familiarity with the details and your concern here. I had a briefing on this earlier this week as I am getting continual briefings on the implementation of the stimulus package. And you are right to indicate that there is a significant difference, that we are working with the local authorities and through their tax system. And we are in the middle of these negotiations right now and there are a lot of technical issues and difficult issues we are working through. I am optimistic we are going to work through them. And I guess what I would say to you, you flagged an important issue and one we are sensitive to. So we are just going to keep working on it and we will work with you and your staff on this, and come out with the best outcome possible. Mr. Serrano. I appreciate that. And let me just say on the record that it was our intent when we put this together in a bipartisan fashion that the dollars go directly to the folks and not be used for any local options or needs. Lastly, as you know, just for the record, some folks commented about dollars going to the territories and said why would that money be going--some folks said overseas. We remind everybody that those folks would take that money and go spend it, and they would spend it in places called Kmart, Wal-Mart, J.C. Penney, Costco and Sam's and other places. In other words, it is the same economy, it is the same retailers who operate in the territories that operate in the 50 States. Secretary Paulson. Thank you for continually reminding us of that because, again, the people in the territories owe a debt of gratitude to you. Mr. Serrano. Thank you. SUBPRIME LOANS Mr. Secretary, one of the organizations that testified before the subcommittee last week, the Center for Responsible Lending, has argued that the subprime situation escalated because Wall Street, as a purchaser of subprime loans on the secondary market, encouraged subprime lenders to abandon reasonable, qualifying standards and ignore whether their customers could actually afford the loan. In addition, the Federal Reserve Chairman was quoted last August as saying that the failure of investors to provide adequate oversight of originations and to ensure that originators' incentives were properly aligned was a major cause of the problems that we see today in the subprime mortgage market. Mr. Secretary, do you agree with these comments that are being made and how should this particular problem be addressed? Secretary Paulson. Yes. Again, thank you for that question because it is very timely. And as I have thought about this problem, I see two major focuses. The first was the one you mentioned in your initial remarks which is, let us figure out how to get help to the people who need it right now and get through this problem with as little individual stress and stress to the overall economy as possible. In other words, so that is--that is number one. And then, second, is what is the right policy response to this? How do we respond to minimize the likelihood that something like this will happen again? And part of this is law enforcement and that doesn't fall under my responsibility. But again, we are seeing aggressive law enforcement activities at the Federal and the State level to go after people who committed crimes. And then there is the question of the right policy response. And there I am really working on a daily basis on helping to formulate the policy response for the President's Working Group on Financial Markets. I chair that group. It has the chairman of the Fed, the chairman of the SEC, CFTC, and other regulators. There are efforts going on globally. And here, when we come up with this response, we are going to be looking at the mortgage origination process, the writing issues and issues surrounding the writing agency, the issues you mentioned on securitization and all of those issues, disclosure, valuation issues, so there are a good number of ones. And then, separately, Treasury has been working now for almost a year on a regulatory blueprint, because we have a good regulatory system in the U.S. But it is not perfect and it is a patchwork quilt that has developed over many years, and it can be improved upon, and there are some gaping holes in it. So you are right and both of the issues you have raised are the right ones: How do we mitigate the harm and then how do we reduce the likelihood we will have this problem again? SPECULATORS Mr. Serrano. Something that I brought up last week and maybe you would like to comment on it. And very few times do we have an opportunity to look to both sides of a committee room and say we are all interested in making sure that this crisis doesn't get any deeper and that we help Americans keep their homes. But I suspect that we are talking about two sets of folks here, the vast majority, people who bought a house and now find themselves in a very difficult situation. But then there is the possibility that some were speculating on a very good market opportunity, and others who bought a second home perhaps that they knew they couldn't fully afford. In preparing a response, how do we protect those that we need to and not necessarily bail out folks we don't need to bail out? Secretary Paulson. Again, Mr. Chairman, you and I are thinking about this very similarly. First of all, let's talk about the people we really need to help, because you rightfully singled out subprime mortgages where there is going to be a reset. There have been resets and there is a wave of them coming. And if we look at foreclosures in the third quarter, there are 55 million mortgages held in the U.S.; 93 percent of those, 51 million, are making their payments every month on time. Then when you look at that pool, 13 percent are subprime. That was 40 percent of the foreclosures in the third quarter. Then if you look at the adjustable rate mortgages those where there was a product problem, you had 6\1/2\ percent of the mortgages and 40 percent of those that entered the foreclosure process. So we have a huge effort in getting to those people and coming up with programs to deal with the mortgage reset and to deal with the issues that they are going to face. Then as you have said, I have seen these news reports about Moody's put out numbers, 8.8 million mortgages are under water that have zero to negative equity. Well, many of those are people who can afford their mortgage payment. And a good number of those are ones that put no money down on a home, speculated on a housing market and the idea that other taxpayers of the government should pay for their losses. If they can make their mortgage payments, my view is they should honor their mortgage payment. If they can not, they are speculators and they shouldn't be the focus of what we are doing and we should be concentrating our efforts on those who want to stay in their house, willing to talk to someone about it, and have a real problem, either an income problem or a product problem. We try to get at the income problem with the stimulus program. And the product problem, we are working on that very hard with the Hope Now Alliance. And there is always more that can be done. Mr. Serrano. Well, we thank you for your response and you are right, we are on the same track. On that, we don't bail people out who make bad investments. In other areas of the economy, we have to be careful that we balance that properly. Secretary Paulson. Yeah. Mr. Serrano. I will now recognize Mr. Regula. I remind Members that I will alternate, obviously, between two sides based on what time you showed up, you came to the hearing. And once Mr. Regula is finished, this gavel is pretty strict on the 5-minute rule. Mr. Regula. Mr. Regula. Thank you, Mr. Chairman. SOVEREIGN WEALTH FUNDS Mr. Secretary, I would like to discuss the role of sovereign wealth funds in the United States financial markets. Do you think that the prevalence of these funds will change U.S. equity markets in the long term? Some commentators are saying that governments in the Middle East and Asia are now the largest net investors in the U.S. equity and bond market. Is this true and should we be concerned? We go back to the Dubai thing which got everybody alarmed some years ago. And do you think that sovereign wealth funds could come to substitute for central banks? Secretary Paulson. First of all, Congressman, thank you for the question because this is very topical now, and let me also say that we benefit and have for a long time in this country greatly from foreign investment. The greatest compliment another government can pay to the U.S. economy is to make a direct investment. Foreign governments, a wide variety of them invest in our Treasury securities. And as you have also said, there are sovereign wealth funds from around the world, including the Middle East. And they have been around the world for a long time. Now, I would say that the absolute size of sovereign wealth funds has gone up dramatically. But as a percentage of global wealth, it hasn't really increased that dramatically. The projections are--and I am always a bit skeptical of projections because they always assume that a trend is just going to continue ad infinitum. But again, I think we need to assume that they are going to be bigger and more important. And the way we think about these investors at Treasury is, first of all, it is important that no one would question their investment if there was a belief and an understanding and some assurance that their investments were going to be driven by commercial or economic means by those objectives, as opposed to strategic objectives, political objectives, whatever. And as far as we know, the vast majority of these investments, and maybe all, are driven by economic objectives. But what our role at Treasury has been is to say we welcome the investment, but then to have an active dialogue at Treasury, an active dialogue with a good number of these sovereign wealth funds. And we are encouraging them to develop a code of best practices as it relates to governance, as it relates to transparency, to work with the IMF and others, and to be more clear and more transparent about what their objectives are, so those countries that will be the recipients of those investments will be more comfortable. Then we are also working with OECD countries, the developing countries that will be recipients of so many of these investments, to again come up with some practices so they won't use sovereign wealth funds as an excuse to be protectionists and to try to screen out investment. SANCTIONS AGAINST IRAN Mr. Regula. As a follow-up to that, is the ability of the Treasury to freeze funds--and I think in particular I read somewhere that if we were to freeze economic activity of the Government of Iran, that this would be some measure of leverage in getting favorable foreign policy initiatives with them. Is that ability an important element in our foreign policy as a Nation? Secretary Paulson. Yes, Congressman. What you are referring to is the fact that now the responsibility of the Treasury Secretary is not just the safety and soundness of the financial system, it is the safety, soundness and security of the financial system. And Treasury is on the cutting edge of looking at financial abuse anywhere in the financial system. And one of the countries that we are monitoring and taking action against in the financial system is Iran, because they use Iranian banks, state-owned banks to engage in their weapons proliferation and acquisition of missile systems. They are continuing to enrich nuclear fuel. We see all kinds of deceptive practices by Iranian banks. So we have been quite aggressive in terms of singling out different Iranian banks for sanctions on the part of the U.S. Government and encouraging organizations like the U.N. The U.N. just took action where a very recent resolution called upon the world to carefully scrutinize Iranian banks, be very careful of their dealings with them, and singled out a couple of banks specifically. So again this is a very important role of Treasury. THE TREASURY ANNEX Mr. Regula. Last question. The Treasury Annex was constructed in 1918 and 1919 and I understand it is in need of some modernization. The fiscal year 2009 budget requests $11.8 million for repair and renovations of the Treasury Annex. I assume this will be a multiyear project, most things in this town are, and require additional funds in future years. Would you tell the Committee why the renovation is needed and do you have any idea how long this will take? Secretary Paulson. Well, I would say if you walk through the building, you would recognize it is more than a renovation; that these are repairs and they are critical repairs to the infrastructure and all of the basic infrastructure in the building. It goes way beyond renovation. And this part of the building houses 320 people. And by coincidence, you know, you just asked about the Office of Terrorism and Financial Intelligence at Treasury. Those people are housed there. So it is a very critical, and as you said, that our budget request is $11\1/2\ million and this will go on, obviously, for a number of years. Thank you. Mr. Regula. Thank you, Mr. Chairman. Mr. Serrano. Thank you, Mr. Regula. Mr. Secretary, when Mr. Hinchey and I were first sworn into the New York State Assembly in 1975, we were immediately hit with the possibility of New York City going bankrupt, then New York State going bankrupt, then the infamous Financial Control Board, then the running out of the bond market. So we quickly learned about some of the work you do. Not at your level, but we were quickly indoctrinated. Mr. Hinchey, what an introduction. Mr. Hinchey. Yeah. It is quite an introduction. Thank you very much, Mr. Chairman, for reminding us of that. That was quite an event. RECESSION Mr. Secretary, thank you very much for joining us and I very much appreciate your being here. As you mentioned in your testimony, the Treasury has a very important role to play as a steward of the United States economy, and I appreciate the work that you do in that regard. Last week, President Bush said that the economy was not in recession. But all the indicators are that we are in recession. I believe fully that we are in recession. It is only a matter of how deep this recession is going to be and how long it is going to last. If you look at all the indicators, you see that I think very, very clearly. The value of the dollar, for example, is now at a very low rate compared to the rate of the euro and it is falling with regard to virtually every other essential currency around the world, including the yen and others. The price of oil has now more than doubled, in fact much more than doubled. But the price at the pump has more than doubled. The price of food has gone up dramatically. The cost of living for the American people is now at a higher and more difficult rate than it has been in a long, long time. Some people say not since 1929. The disparity of income, the concentration of wealth in the hands of the wealthiest 1 percent of Americans, is now at the highest rate since 1929. In January, we saw an increase of more than 1 million Americans who are without work for a lengthy work period, and a whole host of other issues that are facing the American families across the country. We have now essentially doubled the nonmortgage debt. It has gone from $1\1/4\ trillion to up above $2\1/2\ trillion. The credit card debt in November rose at an annual rate of 8.5 percent--rather in October, at an annual rate of 8.5 percent. And then one month later it was up to 11.3 percent. Americans are now paying double the price at the pump that they paid. U.S. manufacturing has shrunk at its fastest rate in almost 5 years while construction spending is down below where it was in 1994. We have lost now over the course of the last 6 years about 1.3 million manufacturing jobs. You mentioned the proliferation of weapons of mass destruction in your testimony. I think that these are the examples of the proliferation of weapons of mass destruction against the economy. So although we have passed the stimulus package, and I think it is a good stimulus package, it is going to be marginally effective only for a short period of time. There are so many other things that we should be doing. We should be reinvesting in our country, reinvesting in the infrastructure, putting more money into health care, for example, opposing what the President did in vetoing that health care program for children. What are we going to do to eliminate the proliferation of these weapons of mass destruction against our economy? For corporations, and even in individuals, the bankruptcy rate has gone up to record levels. You had another hedge fund this morning, a big $1 billion hedge fund just go into bankruptcy. What are we going to do, Mr. Secretary, to deal with this dire situation that we are confronting? Because if we don't deal with it effectively, this recession is going to get worse and last longer. Secretary Paulson. Congressman, I am very, very focused on the economy. Let me begin by saying to you that we had an economy that has grown for 6 years. I have said that I believe it is going to continue to grow this year. Okay? But whether I am right or whether you are right about whether it is going to grow this year, we recognize that the risks are to the downside. And that is why we moved as quickly as we did, with the help of Congress, to put a stimulus package in place. And that is why I get a briefing every day from the IRS or someone at Treasury in terms of what we are doing to get those checks out quickly and get them out in early May. Now, in terms of the employment situation, I would just remind you that there are some positives here--unemployment, the last number was 4.9 percent. By any historical standards--I will just remind you that in 1929 it was 25 percent or whatever. So we have an economy that has grown for a long time. The underlying structure is very healthy. The long-term fundamentals of our economy are healthy. We are facing the head winds that you cited. We are facing high oil prices. We have got this housing downturn. And we have the capital markets turmoil. And I think we are working our way through that with regard to the capital markets and what is going on with our major institutions. I believe all of our major institutions are fundamentally healthy. But, again, whether it is the GSEs who are going to need to continue to play their countercyclical role or we need GSE reform and need them to raise capital, I am urging all financial institutions that think they are going to need capital, to raise capital so they can keep lending and playing an active role in the U.S. economy. Mr. Hinchey. I appreciate what you are saying and I respect everything that you just said. But if I may just take another second, Mr. Chairman. The things that you mentioned are very vague. It is true that the economy has grown to some extent over the course of the last several years, but the number of jobs increase have been averaging about 95,000 when the normal necessary increase in jobs is 150,000 a year. Now we have just seen a reduction of 17,000. In other words, we haven't increased jobs, we have lost 17,000 in the last month. So the consequences are very dire for working people, working families, cost of living going up, the value of their income--now the average value of the American family's income has dropped by almost $1,000. They are not able to deal with the situation. That is why their debt has gone up so much. Particularly credit card debt. People are borrowing 10 percent more than they are taking in every day. So I would just ask deeply if you as a Secretary of the Treasury would consult with this administration more closely and help us in the Congress get legislation signed by the President that is going to effectively stimulate this economy and get people back on the right economic track, because these are the proliferation of economic weapons of mass destruction that we are confronting. Mr. Serrano. Mr. Kirk. NEGATIVE EQUITY Mr. Kirk. Thank you, Mr. Chairman. And, Mr. Secretary, when you came out of Barrington and accepted this job, I thought maybe the Secretary of Defense seat was the hot seat in the Cabinet, but I now think you are it as far as big jobs. I just would note Chairman Bernanke yesterday before the Independent Banker's Association talked about the negative equity position of many mortgage holders, and I think the quote was principal reductions would be a more effective means, he felt of preventing widespread foreclosures. The back of the envelope numbers I have is the value of homes in America, 20 trillion, value of mortgages in America, 10. What we thought was subprime under stress was 1 trillion, but today's ``Wall Street Journal'' has that $2.6 trillion number, meaning the problem would be 2\1/2\ times worse than estimates in December. In America we have about 650,000 foreclosures a year in a good year. Now I think at the current rate we are at around 1.2 million per year. And so I don't know if you ever worked with Alex Pollack, the former president of the Chicago Home Loan Bank Board before. But at AEI, he is talking about restarting the Homeowners Loan Corporation, which is a different concept than Chairman Frank's concept of boosting up the FHA, because the hulk, by definition, is a 3-year institution only and then it gets out; whereas a permanent expansion of the bureaucracy I think might be--so I hope you would be looking--I know your team is working with Alex and talking to him and---- Secretary Paulson. Well, I would say we--just to be very straightforward, Congressman, we are looking at a lot of ideas. I don't think that is a good idea. I think that idea does a lot more harm than good because, you know, something like that was done at the time of the Depression. Then foreclosures were 50 percent. Today they are 2 percent. Unemployment was 25 percent. Today it is at 4.9 percent. We now have the GSEs, Fannie and Freddie. We have the FHA. We have the Federal Home Loan Banks. And so we have--and even when you look at these--and I do agree that foreclosures are very expensive for everyone. And one of the things that--one of the tools that banks have when looking to work with homeowners that are facing difficulty making a mortgage payment is in addition to modifying other terms, another thing to be, you know, considered is reducing the principal on the mortgage. But again, as I look at this, and I very much agree with what Chairman Serrano said, there are a fair number of people in this country, I mean even last year 30 percent of those who bought homes put no money down. And I think investors are going to be demanding in lenders' different practices in tightening up their standards. But I really don't think if somebody can afford to make a mortgage payment on their own and they choose not to--and I think the vast majority will, because I think the vast majority will say, ``I may have negative equity in my home, but I put my roots down here, I am going to continue to live here.'' But if they say, ``I am just going to walk away from it and not honor my obligations unless somebody else pays for my losses,'' I certainly don't think other taxpayers should pay for their losses. So, again, we are really focused on this. We have a program to deal with it--which some people have criticized and said it is not perfect. And it isn't perfect. But it is a tangible idea that has been translated into action. There have been a million people since inception that have received a workout or a modification. So we are going to keep driving that. We are going to keep pushing for GSE reform so that the GSEs can get out there and raise the capital they need to play a countercyclical role. We need FHA modernization. We need the tax-exempt financing---- Mr. Kirk. Let me just hope that if it gets worse, you are still open-minded. WORLD BANK FUNDING FOR IRAN I want to raise one other issue which is World Bank funding for Iran. You have a request for $1.2 billion to the Appropriations Committee. World Bank funding for Iran is totaling about 1.3 billion. You said that the IRGC is so deeply entrenched in Iran's economy in commercial enterprises, that it is increasingly likely that if you are doing business with Iran, you are doing business with the Iranian Revolutionary Guard Corps. And the Treasury did designate the largest foreign bank of Iran, Bank Melli, as a terrorist financing institution. Problem: That was the conduit that the World Bank was using to provide U.S. taxpayer dollars to Iran through the World Bank. And so they then had to find a new financial intermediary--I am not exactly sure that the President of the United States knows that three blocks from the White House an institution is providing funding directly to the Government of Iran. But if that policy is maintained, as it appears it has, my office asked the U.S. executive director, Who is the new financial intermediary that the World Bank is paying to give money to the Government of Iran? And they said, We don't know and you don't have a right to that information. And I would hope that you would be able to tell us who that financial intermediary is. Secondly, yesterday, the world--sorry--the U.N. passed a new sanctions resolution in section 10 calls upon States to exercise vigilance over the activities of financial institutions and their territories with all banks domiciled in Iran. So in conjunction with section 10 of the U.N. resolution which just passed unanimously in the Security Council, we ought to know who is the intermediary that U.S. taxpayer dollars are flowing through to Iran. And I would just ask you if you--it didn't make a lot of sense to me that the World Bank is funding the Iranian Government. But if that is the administration's policy, then who is the intermediary that we are using? You just I think received a letter from half of the Senate calling for us to sanction the Central Bank of Iran. And so if we follow that policy, the question further becomes: What financial institution is the World Bank using to pay the Iranian Finance Ministry? Secretary Paulson. Congressman, let me first of all address your concerns, and I appreciate them because I think we at the Treasury have been as aggressive as anyone could be in terms of going---- Mr. Kirk. And Stuart Levey did an outstanding job. Secretary Paulson. In terms of the central bank, I have cited them myself on remarks, and what we are doing is very contact based. Now, in terms of---- Mr. Serrano. Secretary, is your mike off? Secretary Paulson. Is it? Mr. Serrano. Now it is on. Secretary Paulson. Now in terms---- Mr. Serrano. I can hear you but the camera wanted---- Secretary Paulson. In terms of the World Bank, again these votes predated my arrival at Treasury. But I understand the Treasury voted against every one of these--the U.S. Government voted against every one of these loans and these guarantees. So we clearly voted against them. There haven't been any new programs that have been put in place since I have been down here. I know this is something that Bob Zoellick is very much focused on and he has got his own governance and his own rules to deal with. I do believe actions like those that the U.N. took, in terms of that sanction, are only helpful to him and others as we carry this on, and I appreciate you being the strong advocate you are for being tough there. Mr. Kirk. I have to support the appropriations request. I just hope with regard to Iran, we know who we are dealing with. Thank you. Mr. Serrano. Thank you. Mr. Schiff. Mr. Schiff. Thank you, Mr. Chairman. IRAN'S CENTRAL BANK I want to follow up on the Iran situation because while we have taken action to deal with some of these private banks in Iran, it is now very clear, I think, that the central bank has become the new conduit for some of these private banks to funnel money through and evade the sanctions. The Governor of the Bank Markazi, the central bank, Tahmaseb Mazaheri, admitted on February 5th that the central bank, quote, assists Iranian private and state-owned banks to do their commitments regardless of the pressure on them. And I think he is referring to the sanctions regime. So here the central bank pretty much acknowledges that they have stepped in to help these private banks that we have been trying to shut down in funneling money to Hezbollah and other terrorist activities. As Mr. Kirk mentioned, Mr. Levey is doing a good job, identified banks like Bank Saderat that facilitated hundreds of millions of dollars going to Hezbollah. But now the central bank is accomplishing the same function. And I guess very similar to the sentiment expressed in the Senate letter, what are we doing to shut down the central bank's ability to launder this money? And a further question is, in light of the U.N. sanctions, what efforts are we making to deal with banks in countries like Austria that have picked up some of the slack where other European banks have stopped doing business with Iran in ways that facilitate their terrorist financing. It appears Austrian banks have stepped into the lurch. What kind of communications have we had with Austria to try to curb that practice? So those are two questions I would like to ask you vis-a- vis Iran, and then I have one domestic question. Secretary Paulson. Okay. In terms of Iran, you are focused on the right issue, that almost a year ago, I singled out a number of remarks, Markazi for the work they have been doing with some of the other state-owned banks. We are focused on the issue. As we are working, we work to bring others along with us, because one of the things we have learned that when we have these conduct-based and we very much are a Treasury, we look very carefully at the law. We look at conduct. We look at having very good intelligence and we look at bringing others along with us, because I think these make the actions we take much more effective. But I hear you, I appreciate the letter. This is an issue and an issue we are focused on. Now, in terms of banks around the world, one of the things that I did upon arrival at Treasury is work very closely with Stuart Levey and others to go not just to the governments, but to go directly to the heads of many banks around the world. Because I knew that if they saw what was going on, they would be even more proactive than their governments. They weren't going to want to be unwittingly abusing the system, helping to finance terrorists, helping to finance weapons acquisitions and so on. And we have done that pretty successfully. So as we have done that, what we found is that the Iranians have been forced to open up new relationships with new banks in other parts of the world. And one of the things we do is we just--Stuart Levey just got back from a trip. So we are continuing to work and work in every country where there are banks that have business. But remember, it isn't--all business with Iran is not illegal under these sanctions. It is business with the sanctioned entities. So we are pointing out the risks. But we are all over this. UNDERLYING STRUCTURE OF THE ECONOMY Mr. Schiff. I am going to follow-up with you and Mr. Levey if I could on the central bank issue, as well as on Austria. But I do want to get to the one domestic question before I run out of time. And that is, you mentioned in your testimony that the underlying structure of the economy was still sound in your view. The question that I get asked most by my constituents in town halls or telephone conversations, it always comes out in slightly different fashion, but it raises a question about that very presumption about the underlying structure of our economy. And what people in my district say to me is they say, I am working harder than ever, my spouse is working harder than ever, and we are finding it more and more difficult every year to get by, to pay our bills, to pay our mortgage, to pay our rent, to pay our gas prices, what have you. They look at their parents' generation where the model was one head-of-household income earner. They seemed to have an easier standard of life, less worry about being able to pay for health care, losing their home because of a catastrophic illness. What do we tell these families about what the administration is doing? What do we tell them about the underlying structure of our economy? Because they look at it and they wonder whether the underlying structure of the economy is such that they are going to get squeezed and squeezed every year until something gives. And what do we tell those folks? Secretary Paulson. First of all, I get a chance to talk to a fair number of them, too, and I do understand there are a number of families that are working hard and struggling, and you raised a number of important issues. To begin with, I always begin with telling them that the most important thing--first of all, we have to keep this economy growing because whatever their issues and problems are, they will be more significant if we weren't growing and if we weren't open to foreign investment and if we weren't active world traders, and right now exports are driving a lot of our growth. And then on health care, I really do agree with you when you cited that. I think that is--if we weren't going through this current downturn and mortgage problem, by far the overwhelming issue in our economy would be health care. And there I really do believe we are going to need some dramatic solutions and entitlement reform is going to be a big part of it. Medicaid and Medicare reform is going to be a very big part of it, and work to make private insurance more affordable and more available. And I don't think we have time right here. But I will talk to you off line. We have made some proposals at Treasury. And this isn't right in the middle of our lane at Treasury but we have had some proposals that deal with the Tax Code that would help--at least help jump-start the creation of a stronger and broader private health care insurance market. Mr. Schiff. Thank you, Mr. Chairman. Mr. Serrano. Thank you. I thank Mr. Goode for allowing us to break the order here. It is his turn to allow Ms. Kilpatrick to make a few comments before she returns to a hearing across the hallway. Ms. Kilpatrick. Thank you, Mr. Chairman. First let me thank my gentleman friend from Virginia. Thank you very much. Mr. Secretary, let me apologize for my absence. And the Chair understands we have Homeland Security at the same time across the hall and Admiral Allen is testifying. So I wanted to make sure first I came to say hello. Secretary Paulson. Why, thank you very much for coming. Ms. Kilpatrick. Thank you very much. And for your call during the stimulus package discussion and I hope we can continue that as well. CDFI FUND I want to just bring up, just briefly, community development in financial institutions. This committee worked real hard last year to put some of the money back in to kind of help our communities who are struggling to get back. In the President's recommendation, he is recommending that we cut that appropriation some 70 percent. It is 69.6 to be exact, which means there will still be another deepening hit for the communities across America. And I won't begin to ask you in terms of will you support an increase in that. That is our job to do that. How did you arrive at that? Is it something that you can help us with? I am going to be pushing hard to have it---- Secretary Paulson. First of all, Congresswoman, that is a very good program, it is an effective program. We have good leadership. I was in Chicago last year at NeighborWorks which is a housing counseling, making a CDFI award. We have got good leadership in the program. We put funding in at the same level that we had requested last year. You funded it at a higher level. We have executed the program I think well. There are just tough trade-offs. And we had some very tough trade-offs to make in putting together any budget. But I just want to assure you that we are doing everything we can to execute that program well and it has got strong leadership and I am committed to the program. Ms. Kilpatrick. That will be one of my requests, that we work together to try do what we can. Secretary Paulson. We look forward to working with you on this. SUMMER JOBS PROGRAM Ms. Kilpatrick. My only other question was summer job programs. That is one of the things that we proposed in the first stimulus package that we did not get. Secretary Paulson. Right. Ms. Kilpatrick. We always try do a youth program, but we are now looking for a summer jobs program for the parents of the youth who find themselves unemployed or now laid off. We lost 350,000 jobs in Michigan over the last decade or so. It is really important to us that we try to put a summer jobs program in place. There are mechanisms already set up. We just need the money to be put in. I am advocating a billion or 2 that would put tens of thousands of people back to work during this time. It is not a long, full-term, forever job but something so that the children can feel more secure in their homes. I hope we can work and talk to you on that. Secretary Paulson. Well, I would say thank you, and you have been a real leader in that area. I know how important summer jobs are for everyone, and particularly our youth. Thank you for your comment, and I will look forward to talking with you and others about that. Ms. Kilpatrick. Thank you, sir. Thank you, Mr. Chairman. Mr. Serrano. Thank you. The distinguished gentleman from the Bronx, New York, Mr. Goode. That is not a Bronx accent? Mr. Goode. It is Bronx just south of Martinsville. Mr. Serrano. Thank you. Mr. Goode. Thank you, Mr. Chairman. HEALTH CARE I heard a previous question comment on our health care system and how many changes it has needed and really how bad it is. I have listened to the debates on the Presidential candidates and heard the candidates comment on how bad it is. I have got a letter here from somebody who is in this country that came either from Pakistan or India, and they want their sister to come over here, and now they want their niece to come over because they claim the health care system--and I don't know whether it is Pakistan or India--can't handle what they have got. They want to come over to this country. Secretary Paulson. Yeah. Mr. Goode. And that is repeated about every week in my office, of people who want to come here from other countries to get the health care. What I am going to do--and maybe you can correct me if I am wrong. You need to listen to the Presidential debates. I won't be able to help you because you are in a socialized medicine country and you ought to stay there. Because, you know, everybody in this country--not everyone but a lot of the candidates are saying how bad our system is. So you have gotten wrong information. You need to stay in the socialized medicine system. That is how I am going to respond to that. But, Mr. Secretary, you have to stay where the candidates say it is the best. Stay in India and Pakistan and don't come over here. I don't know which country they were from. I can't tell by the name. But let us go on to another question I have got here. TAXING CARRIED INTEREST Carried interest, I know there have been proposals in bills to say that that should be taxed at ordinary income rate instead of capital gain rate. We had that as an offset I believe in H.R. 2834. Can you explain how that, not for the hedge fund managers but say for real estate partners, what the impact would be if that change were made? Secretary Paulson. Well, it would--I think it would have a negative impact. Because--let me just tell you how I think about this. Because in our Tax Code we tax businesses in different forms. We tax corporations, partnerships, sole proprietorships and so on. And the way we tax partnerships with, you know, the carried interest or mechanisms similar to carried interest, impacts--we have energy partnerships, we have real estate partnerships, and we have a variety of industries, not just finance and asset management. And this has been a big driver of entrepreneurial behavior and activity. So, again, I think it is difficult to just pick one industry out. Part of the problem we have in our Tax Code is we have so much complexity as it is, and we get where we are by sort of singling out one industry or something for special treatment. So, again, I think we need to look at it more broadly and look at it and say, what is going on here? And we have benefited for a long time for the way in which we have encouraged entrepreneurial activity and partnerships. Mr. Goode. So then would it be fair to say then that you think this would discourage, if you changed it from capital gains rate to ordinary income rate, real estate investment, energy investment? Secretary Paulson. Yeah, I'd be very careful before I did that. I just think I wouldn't single that out, and that has been part of a tax code that has worked well for sometime. Mr. Goode. All right. U.S. MINT Last thing, I know the Mint is under your jurisdiction. Secretary Paulson. What did you say? Mr. Goode. The U.S. Mint. Are you all melting down the Gold First Spouse Coins if they don't sell out or have you melted them down? Because I know the price of gold is right much higher now than it was when you first started the program. Secretary Paulson. That is a successful program, and it is a profitable operation, and we are working hard to sell those coins. Mr. Goode. So you--it is 40,000, I believe. It is 20,000 for the proof, 20,000 uncirculated. You are not melting any of them down? You are going to try to sell them all? Secretary Paulson. Not that I know of. Mr. Goode. But you are going to sell--if you had one, say, from James Madison, Dolly Madison, that you didn't sell, but the price of gold is up, you are going to sell it at the cost for James Monroe First Spouse and not--as the price goes up, you raise the price? Or can you? Secretary Paulson. I don't believe we do. If I am wrong on this, I will get back to you. You know, there are a number of things that we are focused on where we would like to make a difference in the cost and save money for the taxpayers. I have been really focused on legislation we have which would let us change the metal content of pennies and nickels to make those more cost efficient. Mr. Goode. Thank you, Mr. Chairman. Mr. Serrano. So you want to get rid of the penny, hey? Secretary Paulson. No, I have got no intent to---- Mr. Serrano. Are you familiar with the program in New York where they collect pennies and they turn it over to charity? It is amazing. Secretary Paulson. Yeah, it is a great program, great program. Mr. Serrano. Speaking of greatness, Mr. Ruppersberger. Mr. Ruppersberger. Well, thank you. That was a very nice introduction. First thing, thank you for being here. As we are talking about the U.S. Mint I am going through a process now to try to direct the Mint to create a commemorative coin in 2012 to celebrate the Star Spangled Banner. The war of 1812, the 200th anniversary, is in 2 years. I never realized the process where you have to get 290 co-sponsors. I have been working the floor for a while. We have 251. We then go to the next step. There are two commemorative coins produced by the Mint a year. The good news, it is budget neutral. So it is not a question, just a statement. Secretary Paulson. Okay. OFFICE OF TERRORISM AND FINANCIAL INTELLIGENCE Mr. Ruppersberger. I am on the House Select Intelligence Committee, so a lot of what we do is in the area of intelligence. I just want to talk to you about your role in helping us with respect to fighting global terrorism. The Office of Terrorism and Financial Intelligence was created I believe in 2005. We call it TFI, yes? Secretary Paulson. TFI. Mr. Ruppersberger. TFI, okay. So many acronyms in the field. It basically provides intelligence analysts, combats money laundering, which is very important, and it enforces U.S. Government sanctions. Now you have asked for an $11 million increase for the TFI in fiscal year '09. This is on top of the 29 percent from fiscal year '07 and '08. I am asking a question--I am probably going to be in favor of this, based on my role. It is so important that we have this component and this resource of fighting global terrorism. Could you explain why the increase and why it is needed? Secretary Paulson. Yeah. Well, I would say, first of all, you need to understand that we are the only office in the U.S. Government with TFI solely devoted to using financial means to track, degrade and disrupt our enemies; and so our budget is the smallest really of any of the U.S. intelligence agencies; and it is less than 1 percent of the overall U.S. intelligence budget. And I guess the way I would describe it to you, Congressman, is, in today's world, the global financial system is so prevalent that it is very difficult for terrorists to operate without using the financial system in some way. And so that is a weakness, but it is a strength, because it gives us a way to track what the terrorists are doing, and it gives us a way to disrupt what they are doing and to--so it helps us from that perspective. Then, as has been pointed out, those countries that are global renegades, as it were, those countries that are pursuing their weapons of mass destruction, the weapons proliferation, Iranians, for instance, are--again attempt to use the financial system to help them pursue their objectives, abuse the system. And we at Treasury are able to have an impact and--have an impact and drive behavior. So, again, I would argue that this is money very well spent and very necessary. Mr. Ruppersberger. You know, fighting terrorism is a team effort. That is why the Office of Director of National Intelligence came together so all agencies can work together to connect the dots. I do know in my role on the Intelligence Committee dealing with the CIA and NSA and FBI and all those groups that they very much feel very strongly about what you just said. Now following the money is clearly a big priority as it relates to terrorists. At some point they have to bring their heads up into the open to get the money; and we have been very effective in catching them. Some of our allied countries, some of our quasi-allied countries, they are still working with us on the money laundering phase. I also know that the sanctions--we talked about Iran, but, as an example, in North Korea, we have been very effective. That bank was Banco Delta Asia. We have put them out of business. Secretary Paulson. Correct. Mr. Ruppersberger. Sometimes they work; sometimes they don't. I think that is one of the main reasons why the North Koreans came back to the table, because we really put them in a position where they could not really do much as it related to money. Could you comment on the success there? Secretary Paulson. Yeah, I would just simply say you are right, that I think when Treasury and the U.S. Government sanctions banks, it has a big impact, and I think that it can change behavior. And I do think the world states that want to, if they understand they need to change their behavior to become part of the world financial system, I think that is a big inducement. And so we---- I think the other thing that makes a big difference is we base our sanctions on evidence, strong intelligence. It is conduct based, and we seek to enlist others to work along with us. Mr. Ruppersberger. They have just imposed sanctions on Burma now---- Secretary Paulson. Yes, right. And, again, bad actors in Burma, right. Mr. Ruppersberger [continuing]. Appropriations process. And I do want--Mr. Chairman, this is important. Because sometimes when you ask for an increase of over 30 percent, our staff and our people will look at that and say, why the increase? I would really hope that this committee look very strongly at the need for what we do on money laundering. It is a really effective tool. Do you also have the resources to continue to do what you are doing in the money laundering phase? Do you have the expertise and the ability to train the people that are following the money working with the other intelligence agencies? Secretary Paulson. I think we do. I think we have got really excellent people. And even more important than how many, it is the quality of the people, as you have pointed out. Mr. Ruppersberger. And these people have to go all over the world, too. Secretary Paulson. We have excellent people. They work hard. Their leader just got back. Stuart Levey just returned from a trip to the Middle East, gone for a whole week, got back on a Saturday. And so we are going wherever we need to go and doing what we need to do. INTEREST RATE REDUCTIONS Mr. Ruppersberger. Switching domestically, just a couple of issues. I think if you look in the past, until we have had this crisis now, a lot of what has helped our economy was the lower interest rates, which allowed people to refinance, use the equity in their homes to have money that we use for spending. It seems that some of the moves that we have made now through the Federal Reserve just haven't really done a lot to bring the actual residential mortgage rates down. Do you have an opinion of where you think that--what we need to do to let the banks understand--I mean, I think the banks want to keep taking the profit in, but sooner or later we will need to--are you hitting the--I think you can answer it, but I can't ask any more. Secretary Paulson. Should I answer it? Mr. Serrano. Sure, go ahead. Secretary Paulson. I would say that, as helpful as the Fed's interest rate reductions have been, and they have been quite helpful to the overall economy, they alone won't be sufficient to work through some of the excesses that have taken place in the credit market and in the housing markets. So we are making progress, but there is still stress in a number of these markets; and it is going to take a while for some of them to perform as normal. But one thing I will say that has been a help is, when you look at the adjustable rate subprime market, that those mortgages were facing resets. If you take an average mortgage before the recent Fed cuts, the reset would have gone from 8.5 to maybe 10.8 percent. On a $200,000 mortgage, that is more than $300 a month. After the Feds cut, the reset goes from 8.5 to 9 percent, which is about $70 a month. So there is definitely help, and it is very tangible help for those people facing resets. But you are right. In and of itself, it will take more time and more---- Mr. Ruppersberger. Do you anticipate the rates to go down? Secretary Paulson. It is not my job to anticipate what the chairman of the Fed is going to do. Thanks. Mr. Serrano. Thank you. IRS PRIVATE DEBT COLLECTION PROGRAM Mr. Secretary, at this time last year--first of all, you know of the opposition of many Members of Congress to the IRS, to private debt collectors. We feel that, as scary as it has been in the past to see an IRS agent at your door, you would rather have that than a private company, I believe, getting paid $0.25 on the dollar to collect. Because, eventually, we will start hearing more horror stories about tactics used to collect those debts. At this time last year, there was talk of expanding the program to include, at the minimum---- To include ten more private debt collection companies. Now it seems like you are going keep the same two. Now does this indicate that the department is losing confidence in the private debt collection program or you are just trying to make the chairman of this committee somewhat happy? Notwithstanding the last---- Secretary Paulson. Mr. Chairman, listen, your views are well-known; and I would say we are very focused on making this program work and work whereby protecting taxpayer rights. And so we have been careful in the implementation. We have, as you say, two contractors we are working with; and so we are really focused on enforcing the law and making this program work and work properly. Mr. Serrano. So it is basically not that you want to expand it as you are being careful about how to expand it? Secretary Paulson. We are maintaining the activities but being very careful here and implementing it, and these are the contractors that have measured up, and we are proceeding with this in I think a responsible, careful way. RESPONSE OF LENDERS Mr. Serrano. Thank you. Going back to the mortgage issue, it would seem to so many of us that it is in the best interest of the lenders to make sure that things work out properly. Yet it also appears to us that the lenders themselves did very little to try to deal with this problem when it became a problem, that it took you personally, your agency, your department, government to be involved. Why did it take them so long to rule? Why did they not want to move when it was in their best interest? It is not just the folks who own the home that run the risk of losing it, but they are losing money, too. Secretary Paulson. Mr. Chairman, a very good point. I would say a number of them did and were moving, but what we needed to do was get the whole industry to come together and let me tell you why. Because, if you go back many years ago, a homeowner would have a mortgage from a bank. If there was a problem, the homeowner would go to the bank. And if the homeowner was able to afford to stay in the home, the bank would make some modification, and they would work something out. Because foreclosures are very expensive for lenders. But now, as a result of a securitization process, we have investors spread all over the world. It is highly complex. There are various tranches of the same loan with different interests. So what it took to get this program up and going was to have, first of all--to get through a number of technical issues, technological issues, to get guidance from the SEC on accounting. So we got that guidance in early January, support from the investors, legal support. And so what has happened here, I think that there have been certain lenders, I think, that would have done something here without the government getting involved, but the beauty of this is we now have servicers covering 90 percent of the subprime market. And some firms have been doing the right things very quickly. Others have been slower to follow. But, again, I think there are different levels of sophistication, different levels of resources. And there were some huge technical issues, legal issues, accounting issues that we have worked through; and now I think we are in a position where we have got this up and going at a time when we are going to be having the biggest wave of resets coming. Mr. Serrano. Thank you. Let me ask you one last question, because we need to finish up so that you can go resolve all these problems; and we also have to give up this wonderful room in a little while. TRAVEL TO CUBA One of my favorite subjects that we always discuss in private and public, travel to Cuba. I know that Treasury is bound by certain White House regulations, orders that are put in place and law. But within the law and within regulations there are also decisions made on what travel is allowed and what travel is not allowed. And it would seem to many that lately, the last year or so, travel to Cuba has tightened to the point where even people like Jose Basulto, a veteran of the Bay of Pigs and founder of the Brothers to the Rescue and the gentleman who was involved in the shooting down of the two airplanes by the Cuban government, even he has done a total turnaround and said the current type of tightening hurts individual victims more than it damages the government of Cuba. Why the feeling by most folks that Treasury has actually tightened the ability of people to travel to Cuba? Secretary Paulson. Mr. Chairman, I don't believe at least the facts I look at bear that out when I look at the huge number, you know, of over 50,000 licenses that are being processed for travelers to Cuba. So, again, we clearly are going to enforce the law until the behavior changes there, which is odious behavior. But in terms of the way that--there are licenses being processed all the time for people with legitimate reasons to go to the country. So, again, I'd be happy to talk to you about that off-line. Mr. Serrano. Okay. I would like to do that. Because one week doesn't pass when our office, either here or in the Bronx, gets calls from what we would consider legitimate groups--you know, church groups, people involved with technology, educators, Little League baseball teams--who are having such a hard time traveling to Cuba. Secretary Paulson. There are a lot of church groups going to Cuba. There have been some groups that have gone and it looks like they use the church as a bit of a shield to pave the way for other forms of travel. But you probably don't hear from all those that are able to get their licenses approved quickly. But, again, I think the data that I look at looks like we are not tightening it up, but we are administering an important program. Mr. Serrano. Well, that may be true. I am open to that discussion about not knowing about the other groups. In fact, Mr. Regula and I off-line, as you would say, were discussing immigration a moment ago. He says we get a lot of calls about people who want to bring relatives into the country. We don't remember a call about somebody who wants to get out of the country. Mr. Regula. FINANCIAL LITERACY PROGRAM Mr. Regula. How is the financial education program working? Are you having some degree of success? The fact that so many people got into financial instruments that they didn't fully understand the implication of, illustrates the need to improve financial education for young people. Secretary Paulson. Oh, you are so right; and we have a quite active financial literacy program where we outreach to not just schools but to communities and to workplaces. We have--our Treasurer, Anna Cabral, who provides great leadership there. There is much going on, but it is a huge need and will be a need in this country for a long time, including having disclosure that is simple and easy to understand, for consumers to understand, rather than consumer disclosure written by some lawyer that no one can understand. And so there is--you are very right to highlight the need for more work there. BANKRUPTCY COURT REFORM Mr. Regula. I know that the Senate has kicked around the proposal that bankruptcy judges could alter the terms of the contracts. It seems to me it is getting into treacherous ground when you begin to allow a third party to order what is an agreed set of conditions on a mortgage or any financial instrument. Secretary Paulson. Right. Congressman, I think you are right. First of all, a lot of people are focused on this and a lot of people who are working with the same objective we have, which is to keep people in their home that have--some of whom have been abused by being put into financings they don't understand. But, as I thought about it, it is a slippery slope. First of all, property rights are key to our country; and changing a contract retroactively is something you shouldn't do without an awful lot of thought. And it can also dry up financing in the future for those you want to help. And then, secondly, our focus is on getting to people who want to stay in their home and we want them to pick up the phone and call a lender and do a workout, as opposed to slowing up the process and bogging down the court system. That is how I have thought about it. Mr. Serrano. Thank you. Mr. Hinchey. THE ECONOMY Mr. Hinchey. Thank you very much, Mr. Chairman. I don't mean to press you on this, Mr. Secretary, but your role as steward of the economy is very important to all of us; and the situation that we are confronting nationally is getting worse and worse. A few moments ago, we talked about the situation of unemployment; and you rightly said it wasn't nearly as high as it was in the 1930s. Secretary Paulson. It is way below--it is 4.9 percent. The average has been 6 percent. Forget about the '30s. This is about as good as it gets in terms of unemployment. Mr. Hinchey. Not really, because what we have seen over the course of the last few years is a dramatic increase in the number of people experiencing long-term unemployment, more than 26 weeks. It has gone from a little--just under 1.4 million to now more than 2.5 million people who are experiencing long-term unemployment, more than 26 weeks. As a result of that, they are not included in the unemployment list. They and other people who are struggling and looking for jobs, may be working a day or two a week, they are not included, either. When you bring all of those people in, the unemployment rate in our country now is about 9 percent. That is the real unemployment rate, the real number of unemployed people looking for work. So I am deeply concerned about this recession that we are experiencing and what appears to be the way in which important people who have the responsibility to deal with the economy are avoiding it. Let me just read you a couple of in things that showed up in the newspaper headlines today. One says, productivity growth slows sharply; and another says, unexpected drop in private sector jobs reported. We are seeing this kind of thing every single day. More and more, the experts are telling us that there is a recession. We had individuals from two major Wall Street firms, Merrill Lynch and your old company Goldman Sachs, indicate we are in a recession. Now Warren Buffett echoed that same statement. So I just think that we have got to do more. I don't think it--I think it is very clear. Talk to anybody across the country. They will say the same thing. They are struggling. What are we going to do? When are we going to face up to the fact that the economy is in recession? What are we going to do it prevent it from getting worse? Secretary Paulson. Congressman, I don't mean to sound defensive, but I think this administration and I have been really focused on the economy, and as soon as we saw it slowing down in December we began work on a stimulus package. Whether I turn out to be right when I say I think the economy is going to grow this year or others that say we are in a recession are right, we both agree the economy is slowing down significantly. We agree that's the resurge of the downside, and we are focused on them. And, as I said, my focus has been right now sort of a three-part focus. It is getting the stimulus package out. Obviously, we don't want to raise taxes, so I would just urge Members of Congress let us get the AMT patch done early this year and reduce that uncertainty. But that is one focus. Another focus is on minimizing the impact of the housing decline, and we have got a variety of programs, and we really-- I would like to see FHA modernization. You know, the House has passed it. The Senate has passed it. I would like to get it out of Congress and get it signed into law. I would like to see GSE reforms. The GSEs can play their countercyclical role in housing. I think that is the second part. And the third part is I am concerned that the financial institutions who are so key to keeping our economy going and needing to lend and make money available to consumers and businesses that they are able to continue to do that, so I am pressing them to raise capital. But those are my big focuses. Mr. Hinchey. I think they are appropriate focuses, but I don't think they will do the job that really needs to be done. You mentioned the idea of no taxes, but the fact of the matter is that one of the ways in which people have pretended that the economy is doing well is borrowing and spending, borrowing more and more and spending more and more. The national debt now has gotten close to double over the course of the last 7 years. We are now well above $9 trillion. And so much money is being spent in ways that border on corruption, particularly in the situation in Iraq, if you look at the hundreds of billions of dollars that have been spent there. IRS PRIVATE DEBT COLLECTION PROGRAM One of the issues that is much more smaller than that I would like to ask you as my last question has to do with the IRS and the way in which the privatization of collection has been instituted by this administration, in other words, bringing in private companies to collect money owed to the Internal Revenue Service in taxes. The way in which that has been done has been so terribly ineffective. In fact, the analysis indicates that we have lost more than $50 million over the course of the last couple of years by investing in these private companies to go out and collect taxes. They are spending more than they are taking in. It just doesn't make any sense. Is there any way that we are going to deal with this ineffective, inefficient, bordering on corruption privatization of the responsibilities of our government? Secretary Paulson. Well, in terms of the PCA as a private collection agency--your chairman asked me about that earlier-- that was a program that I inherited. I think as I have looked at it we have got two contractors, and the money that they are raising is money we wouldn't get if we didn't have the program, and so it is more than paying for itself now. In terms of what happened in the past, as you look at now that is pretty much a sunk cost; and right now they are operating efficiently and are raising money that wouldn't be raised if they weren't there. Thank you. Mr. Hinchey. Thank you. Secretary Paulson. Saved by the bell. Mr. Hinchey. I can hear the tap. Mr. Serrano. You guys are never through. Mr. Goode. Mr. Goode. Just a couple quick questions, Mr. Chairman. Mr. Hinchey mentioned the debt. How much is the national debt right now? Secretary Paulson. It is around $9 trillion. Mr. Goode. All right. And your deficit in the budget you submitted is what, $400 billion? Secretary Paulson. Yeah, it was 162 at the end of last year, and it will be a bit over $400 billion in the coming year because--to a large extent because of the stimulus program. Mr. Goode. The stimulus, is that a--this year, it is 125. Secretary Paulson. This year, it is 125; next year, 20, roughly. Mr. Goode. That will go down, because some of the tax things will bring money in. Secretary Paulson. You are correct. EX POST FACTO LAWS Mr. Goode. All right. On the issue raised by Mr. Regula, some States in their constitutions have provisions against ex post facto laws. Would those provisions--I am not sure whether this one there is one in the U.S. Constitution or not. Would those provisions come into play if you empowered the bankruptcy judge in his example to go in and reform an existing contract? Secretary Paulson. Congressman, you would have to ask a very good lawyer or the Justice Department that question. I just looked at it, and the way I answered the question, I said I don't like to change contracts retroactively. Mr. Goode. So you are not going to say yes and you are not going to say no? Secretary Paulson. No, I am just going to say---- Mr. Goode. Possibility? Secretary Paulson. I am not even saying a possibility, I am just saying someone else is going to answer it. I don't even need to answer it, because I think it is the wrong policy. Mr. Goode. Okay, thank you. That is it, Mr. Chairman. Mr. Serrano. Wow, I am recommending you for baseball commissioner. Secretary Paulson. Thank you. Thank you. But take care of this steroid scandal before I get there. Mr. Serrano. Yeah, that is tougher than anything you inherited here. Mr. Secretary, we are going to thank you for your testimony, for spending time with us today, for the work that you do. We don't always agree on some of the policies, but we respect the work that you are doing and the fact that you want the best for our country and economy, and we respect that and appreciate that. Secretary Paulson. Well, Mr. Chairman, thank you for all the support your committee gives Treasury in supporting our initiatives with the funding. It is very important, and it is very important to our country. Mr. Serrano. So, remember, get the Puerto Rico quarter out as soon as possible, solve the territory's dollars directly, ease travel to Cuba and make Mr. Hinchey happy. If you do all of that---- Thank you so much, and the meeting is adjourned. Secretary Paulson. Thank you.
Thursday, March 6, 2008. OFFICE OF MANAGEMENT AND BUDGET WITNESS HON. JIM NUSSLE, DIRECTOR, OFFICE OF MANAGEMENT AND BUDGET Chairman Serrano's Opening Statement Mr. Serrano. The Subcommittee will come to order. Welcome to this hearing of the Financial Services and General Government Subcommittee. Today, the Subcommittee will hear from an old friend and former colleague, director of the Office of Management and Budget, the Honorable Jim Nussle, my locker mate. We will explain that later. The locker is still there. Mr. Nussle. Does this all have to be on the record, Mr. Chairman? Mr. Serrano. Well, before the fireworks start, we should let people know that we actually like each other. Remember, it is all about the meanness. Mr. Nussle. It is. It is. Mr. Serrano. Good morning, Mr. Director. We do welcome you. This is your first appearance before the Appropriations Committee as OMB director, and we are pleased to have you. Today's hearing has a dual purpose. Our Subcommittee has jurisdiction over OMB's budget, and we will be interested in your presentation on that budget. The hearing will also delve into government-wide budget and management issues at OMB overseas. With respect to OMB's budget, the Fiscal Year 2009 request is about $5 million below the enacted Fiscal Year 2008 level, but that decrease is due to a proposed shift of rent costs from OMB's budget to the White House Office of Administration. The actual proposed change from the current year is an increase of nearly $2 million, or about 2.5 percent. This will allow you to maintain your current staffing levels. The Subcommittee will continue to take a close look at your budget proposals, and we look forward to working with you on that. I would also like to make a few comments regarding the bigger budget picture. The president's Fiscal Year 2009 budget proposes $991.6 billion in nonemergency discretionary spending, according to the Congressional Budget Office. While this is a substantial increase over Fiscal Year 2008, the increase is for defense and other security spending. Nondefense, nonsecurity spending for the basic operations of government would actually decline by 1.6 percent, even before accounting for inflation, based on CBO estimates. This budget continues to squeeze on the programs that provide essential government services to the people who need them most. These include programs to protect the environment, educate our children, provide medical research and health care, retrain jobless, support law enforcement, revitalize communities, and offer social services to the most needy. Cuts to these programs hurt the most disadvantaged of the population, and they concern me deeply. The total proposed cut to domestic discretionary programs, according to nonpartisan Center on Budget and Policy Priorities, is around $15 billion. As a share of the economy, nondefense, discretionary programs have declined from 5.2 percent of gross domestic product in 1980 to 3.7 percent today, and further declines in coming years are anticipated under this budget. But talking about these raw numbers does not do justice to the millions of Americans who are affected by these cuts. Take, for example, the proposed cuts to the Community Services Block Grant and the Social Services Block Grant, a combined $1.2 billion cut from the current funding level. This will affect services for low-income seniors, children, the unemployed, and disabled. The Social Services Block Grant touches the lives of nearly 17 million people, most of whom are children. The Community Services Block Grant supported services to about 21 percent of people living under poverty in 2005, or about five million people. There is a significant human cost to making the kind of cuts to these programs that are envisioned. It is my hope that, over the next several months, the Appropriations Committee will play a key part in restoring balance and fairness to the budget, and while we may not see eye to eye on all matters, I am hoping to work closely with Director Nussle on the issues relating to the Subcommittee, and I want to reiterate what I said before. We have this wonderful, two-party system, and the times that you were in the House, we disagreed on many issues. We did not disagree, however, on being friends, and it is always exciting to see a former Member come back. I will say that Mr. Regula will say wonderful things. But it is always nice to see a former Member and a friend. Mr. Regula? Mr. Regula's Opening Statement Mr. Regula. Well, I think the best thing about the Director is he comes from a state where they make John Deere tractors, so that is my likely slight prejudice here. We are happy to welcome Director Nussle. It must be kind of a new experience because you chaired the Budget Committee, and you proposed a budget, which we kind of tended to ignore in the appropriations process. Now you have got a little more clout as Director than you did as chairman of the Budget Committee. I really think that we do not realize the important role that OMB plays in our governmental structure, because in effect your budget sets forth the priorities of the administration, which is a partner with the Congress in ultimately setting national priorities and the way in which we commit our resources and priorities as a nation. I have often said that Appropriations is a great committee because policy follows the money, and you, as director of OMB, at least, outlined where the administration wants to go, and we, in turn, have to react as appropriators on behalf of the people that we represent, and we have different sets of priorities, depending on the makeup of our districts. This is a wonderful system we live in. I said to somebody the other day, and I was eight years in the state legislature and 36 years here, and if somebody gave me a clean sheet of paper and said, ``Design a governmental system,'' I would not change a whole lot. I think the genius of the Founding Fathers is remarkable in how they put together the Constitution. Well, so much for my sermon. I notice you want to eliminate the deficit by 2012. I have been here 36 years, and every administration wants to eliminate the deficit. It is a standard refrain, and Members do the same thing. We go out and give speeches about how terrible it is that we do not balance the budget. I am pleased that you believe that the economy will not fall into recession. Yesterday, I was with the Secretary of Treasury, who takes the same position that we are not that bad off. I notice, out in my area, the traffic is as heavy as it has ever been, and we are an area tied to heavy industry. So if we had this huge recession, there would not be a lot of people on the road, but they are out there, going to the marketplace or wherever. I do not know if you have the same experience up your way, but there are a lot of cars on the road. Mr. Serrano. Up my way, there are always a lot of people on the road. Mr. Regula. Well, I think that perhaps things were going a little too much boom town, and we needed to take a deep breath. I noticed that you take a little whack at congressional earmarks, which is a very popular topic at the moment, but it is less than one percent of the overall budget. My feeling is that transparency is the way. I have never had an earmark that I would not be happy to have an interview by the press as to what happened to it because, in many cases, the local people call them the ``Good Housekeeping Seal of Approval.'' I have one university that got a million dollars, raised five, and has one of the top science classrooms in our area in a small school. So there can be positive things, and I noticed that, while you do not call it ``earmarks,'' you have put in a number of things like West Wing construction projects, new port-of-entry facilities, federal courthouse renovations, science labs, veterans' hospitals, dams, and levees. Now, they are a form of earmark, maybe not classified as such. One last comment: You devote about the same amount of space to earmarks in your testimony as you do to the funding requests that involve the mandatories. There is a world of difference. I think the mandatories are going to be an enormous challenge down the road, when the baby boomers hit. We had testimony from the Office of Personnel Management the other day that, in 10 years, 60 percent of the federal workforce will retire, and probably the same thing applies to the private sector. That is going to put a huge challenge on the mandatories, and I think perhaps it deserves a little more attention than earmarks, in terms of your long-term thinking. So I will have a few questions, but I think OMB, the role it has in government is not given the visibility it should have because you set, at OMB, the priorities for the administration, which is half of this equation, and that is a pretty important challenge. Mr. Serrano. Thank you, Mr. Regula. Let me, before you begin your testimony, Mr. Director, just make a quick observation. Mr. Regula did bring up the issue of earmarks, and that is an issue that is not going to go away. As we have discussed on many occasions, you and I, on a very friendly basis, I am in a unique situation. I represent the poorest congressional district in our country, which is located within the richest city on earth, which is within walking distance of the wealthiest congressional district in the United States: the south Bronx to the east side of Manhattan. Earmarks, to me, is simply a way to tell a federal agency that they should pay attention to some of the needs of my district. Traditionally, it did not happen. The people did not vote. The people were poorer. Therefore, as part of that behavior, they did not vote. They were not a political force. Now, we have even more folks who are not citizens, whereas, before, it was just folks that did not get involved. So I am a big believer that the issue is, as Mr. Regula has said, to make sure that that system is tightened up properly so that the waste factor does not become the overriding factor. But the idea that only an agency head knows how to spend money in any congressional district is really absurd to me. Lastly, no one ever really complains about an agency head sending grants to a district that may not be working, but everybody complains about a Member of Congress sending an earmark to a district if it runs into any kinds of problems, so just that point. My last point to you is there are 10 subcommittee hearings going on right now on appropriations, so do not look at the attendance here today as a sign of how we feel about you or OMB. Everybody is running on to different hearings. Thank you so much. We are glad to hear your testimony. All of your testimony, as you know, will go into the record. We hope you stay within five minutes so that we can ask you 1,375 questions. Director Nussle's Testimony Mr. Nussle. I am happy to, Mr. Chairman, and I am probably the least that you have to explain to when it comes to being pulled in many directions here on the Hill. I am aware of that, and I appreciate it. First of all, thank you. It is nice to be back. It is a real honor to be before you, as a friend and a former colleague and still a colleague, as well as my friend, Ralph Regula, who has been chair, as well as a colleague of mine for many years. Just while I have the microphone and the opportunity, let me thank you both for your service, but particularly you, Ralph, because you made a decision to retire, and that is a tough decision, but you have served your communities so well, and you have been a good friend and a great colleague, so thank you for your service. I guess, a couple of things. First, you are right. On the testimony, because you are before this Subcommittee, the testimony is focused on appropriations, on OMB and on appropriations, and those things that would be important, I thought, for the Appropriations Committee to be mindful of, or that I was hoping you would be mindful of. But I take it very seriously your admonition, and I have, in my testimony, in a more macro way to the Budget Committees, as well as speeches that I have given, as well as my tenure here in the Congress, to quickly point out that now 62 percent of the budget is on automatic pilot and has nothing to do with the appropriations process, and that is where most of the big bucks and the highest rates of growth and the most uncontrollable, unsustainable spending occurs. So all I can say is, ``amen, you are right.'' We, unfortunately, get wrapped around the axle over, you are right, one percent, whether it is earmarks. We get wrapped around the axle of discretionary spending very often. That does not mean that those dollars are not important, so I am not here to suggest that we do not care about the nickels and the dimes because they do add up to dollars, but you are correct, and it has always been something that I thought I, at least, had some standing. Even though there is a natural tension between Budget Committees and Appropriation Committees, I always felt I had, at least, some standing with your chairs and ranking members because I did take on the issue of mandatory spending. To focus first on what I wanted to make sure I touched on, because this is the reason for the hearing, is to talk a little bit about the funding request for OMB. Our request this year, and the Chairman rightfully stated it, is $72.8 million, and if you compare that, because we now are excluding rent that goes over to GSA through the Office of Administration, if you compare that to recent amounts, we are asking for a 2.60 percent increase. That is a requested increase in order to deal with and fund 489 staff people and FTEs. The 489 for 2009 is a slight increase to cover GSA rental costs. The requested funding also includes budget savings, including reductions and information technology support and transfer of GSA rent to OA. For the last seven years, we believe that OMB has submitted a disciplined budget. It is a small agency. It is an important agency, as you have suggested, or, at least, I think it is. I think you do, too. We have got some great people who work there. But over the seven years of those requests, our request has only grown by 13 percent. We believe that is a very disciplined approach toward management of the agency and fiscal management of the agency. It is a great team, and there is a lot of cross- pollination, I am told, both from the Appropriations Committee and OMB, and a few alumni are here in the room today. It is a great team. They work with professionalism and dedication. They do not work in a partisan way. They work for the public good and for the public service, and I am proud of the job that they do. Before I began as Director, I had a healthy respect for them, but I can tell you, having had a chance to get to know them on that kind of professional basis, it has only grown. I would like to, if I can, just touch on a couple of things with regard to the President's Budget overall, and then I am pleased to take your questions and comments. First of all, the President asked me to do five things when he asked me to write the budget. He wanted me to make sure that we addressed the initial economic concerns that the country was facing, and we have done that in a bipartisan way, and that is included in the budget. The fiscal stimulus and growth package that we have already passed was included in the budget as we prepared that, at $150 billion, one percent of GDP, but, nonetheless, we included that in the projections. Second, we wanted to ensure sustained prosperity, which the President believes is not only important but is required if, in fact, we are going to tackle so many challenges that are laid before us. Economic growth is very important, and he believes that is best done by keeping taxes low and by making sure that the tax relief is permanent and that the tax code is predictable. So tax relief continues in this budget. He wanted to make sure we kept the country safe. That was obviously a very high priority because, as the Chairman knows, if the country is not safe, the rest of this conversation does not matter. It is so important, both from the standpoint of national security and homeland security, that that is accomplished. He wanted to get the balance, as the Ranking Member said, by 2012. I view that not as the destination, however, which brings me to my last point, and that is he also wanted us to tackle the long-term spending challenges, which are, what I would suggest, out-of-control, mandatory, fiscal obligations that we are creating and continue to create, and we begin to address that in this budget, too. So, if I may, let me just cover a couple of things and do so. We believe spending continues to be the challenge, and we have done a number of things here in order to address that. Revenue, to our mind, is not the challenge. Even when we cut taxes, more revenue came into the federal government. It is our view that getting more revenue to come, except through economic growth, is really not what we ought to be working on. We ought to be working on the spending challenge, and we see it, certainly, as two parts. The first part is on the discretionary side. We have sent up another package of programs, totaling about $18 billion, that we believe either should be eliminated or significantly reduced, and I commend the Appropriations Committee for looking through that list very seriously and, over the years, has taken that list very seriously and has reduced or eliminated programs from that list. I can understand how there will be some who say, ``That list is getting too long,'' or ``something is appearing on the list that we have not approached in the past. Why is it still on the list?'' But I will tell you that I think we have worked together in a good fashion to cull through many of those programs and try and either improve them or eliminate them where they are duplicative, or they are not meeting the objectives. As far as earmarks, having been a Member of Congress and understanding that process, I would again agree with you both that transparency, I think, is probably the biggest issue that concerns the Administration and the American people. Certainly, that is why the President wanted them to be reduced in half and to be put in bill text, as opposed to having report language earmarks, which are often difficult for the Administration to define or understand without more follow up from the Committee or from staff or, for that matter, earmarks that are phoned in that are done later on in some fashion. Having more transparency in this process, as the Ranking Member has suggested, for those that we are proud and for those that you are proud of, there should not be a problem, and we are not suggesting that the Article 1 responsibility of determining that spending is wrong at all. It is exactly the way it should go, but it should be done in the open, and the Administration, where it has designated funding, has done so in the open, and those dollars and requests are put in the budget a year in advance. We put the justifications with them. We assume that you are going the work through them and not take them all, eliminate some, complain about others. But they are our requests, and most of them, if not all, are done in a competitive way that, we believe, is a better way of approaching it than in the past. Finally, on the mandatory spending, as I said, 62 percent now is on autopilot, and, in the next 35 years alone, there will be no money left for discretionary spending, given the rate of growth in revenues. There just will not be anything for national defense, homeland security, any of the other priorities that are within discretionary spending with the automatic spending trends that we find. So the President has said, Look, let us try and deal with this long-term problem in bite-sized pieces, and we look back at some of the ways this has been done before. In 1997, in a bipartisan way, the Administration and the Congress, Clinton and a Republican Congress, in this instance, worked together on a package that is actually larger than the package that we are putting up. The package that we are putting up is a smaller package than the one we were able to agree on in 1997, where we dipped the growth curve of mandatory spending for one of the first times, and we propose that again here. We are saying, instead of, for instance, Medicare growing at 7.2 percent, let us allow it to grow. It should grow. There is natural inflation that is in there, but it should grow at five percent, not at 7.2 percent, and we find savings in that as a way of accomplishing a bending of the growth curve and dealing with one-third of the mandatory challenge that is out there. It does not address all of it. It does not solve the problem, but, as true in any situation, you have got to take this in steps. We know that. Congress, I think, recognizes that as well. Hopefully, we are not going to come to a situation where it has to be dealt with all in one big bite. So we are saying, let us take it in bite-sized pieces. We are proposing that first bite to be one-third of the problem, and we do put that in there, and we are asking Congress to consider it. But, as this Committee, as the Appropriations Committee, well knows, the fights, unfortunately, will be about the discretionary package, and it appears thus far, at least from what we have seen from the Budget Committees, that they will not consider mandatory savings, and I think that is a missed opportunity, given the fact that we have this looming challenge and that if we do not begin to address it in bite-sized pieces, it will come up to bite us. So that is what I wanted to come and present to you. I am pleased to try and answer your questions, and if you stump me in an area, I have got some good people from OMB behind me who might have the answer, and if we cannot do it, we will get it to you in writing. Mr. Chairman, thank you. [The information follows:]
Mr. Serrano. Thank you so much. I know you have folks from OMB behind you, and we have folks formerly from OMB all around us. Mr. Nussle. I know. So I cannot hide. I realize that. Mr. Serrano. In fact, I just came from a hearing of the Homeland Security Subcommittee, and when I said that I was coming here to spend time with you, half of the staff said, ``We were there also.'' Before I get to my first question, which has to do with that subject, let me just ask you a question, based on what you have said. MEDICARE So Medicare, for instance, is naturally going to grow to seven percent, and the Administration would want to see a growth of five percent. Is that understood to mean that the natural growth would cover people in need, and the reduced growth would then leave out some people who are in need? When we deal with numbers, we are also dealing with people, so how do we cut in those areas where we know we can cut and not hurt an individual's need but not cut in the areas where the person or a group of people will be served? Mr. Nussle. We have tried to go through and take proposals from MEDPAC, which provides the proposals and alternatives, for ways that we can reform these programs, Medicare and Medicaid, and we have asked them, you know, what is the best way to approach this? We have tried to take proposals that they have come up with that go toward efficiencies, improving the system, and saving money, as opposed to, as you say, cutting into beneficiaries. So, yes, we have tried, in those instances, to work on program changes for efficiencies and not to, as some might say, go after beneficiaries. In fact, we are trying to improve the program constantly. That is what Part D was for. That is what Medicare Advantage was for, was to try and expand the program in ways that can better serve the beneficiaries and provide them with access to quality health care. Mr. Serrano. I think that any time any administration--this one, the next one, a Democratic or Republican administration-- talks about reductions, if they mean, or they are interpreted to mean, that they will leave people out, beneficiaries out, then you are going to run into that trouble. You know that, and that is what we have to deal with here. OMB RECRUITMENT AND RETENTION But you did mention folks from OMB. That is my first question, which is, last year, Director Portman told this Committee that OMB had a very aggressive recruitment program, but we also know that OMB loses a lot of very talented people to go elsewhere. How do you keep doing the job properly? How does the agency do what it is supposed to do when you are losing people, and what is the rate of turnover? Mr. Nussle. We were just talking about this on the way over because we are in the middle of a recruiting period right now. We have been in a number of schools. We are reaching out to schools, in particular, where we have alumni that are at OMB, and we actually use them, ask them to go and talk to the people in their colleges and universities in order to try to accomplish that. We have already covered 27 schools during February, as an example, to try and build on that recruitment. But you are right, and we talked about this in your office privately as well, that there is this concern, not only about recruitment but also retention. Once you get some good folks, you want to make sure you hold onto them because it is tough to train them. Obviously, we are talking about public service, and this is not the highest-paid jobs in the world on either side of Pennsylvania Avenue, but I think some recognition of that is something that we have tried to build into the budget, as well as recognizing that there are ways within the agency to improve the work. One of the biggest complaints I had when I got in was about the trade-off. We do surveys within OMB, and they said it was one of the best places in the federal government to work but some of the heaviest workload. So we have been trying to work on workload. It is not just a matter of hiring more people, but it is also making sure that the work is distributed appropriately. So we are working on a number of areas, but, specifically to recruitment, we have been in 27 schools in February, and we hope that that, as well as a number of other things, pays off. Mr. Serrano. You know, speaking on that issue, I have often said that when a person becomes chairman of a committee in Congress, you do X amount of what needs to be done by any chairman. And X amount is what you bring to it, and so part of my rallying cry is always to remind folks that we have American territories that are not states. So I hope that the 27 schools could include some schools in the territories. In fact, I wish there was a way that OMB could help us in putting forth a notice throughout the federal government that when it comes to recruiting from schools, there are territories that prepare fine English-speaking folks. In fact, NASA started recruiting--we do not know how--20 years ago or so, at the University of Puerto Rico at Mayaguez campus, Mayaguez being the hometown--I will spell that later--my hometown in Puerto Rico. Now whenever NASA sends up a flight, you would be surprised at the number of people who graduated from that university who work at NASA. So one way to score great points with this chairman is to either let me know that within the 27, there are some in the territories, and, if not, they will increase it to 35 or whatever. Mr. Nussle. I will confess to you, Mr. Chairman, I cannot make you happy today, but I already have one volunteer who wants to go to Puerto Rico and do some recruiting, and I may go, too. CUTS TO SERVICES Mr. Serrano. Good job. Now, let me ask you a question. The President's Budget request would make deep cuts in inflation- adjusted, domestic discretionary spending. As I said in my opening statement, this affects needed services for many Americans, including low-income seniors, children, the unemployed, and the disabled. How can a budget that makes deep cuts to the domestic discretionary side of the budget provide essential services to those Americans who are most in need, especially at a time when, if indeed this economy is where many of us feel it is already, and where it may head to, some of these folks will be even hit harder? Is this the time to make cuts there, which will affect them? Mr. Nussle. Well, that is always a challenge, and it is particularly a challenge, given the fact that now 62 percent of our choices are basically off the table for discussion. We are only working with a certain pot of money that we can work from. So you are right. Whenever there is a budget document that is put together, first and foremost, those choices typically come from discretionary spending. We have tried to balance that, but recognizing what Congress might be willing to do, that balance, most likely, will not occur this year. Second, we also do a job to try and rate all of the programs and to do it as objectively as possible so that we can see whether or not the programs are actually meeting the goals that you and I and others have intended for the programs to meet and to address the needs of the people that they were intended to meet. Some do an excellent job, some are duplicative, some need to be improved, and some need to be eliminated. So we have gone through and tried to rate them in that way and make choices between some that are doing a good job and some that are not doing as good a job or need to be reformed. So you will see those in the budget as well. Then, finally, and I am not going to pretend I know your community. I know the communities that I served, and I can tell you that, at least in my instance, most of those communities were not waiting for the federal government, or most of the people there were not waiting for the federal government, in a program or in an earmark, in order to solve their problems. Most Americans know that the problems are going to be solved around their kitchen table, around their neighborhood, around their community, first and foremost, before anybody from Washington is actually going to be able to help them, and I think so much of what we try and do in this is recognize that and to make sure that they have the resources to accomplish those solutions. So that is the direction that we have when try and put together a budget. Mr. Serrano. Well, we do not disagree on that comment. I am glad to say, and I am impressed, that you have not changed your line of presentation for a long time. We have discussed this in the past. But there are services that, whether people are waiting for them or not, do come from Washington: educational services, services to the hospital, dollars that come to their local hospital, dollars that come for programs in their community. They may not be waiting for them, but it is part of what happens to them on a daily basis, whether they mention it or not, called to their attention or not, it is there. When we cut that, we run into a problem. VETO THREATS One last question before I turn to Mr. Regula, as a follow up. You wrote recently, I think, last week, to the Chairman and Ranking Member of the House Budget Committee, saying that the President would veto any appropriations bill that exceeds his request. That is fine. We understand that statement. We went through that last year. That is why we had one large bill in December. But how could you be offering veto threats if you have not even seen a plan for what we hope to present to you? Is that kind of a declaration of some sort of government war before we even begin? We are still holding hearings here. I have no clue what this bill will look like, and you are already telling me that if it exceeds what the President asked for, not knowing where the amount may be that exceeds what he asked for, and you are listening to the Chairman, who, last year, started off under the President's request, did not get me a gold star or a nickname. I do not want a nickname. How do we offer so early veto threats? Mr. Nussle. I think the challenge here, as the Chairman is well aware, is that we are, unfortunately, not just talking about the 302[b] allocations to the subcommittees and where you will be writing your bills; it was a signal that suggests that, at least from the discretionary top line, the President has set a number, realizing that Congress will have puts and takes, will add and subtract, will decide within its committees how to distribute those resources. But we wanted to send a signal early on that we thought that it was a reasonable amount that the President was requesting and that that should be the number that we all work from because if we do not work from that number, if we do not start with that top-line number in mind, then we know from the beginning, as soon as those allocations are given, that there is going to be a fight, that there is going to be a problem. Last year, that signal, in my view, was not given clear enough maybe as early as it could have been, and so we wanted to give that signal early this year, and we got a signal back from the leadership that said, maybe we will wait for the next administration. So I think it sets up the discussion early on, and, hopefully, it gives some guidance, as you are looking through it, about what the Administration is interested in working together on. Mr. Serrano. Well, as I turn to Mr. Regula, it is nice to see that the President has become a fiscal conservative in the last year. Mr. Regula. Mr. Regula. That was a gratuitous comment. Mr. Serrano. It was off the record. It was just between you and I. BUDGET PRIORITIZATION Mr. Regula. Right. Following up on that, how do you establish your priorities? Do you sit down and consult with Josh Bolten or the President? Because, without any question, the document you present here does clearly establish the priorities, as they are viewed by the Administration, for the expenditure of all of the discretionary money, and, as such, they obviously influence the way in which we have programmatic direction of the federal government. How do you go about this? Mr. Nussle. It is an amazing process, I would say to you, having not been part of it until this year. It starts very early in the year. Usually, probably in the months coming up now, the agencies and the departments will begin formulating their requests, and it starts in that process, and then it goes through a review process at OMB where we include not only the President's advisers but also recommendations from those department heads and agency heads and folks, and we go through a very rigorous process of trade-offs, of what is working and what is not, asking, hopefully, some very tough questions about the programs. We do not just look at how much money is being spent. We look at whether the program is working and how effective it is. Certainly, everyone, including the President's chief of staff and former OMB director, as well as the President, is consulted for their views. But it starts with the President. That is why I outlined the goals that he wanted me to consider as I was trying to put a budget together for him. So it starts with him, at the principal level. It flows through a very complicated process back up to the President for final recommendation and final approval, and it is a fascinating process to go through. But there are many trade- offs within there as you go through it, obviously. DISTRICT OF COLUMBIA Mr. Regula. I was pleased to see that you increased the federal payment to the District of Columbia. I think Mayor Fenty and Chancellor Rhee are making a real effort to deal with the challenges of the education program in D.C., and I think that, by putting the amount you did in the budget on that, it gives a stamp of approval to their effort, and it certainly is well overdue for the city to become what President Reagan called the ``shining city on the hill.'' We need to address the education challenges. Mr. Nussle. Well, we see this as a package deal, too, and one that was worked on--it is very delicate--in order for improvement, not only in the public schools but education in general in D.C., so we hope that the Appropriations Committee will take a look at that. Mr. Regula. I hope so, too. Also, I had put language in on HIV/AIDS, which the Subcommittee did, and report language asking the Administration to help the city address this epidemic, and it is an epidemic in this city. I have been disappointed that you have not acted on the report language. Any reason? What do you propose to do in the future? Mr. Nussle. As far as that goes, I certainly would take that into consideration and your concerns in mind at this point in time, but you are right. There is some controversy surrounding the proposals. We understand that and the policy, but I certainly would keep that concern in mind. Mr. Regula. Well, it is a real challenge in this city---- Mr. Nussle. Yes. Mr. Regula [continuing]. Because the incidence of cases is very high, and it has to be part of what you are trying to do with education and so on to make this a better place for everybody. TREASURY DEPARTMENT FUNDING IN STIMULUS BILL I noticed that you put $250 million to the Treasury Department in the stimulus bill that was done at kind of the last minute, and it was a form of administration earmark to carry out the stimulus bill. It seemed to me that maybe that should have had some scrutiny before it was made part of the package. Mr. Nussle. Did you have an opportunity to ask Secretary of Treasury Paulson about that? I believe, if I am not mistaken, that is the amount to actually do the checks---- Mr. Regula. I know. Mr. Nussle [continuing]. Because it is outside the normal process for the IRS. I may be mistaken about it, but I think that is what it was. Mr. Regula. I think that is right. It was just an arbitrary figure that went in at the last minute, without any scrutiny on the part of the Congress. Mr. Nussle. This may not be enough scrutiny for your liking, but we did scrutinize it at OMB before we approved it. Mr. Regula. So you thought it was a legitimate figure. Mr. Nussle. Yes, we did. In order to accomplish it and get the checks out as quickly as possible, which, we believe, will be the first couple of weeks of May. We thought it was important, you know, to get those out the door, if, in fact, they were going to have the stimulative effect that was required. [Discussion held off the record.] Mr. Serrano. Before we leave, we have a few minutes we can take. Mr. Visclosky. Mr. Chairman, thank you, and I appreciate your courtesy, Mr. Regula's, and, particularly, Mr. Cramer's for coming in late. Mr. Nussle, very good to see you. LAKE COUNTY HIDTA I have a serious concern and dispute with the Office of National Drug Control Policy, and, given your testimony today, you are the closest administration official I can get on the record, so I appreciate your attendance. Lake County, Indiana, was declared a HIDTA in 1997, High- Intensity Drug Trafficking Area. In 2006, $3,022,000 were appropriated. I would point out that, in August of last year, ONDCP approached me in my office and suggested that there are problems with the HIDTA in Lake County, Indiana, from their perspective. I would point out for the record that, subsequent to last August, there was a change in the chairmanship of the executive board, and you now have an official from the Federal Bureau of Investigation who chairs that HIDTA. There was a change at the request by the agency of the fiduciary. There were multiple changes in the budget process and also in elimination of what was declared unnecessary spending, all at the request of the Administration. The HIDTA is also in the process of physically moving their operation to another location, again, at the request of the Administration. When the Administration came in in August, they suggested that, given their concerns, they wanted to move the jurisdiction and the money and the resources to the Chicago HIDTA. I suggested that we were willing to work with the administration to make the necessary changes and, again, would point out for the record that it is now headed by someone from the Federal Bureau of Investigation. The Administration's budget this year cut the Lake County HIDTA by $1,272,000. I find it very interesting that the Chicago HIDTA was increased by $1,200,000. So, from my perspective, the administration, in a very cavalier fashion, did exactly what they threatened to do in August, despite what I think was significant cooperation in changes and reforms of the HIDTA. In reading why there was a decrease, there was an indication of poor performance. I have acknowledged there that the changes were apparently necessary and were made subsequent to last August. There is a decrease due to small geographical area. I think that is subject to definition. Lake County is the size it is, and I cannot change that. But, finally, I am particularly disturbed that the justification was there is a diminished threat compared to other areas of the country. The largest city in Lake County, Indiana, is Gary, Indiana. In 2006, there were 55 homicides in Gary. In 2007, as of December 18th, there were 71. Homicides in Gary, Indiana, went up 40 percent last year. It was, on a per capita basis for communities in excess of 100,000, declared the murder capital of the United States of America. The county in which Lake County resides had their homicide rate increase by 32 percent. So I hate to see what the threats in some other communities are if that is a diminishment of the problem that we are facing. I certainly would ask for your intervention and investigation of this matter because, again, people went to great pains and much cooperation to make the necessary changes, and, from my perspective, most importantly, looking ahead to the people I represent, there is a huge threat, given the fact that homicides increased by 40 percent in Gary. With that, Mr. Chairman, I just wanted to pour my heart out and suggest that I am very unhappy with that decision. Mr. Nussle. May I get back to you? This is not something I have---- Mr. Visclosky. No. I understand that. Mr. Nussle [continuing]. Personal familiarity with, so let me do some digging and checking and get you a response rather than trying to do it off the cuff. Mr. Visclosky. I would appreciate that very much. Mr. Serrano. We have just a few minutes to vote, so we shall break right now. When we come back, Mr. Cramer will be our first speaker. [Whereupon, at 10:50 a.m., a recess was taken.] Mr. Serrano. I do not know, Mr. Director, if you saw those power rankings that came out recently, these things called ``power rankings'' on Members of Congress. Mr. Cramer was way up there. Mr. Cramer. I was? Mr. Serrano. You were certainly ahead of me. You were in the top 20 or something, yes. Mr. Cramer. Really? Mr. Serrano. Right after Pelosi. It is incredible. Mr. Cramer. Twenty-six. Mr. Serrano. Twenty-six out of 435 is not bad. Mr. Cramer. Mr. Cramer. I am sure that makes you tremble there. Jim Nussle, I said to you before I left, welcome back. FARM BILL We know you, and we are glad you are here today, and you have got a tough job under tough circumstances. I wanted to talk to you about the Farm Bill, and you live and breathe farm issues just like we live and breathe farm issues, kind of where we are and why we are where we are. With talks ongoing, the Administration recently released the parameters for a successful Farm Bill. It stated that a Farm Bill final product must not include any tax increases. What I wanted to know is what would be acceptable as offsets to the Administration? I understand we need to get $10 billion above the baseline that we now have. What do you see happening, or can you look down the road, with a March 15th expiration date or deadline for the bill? Mr. Nussle. At this point in time, it is difficult to project what will happen because we are closing in on a deadline, and just the physical production of a Farm Bill during the next basically week before recess is going to be pretty difficult to do. As far as what is acceptable, we have been--when I say ``we,'' I say the Administration, the royal ``we''--have been in many conversations and negotiations and meetings about what that might entail. We have provided lists to USDA, as far as different things that might be acceptable. We draw from the budget, obviously, as a starting point of spending offsets that we think might be acceptable, that we have floated, if you will, as part of it. But I think the offsets are probably just one of a number of challenges. There is separation still on how much money the Farm Bill should spend. There is separation still on how much reform could be entailed in the bill. So I think there is still a lot of separation that only coming to some agreement on offsets probably would not necessarily be the final resolution of. I have been in a couple of the meetings. I have not been in all of them. Most of this is being led by our new Secretary of Agriculture and his deputy, and I have been invited to a few of the meetings but have not participated in all of them. Mr. Cramer. All right. Well, thank you for that insight, and, Mr. Chairman, that is what I wanted to bring up. Thank you. Mr. Serrano. Thank you. Boy, people are treating you well today. Mr. Nussle. Bud and I came in---- Mr. Cramer. We were classmates. Mr. Serrano. We were locker mates. Mr. Nussle. It is old home week. Does that not mean anything? I have thought of a nickname, Mr. Chairman, but I will have to share it with you later. Mr. Serrano. Ahead. I think ``commandate'' would be a little too much for the President, do you not think? OMB INPUT IN BUDGET Let me ask you a question a little off the path here. Obviously, your office and you, personally, get involved in all of the fiscal issues of presenting the budget, but the budget also carries language issues, visions that the administration has, and I single out, for instance, this whole issue with the needle exchange program in Washington, D.C., something that I worked hard to get rid of--the ban on using local funds. Now it appears in the budget again. Does your office get involved in that kind of thing, or does OMB get involved in that kind of thing, at all, or is that other folks' input into the budget? Mr. Nussle. Well, there are many other folks who have input into the budget. We have policy councils, as you know, that help make determinations of what should be and what should not be the official administration policy, and, obviously, the President has the final decision of what those policies should be. But there is an entirely separate, from just the budgetary aspect, an entirely separate policy process that different policy counsels control within the Administration. Mr. Serrano. That particular issue is one that is going to stir up some issues again around here, some feelings, because it was believed, strongly by many Members, that D.C. should be able to spend its own money on this particular program. We were able to accomplish this. They are very happy. They allocated dollars to it. They have a serious problem with the HIV virus issues in the city, in the District, and we would just hope that the Administration would have left that alone. FEDERAL CONTRACTS On this whole issue of the value of federal contracts, which have increased significantly during the Bush Administration to around $400 billion, about 40 cents of every discretionary dollar is going into contracts. At the same time, the Administration has pressed for reduction in the federal workforce, with many responsibilities being shifted away from federal employees and toward contractors. What is most troubling, however, is the increase in the amount of noncompetitive contracting under this Administration. Noncompetitive contracting doubled, to about $145 billion in 2005. So the question is, how does this Administration justify the enormous expansion of contracting and, in particular, noncompetitive contracting, over the past eight years? Do you think the federal government relies too much on contractors, and how should we define inherently governmental functions? Mr. Nussle. First, on the contracting in general, we have gone through a process. I have not been here for much of it, but, as I understand it, a process of reviewing those contracts with an eye toward making them competitive in those instances where a sole-source contract is not either appropriate, or there are obviously more entities that could compete for them. So there has been a process undergoing that has attempted to try and improve on that. Some very good improvements have been made. The amount of dollars, however, is probably not the only comparison. When you say it has doubled in 2005, doubling from when, that is? Mr. Serrano. From 2000 and 2001. Mr. Nussle. Okay. I mean, I think there is some comparison here that is important. We have tried to scrutinize those sole- source contracts in a new way to ensure that those situations where there are sole-source contracts are only in those situations where there is no competition available, that there is usually one entity that does the kind of work that we are looking for. Within the agencies themselves, that kind of competitive process is one that, frankly, when you allow the workforce to compete for a contract that is put out for bid, we see that it not only improves the work that the agencies are doing in those entities that have been put out for bid, but, in many instances, the government workers themselves are the ones who win the contract. So we think this has improved the system. More improvements certainly can be made. I think all of those contracts should be scrutinized. That is why we have gone through that process. We believe some improvements have been made in this area. It is not just a matter of looking at how much money is being spent in these areas as the only comparison. Mr. Serrano. One of the issues that comes up, Mr. Director, is the fact that, under contracting, you will have, or already have, situations where a person under a contract is working in the same workplace, sitting next to a person who is a federal employee covered, we understand, under different rules at times, ethics rules, and so on. One is covered by the people they work for, and one is covered by the rules that you and I are covered by. Does that not create a problem, and is that not a dangerous situation that you could have in the workplace? Mr. Nussle. It may. It may be more circumstantial. Right off the cuff, this is not an issues that has been brought to my attention. I appreciate you doing that. So, I guess what I would like to do is explore those instances where you feel it would be a problem. My gut reaction is that there may be some reason why those differences are there and that those differences may very well be appropriate, but you are obviously singling out some areas where they may not be. I would be happy to work with you and investigate that a little bit further. Mr. Serrano. We would like you to look at that and see if there is a way of dealing with that. Let me go to Mr. Regula now. Mr. Regula. I have no questions. I am okay. Mr. Serrano. Mr. Hinchey. Mr. Hinchey. Thank you, Mr. Chairman. Mr. Director, it is nice to see you. Mr. Nussle. Good to see you. FOOD SAFETY AND INSPECTION SERVICE Mr. Hinchey. It is reminiscent of old times. I wanted to ask you a question about the Agriculture Department. Mr. Nussle. Yes. Mr. Hinchey. We were just at a hearing with the Food Safety and Inspection Services, and there is a very good man, a man by the name of Raymond, I think, who is very good. He heads that program up, and I think he does a very good job. In the context of the discussion with him, we made the observation that the number of inspectors for food safety across the country has gone down by about 10 percent. It was unclear as to why that was happening. I would not expect you to be able to answer anything like this now, but I wonder if you would not mind taking a look at this and seeing why that number has dropped down. The reason I asked that question about the Food Safety and Inspection Service is now, in the context of these lesser and lesser people out there doing inspections, is the fact that recently we saw, in fact, last month, the largest withdrawal of food from the market in the history of the country. It was beef products. In the context of that withdrawal, the Agriculture Department, particularly the Food Safety and Services operation within the Agriculture Department, was not permitted to reveal the name of the companies or the stores from which this adverse product had been sold, and a lot of it had been sold. A lot of people had bought the stuff. So that just does not make any sense to me. So I would like very much to try to figure out and be told, frankly, where those products are being sold from so that we could get a better idea as to what the consequences were, and if that information is put out, we are less likely to see something like this happening in the future. So if your excellent staff here would not mind taking a look at that, and if you would not mind giving us that information, we would appreciate it. Mr. Nussle. I am sorry to ask you the question, but you stated a number. Do you remember what they said? How many inspectors were less than the year before? Mr. Hinchey. Yes. The number of inspectors that is supposed to be out there is 8,000, and that number, I think, has been standard for quite a while, but the actual number that is out there now, I believe, is 7,310. Mr. Nussle. Okay. The reason I am asking that--I do not mean to ask you the questions--the answer that I immediately go to is, well, let us see if there has been less money appropriated. You have increased our request, and we have increased your request every year. I think there has been a steady increase here. In fact, this year, we are asking for a seven-percent increase in that area, so there may be a deeper issue here that I would be happy to look into and that you obviously are looking into as well. But it is probably not as a direct result of cuts as much as maybe something else that is going on. But I would be happy to look into it. Mr. Hinchey. Well, your conclusion is exactly the same as the one that I came to, based not upon all of the information but based upon the amount of information that we have. So I would appreciate it if you would. Any more time, Mr. Chairman, or is my five minutes up? Mr. Serrano. For you? Mr. Hinchey. For me. Mr. Serrano. You can take a little more time. Do not push it, though. Mr. Hinchey. Absolutely not. If you are a guy originally from Manhattan, and you have to deal with a guy from the Bronx, you know, there is always that little bit of tension. PRIVATE CONTRACTORS I think the issues that were raised earlier, and I was not here, unfortunately, because of the other committee hearing, having to do with these contracts, the contractual situations that are out there, we know, for example, that with regard to the private contracts that have been engaged in Iraq, they have been very, very expensive. I think the largest one is something in the neighborhood of $122 billion--that is Kellogg, Brown & Root--and there are others that are in the multiple billions of dollars, many of them in the tens of billions, some of them up close to 100 billions of dollars. Huge amounts of money have been spent on these private contractors, and I think that this is something that really needs to be overseen much more carefully. I think a lot of that money, frankly, has been spent corruptly, corruptly in the sense that the reason for which that money was sent to these contractors did not result in the expectation that should be coming from it as a result of it. This is something that is bad on two counts: It is costing us a lot of money and not giving us the results. On a smaller scale, there is now a contracting operation engaged in security at West Point, and I am wondering why that is. Why is it that the Army, and I assume this is happening at Annapolis and the Air Force Academy--I do not know for sure, but I think it probably is--why is it that the military is not continuing to be allowed to provide the security for itself? Why are we bringing in private contractors? I do not like it. It makes me very uncomfortable. So I would appreciate it if this is something that you would not mind taking a look at. Mr. Nussle. This is an instance, again, where West Point is providing security to the campus using a private contractor, is what you discovered. Mr. Hinchey. Yes. Right. Mr. Nussle. Okay. Mr. Hinchey. So when you come into the campus of West Point, you have to go through a security operation, of course. All of the cars are checked, et cetera, stopped. I am just wondering what the policy was. How did it get initiated? Why is it being carried out, so that the military does not provide their own security at these bases? Instead, we have a private corporation providing that security. Mr. Nussle. Okay. Mr. Hinchey. I would appreciate it very much. Mr. Nussle. Thank you. Mr. Hinchey. Thank you. Mr. Serrano. Mr. Regula. AMERICAN COMPETITIVENESS INITIATIVE Mr. Regula. A couple of quick ones. I noticed you request $12.2 billion for the American Competitiveness Initiative to support basic research in world-leading facilities. Tell me how you see this being achieved. How are we going to use that money, and how are we going to achieve competitiveness? Mr. Nussle. Well, giving you this answer--I should ask you because you have been a leader in this area. Basic research is vitally important to our country. Mr. Regula. Well, do you see this money going out to schools, for example? Mr. Nussle. Well, there are some instances, yes, where that is how it could be done. It should be awarded in a competitive way, and it should be done for basic research, and that is the basis surrounding this initiative. Mr. Regula. I like the idea. Do not misunderstand me. Are you telling me that a university that has a program that will enhance the competitiveness of the United States through the students that they educate would be able to apply for a grant or put a program in place? Would that be the way? Mr. Nussle. Yes. Mr. Regula. Well, it will be interesting. Are there defined guidelines? Mr. Nussle. Well, we assume, and we will be happy to work with the Congress on those kinds of guidelines. Our intent is to try and provide the incentive and the seed money for that basic research, and there are a number of ways that that could be handled, some of which have been tried before, and, certainly, Congress has experience in this area of setting up these kinds of initiatives, but this is one that the President felt was an important one. Mr. Regula. I think so. I agree. Mr. Nussle. He mentioned this in his 2006 State of the Union, and it was set up for that purpose. But it was, as you say, a way to try and get ahead of the curve when it comes to some of the basic research that we need in order to make sure that we stay on a competitive edge with not only our partners but also our competitors around the world. Mr. Regula. Well, should Members be telling higher education facilities in their districts, you ought to look into this? Mr. Nussle. Well, not until we get it up and funded and everything else. Mr. Regula. So you do not have guidelines. Mr. Nussle. I will trust you on your communication with your universities, I am sure, but, at this point in time, most of those are going to be through the agencies that are already established that, I think, have become partners in this initiative, or could be partners in this initiative, including the National Science Foundation and the Department of Energy and the National Institutes of Standards and Technology Labs. Those are the ones that we see. So there are ways that we can formulate this. That is the way we suggest it being done, and we also suggest that it should receive a pretty healthy amount. Congress did not see that last year and cut it back from the request, but we believe that this is a worthwhile priority that can give us the edge that we need. EARMARKS Mr. Regula. One other question. How would you define a congressionally mandated earmark, euphemistically known as an ``earmark''? How would you define it? Mr. Nussle. How would I define it? Well, how I define it is I think it is any time the Congress designates dollars to a particular project or program in a noncompetitive way, and the ones, again, that we believe are the onerous ones are the ones that are not found in bill language but are in the report language or within funding that is then phoned in to the different agencies or departments. Those are the ones that we find concerning. So that is how I would define it. Mr. Regula. Would you concede that there are good, useful earmarks? Mr. Nussle. Oh, sure, and that is why the President does not say, you know, get rid of all of them. But I think, too, what we have tried to do is to shine the light on the problem. Not only are there situations where they are not all good; they are not all bad. You are right. Both sides of that coin are true. But any time that they are not transparent, when they are air dropped in at the last minute in a conference report, when it does not receive the scrutiny of this Committee or the Congress, that is when I think you start running into trouble, and that is the reason why I think we have the controversy set up the way we do right now. Mr. Regula. Thank you, Mr. Chairman. Mr. Serrano. Thank you. Mr. Director, our newest Member of the Committee, Mr. Bonner, who has got nine questions for you. Mr. Bonner. Mr. Chairman, I am sorry I was absent yesterday. Mr. Serrano. It was noted. Mr. Bonner. My perfect attendance has already been blemished, and I apologize. Mr. Serrano. That is okay. Mr. Bonner. But, in fairness, the Director can probably appreciate more than some why we were not here. I hope you had a good, restful night's sleep last night, Mr. Director. Where were you at twelve-thirty in the morning? Mr. Nussle. At twelve-thirty in the morning? Mr. Bonner. Yes, sir. Mr. Nussle. I hate to admit this. I was in bed. Mr. Bonner. Well, your former colleagues on the Budget Committee were not. Mr. Nussle. I did have an eye on the goings on and was amazed that it took them so long to get a budget out. We were always able to do it before midnight. Mr. Bonner. And you gave us a blueprint that we could have just rubber stamped, if we had only taken your offer. JOBS Mr. Chairman, thank you. I do have one question because there has been a lot of conversation around the country. Some television celebrities who pretend to be journalists talk a lot about the outsourcing of jobs in our country. It is a legitimate question, and, in some parts of the country, we have seen tremendous job losses in states like Michigan, who have seen literally tens of thousands, if not hundreds of thousands, of people who have to leave because the economy in some states is not doing as well as it is in other states. Let me give you quick example of where I am going with my question, and then I will get to the question. Fifteen years ago, in my home state of Alabama, we did not make a single automobile. Despite the image that some might have about Alabama, we knew how to spell ``automobile,'' but we did not make an automobile. Then, about 15 years ago, our leadership in our state went out, borrowed money in a bond issue, and incentivized a company, Mercedes Benz, to come to the United States and to locate in Alabama. Today, that $250 million investment has created 50,000 jobs in the state of Alabama alone, and Honda, who is in the Ranking Member's state, and Hyundai, the Korean company, and Toyota--many foreign companies have invested, have followed the lead that Mercedes had--BMW is in South Carolina. So I know it gets to be a tricky question, especially when people like Lou Dobbs get on TV and talk about all of the outsourcing of jobs. In your position as director of the budget, how important is it, would you say, that we also consider in-sourcing of jobs, foreign investment coming into this country and creating job opportunities, many times making two or three times what previous job opportunities were in those districts and those communities and those states? Mr. Nussle. That is a huge opportunity and factor in our growing economy, that we are attractive to capital and that we continue to promote that kind of investment, whether it is investment here in the United States or investment from abroad. All of that is very important to not only job creation and retention but to the future job growth and economic growth of our country. As you know, you do not solve a lot of the budgetary problems and the fiscal problems with growth alone, but growth is extremely important, having people who have good-paying jobs that are able to pay their taxes and to deal with some of the challenges at the local, state, and federal level is an important part of how we deal with these things, from a fiscal standpoint. So I would view that as a very important component in our continuing economic growth. Mr. Bonner. And a positive one? Mr. Nussle. Yes, sir. FOREIGN INVESTMENT Mr. Bonner. Just a quick follow up. Some have said, some of the critics, have said that, by allowing foreign corporations to invest in the United States and employ U.S. workers, we are, in fact, providing an economic stimulus plan to that foreign country. What role does foreign investment play in support of the President's economic stimulus plan and plans going forward? We will have a new president next year, but what role, in your view, does it play going forward? Mr. Nussle. Other than just generally answering that, that I believe it is an important role, and it is a vital part of our economic growth, I think those are probably questions that are better asked of the Secretary of the Treasury, who probably has a little bit more of a handle on all of those different component parts. But I view it, and I think the Administration continues to view that, as a very important component of our continuing economic growth and our success in the future. Mr. Bonner. Again, we missed you last night and yesterday in the budget, but we appreciate you coming to this Committee today. Mr. Nussle. Congratulations on your committee assignment, too. Mr. Bonner. Thank you very much. I not only got on a great committee, but a great chairman to work with. I said, last week, that he was handsome, debonair, smart, and he is not listening to anything I am saying now, but I stand by all of those comments. Thank you for being with us. Mr. Serrano. You must be referring to Ralph Regula. Mr. Bonner. Thank you, Mr. Chairman. Mr. Serrano. Thank you. Should we read back the record? Mr. Nussle. It was all good things. Mr. Serrano. Yes, I understand. I am going to just ask you a couple of more things. We do not want to keep you here much longer. A-76 AND OMB DIRECTION On this outsourcing issue, OMB has been very aggressive in telling agencies how and when to use the A-76 process. OMB's A- 76 direction to agencies has taken the form of everything, from numerical quotas to quarterly PMA score cards. This has generated bipartisan congressional concern. The 2008 Financial Services Bill from this Committee included a government-wide prohibition, 739[d], against, one, OMB directing or requiring agencies to prepare for, undertake, continue, or complete any A-76 activity; two, any agency following OMB's direction or requirements to prepare for, undertake, continue, or complete any A-76 activity. On February 20th, OMB issued guidance to ensure compliance with several A-76 related provisions in the bill, but absent from the OMB guidance was any discussion of 739[d]. So the first question is, has OMB implemented 739[d]? If so, how has that happened? Has OMB issued guidance that makes it clear that OMB will not force agencies to meet privatization goals if the agencies determine that it is inconsistent with their missions? Please provide the Subcommittee with copies of that direction to agencies and show me how agencies' A-76 schedules have changed, and, if not, is it reasonable to expect that the Congress will allow the Administration to pursue its A-76 agenda if OMB cannot follow the law? Should A-76 activity, as of the date of enactment of 739[d], be suspended administratively or legislatively until the prohibition is satisfactorily implemented? Mr. Nussle. I guess, to start with, Mr. Chairman, I think it might be good for me to provide this answer in writing for you and be very direct to your very direct question. Generally speaking, we believe we are following the law. We believe we are not giving direction to the agencies on any kind of specificity of how they should handle this, and we believe we have followed that directive. But I am sure there is a difference of opinion on that score, from what I understand, and so rather than to try and do it here verbally, I would recommend or suggest that I take that question and give it a very serious answer, in writing, to the Committee so that you can review that. Mr. Serrano. Well, we would appreciate that, but I still would like to know, if you can tell me, why there was no mention of 739[d] in the directive. Mr. Nussle. We thought it was covered within the directive. That is why I say, I think there may be a difference here in interpretation. We thought it was covered, would be my answer. Mr. Serrano. All right. Okay. So we will get that in writing from you. PRESIDENTIAL EARMARKS Last question: Does the President submit earmarks, and, if so, how much? Mr. Nussle. The President does not submit earmarks. We believe that the difference here is that, and I understand there is a difference of opinion as to what is an administration earmark and what is not, I think the big difference here, if I may say, is that, first of all, anything we propose, as far as spending, was submitted in February and will be laying out there for the entire world to see, including justifications for the next however many months it takes for any of those to be considered before they may be put into possibly an appropriation bill as much as nine months to a year later, and they are based on what we think is a meritorious process. Often, if they are directed spending, they are directed in order to complete a task that has been part of a bill for some time, or part of a spending measure for some time, and in those instances where they are not, where there are pools of money, they are meant to be done in a competitive way. In fact, I went through the budget this year in a specific way to try and root out any of those that were not done, based on merit or based in a competitive process. Mr. Serrano. But here is where we may have the difference, and here is where you may want to answer later on. If the president says, ``I want X amount of billions for education,'' that is no different than if we say, ``We are allocating, appropriating, X amount of billions to education.'' But if we say, within the bill, ``and with that X amount of billions, $2 million are going to go to Serrano's district to build a particular school,'' that is an earmark. So when the President says, ``I want this from Congress for a particular program,'' that is fine, but when the president says, ``And within that, I am going to create a program in your district for so much,'' is that not an earmark? Mr. Nussle. You will not find those in our budget. Let me go back to your---- Mr. Serrano. You do not find in your budgets, for instance, on the HIDTA, certain amounts of money going directly to certain communities? Mr. Nussle. But those are already competitively done as part of the process. They are based on merit and criteria that determine that. It is not a decision that was made arbitrarily, where I say, for instance, for Mr. Visclosky's district, that it goes specifically to Lake County and Gary, Indiana, based on only my judgment, as the OMB Director. Mr. Serrano. Well, that is basically the whole argument about earmarks. Remember, I started off by saying that I do not think only someone at an agency level understands what my district needs. That is where I think the basic difference comes in. Mr. Nussle. Sure. Mr. Serrano. I do not see a difference between me sending dollars to clean up the Bronx River because, otherwise, that agency would have never sent dollars to clean up the Bronx River, or the President, within an environmental dollar expenditure, sending dollars to clean up a particular river in California, Texas, Ohio, wherever. To me, that is an earmark, too. Anyway, to be continued. Mr. Hinchey. Mr. Chairman, one last question. Mr. Serrano. I was pointing to my right. Mr. Hinchey. I am usually to your left, Mr. Chairman. Mr. Serrano. Anyway, Mr. Hinchey will end our hearing. Mr. Hinchey. Thank you, Mr. Chairman. Mr. Serrano. All right. TCE RISK ASSESSMENT PROGRAM Mr. Hinchey. I just wanted to ask you about one question involving the EPA, which is a critical question in a lot of communities across the country, and it involves a substance called trichloroethylene, TCE. TCE was used abundantly by a lot of manufacturing corporations up to a decade or two ago, and a lot of it is in ground water and is being absorbed by breathing into homes and businesses in various places. A lot of attention has been paid to it. In July of 2006, the National Academy of Sciences, their National Research Council, came out with a report that said that the health impacts of TCE were severe in terms of things like kidney cancer, neurological problems, heart defects, and that they were particularly severe on women and children, particularly women with pregnancies. The EPA went to work on that, and they began to develop a risk-assessment program. Actually, they revised what they had. That risk-assessment program now has been essentially completed, but I understand that putting it into effect, is now being held up by the information and regulatory affairs operation of OMB. Now, if that can be overcome rapidly, it would be in the very direct and important interest of hundreds of thousands, maybe millions, of people across the country because there are thousands of these pollution sites all over the country. So I would appreciate it, Mr. Director, if you---- Mr. Nussle. I will look into that. Mr. Hinchey. Thank you. Mr. Nussle. I am not familiar with where that is in process, so let me look into that. Mr. Hinchey. Okay. Would you get back to me on that? Mr. Nussle. I can, yes, sir. Mr. Hinchey. I would appreciate it. Mr. Nussle. Okay. Mr. Hinchey. Thank you very much. Thank you very much, Mr. Chairman. Mr. Serrano. Thank you. Mr. Bonner, you have no further questions? Mr. Bonner. No. Thank you. Mr. Serrano. Mr. Director, we thank you so much for your testimony and for being here with us today. Mr. Nussle. Thank you, Mr. Chairman. Mr. Serrano. We thank you for agreeing with us on earmarks. Mr. Nussle. That is the way I heard it. Mr. Serrano. We thank you for the fact that you will now start recruiting in Puerto Rico and the territories. Mr. Nussle. I am leaving this afternoon. Mr. Serrano. We really do. We look forward to working with you for the benefit of the American people, and I thank you. And this meeting is adjourned.
Tuesday, April 15, 2008. INTERNAL REVENUE SERVICE WITNESSES DOUGLAS SHULMAN, COMMISSIONER OF INTERNAL REVENUE LINDA STIFF, DEPUTY COMMISSIONER FOR SERVICES AND ENFORCEMENT Chairman Serrano's Opening Statement Mr. Serrano. Good morning to all. For those who may wonder, although there shouldn't be anyone who wonders, the 42 in front of my nameplate is a tribute to number 42 for the Brooklyn Dodgers, Jackie Robinson. Today is Jackie Robinson Day throughout baseball. It is the day when all baseball players are being asked to wear 42, or at least a couple of members on each team. Of course, my beloved Yankees have the only person grandfathered with 42, Mariano Rivera. As soon as he retires, that number will not be used any longer. And it is just a small way for me to pay tribute to a person who not just integrated baseball, but in my opinion, he integrated our country. I don't think our country has been the same since that 1947 season, and it has been for the good. And just an aside, Mr. Regula. We claimed that we work a lot of times under pressure, and we do. I can't imagine what it must have been like to play that first season under that pressure and still perform at Rookie of the Year quality. This is a special person. The National Archives, one of the agencies in our portfolio of agencies, just published a document about Lieutenant Jackie Robinson and his refusal to sit in the wrong bus as an officer of the military. There was a bus for African American soldiers, there was a bus for white soldiers, and there was a bus for officers. So he went into the officers' bus, and he was sent into the bus for African American soldiers. And he said, ``I am an officer, and officers go in that bus.'' He was court- martialed. They didn't get too far with it, but it just shows you, especially if you are younger than some of us on this panel, what an incredible person that he was. And so today we honor, at least this Chairman, and I know this committee joins me, in honoring number 42. We would like to welcome our guests today. The subcommittee will now come to order. And today is April 15th, not only the day when we honor Jackie Robinson but it is also the day when we pay our taxes. And I hope everybody did. I filed, e-filed, and my 22-cent return came back immediately. It is fitting that the subcommittee is meeting today to hear testimony from the Internal Revenue Service on its budget request for fiscal year 2009. As the largest component of the Financial Services and General Government Appropriations bill, comprising more than half the total amount of funds provided by our subcommittee in fiscal year 2008, the IRS is clearly a major focus of our work. In addition, as the collector of approximately $2.4 trillion in Federal revenue each year and as an employer of more than 100,000 people, the IRS is an important presence in the Federal Government. The IRS plays a very public role as a representative of our Federal Government in the lives of most Americans. In many cases, it is one of the few contacts many Americans have with the Federal Government. It is up to all of us to ensure that the IRS is able to perform its functions in a fair, competent manner and to ensure that the IRS has the resources to do so. Today the IRS is involved in numerous activities, including explaining tax law, answering taxpayers' questions, assisting with tax return preparation, processing returns, conducting criminal investigations and much more. At the same time, the IRS is working to improve its business processes and computer systems through the multiyear business systems modernization program. Currently the IRS is playing a vital role in helping to implement the Economic Stimulus Act of 2008 and the rebate program, in addition to processing nearly 140 million individual tax returns. We look forward today to discussing some of the issues facing the IRS. In the area of taxpayer service, the IRS is in the midst of implementing the Taxpayer Assistance Blueprint, a 5-year plan for improving IRS taxpayer services. At the same time, however, I am concerned that the IRS budget request freezes funding for taxpayer services at last year's level, even as funding for tax enforcement is proposed for a 7 percent increase. I look forward to discussing the IRS budget request today. Another major concern is the ongoing private debt collection program at the IRS. If you hear any hissing in the background, it is not by any Members of Congress; it is just the general feeling. I continue to oppose the private debt collection program, as many other people do. The program allows private companies to collect unpaid taxes and to pocket up to 24 percent of the tax revenue they help collect. This issue was raised at the Commissioner's Senate confirmation hearing as well as at this subcommittee's recent hearing with Secretary Paulson. And I look forward to discussing the issue again today, as well. It is my hope that although he has just begun in his new position, the new Commissioner will have come to the same conclusion as many in Congress--that this program should not be continued. On March 13th, Douglas Shulman was confirmed by the United States Senate to be the 47th Commissioner of Internal Revenue. We thank you for your service. We thank you for joining us today. We thank you for accepting this important position in our Government, this 5-year appointment. And we look forward to your testimony. We remind you that your testimony should be held to 5 minutes. Your full statement will go in the record, and then we will have a chance, as taxpayers, to get even with you on this special day. And now a man who has always paid his taxes on time--in fact, he asks the Government to take more, just to be a great American--there he is, Mr. Regula. Mr. Regula's Opening Statement Mr. Regula. I think I saw somewhere that there is a proposal for legislation that would allow those who feel that taxes aren't high enough to add an additional amount to the taxes they pay. I believe that is a legislative proposal floating around here somewhere along those lines. Mr. Serrano. Well, I send an extra bunch of money to New York every month, but that is because they don't take out city taxes. Mr. Regula. Right. Well, you covered this topic pretty well. I think what the taxpayers really want is to feel a sense that everyone is paying their fair share. They understand that you need taxes to operate Government, but when they read in the paper that $300- plus billion are not collected that should be, that is always a little bit distressing to the average taxpayer, because he or she thinks, ``Well, I am paying my fair share and filing a return. Why doesn't everybody else have to?'' And I just saw an article--I think it was in Time or Newsweek, one of them--where a number of corporations aren't paying all the taxes they owe. And those are the kinds of things that distress the public. And I see that, in our budget, we have an additional $358 million to enhance your collection procedures. And I hope that in your role as the Commissioner that you do push hard to ensure that we have fair and adequate enforcement of the tax laws so that everybody is paying their fair share. One other comment. I think you have done a remarkable job of adapting to Congress's constant changes of the tax law. And this year, particularly with the requirement for the extra funding for citizens and also the changes in the AMT, that you have had challenges in getting forms out. I am sure this was quite a difficult problem, to get everything out on time for taxpayers who wanted to file and were required to file. So we will be as supportive as possible of programs that ensure fairness and ensure prompt information to the taxpayers so they can make the right decisions in filing their own tax returns. And it has to be a challenging assignment, to say the least, because going back to biblical times, tax collectors were not the most popular people in town, when you read about their role in ancient history. And so we wish you well in your new assignment. Mr. Shulman. Thank you. Mr. Serrano. Thank you, Mr. Regula. You know, Mr. Regula and I were discussing the other day-- of course, he is leaving Congress, much to the loss of the Nation. He is leaving Congress, but next year at this time, what do we do about hearings and about conversations with a new President, new administration and a lot of new folks that, at this point next year, may not even know what their budgets should be like, you know. And we just had a comment from Mr. Nussle, where he said they would not prepare a budget. And yet you are one of the few--you, I believe the Archivist and just a couple of other people--in the Government who don't have to leave. And so we hope to establish a relationship with you that will carry over to the next administration at the White House. So we welcome you once again, and we welcome your testimony. Commissioner Shulman's Testimony Mr. Shulman. Thank you, Chairman Serrano and Ranking Member Regula, and thank you to all the members of the subcommittee for having me be here today. I have been Commissioner for 3 weeks, as you said. And I would like to reiterate to all the members what I have assured the Chairman and Ranking Member in private conversations: that I look forward to working with this Subcommittee for the years to come, and to address all the critical issues facing the IRS. I would also like to introduce the two Deputy Commissioners of the IRS, Richard Spires and Linda Stiff, and really commend them for doing an excellent job running the agency for the last 6 months while I was going through the confirmation process-- Linda, as Acting Commissioner; Richard, as Deputy. They helped guide the agency through a difficult filing season and the stimulus payment process, which is ongoing. This morning what I would like to do is touch on the filing season, stimulus payments and the 2009 budget, take a minute or two to discuss a few important issues to me as IRS Commissioner, and then I'd be happy to take your questions. We are completing what, by all measures, looks like a successful filing season. I have some statistics from April 5th that I would like to share with you. One is the substantial increase in the number of electronic filers, a substantial--up 10 percent from a year ago. Mr. Chairman, I was heartened to hear that you are an electronic filer. And I know, Mr. Regula, you prepare your own taxes. The number of returns prepared by volunteers through our VITA program and tax-counseling-for-the-elderly program is up 26 percent year-to-date. Our usage of the Free File program, which allows 70 percent of Americans to prepare and file their returns electronically, is up almost 20 percent. And the IRS Web site, which is really designed to give assistance to taxpayers, has seen the usage increase 21 percent. We are also having what looks like a successful filing season, despite the late enactment of the AMT patch and the fact that we have been simultaneously preparing to send out economic stimulus payments to millions of Americans. Regarding economic stimulus, we conducted extensive outreach to make sure that the American public understands this program. And we have put special emphasis on the group of Americans who normally wouldn't have to file their tax returns, but need to file a tax return this year to get the stimulus payment. That group includes people on Social Security, people getting veterans benefits, low-income workers. I also want to urge this subcommittee to support full funding of the IRS's proposed 2009 budget. The budget will allow us to continue our strong focus on both taxpayer service and enforcement. During my confirmation process, I was asked the question that I think all IRS Commissioners are asked: ``Are you going to focus on service or enforcement?'' What I told the Senate Finance Committee and what I tell you is I actually believe this is a false choice. I fervently believe that, in order for the IRS to achieve its compliance goals, it needs to focus on both. If I state that another way, in my own language, the IRS should do everything it can to make it as seamless and easy as possible for those taxpayers who are trying to pay the right amount of taxes navigate our organization, get their questions answered, pay their taxes and get on their way. But for those who understand their Federal tax obligations but fail to comply, we must have an aggressive enforcement program. The IRS has been very active in its compliance programs in recent years. We collected $59 billion in additional revenue through enforcement activities last year, which is a substantial increase over the last 5 years. And that is only direct revenue attributable to specific enforcement actions, not taking into account the deterrent effect of enforcement programs. Another area of focus during my tenure will be maximizing the effectiveness of IRS's technology and systems. The evolution of technology has profoundly altered the way that both business and Government operate. The IRS is continuing to adapt to this changing world. And our goal is pretty simple: It is to get the right information into the right hands of the right people at the right time. My vision for modernization starts at a fundamental place, which is that the expectations of taxpayers are high and only getting higher, and we owe it to them to do everything we can to meet those expectations. And finally, during my tenure as IRS Commissioner, we--like other Federal agencies and other private-sector industries that are facing a retiring workforce, a change in the demographics of the workforce--are going to need to continue to focus on our leadership development and our workforce. A talented, dedicated workforce will form the foundation of what we do in the future. Thank you again, Mr. Chairman, for the opportunity to appear this morning before this Subcommittee. In my short tenure, I have found the issues complex at the IRS, but the people and the professionals who lead the IRS and work at the IRS to be professional, hard-working and dedicated. You have my commitment to show up every day and try to provide taxpayers the high level of service that they deserve and to pursue enforcement actions against those unwilling to meet their tax obligations. Of course we need resources to execute our plan. I hope this Subcommittee will support full funding of the Administration's 2009 budget proposal. Thanks again for having me here, and I am happy to respond to questions. [The information follows:]
ECONOMIC STIMULUS REBATE CHECKS Mr. Serrano. Well, I thank you. And I want to echo momentarily what Mr. Regula said. If there is ever a problem, it is the belief by many Americans-- for our purposes, say some Americans--that some folks are not meeting their obligations. And sometimes, for instance, when we see in the budget or we read that there is more emphasis being made on lower-income or Earned Income Tax Credit folks in terms of auditing them and that corporate America is getting less and less audits, that adds to that perception that Mr. Regula speaks about. Let me talk to you briefly about the economic stimulus rebate checks. As we all know, the IRS is working with the Financial Management Service on getting out the rebate checks for taxpayers as part of the Economic Stimulus Act. One thing I would just like to clarify with you: As long as an individual files a tax return and fits the income qualifications for getting a rebate check, they will, in fact, get the check as long as they don't owe back taxes, Federal taxes--am I correct?--or have outstanding debts like student loan debt or overdue child support. Is that correct? And my understanding of outstanding student loan debt means not that they are ongoing in their payments but that they are behind in their payments. Mr. Shulman. That is correct. Mr. Serrano. So a person who has a student loan outstanding is not in trouble here, just a person who hasn't made their payments. Mr. Shulman. That is correct. Mr. Serrano. Okay. Now, does that include also child support issues? Mr. Shulman. I believe so. Yes, I believe so. It is about if they are behind in payments, not just that they have child support payments, student loan payments. And you are correct, as we had a chance to discuss, regarding Federal taxes. Mr. Serrano. Okay. Now, do States get into the act? Mr. Shulman. No. This is a Federal program, not involved with State---- Mr. Serrano. So if you owe State taxes, this does not affect your ability to get the check? Mr. Shulman. Correct. Mr. Serrano. Have you clarified with the territories--one of my favorite subjects--how those checks will go out to the territories? You know, our big victory was including the territories in the rebate. Now, we know that they don't have Federal tax lists for you to work off, so the money has to go--the funds have to go to the local government. Can the local government then say, ``You owe us, the Commonwealth of Puerto Rico, you owe Guam money; therefore, we are going to take that out of these''? Because then technically what we would be doing is using Federal dollars to subsidize a local issue. Do we have a reading on that? Mr. Shulman. Well---- Mr. Serrano. And I don't think we should, just for the record. Mr. Shulman. As you know, the territories were included in this stimulus program that the Congress passed and the President signed. We do not administer the tax laws in jurisdictions of the territories. Actually, we are working with the territories now--it is in the hands of the Treasury Department--to work out exactly how we will be refunding them their payments. The final details of those are not settled yet, but my understanding is, the talks are going very well, and that these discussions--that a decision is relatively imminent. It should happen soon. Mr. Serrano. But these are more Treasury discussions than IRS discussions, is what you are saying? Mr. Shulman. Correct. Mr. Serrano. But if it comes by your desk, it wouldn't make any of us unhappy if you reminded the territories that this is not to pay for any local debt. Mr. Shulman. Understood. Mr. Serrano. The idea is for them to go spend that money and stimulate the economy. That was the purpose. IRS PRIVATE DEBT COLLECTION Mr. Serrano. Let's turn to something more controversial, the private debt collectors or, as I have said on a couple of occasions here, a wonderful idea for a ``Sopranos'' episode, collecting debt. The Commissioner doesn't get it. Any time you give somebody an incentive of 24 percent on the dollar, the behavior could be something that we live to regret. I asked this question of Secretary Paulson, and I would like to ask it today as well. This time last year, the IRS was planning to greatly expand the number of private companies conducting IRS collection work, but now you are planning on sticking with just the current two companies. What are your thoughts on the program? Do you believe it should continue? Does this change in plans indicate that the IRS is starting to have the same doubts about the usefulness of this program? Or is it an IRS reaction to the many people in Congress who disagree that this program should continue? Mr. Shulman. I am well aware of this program. I had a number of conversations with Senators about this program throughout my confirmation process. If I can step back just a little bit, with the topic of the hearing being the budget and resource allocation, it is very clear to me that one of the most important parts of my job is going to be getting my arms around all of the activities of the IRS, both the service activities that help taxpayers voluntarily send in their money and provide services to them, as well as all of our enforcement tools, whether it be collection--our internal systems or this private debt collection--our audit program, our enforcement program, our criminal investigation resources. And how we choose to fund and focus those resources will be some of the most important decisions I make. This program specifically, like a lot of programs, I am just getting my arms around it. I make a commitment to all members of this Committee that this program is one I will focus on, understand better and come to my conclusions about whether it is meeting its purpose. A couple of things I have seen. One is, it is my understanding it has been authorized by Congress, and I know that the people at the Service are doing their best to run it well. ``Run it well'' means to meet the intent of bringing in taxes that otherwise wouldn't be collected, as well as making sure that taxpayer rights and data privacy are protected and that there is proper oversight. I think it is too early in my tenure to really have a lot more opinions about the program, but I understand the concerns that you and others have expressed, Mr. Chairman. And you have my commitment to get my arms around the program and come back for more conversations. Mr. Serrano. Sure. Thank you for that answer. And let me just clarify something for you in a very friendly way. You made an interesting point and a right, correct point. You said this is a budget hearing. There are two things you should know about the appropriations process. One is we are not supposed to legislate on appropriations bills, but it happens all the time. And secondly, we are only supposed to discuss budget at these hearings, but most of the time we end up also discussing issues that are not necessarily just budget issues, although they all have dollars attached to it. So this stopped being, really, a discussion of dollars a long time ago and just of the process. But speaking of dollars, the IRS taxpayer advocate noted in a hearing last month that the IRS projects that the program will generate gross revenue averaging about $23 million this year and next year. At the same time, it is costing $7.6 million a year in appropriated funds, as well as roughly $4.6 million in tax collections that the companies get to keep for themselves, the 24 percent. If these two expenditures, the $7.6 million and the $4.6 million in lost revenue, were instead invested in IRS employees to work these same cases, how much revenue do you believe could be collected? Mr. Shulman. Again, I am still getting my arms around these issues. I have seen a lot of the numbers, and I need to understand them better. And if I can just make the point, by no means was I giving a broad budget update. Any discussion, of course, this Committee wants to have, I am happy to have. Mr. Serrano. It was a very friendly comment. Nothing that is nasty on Jackie Robinson Day, trust me. I have many more questions, but we will move on now to Mr. Regula, our Ranking Member. Mr. Regula. Well, as I said earlier, what most taxpayers want to have is a sense that everyone else is paying their fair share. And the question then arises on private debt collection whether or not that does enhance the ability of the Government to ensure that that number, whatever it is, $300 billion or so, is collected. And they estimate that this increases revenue by $600 million over 10 years. And I know there are other agencies who have successfully used private contractors, such as Education, Health and Human Services. And there is some concern that this takes away from employees, but I think it really provides assistance to them. What do you see--and I realize it is early in the program-- as the benefits of this program? Mr. Shulman. Well, my understanding is that it was authorized specifically as money to go toward collection efforts for cases that otherwise wouldn't be pursued by the IRS. And I know, again, there is a lot of debate about both sides of this. And so, to the extent it is money that we wouldn't otherwise get and to the extent it is going after cases we wouldn't otherwise get to, I think that is the obvious benefit. Mr. Regula. Well, if the private debt collectors can collect, why can't agents of the IRS do the same? Mr. Shulman. Well, again, I am still getting my arms around it, and I apologize to the Committee to come so early and that I still have to get my arms around it. But I want to make sure that any conversation I have with you is fully informed. My understanding is that, because these are private contractors, there are some limitations on the kinds of cases that they can work. And they clearly can't use some of the tools that the IRS has, like liens and levies and other things. So these are cases where there is clearly debt owed, some lower-dollar-amount cases. The IRS only has so many resources. It can't pursue every single case and every single time that we think that there is money that ought to be coming. We have to allocate our resources appropriately. And so these are cases that otherwise weren't being worked, that meet those criteria, and the IRS can pursue these cases with these---- Mr. Regula. I don't think the public would believe that you can't pursue some cases. If they have dealt with the IRS, they have been convinced that you do, just like the FBI or whatever. There isn't any place to hide. It seems to me you ought to at least take a good look at whether your collection procedures are adequate, and if therefore you would not need private debt collectors. They certainly can't have any magic, as to how they get it done, as opposed to what could be done by your own agents. But, again, this is part of ensuring the public that everybody is paying their fair share. I have a number of questions for the record, a couple of things. IRS TAXPAYER SERVICES Do you let the public know about your taxpayer services adequately, like the Taxpayer Advocate Service, Voluntary Income Tax Assistance and so on? I am not sure the public realizes that these services are available, and maybe there ought to be some enhancement of letting people know. Mr. Shulman. Yes, you know, people have asked me. One of the main reasons I took this job is because this agency touches and has interaction with every single individual adult in the country, as well as every business and every nonprofit group. It has a profound effect on the way that Americans view their Government. And I believe--again, I am still getting my arms around our exact outreach, et cetera. I am very committed to making sure our service programs are effective when people come to us and people understand that the IRS can help. Because I happened to take this job right around April 15th, which in addition to Jackie Robinson Day is a big day for us, I had the opportunity to go out and talk with a variety of people and some media outlets. And one of the interesting questions that came to me was, ``if someone just can't pay, what should they do?'' And my notion--you should reach out to us, you shouldn't disappear, you shouldn't go dark, you should call us and we have people who will help you work through those issues--I think a lot of people don't recognize. And under my tenure, I am going to make sure, it is a major focus of ours to make sure our services are excellent and let everybody know that those services are available. Mr. Regula. Well, I am always struck when I see the TV ads from the professionals who say, ``Got a problem with IRS? Call us.'' And they imply that their services will result in your tax bill being substantially reduced. Now, I question that. The law is the law, and they don't have any magic understanding of the law. But at least, if you have the services I have just described, they ought to be available to taxpayers, in lieu of having to pay these professionals to do the job. SIMPLIFYING THE TAX CODE Tax complexity, we always--that is a very popular thing on the campaign circuit, is to say, well, we are going to reduce the tax code and so on. But, of course, so long as you don't reduce any preference that I might have, why, it is a good idea to simplify the tax code--1,395,000 words. I was really struck by the fact that Tom Friedman, in his book, ``The World is Flat,'' said that 400,000 U.S. tax returns were done in India last year. I find that rather appalling, in a way, that people have to send their tax returns to India to be done and that we can't do that in this country. And there is an increase in the use of tax consultants, if you will. I know it is not your responsibility. In a way, it is up to the Congress to deal with the complexity in the tax code. And we usually end up adding instead of subtracting. But do you have any capability in the agency to reduce the number of outsiders that do tax returns? Is there any simplification that you can build into the returns themselves? Mr. Shulman. Well, it is a good question. It is one that I have asked myself. What I would say is, I am on the record, I think the tax code is complex. And as the representative of the Government trying to interact with the American people getting their taxes done, the simpler we can make the tax code, the better. With that said, I am going to stay out of tax policy questions, leave that to Congress, the Treasury and people who are more engaged in tax policy than I am. I think to the extent we can make life easier for people and simplify things, we should. I actually did some surfing on our Web site as I was preparing for this hearing and through my confirmation process. I think we have done a pretty good job of posting frequently asked questions, having the ability to get questions answered. I think the more we can do to get good information out there, the better. Regarding tax preparers and who prepares people's taxes, what I will tell you is I want to make sure--you know, they are a vital part of the system. Whether we like it or not, a lot of people use professionals to prepare their taxes--sure we have good information for individuals, we make it as easy and cheap as possible for them to comply, and we support the professional community so that their costs are low for people using them. Mr. Regula. I was in a bookstore, and I saw a whole array of volumes, and they looked like a telephone book, of how to prepare your taxes, ``J.K. Lasser'' just one of many. And it must be sort of overwhelming to the average citizen to go in there and see all these different volumes of information on how to do your taxes. And I suppose simplification lies somewhere out in the far distant future. Thank you, Mr. Chairman. Mr. Serrano. Thank you. I must tell you, Mr. Commissioner, that I know some of these questions seem leading to some difficulty in the future, some tough issues. But the good news is that when Mr. Hinchey and I started out in politics on the same day in 1975, elected office, the two most disliked agencies in my district were the IRS and Immigration. Well, since September 11th, you are not even an issue; Immigration outweighs you. They are highly disliked in my district, trust me. And, you know, the Commissioner has a connection to both of our States. He is from Dayton, Ohio, and he was a school teacher in my congressional district. Mr. Regula. Teach for America? Mr. Shulman. I was involved in the starting of it, Teach for America. And I taught at Bronx Regional High School off of Prospect Avenue for a while. Mr. Serrano. There you go. Mr. Regula. As someone very interested in education, if you will permit me, Teach for America I think is a terrific program. And you were involved in starting it? Mr. Shulman. I was one of the first few staff members who put it together. So I am one of the original co-founders. Mr. Regula. I congratulate you. Mr. Serrano. You served how many years on the Ed and Labor Committee? Mr. Regula. Oh, well, I was Chairman for 6 years, where we had labor and education and so on. And I know last year Teach for America had 20,000 applications, with something like 2,000 slots. Terrific program. Mr. Shulman. Yes, it is an amazing thing, what they have done. Wendy Kopp, who runs it, has done a phenomenal job over the years. Mr. Serrano. Mr. Hinchey. Mr. Hinchey. Thank you, Mr. Chairman. Mr. Shulman, it is a great pleasure seeing you, and thank you very much for being here. Meeting you has been very comforting and instilling in confidence. I think that we are very fortunate to have someone as intelligent and wise and committed as you are working on this very important job. As you said, it is the one aspect of Government with which people have the most contact, and stays in their minds more than any other aspect of this Federal Government. And I very much appreciate our Chairman for the questions he asked and the opening statements that he made. I think they were really right on target. As he said, we have been friends and associated for a long time. The only difference now is immigration is not as big a problem in my district as it is in his. It is a little bit different situation in upstate New York as it is in the Bronx. Mr. Serrano. It was a couple hundred years ago. Mr. Hinchey. Yeah, it was, I know. When you are having fun, time flies. OUTSOURCING DEBT COLLECTION There is an interesting story in the Post today about--the headline is, ``Collectors Cost IRS More Than They Raise,'' which was an important question that was raised by the Chairman. I know it isn't anything that you have been involved in, but it is something that you have to deal with. And the interesting part of the story is that we are paying more for the outsourcing of this activity, almost twice as much as is being taken in. So it doesn't seem to me to make an awful lot of sense, and I think it is something that the Congress really has to address its attention to, as to whether or not this is the best way for the Internal Revenue Service to have to function. I think that it has always functioned best when the work was done here, locally, internally, within our own country. And the idea of sending some of this work out to countries in other parts of the world, particularly as far away as India, just doesn't make any sense whatsoever. The outsourcing of that work is, I think, a big mistake. It is something that was done intentionally, I think, and it began back in 1995 when a new Congress came into effect. And the results of what they put into place has reduced the number of IRS employees by--I think the number is more than 27,000, reduction in IRS employees. I think that needs to be corrected. I think we need to change this set of circumstances and bring back the Internal Revenue Service wholly within our country and wholly within the Government. That is the best way that we can make sure that it operates effectively and in accordance with the law. I think there are a whole host of potential problems that arise by the privatization of this kind of work, including the potential exploitation of people who could have that kind of situation inflicted upon them as a result of the privatization. So I just raise these issues, knowing that this isn't anything that you have had anything to do with. You are just coming into a situation where you have to confront these issues. But over time, I would greatly appreciate it if you would consult with us and provide us with information that you accumulate as a result of your ongoing experience here, to let us know what you think about this situation, the outsourcing of this work, the downgrading in the number of employees. There is some legislation now which is pending. In fact, the bill in the House here, I believe, has recently passed through the Ways and Means Committee, which would change the privatization and the outsourcing of this work and bring it wholly back within our own country, within our own Government, so that I think it works in a much better way. So I just want to express to you my appreciation and gratitude. I know you have only been here a few weeks, but you are going to be here hopefully for a good number of years. What is it, 10 years? Mr. Shulman. Five. Mr. Hinchey. Five. Well, maybe it will be 10. At least 5, because I have a great sense of confidence in the way in which you will be able to carry out this very, very important job. And as I have asked, if you wouldn't mind keeping in touch with us and letting us know what you see, insightfully from your position as the Commissioner now, about how this outsourcing is working, what we need to do about this cutting back on 27,000 people to make the IRS weaker. And I think a lot of that weakness was intentionally focused on the highest potential taxpayers in the country. But that is my own observation based upon the legislation that was passed back in 1995, something that I opposed then and continue to oppose, because I believe that this is an issue that the Government should be involved in, and it should be held accountable to the people of the country. And I think that is the best way to do it. So other than that, I don't have any questions. But I just want to say again, I am very grateful to you for being here. I have a lot of confidence in the way in which you are going to operate the situation. And I hope that you will provide us with the insightful information that you acquire over the course of the next few years. Thank you very much, Mr. Shulman. Mr. Shulman. Thank you. I appreciate the confidence. And as I said, I am looking forward to an ongoing dialogue with you and other members of the Committee. Mr. Hinchey. Thank you. Mr. Serrano. Thank you. Say, are movie stars allowed to claim clothing and other things? Does anybody know? Because we are on stage a lot. Mr. Shulman. Somebody does, not me. Mr. Serrano. Let's find out if they do. Because, you know, Mr. Hinchey has to keep up an appearance and all that. Mr. Regula. Deduct our suits? Mr. Serrano. Why not? We are on stage most of the time. The gentleman who is never on stage but always performing properly, Mr. Bonner. Mr. Bonner. Thank you, Mr. Chairman. I wondered if you thought about seizing this opportunity with the Commissioner and asking for the Internal Revenue Service to look into that dastardly act of some Red Sox fan trying to plant a jersey at the new Yankees stadium. That seems to be a case worthy of the IRS's attention. Mr. Serrano. Let me tell you what almost happened to me, and I was saved by something wonderful from up above. I was going to put out a statement saying, ``The nerve of these outsiders who come and work in the Bronx, work in a poor community, make a lot of money, and then leave and go upstate or Long Island and insult us.'' Turns out, the guy lives in the Bronx, who did that. But we took it out of there, at the cost to the management company, to the construction company. And in typical New York fashion, we kind of gave it back to them. We took the shirt and sent it to The Jimmy Fund, and The Jimmy Fund will auction it off in Boston. And it will probably get more than the Barry Bonds baseball. Mr. Schiff. Will the Chairman yield? Mr. Serrano. Only if you say something pro-The Bronx. Mr. Schiff. I just want to say, go Red Sox. So I yield back to the Chair. Mr. Hinchey. Not after the last two days. Mr. Serrano. Does the phrase ``no earmarks'' sound familiar? Mr. Bonner. IRS SCRUTINY OF POLITICAL ACTIVITY Mr. Bonner. Mr. Chairman, thank you. I think each of us represents somewhere in the neighborhood of 635,000, 640,000, 650,000 Americans as part of the privilege of serving in Congress. And so I can imagine at least the 635,000 people in my district would probably love to have the chance I have to question, on tax day, the tax man. So, Commissioner, as you have heard from others, we thank you for your willingness to serve in this important position and certainly look forward to working with you. Let me ask a couple of questions. Yesterday I don't know if you had a chance to see Roll Call, which is the Capitol Hill newspaper, but there was an article on the front page entitled, ``IRS Scrutinizing Political Activity.'' And it went on to say that the Service has focused on charities and churches in the past to ensure that they don't violate the tax code by participating in excessive political activity. How, in your judgment, would you like to see the Service intensify its scrutiny of social welfare groups in addition to charities and churches? And the article also indicates that the IRS may believe that its strong arm could be more effective than, say, the Federal Elections Commission in reeling in nonprofits. And I was just curious if you had any thoughts about how the IRS could provide more effective enforcement. Mr. Shulman. Let me say a few things at a philosophical level around this issue. Again, like many programs, this is one that I am going to need to gain more familiarity about, but I did discuss the general issue of nonprofits and political activities with the Senate Finance Committee, and I will repeat here a couple of things I said here. One is I think it is very important that we be viewed as a nonpartisan institution that is administering our laws in a fair and equitable fashion. And you have my commitment that will be a focus of ours as long as I am Commissioner of the IRS, and I have every indication to believe that is what we do. Second, anyone who gets tax-exempt status gets a privilege from the Government and gets some monetary relief from the Government and, therefore, has to abide by the rules. And so my belief is that the group in the IRS, the professional staff who has year-in, year-out responsibilities to oversee the tax- exempt groups--and this will include their political activities or any other things that fall within the rules--owes it to the American people to make sure we are fair, we are even-handed, we give clear guidance. Anyone who is abusing the law, we are there. For people who aren't abusing the law, we are out of their way. And so I will look into it more, but I think the most important thing we can do is be very nonpartisan, by-the-book, and administer the law clearly and fairly in this area. IRS CUSTOMER SERVICE CALL CENTER ACCURACY Mr. Bonner. Separately, I will give you the example upon which I am basing this next question. But in your testimony and in your answer to the first question, talking about the importance of a group maintaining its tax-exempt status in a legal way, in your written testimony you provide several highlights of the IRS's 2007 accomplishments, one of which is that your customer assistance call centers last year provided a 91.2 percent accuracy rate on tax law questions. While that number is pretty high, I think a question--and I will give to your staff the example that I have in mind. How would you like to see the Service respond to cases where the taxpayer is given inaccurate information from the IRS, bases their actions on that information and then brings in a Member of Congress to try to resolve a dispute with the Service? Is there a way that we can get that 91 percent up? Mr. Shulman. Well, my hope would be--and I can't tell you the resources we have, the skill sets we have, et cetera--that when anyone has a question, we answer it in a timely and accurate manner. So that would be my guiding principle. I think any time there is a mistake by a Government agency, we should do everything we can to right that mistake. I would be happy to follow up on specific issues, so I can understand your question a little better. Mr. Bonner. All right. FAIRNESS And then the last question--the ranking member and the Chairman both talked about that fairness. And I know you were not on the job at the time, but last year there was a pretty high-profile case involving a Hollywood actor who many taxpayers, at least in my district, were shocked when he was found not guilty of Federal tax fraud. It sent a public message to some that you can fail to file a tax return for 6 years, making millions of dollars during that time, and that you may not have to pay taxes. Since we are talking about fairness, does that create a problem for you and your tens of thousands of employees when yesterday's USA Today had three other high-profile citizens of this country who have had tax problems? We may all one day come into that situation. But does a situation like the Wesley Snipes case, not to focus specifically on that gentleman, but just--does that create a problem, when average Americans who don't make that kind of money file their tax returns and feel some sense of frustration that the system is not fair? Mr. Shulman. As I have gotten a little bit of a look at our statistics, there are some interesting trends. One is, for individuals, our audit coverage has increased at the highest rate for million-dollar-plus incomes. And so we now audit one of every 11 people who make over $1 million a year. I think that is a good signal for the IRS to send out, that people who have a high income must pay their taxes. The next highest rate is above $200,000, and then we have some increases for other areas. But we have been putting more and more emphasis on high-income individuals, which I think is appropriate. And so I think those statistics that I have seen, that I support, speak to your question. Mr. Bonner. Okay. Thank you, Mr. Chairman. Mr. Serrano. Thank you. Now I would like to recognize my former friend, Mr. Schiff. ALL SAINTS CHURCH OF PASADENA Mr. Schiff. Thank you, Mr. Chairman. Commissioner, I want to follow up on Mr. Bonner's first question and familiarize you with a case out in Pasadena that you may not have had a chance to become acquainted with yet. On June 9th, back in 2005, the IRS notified All Saints Church of Pasadena that it was being investigated for violating rules regulating political speech for tax-exempt charitable and religious organizations. An investigation was launched in response to a sermon delivered by Pastor Emeritus George Regas in 2004 criticizing the President's policy in Iraq. All Saints is a large and historic congregation of Pasadena with a long history of commitment to social justice and peace values which are deeply rooted in the theology of All Saints. Pastor Regas's speech specifically declined to make any endorsement, saying, quote, ``good people of profound faith,'' unquote, may support either candidate. In its complaint, the IRS relied on a subjective characterization of the sermon's content from an LA Times article as a, quote, ``searing indictment,'' unquote, of the administration's policies in Iraq and at no point provided a contextual analysis of the sermon to explain why that investigation was warranted. Indeed, the impression was that the article, written by someone who I don't think was even present in the church, and its characterization of the sermon was more important to the IRS than the actual sermon that was given. Over the next 2 years, the IRS and All Saints exchanged extended correspondence, including an offer from the IRS to consider the matter closed if All Saints would only admit wrongdoing. All Saints refused. Finally, in 2007 the IRS sent a letter to All Saints stating that the investigation had been closed, yet, in a very self-serving way, still stating that All Saints had violated the rules against electioneering. So the IRS couldn't prove its case. All Saints never admitted wrongdoing. And so the IRS closes the case and says, ``Well, you still did wrong,'' effectively slurring All Saints without ever giving All Saints the opportunity to clear its good name. I am deeply concerned, Commissioner, that nearly 2\1/2\ years after the first notice of a church tax inquiry and after hundreds of pages of correspondence, All Saints and every other church or tax-exempt entity in the Nation has no better understanding of why the IRS found them to be in violation of their responsibilities as a 501(c)(3) organization. The lack of guidance from the IRS on tax-exempt organizations and of a standard of political interference creates the risk that legitimate political speech, and speech that relates to the theological roots of a religious organization to the present world, will be discouraged and shilled. I have advocated for some time that we develop a brighter line. I don't support having religious or charitable organizations get involved in electioneering. They should not. But I do think that they should have the ability to speak from the pulpit about issues like war and peace, justice and poverty, without risking losing their tax-exempt status. And I think that the line that we have now is so vague, it is very hard for religious organizations to know what they can and cannot say. And when the IRS treats a church like All Saints the way they did, saying, effectively, ``We think you violated the prohibition, but we won't tell you why, and we can't prove it sufficiently, so we are going to close the case, but we are still going to make the declaration that somehow you violated the law,'' that I think not only disserves that church, but also the broader community doesn't have any guidance from that about what it should think. All Saints wrote a letter to the Acting Commissioner, Linda Stiff, back in September of 2007 after the IRS closed the case, posing several significant issues with how the IRS conducted the investigation and also posing, I think, some very legitimate questions. One took issue with the fact that a threshold 7611 determination was never made by a high-level official, as required by law. Second, pointing out that the IRS had discussions with the Department of Justice prior to initiating the investigation and may have violated the privacy rights of the church, in violation of existing law as well, and asking, I think, several legitimate questions about the nature of the investigation. It has been 6 months since the church made this request of the IRS. It has not heard back on any of these points. I have the church's letter, Mr. Chairman, as well as a consent to the disclosure of tax information, a waiver by the church, so that you could both speak today about the case if you know any facts of the case or respond to this committee as well. And I would ask that both of these be admitted for the record. And I will provide them to you, Mr. Commissioner. Mr. Serrano. Without objection. [The information follows:]
Mr. Schiff. What I would ask is that, number one, the church has been waiting 6 months to have legitimate questions answered. I would ask that in 30 days that you give the church and this committee a response to the legitimate questions the church has asked. Seven months ought to be a sufficient time to answer these questions. So that is my first request. And beyond that, I would like to know, if you can, with greater specificity, how you think religious organizations can be guided, what do you advise a church that wants to talk about war and peace, that doesn't want to just talk about it maybe certain times of the year or during certain years but has to forgo discussing it around elections, what kind of advice do you give a religious institution? So if you could answer both those questions. Will you commit to responding within 30 days? And could you give us your thoughts on how a religious organization is supposed to know, based on this kind of track record, what it can and cannot say? Mr. Serrano. The Chair will note that the gentleman's 5 minutes are up. However, this merits an answer, and so we will take the answer. Mr. Shulman. Let me make a couple of brief comments. One is, as I told you, I am 3 weeks on the job, and am not familiar with the details of this case. I don't want to speak about anything that I can't speak about on a specific investigation. And so I really don't know where this case is and where the request is. And so I can make a commitment to you that I will go back and look into this and come back in what I view is a prompt fashion. Thirty days, I just--I don't know where this is in the pipeline and most of the information I have about this case comes from you. Mr. Schiff. Let me ask you for this commitment. The church has been waiting 6 months for an answer to this letter. Will you commit to giving a response to this committee in 30 days either to the questions or tell us in 30 days why you can't answer the questions yet? Mr. Shulman. I will commit to come back to you within 30 days and have a discussion. As a general principle, whether it be for this kind of guidance or other guidance, I think we are well-served as an agency to be as clear as we can with individual taxpayers, corporate taxpayers, nonprofit taxpayers, churches, about what are our rules, how do you stay on the right side of the line, so that there is not confusion. I have made public statements about that. I have talked to the staff about it, that during my tenure at the IRS I plan to push to have clear guidance. I think in this area, it is especially important that we have clear guidance because it is a sensitive area for churches, for politics, et cetera. It is also incredibly important that we be a nonpolitical, nonpartisan agency. The more we can be clear up front, the more that there is never any question of perception about that. And so I can't speak to the specific guidance to churches now. I am still getting my arms around a variety of issues. I can tell you, on a general level, I truly do believe that clear guidance is a good thing. This is something that I think is a valid point. And I will definitely be happy to come talk to you and talk to other members of the nonprofit community and church community about this going forward. [Clerk's note.--Upon completion of the hearing, Commissioner Shulman informed Congressman Schiff there had been additional correspondence with All Saints Church in Pasadena, and pursuant to the disclosure waiver, provided the Congressman with a copy. The correspondence is included for the record.]
Mr. Schiff. I thank the chairman for his indulgence of someone from Boston; and I look forward to, within 30 days, hearing back from you either in writing or if you want to meet instead. I would like to have the church involved, since it has most directly impacted them; and I will provide you with a waiver that they provided as well as their written request. And I thank you. Mr. Serrano. Thank you. The problem is not indulging over the 5 minutes. It is that Boston comment that keeps haunting me. Mr. Schiff. I realize that, Mr. Chairman. You are Mets, not Yankees, right? Or you are Yankees, not Mets? Mr. Serrano. I really think, Mr. Schiff, that you should talk to Mr. Hinchey and cut your losses just about now. Mr. Alexander. ECONOMIC STIMULUS REBATE CHECKS Mr. Alexander. Thank you, Mr. Chairman. Commissioner, I don't know if this will come as comfort to you, but in my congressional district you are still just like a lot more than immigration. When you say one has filed their tax statement, that doesn't necessarily mean that they owe money; is that correct? Mr. Shulman. I---- Mr. Alexander. There were many people who filed income taxes but don't owe anything? Mr. Shulman. Oh, absolutely. Mr. Alexander. So of this number of people that have filed, if some owe money but have not yet paid, do we still expect them to get a stimulus check? The rule is you have to file a return. Mr. Shulman. Yes, we do. I think until you are delinquent on your taxes and it is clear that you owe us, that once you file you get a stimulus check, unless you are in dispute and it has not been established that you owe us money. Mr. Serrano. That is a good question. If someone files an extension and we still don't know at that point if they owe, does that hold up their ability to get a check or does that take them out of the running to get a check? Mr. Shulman. Well, it doesn't take you out of the running. You actually have to file your return to get your stimulus payment. So if you file an extension, the government owes you a stimulus payment once you file your return. Mr. Serrano. Your return? Mr. Shulman. Your return. Mr. Serrano. This answers another question. So not everybody well get a check at the end of May? Mr. Shulman. What is that? Oh, no, you need to file. Mr. Serrano. So some checks will go out throughout the year? Mr. Shulman. Absolutely. Mr. Serrano. Okay, that is good to know. There is hope for all of us here. We don't qualify. IRS TAXPAYER SRVICES FUNDING The fiscal year '09 budget proposes to increase funding for enforcement by 7.1 percent. But funding for taxpayer services is flat. Why is this, Mr. Commissioner? If services plus enforcement equals compliance, why shouldn't both categories be increased, especially as the tax-paying population continues to increase? Couldn't the IRS make use of an increase in taxpayer services funding, especially as it continues to implement a taxpayer-assistance blueprint? Mr. Shulman. I know that the people at the IRS have been continuing to work on the taxpayer-assistance blueprint. Another thing I should point out is modernization funding isn't for widgets and servers and guys with propellers on their heads. It is to support enforcement and services. So part of the modernization funding actually supports services. I think the most important thing happening in modernization is trying to get real-time information into the hands of the people at the IRS who are helping people on the phone. So when you send in information in a real-time fashion you have to have the right information in their hand. And so, again, I am still getting my arms around the budget issues. I would say some of the modernization budget really is going to help with services. I think on the enforcement and services I would really need to understand better. This is a budget I inherited. I support full funding of it because our team has said it would help move the IRS forward. I think some of the very specific issues are trying to target areas where we know there is noncompliance. There is only so much money in the pot, and we needed to adjust it and make resource allocation decisions accordingly. And so my belief, from what I know now, is this budget will move us forward and will allow us to focus on both service and enforcement. I think there is always room for a very legitimate debate about how much you are putting in one till or the other. My goal is to get the right amount of money for both service and enforcement year in and year out to pursue our dual mission. Mr. Serrano. This makes me think about my initial comment about you having something in common with the Immigration Department. Mr. Hinchey can attest to this. There are many people who support border protection; and there are others who feel like we do, that, yes, border protection is important but also make it easier for those people waiting in line to become citizens who have been waiting for years to become citizens, balance it off. Here is the same thing. We want enforcement, but we also want you to supply tax services so that there is a balance, so it doesn't look only that you are going after a problem but rather helping people figure out the system. And that is where the discussion will always be on what money we are allocating, what you are asking for and what you are putting into it. EARNED INCOME TAX CREDIT DELAYS Let's talk a little bit about the Earned Income Tax Credit delays. At previous hearings I have raised the issue of IRS delays in processing many Earned Income Tax Credit refunds. This hurts those hard-working, low-income Americans who legitimately claim a credit. Do you have updated data on, one, the number of legitimate EITC claims that experience delays each year; two, how long, on average, are these delays; and, three, what is the IRS doing to further minimize the number of the legitimate EITC claims that experience delays? Mr. Shulman. If you would let me come back to you with the data, I don't have it at my fingertips. I will tell you I have sat down and talked with our team about the Earned Income Tax Credit. I think everyone at the IRS recognizes it is an incredibly important program for the Federal Government and for the taxpayers it serves. We have an extensive outreach program on the Earned Income Tax Credit. I think, regarding the delays, my understanding is new procedures were put in place to expedite getting out legitimate Earned Income Taxpayer Credit refunds. Anytime there is a question about it being a questionable claim, we apply due process to quickly resolve issues and avoid delaying legitimate payments. When I met with the team, it was very clear to me that they were trying to balance fraud prevention and fairly administering a refundable credit, which is susceptible to fraud, with making sure that low-income taxpayers, who often don't have the same resources to wrestle with their government, are getting very quick service. They are trying to balance both of these issues. I know the people are very dedicated to that, and I will remain dedicated to it. And if you let me come back to you with the numbers, I'd appreciate it. [The information follows:] Questionable Refund Program (QRP), Earned Income Tax Credit (EITC) April 8, 2008--Response to GAO's question about our proceses to ensure that legitimate EITC claims are given to the taxpayer expeditiously if selected for QRP. The IRS makes every effort to ensure legitimate refunds are not unnecessarily delayed. Improvements to the Questionable Refund Program since 2006 include notification to taxpayers when refunds are held and implementation of a systemic release of refunds when the IRS has been unable to verify the refund is false within 70 days. Criminal Investigation (CI) uses the Electronic Fraud Detection System (EFDS) to identify returns claiming false income and credits, i.e., withholding and Earned Income Tax Credit (EITC), and where appropriate criminally investigates perpetrators who create the schemes. Last year more than 200,000 returns were verified as false with refunds claiming $1.4 billion. EFDS screens all refund returns and flags suspicious returns for review. Refunds on approximately 400-500 thousand (includes both EITC and non-EITC returns) of the 100 million refund returns filed (\1/2\%) are delayed up to two weeks while CI reviews the returns. CI completes the verification within 14 days on average and remaining refunds (not verified false) are systemically released at 70 days. When income is verified as false, IRS disallows the income and resulting false credits, including EITC. TAX PREPARERS Mr. Serrano. Okay. Let me ask you a related question. Some folks, like the ranking member, prepare their own taxes, but the folks who do the EITC for the most part go to someone, and at times it may be a tax service. That is totally legitimate. It seems that around this time of the year I see, in neighborhoods like the South Bronx, every store front that is empty has a tax place open up. When you look at these alleged claims of abuse and fraud, is there anything within your power, the agency's power, to look at the folks preparing those returns, also? Mr. Shulman. Well, some of the fraud that you see, from what I understand, is people processing lots of returns and sending in false information, et cetera. Mr. Serrano. When you say ``people,'' you mean like a tax place? Mr. Shulman. Well, there are two types of preparer issues I am trying to get to. There is the preparer who doesn't sign the return, and the circular--I think it is 230--that oversees activities of certain preparers. So we do have some outreach there. And then there are people who are just preparing returns and claiming to be the taxpayer in order to get refunds, and perpetrating clear fraud that we can easily and obviously reach into. I think this is one of the discussions I had with the Finance Committee about our ability to enforce the law vis-a- vis preparers, not just taxpayers. I think, given the number of people that avail themselves of preparers, it is clearly an issue we are spending more time on now, seeing what our options are, to make sure the taxpayer and the person they work with are---- Mr. Serrano. Do you have the ability to enforce law there? Mr. Shulman. We do with accountants, lawyers, enrolled agents, but not with all preparers; and that is the ongoing discussion. Mr. Serrano. Because the law doesn't cover all preparers? Is that the reason? Ms. Stiff. We actually do have a program that allows us to screen preparers for IT concerns. Mr. Serrano. But is there a law that allows you to go after these storefront operations, with all due respect to them, that open up in the poorer neighborhoods? Ms. Stiff. If there is tax fraud, the law does give us the ability; and we do that every year. We actually prosecute several hundreds of these a year. Mr. Shulman. We will come back with the statistics. Mr. Serrano. Okay. One of the advantages of having a tax accountant, if you will, is that if I have a problem he's going to go with me. But Mrs. Rivera, who went to a place and she might have been given some information as to what was available to her that actually wasn't available to her, now she's alone because these places don't show up to give her support when she has to go face you folks; and that is something that we have to keep a look on. Mr. Shulman. As you know, I come from---- Mr. Serrano. Mrs. Rivera is just a name I picked out. It is like Jones. I don't want anybody to go look for Mrs. Rivera. Mr. Shulman. I come from an agency responsible for regulating an industry, the financial industry, so I am pretty familiar with overseeing professionals who deal with ordinary Americans; and so this is something that I am committed to really grappling with. Mr. Serrano. I would like us to stay in touch about that. That is an issue that concerns me. I have no proof of any wrongdoing, in all honesty, but I just see that in every available storefront in my district, somebody opens up a tax preparer office, and people stand outside handing out fliers for customers to come in. The whole thing about the payday loans--there is just something that doesn't feel right to me. It may be that everything is fine, but I would like to stay in touch to see if everything is, in fact, fine. COORDINATED CASE AUDITS Let me ask one last question before I turn it over to my colleagues. Audits of larger corporations--now you know that liberals like me have to finally ask this question, right? A new study released by the Transactional Records Access Clearinghouse at Syracuse University and reported in the New York Times shows that the number of coordinated industry case audits, the in-depth audits of the largest corporations, declined from 428 in fiscal year 2002 to 353 in fiscal year 2007. This is despite the fact that coordinated industry case audits uncovered $24 billion in unpaid taxes in 2007. Why such a sharp decline in coordinated case audits? Mr. Shulman. I looked at the TRAC data and had a chance to discuss this with our large business division. Let me make a couple comments, if I could, about this. First, I have made it very clear, and said this in the only speech I have given and in statements, that focusing on large corporate taxpayers, making sure that they pay their fair due, is going to be a focus of mine as Commissioner. I really think, for the integrity of our system, that Americans expect large corporations to be good corporate citizens, which means paying the amount of taxes due. Regarding the TRAC data, I think it is one view and an interesting view for me to see as a new person coming in, but it doesn't paint the full picture of what has happened in the large corporate area. Enforcement revenue is up, which means the IRS has been doing something right in the large corporate area. Second, and it is a program that I support, the IRS has taken a number of large corporations, like 70 some odd corporations, and moved them to a program called the Compliance Assurance Program, which means they are in with the large corporation before they file their return negotiating all of the taxes due so that when the number goes in there is not going to be an audit and there is not going to be a dispute. And a lot of the CAP data was showing the disputed amount. This brings in money to the FISC, and so that is not reflected in the TRAC data. Mr. Serrano. It sounds like a preemptive rehab program. Mr. Shulman. Well, I think it is along the lines that I mentioned to Mr. Schiff. The more we can be clear up front, that is a good way to administer the tax law and be clear with our guidance. And so we are trying to do some innovative things, which I applaud. Third, there was a conscious decision to shift some of the people who can deal with sophisticated large business audits to tax shelters, promoters of tax shelters, and to get some more coverage in the mid market. So those are management decisions that are made every day at the IRS. I am not going to tell you that everyone got it right in the past or I am always going to get it right, but trying to get that balance right was important, and those decisions were made. And then, finally, just around large cases, I would be remiss if I didn't say this. I talked in my opening statement about the fight for talent that we are going to have with the private sector and on having to work on our workforce. In a Sarbanes-Oxley environment, in a pretty heavy regulatory environment, the people working large cases are very attractive to people in the private sector; and I think we are going to have to stay focused on keeping our best people here. It is not going to be the easiest thing in the world for us to do. And so I think this was one slice. I think we will be focused on large corporations, and we will use a variety of tools to do that. Mr. Serrano. Well, that is very encouraging, and I thank you for those comments, and I thank you for that initiative. We will stay in touch on that, but it is encouraging to know that you understand the issues here for what they are and want to do something about them. Mr. Regula. Mr. Regula. I thought about how I went by an auto dealer the other day. They had a sign out: We will do your tax returns. Obviously, what they want to do is do the tax returns so they get the refund and sell you an automobile while they get that refund for you. Mr. Serrano. Really? Mr. Regula. I assume they have somebody doing it at the dealership. But it is interesting that they are into tax returns. Mr. Serrano. Don't ever get your tax returns done by your auto dealer. That is the only advice I can give. NARCOTICS TRAFFICKING Mr. Regula. A couple questions. I notice the oversight board recommended a $24 million increase to enhance investigations of narcotics trafficking, and I think back that Al Capone was convicted by using the IRS code, rather than for killing people or whatever else he was involved in. Are you doing an adequate job of using the tools that you have on narcotics, in the narcotics area? Mr. Shulman. You know, I am not familiar with the narcotics area. Our Criminal Investigation division works on everything from counterterrorism to anti money laundering to narcotics to pursuing all of the criminal tax violations. I think we are asking for sustained funding for that division. I think that is important. PROTECTING TAXPAYER DATA Mr. Regula. Another area of concern is identity theft. I think with the use of credit cards there's a growing problem with that. Do you feel that the IRS is adequate in its protection of very sensitive information that is contained on tax returns? Mr. Shulman. Um---- Mr. Regula. And that is, again, a subject I assume is somewhat new to you at this point. Mr. Shulman. Protecting taxpayer data or protecting personal data is new to me at the IRS. We did examinations of brokerage firms in the past, and we had brokerage firm information, sensitive information. So I am familiar with the issues of data protection. What I would say is the IRS doesn't do it perfectly. There have been some recent reports that have pointed that out. This is hard for everyone to do. I know the IRS has made some progress. It has encrypted all laptops, which is a step forward. It is in the process of centralizing all of its information technology access, which will allow us to have clear protection, and we are reviewing everyone inside the agency who has access control. So we are basically saying, the presumption is you don't have access to a system until you prove that you need it; and every division is working through that right now. I also have a strong belief that data protection is as much about a culture as it is about firewalls and encryption and all the sophisticated language that we use. And something I am proud of, which we are launching right now, is Operation RED. We are taking every single IRS employee, all 100,000 plus, off-line for at least 2 hours so they may have discussions with their managers about what data comes in. What are you doing about it to protect it every day? It's not just about the procedures, because everyone is always getting e-mails about procedures, but to have a real discussion about it and to try to make it top of mind for every employee. They have a sacred trust with the American people and need to protect this data. My second week I actually filmed a video that every single employee is going to see, with me talking about how seriously I take this issue. I actually think that the IRS has a long tradition, because of taxpayer privacy rights, thinking about this issue, but since technology has changed we just need to be all over this. So I have every indication to believe when I came in Linda and Richard understood this issue and were focused on it and we are going to keep pushing. It is very hard to do. The private sector and the government are wrestling with these issues, but we are going to do what we can to make sure we are taking very seriously the protection of taxpayer data. Mr. Regula. Thank you. TAXPAYER ADVOCATE SERVICE FUNDING The taxpayer advocate program has worked in Ohio in my area very effectively on behalf of people that use the service, and I notice there is a proposed reduction of $7.5 million below the current year. Do you think, in your opinion, the budget request is adequate to do the job on the Taxpayer Advocate Service? Mr. Shulman. Let me say a couple of things. One, I think the Taxpayer Advocate Service is an asset to the IRS and a good thing for the American people. I met twice with the current Taxpayer Advocate and plan to work with her going forward. I think these budgets are always a balance. The IRS has billions of dollars focused on taxpayer service. We do a lot of taxpayer service. The Taxpayer Advocate does some things. I wasn't there when this budget was put forward, but that balance was trying to be met. What I do know is over the last 2 years the Taxpayer Advocate Service budget has risen 9 percent. The IRS budget as a whole has risen about 7 percent. So I think it is important that we fund it well. I can't speak to the specifics beyond that. Mr. Regula. Well, I can only say my experience in Ohio works very well. It does provide the taxpayers a place to go for help if needed. Thank you, Mr. Chairman. Mr. Serrano. Thank you. Mr. Hinchey. Mr. Hinchey. Thank you very much Mr. Chairman. Mr. Shulman, thank you very much. It has been an interesting session here; and I very much appreciate the candor and the way in which you are effectively trying to deal with the situation, even though you have only been there a short period of time. One of the things I want to say, again, in gratitude and appreciation, is the way that the IRS has set up these helping operations, these offices, phone operations, to help people, particularly senior citizens, retired people who are interested in trying to qualify for the help that is coming in as a result of the stimulus package--my understanding is that just in New York alone there were 37 operations set up across the State. I think that was a very good thing to do, and I very much appreciate that being done. TAXPAYER COMPLAINTS AGAINST PRIVATE COLLECTION AGENCIES I want to talk a little bit more about the privatization action that is taking place; and I know that this is going to be the major focus of your attention, to make sure that it is working right and to even consider excluding it, as some of us have recommended. There were, according to my understanding, something in the neighborhood of five dozen taxpayer complaints against private collection agencies, including violations of taxpayer privacy laws. So there is a certain amount of uncertainty or unhappiness about that. I wonder if, not now but as a result of maybe some of the people who are with you here, they might be able to give us the number of actual complaints that came in as a result of the privacy operations and maybe even the amount of fines imposed, if there were any, on private collection agencies for taxpayer violations and the number of validated penalty cases and the overall number of taxpayer complaints that were filed against the private collection agencies. [The information follows:] Of the 108,905 cased placed with the private collection agencies (PCA's) though March 2008, the IRS has received 102 complaints, with 17 of these received from or on behalf of taxpayers and the remainder self-reported by the PCA's. All complaints are investigated by both the IRS and the PCA's, with a validity determination made by a Contract Concerns Review Panel. There have been 5 validated complaints (0.005%). There are three categories of complaints, classified based upon the severity of the incident. Type One validated complaints involve inappropriate PCA employee behavior (rudeness, poor attitude). Type Two complaints involve intimidation, heavy-handed behavior, or similar activity rising above the level of a Type One complaint and bordering on a statutory violation. Type Three complaints involve a violation of statute or applicable law. There have been two validated Type One complaints which were not serious enough to warrant monetary fines; however, corrective actions were implemented. Three validated Type Three complaints have resulted in monetary fines totaling $10,000. Any validated complaint, IRS or contractor, is one too many. We are committed to improving the protection of taxpayer rights throughout all IRS programs. AUTOMATED COLLECTION SYSTEM FUNDING Mr. Hinchey. Also, the Appropriations Act of '08, this appropriations bill requires the IRS to spend $7,350,000 to increase personnel in the automated collections system. I wonder if--I don't expect it now, but if you could look into that and inform us where the IRS is in implementing that provision and whether or not the managers statement which accompanied the bill urging the IRS to take the $7.35 million in funding from the private tax collection program, whether or not that actually occurred. That was in the managers amendment asking that that $7.35 million, which was put in the appropriations bill to upgrade the automated collection system, if that could be taken out of the private collection system. [The information follows:] We are on track to spend the $7.35 million increase for the Automated Collection System (ACS) functions as required by the FY 2008 Consolidated Appropriations Act. We allocated the funding evenly between our Wage and Investment (W&I) and Small Business Self-Employed (SB/SE) functions and will be spent on new hires, overtime and support costs. In total, this funding equates to 126.5 FTE for ACS operations. We allocated 83.8 FTE to ACS and ACS Support hiring, and 42.7 FTE to overtime. We hired in eleven of the fourteen call sites and three of the four support sites. We started hiring in February 2008 and will complete the remaining hires June 2008. We based the new hire allocation on the sites' capacity levels and ability to recruit and deliver the training. We are using the overtime to provide training support and to work ACS inventory and correspondence. The following worksheet provides a breakdown by FTE and Dollars. -------------------------------------------------------------------------------------------------------------------------------------------------------- FTE new hire New hire cost Overtime Overtime cost Total FTE Total dollars -------------------------------------------------------------------------------------------------------------------------------------------------------- SBSE ACS..................... 37.2 $2,008,800.00 12 $873,600.00 49.2 $2,882,400.00 SBSE ACS Support............. 9.3 502,200.00 4 291,200.00 13.3 793,400.00 -------------------------------------------------------------------------------------------------------------------------- 46.5 2,511,000.00 16 1,164,800.00 62.5 3,675,800.00 WI ACS....................... 29.8 1,442,863.00 21.4 1,498,000.00 51.2 2,940,863.00 WI ACS Support............... 7.5 363,137.00 5.3 371,000.00 12.8 734,137.00 -------------------------------------------------------------------------------------------------------------------------- WI Subtotal.............. 37.3 1,806,000.00 26.7 1,869,000.00 64.0 3,675,000.00 Grand Total.......... 83.8 4,317,000.00 42.7 3,033,800.00 126.5 7,350,800.00 -------------------------------------------------------------------------------------------------------------------------------------------------------- EXXON MOBIL Mr. Hinchey. And just finally, I would be very interested to learn what the tax amount was on the $40.6 billion that was earned by Exxon Mobil last year. I don't expect the answer now, Mr. Chairman, but if that number could be provided to us at some point soon we would appreciate it. [The information follows:] The Congressman is referring to the earnings reported by ExxonMobil for the year ending 12-31-07. Returns for last year won't be filed until September 2008, so the IRS does not have the data requested at this time. In addition, the IRS cannot respond to the request at the present time, since the IRS is prohibited from disclosing taxpayer information requested without proper authorization, pursuant to disclosure rules and privacy laws. Mr. Hinchey. Again, I want to thank you very much for doing this job and the confidence that we have in how much better this operation is going to work. Thank you very much. Mr. Shulman. Thank you. Mr. Serrano. On a personal note, I bet you that it was a large amount that they paid but probably a lower percentage than Mrs. Rivera paid in my district on her $25,000, maybe. One of the dangerous things, Commissioner, to do at a hearing like this is to praise you as much as we have. Mr. Shulman. It feels dangerous. Mr. Serrano. But there seems to be a sense in this committee that you are very interested in doing this in a very fair and balanced way. Does that sounds like a news station or something? And we appreciate that, and we hope that that continues. And we also commit ourselves to trying to help you in any way we can to do your job. And so I have a few questions that I will submit for the record. Mr. Regula. Same here. Mr. Serrano. And so will you and so will you. And we thank you for your testimony today. We thank you for taking Mr. Hinchey's tax return personally to handle for him, and we stay committed to helping you. And I personally thank you for no Boston Red Sox comments, as my colleagues like to make. Thank you so much. The hearing is adjourned.
Wednesday, April 16, 2008. SECURITIES AND EXCHANGE COMMISSION WITNESS CHRISTOPHER COX, CHAIRMAN Chairman Serrano's Opening Statement Mr. Serrano. Good morning. The subcommittee will come to order. But before I do, Mr. Regula, I would like to ask you a question in public because you have been a chairman much longer than I have. When the Pope calls a meeting of Cardinals, am I supposed to show up? Mr. Regula. Absolutely. Mr. Serrano. Just checking. Mr. Regula. Let him know ahead of time, so he can deal with the problem. Mr. Serrano. Get used to me, right? I welcome you to this hearing on the Financial Services and General Government Subcommittee. Today the subcommittee will hear from the Chairman of the Securities and Exchange Commission, the Honorable Christopher Cox. Always nice to see a former colleague with us. Chairman Cox, welcome to the hearing. We are pleased to have this opportunity to discuss the fiscal year 2009 budget with you. The SEC is responsible for promoting investor protection and education as well as for overseeing the integrity of capital markets. These responsibilities are essential so that businesses have access to capital so they can grow, add jobs and contribute to the Nation's economic strength. The Commission's budget request for fiscal year 2009 is $913 million, which is $7 million above the enacted fiscal year 2008 spending authority level. Part of this funding will be provided through $42 million of prior year balances, resulting in an appropriated level of $871 million. This modest funding increase is allocated toward the 2009 Federal pay raise as well as promotions and merit pay increases. However, this funding increase will not be enough to pay for all of the agency's salary needs at its authorized personnel level. To meet its salary requirements, the Commission is proposing to decrease its authorized number of full-time employees down to its actual fiscal year 2007 levels. This troubles me, as recent market trends have raised legitimate questions about the overall integrity of the market. It seems that a reduction in workforce at the SEC would send a signal that the government is not committed to the important goals of improving market structure and transparency. We want to be sure that you have enough people to accomplish your mission, and I will be interested in your comments on the staffing at the Commission. The SEC has been in the news a lot recently resulting from the Treasury plan for regulatory reform. This plan would dramatically change the structure of the SEC by merging it with the Commodity Futures Trading Commission. The subcommittee looks forward to hearing the Commission's response to this plan. And we welcome you today it, and we will remind you that your statement will be fully put in the record. You have said this yourself so many times, and we ask you to keep your verbal comments to 5 minutes so that we can drill you and grill you and put you through all kinds of terrible things. But a man who has never put anyone through anything terrible is Mr. Regula, our ranking member. Mr. Regula's Opening Statement Mr. Regula. Thank you, Mr. Chairman. And as you know, Chairman Cox, recent events have put you in the eye of the storm. And people are having some misgivings as to whether there is adequate regulation in the market to protect the average investor. Bear Stearns of course is a classic where you go to $172 a share--thousand a share down to $2, ultimately $10. But I am sure you are challenged always to strike a somewhat delicate balance between regulating and letting the market work in a free way, which historically we have done. So I will be interested in your insights as to how we address that problem. I know that you have a somewhat limited budget number. And how do we go about restoring confidence? We went through this with Enron, Global Crossing, Arthur Andersen; the result was a doubling of your budget. As people understood it, the fragility of these institutions and now the temptation is to say, okay, we will just double the budget, and somehow this solves subprime and all the other problems go with it. So I am very interested in your comments. I think the chairman did a good job of summarizing the challenges that confront the Subcommittee. Mr. Serrano. Thank you. You are on. Chairman Cox's Testimony Mr. Cox. Thank you very much, Chairman Serrano. Ranking Member Regula, Representative Kilpatrick, members of the subcommittee who are not here but represented undoubtedly by staff. I want to thank you for the opportunity to testify today about the President's 2009 budget request for the SEC. To answer directly your question, in return for the SEC's not quite $1 billion budget, the taxpaying public is getting significant value. The SEC oversees the nearly $44 trillion in securities trading every year on America's public equity markets; the disclosures of almost 13,000 public companies; the activities about 11,000 investment advisors; nearly 1,000 fund complexes and 5,700 broker dealers. And the Commission is active on a number of other fronts: working to protect investors, promote capital formation and foster healthy markets. The SEC is pursuing wrongdoers in all corners of the securities markets while applying enforcement resources to the areas of greatest risk for investors. The Enforcement Division's subprime working group is aggressively investigating possible fraud market manipulation and breaches of fiduciary duty. The SEC is also investigating insider trading; wrongdoing in the municipal bond market, Internet and microcap; fraud and scams against seniors. In our most recent year, we brought the highest number of corporate penalty cases and the second highest number of all enforcement cases in the agency's 74-year history. In the current fiscal year, the Commission has already broken the record for the largest penalty ever assessed against an individual defendant when the former CEO of United Health paid over $600 million to settle charges related to options backdating. Through our Office of Compliance, Inspections and Examination, the SEC is aggressively using a risk-based approach to our program of regular examination of securities firms. Those examinations are focused on the firms' controls over valuations; their controls to prevent insider trading; the procedures they have in place to protect seniors in our markets; and the adequacy of the firms' compliance programs to prevent violations of the securities laws. The SEC is also working closely with our fellow regulators to promote the fairness and stability of the markets. Under a recently concluded Memorandum of Understanding with the CFTC, we have established a formal cooperative process to better regulate today's increasingly interconnected markets. The SEC has immediately acted to implement the new authority from Congress in the Credit Rating Agency Act. Under this new authority, the Commission is conducting inspections of rating agencies to evaluate whether they are adhering to their published methodologies for determining ratings and managing conflicts at interest. Very soon this year, the Commission will formally consider new rules to regulate credit rating agencies that build on the lessons learned from the subprime market turmoil. To anticipate future problems, we are more than doubling the size of the SEC's Office of Risk Assessment. It will help staff throughout the Commission look around corners and over the horizon to identify potentially dangerous practices before they impact large numbers of investors and the economy as a whole. The failure of Bear Stearns has brought to the fore the regulatory gap in the supervision of investment banks. Although Federal law provides for the supervision of commercial banks, no such scheme exists for the largest investment banks. The Commission created the Consolidated Supervised Entities program to fill this gap. Without this voluntary program, there would have been no consolidated information available to regulators, including the New York Fed, when Bear Stearns precipitously lost liquidity in mid-March. While the CSC program is at present voluntary and receives no dedicated funding from Congress, we understand that Congress may be acting to fill this gap. The Commission has also taken additional steps to safeguard investors and protect the integrity of the markets in short selling transactions, by proposing a rule that would specify that abusive naked short selling is a fraud. Since the SEC first received authority under the Sarbanes- Oxley Act to use Fair Funds, we have returned a total of more than $3.7 billion to wronged investors. We expect to distribute another $1 billion in the next 6 months alone. The SEC is also building on its growing success in returning funds to harmed investors by creating the Office of Collections and Distributions to professionalize this task. We are also using a new computer tracking system, called Phoenix, to speed up the return of funds to investors and a new agency- wide enforcement database called The Hub. The SEC's efforts in the international arena have by necessity been a key focus of my chairmanship. The world's regulatory and enforcement authorities are finding that we have to collaborate if we hope to protect our own investors. Accordingly, the SEC is working closely with our international counterparts to monitor the markets and pursue fraudsters wherever they may run. We are also exploring the idea of mutual recognition among a very few high-standards countries with robust regulatory and enforcement regimes. In recognition of the interconnectedness of global markets, the SEC will continue to expand our own expertise in IFRS and explore additional ways that U.S. investors might benefit from increased comparability using a high-quality international standard. After years of experience through the SEC's voluntary interactive data pilot program, the Commission will consider a rule in 2008 that requires the use of interactive data to give investors the ability to easily find and compare key data about the companies and the funds in which they invest. There are other investor-friendly improvements in store for mutual fund disclosure. In the coming months, the SEC will consider authorizing mutual funds to issue a summary prospectus that will present key facts about the fund up front with more detailed information available for investors on the Internet or in paper on request. These improvements build on the resounding success of our comprehensive enhancements to the disclosure of executive compensation, which took effect last year. Mr. Chairman, these are only some of the highlights of what the SEC has recently been focused on and what we have planned for the coming year. The agency's mandate is as broad as it is important to America's investors and to our markets. The budget request for fiscal year 2009 will allow the SEC to continue to aggressively pursue each of these ongoing initiatives on behalf of investors as well as to address new risk areas as they emerge. The request will allow the SEC to fully maintain our current program of strong enforcement; of risk-based examinations and inspections; our disclosure review program for America's public companies and mutual funds; and our extensive rulemaking agenda across a wide array of regulatory topics. I want to thank you for this opportunity to discuss the SEC's appropriation for fiscal year 2009, and, on behalf of the over 3,600 men and women at the SEC, I want to thank you and this subcommittee for the support that you have so well provided over so many years for these vital efforts. I look forward to continuing to work with you. And I would be happy to answer your questions. [The information follows:]
TREASURY REGULATORY REFORM PLAN Mr. Serrano. Thank you so much for your testimony. As we all know, Chairman Cox, last month the Treasury Department issued its plan to dramatically overhaul the entire financial regulatory structure. One of the key proposals highlighted in this plan is the merging of the SEC and the Commodity Futures Trading Commission, CFTC. Chairman Cox, was the Commission consulted during the development of this plan? Has your agency developed an official response in favor or against the Treasury plan? Mr. Cox. The Treasury plan was the Treasury plan. It was not a product of the President's Working Group on Financial Markets, of which the SEC is a member. It was, rather, the effort of the Department, and I think the Secretary personally, to set out a vision for how things might be different in the future and to challenge the status quo. I think, in part to achieve that objective, it was deliberately not a consultative process. It was not a committee process. The SEC was certainly aware that this was going on. And we have discussed in other fora the possibility of better integrating the balkanized financial regulatory structure in the United States. But, to directly answer your question, this was a Treasury product, and the SEC was not part of its preparation. With respect to the specifics of a CFTC-SEC combination, it has been advanced by people over a number of years. For example, former Chairman Arthur Levitt wrote an op-ed in The Wall Street Journal, I believe it was last year, urging this combination. Since the Treasury report, he has said that there is a right way and a wrong way in his view to do this and that it matters greatly how it is done. But I would simply observe, as a former Member here, that there are serious jurisdictional challenges for Congress in what is obviously a legislative and not an executive initiative. If that merger were to occur, it would have to be done by legislation. From an authorizing standpoint, jurisdiction over the SEC rests with the Financial Services Committee in the House. Jurisdiction over the CFTC has existed with the Agriculture Committee for many years through many administrations. That jurisdictional divide has presented a significant barrier to consideration of legislation of that kind. Mr. Serrano. So you feel that it has to be a congressional decision? Mr. Cox. Indeed, I would say that about the entirety of the Treasury proposal. There is one item in the entire blueprint that is susceptible of being accomplished by executive action, and that is an initiative of the President's Working Group. That can be done by executive order. Everything else is entirely a legislative proposal. Mr. Serrano. All right. It is interesting, just for the information of the members of the committee--Mr. Regula knows this already--but the only difference between the Senate Financial Services Appropriations subcommittee and our subcommittee is that the commodities in our jurisdiction exists in the Agriculture Subcommittee of Appropriations. Whereas Mr. Durbin's committee, Senator Durbin's committee in the Senate includes it already. That is the main difference. So it has an effect on this subcommittee. But certainly that is not what we should base the decision on. So unless I didn't hear right, you didn't tell me you are supporting the merger. Mr. Cox. Well, I think---- Mr. Serrano. Or has it reached that point yet? It has been presented by Treasury. Mr. Cox. Well, I think, first, the merger of the CFTC and the SEC is something that is far beyond the capacity of the Chairman of the SEC or the SEC as an agency or the executive branch in its entirety to accomplish. It is solely up to the Congress to do that. So, I mean, I suppose I can tell you that I think it would be very wise for the Congress to take a look at how better to integrate our financial services regulation. But beyond that, unless the Congress wants to initiate this, it is not possible for me, as Chairman, to undertake it. I will tell you that I have recently executed a Memorandum of Understanding with the CFTC that takes the landscape as it presently exists and makes it work. It puts a little grease in the gears so that, while they do their job under their statutes, their rules and their approach, and we do ours under ours, it makes sense. But as you know, options and derivatives can compete head to head. Mr. Serrano. Right. But just one last comment on this. If it reaches a point where it is before Congress and you are asked about this, what would be your answer? Mr. Cox. It would be entirely dependent on the how. But I would be at a very broad level supportive of closer integration, not just of regulations and derivatives and options, but commercial and investment banking across the board. We have in this Nation a lot of different regulators for things in the marketplace that become very much intertwined. FTE ISSUES AT THE SEC Mr. Serrano. Chairman Cox, since fiscal year 2008, the SEC has had some form of performance-based pay system. The goal of these performance-based systems is to stimulate retention and recruitment so that the highly qualified workers at the SEC and the best and brightest college graduates that the Commission recruits are not as enticed by the greener pastures of the private sector. In recent years, however, the SEC has not fully budgeted for the increases needed to adequately pay the salary increases that were earned by their employees. In fact, the SEC has seen an uptick in attrition during this time period. This year's budget request only includes a 2 percent increase over what was approved in 2008. It is very unlikely that this level will provide the Commission's employees the pay increase they deserve. So my question is, at a time when we need a strong workforce at the SEC to maintain and improve the integrity of the securities markets, why is the agency putting itself in the difficult situation of risking the loss of its best employees in order to save a few dollars? Mr. Cox. Mr. Chairman, for the coming year, the budget that we are submitting assumes that the SEC will offer merit raises and COLAs equal to an average of about 4.5 percent. And that puts us at parity with other financial regulators against whom we compete in the Federal Government. We also offer a competitive compensation package across the board. We offer some things that others don't. We provide health and vision and dental benefits, the latter two which the SEC pays for in its entirety, that others do not. We just opened a Cadillac of a child care center, which I am very proud of. It has been one of my initiatives as Chairman. That really contributes to the quality of life for employees with families at the SEC. And we have currently been rated one of the top places to work in the Federal Government, number three in the last year. So I think that we are doing everything necessary to make sure that the SEC continues to set the pace for being the best place to work in the Federal Government. Mr. Serrano. Well, obviously, we respect your comments and your knowledge on the issue. But I have to tell you that on this side of where we are sitting today, there seems to be a sense that maybe not enough is being done to protect your workforce and to retain the folks you have now and to make sure you can recruit the people you need. And again, as we get into this situation that we are already in to a certain extent, you will be looked at, the Commission will be looked at, to provide assistance and commentary in how we deal with this crisis. I was going to say looming crisis, but the crisis may be here already. So please understand that it is not our intent to banter you about the issue, but there is a sense on this side of the table that we are running the risk of losing good people and not getting the opportunity to bring some bright folks into the Commission. Mr. Cox. Well, that is why you have me here to ask me questions and share the data. I will just start by observing that we are, in terms of turnover, at 25 percent lower rates of turnover than were common during the 1990s. Turnover is now, you know, historically low. And from 2006 to 2007, the most recent year, it went down. So I think we are in very, very good shape. Experientially, in terms of whom one can attract to work at the SEC, the quality of people that come to our agency and that dedicate their lives and their careers to it is just absolutely striking and extraordinary. So we have absolutely the best people at the SEC that the country can offer. And you know, this is sometimes not the case in the Federal Government where you have to compete against the private sector. But, not only do we go toe to toe with the private sector, but when people do leave the SEC, they are recruited to the very top ranks of the private sector and not because of their contacts with government but because of their skill and experience. Mr. Serrano. Thank you. Mr. Regula. Mr. Regula. Thank you, Mr. Chairman. And I do note that you have been rated very high as a desirable place to work. And I think you have some unique authority on matters of benefits and wages as compared to other government agencies, which has enabled the SEC to attract top- rate employees. SUBPRIME MORTGAGES Question, what was the role, if any, of the SEC in the recent meltdown of the subprime activities which caused bank stocks to take a real hit? And it certainly has, to some extent, eroded investor confidence. Was there an SEC role? If so, what was it? Mr. Cox. Most certainly. We are not the frontline regulators for lenders, of course. And that is where the problem started, with a deterioration in underwriting standards for loans, which you are all too familiar with from your work. Mr. Regula. But that started at the root. The cause was a collateralization of these subprime mortgages were made into financial instruments. Mr. Cox. Yes, the securitization of those loans then had that problem bleed into the securities markets. The rating of the packages by the rating agencies was a contributor to this problem. Congress wisely, with uncommon foresight--usually we find that we are passing remedial legislation after the fact when it is too late--just completed work on the Credit Rating Agency Act and gave the SEC the authority to go in and regulate. So we don't need to write new legislation. We have brand-new legislation. We worked very, very fast so that, at the first opportunity, we put rules in place and then started inspecting these rating agencies. We have been in with the credit rating agencies examining them for some months now. That will inform our rule writing this year. So that is a piece of it that the SEC did not have but now does, and we are using that authority very, very aggressively. With respect to the large investment banks, as I mentioned, our Consolidated Supervised Entities program was being put together when I first came to the Commission. It is a voluntary program. It doesn't exist in law. I believe it should. But thank God that that program existed because then, when the Fed needed to go into Bear Stearns and look at what was going on, there was a history of at least a few years of Bear Stearns having to compute at the consolidated level for the whole entity, not just the regulated broker-dealer subsidiary that we have authority over, their Basel capital ratios and so on. SEC AND FEDERAL RESERVE AUTHORITIES Mr. Regula. Does the Fed and SEC have corollary authority? Or do they each have a niche in this regulatory structure? Mr. Cox. Well, the Fed is traditionally a bank regulator. Mr. Regula. Right. Mr. Cox. And post-Gramm-Leach-Bliley, we have a regulatory gap. We don't have in law a program of consolidated supervision for investment banks, and we need one. Mr. Regula. You will in the future? Mr. Cox. That is up to the Congress. We have a program, just to be very clear, at the SEC, the Consolidated Supervised Entities program, that we created as it were out of thin air. It is built on the slender reed of an exemption from the net capital rule. The reason that I think there was largely take-up among the major investment banks in this voluntary program is that, if the United States did not offer something like this, Europe was going to. Probably what the firms would have done, although we won't know for sure, in that circumstance is that they would have perhaps ring-fenced their operations in Europe--separately set up European operations and consolidated supervision by the European regulators, and then we would have had no consolidated supervision whatsoever of the consolidated entity. So I think it is vitally important that there be consolidated supervision of the large investment banks, and it is something that, post-Bear Stearns, has gotten your attention in Congress. BEAR STEARNS COLLAPSE Mr. Regula. Are we gaining understanding as a result of Bear Stearns, which was the most visible evidence of this, as to preventing these things from happening in the future? Mr. Cox. No. There is no question that an important lesson was learned in the Bear Stearns debacle. And that is that short-term secured funding can be a significant risk factor. SOVEREIGN WEALTH FUNDS Mr. Regula. A couple of other things. What is the role of sovereign wealth funds as investors in the U.S. financial markets, and they are more and more in our marketplace? Is this a cause for concern? And will it affect governance and corporate governance in the United States? Mr. Cox. Sovereign wealth funds and other large private investors that are generally lacking in transparency challenge our regulatory system in a number of ways. As a matter of national policy, the Treasury just made it very clear that the United States welcomes this type of investment. Our markets are open to all forms of foreign investment. At the same time, at the Securities and Exchange Commission, our approach is to treat sovereign wealth funds the same way in which we would treat any large nonpublic investor. We have challenges that are somewhat unique in the case of sovereign wealth funds, however, such as the fact that, whereas normally we would ask for enforcement cooperation from the sovereign, if the investor that we might have an enforcement concern with and the sovereign from whom we have asked for enforcement assistance are one and the same, you can see the conflict of interest. U.S. FINANCIAL MARKETS CHALLENGES Mr. Regula. What do you see as the biggest challenges facing U.S. financial markets? And how do you see the SEC adapting to build future investor confidence. Mr. Cox. Well, the SEC comes at that question from the investor standpoint. It probably matters where you get on the circle. They are all related answers. But if one tackles that question from the investor standpoint, then the rest of your question is extremely relevant. It is all about market confidence. People, not just in this country but around the world, put their money where they think it is going to be safe, first, and, second, where it can earn a fair or perhaps an impressive return. They want to make sure that they have the rule of law, predictability, sound and orderly markets and so on. That is the part that the SEC provides. So it is vitally important, as our markets become increasingly interconnected, that the United States play to its strengths, that we align ourselves with other high-standard countries and that we not join in a race to the bottom because that is not America's comparative advantage, and we would lose that race. PENSION FUNDS Mr. Regula. Well, obviously a great chunk of pension funds are invested in the market, and therefore, the individuals who are depending on the financial security of their pension funds ultimately tracks back to SEC, I think, in ensuring that these funds are invested in what would be a stable market. Is this a concern? And is this something that is part of SEC's mission, to give the John Q. Public a sense of security that his pension fund is going to be there when he needs it? Mr. Cox. Orderly markets are at the center of the SEC's mission. ORDERLY MARKETS Mr. Regula. The SEC was created in the absence of orderly markets, wasn't it, back in the 1930s? Mr. Cox. Yes. Mr. Regula. I think Franklin Roosevelt said we have to do something about this. Mr. Cox. In fact, our three missions are investor protection, orderly markets and capital formation. Those three are highly complementary. MARKET SECURITY AND STABILITY Mr. Regula. Well, I have a lot of questions for the record, but is the present environment conducive to capital investment and a sense of security? Because moneys have to flow from many different sources to build our industrial and our business structure. Mr. Cox. Well, I think it is a testament to the strength of the U.S. market and the resiliency of our economy that, despite all of the shocks that we have been through, including record high oil prices and other commodities prices, tax increases on the horizon and subprime crises and so on, equity values, although there is a great deal of volatility in the market, are remaining fairly constant. Mr. Regula. Well, I see the Dow Jones keeps kind of fluctuating where they are trying to decide whether the market is stable. Mr. Cox. Well, that is right. There is a good deal of volatility now. And, of course, the market is off significantly this year. So while we are stable, I think, from a standpoint of investors, the best investor protection is a rising market. Mr. Regula. A lot of 401(k)s riding on that. Thank you, Mr. Chairman. I will have some questions for the record. Mr. Serrano. Thank you. I was going to ask the Chairman if the Yankees were still a better investment than the Red Sox. But I don't want him to break my heart on national television. So I won't ask. Ms. Kilpatrick. SEC'S RELATIONSHIP WITH OTHER REGULATORS Ms. Kilpatrick. Thank you, Mr. Chairman. Good to see you again, Chairman Cox. Interesting discussion, and you are very calm in light of what I see as a very unstable financial market. Probably in the world because we do contribute to much of that, everyone looks at the U.S. in terms of the world market and how we are doing, which is why I see much of the instability that we are witnessing today. I have a couple of questions, and I love the ranking member's dialogue as he was taking us through it because one of the things, when he talked about Bear Stearns originally, early March, and JP Morgan buying them out, $30 billion by the Fed, and then it ended up at the end of March at $2 a share. I think they settled at $10 and that JP would take $1 billion of that loss, and the Fed would take $29 billion, give or take something, still the $30 billion. It is amazing to me, and I am a retired investor in much of that system, so I watch it regularly. Thought I could retire early, and I will have to work 5 or 10 more years, as it goes, as it is spiraling. I am concerned that we have helped Bear Stearns. I believe that--I used to be a high school teacher many years ago--and taught how stable it was and how it kept the rest of the country strong. Today I am not so sure. And with some of the other financial institutions having the problems that they are having and then going to the market and having China and India and Singapore and others buy them or save them--save them would be better--I am concerned about what that means for our children and my grandchildren as well as our economy as a whole. And as the SEC looks at it, and you talked about the regulatory gap, and I honestly believe there is one, I am not sure what it ought to be and how we can bring it together to make it more sound and perfect and healthy for our nation as well as for our investors. And I hope you will come to that. You also talked about a race to the bottom, which I don't want to put in the universe right now because we are not there; we are not going to be there, and we are going to stay up high. I believe that because we are the strong country that we are. But with foreign investment buying up much of our, not only real estate and housing, you also mentioned short-term secured funding, which is what a lot of Bear Stearns and other banks rely on, mortgages in this instance. What do we see? Give us a picture. I want to hear from you. You are the professional on this. And as we go back and talk to our institutions as well as our constituents, they really want to know. And I know you don't have a crystal ball. You can't really predict this. But as it goes now and as we have been seeing all of this year and really at the end of last year, what can the SEC do in partnership with the Fed? And what is that relationship between the Fed and the SEC? Separate of course, both in Treasury. How do you work together? How do you save America's financial institutions and investors at the same time? By doing what? Mr. Cox. Well, increasingly, as commercial banking and investment banking, and as securities products and derivatives products all start to become of interest to investors from an economic standpoint and compete against one another to be substitutable, regulators that decades ago used to have very well-defined, if you will, stovepipe functions are now forced into one another's arms. And I should add that this isn't just true in the United States. It is also true overseas. Almost everyone here today, if you have any kind of a mutual fund or a retirement plan of any kind, probably is invested in foreign equities and foreign securities as well as domestic ones in that way, and you might have chosen to do that even directly on your own. The fact that there is so much cross-border trading now has forced the United States and regulatory counterparts overseas also into one another's arms. We have to work together and collaborate as never before. What will provide the confidence that every single individual investor needs to put their money in the market is a sense that in this country and abroad--it is increasingly necessary abroad--there is a rule of law and there is a certainty and a predictability to the rules that they can rely upon. We will never erase the risk that is inherent in what we call a security because the prices will go up and down. That is part of the arrangement. But we can take away the risk, or at least we can minimize it, that the system itself is somehow not on the level. And we want people to be very, very highly confident that the system is set up to protect them. And that also extends, I should add, to disclosure. The SEC administers a rather elaborate system of disclosure to put information out there so people can make up their own minds. That is really important for the market to work. Information is really the oil that greases the wheels in the market. Increasingly over the last many decades, I think that disclosure has been junked up with a lot of people writing, as it were, an insurance contract for themselves to cover their own assets but not with a view to inform investors and making the information accessible to them. So a lot of our initiatives at the SEC are aimed at making that big investment that public companies make in disclosure more useful for individual investors and for the marketplace. BUDGETARY AND LEGISLATIVE NEEDS Ms. Kilpatrick. So does the SEC have what it needs to do what you just described? Or are you recommending or will you recommend that Congress take further action? It is a global market. It has been heading that way for the last couple decades. We seem to be spiraling down; others spiraling up. Do you have what you need in terms of law and policy, administrative rule that will keep us strong? Mr. Cox. The budget that we are proposing this year for the SEC will be the largest in the agency's history, and it will be the second year of rising budgets after 3 years of flat budgets. Ms. Kilpatrick. Sometimes it is not budgetary, because you get most of your operating money from fees. So if we are just giving you under a million, you will handle the $44 trillion in securities. Do you have enough wherewithal, legislative power as well as other things, with the world market changing, should we be doing something different than we did in 1930 or 1940? Is the market now--because it is different and you are the professional here, we need some help. That click there, one last question, sir, may I? Mr. Cox. Just to be clear, I want to say that our budget is entirely appropriated. We do not get to use the fees that we collect. So the budget that I am submitting to you, the just under $1 billion budget. Ms. Kilpatrick. $913 million. Mr. Cox. That is the real number. Ms. Kilpatrick. All right. So you didn't understand my question then. Is SEC as strong as it possibly can be in terms of the global economy and the world that we live in? Mr. Cox. The SEC is exceptionally strong. We are doing the job I think better than ever before. There is nearly unlimited opportunity for us to do more. The markets are vast. But, given that we are making choices and we operate in a world of finite resources, by asking for the largest budget that the SEC has ever had, I think we are putting ourselves in a position to do the job well. Ms. Kilpatrick. Thank you. Mr. Serrano. Thank you. Mr. Bonner. IMPACT OF SARBANES-OXLEY ON SMALL BUSINESS Mr. Bonner. Thank you, Mr. Chairman. Chairman Cox, welcome. I must confess that I was telling my 10-year-old son, who lives in Alabama, that I was coming to this hearing today, this morning when I was wishing him well as he went off to school. And he said, ``Well, who is coming before the committee?'' And I said, ``Well, the Chairman of the SEC.'' And while this is a baseball, and Yankees predominantly, committee, in Alabama, he was thinking I was talking about the commissioner of the Southeastern Conference. So he will be disappointed that I don't have that opportunity. Mr. Cox. You won't be surprised to know the same thing has happened to me. Mr. Bonner. We all recognize the need for the reforms that came about as a result of Sarbanes-Oxley. But there are many small- and medium-sized public companies that have been hit with unnecessary and expensive regulatory requirements as a result of that legislation. What steps could the Commission take to address some of these problems? And how quickly do you think that it could be done? And also, if it were to require legislation, would you be willing to submit that or work with Congress to help enact such legislation? Mr. Cox. When I first came to the Commission 3 years ago, compliance with Sarbanes-Oxley, section 404, was a major irritant across, in particular, the smaller public company regulated community, but really across the markets as a whole. And there was great concern, not only in this country but also abroad. I have met extensively with Members of Congress to formulate a plan of attack to solve that problem. And, with a great deal of support in the House and in the Senate, we overhauled completely the audit standard that the Public Company Accounting Oversight Board was using for 404 compliance. We also introduced the first ever management guidance so that the companies in their own assessments would not have to rely on the very elaborate, extensive and complicated guidance that had been given for auditors. That new guidance and the new audit standard are now in place. So this will be the first year that we will see whether or not the 404 process is efficient as we expect it to be. When Congress wrote that provision of Sarbanes-Oxley, as I well recall because I was a Member of the House-Senate conference committee, no one expected that it would be a poster child for waste and inefficiency. Everyone wanted to get the benefits of strong internal controls for the benefit of investors. So that is the object. We want to get the benefits that were intended by Congress but not all of the waste. And to make sure that smaller public companies don't have to be a guinea pig as we try out what we would expect to be the vastly different, more efficient approach, we have postponed for another year their compliance with the audit portion of section 404(b). And the SEC has undertaken a very formal study of the costs this year, in the first year of the new procedure. That will then inform our determination of how to proceed at the end of this year. CURRENT MARKET STATUS Mr. Bonner. Thank you. To follow up on the line of questioning the vice chairwoman and the ranking member had for you, I noted in your biography that when you served in President Reagan's administration, one of the things that you advised the President on was the 1987 stock market crash. And since there is so much concern about consumer confidence is not strong and there is a lot of concern about the economy, I know you are not the Chairman of the Federal Reserve or the Secretary of the Treasury, but from the position you sit on and with your historical perspective and knowledge, fundamentally is the market strong, weak, sound? How would you describe it? Mr. Cox. Well, long ago, it was appropriately noted that the market will fluctuate. In these days, it is fluctuating. I think that is going to continue. The question of the market's strength ultimately is and should be connected to the Nation's economic strength. I think our market should be and generally is a good reflection of that at any moment because I strongly believe in the overall sustenance of the American economy. I think it is a good bet for the long term to invest. What the SEC is responsible for, however, is not the prevailing price level in the market but rather the rules of the road so that the price discovery works. And we are doubling, as you might imagine, our efforts on the enforcement side, on the regulatory side. I mentioned credit rating agencies here, and there are other important initiatives relating to these current topics, so that everyone can take away confidence that the rules of the road are sound and security will be enforced. FTE REDUCTION Mr. Bonner. And the chairman and the vice chairwoman both focused on whether you have the staff and the tools that you needed to do the work. And I noted that the SEC budget more than doubled since fiscal year 2001. But what considerations led to your decision to request a less than 1 percent increase, eliminating 97 positions? And what positions would be eliminated? And how were those chosen? Mr. Cox. Well, first, you need to understand that we are talking about FTEs, full-time equivalents. In real life, what happens is that we don't have FTEs working for us. We have real people. And so as always there is a difference between the authorized level, the number of slots and actual people that you have working. There is normal turnover. People, some of them sometimes die. Sometimes they leave and go on to other things. New people join and so on. What we are talking about doing in real life is actually slightly increasing the number of human beings that work at the SEC compared to last year. Mr. Bonner. Thank you, Mr. Chairman. Mr. Serrano. Thank you. Mr. Cramer. TREASURY REGULATORY REFORM PLAN Mr. Cramer. Thank you, Mr. Chairman. Welcome back, Chairman Cox. We are glad to see you here. We have enormous respect for your role there at the SEC. I want to make reference to, Secretary Paulson a few weeks ago announced the biggest overhaul of the financial regulations since the Depression, and there has been reaction and commentary. I am referring right now to an AP story that looked or reacted to that plan, that proposal. And it seemed to be evaluating whether the power and authority of the SEC could diminish as a result of that plan. So I would be curious, I know Kathy Casey is one of your Commissioners for whom I have a lot of respect, and I have known her since she was at the Senate Banking Committee, seemed to be carefully defensive or clear to say that your regulations would not be affected and that investors would be protected under this planned plan and that your regulatory approach is really not different from the principles-based philosophy recommended in Paulson's proposal. So, for the benefit of investors, particularly small investors, I would like for you to give us some insight as to your reaction of that plan, your participation in that plan, and if in fact the SEC's role could be diminished. Mr. Cox. Let me pick up where I left off. We had a brief discussion in my colloquy with the Chairman on this topic. As I mentioned, the Treasury proposal is a Treasury proposal. It is meant I think to stimulate discussion and thought. And it has as its major premise the notion that there is a balkanization of regulation of financial services in the United States today. I agree with that major premise. I think we can do a much better job. And in this respect, I may be wearing my U.S. Government hat or my former Congressman hat as much as my SEC hat. But if you are looking government-wide, there is a better job that we can do at coordinating the regulation of the financial services and products that today are much more integrated than when we first came up with these legislative schemes. One of the things that we do at the SEC is try to stretch the Investment Company Act of 1940 to cover today's mutual funds and their competition with ETFs. None of this was really imagined when the law was written, and it gets increasingly harder with every passing year. But with respect to the particulars, it is important to recognize not only that this is a Treasury proposal, not an SEC proposal or Fed proposal or anything collaborative in that sense, but also that it is 100 percent a legislative proposal. So whether you go with the three-pot approach in that blueprint or twin peaks approach that others have adopted or the unified approach that some have recommended, there is an awful lot there for the Congress to chew on. And it would be entirely your choice how to do it. Then you get into some of the fine print, the detail, such as, do we want to be more principles-based or rules based? And that discussion to me has always reminded me of the old beer commercial, ``Tastes great. Less filling.'' How one comes down on the question of whether you want to be more principles-based or more rules-based is something of a Rorschach test. In a principles-based system, or at least a system that wishes to be called that, such as the U.K.'s system, they actually have a big rule book that sits behind their principles. We, on the other hand, have a lot of detailed rules that everyone is aware of, but we also have some pretty broad principles that we like to put into effect. We start out with very sturdy notions of investor protection and orderly markets and the promotion of capital formation that I hope that ultimately our rules always build towards. So I don't know that calling yourself one or the other is going to help resolve what ultimately would be very difficult questions of implementation. There are different marginal rules that apply for derivative products on the one hand and options on the other. At some point, whether you call it principles- based or rules-based, somebody in Congress, if you were going to merge those things, will have to say, here's how it is going to be done. Those are tough questions. And apart from the jurisdictional divide that I mentioned earlier, if some day there is a conference committee hammering those things out, you are going to need the future Kathy Caseys of the world to sort this out. Mr. Cramer. Thank you. I think that is part of my point. This is a little overwhelming, and it is extremely important that we get this right, especially in the context of the problems of today. So I appreciate that comment and further information. Thank you, Mr. Chairman. Mr. Serrano. Thank you. Sen'6or Kirk, por favor. Mr. Kirk. Mi jefe supremo. Mr. Serrano. Comandante. CREDIT RATING AGENCIES Mr. Kirk. Mr. Chairman, I want to thank you for all you have done on Sarbanes-Oxley 404 for the small companies. I know we are in a new delay for small companies, and my hope is maybe we just permanently extend that to relieve what was a huge unintended burden on the most dynamic part of our economy. I want to turn to another topic raised in your testimony. With the Credit Rating Agency Reform Act, we eventually gave you the power to look at these agencies. You started operation in June of 2007. Just 4 months later, the price of non-agency asset-backed securities plunged. Assets declined. Investors lost confidence. We then entered into a decline in the U.S. market and a severe liquidity crisis. And did you do that? Mr. Cox. Well, I want to congratulate, once again, Congress. I don't know that Congress had a crystal ball, but it is always better to legislate authority ahead of time rather than after the fact. The statute got enacted towards the end of 2006. We put our rules out lickety split. You know, under the Administrative Procedure Act, there has to be notice and comment and so on and so forth. So, by June 26, 2007, we had the opportunity then to go out and start our program. Mr. Kirk. It is a bad timeline that you got there. Mr. Cox. Well, I wish that it had been a year earlier. That would have made a big difference. Mr. Kirk. Absolutely. Mr. Cox. But the good news is that we are going to be able to put sturdy rules in place this year based on what we learned without having to come to you and ask for legislation. Mr. Kirk. So here is the appropriations question I have though. The Consolidated Supervised Entities program, which is voluntary, and we don't have a dedicated funding stream by the Congress, let me ask you the direct question, would you support this committee providing that dedicated stream so that we have---- Mr. Cox. Yes. Mr. Kirk. Which is the correct answer I think for us. And secondly, you know the legislation limited the operations of your staff and operations so that we can't rewrite credit and agency reports. We can just expose them. But I am wondering, do we have a long-term problem with market concentration of credit rating agencies? Because if there is too much power in just three firms, then an arrogance and concentration and market ability to have customers with no other place to go means that this committee would have to appropriate an enormous amount of resources. On the other hand, if there were not three powerhouses but say seven or eight, a credit rating agency that poorly advised its clients would quickly lose--well, officially but really we are talking three. And I am thinking of it like a Justice Department antitrust lawyer would look at it. You just look at the HHI index and see, do we have real market power here? Obviously, that is a similar problem with the big four and a half accounting firms. What do you think of that? With a dedicated stream, do we also need to look at market power of the agencies themselves? Mr. Cox. Yes, and I think that that is one of the two main purposes of the Credit Rating Agency Reform Act. It went after conflicts of interest, and it went after the problem of competition or the lack of it. So what we have been able to do with new standards for NRSRO rules that are in place under the new law is to start and grant registrations for new competitors. And I think that with the rules that we will put in place later this year, we will have even more grounds for fair competition because you will have some data to be able to compare and contrast the performance of others. And if a firm is routinely putting out bad ratings, then it will be in the interest of the other competitors, just as Coke goes against Pepsi, to point out why they are better and others are not. Mr. Kirk. Bud raised the point that the Secretary raised, which is the systemic risk which is not your purview; you don't have that portfolio yet. He made some proposals here. But for me, let me nail you down further. Could you get back to us on what your recommended funding line-item for the CSE would be? Mr. Cox. Yes, and in fact, I would endorse the same thing for CRAs, because when that new authority was given to the SEC regarding credit rating agencies, it was without any specific allocation of resources to it. [Clerk's note.--The Securities and Exchange Commission provided the following in response to the question:] Below is proposed report language for the Subcommittee's consideration: Proposed Committee Report Language related to sec's consolidated supervised entities (cse) and credit rating agencies programs ``The Committee's recommendation assumes that no less than $5,750,000 will be obligated for the personnel compensation expenses of the Consolidated Supervised Entities (CSE) program and that no less than $2,200,000 will be obligated for the personnel compensation expenses of the oversight of nationally recognized statistical rating organizations (NRSROs).'' Mr. Kirk. Yeah. I would just say, Mr. Chairman, I mean you are presiding over the implementation of Basel II, FASB 157 and now which are giving you tools to look at these agencies. Obviously, if they had got it right, the market would have corrected itself without this huge jolt. And so I want to make sure that you have the resources to create much greater transparency within at least these three agencies and maybe give some opportunities to the competition, which would also help. Mr. Cox. But I think there is great reward for a very small investment relatively speaking of money and people in these areas. Mr. Kirk. Yes. Thank you, Mr. Chairman. Mr. Serrano. Thank you. I was getting a little nervous where you were going with that line of questioning, when you asked him what he had to do with something at the beginning there. Because just a day or two I was announced--it was announced that I would be chairing this committee, the market crashed in New York. I hope---- Mr. Kirk. The Havana stock market went up. Mr. Serrano. Oh, that went up big. Chavez was very happy. The whole socialist world was very happy. Mr. Hinchey. HEDGE FUNDS Mr. Hinchey. Thank you very much, Mr. Chairman. I must say, this is the most entertaining subcommittee on the Appropriations Committee. Mr. Serrano. In more ways than one. Mr. Hinchey. Mr. Cox, great to see you. And thanks very much for the job you are doing. I think you are involved currently in what appears to be a very complex set of circumstances. And I think that that is primarily associated with the hedge funds and the way in which they are behaving. Hedge funds apparently have been around for a long time. I think they go back to 1949. But I don't think they have ever been anywhere near as prominent as they are today. And I think the main reason for that is the deregulation legislation which was passed by this Congress and which opened up the ability for a number of financial operations to engage in practices which are not overseen by the government, and that is particularly true of hedge funds. I agree with what you said; I think the investor should have some confidence in their investment. But the confidence that they should have in their investment doesn't come about without the regulation, the oversight of these investment operations. So the deregulation of investment I think has had a major impact on the way these hedge funds operate. And right now, they are very, very prominent. They control something in excess of $2 trillion of investment capital out there in the economy. So my first question I think is, what do you think we should do? There is a speculation out there now that calls for internal monitoring. All of the people involved in hedge funds should now start behaving in a different way. This is what we are recommending. But there is no guarantee that they are going to do that, even though the most responsible people involved in hedge funds are saying that, yes, this is the way it should happen. I think that we need is to go back to regulation. Senator Grassley has introduced a piece of legislation in the Senate which would begin to move us in that direction. A lot of people around the country now are blaming the subprime mortgage, subprime market, rather, and the fact that people unable to pay their mortgages for the decline in the economy that we are experiencing. But I don't think that that is exactly accurate. I think that that is more a result of the decline in the economy. And I think a decline in the economy is primarily driven by the manipulative way in which investments have been engaged in, including the incorporation of large amounts of these mortgages into these hedge fund investments. So I would be very interested to hear what you think about that and how quickly you think we should go back to a system of complete regulation of this operation. Mr. Cox. Well, two points. First, the term hedge fund covers a variety of animals, as you know. Mr. Hinchey. Yes. Mr. Cox. And I think we would all agree, given the breadth of the definition, that there is a lot of good that goes on in that space and there is a lot that goes on to be concerned about or to be suspicious of. Based on the fact that we are primarily a law enforcement agency, we are bringing scores of enforcement actions against hedge funds, 71 since I have been the Chairman, focused on a number of areas, including fraud and insider trading. Mr. Hinchey. Yes. Well, that is a good point, what you are making right now. The kind of fraud that is being engaged in by investment practices is becoming more and more obvious. I mean, things like money laundering, for example, the hedge funds are not exempt from money laundering. They can bring all kinds of money in from any place; nobody knows where it came from, what were the circumstances, how legal it may have been, how corrupt it may have been, how it may have been involved in the importation of narcotics, for example, and things of that nature. None of that is being overseen. Mr. Cox. Well, I am not sure that is the case. I think---- Mr. Hinchey. No. It is specifically the case. There is no-- there is no monitoring of the introduction of money. So money laundering is fully capable within the operation of hedge funds if there are some hedge funds who want to engage in that kind of activity. Mr. Cox. Well, the AML surveillance that is conducted routinely, since it is directed, among other things, at notorious felons and so on, does not require that it be set up in any specific way in order for it to work. And I know that, to the extent that anyone suspects that a particular hedge fund were engaged in that, law enforcement would be interested, and we have tools, and the SEC does civil work of course. But we have the Department of Justice and many other authorities that are interested in that. Mr. Hinchey. Yes. Well, I am not suggesting that the SEC is at fault there. Because the SEC can only engage in the kind of oversight examination, insight that they are allowed to under the law. Mr. Cox. That is right. And that is the second point that I want to make. As you know, shortly after I became Chairman, we went effective with a rule requiring a registration of hedge fund advisors which was then thrown out by a court. And there was a good deal of concern at the time that that meant the end of the SEC's program of registering hedge fund advisors. What has happened--in fact, we now have a good experiential base to look at--is that nearly 2,000 hedge fund advisors representing over $2.5 trillion, the number that you quoted, are registered with the Commission voluntarily. And so, in addition to the anti-fraud authority that we have with respect to any hedge fund, whether it is registered or not, we also then have the opportunity to go in and examine those hedge funds and to subject them to our regulatory regime. Mr. Hinchey. How frequently has that been done? Mr. Cox. We do that as a matter of course through our Office of Compliance, Inspections and Examinations. Mr. Hinchey. But how frequently has it been done? What is the major head hedge fund that has been examined in great detail recently? Mr. Cox. I would be happy, in response to your question, to submit a detailed answer for the record. Mr. Hinchey. Okay. Any more time? My time is up? INVESTOR EDUCATION Mr. Serrano. Thank you. It is not the practice of any committee to mention folks that come into a hearing. But it is interesting that my next question relates to the fact that some young folks walked into our audience a few minutes ago. The Fiscal year 2009 budget requests states repeatedly that the SEC Office of Investor Education and Advocacy will continue to focus on educating seniors and retirees about ways to assess investment commonly marketed to them and detect and avoid potential frauds and scams. This is clearly an admirable goal that the subcommittee fully supports. However, this subcommittee is concerned because no other demographics are mentioned in the request when there are clearly additional groups in need of investor education. For example, for many young investors and recent immigrants, the recent market downturn is the first time that they have seen their investments negatively impacted by market conditions. Are there any other demographics that the office is trying to actively reach, such as minorities or young investors? Mr. Cox. Indeed, that is the pedigree, Mr. Chairman, of this office. Young people are the first demographic that everyone thinks of when they think of investor education or any kind of education. The good news is that young people have the most to benefit by having this education because they have the one thing that some of us older people don't, and that is time. As you know, a major premise of investor education is to help people understand the time value of money. If you set aside money and leave it there for 20, 30, 40 years at a reasonably safe prudent investment with compounding and with growth, you get something that you just can't get for yourself when you are 50 years old or 60 years old or 70 years old. So getting the young people with those kinds of messages is really important. We work in a number of ways, not only through schools, as you would expect, and groups that are set up across the country to help young people with financial literacy, but with our armed services. A lot of men and women in the armed services are getting a steady paycheck for the first time when they first join, and they are remarkably busy people. They don't have a lot of time to spend thinking about what to do with their money. And so, at the highest levels, including the Commissioners themselves, we go out to these bases and put on big educational events. We are doing everything that we can to focus on that demographic. Second, with respect to different language groups and ethnic groups and so on, we try and have our over, you know, 800 tapes that we have and other means of presentation translated into a number of languages and make them available through channels that are likely to reach the target audience. So the reason you are hearing about seniors from us is that that is a new addition to an old line-up. We have always been interested, of course, in older Americans as well, but having a big push for seniors has been thought appropriate because of the aging of the population and the fact that there are going to be a lot of people living longer without the kind of nest eggs that they thought they needed when they followed their parents' example, you know, 30 years before. And that is going to present a lot of new risks that we have never faced before. Mr. Serrano. Let me ask you a question, a related question. Do you get any kind of a pushback on the issue of immigrants and helping them invest? You see, as you know, we have two immigrants in this country. We have the one who is here with documents and is on his way to becoming a citizen; or who has become a citizen and we don't call an immigrant any longer. Then you have the person who is not here documented. That person may have money. One of the biggest mistakes we make is that we seem to stop those people from taking their money to a bank or investing because they are not here legally. Do you single out just folks for help that are here legally? Do you ask that question at all? Do you get a pushback when you meet with other folks and say, well we are not supposed to be dealing with those folks? Because I suspect that there is a lot of money under mattresses in this country out of fear of putting it somewhere else because that somewhere else may indicate how you are here in this country. And meanwhile, the economy is hurting because that money should be invested and put up somewhere. You know my whole theory on this immigration thing is, all right, you have a border issue; deal with that. You have an issue of what to do about folks in the future; deal with that. But while you are here, while you are here, you are paying taxes. You have money, some money, then let's make use of that. Let's not keep you apart because that only hurts the rest of us. Any thoughts on that? Mr. Cox. Well, first, our investor education initiatives are aimed through a lot of channels, including the Web, and at as many people as we can find. For all I know, we are reaching people around the world, and I hope we are. Second, some of the problems that you have described with people who are, for a number of reasons, are either frozen out or freezing themselves out of the financial system, there are some good initiatives underway that start with trying to get people to open up savings accounts and checking accounts so that they are not completely disintermediated. That, of course, is a commercial banking initiative ultimately, but we are all aware of the paycheck cashing services and the fees that people pay and how much abuse and potential for abuse exists in that space. And we find ourselves partnering, even though commercial banking is not our line of country, we find ourselves partnering with them in our investor education initiatives. SUBPRIME LENDING Mr. Serrano. Right. Right. I have a few questions that I will submit to the record. I just have one more that I want to ask you. And it is, of course, on the subprime lending issue. Chairman Cox, in the testimony you submitted for today's hearing, you mentioned that a subprime working group was formed within the enforcement division of the SEC and that this group is investigating possible fraud, market manipulation and breaches of fiduciary duty related to the subprime crisis. The group was probably formed too late to help prevent or mitigate this particular crisis, But what steps are being taken by the group, or by the SEC in general, to prevent a crisis like this from happening again? Is the SEC working with other agencies on a lessons-learned strategy, if you will, from the recent housing crisis? Mr. Cox. Yes, to the second question. And I will answer it in more detail. To the first question, what are we doing in the subprime working group? We have, as a matter of public record, as you know, ongoing law enforcement that we have some trouble talking about publicly. But as a matter of open record, we have opened up approximately three dozen investigations through this task force. The kinds of issues that we are tackling with the subprime task force include whether or not the underwriter that was involved in the offerings knew or was reckless in not knowing that the issue and the lender were not complying with its disclosed lending policy, whether the lender was misrepresenting the loan or the loan's characteristics or whether the lender failed to maintain adequate reserves. We are, in fact, working closely with other agencies that have regulatory oversight over subprime lenders as well as coordinating our investigative efforts with the Federal Reserve, the FDIC and the Department of Justice. There have been a number of international fora that I have been heavily involved with that have also been inferring lessons learned from this, including the Financial Stability Forum, which reports to the G-7, and the International Organization of Securities Commissioners, where I am going to become chairman of the technical committee this summer. I am the co-chairman of the task force that is looking at this from an international level. And you full well know there are many countries, not just the United States, that have been harmed by this problem. Mr. Serrano. Thank you. I will submit, Mr. Regula, the rest of my questions for the record. Mr. Regula. Mr. Regula. I am curious, do other countries, industrial countries, have an agency comparable to the SEC? Mr. Cox. Yes. FOREIGN REGULATORS Mr. Regula. It seems like financial securities don't know borders anymore. Mr. Cox. The answer to your question is, most definitely, other countries do have agencies that are our counterparts to the Securities and Exchange Commission. And in fact, the SEC, for most of them, has been the model. Since we created the genre in 1934, virtually every country with a market economy has thought it necessary to have a securities regulator. Our International Securities Regulation Institute, which we conduct at the SEC and is currently underway, has attracted 78 countries to come and be trained and learn how we do things at the SEC and to share best practices. MONOLINE INSURERS Mr. Regula. One of the keys to security in the marketplace is monoline insurers, because they guarantee to some extent. Do you regulate them in any way? Mr. Cox. No. We are not the frontline regulators for monoline insurers. They are regulated by the State insurance commissioners chiefly. Mr. Regula. Mr. Chairman, I will submit the rest of my questions for the record. Mr. Serrano. Thank you. Mr. Hinchey. HEDGE FUNDS IMPACT ON ENERGY PRICES Mr. Hinchey. Thank you very much, Mr. Chairman. Chairman Cox, I wanted to ask you another question about the hedge funds and the way in which they seem to be having an impact on the price of energy, particularly on gasoline and home heating oil. One of the things that we have seen recently is a statement by the Energy Information Administration and a brief quote is, ``Weakness in the U.S. economy has led to softening gasoline demand.'' And we know that is true. The demand has gone down because of the fact that there is a weakness in our economy, and particularly people throughout the middle class are having a very difficult time meeting their daily obligations, whether it is energy, food, whatever it might be. So I am just curious as to what extent the hedge funds in bidding out for large amounts of these commodities, these oil commodities, are driving up the price, particularly in the context of the weaker dollar. It seems to me that, based upon the information I have been able to look at, that that is exactly what is happening. And a large amount of the increase in the price for energy, particularly oil, is going up based upon hedge funds intruding themselves in there and investing in those commodities. I have to laugh a little bit when I say intruding themselves in there because I mean they are free and open to do that. There is no regulation against them. They can just do it in whatever way they want to. But do you think that we ought to have some sort of regulation on these kinds of investments to ensure that people aren't doing this or these funds aren't doing it in ways that are making it more and more difficult for ordinary people to be able to drive their car back and forth to work, feed their family, all of the things that people are having a difficult time doing in this country today? Mr. Cox. Well, the abuse of trying to corner the market or manipulate the price of the commodities is sufficiently old that one of the oldest playing card games in the country, Pit, is based on that. We can go back to the early 20th century and find an example with that pathology. So not only should there be regulation against that kind of manipulation of the market, but there is. And, to the extent that surveillance can detect it, to the extent that we can get a trail of evidence that leads us to it, our law enforcement can be all over it. It is even possible for that kind of behavior to run afoul of the criminal laws as well, so not only the SEC but the Department of Justice could become involved. Mr. Hinchey. Is that an internal regulation within the SEC? Is it based upon Federal law? What is the basis for it? How does it operate? Mr. Cox. Yes. The manipulation of a market or other kinds of abuses or manipulative behavior that is designed to influence particular security of any kind is prohibited by section 10(b) of the Securities and Exchange Act of 1934. And we have a special rule that implements that, rule 10G-5 that we have used very aggressively and for a long time. Mr. Hinchey. To what effect was the Deregulation Act of 1999 impinging upon that? How does that make it weaker and more difficult---- Mr. Cox. I don't think that in any way affects our ability to use rule 10G-5. Mr. Hinchey. So can you give us an example, and I don't expect you to do it right now, but can you give us some examples directly how the SEC is engaging in actions to try to ensure that hedge funds manipulative investments are not actively engaged in driving up the price of energy, particularly oil? Mr. Cox. I will do my level best to answer the question. In fact, if I provided the answer for the record, I might be able to provide you more information than I could in this public hearing about ongoing law enforcement and give you a good inventory of the cases that we have had of late on hedge funds. And then, second, to tell you what we have got going on with respect to energy in particular. Mr. Hinchey. Okay. I appreciate that very much. Thank you. Thank you, Mr. Chairman.
Mr. Serrano. Thank you. Well, we thank you for your testimony today. We thank you for your service to our country, and we thank you for your agreement to give us some further information. Mr. Regula. REFORMS RESULTING FROM SUBPRIME MELTDOWN Mr. Regula. One more question. Are we putting in place regulatory mechanisms to preclude another meltdown prospectively as a result of the subprime situation? Are we doing something to avoid this down the road? Mr. Cox. Yes, indeed, I would say that not only in the United States but around the world we are very rapidly putting in place reforms that are designed to address each of the kinds of problems that have been identified. We talked about one of them in this hearing, credit rating agencies. There is a great deal of international focus on that and a good deal of focus on the new rules that we will be writing this year. There are accounting issues that are very central to these questions. There were a lot of off-balance-sheet activities that ended up affecting sponsors when either directly or indirectly it was taken back on. There are obviously problems with underwriting standards for lending that gave rise to all of this in the first place. And there are important lessons to be inferred from the Bear Stearns incident. And we are already adjusting both the Federal Reserve and the SEC, the way we look at liquidity measures. Mr. Regula. Well, the Fed is getting into the investment banking field, which they had not traditionally regulated. Is that correct? Mr. Cox. Yes. By opening up the discount window, they have done that in a very significant way. Mr. Regula. Thank you, Mr. Chairman. Mr. Serrano. Thank you. Once again, we thank you for your testimony, and we thank you for your service. Mr. Cox. Thank you, Mr. Chairman. Mr. Serrano. Meeting is adjourned.
Securities and Exchange Commission April 16, 2008 Page Chairman Serrano's Opening Statement............................. 261 Mr. Regula's Opening Statement................................... 262 Chairman Cox's Testimony......................................... 262 Treasury Regulatory Reform Plan.................................. 274 FTE Issues at the SEC............................................ 275 Subprime Mortgages............................................... 277 SEC and Federal Reserve Authorities.............................. 277 Bear Stearns Collapse............................................ 278 Sovereign Wealth Funds........................................... 278 U.S. Financial Markets Challenges................................ 278 Pension Funds.................................................... 279 Orderly Markets.................................................. 279 Market Security and Stability.................................... 279 SEC's Relationship with Other Regulators......................... 280 Budgetary and Legislative Needs.................................. 281 Impact of Sarbanes Oxley on Small Business....................... 282 Current Market Status............................................ 283 FTE Reduction.................................................... 284 Treasury Regulatory Reform Plan.................................. 284 Credit Rating Agencies........................................... 285 Hedge Funds...................................................... 288 Investor Education............................................... 290 Subprime Lending................................................. 291 Foreign Regulators............................................... 292 Monoline Insurers................................................ 292 Hedge Funds Impact on Energy Prices.............................. 293 Reforms Resulting from Subprime Meltdown......................... 296 Questions for the Record: Chairman Jose'1 E. Serrano............ 297 Ranking Member Regula............................................. 302 Mr. Hinchey....................................................... 308