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44–244 CC



before the





FEBRUARY 11 AND 12, 1997

Serial 105–17

Printed for the use of the Committee on Ways and Means

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BILL ARCHER, Texas, Chairman

BILL THOMAS, California
E. CLAY SHAW, Jr., Florida
NANCY L. JOHNSON, Connecticut
WALLY HERGER, California
JIM McCRERY, Louisiana
DAVE CAMP, Michigan
JIM RAMSTAD, Minnesota
PHILIP S. ENGLISH, Pennsylvania
J.D. HAYWORTH, Arizona
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ROBERT T. MATSUI, California
WILLIAM J. COYNE, Pennsylvania
JIM McDERMOTT, Washington
RICHARD E. NEAL, Massachusetts
JOHN S. TANNER, Tennessee

A.L. Singleton, Chief of Staff

Janice Mays, Minority Chief Counsel

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records of the Committee on Ways and Means are also published in electronic form. The printed hearing record remains the official version. Because electronic submissions are used to prepare both printed and electronic versions of the hearing record, the process of converting between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process is further refined. The electronic version of the hearing record does not include materials which were not submitted in an electronic format. These materials are kept on file in the official Committee records.
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    Advisories announcing the hearings


    U.S. Department of the Treasury, Hon. Robert E. Rubin, Secretary; accompanied by Jacob J. Lew, Deputy Director, Office of Management and Budget
    U.S. Department of Health and Human Services, Hon. Donna E. Shalala, Secretary


    American Bankers Association, statement
    Chicago Board of Trade, and Chicago Mercantile Exchange, joint statement
    Home Care Association of America, Jacksonville, FL, Dwight S. Cenac, statement
    International Swaps and Derivatives Association, Inc., New York, NY, statement
    Interstate Conference of Employment Security Agencies, Inc., Debra R. Bowland, letter
    National Association of Realtors, Russell Booth, statement and attachments
    UBA, Inc., Eric J. Oxfeld, letter and attachments

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House of Representatives,
Committee on Ways and Means,
Washington, DC.

    The Committee met, pursuant to notice, at 1:10 p.m., in room 1100, Longworth House Office Building, Hon. Bill Archer (Chairman of the Committee) presiding.
    [The advisories announcing the hearings follow:]



CONTACT: (202) 225–1721


January 27, 1997

No. FC–1

Archer Announces Hearings on

President's Fiscal Year 1998 Budget
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    Congressman Archer (R–TX), Chairman of the Committee on Ways and Means, today announced that the Committee will hold hearings on President Clinton's fiscal year 1998 budget proposals that are under the jurisdiction of the Committee. The hearings will take place on Tuesday, February 11, 1997, beginning at 10:00 a.m. and Wednesday, February 12, 1997, beginning at 9:30 a.m., in the main Committee hearing room, 1100 Longworth House Office Building.
    In view of the limited time available to hear witnesses, oral testimony at these hearings will be heard from Administration witnesses only. On February 11, testimony will be heard from Secretary of the Treasury Robert E. Rubin. On the morning of February 12, testimony will be heard from Secretary of Health and Human Services Donna E. Shalala, and in the afternoon from Donald C. Lubick, Assistant Secretary of the Treasury for Tax Policy. However, any individual or organization not scheduled for an oral appearance may submit a written statement for consideration by the Committee and for inclusion in the printed record of the hearing.
    On February 6, President Clinton will submit his fiscal year 1998 budget to the Congress. The official presentation of the Administration's tax, Medicare, and welfare proposals represents the beginning of the process towards agreement on a balanced budget by fiscal year 2002.
    In announcing the hearings, Chairman Archer stated: ''These hearings are the first of many opportunities the Administration will have to present their plan to balance the budget. I am eager to hear the President's proposal for ending decades of deficit spending. I am hopeful these hearings will mark the start of a bipartisan commitment to get our job done.''
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    The Committee will receive testimony on the President's revenue proposals from Secretary Rubin. In addition, the Secretary is expected to discuss general spending trends, and revenue and deficit projections, including economic trends forecast by the Administration.
    The following day, the Committee will focus on the details of the Administration's Medicare and welfare proposals, and additional details of the Administration's revenue proposals.
    Any person or organization wishing to submit a written statement for the printed record of the hearing should submit at least six (6) copies of their statement and a 3.5 inch diskette in WordPerfect or ASCII format, with their address and date of hearing noted, by the close of business, Thursday, February 27, 1997, to A. L. Singleton, Chief of Staff, Committee on Ways and Means, U.S. House of Representatives, 1102 Longworth House Office Building, Washington, D.C. 20515. If those filing written statements wish to have their statements distributed to the press and interested public at the hearing, they may deliver 200 additional copies for this purpose to the Committee office, room 1102 Longworth House Office Building, at least one hour before the hearing begins.
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    Each statement presented for printing to the Committee by a witness, any written statement or exhibit submitted for the printed record or any written comments in response to a request for written comments must conform to the guidelines listed below. Any statement or exhibit not in compliance with these guidelines will not be printed, but will be maintained in the Committee files for review and use by the Committee.
    1. All statements and any accompanying exhibits for printing must be typed in single space on legal-size paper and may not exceed a total of 10 pages including attachments. At same time written statements are submitted to the Committee, witnesses are now requested to submit their statements on 3.5 inch diskette in WordPerfect or ASCII format.
    2. Copies of whole documents submitted as exhibit material will not be accepted for printing. Instead, exhibit material should be referenced and quoted or paraphrased. All exhibit material not meeting these specifications will be maintained in the Committee files for review and use by the Committee.
    3. A witness appearing at a public hearing, or submitting a statement for the record of a public hearing, or submitting written comments in response to a published request for comments by the Committee, must include on his statement or submission a list of all clients, persons, or organizations on whose behalf the witness appears.
    4. A supplemental sheet must accompany each statement listing the name, full address, a telephone number where the witness or the designated representative may be reached and a topical outline or summary of the comments and recommendations in the full statement. This supplemental sheet will not be included in the printed record.
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    The above restrictions and limitations apply only to material being submitted for printing. Statements and exhibits or supplementary material submitted solely for distribution to the Members, the press and the public during the course of a public hearing may be submitted in other forms.

    Note: All Committee advisories and news releases are available on the World Wide Web at 'TTP://WWW.HOUSE.GOV/WAYS_MEANS/'.

    The Committee seeks to make its facilities accessible to persons with disabilities. If you are in need of special accommodations, please call 202–225–1721 or 202–225–1904 TTD/TTY in advance of the event (four business days notice is requested). Questions with regard to special accommodation needs in general (including availability of Committee materials in alternative
formats) may be directed to the Committee as noted above.




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CONTACT: (202) 225–1721


February 7, 1997

No. FC–1–Revised

Time Change for Full Committee Hearing on

Tuesday, February 11, 1997,

on the President's Fiscal Year 1998 Budget
    Congressman Bill Archer (R–TX), Chairman of the Committee on Ways and Means, today announced that the full Committee hearing on the President's fiscal year 1998 budget previously scheduled for Tuesday, February 11, 1997, at 10:00 a.m., in the main Committee hearing room, 1100 Longworth House Office Building, will begin instead at 1:00 p.m. Additionally, the afternoon hearing session scheduled for Wednesday, February 12, 1997, on the President's fiscal year 1998 budget has been canceled.
    All other details for the hearing remain the same. (See full Committee press release No. FC–1, dated January 17, 1997.)
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    Chairman ARCHER. The Committee will come to order. The Chair invites guests, staff, and Members to take their seats.
    This is an important and historic hearing today because for the first time since 1969, we are going to seriously discuss a real balanced budget for the people of this country, and I welcome you, Mr. Secretary, to participate in that and thank you for joining us today, particularly with the knowledge that you are a little bit under the weather, so we are very, very grateful and we will try to release you as soon as possible.
    If there was ever a year to balance a budget, this is it, and as difficult as the task may be, the American people expect us to work together and to get the job done. Let us do it.
    This country has two major legislative goals that I want to see signed into law and your good efforts are crucial to both of them. Number one, I want to balance the budget without raising taxes on the American people, and the best way to do that is to provide permanent tax relief so we can downsize the power of Washington and upsize the power of people, increase their individual freedom and their opportunities and responsibilities.
    Number two, as you know and I think most people in this country know by now, I want to totally abolish the Federal income tax and replace it with a new tax that is fairer, simpler, less intrusive in the lives of individual Americans, and one that is conducive to even greater economic growth. The budget you have submitted to the Congress advocates balance by 2002, but I am concerned it approaches that important goal with too high a level of taxation and with too much spending. I believe we can balance the budget with fewer taxes and less spending, and I look forward to working in a bipartisan fashion with you and the Democrats on the Hill to achieve that result.
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    On Sunday, together with the leaders of the House and the Senate, I sent a letter to the President urging him to propose a new tax system to take our Nation into the 21st century. The recent announcement by the IRS that it has spent over $4 billion on a new computer system that does not work is yet another reason why we need a new Tax Code for America. We need a code that can be administered after the expenditure of that large amount of money. If the current Tax Code is so complicated that the IRS cannot design a computer capable of dealing with it, then maybe it is time to give the American people a newer, fairer, and simpler code. So I am looking forward to your proposal, which I understand you are working on, so that we can work together on this issue.
    I have many other thoughts about the specific proposals in the budget which I intend to address during the questioning period. But for now, that concludes my opening and welcoming statement to you, which is a very sincere welcoming one in the hopes that we can work together.
    [The opening statement follows:]

    [The official Committee record contains additional material here.]



    Chairman ARCHER. I yield to the Ranking Minority Member, Mr. Rangel, for any statement he might like to make.
    Mr. RANGEL. I was just about to yield to the less-senior Members for their opening statements, but since that did not fly the last time, I will stick by the Committee's rules.
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    Chairman ARCHER. The Chair would not object.
    Mr. RANGEL. We will do it the right way this time.
    Let me join in in this first hearing in the spirit of bipartisanship as we move forward. I would like to say, I am so pleased with the expressions of the Chairman and his willingness, publicly as well as at this hearing, to work with the President and to work with the administration. In the spirit of bipartisanship, I would like to take a shot at the IRS for the record so that we can get it out of my system and we can move forward.
    I do not think the President needs any help in how to reach a balanced budget. This is the first time, as you pointed out, a President has done more than talk about it. President Clinton actually did it. And as you say, we have to start talking about upgrading the power of people. The most powerful State of the Union speech I have ever heard was the one that President Clinton recently gave where he focused on education as a top priority within the balanced budget plan.
    All of us are concerned with the cost of incarceration, of jails, police, crime, drugs, violence, unwanted children, poverty, unemployment. If we had to find just one key, I think the President has found it. That is improving the educational system of this great republic so that we can be competitive.
    And while it is true Members have different ways that they could achieve the balanced budget, I think Republicans have gone out of their way to say this is a document they can work with. Some of the Democrats have problems with it. But as long as we can put the rhetoric and passion of the past behind us and seriously attempt to work our will so that our Nation can continue to move forward economically, we can accomplish our goal. I think you deserve a great deal of praise, Mr. Rubin, as does our President. Together I hope we can do even better. I hope you recover from the flu soon and we wish you well.
    Again, Mr. Chairman, I want to thank you and congratulate you for the spirit in which we are starting these hearings.
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    Chairman ARCHER. Thank you, Mr. Rangel.
    [The opening statement of Mr. Ramstad follows:]

    [The official Committee record contains additional material here.]



    Chairman ARCHER. Mr. Secretary, you may proceed with your testimony, and again, welcome. We are glad to have you with us.

    Mr. RUBIN. Thank you, Mr. Chairman. I also have with me, as you can see, Jack Lew, who is the Deputy Director of OMB. Mr. Lew and I will be delighted to respond to questions when I complete my testimony.
    I want to start, Mr. Chairman, by thanking you, Mr. Rangel, and the other Members for giving me this opportunity to discuss the President's 1998 budget. It is a budget of which we are very proud, and we gladly welcome the opportunity to discuss it with you today.
    This past weekend, I was in Berlin. I went over Friday night and came back Saturday night, which I do not recommend. But I was in Berlin for a meeting with our G–7 economic partners. It was not long ago, and I remember well, when other industrial nations wanted to criticize the United States for not facing our problems, problems that affected not only us but them, as well, and we were viewed as yesterday's economy.
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    The situation is now exactly the opposite. At G–7 meetings today, the United States is once again viewed as the world's economic leader, and we are enormously respected for having dealt squarely with the problems that we face, both in the private sector and the public sector, and in the public sector for having made dramatic progress with respect to fiscal responsibility. I do have a chart here that shows the American deficit as a percentage of GDP, and as you can see, we now have the lowest deficit-to-GDP ratio in the G–7.
    In Berlin, we also discussed many of the other issues that the President discussed in his State of the Union as issues which are critical to the economic health of any nation in today's global economy—education and the critical effect that has on productivity, the importance in all of our Nations of bringing the least well off into the economic mainstream and tremendous productivity gains that can come therefrom, and how essential it is for all of our Nations, but particularly the United States, to maintain a leadership position with respect to the issues of the global economy.
    Mr. Chairman, I believe we have an extraordinary opportunity to build on what has been accomplished over the last several years, accomplished both in the public and the private sectors, to put our country in a very strong position for the next century, and I believe the President's budget is designed to accomplish exactly that.
    We are, as you said, in a historic time, within striking distance of balancing the budget. This certainly is building on what was accomplished in 1993. The 1993 deficit reduction program led to a reduction in the deficit from 4.7 percent of GDP to what is now 1.4 percent of GDP. That deficit reduction, in turn, lowered interest rates, increased business confidence, and those factors contributed very substantially to the economic recovery that we have enjoyed the last 4 years. Just as deficit reduction has been critical over the last 4 years, so it is absolutely critical going forward.
    I also believe there is a change in public attitude toward fiscal responsibility in this country. We have the political environment in which we can accomplish this year the historic objective the Chairman mentioned in his opening remarks.
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    Moreover, there is a new factor at work in the global economy that provides an enforcement for fiscal discipline which did not exist but will exist ever forward, in my opinion, and that is the power of the global financial markets to punish those nations that practice fiscal laxity with high interest rates, which in turn are inimical to economic growth.
    We can, should, and must work together to capitalize on the moment we now have, and I believe it is very likely that in this context we will, in fact, put in place balanced budget legislation this year.
    The President's budget does this and gets us to balance by 2002. It does so using realistic numbers and sound policies, by protecting priorities the President believes are critical to future productivity and a healthy society.
    I can remember from my days on Wall Street how often administrations' forecasts were based on rosy scenarios, and then when the deficits came in, they were higher than projected, not only undermining fiscal responsibility but also creating cynicism about government. Under President Clinton, we have used prudent and realistic economic assumptions, and as a result, deficits have been lower than either OMB or CBO in each of the past 4 years, and I think we have a chart to that effect, too. It is over there.
    Our 1998 budget is done in exactly the same spirit of sound policies and prudent, realistic economic and technical assumptions. I said a moment ago, in each of the last 4 years, the deficit has come in under the deficit projected in the budget, which I would guess must be pretty much unprecedented in the fiscal history of this country.
    Our budget also makes tough choices. For example, it eliminates 254 programs outright for roughly $2.9 billion in savings. We carefully looked in the discretionary benefits, discretionary accounts for each of the agencies to make sure that we have done everything we could to bring spending down, at the same time maintaining the critical function of those agencies. We auction broadcast spectrum. We closed corporate loopholes, eliminated subsidies that may have made sense at one time but are no longer warranted.
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    We cut $100 billion from Medicare over 5 years, in our judgment, in ways that will not adversely affect beneficiaries, and certainly in ways that will not affect their out-of-pocket expenses, and the list goes on. In the course of doing this, the Part A Hospital Trust Fund, which was otherwise estimated to be exhausted in 2001, will be extended to 2007.
    At the same time, Mr. Chairman, we all recognize, and I know you recognize, that there are long-term entitlement problems due to demographic trends, problems that have not been addressed in either the congressional majority's budgets of the last 2 years or the President's budget, and it is for this reason the President has called for a bipartisan process to deal with long-term entitlement problems.
    Raising another subject, if I may, that is germane at the present time, Mr. Chairman, in the State of the Union, the President said he was totally committed to balancing the budget and then he said he was equally convinced we should not have a balanced budget amendment because, in his judgment, it would subject our Nation to unacceptable economic risks in perpetuity and also because it would increase risks to the Social Security system. That is a view I very strongly share.
    Within the context of any totally balanced budget, it is extremely important that we invest in areas critical to future productivity and U.S. global leadership. There are many initiatives in the budget toward these ends. What I would like to do today is to focus on a few, particularly those that involve use of the tax system.
    We have the President's proposed middle-income tax cuts which are designed to help middle-income people obtain the skills they need to prosper in the modern economy. They increase savings and improve child care that is through our child tax credit. We also have programs to help move people from welfare to work and more broadly to help distressed inner cities.
    Before proceeding to discuss various other programs, let me stop for a moment to talk about the total of the tax cuts. We have proposed a total of $100 billion over 5 years. That is, in our judgment, a moderate, and because of its structure, a carefully targeted tax program designed to serve the purposes that I mentioned a moment ago. We believe it strikes the correct balance between advancing the goals of the balanced budget and providing tax relief. Tax cuts that are much higher would, in our opinion, require program reductions that would unduly harm our economy and our society.
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    In many areas, the President's budget and the congressional view of the budgetary matters have many similarities. In the tax area, they are not particularly close. Hopefully, we can close this gap. What we should not do, in our judgment, and we must not do, is to get engaged in a bidding war over tax cuts.
    Now, to go back to the President's priorities, areas critical to future productivity, the administration proposes extending the R&D tax credit for another year. It proposes substantial additional spending on education and training, as well as the education tax credits and deductions I already alluded to, a new effort to ensure health care for children, and new initiatives to encourage businesses to hire former welfare recipients and to help States and cities locate jobs to move families from welfare to work.
    I mention moving families from welfare to work in the context of enhancing productivity because I believe that bringing welfare recipients into the economic mainstream and eliminating the social cost associated with welfare is critical to the future economic growth of the country and affects everyone. Revitalizing our cities and moving welfare recipients to work are part of a much broader effort to bring the economically disenfranchised, whether urban or rural, many of whom are not welfare recipients, into the economic mainstream.
    The budget contains tax incentives to clean up environmentally contaminated land in distressed areas known as brownfields, new empowerment zones, and increased investments in the CDFI, Community Developed Financial Institutions, fund.
    The concept is to empower the disenfranchised to join the economic mainstream and is based on a strong belief in the private sector and in bringing in the private sector to help solve these problems with proper incentives.
    As I said a moment ago, it is the President's strong view that while these issues of the inner city are indeed social issues, they are also economic issues for all of us, and that all of us have a vital interest in seeing them effectively addressed.
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    The third area I wish to mention in our budget regards the importance of providing adequate resources to maintain U.S. leadership in the global economy. The budget seeks a significant increase in overall funding to sustain our international engagement and our role, as the President likes to say, as the world's indispensable nation.
    There was no question in our G–7 meeting this past Saturday in Berlin that there is only one country in today's world that can provide leadership on the critical issues of the global economy and that is the United States. But if we are going to maintain our ability to have the leverage we now have and to shape the world's agenda on economic issues, we must meet our commitments to the United Nations, we must meet our commitments to the World Bank and its sister institutions, and we must participate in all of these institutions in a meaningful way on an ongoing basis, and we do so not for charitable reasons but because doing so serves our economic and national security self-interest.
    Mr. Chairman, let me conclude by saying, as I said earlier, that I believe we have a historic opportunity to complete the job that we began in 1993 and balance the budget, and to do so in a way that promotes the areas that are critical to future productivity, economic health, and societal health for our country.
    Let me conclude by thanking you again for the opportunity to discuss the President's budget. Mr. Lew and I would now be delighted to respond to any questions you may have.
    [The prepared statement and attachments follow:]

Statement of Hon. Robert E. Rubin, Secretary, U.S. Department of the Treasury

    Mr. Chairman, I appreciate this opportunity to appear today to discuss the President's budget proposal for fiscal year 1998.
    This weekend I was in Berlin for a meeting of our G–7 economic partners. It wasn't so long ago when the other industrial nations roundly criticized the United States at G–7 meetings for not attending to its economic affairs and we were viewed as yesterday's economy. That situation is now exactly the opposite. The United States is once again viewed as the world's economic leader.
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    They understand that the primary source of U.S. economic strength today results from having squarely faced our challenges—in both the private and public sectors—including dramatic progress in restoring fiscal order. In Berlin, we also discussed the issues which the President emphasized in his State of the Union: how the globalization of the economy and the information revolution has made it more important than ever to have an educated workforce; how we must initiate policies which will bring more people into the economic mainstream; and how essential it is for all nations to remain engaged in the world. Meeting these challenges will further advance U.S. economic strength going forward, and that is the right path for the rest of the world as well.
    It is in this context that I want to talk about the President's budget this morning.
    We are in strong economic shape today and within striking distance of balancing the budget. This would not have happened without the deficit reduction program enacted in 1993, which has reduced the size of the deficit from 4.7% to 1.4% of GDP. That deficit reduction, in turn, inspired broad business confidence and drove down interest rates, which then drove and sustained the economic recovery. In fact, the United States now has the best economic conditions among all of the developed major industrial nations. Our economy has created over 11 million new jobs since 1993; inflation has remained low; exports are booming; and we've experienced record levels of investment, which is critical to future productivity. And just as deficit reduction has been the critical factor in these economic conditions, so is it critical to a strong economy over the long-term.
    We have an historic opportunity to work together and finish the job. There is strong support among the public for balancing the budget and there is, I believe, a change of attitude in Washington about the importance of fiscal responsibility. Moreover, the global capital markets have created a powerful new incentive for fiscal order, by punishing fiscal laxity with high interest rates that are inimical to economic health. We can, should and must work together to capitalize on this moment and get the job done.
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    The President's budget will get us to balance by 2002. It does so using real numbers and no gimmicks while protecting our priorities and investing in our people. In prior Administrations, budgets were too often based on rosy economic scenarios—and, when the actual deficits came in much higher than projected, the result was not only a higher deficit but increased public cynicism about the ability of the government to get its fiscal house in order. Under President Clinton, we have used prudent and realistic economic assumptions. As a result, actual deficits have come in lower than either OMB or CBO have projected in each of the last four years, which, I believe, is unprecedented. Our 1998 budget is done in the same spirit of sound policies and prudent, realistic economic and technical assumptions.
    Our budget makes tough choices. It eliminates 254 programs outright for $2.9 billion in savings, combs discretionary spending, auctions broadcast spectrum, and contains a number of proposals to close corporate loopholes and improve compliance. Our proposal cuts Medicare spending by $100 billion over five years, but without adversely affecting the quality of care for beneficiaries or the amount they must pay out-of-pocket. In the absence of change, the Part A Hospital Trust Fund will become insolvent in 2001. The President's proposal extends the solvency of the Part A trust fund to 2007. At the same time, we recognize that there are obviously long term entitlement problems due to demographic trends such as the aging of the baby boomers, which we must address through a bipartisan process.
    Mr. Chairman, as the President said in his State of the Union Address, balancing the budget requires votes by Congress, and the President's signature. It does not require a balanced budget amendment. Indeed, as strongly committed as the President is to a balanced budget, he has an equally strong conviction, which I firmly share, that a balanced budget amendment is a threat to our economic health and should not be adopted. Such an amendment will not make for us the tough policy choices that we ourselves must make to balance the budget, and it will subject our economy to unacceptable risks.
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    Within the context of moving toward a balanced budget it is extremely important that we invest in areas critical to future productivity and U.S. global leadership. There are, obviously, many specific initiatives in the budget worth mentioning, and most of them were mentioned last week by OMB Director Raines in his testimony before the Senate Budget Committee, but today I would like to focus on just a few significant ones—the President's proposals aimed at giving middle class people the opportunity to obtain the skills they need to prosper in this economy, as well as proposals to move the residents of our inner cities and distressed rural areas into the economic mainstream.
    First, the President's tax program provides targeted tax cuts for the middle class.
    The Administration's program would make it easier for middle class families to raise children, save for retirement, and pay for post-secondary education. In addition, the Administration is proposing to eliminate capital gains taxes for nearly all homeowners when they sell their home.
    The President is proposing tax cuts that total $100 billion over five years. I believe that amount strikes the correct balance between advancing the goals of a balanced budget, and providing tax relief. Tax cuts that are much higher than the Presidents' proposals would require us to make program reductions that would unduly harm our economy and our society. In many areas, the Congressional budget and the Presidential budget are close: not on tax cuts. I hope we can close this gap. What we should not do is engage in a ''bidding war'' over tax cuts.
    Second, the President's budget bolsters areas critical to future productivity. The surest way to enhance productivity, and maintain our country's competitive edge in the future, is by investing in areas that have long term payoffs. To that end, the Administration proposes extending the R&D tax credit for another year; substantial additional spending on education and training; a new effort to ensure health care for children; and new initiatives to encourage businesses to hire former welfare recipients and to help states and cities locate jobs to move families from welfare to work. I mention moving families from welfare to work in the context of enhancing productivity because I believe that bringing welfare recipients into the economic mainstream and eliminating the social costs associated with welfare is critical to the future economic growth of the country and affects everyone. Welfare reform is an economic issue, as well as a social issue. Revitalizing our cities and moving welfare recipients to work is part of a much broader effort to bring the economically disenfranchised, many of whom are not welfare recipients, into the economic mainstream. The budget contains tax incentives to clean up environmentally contaminated land in distressed areas, known as brownfields; new empowerment zones; and increased investments in Treasury's CDFI fund. This is the right time to implement these leaner, private-sector oriented approaches toward fostering growth in the inner cities as we move to balance the budget.
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    The final area I wish to mention regards the importance of providing adequate resources to maintain U.S. leadership in the global economy.
    The budget seeks a significant increase in overall funding to sustain our international engagement, and our role, as the President says, as the world's indispensable nation. To shape world events to advance our security and economic self-interest, we must meet our international obligations and support and lead in the United Nations and in the international financial institutions, such as the World Bank, the International Development Association and the International Monetary Fund. We should do so not for charitable reasons, but because it is in the economic self-interest and national security self-interest of the United States and our citizens. Bringing developing countries into the economic mainstream raises living standards, promotes political stability—and it increases markets for U.S. exports.
    Mr. Chairman, as I said earlier, I believe we have an historic opportunity to complete the job we started in 1993 and balance the budget; and to do so in a way that protects our priorities, both for now and the future. Let me conclude by thanking you again for this opportunity to discuss the President's budget proposal. I look forward to working with all of you this year.



Appendix: Summary of Tax Provisions

    The President's FY 1998 budget provides much-needed tax relief for middle-income families, and tax incentives to boost investment in distressed areas and promote hiring of the economically disadvantaged. It also eliminates unwarranted corporate tax subsidies, closes tax loopholes, and improves tax compliance, and it reinstates the expired excise and other taxes that are dedicated to various trust funds.
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Middle Class Bill of Rights

    These tax cuts will help middle-class families pay their bills, raise their children and send them to college, upgrade their own skills, and plan for retirement.

$500 Child Tax Credit.

    Taxpayers would receive a $500 nonrefundable credit ($300 in 1997, 1998 and 1999) for each dependent child under the age of 13. The credit would be phased-out for taxpayers with adjusted gross income (AGI) between $60,000 and $75,000. Beginning in 2001, both the amount of the credit and the phase-out range would be indexed for inflation.

Education and Training Incentives.

    The Budget provides carefully targeted education and training incentives to make postsecondary education more accessible for middle-income Americans and to make 14 years of education the norm.
    HOPE Scholarship Tax Credits. Taxpayers would be able to claim a nonrefundable tax credit of up to $1,500 per year (indexed for inflation beginning in 1998) for two years, to cover tuition and fees for themselves, their spouses, or their dependents while enrolled at least half-time in the first two academic years of a degree program. To take the credit in the second year, the student must have attained the equivalent of at least a B minus grade point average in course work completed before that year. No credit is available if the student is convicted of a drug-related felony. Federal grants (but not loans or work-study payments) reduce the allowable credit. The credit is phased out for families filing a joint return with modified AGI between $80,000 and $100,000 (between $50,000 and $70,000 for single filers), indexed for inflation beginning in 2001. The credit would apply to course work beginning after June 1997.
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    Education and Job Training Tax Deduction. As an alternative to the HOPE scholarship, taxpayers could elect to deduct up to $10,000 per year ($5,000 in 1997 and 1998) of tuition and fees for students enrolled at least half-time in a degree program or for courses to improve job skills. The deduction is taken in determining AGI, so it is available to all taxpayers whether or not they itemize. Unlike the HOPE Scholarship credit, which is calculated per-student, the deduction does not vary with the number of students in a family. The deduction is phased out at the same income levels as the HOPE Scholarship credit and would apply to course work beginning after June 1997.
    Expanded Tax-Free Treatment for Forgiveness of Student Loans. The Budget eliminates the tax liability that normally arises when debt is forgiven, if the lender is a charitable or educational institution that lends money to a student to pay for education and then forgives the loan after the student fulfills a commitment to perform community or public service at low pay for a certain period of time. The same tax-free treatment would also apply when the Federal government forgives a loan made through the direct student loan program for a student who has been making income-contingent repayments for an extended period.
    Tax-Free Employer-Provided Educational Assistance. Currently, up to $5,250 of tuition paid by an employer pursuant to a qualified educational assistance program need not be included in the income of the employee. However, the exclusion for undergraduate education expires in mid-1997, and the exclusion ceased to apply to graduate-level courses after mid-1996. The budget would reinstate the exclusion for graduate-level assistance retroactive to its prior expiration, and would extend both undergraduate-and graduate-level assistance through December 31, 2000.
    Ten Percent Tax Credit to Small Businesses that Provide Educational Assistance to Employees. For taxable years beginning after December 31, 1997, and before January 1, 2001, small businesses (employers with average annual gross receipts of $10 million or less for the prior three years) would be allowed a 10 percent income tax credit for payments for education of employees by third parties under an employer-provided educational assistance program.
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Expansion of Individual Retirement Accounts.

    The Budget expands the availability of deductible individual retirement accounts (IRAs) by doubling, over time, the current income limits for deductible contributions. In 1997 through 1999, eligibility would be phased out for couples filing joint returns with AGI between $70,000 and $90,000 ($45,000 and $65,000 for single filers). Beginning in 2000, eligibility would be phased out for couples filing joint returns with AGI between $80,000 and $100,000 ($50,000 and $70,000 for single filers). The income phaseout, as well as the $2,000 annual contribution limit, would be indexed for inflation beginning in 2001. As under current law, any individual who is not an active participant and whose spouse is not an active participant in an employer-sponsored plan would be eligible for deductible IRAs without regard to their income.
    In addition, beginning in 1997, taxpayers would have the option of either deducting the amount deposited in an IRA account, or foregoing an immediate deduction and be free of tax and penalties when the funds are withdrawn from a new Special IRA, provided the funds remain in the Special IRA for at least five years.
    Finally, penalty-free early withdrawals from either type of IRA would be expanded to include withdrawals to pay for higher education costs, first-home purchases, long-term unemployment, and catastrophic medical costs of certain family members not covered under current law.

Exclusion of Gain on Sale of a Principal Residence.

    The Budget provides substantial simplification and tax relief for millions of Americans by replacing the current-law tax treatment of capital gains on home sales with an exclusion of up to $500,000 of gain for married taxpayers filing joint returns ($250,000 for other taxpayers). The exclusion is available every two years, so long as the taxpayer used the house as a principal residence for at least two of the five years prior to the sale. The exclusion generally applies to sales on or after January 1, 1997.
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    [The official Committee record contains additional material here.]



Empowering Communities and the Economically Disadvantaged

    The Budget will spur private-sector participation in revitalizing distressed communities and generate job opportunities for long-term welfare recipients.

Tax Incentives to Clean Up Blighted ''Brownfields'' in Distressed Areas.

    To encourage companies to clean up abandoned, contaminated industrial properties located in distressed communities, remediation costs incurred in connection with the abatement or control of certain environmental contaminants would be immediately deductible if incurred for a qualified site. Qualified sites include business or income-producing properties located in specified high-poverty areas where it has been certified that hazardous substances are present or potentially present in the property. The deduction would be subject to recapture as ordinary income upon a subsequent disposition of the property at a gain. The proposal would apply to expenses incurred after the date of enactment.

Additional Empowerment Zones and Enterprise Communities.
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    The Secretary of Housing and Urban Development would be authorized to designate two urban empowerment zones in addition to the six urban and three rural zones designated on December 21, 1994. This would have the effect of extending the current empowerment zone tax incentives to these additional areas, with technical modifications. In addition, 20 additional empowerment zones and 80 additional enterprise communities, which will be subject to modified eligibility criteria, would be authorized. These additional zones would have available a different combination of tax incentives than those available to existing zones. Among the 20 zones, 15 would be in urban areas and 5 would be in rural areas. The 80 communities would be divided between 50 urban areas and 30 rural areas. Areas within Indian reservations would be eligible for designation.

Tax Credits for Community-Oriented Equity Investments.

    The Community Development Banking and Financial Institutions Act of 1994 created the Community Development Financial Institutions (CDFI) Fund to provide equity investments, grants, loans, and technical assistance to financial institutions that have community development as their primary mission. The Budget would make $100 million in nonrefundable tax credits available to the CDFI Fund to allocate among equity investors between 1997 and 2006. The allocation of credits is capped at 25 percent of the amount invested in any project and would be determined by the CDFI Fund using a competitive process.

Tax Credits to Facilitate the Transition from Welfare to Work.

    The goal of the Welfare Reform Act of 1996 (the Welfare Act) is to move individuals from welfare to work. To help achieve this goal, the Budget includes a new welfare-to-work credit that would enable employers to claim a 50-percent credit on the first $10,000 of annual wages paid to certain long-term public assistance recipients for up to two years. In addition, the Budget would expand the existing Work Opportunity Tax Credit to include able-bodied adults, ages 18–50, who have met their responsibilities under the law but are subject to the time limits for food stamps under the Administration's proposal to amend the Welfare Act. These proposals would be effective from the date of enactment through September 30, 2000.
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Estate Tax Relief for Small Businesses and Farms

    Under current law, estate tax attributable to certain closely held businesses may be paid in installments (interest-only for four years, followed by up to ten annual installments of principal and interest). A special four-percent interest rate is provided for the tax deferred on the first $1 million of value. Only certain types of business arrangements are eligible for the installment payment provision, and a special estate tax lien applies to property on which the tax is deferred during the installment payment period. The Budget increases the value cap on the special low interest rate from $1 million to $2.5 million, expands the availability of these rules to other comparable business arrangements, and authorizes the Secretary to accept security arrangements in lieu of the special estate tax lien. These proposals would be effective for decedents dying after 1997.

Other Tax Relief Provisions

    Extension of Expiring Tax Provisions. The Budget would extend each of the following provisions for one year from their current expiration date:
    •  The 20-percent credit for research and experimentation expenditures (expiring May 31, 1997);
    •  The 35-percent Work Opportunity Tax Credit for employment of targeted hard-to-employ groups (expiring September 30, 1997);
    •  The 50-percent credit for qualified clinical testing of certain drugs for rare diseases or conditions (known as ''orphan drugs'') (expiring May 31, 1997); and
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    •  The fair-market-value deduction allowed for contributions of appreciated stock to private foundations (expiring May 31, 1997).

Equitable Tolling of the Statute of Limitations.

    To ensure that disabled persons are fairly treated when filing for tax refunds, the statute of limitations for refunds from the Internal Revenue Service would be delayed when the individual is under a sufficient medically determined disability and no other person has been authorized to act on the taxpayer's behalf in financial matters. The proposal would be effective for taxable years ending after the date of enactment.

Tax Incentives for Economic Development of the District of Columbia.

    To encourage employment of disadvantaged residents and to revitalize those D.C. areas where development has been inadequate, tax incentives are proposed.

Tax Credit for Economic Development of Puerto Rico.

    To provide a more efficient and effective tax incentive for the economic development of Puerto Rico, the Budget modifies the economic-activity credit for Puerto Rico by extending it indefinitely, opening it to newly established business operations, and removing the income cap.

Foreign Sales Corporation (FSC) Benefits for Computer Software Licenses.

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    To reflect technological advancements, the Budget extends the current FSC export benefit to include computer software licensed for reproduction abroad, effective for licenses granted after the date of enactment.

Closing Corporate Tax Loopholes and Other Revenue Measures

    The Budget includes proposals previously proposed by the Administration to eliminate unwarranted corporate tax subsidies, close tax loopholes, and improve tax compliance. Such measures include:
    •  Proposals focused on financial products, to maintain the distinction between debt and equity, curtail arbitrage opportunities, prevent avoidance of gain recognition on functional sales, and properly measure income;
    •  Proposals focused on corporate transactions, to prevent tax-free disguised sales of businesses, prevent the manipulation of the stock redemption rules to distort income, eliminate the use of inventory methods that mismeasure income, and reduce corporate subsidies such as percentage depletion on lands received from the Federal government at a bargain price;
    •  Proposals focused on the international tax rules, to measure export income more accurately, prevent manipulation of the foreign tax credit rules through artificial labels, and eliminate distortions resulting from the use of derivative financial instruments; and
    •  Proposals focused on increasing tax compliance, for example by tightening the substantial understatement penalty for very large corporations, expanding withholding on gambling winnings, and streamlining debt collection procedures for non-means tested, recurring Federal payments.
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Extension of Expired Excise and Other Trust Fund Taxes.

    The Budget also proposes reinstatement of the excise and other trust fund taxes that have expired: the Airport and Airways Trust Fund excise taxes; the Hazardous Substance Superfund Trust Fund excise and income taxes; the Oilspill Liability Trust Fund excise taxes; and the Leaking Underground Storage Tank Trust Fund excise tax. These are not new taxes: they have been applied for years to finance specific programs, such as the provision of air traffic control services and the cleanup of certain hazardous waste sites. Each of these taxes would be extended through 2007.

Tax Simplification and Taxpayers' Rights

    The Administration continues to support revenue-neutral initiatives designed to promote sensible and equitable administration of the tax laws, including simplification, technical corrections, compliance, and taxpayers' rights measures. In the near future, the Administration will propose to Congress a package of such measures.



    Chairman ARCHER. Thank you, Mr. Secretary.
    To me, this is one of the most important things we will do for our children and their children. All of us recognize today that the average debt service charge for every child born this year is going to be almost $300,000 during their lifetime and that will go up until we balance the budget.
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    Under the President's budget, I believe I saw an estimate that the debt will increase $1.2 trillion before it gets into balance, so those interest service charges will continue to increase. And although we might pat ourselves on the back that we have the lowest deficit relative to GDP of any of the G–7 countries, that meter on interest charges is still running for future generations.
    So I am glad you are here to say today, We are going to change that and we are going to get this budget balanced. I believe we have to exert all effort on both of our sides to come together. It is not going to be easy. There are very difficult choices involved in this, and we are going to have to find ways we can bridge those choices between each other.
    But I am pleased you have expressed a willingness to have a real balanced, a real credible balanced budget which will be evaluated as in balance by the Congressional Budget Office. Is that correct, because that is what I——
    Mr. RUBIN. Ultimately, the balanced budget—ultimately, we are committed to having a balanced budget that is so scored by the CBO.
    Chairman ARCHER. And that is an extremely important starting point. We have not yet received the evaluation or scoring of the Congressional Budget Office on your budget. I assume we will have it within the next week or so.
    Mr. LEW. Mr. Chairman, we have been working with the Congressional Budget Office. Our understanding is that they are trying to do it very quickly, but it normally takes 6 weeks, so you would have to check with the CBO as to how quickly they will have it finished.
    Chairman ARCHER. All right. Well, in any event, I think they are pushing it as fast as they can, but until we get that, we have, to a degree, an uncertain starting point, and it is a little difficult to question you today about things that might happen until we know for sure how the Congressional Budget Office is going to evaluate this budget.
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    For example, on the tax reductions, whether they will be, in fact, permanent or whether they will trigger off at the end of the year 2000, and that is a significant item of interest to the Members of this Committee and also to the country. But I am not going to probe that specifically with you because we do not have that yet. We do not have the data from the Congressional Budget Office.
    But I would hope you would agree that if, in fact, the Congressional Budget Office evaluates your budget as not being in balance—forget about the details of the triggers on the taxes and the other things—but if they evaluate it as not being in balance, you will go back and revise your budget and submit another one to us that will be scored in balance so we will have a starting point that we can work from.
    Mr. RUBIN. Mr. Chairman, we are not so sure that is the process. We have submitted a budget that, in our judgment, goes to balance. Now, they are going to come back with their evaluations. We will then be working with the Congress, and ultimately, we all have to work together to get to a budget that is scored as being in balance by CBO. But I am sure there will be a lot of discussions and negotiations before we reach that point.
    Chairman ARCHER. I think that is going to make it far more difficult. If we start from a basic document that is not in balance, based on the agreed upon——
    Mr. RUBIN. Well, ours will——
    Chairman ARCHER [continuing]. Critical evaluators' determination, which you have just agreed——
    Mr. RUBIN. Yes, but as you well remember, last year, or 2 years ago—I guess both cases, actually—by virtue of the trigger mechanisms that we will submit—have we submitted them yet, Jack?
    Mr. LEW. We have submitted it in outline form to the Congressional Budget Office, and we would be happy to make it available to the Committee, as well.
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    Mr. RUBIN. Yes. We will have a budget that scores under CBO—I mean, it may have some adjustments and some of the changes we have made, and that is a different issue to have to deal with, but we may still have a difference with them as to whether, ultimately, a budget balance will be reached because of the trigger mechanisms or because of the realization of the assumptions that we have been using, which we think are realistic. So I do not think it necessarily will parse out quite as easily or the way you have just described. In other words, you could easily have——
    Chairman ARCHER. Well——
    Mr. RUBIN. You could have the situation we have had the last 2 years, that we had a budget that we believe, based on the exact same kinds of numbers we have used over the last 4 years, will ultimately balance and would balance without having to use the trigger mechanisms because, by using what we think to be prudent and realistic numbers, the actual numbers will turn out to be at least as good as our projections, if not better.
    On the other hand, in what we think is the rather small chance that did not happen, we have a trigger mechanism that brings us back down so that CBO can score us as having reached balance whether or not our numbers turn out to be accurate.
    Chairman ARCHER. I understand that when you submit your budget, you have to do it on the basis of the OMB numbers. That is all you have to go with. And you submit it up here in good faith on those numbers, and I understand that.
    But if we have the agreement that we in the end are going to have to have a balanced budget that has been evaluated by the Congressional Budget Office as being in balance, then it seems to me we will hurry along our negotiations if the beginning document can be evaluated by them as being in balance, rather than saying that somewhere down the line, we are going to——
    Mr. RUBIN. Mr. Chairman, they can evaluate it, and I believe 2 years ago they did—last year, they did evaluate a document as being in balance because their view was that if our numbers come out to be right, we balance, and if our numbers turn out to be wrong, we have an adjusting mechanism. So I do not think their evaluation is going to solve the problem that you are trying to address.
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    Chairman ARCHER. The main thing I am trying to get at is what their evaluation is going to be. But if their evaluation comes back and says it is not in balance, even though you feel certain they will say it is in balance, if it is not in balance, then we have to have a new starting point and I hope we can agree on that.
    Now, let me, if I can, get on to a couple of other things. First, the balanced budget amendment is something that I will be happy to debate with you for several hours in another forum. That is not our Committee's jurisdiction and so I hope we will not spend a lot of time in our questioning today trying to debate the pros and cons of the balanced budget constitutional amendment.
    But I do think we might talk for 1 minute about the basic assumptions you mention because they become exceedingly important in determining whether the budget is or is not going to be in balance, and I must say that having lived a life with many ups and downs, both in the stock market and also with the economy and what is being called by economists the business cycle, that things do not go up forever, that they do not stay stable forever.
    If I am correct, your budget is based on assumptions that we basically have growth similar to what we have had in the last 4 years, with very little inflation, pretty much as far as the eye can see. Am I accurate in that?
    Mr. RUBIN. The assumption we have made, Mr. Chairman, which is the same assumption the blue chip private sector forecasters, the group of 50 forecasters that are the blue chip has made, is that we will have—I think our projection was 2 percent growth over the 5-year period. If there are ups and downs, our assumption is that they will even out over time. We are slightly more conservative than the average of the private sector forecasters.
    Chairman ARCHER. What about the window outside of the 5 years? What about the long-term projections for your basic assumptions? What are they, in general?
    Mr. RUBIN. Well, we have, as you know—I do not know if you have seen it or not, but in the budget document, we have both our 5-year budget and then we have a projection that if we reach balance in accordance with this set of policy prescriptions by the year 2002, we will then remain in balance until the year 2020——
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    Chairman ARCHER. No, I understand that, but I am asking about the basic assumptions——
    Mr. RUBIN. The basic theory, and I think, Mr. Chairman, it is a sound theory, is the same one the blue chip uses in terms of taking into account ups and downs, and that is that over time, if you have—and you surely will, I agree with you, you will have ups and downs, that those will even out so that over time, you—just as last quarter was above the potential full-capacity rate of growth of the economy, so it was above what you could expect to achieve on an ongoing basis for the other quarters, but our expectation is that over time, those things will equal out.
    Chairman ARCHER. But as I read your basic assumptions, nowhere in this 25-year period, roughly, do you show any recession.
    Mr. RUBIN. No. Let me put that a little differently, if I may, Mr. Chairman. We do not see a recession as far out as we can reasonably look to see right now, but if you look out over the 25 years, the theory that we operated on I think is consistent with how private sector forecasters look at very long periods of time. It is assumed that there will be downs and ups, but that the downs will be compensated for by the ups and that they will even out to something that is approximately the full capacity rate of growth of the economy.
    Chairman ARCHER. But the problem, though, Mr. Secretary, is that they do not even out as a result of the reactions in a democracy. When you go into a recession, you do a lot of things that are different. Government takes a different role, spending goes up, and there are demands for things that do not otherwise exist and that does not average out. A lot of that stays in place permanently. I am not going to belabor this anymore, because other Members may——
    Mr. RUBIN. In theory, though, if we could get back to true balance, which you are committed to and we are committed to, at least the model or the theory of it is just what you said. The automatic stabilizers would work when we are below capacity. That would help us get back to balance. And then when we were functioning above capacity, you would actually get a small surplus, and once again, you would have an evening out.
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    Chairman ARCHER. But history teaches us it does not even out, and that is what bothers me. It is like the story of the river that is only 1 foot deep and how could you drown in it because it is an average of 1 foot deep, but there are potholes in there that are 8 feet deep and if you happen to hit that, you drown. So I am a little concerned about the idea that this is just going to keep going along without change, but I have overused my time and we have probably worn that subject out.
    Mr. Rangel.
    Mr. RANGEL. Thank you, Mr. Chairman.
    First, let me join with you in saying that the question of a constitutional amendment should be left up to those Committees that have the luxury of debating the issue as it relates to a balanced budget while we concentrate on actually balancing the budget, as suggested. There are going to be many bumps and differences of opinion on the road toward balance. I assume these difficulties may arise on the Republican as well as the Democratic side of the aisle. But I think we start, Mr. Secretary, with a spirit that you should appreciate. We are not going to stop until we reach that conclusion and present to the President and the Nation our solution—a commitment that has been kept.
    The question of bipartisanship, of course, is viewed differently by different people. I remember former Speaker Jim Wright used to talk about horse and rabbit stew. It was so delicious. Everyone liked it and they asked for the recipe for the stew. The cook responded, Oh, it is just equal horse and equal rabbit. And they said, Well, it certainly is good, but it tastes rather horsey. And the cook said, Well, maybe that is because we use one horse and one rabbit. [Laughter.]
    So we on the Democratic side hope that in the spirit of bipartisanship, we are not the rabbit. We will be working very closely with our Republican colleagues and the President of the United States to make certain we can all take pride in reaching this historic moment together as partners in government.
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    Thank you so much.
    Chairman ARCHER. Mr. Crane.
    Mr. CRANE. Thank you, Mr. Chairman.
    Let me just remind my distinguished colleague and friend Charlie that it is not Committees that debate balanced budget amendments or any other amendment, it is States.
    Mr. RANGEL. Very good. Thank you so much. We will leave it to the Governors. [Laughter.]
    Mr. CRANE. Mr. Secretary, I got what is called an Executive Alert Service publication dated February 4. It was prior to your G–7 visit to Berlin. But in this, if you have not seen it, it says that in Berlin, Secretary Rubin is expected to make a push for vigorous economic stimulus policies by other governments, especially Japan and Germany, and the U.S. Government is very concerned that severe budget austerity as presently enforced with Maastricht criteria and Japan's new austerity budget threatens to detonate a systemic financial crisis. Is that accurate?
    Mr. RUBIN. What are you reading from, Mr. Crane?
    Mr. CRANE. It is called the Executive Alert Service. It is based here in Washington, DC.
    Mr. RUBIN. Yes. I am not familiar with it. I do not want to cast aspersions on a publication I am not familiar with, but we are not concerned about a systemic—what is it, a systemic financial crisis? No. We do not have concern about a systemic financial crisis. We do have concern that Japan has had a low rate of growth for 4 or 5 years now and conditions are uncertain, and we do feel it is very important that Japan focus on domestic demand and growth. Germany reported the highest unemployment since, I think, the end of the Second World War last Friday, so clearly, there are a lot of issues that need to be addressed in other countries of G–7 if they are going to have robust economies, and that is important to us.
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    Mr. CRANE. But is it fair to say, which is a part of their quotation, about our government being concerned that budget austerity, in Germany and Japan especially, should be addressed by stimulating further expenditures?
    Mr. RUBIN. It was President Clinton's fundamental economic strategy to employ fiscal responsibility in this country to get us back on the right track in 1993, and in our judgment, that was the right strategy for this country. It was the right strategy for other countries. But on the other hand, you have to use common sense in doing it.
    What we did in 1993 during the transition, we met with the President for 6 hours and we sat down and tried to make a judgment as to what pace you could phase in fiscal contraction and get interest rates that would, by virtue of their falling, create an offsetting positive impact, and as a consequence, have net economic growth. It is a question of the condition and circumstance in each of these countries and their total package of macroeconomic policies with respect to those circumstances that raises the questions about their growth prospects.
    Mr. CRANE. The only reason it jumped out at me when I saw it this morning was, Are we not basically committed to a course of budget austerity to get our books in balance and is that consistent with the thinking of the administration?
    Mr. RUBIN. Oh, listen, our fundamental policy from the day we stepped in the Oval Office was deficit reduction, and we put in place a very tough program in 1993 and it has worked. I think the question of what each of these countries has to do is to construct a total package of macroeconomic policies that accompany their fiscal objectives, but also on net provide it with a robust domestic economy, and right now in both Japan and Germany, there are serious issues.
    Mr. CRANE. All right. Well, I wholeheartedly approve of your commitment to budget austerity; namely, that we get our books in balance by 2002. We may disagree over particulars, and I will have the staff make up a copy of this and give it to you so you can examine it personally.
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    Mr. RUBIN. Thank you.
    Mr. CRANE. Thank you, Mr. Chairman.
    Chairman ARCHER. Mr. Thomas.
    Mr. THOMAS. Thank you, Mr. Chairman.
    Thank you, Secretary Rubin. I am obviously interested in the larger budget package and the tax questions as a Member of the Ways and Means Committee, but as Chairman of the Health Subcommittee, I am more concerned about subsets or particulars.
    Number one, Are you pleased with your current health care program in terms of the way they are treating you with your current problems?
    Mr. RUBIN. I am presently taking a bunch of pills that were prescribed to me by a White House staff aide last night, and if it works, I will be very pleased. And if not, I will know who to send my lawyer after. [Laughter.]
    Mr. THOMAS. Something that others do not have the ability to use, I guess. [Laughter.]
    The other thing that struck me, and it is very ironic in this business how coincidences occur, in your testimony you indicated that the President's program cuts Medicare spending by $100 billion over 5 years, and you indicate that the President is proposing tax cuts that total $100 billion over 5 years. So my assumption is it is a coincidence that the Medicare cuts equal the tax cuts in the President's budget. I assume that is a yes or no answer.
    Mr. RUBIN. The answer is that those programs were developed totally independently of each other.
    Mr. THOMAS. I had not perfected the coincidence argument. Perhaps some of my colleagues on the other side who spent a Congress perfecting the coincidence of two numbers being the same in a budget might want to pursue that.
    Mr. RUBIN. If you are asking me if these were constructed separately or related to each other, the answer is, They were constructed totally——
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    Mr. THOMAS. So your argument is there is no relationship. It is a pure coincidence that the Medicare cut number equals the tax cut——
    Mr. RUBIN. Yes. That is not actually my argument, that is a fact.
    Mr. THOMAS. It is a fact that they equal the same amount?
    Mr. RUBIN. No. It is a fact that they were——
    Mr. THOMAS. That is also a fact.
    Mr. RUBIN [continuing]. Constructed—well, one of them is actually 98.4. The tax cut number in the budget, the 5-year number is 98.4
    Mr. THOMAS. I just find it an ironic coincidence.
    Mr. RUBIN. Well, life is full of irony, but the fact is that they were constructed independently and——
    Mr. THOMAS. I understand, and I look forward to any written materials you wish to submit to support the argument that there is no relationship between the two.
    On the home health care transfer, which we obviously do not have the CBO numbers on and so I have to rely on the OMB numbers——
    Mr. RUBIN. Right.
    [The following was subsequently received:]

    The Secretary is not aware of any written materials that state this point but, having attended the Administration's meetings at which these numbers were developed, he is definitely confident that they were constructed independently.

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    Mr. THOMAS. In your testimony you indicate that the budget extends the solvency of the Part A Trust Fund to 2007.
    Mr. RUBIN. Correct.
    Mr. THOMAS. Our best estimate currently is that without the transfer gimmick, the changes you propose will get us to 2004 or into 2004. Is that close enough for approximation here?
    Mr. RUBIN. Well, you use the word ''gimmick.'' You mean without the policy changes with respect to home health——
    Mr. THOMAS. Well, actually, I did not use the word gimmick. I am using it because Dr. Reischauer, former Director of the Congressional Budget Office, used it first and Dr. Charles Schultz, who was the Chairman of the Council of Economic Advisers under President Carter, used it first, and so I am relying on their interpretation.
    Mr. RUBIN. Well, let me suggest, Mr. Thomas, that the facts are, we have $100 billion of Medicare cuts and the facts are that they said what we have done in the Part A Trust Fund, it extends—the actuaries say it extends it to 2007.
    Mr. THOMAS. OK. My concern is that the first year of savings, OMB numbers, is only $14 billion, and if as prominent economists as these call it in actuality a gimmick, and we can extend the life of the trust fund until 2004 with the other programmatic changes and redirections that you have proposed, and since it is my understanding that two-thirds to three-quarters of the reductions in the budget to reach balance occur after President Clinton leaves office, and that 2004 is the last year of the next President's term, it seems to me that between 1998 and 2004, we ought to be able to sit down, and I would pledge to you that if we push back this transfer gimmick, we can begin to make programmatic policy changes that will be a wave in front of us, buying us years, and we have almost 8 years in which to do it.
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    Mr. RUBIN. Let me, if I could respond to that——
    Mr. THOMAS. Sure.
    Mr. RUBIN. Part of it is what I already said and part of it, I would like to respond to a piece that you just mentioned for the first time.
    It seems to me that the way to look at Medicare is to say what has been done in the total Medicare Program. The answer is, What was done in the total Medicare Program is $100 billion of cuts, and that was a bunch of tough decisions.
    In terms of dealing with the technical question on the Part A Trust Fund, we did move home health care. I think that there are very good policy reasons for doing it.
    Mr. THOMAS. You are proposing to move home health care.
    Mr. RUBIN. Well, we move it in the budget and the budget is a proposal. That is exactly the same proposal which I believe you voted in favor of in 1995——
    Mr. THOMAS. No, it is not exactly the same. It was a much smaller amount, and once we understood the errors of our way, we corrected it. We never did it again.
    Mr. RUBIN. Well, I think you all voted for it twice in the House on the floor, if I remember correctly.
    Chairman ARCHER. Mr. Secretary——
    Mr. RUBIN. Be that as it may——
    Chairman ARCHER. Mr. Secretary, you may finish your answer, but Mr. Thomas' time has expired.
    Mr. RUBIN. OK. Good. [Laughter.]
    I will finish at length. No. The only other thing I would say, Mr. Thomas, is that there are a number of ways of looking at how much of the deficit reduction occurs in the last 2 years, but let me just say, on a number you mentioned, Mr. Reischauer, whom you referred to, wrote a piece about 1 week ago in the Washington Post in which he said that it was, in his judgment, acceptable budget practice for something like 62 to 68 percent, because of the law of numbers, cumulative effect of numbers, of deficit reduction in a 5-year program to occur in the last 2 years. The CBO had an illustrative budget path that showed about 65 percent. With the President's budget, about 67 percent occurs in the last 2 years. And if you take out particularities with respect to the spectrum, it is about 65.5 percent. So it falls in the range both of Mr. Reischauer and the illustrative path of CBO.
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    Chairman ARCHER. Thank you, Mr. Secretary.
    Mr. Stark may inquire.
    Mr. STARK. Thank you, Mr. Chairman, and thank you, Mr. Secretary.
    I applaud your efforts to present a credible budget and I am pleased you do not have too many high-cost tax cuts in your budget which might, in fact, force us to get even tougher on Medicare to pay for those tax cuts. There will be pressure, I think, to increase the size of the tax cuts. I have heard press reports indicating that there is interest in tax cuts of over $200 billion. I hope we can have your commitment to keep the tax cuts in the range that they are now. A larger tax cut would make it difficult for us to preserve programs like Medicare and Medicaid and perhaps would force us to return to debates of the 104th Congress, which I do not think we want to do.
    I would, in an effort to be bipartisan, like to beat up on your budget a little bit and suggest one thing. I do not argue against your middle-class relief package, but I am perplexed about weighting it so heavily toward families with college-bound children when the unmet needs of younger children seem to me to be more important.
    As you are aware, there is a sizeable population of working families who would get no benefit from the proposed tax credit due to its nonrefundable design, and I am aware of the concerns the Treasury has had with refundable tax credits. We have 10 million uninsured children and the President graciously proposes to cover 5 million of those. But to me, that is a halfway solution and perhaps it is heartless. It still leaves millions of children without access to preventive care and without diagnosis and treatment, without which they will become much more expensive to society as a whole.
    Now, I have looked at the variety of options. There is no free way to do this. Florida is one State that has a program that is school-based, at least in finding children who would qualify for a subsidy, and in using a refundable credit. It is pretty hard to phony-up a child, and if the credit can only be used for health care, it does not have the incentive for fraud that other refundable tax credits might.
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    I would hope we could work together to find a way to expand the President's program to all children. I think we would all, on a bipartisan basis, get a good feeling out of providing health insurance to children if we could work it into the budget. That is my request and I thank you very much for being with us today.
    Mr. RUBIN. Mr. Stark, if I could just make a comment or two, the President shares your concern about health care for children, as you know. I know Senator Daschle has made some proposals that also share that concern.
    In terms of the education credit not being refundable, that is true, but on the other hand, we have made changes in the Pell grants which are really designed to accomplish the same purpose as making our child credit refundable. And, of course, we have increased funding for Head Start. But I think the spirit of everything you say, to me, at least, makes sense.
    Mr. STARK. Thank you.
    Thank you, Mr. Chairman.
    Chairman ARCHER. Mr. Bunning.
    Mr. BUNNING. Thank you, Mr. Chairman.
    Mr. Secretary, welcome. I know our Chairman said we were not going to deal with the constitutional amendment to balance the budget, but since you brought it out in your remarks and the President certainly did in his State of the Union, I do not think it can be left out of our discussion with you today as far as the overall approach of balancing the budget. Because, maybe you do not know it, but we do not have the political will to do it without someone holding our feet to the fire.
    So knowing full well that you are not for a constitutional amendment to balance the budget, I am wondering if we, in fact, had the political will to pass one with or without a Social Security exemption, would that not create some major problems in balancing the Federal budget over the next 5 years, if, in fact, the $60 to $65 billion in surplus for the system would also have to not be spent?
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    Mr. RUBIN. Are you asking the question of the unified versus the nonunified budget, Mr. Bunning?
    Mr. BUNNING. I am asking the question of the nonunified budget, if we removed the Social Security offset.
    Mr. RUBIN. Well, as you correctly say, I do not believe we should have a balanced budget amendment. I think it is really a dire mistake in terms of the economic future of our country. But if we are going to have a balanced budget amendment, then as I have observed on other occasions, and I did not begin this conversation, but since you have, let me respond to it, I do believe that if you have the balanced budget amendment as proposed, it will create additional risks to Social Security. That is an analytic fact and I think it is unquestionable.
    Mr. BUNNING. I do not think it——
    Mr. RUBIN. The problem that——
    Mr. BUNNING. That was not my question. I disagree with you 100 percent on that. That was not my question. My question was, With or without the Social Security exemption in a balanced budget amendment, why is it not a good idea, with or without it? With it in, I can understand——
    Mr. RUBIN. Why is what not a good idea?
    Mr. BUNNING. With the Social Security exemption in, I can understand the problems with the $65 billion each year, trying to find offsets.
    Mr. RUBIN. Right.
    Mr. BUNNING. We are not going to go back retroactively and pick up the $450 to $500 billion that is also supposed to be sitting there and we know we have already spent that for other purposes. Why is a normal balanced budget without Social Security a bad deal?
    Mr. RUBIN. Oh, a balanced budget amendment?
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    Mr. BUNNING. Yes.
    Mr. RUBIN. Oh. I am sorry. Oh, I would be delighted to respond to that. You want to know why I think a balanced budget amendment is a bad idea? I think for the same reasons the 1,100 economists and 11 Nobel Prize laureates——
    Mr. BUNNING. You are going to have to talk just a little louder because I cannot——
    Mr. RUBIN. I am sorry. My reasons track very much with the reasons the 1,100 economists and 11 Nobel Prize laureates had when they signed a letter which was then run as an ad in the New York Times a week or two ago. The automatic stabilizers which have played such an enormous role in moderating the business cycle in the post-World War II period, and as you know, the downsides of the business cycle in the post-World War II period have been enormously more mild than the prewar period. A lot of that is due to automatic stabilizers.
    I believe there is significant risk that—I think there is no question of the significant risk that with a balanced budget amendment, the automatic stabilizers will not work as they have during this postwar period, therefore running the risk that recessions will become worse recessions and worse recessions will become severe recessions.
    Second, you have a debt limit provision which requires super majorities in both houses. Given the difficulties of getting debt limit votes, it increases the risk of default.
    Third, there is a real possibility of legislative impasse. If you have legislative impasse, then budget decisions will go into the courts or into the unilateral action of the President, which, in turn——
    Mr. BUNNING. All right. I know my time is almost up.
    Mr. RUBIN. I am responding to your question. I am sorry.
    Mr. BUNNING. Well, I understand that, but if we remove Social Security from the balanced budget in the offset——
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    Mr. RUBIN. Right.
    Mr. BUNNING [continuing]. Then why do you object to it?
    Mr. RUBIN. Well, you have solved one set of problems, and it is a serious set of problems, which is the additional risk to Social Security the balanced budget amendment creates, but what you have not solved is the nub of the issue which is that under the system as it now exists, if we start to have a slowdown, your unemployment insurance payments go up, your tax revenues go down, and that automatically moderates the recession.
    Mr. BUNNING. OK. Thank you.
    Chairman ARCHER. The gentleman's time——
    Mr. BUNNING. The same problem exists in the budget when you tried to make 70 percent of the budget cuts in the last 2 years. That is physically impossible to do.
    Thank you.
    Chairman ARCHER. The gentleman's time has expired.
    Mr. RUBIN. No. That actually is not so—first of all, we do not cut 70 percent. And second, in the law of numbers, if you cut 1 percent each year, you will find out it comes out to about 62 to 65 percent in the last 2 years. It is the cumulative law of numbers.
    Chairman ARCHER. The gentleman's time has twice expired.
    Mr. Houghton.
    Mr. Matsui.
    Mr. MATSUI. Thank you, Mr. Chairman.
    Thank you, Mr. Secretary, for coming. I have problems with some of the tax cuts. As Mr. Stark has indicated, the $1,500 credit and the $10,000 deduction raise a number of questions, and it is my hope we can work together if, in fact, these two tax provisions look like they might become law sometime down the legislative process.
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    Certainly, the B-average situation, I have been doing some research in this and talking with some community college administrators and there is obvious concern about that, as well, because inner-city children, low-income children may not do as well as middle-income children when it comes to a B average, particularly the first year of community college.
    So some of these things are matters I would like to continue to discuss with you and your staff. But I would say, overall, the budget is a very credible document and had the budget hit the floor today or if it should hit the floor tomorrow, it would be something I would be prepared to vote for because I think it is extremely credible. Obviously, this is step one of a number of steps that you plan to take.
    The one area where I would like to add a caution, and this would be my only observation, actually, is in the tax cut and the dangers of having a bidding war that might go on, which I believe you mention in your opening statement. In the last 2 years of this budget, about $150 billion in spending cuts will have to occur in discretionary programs. In addition, entitlement reform will have to occur, particularly in the two big areas of health care and retirement benefits.
    As you know, Mr. Secretary, the possibility of having the trigger you have suggested and the budget suggests is probably remote. I think when all is said and done, there will not be a trigger. You might disagree with that, but that is my analysis on the basis of experience here and working on the legislative process, particularly on budget resolutions and in the reconciliation process.
    That being the case, if, in fact, the tax cut becomes too large, you are going to have in the year 2000 and beyond entitlements to deal with, the discretionary program cuts of about $150 billion or more, and also how to deal with these enormous tax cuts which I believe will really start to occur in the outyears, not in the beginning. Because if, in fact, we have a capital gains tax, there might even be a revenue gain in the first 2 or 3 years, but there will be significant revenue losses in years 5, 6, 7, and 8.
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    So it is my hope the President and his staff draw a line someplace. It does not have to be made public. It should not be made public, but draw a line someplace in this legislative process that you at least commit to yourself that you will not cross, because you know what happened—in fact, I met you in 1981 when a number of us met with many of your counterparts in the business community, that these things do get out of control and it is possible to get out of control in this situation. So that is the only matter I would like to add a caution on.
    I have no further questions.
    Thank you.
    Mr. RUBIN. Mr. Matsui, I agree with the spirit of what you have said and I think we also, and I am going to just repeat what you said—I think it is very important—in addition to looking at the effect of tax cuts within the window, it is very important that we look at the effect of tax cuts in the period subsequent to the window.
    Chairman ARCHER. Mr. McCrery.
    Mr. MCCRERY. Thank you, Mr. Chairman.
    Mr. Secretary, welcome. You and I may not agree on everything with respect to public policy, but I will say that I am pleased to have someone as capable as you in your position at this time.
    Mr. RUBIN. Thank you.
    Mr. MCCRERY. Having said that, let us get into some areas of possible difference. First of all, I liked your charts, but you left out one chart that I think probably should be exposed in the debate about the budget and that is the debt of the United States expressed as a percent of our GDP. Do you know what that is?
    Mr. RUBIN. The debt as a percentage right now—we have it here, actually. You are talking about—there are two different——
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    Mr. MCCRERY. Yes. Just——
    Mr. RUBIN. All debt, or debt held except by the trust funds?
    Mr. MCCRERY. You probably have both, so let us use the Federal debt first, and then if you want to do general——
    Mr. RUBIN. The Federal debt is roughly $5 trillion and GDP—we will get you the exact numbers, but roughly $5 trillion and the GDP is roughly $7 trillion.
    Mr. MCCRERY. Yes. It is around 70 percent, is it not?
    Mr. RUBIN. But remember, that includes the debt held by the trust funds.
    Mr. MCCRERY. Right.
    Mr. RUBIN. So if you take out—if you had the debt held by the public—we will get you the exact numbers. I think it is around 50 percent, but do not hold me to that. We will get you the exact numbers.
    Mr. MCCRERY. Including the trust funds, it is closer to 70 percent?
    Mr. RUBIN. It would be up around—that is a touch high, I think. It is between 65 and 70, I believe, but we will get you the exact numbers.
    [The following was subsequently received:]

    In February 1997, the gross national debt, including debt held by federal accounts, was 69.4 percent of GDP. Source: Historical Tables, Table 7–1 (p. 103).


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    Mr. MCCRERY. And that is, except for a few peaks in our history, that is fairly high.
    Mr. RUBIN. Well, the debt quadrupled between 1980 and 1992.
    Mr. MCCRERY. Let us not discuss how we got there. It is there and we have to deal with it.
    Mr. RUBIN. Well, I am not the one—I am just making the observation.
    Mr. MCCRERY. I am saying that——
    Mr. RUBIN. It has actually come down a touch as a percentage of GDP since then.
    Mr. MCCRERY. We cannot go back in time. All we can do is prepare for the future and that is what I hope you are trying to do, Mr. Secretary, and that is why we are here.
    Mr. RUBIN. Look, I agree, we need to balance the budget. I have no argument about that.
    Mr. MCCRERY. Yes, but your previous charts, I think, lessen the argument for balancing the budget, and I just wanted to point out that it is not just the deficit but the debt that we have to worry about. Obviously, by getting the balance and staying at balance, we are going to reduce that debt as a share of our GDP and that is, I think, advisable at this time.
    Mr. RUBIN. Yes. We have actually, by having deficits as low as we have had in the last couple of years, we actually have started the process already of reducing the debt-to-GDP ratio——
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    Mr. MCCRERY. Exactly.
    Mr. RUBIN [continuing]. That you correctly say is critically important.
    Mr. MCCRERY. So you agree we should continue to try to reduce the debt as a percent of GDP?
    Mr. RUBIN. Absolutely.
    Mr. MCCRERY. Thank you. You also mentioned, I think in response to a question, that we may have some surpluses in some years between now and 2020, is that right?
    Mr. RUBIN. I said that—I was actually responding to Chairman Archer's comment that in years when you had recessions, you would have some deficits, and then I said, Yes, but once you get to structural balance, then when you had periods during which you were performing above the full capacity rate of growth of the economy, in theory, at least, if you have structural balance over all, you would have some surpluses and that would balance out. That was my comment.
    Mr. MCCRERY. If we were to have a surplus in a given year, do you have any plans or proposals for how to use that surplus?
    Mr. RUBIN. That really is not a problem immediately in front of us. I have not given it any thought.
    Mr. MCCRERY. So would it be advisable to try to run a surplus between now and 2020 in a good year?
    Mr. RUBIN. I think once you hit structural balance, at least in theory, and I guess I think in practicality, too, it would be.
    Jack, do you want to comment?
    Mr. LEW. Congressman, in our long-term analysis, we show surpluses pretty much throughout the period 2002 through 2020, and we have no policies that call for additional spending to bring that down. Obviously, beyond 2020, there are additional structural issues in Medicare and Social Security that we have talked about and the challenge once we reach structural balance between now and 2020 is to go on and deal with the remainder of the problem.
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    Mr. MCCRERY. I would hope you would maybe give some thought to some policy being provided for dealing with a surplus, even though you are right, we do not have to worry about that in the next couple of years, but perhaps 10 years from now we will, we hope, or 15 years, because we do have some problems long term that are going to be very difficult to solve.
    One last question about the tax proposals. You entertained a question earlier about the difference between OMB scoring and CBO scoring and I think you said you were going to try to reconcile that and, I presume, once it is reconciled, come up with some additional spending cuts to reach balance by 2002. Is my assumption correct?
    Mr. RUBIN. No. What I said in response to the Chairman, it is a little bit more complicated than that.
    Mr. MCCRERY. It always is, Mr. Secretary, with you, but try to help me.
    Mr. RUBIN. It is not just that we have duality, it is that we believe very strongly in our numbers, and we think the fact that the deficit has come in under our projection the last 4 years is a strong basis for believing in our numbers, and that is the basis on which our budget is done. On the other hand, we have also provided trigger mechanisms, though I do not think we have given the details to Congress yet.
    Mr. LEW. We have provided the details in outline form——
    Mr. RUBIN. Oh, we have.
    Mr. LEW [continuing]. And would be happy to submit them to the Committee for the record.
    Mr. RUBIN. And it is those trigger mechanisms that would come into play if, in fact, circumstances turn out to be worse than our numbers, which we do not expect to have happen. That way, CBO can score our budget and, we expect, will score our budget as being in balance under Congressional Budget Office standards even though the budget track is based on our numbers with the reconciliation to——
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    Mr. MCCRERY. I think I have got you now, Mr. Secretary.
    Mr. RUBIN. Good.
    Mr. MCCRERY. So if CBO turns out to be closer than OMB——
    Mr. RUBIN. Excuse me? I am sorry.
    Mr. MCCRERY. If CBO estimates turn out to be closer than OMB's, then your trigger mechanisms come into effect——
    Mr. RUBIN. Correct.
    Mr. MCCRERY [continuing]. Most of which deal with taxes, I believe——
    Mr. RUBIN. Well, some deal with taxes and some with spending, right.
    Mr. MCCRERY. And so it is possible under your budget proposal that, in fact, over a 5-year period, we could have a tax increase and not a tax decrease.
    Mr. RUBIN. We do not expect that to happen for the reason that we do not expect—or certainly the most likely outcome, in our judgment, at least, is the circumstances that accord with our numbers.
    Mr. MCCRERY. I understand you do not think it will, and I believe you when you say your numbers are honestly arrived at and you really believe your assumptions, and I grant you that. But would you say it is possible that CBO is closer to what will be the facts than——
    Chairman ARCHER. The gentleman's time——
    Mr. MCCRERY. And if so, you will have a tax increase and not a tax cut.
    Mr. RUBIN. I will stick with what I said. I think it is likely—
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    Chairman ARCHER. The gentleman's time has expired.
    Mr. RUBIN. Will turn out to be correct.
    Chairman ARCHER. Mr. Ramstad.
    Mr. RAMSTAD. Thank you, Mr. Chairman.
    Mr. Secretary, I would like to focus on the administration's forecasts of economic trends, if we could for 1 minute, because I have serious questions about the value of the dollar and its impact on trade. As you know probably as well, Mr. Secretary, as anyone in this country, the value of the dollar against the Japanese yen has appreciated over 50 percent just since the spring of 1995.
    How do you explain such a huge jump in the value of the dollar? It seems to me and to most economists I have talked to, if left alone, the market force would not have lifted the value of the dollar to such a lofty level.
    Mr. RUBIN. Well, we are getting into a little bit of a difficult territory. Let me tell you why, if I may. I did this sort of thing for 26 years before I came to government. I actually ran trading operations. That is what I did for a living, and they were big and they were global, so that is the sort of world that I know a little bit about.
    Anything the Secretary of the Treasury says about markets has a tendency to affect the markets, and so what I have done in the time—in the first 2 years in the White House, now in 2 years as the Secretary of the Treasury, is really to say almost nothing about why I think markets have behaved the way they have and to really just address the policy. If you would like, I would be happy to discuss this with you privately sometime, but I think it is really very undesirable for me to discuss market behavior in a public forum.
    Mr. RAMSTAD. I certainly do not mean to put you on the spot, but obviously——
    Mr. RUBIN. It is a legitimate question you are raising. I am just saying that my answer could set off all sorts of effects that we might not consider to be in our interest.
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    Mr. RAMSTAD. And I can appreciate that and I do understand that, and I also am concerned the strong value of the dollar has hurt corporate profits, job creation, and capital spending——
    Mr. RUBIN. Oh, may I respond to that?
    Mr. RAMSTAD. Yes.
    Mr. RUBIN. Oh, that is a policy issue I can respond to. We have had, as you know, a record number of jobs created in the last 4 years. We have had unemployment fall to 5.4 percent, even though most economists felt it could not fall below 6 percent without regenerating inflation.
    And I think that, as I have said on many occasions, while many factors contribute to this, and I think the deficit program of 1993 being the principal one, the strong dollar has contributed to this because what a strong dollar—the exchange rate, your terms of trade with the rest of the world—a strong dollar brings us lower inflation and lower inflation brings us lower interest rates. It increases confidence in dollar-denominated assets which in turn brings us lower interest rates. So I think a strong dollar has actually contributed to the prosperity we have had in the last 4 years.
    Mr. RAMSTAD. I understand that, too, Mr. Secretary, but it is certainly a fact that about 20 percent of Fortune 500 earnings come from international operations tied to either yen or European currencies, and I just heard or read that the chairman of IBM said that fourth quarter earnings there would have been at least 33 percent higher if it were not for the rebounding dollar. Northwest Airlines, which I represent, has been concerned. Pfizer, AMP, other multinationals have talked about the so-called double whammy. Overseas revenues, as you know, buy fewer dollars and economic conditions overseas have been weak and have hurt sales.
    I guess my main concern is that if we lose market shares to foreign firms with cost in yen or European currencies, how easy is it for U.S. companies to regain market share when the value of the dollar depreciates?
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    Mr. RUBIN. Well, I think the key to competitiveness in the world economy for American businesses—what American business has done so well for the last, oh, roughly 10 years now, I guess—is to address its own efficiency, and by doing so, American business has reestablished competitiveness across a broad array of industries. I do not believe the dollar should be used as an instrument of trade policy.
    But as I said in Berlin, or, rather, I said in Washington and then we all said in Berlin on Saturday, the dollar had fallen greatly against the yen and against the mark and has now corrected itself, and in our judgment, those asymmetries have been corrected and things have come back into a normal mode.
    Mr. RAMSTAD. And I appreciate your comments here today. I certainly hope you feel better. I did not mean to put you on the spot, but I did recognize, as I am sure a lot of people did, what seemed to be a recognition on your part of the problem over the weekend as reported in the press and that is encouraging and I look forward to that private discussion because I would like to get into it in more depth, representing, as I do, many multinationals that are very concerned.
    Thank you, Mr. Secretary.
    Chairman ARCHER. The gentleman's time has expired.
    Mrs. Kennelly.
    Mr. Coyne.
    Mr. COYNE. Thank you, Mr. Chairman.
    Welcome, Mr. Secretary. In response to Congressman Stark's question concerning the refundable tax credit for education, you indicated the nonrefundable component is addressed in another section of the President's budget.
    Mr. RUBIN. The Pell grants.
    Mr. COYNE. Would you care to elaborate on that?
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    Mr. RUBIN. Yes. It is addressed in a compensating increase in our Pell grant proposals, and let me ask Jack Lew if he would respond to that.
    Mr. LEW. We have been proposing over the past several years annual increases in the Pell grant award amount, and in this year's budget we proposed increasing it to $3,000, which would have the effect of substantially increasing the amount of the Pell grant award to people currently in the program, and it would on the margin increase the income threshold so that the lower middle-income families that are just missing eligibility now will become eligible.
    That is the most efficient means of delivering a subsidy to a very targeted population and it is a program that works very well. We think that that is a very effective means of spreading the benefits of opportunity to education and targeting it to that group in particular.
    Mr. COYNE. Does your proposal address those segments of the population unable to take a $1,500 tax credit?
    Mr. LEW. Yes, sir. It is a grant, so it is delivered in a student's financial aid package as part of the cash award that they obtain in order to go to school. They would have access to guaranteed loans, to student loans, as well. But for a student for whom cash was a problem, the Pell grant would be a very effective means.
    Mr. COYNE. Mr. Secretary, as you know, there is a National Commission on Restructuring the Internal Revenue Service. The commission is charged, inter alia, to make the IRS efficient and more responsive to the taxpayers. Many people were critical of the $4 billion investment that was made in the IRS computer program. In fact, some would call it a total loss. Is that your assessment, that that $4 billion investment has gained us nothing?
    Mr. RUBIN. The answer—I am glad you asked that, Mr. Coyne. I meant to respond to Chairman Archer when he mentioned it and then got caught up in other questions. The answer to your question is, No. There has been a very substantial investment in systems modernization in the Internal Revenue Service. I am not quite sure where that $4 billion number came from, but we believe the correct number is a somewhat lower number.
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    Be that as it may, at least $1 billion of that is in what in effect was a replacement of existing equipment, of other equipment that would have had to have been replaced in any case, and the rest of that has been spent in various ways, some of which has had good returns, some of which has not. But the answer to your question is, No, there has been substantial value received for that invested.
    Having said that, some of that money has been spent in ways that have not worked. The key, in my opinion, and this is a critically important question in terms of our national interest, is that problems in the systems in IRS have developed over decades. There was a very good article in the New York Times, I do not know, a day or two or three ago, I have forgotten exactly, that tracks it back to some decades back.
    We are absolutely and totally committed at Treasury to working in a proactive oversight capacity with the IRS to remedy these problems and get this thing back on the right track, and toward that end, we have an outstanding new chief information officer who has been there several months. We have set up a management oversight operation, institutionalized it in the Treasury. We have taken various other steps.
    But I think it is critically important that we all approach this in a constructive fashion so we can return the IRS to the place it needs to be to do the Nation's business, and if we all work together constructively, I believe we can accomplish that.
    But no, I think there has been a lot of value, electronic filing, telefiling, reduction of the FTEs by about 12.5 percent over the last several years that have resulted from that systems expenditure, and how much of that has actually wound up not having value, I do not know the answer to, but it is nothing like the $4 billion that was reported in the press.
    Mr. COYNE. Thank you.
    Chairman ARCHER. Ms. Dunn.
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    Ms. DUNN. Thank you very much, Mr. Chairman.
    Secretary Rubin, thank you for coming today. I do want to tell you that I was very happy to see in the President's budget the Software Export Equity Act proposal. That is something we have needed and we have, as you know, considered a technical correction, basically because it is so close to revenue neutral. Mr. Matsui and I worked together on that proposal and we call it the Software Export Equity Act, and I am looking for signators on that proposal right now and we want to work very closely with you as we make that reality.
    I have a general concern, though, about the targeting of some of your tax relief. For example, in capital gains, you are giving relief to homeowners who own homes up to $500,000, and I think that is good and I want to see broad capital gains relief. But on your child credits, you are eliminating a huge group of folks, for example, in their teenage years and you are giving credits only to parents whose children go to college.
    My concern with these proposals is that they are targeted in this way and are not moving to the individual the responsibility and they are not inclusive and actually giving funds back from the paychecks of the folks who work in this country money that they can spend in the way that they would like to.
    So my question to you is a general question. Are you willing to deal with some of these issues? Is capital gains in there as a foot in the door so we can move in with some other suggestions that will broaden the base? Are you willing to do some moving on the child tax credit, because if you are, I want to work with you.
    Mr. RUBIN. Well, let me say where we started. We started feeling that, or, I should say, recognizing, but maybe you would characterize it as feeling, that we had scarce resources in the context of going to a balanced budget and dealing with the question of tax cuts at the same time. The President was committed to having tax cuts. So then the question was, what tax cuts could we have that we felt would do the most good for our society and do the most good for middle-income people, and that is how we came up with the program we came up with.
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    In terms of capital gains tax cuts, since that is what you raised specifically, our view is that the tax cuts that we proposed were useful to middle-income people and more useful in terms of promoting productivity in our society than the capital gains cut would be, and, therefore, a capital gains tax cut is not in our priorities and these others are, with the exception of the targeted capital gains cut that we have.
    Clearly, many Members of the congressional majority believe in the capital gains tax cut. I presume they will bring that to their side of the negotiating process and we will have to see where we go from there.
    Ms. DUNN. Mr. McCrery and I will be putting a piece of legislation together that we would like to have——
    Mr. RUBIN. But ours was not intended as a foot in the door. Ours was intended as the proposal that we believe made sense in the context of using the scarce resources we have available or we feel are available for tax cuts.
    Ms. DUNN. I understand, and I am glad to see it there. I think a capital gains tax cut coming from a Democrat administration is very hopeful, and we would, as you can well——
    Mr. RUBIN. Limited and carefully targeted.
    Ms. DUNN. Yes. Right. OK. Well, we can talk.
    I would like to ask you also about estate tax relief. Mr. McCrery and I put together an estate tax bill last year and we did a lot more than what you are doing in this budget. You have decreased the percentage of interest that is paid over a period of 14 years by people who are leaving their family-owned business or their closely owned business, I guess is the way you designated this piece of relief, after their death, and Mr. McCrery and I would like to start out with something similar to the bill that we proposed last year, where you have zero estate tax paid up to $1.5 million. We will move from that, and then 50 percent from that point on of a small family-owned farm or business. I would like to know if that is something that is within the area of discussion from your point of view.
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    Mr. RUBIN. Well, we started, again, with the idea of trying to provide relief to small businesses, family-owned small businesses or family owned farms, and our judgment again, giving that we had scarce resources to spend, was that this was the way we could afford to do it that was consistent with meeting our other priorities. So we came out with this program and this is where we are. This will undoubtedly bring other ideas to the table.
    Ms. DUNN. Good. Let me just make one last comment, because my time is running out, on capital gains. I would think the administration would be very interested in spending some time to propose a very strong capital gains package because of the fact that we have learned this is a revenue increase, and I would think that at this point, you would be looking for ways to raise revenue.
    Let me just say one last thing on that, that we want to support you, particularly in the area of capital gains. I include corporate capital gains in my comments.
    Mr. RUBIN. Capital gains tax cuts, at least as proposed by the congressional majority in their last budget, we did not score as a revenue raiser. We scored it as a rather substantial coster. Now, it obviously depends on what the provision is. If you have AMTs and depreciation recaptures and various other provisions, you can affect the revenue effects.
    Chairman ARCHER. The gentlelady's time has expired.
    Mr. Collins.
    Mr. COLLINS. Thank you, Mr. Chairman.
    Thank you, Mr. Secretary. Just a bit of trivia. Based on a $17 billion surplus in the year 2002, disregarding any interest owed, it would take almost 400 years to retire the principal of debt based on that figure, so we have a lot to look forward to and I hope I can live to see it paid.
    Mr. RUBIN. Four hundred years, you say?
    Mr. COLLINS. I have two questions. One is pertaining to the President's budget where he mentions extending funds for airline safety and also the aviation tax, reinstating the aviation tax or a similar tax. But I want to go back to a letter that was written to you last fall regarding the schedule D maintenance of aircraft and the potential of requiring capitalization of the expenditure for the schedule D maintenance. Are you familiar with that?
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    Mr. RUBIN. Mr. Collins, I vaguely remember that letter but I certainly do not remember its substance. Yes, I do remember both seeing and thinking about it, but I do not remember the substance anymore.
    Mr. COLLINS. I wish you would check back into that because we, too, as the Task Force on the Transportation Taxes——
    Mr. RUBIN. This is a question of capitalization versus expensing, if I remember correctly.
    Mr. COLLINS. Capitalization of schedule D maintenance rather than the expenditure that it has been in the past.
    My other question pertains to unemployment tax, the accelerated deposit of unemployment insurance taxes from quarterly to monthly and also the extension of the 0.2 percent FUTA surtax. Both of those, I believe, are in the proposal, is that not true?
    Mr. RUBIN. I believe so, but I cannot say that I have—I believe that is correct, but I am really not familiar with the details of it.
    Mr. COLLINS. If you are not familiar with it, then I do not believe you will be able to answer very many questions about it, but I would like to raise the concern of the additional costs that we will be putting on States for collection and also the additional cost we will be putting on businesspeople to make those monthly deposits rather than those quarterly deposits. If I understand it, the purpose of it is to receive a one-time windfall of $1.3 billion based on the first month that would be the requirement of deposit rather than the normal quarterly deposit. We have a lot of concern with that.
    Also, businesses and States are looking at the devolution of the FUTA tax back to the States rather than through the current Federal system. Do you have any comments on that?
    Mr. RUBIN. I do not, but we would be delighted to get back to you on that in writing, if you would like.
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    Mr. COLLINS. Very good.
    [The following was subsequently received:]

    The Administration did propose extending the 0.2 percent surtax on FUTA taxable wages. This surtax was first enacted in 1976, and has been extended periodically in order to build up reserves in the Federal trust accounts and thus help avoid future funding problems in these accounts. We proposed extending this surtax through 2007 so as to support the continued solvency of the Federal unemployment trust funds and to maintain the ability of the unemployment insurance system to adjust to any economic downturns.
    The Administration also proposed a requirement that employers pay their FUTA taxes on a monthly rather than a quarterly basis. This proposal was designed to reduce losses to the Federal unemployment trust funds caused by employer delinquencies—which can be detected more quickly when reporting is more frequent—and to provide a regular inflow of money to State funds to offset the regular payments of benefits. This proposal was limited to larger employers to avoid imposing additional burdens on small businesses.
    As you may already know, the Taxpayer Relief Act of 1997 extended the FUTA surtax through the year 2007, but did not shift FUTA tax collection to a monthly basis. As for state and business initiatives regarding the FUTA tax, we have no comment at this time.



    Mr. COLLINS. Those are all the questions I have. Wait 1 minute. There is one other thing. I did notice, too, there was some mention of a charge for entities that paid their tax with paper check. What are you referring to there?
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    Mr. RUBIN. A charge for what?
    Mr. COLLINS. By remitting taxes with a paper check. I know there are a lot of rubber checks that are passed around, but——
    Mr. RUBIN. There are a lot of rubber checks.
    Mr. COLLINS. The bank usually takes care of the charge for those.
    Mr. RUBIN. Mr. Lew can respond to that and would be delighted to.
    Mr. COLLINS. The President proposes charging people for remitting their tax with a check.
    Mr. LEW. Congressman Collins, this actually has to do with payments that the Federal Government makes to contractors and most contractors are choosing to be paid by electronic transfer. It is much more costly for the Federal Government to make paper check payments. As we move farther and farther down the road toward electronic transfer, the purpose of the policy is to get us all the way down the road.
    Mr. COLLINS. So, then, you would penalize the person that you owe the check to for requesting a paper check?
    Mr. LEW. It would be a very modest charge for a paper check as opposed to an electronic transfer.
    Mr. COLLINS. Everything is modest around here, is it not?
    Thank you. [Laughter.]
    Chairman ARCHER. Mr. Levin.
    Mr. LEVIN. Thank you.
    Welcome, Mr. Secretary. In your testimony, I think your excellent testimony, what leaps out perhaps most of all is the reference to the reduction in the size of the deficit in terms of GDP from 4.7 to 1.4 percent. We tend to, I think, forget sometimes what good has been accomplished, and I am glad that you emphasized it. Taking into account what Mr. McCrery said, that drop does mean we are moving ahead also in terms of the relationship of the debt to GDP.
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    Let me just say a word about two issues and ask your judgment, especially on the second one. They relate to our competitiveness, and perhaps, if I might say so, one of the most significant bits of your oral testimony related to the currency valuations. If I heard you correctly, you said that they should not be used for trade policy, but I think we would agree that sometimes, some nations have so used them. Your judgment is that whatever asymmetry has existed has been basically corrected.
    Mr. RUBIN. Well, that is what the G–7 said in their noncommunique on Saturday.
    Mr. LEVIN. You basically agree with that?
    Mr. RUBIN. I basically agreed with the G–7, Yes, that the asymmetries that they had—well, what it basically said, Mr. Levin, is the asymmetries that they had referred to some 2 years ago in a communique, and I believe it was April 1995, had been corrected. I think that was the language of the press guidance on Saturday in Berlin.
    Mr. LEVIN. And clearly, the reference included any asymmetry in the yen-dollar ratio, right?
    Mr. RUBIN. It did not refer to any specific currencies. I think it referred to the asymmetries of——
    Mr. LEVIN. But that clearly would have been included in the statement of a few years ago?
    Mr. RUBIN. I am trying not to say more about the dollar than I ordinarily do because doing so can turn out to not be a good thing to do. Let me stick with what I said.
    Mr. LEVIN. OK. Also regarding competitiveness, let me just mention one of the income raisers—and by the way, this hearing has not been marked by a lot of jockeying back and forth and I think that is a very positive sign. For example, I have heard some comment that if the triggers went into effect, the income tax cuts would be less than the tax increases. But that would include, for example, the fuel excise tax which we could well have passed last session. So I think it is better for us not to try to shape the relative amounts of tax increases and tax cuts, especially using the triggers, because I do not think they will be in effect.
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    But I want to ask you——
    Mr. RUBIN. It is also true, Mr. Levin, that the two sets of triggers, one has to do with the tax cuts and one has to do with spending cuts——
    Mr. LEVIN. Exactly.
    Mr. RUBIN [continuing]. And the spending triggers would function first in order to preserve the tax cuts.
    Mr. LEVIN. Good. Good. Let me just ask you or say a word about the proposal to replace the sales source rule with the activity-based rule, and this relates to our competitiveness and to our exports. In the State of the Union Message, the President pointed out how exports can be an asset to this country, especially when we are making sales of American-made goods, and I would just urge, if I might, that you take another look at the potential impact of that proposal on production of goods in the United States because I think there is some evidence that that could stimulate movement of production overseas, which we do not want and you do not want.
    Mr. RUBIN. Well, Mr. Levin, let me say, I have no doubt that particular provision is one we will all have an opportunity to discuss at some length because it seems to be of some interest. But exporters get the full benefit of the Tax Code under our provision. What they do not get is a change that was put in place 70 years ago at a time before tax treaties existed that was designed to, amongst other things, avoid double taxation, an issue that no longer exists because of the tax treaty. So the provision that was designed to avoid double taxation has become an unwarranted benefit.
    What our proposal suggests is that the exporters get the full benefit of the Tax Code but they not get an unwarranted benefit. However, that is——
    Mr. LEVIN. All right. Let me just finish, if I might, by urging we all take a look at that because there are some very rough edges in our international tax laws and I think there is a good argument that that sale of source rule, true, originated 70 years ago, has been one of the instruments to strike some kind of a rough balance so that people who produce here and sell overseas are not put at a disadvantage. So I think it is practice as well as theory that we have to look at.
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    Thank you, Mr. Chairman.
    Chairman ARCHER. Mr. Secretary, if I could just jump in here for a moment, I have just been informed by the Joint Committee that they want to get going on estimating your tax provisions, so that will be a part of the official Congressional Budget Office final estimate, and they tell me they are not able to do so because they do not have the specifics as to how the mechanism will work for sunsetting the tax provisions. I just want to mention, without getting into a debate about it, that I hope your people will be forthcoming with them as early as possible so that they can get this estimate done.
    Mr. RUBIN. Oh, yes. That is no problem.
    Mr. LEW. Mr. Chairman, over the last couple of days, we have been in touch with the Joint Tax Committee and the Congressional Budget Office. We have given everything through the Congressional Budget Office because that is how the scoring of the budget overall is done, and we have indicated exactly which provisions would be affected by the trigger.
    There are some details about the drafting of the trigger language which, frankly, we need to work out with the Congressional Budget Office to ensure that it scores and they have said that they have everything that they need. If there is anything in addition that is needed to score the trigger, we would be delighted to provide it.
    Chairman ARCHER. OK. Well, I would urge you to do so because as of this moment, the Joint Committee has just told me they do not have the necessary language in order to make an estimate on the tax provisions. They say they have it relative to the IRA provisions but they do not have it relative to the rest of the tax provisions. They have it also from OMB relative to the way spending will be reduced but not for the other tax provisions. So I just simply urge you to get that to them so we can get that up as soon as possible.
    Mr. LEW. We have provided it to the Congressional Budget Office. We are delighted to provide it directly to the Joint Tax Committee, as well.
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    Chairman ARCHER. Mr. Ensign.
    Mr. ENSIGN. Thank you, Mr. Chairman.
    Secretary Rubin, I want to talk a little bit about, first of all, the graph, except I want to take it out farther and talk a little bit about the baby boomers and when they retire. From what I understand, and I would like your comments on it, if we do not enact structural reforms early, fairly early on to entitlement programs, that the deficit and the debt as a percentage of GDP, and the deficit in particular as a percentage of GDP, when the baby boomers start retiring, without those structural reforms in place early enough, those percentages go to 4.5 to 6 and even up to 10 percent of GDP. I would just like your comments on that and is that, in fact, the numbers that you understand?
    Mr. RUBIN. Well, there is a chart in the—which I do not have with me, but it is actually in our budget book—oh, in the analytical perspectives book of the budget, I am sorry, that shows if the President's budget is adopted, then we will be in balance or surplus until 2020, which is a very substantial improvement, by the way, over what it would be without the President's budget.
    After 2020, we get into the situation that you have just suggested, where the demographics and other factors with respect to the baby boomers begin to create larger and larger deficits as a percentage of GDP. That is why the President has called for a bipartisan process now—agreeing with you—around long-term entitlement reform.
    Mr. ENSIGN. I would just like to follow that up by saying that Congress, also, and the President—this is going to be a very, very difficult process politically. We need to do what is right for America on this, and sometimes putting things to a commission like this tries to give people cover and then when the commission report comes out, everybody attacks it from every side.
    So I would just suggest that you implore our President that he also show some leadership with the Congress, sitting down and trying to get some of these things worked out while we are all still in office, because the earlier these changes are—we know, from what I understand, from what everybody tells me, the earlier we make the structural changes, the more manageable the crisis of the demographics are when we get out to that point.
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    Mr. RUBIN. That is, without question, true, and it is why the President said in his State of the Union Address that he thinks we should get at it and get at it in short order, although our first priority, and I think rightly our first priority, is to put in place the balanced budget legislation this year. But I think, without question, we must also do as you have just suggested.
    Mr. ENSIGN. The second question I would like to follow up takes a different tack and gets back to some of these education tax credits, and this is a philosophical question that actually, Mr. Lew, maybe you could comment on, as well, and that is, it has been suggested that because education costs are increasing dramatically faster than inflation over the last however many years that we can look at that, that some people suggest it is like, you put more money into a system and instead of more people being helped in that system, actually, people just say, Hey, there is more money here. We can raise our tuition costs. We can raise the other costs.
    Was that taken into account, and I guess, obviously, you must have disagreed with it, but do you think that is going to have an effect and what effect?
    Mr. RUBIN. No. It is a good observation and it was analyzed very carefully from the very beginning phases of the development of these proposals. It was the view of those who were involved that there are many competitive—the competitive pressures on tuitions are sufficient so that the additional resources that would become available through these mechanisms would not, in fact, have a material effect on tuition prices.
    Mr. ENSIGN. Do you think that has led at all, the vast sums of money from public financing into our system, has that led to——
    Mr. RUBIN. In the aggregate?
    Mr. ENSIGN. And also for the last several years. What is the explanation, I guess, from your perspective, from your experts that are telling you why educational costs have gone up much faster than inflation?
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    Mr. RUBIN. Yes. Maybe Jack Lew can respond initially to this. I do not know the answer to that question, although it is a very good question. I do know that our people looked very carefully at the question that you are asking about the impact of this particular set of proposals and would the benefit of those proposals be lost to tuition increases, and the answer was that the competitive pressures were sufficient to prevent that from happening. I do not know the answer to the more general question you are asking.
    Mr. LEW. Congressman Ensign, the only thing I would add is that the part of the higher education system that would most benefit is the junior college, the entry level to higher education. The dollars that we are providing are pegged to the cost of tuition in those schools. So for a school that is already many times more than the credit would be, this will be a small percentage of the total in the future. But for a junior college or for a school that is a more competitively priced school, it will be a very high percentage.
    Mr. ENSIGN. Mr. Chairman, if I may, just to sum up, the only reason I raised this question is because if we do not understand why—in other words, if it is more money into the pot, we get into a tradeoff factor. On the one hand, this tax credit will allow certain people to go to college. Maybe the people with incomes just above that, though, it makes it more expensive. In other words, if we do not understand why college educational costs have gone up faster than inflation, I think we have to understand that question to know for sure whether or not this proposal will, in fact, increase costs.
    Mr. RUBIN. Let me say, the people who did the analysis here are people who are expert in this kind of thing. This is their world, and I think—in fact, we will get you a response to that, a written response.
    Mr. ENSIGN. I would appreciate that.
    [The following was subsequently received:]

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    There are a number of reasons why we believe our postsecondary education proposals will not lead to inflation in tuition. Our reasoning is based on what we know about institutions of higher education and the market for their services. First of all, there is significant competition among institutions for first-year students. The recent moderation in tuition increases supports this view. Raising tuition in such a competitive environment would be risky.
    Second, we have decades of history with federal student aid programs, and there is no credible evidence that existing student aid programs have caused tuition inflation. In fact, the National Association of Independent Colleges and Universities recently issued a study that concluded that increased federal grant aid to students helps slow the rate of growth for tuition. Their study looked at 580 four-year independent colleges enrolling approximately 2 million students. What we do know is that in the past decade and a half, tuition has risen at more than twice the rate of inflation and has far surpassed the rate of growth of federal student aid. There are important, structural factors driving up the cost of education that have nothing to do with the effect of federal aid policies. Since the mid-1980s, there has been a particularly dramatic reduction in the share of revenues provided by state governments through appropriations to public colleges and universities. States went from providing 43 percent of revenues in 1979–80 to providing only 33 percent of revenues in 1992–93.
    Third, the Hope Scholarship is available only for the first two years of postsecondary education.
    Any attempt to capture the credit by four-year institutions, by raising tuition would have a negative effect on enrollment of third and fourth year students who would not receive a credit to offset the increase. Because institutions care about graduation rates, they do not want to discourage students who are already half-way through school from completing their degrees.
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    Finally, there are the two-year institutions. Even here students will be quite sensitive to price increases. To the extent tuition is over $1,000 and must be covered by the students (50 cents on the dollar up to $2,000 and dollar for dollar thereafter) rather than the credit, competitive pressures to attract students will check tuition increases. And even if tuition is less than $1,000, institutions will not be able to raise tuition without hurting their ability to attract students who are not eligible to receive the credit. Many two-year college students will not receive the credit because they are enrolled less than half-time. Others will not receive the credit because they are currently receiving Pell grants in excess of $2,000 or do not have sufficient tax liability. These schools cannot simply assume that no one will notice if they increase tuition.



    Mr. RUBIN. But I think the bottom line was, they did not feel these credits would create the kind of problem you are outlining, and your question is obviously a very good one.
    Mr. ENSIGN. OK. Thank you, Mr. Chairman.
    Chairman ARCHER. Mrs. Kennelly.
    Mrs. KENNELLY. Thank you very much, Mr. Chairman.
    Mr. Rubin, I notice the President's budget would extend the empowerment zones and the enterprise communities, which I support. In fact, we know how competitive they were in the last round and now the President is proposing 80 and 20 additional zones.
    However, I would like to bring to your attention the fact that we have some communities that do not meet the criteria for the empowerment communities or the enterprise zones. I really would like to expand on the concept. As a country, we are becoming more and more service oriented, with banking, financial centers. I wonder, is there any possibility of expanding enterprise zones and empowerment communities into service areas so that the communities that are interested in becoming world leaders in financial services could somehow get in this competition?
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    Mr. RUBIN. I am sorry, Congresswoman. The question—I do not quite follow the question.
    Mrs. KENNELLY. As you know, we have empowerment zones and enterprise centers and we compete for them.
    Mr. RUBIN. Yes.
    Mrs. KENNELLY. I will give you my example why I am so interested. I come from a financial center, a town that has banking and that type of thing. Current law specifically precludes services. I wonder why we cannot look at that as an empowerment zone rather than having us not be eligible——
    Mr. RUBIN. Oh, I see. Your concern is that, if I understand it correctly, because of the financial center—I know your district—because of the financial services centers that you have, you are not going to be able to meet the criteria, and yet you have areas of poverty and things of that sort.
    Mrs. KENNELLY. In fact, we would prefer to have increased financial centers. We need help and we cannot get that help through the present legislation. I wonder if the President and yourself would be interested in expanding enterprise zone areas like mine.
    Mr. RUBIN. Well, the enterprise zones themselves were designed for a very specific purpose, which really was to help very poor areas, rural and urban. There are many parts of the country that have serious poverty problems that cannot qualify or qualify but do not succeed, and we have been very actively promoting a whole host of other programs other than the enterprise zone and enterprise community programs.
    I do not know that there is anything particularly designed, though, for districts that have large financial services industries and also happen to have poverty. I am not sure what——
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    Mrs. KENNELLY. Well, I have a piece of legislation in and maybe we can sit down and talk about this——
    Mr. RUBIN. OK.
    Mrs. KENNELLY [continuing]. Because I think it is something that might be good for the country as we become an international trade area.
    Mr. RUBIN. If you have something, we would obviously be delighted to discuss it with you.
    Mrs. KENNELLY. Let me ask you about something that you and I do know about and agree on. You have had a wonderful history in front of this Committee concerning the debt ceiling, and you also have done yeoman's service speaking out on the balanced budget amendment. I wonder if you would share with the Committee your thoughts on the debt ceiling and the balanced budget amendment at this time. If you would like to tell us how you look at those two as they interrelate.
    Mr. RUBIN. Well, as we found out in 1995 and 1996—or I should not say found out, rediscovered, because it was known before this—it is very, very difficult to get Congress to vote to increase the debt limit and the result was, in 1995 and 1996, we went through an 8- or 9-month period during which Congress would not increase the debt limit, we faced at least the possibility of default. Treasury was able to take extraordinary measures. We were severely criticized in some quarters for taking those measures, but the result was, we were able to assure that the United States met its financial commitments, and ultimately, this was all resolved, though not without some difficulty, and you were certainly a very constructive force in resolving those matters.
    I am deeply troubled, amongst other things, by the balanced budget amendment provisions that require super majorities in both Houses to increase the debt limit. Right now, you need 50 percent in each House, and that includes the Senate because you can increase the debt limit under the reconciliation provisions and, therefore, you can do it with 50 votes. Under the balanced budget amendment, you would have to have a super majority in each House.
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    I believe that considerably increases the risk that the debt limit will not get lifted and, therefore, increases the risk of default to the U.S. Government, which has to be absolutely unthinkable, in my mind, and I think that is a very, very serious problem with the balanced budget amendment.
    Mrs. KENNELLY. Thank you, Mr. Rubin.
    Chairman ARCHER. Mr. Watkins.
    Mr. WATKINS. Thank you, Mr. Chairman.
    Mr. Secretary, welcome. I would like to commend you and some of your staff. Jack Lew there and Linda Robinson, I have known for a long time and I know they are very qualified people.
    Let me ask you something about what I am concerned about and one of the reasons why I am back here in Congress. It concerns me. It seems as though the administration has settled for or has adopted a policy of having a slow economic growth, a slow growth in our GDP of 2.2 to 2.5 percent a year. Many of the economists say we can go up at least another full percent or about 3.5 percent without igniting inflation. What percent of growth do you feel we can have before we have any type inflation?
    Mr. RUBIN. Let me tell you what our policy is, just for clarity's sake. Our policy is to have the highest possible rate of growth we can have in this country without reigniting inflation.
    I do not believe anybody knows, Mr. Watkins—you raise a very important question. I do not believe anybody knows what that rate of growth would be. Marty Feldstein, who was chairman of the Council of Economic Advisors under President Reagan, wrote a piece about 2 or 3 years ago, if I remember correctly, in which he said he thought if unemployment got below 6.25 percent, you would begin to run the risk of reigniting inflation. Many would not agree with that. Well, we are now at 5.4 percent.
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    Mr. WATKINS. Yes——
    Mr. RUBIN. But our policy is to have the highest possible rate of growth you can have without reigniting inflation. I do not know what that rate of growth is, but I think what we do know is what policies to follow to try to get that highest rate of growth.
    Mr. WATKINS. The economists that I have read and studied, a lot of them say we can go at least another percent or up to the 3.5 percent, and that would solve a lot of our deficit, a lot of our problems.
    I agree with Ms. Dunn. I am concerned about the reduction of the capital gains tax not going far enough to businesses, and you said, Well, it did not bring in more revenue. Well, let me tell you, the economic policy John F. Kennedy initiated during his administration brought in the greatest growth of revenue to government that we ever had, 4.7 percent, greater than the Reagan administration's reduction in taxes and everything else. I think we are missing a big bit without moving this forward with a faster, more aggressive policy, and I would like to see the administration do that, which would help us build a stronger economy for our children and our grandchildren.
    Mr. RUBIN. Well, our policy objective and our economic strategy has been designed to produce the highest rate of growth we can in this country without inflation. I personally believe our program of deficit reduction on the one hand and investment in education and the like on the other has been the right path to go, with free trade and leadership in the global economy.
    Mr. WATKINS. Mr. Secretary, I would like to, and I would like to ask maybe even the Committee to—in yesterday's U.S. News and World Report, on February 10, the former president of Harvard University, President Bok, has been studying the rate of growth of various countries and we have one of the lowest growths. There are a number of other States, the industrialized States, moving at a much faster rate of growth than we have, and that concerns me because I would like to see our country maintain as the global leader, economically speaking, instead of settling in, just settling down——
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    Mr. RUBIN. Well, we do not disagree on having—and I can tell you, the President is consumed with the idea of having a strategy that will produce the highest rate of growth we can have in this country with low inflation. We may have some disagreements about what policies would accomplish that——
    Mr. WATKINS. That is debatable, whether he is really consumed by this being the policy. If he is, he would be advocating, I think, a much more aggressive reduction in capital gains tax in some other areas.
    Mr. RUBIN. Well, we may disagree about the effects of reducing capital gains tax cuts on growth.
    Mr. WATKINS. Let me share with you——
    Mr. RUBIN. If it makes you feel any better, in terms of other countries, Japan has basically had—or has had virtually no growth in most of the last 5 years. Germany has 12.5 percent unemployment. Continental Europe is suffering from high rates of unemployment, low rates of growth, no job creation.
    Mr. WATKINS. Let me share with you, I have a 3-year-old grandson. By the time he graduates from high school, China will have the world's largest economy if we continue with this slow rate of growth and we settle back down and we are satisfied, and that means we are forfeiting the future of our children that have to go somewhere else.
    Mr. RUBIN. Mr. Watkins, you keep saying satisfied and I keep telling you we are not satisfied. We are consumed with trying to get the highest rate of growth we can. China has 1.2 billion people. It started from a very low base. It has a very high growth rate——
    Mr. WATKINS. Right.
    Mr. RUBIN [continuing]. And I think it is very important that we have an effective economic relationship with China. I agree with that.
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    Mr. WATKINS. I agree with you totally. I strongly believe in international trade. Like Ms. Dunn, I would just like for us to be more aggressive in it and move forward so we can build that future here, and I would be happy to work with any of your people and see what we can do about getting that done.
    Mr. RUBIN. We agree with that.
    Chairman ARCHER. The gentleman's time has expired.
    Mr. Cardin.
    Mr. CARDIN. Thank you, Mr. Chairman.
    Mr. Secretary, let me offer my congratulations for the record over the past 4 years in reducing the deficit, and also my observation that, as you pointed out, you have achieved every year lower deficits than you had predicted for that year for 4 years running. At least my observation may be that the impact of reducing the deficit has had a more positive impact on our economy than we had predicted it would have and that reducing the deficit as our top priority was well founded. I would just appreciate your comment on that.
    And second, if I might point out, we have really reduced the expenditures and revenue gap in this country, so we are getting a lot closer. The steps we took each year, including 1993, clearly have carried forward that objective, even though there were some people who doubted it at the time.
    I guess my main question to you is that although I like the specific proposals you have made on reducing taxes, if, in fact, our highest priority is to reduce the Federal deficit and to bring it into balance, can you give me some sense of assurance that we are not making it more difficult on ourselves by reducing taxes first rather than waiting for the budget to be in balance before we put tax cuts in the law that are going to become difficult in the future to adjust? I understand you have a trigger mechanism in here, but it is still difficult to take away a tax break once it has been given to the American taxpayer.
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    Mr. RUBIN. Well, you are raising, Mr. Cardin, a very fundamental and very important question. In 1993, when the President took office, he was determined to forgo tax cuts because he felt the fiscal mess he inherited had to be repaired, and he felt we did not have room in that context to have tax cuts.
    We are now going into our fifth year, and it is his view, which I share, that with all that has been accomplished, the deficit having come down over 60 percent and so forth, we can now afford to do both at the same time, and that is to say we can continue on the rest of the way to a balanced budget and at the same time provide a moderate and well-targeted set of tax cuts to the American people, and that is the judgment we made. But we wrestled with the same question you asked 4 years ago and decided at that time we needed to defer the tax cuts.
    Mr. CARDIN. I guess the other way of putting this, if we were to forgo the tax changes you are suggesting here, would we not bring the budget into balance sooner?
    Mr. RUBIN. The answer to that question is, Yes, and that is really a tradeoff judgment we made. The tradeoff judgment we have made is that we can afford, given the cuts we have been willing to make in the rest of the budget, to do both at the same time.
    Mr. CARDIN. Well, again, I just point that out, that it seems to me some of the figures that were bandied around earlier about the extra debt that we are creating, that if we would balance the Federal budget first, we would have less debt outstanding, fewer interest payments that our children are going to have to pay, and we would then have an opportunity later to deal with the revenue side.
    I appreciate the fact that you have a well-targeted tax proposal, and it is very popular. It is very popular in my district, things that we all like to support. I am just questioning whether it is the best strategy or not before we actually have the budget in balance.
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    Mr. RUBIN. It is also a moderate program, but as I say, I do not think we disagree on our analytic framework. We just made a different set of tradeoff judgments than you are suggesting.
    Mr. CARDIN. I thank you.
    Thank you, Mr. Chairman.
    Chairman ARCHER. Mr. Hayworth.
    Mr. HAYWORTH. I thank the Chairman.
    Mr. Secretary, I thank you for coming down today. It is interesting to reflect on many things I have read and heard, both as a Member of Congress and then prior to coming to this institution. I remember in particular the bipartisan approach that our former leader of our party in this House had before I got here, the gentleman from Illinois, Bob Michel, who often talked about the definition of taxes, taxes being a necessary evil, our friends in the Democratic Party putting the emphasis on necessary, those of us on this side of the aisle putting the emphasis on evil.
    But be that as it may, Mr. Secretary, I represent the Sixth Congressional District of Arizona, an area in square mileage about the size of the Commonwealth of Pennsylvania, and I would like to follow up on something that my colleague from Washington State, Ms. Dunn, spoke about rather briefly in terms of her concern about the targeted tax relief in the preteen years, because, Mr. Secretary, I think of single mothers not only in the Sixth District of Arizona but really nationwide, single mothers who may have two children, ages 13 and 15, single mothers who are working hard to make ends meet, to provide for their children, many times, those single mothers not receiving child support.
    As I understand it, under the current provisions, those single mothers, in terms of tax relief, would receive nothing under the current plan of the 500-dollar-per-child tax credit, is that correct?
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    Mr. RUBIN. This child tax credit is designed for children under 13 years of age.
    Mr. HAYWORTH. Mr. Secretary, I think that perhaps your personal experience, certainly my personal experience and that of other mothers and fathers, would tend to indicate that when a child reaches those teenage years, in addition to offering their own little debating society within the home, the costs do not magically decrease for children entering their teen years. Indeed, sometimes it has been our experience that the costs of raising children grow exponentially because of different concerns, different involvement. Explain to me the rationale of why we should deprive that single mother with two teenagers of 500-dollar-per-child tax relief.
    Mr. RUBIN. Well, it is not a question of depriving anybody of anything. The issue was, How do you spend scarce resources, and in our judgment, we had very scarce resources with which to provide a tax cut within the context of going to balance. It was our view that children under 12 do have some special costs associated with them, for example, child care and looking after, as a single mother works and things of that sort. So while it would have been nice to provide tax credits to everybody, our feeling was the need was greatest for children under 13 in the context of a situation where there were very scarce resources available for tax cuts.
    Mr. HAYWORTH. Well, Mr. Secretary, good people can disagree and the essence of both this hearing and, indeed, in the broader context, what we are about in this Congress, working together with the administration in a bipartisan fashion, is to find those ideas that work for the greater good and at the same time do not abandon our responsibilities.
    I would just simply suggest that by tightly targeting the preteen years, in essence, this tax cut, at least to this degree, is off target in my opinion, but good people can disagree and I look forward to discussing this more and more because I think we do need to be concerned about those single mothers and those children in their teenage years.
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    I see my time is about to run out. One other thing I would like to point out, Mr. Secretary, is that many of the resource-based industries within the Sixth Congressional District of Arizona have some technical questions concerning some of the provisions provided in this piece of legislation. I will contact you in writing, and I would appreciate your reciprocation to try to answer those questions as best you can and we will get that information to you.
    Mr. RUBIN. We would be delighted to.
    [Mr. Hayworth did not submit questions to Mr. Rubin at the time of printing.]
    Mr. HAYWORTH. Thank you, Mr. Secretary.
    Chairman ARCHER. Mr. Kleczka.
    Mr. KLECZKA. Thank you, Mr. Chairman.
    Mr. Secretary, a couple of Members have already spoken to you about the child tax credit and the cutoff at age 13. I guess in my mind, the same argument can be made about the Republican proposal to cut the poor child off at 18. He is still at home or she is still at home going to school, probably eating more now that he or she has turned 19, and boy, you just go and cut out that $500 and the kid almost starves to death. So maybe we should in both proposals extend it to 19 or 20, or maybe a little longer.
    But my question is the entire policy of the child tax credit. Under current law, we do have the personal exemption for all tax filers. I do not know what the cost of the administration proposal is this time around. I am assuming it is something similar to last time. But Mr. Secretary, why can we not take that same dollar amount and just increase the standard deduction for everyone in this country who happens to file taxes? I think that would be ultimately fairer than picking out only kids, only up to 13 or whatever the case might be, creating a separate line on the tax form for this credit, be it either permanent or short lived, as is the administration's.
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    But what kind of bang could we get for that buck if we would increase the standard deduction under your proposal using that dollar amount or under the Republican proposal? What could we get out of that?
    Mr. RUBIN. That is a legitimate policy debate. Our view was that we wanted to target these resources, about $46 billion or something over 5 years——
    Mr. KLECZKA. Twenty-six——
    Mr. RUBIN. Forty-six. We wanted to target that on what we thought was a particularly hard-pressed segment of society, that is to say, singles or young married couples with young kids, and so we designed this child tax credit for kids under 13. There was a good debate about the ''over 12 children.'' A teenage kid can get babysitting jobs, lawn mowing jobs, whatever it may be. And given the scarce resources we had, we felt that the targeted approach made the most sense. But I am sure this is a debate we will have before we ultimately wind up with a bill.
    Mr. KLECZKA. OK. But going back to the original question, for $46 billion over a period of time, what could we increase the current standard or personal exemption to?
    Mr. RUBIN. Oh, I do not know that in my head but we would be happy to make the calculation and get back to you.

    Mr. KLECZKA. I am assuming—I guess you cannot really take it off the top of your head.
    Mr. RUBIN. I cannot.
    Mr. KLECZKA. OK.
    Mr. RUBIN. But we can get back to you with the calculation.
    Mr. KLECZKA. If you could share that with me, and then we will use the Republican amount——
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    Mr. RUBIN. But whatever the amount is, it does not matter because it is going to get back to the same general question. Do you want to simply have a general tax cut or given that you have scarce resources to use for tax reduction, do you want to have one that is targeted to where you think the needs and purposes are greatest, and our judgment was the latter.
    [The following was subsequently received:]

    The standard deduction could be increased by approximately 15% to spend an amount roughly equivalent to the cost of the Administration's child credit proposal over the FY 1997–FY 2002 period.



    Mr. KLECZKA. And I appreciate that, but my question is, are we talking targeted or are we talking a political tax cut? I think as it is has been used over the last campaigns, what we are talking about here is a political tax cut. We are for kids. You are not for kids. But if we are talking a tax cut, I think what I would like to do is be fair to all filers. How about the childless couple who are low-income who could also use a break from the taxation of——
    Mr. RUBIN. Well, but the question is, where is the need greatest? This was not a—to go to your question, we spent a long time debating this, as to where we felt the needs and purposes were greatest in a totally nonpolitical context and the judgments we came up with were the judgments as to which segments of taxpayers both had the greatest needs and could be benefited most in terms of future productivity and matters of that sort.
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    Mr. KLECZKA. So, then, I guess my idea of a tax cut, and I agree with my colleague from Maryland, I think we should be talking tax cut after we have achieved the balanced budget, but we are not going to have that luxury. But if we are going to be talking tax cuts, let everyone who put into the pot share in the cut handed down.
    Mr. RUBIN. Well, that is a debate I am sure we will have before we end up with a final tax bill, or a final budget, I should say.
    Mr. KLECZKA. We sure hope so.
    Thank you very much.
    Chairman ARCHER. Mr. Weller.
    Mr. WELLER. Thank you, Mr. Chairman.
    Good afternoon, Mr. Secretary. It is nice to be here and have a chance to talk with you.
    First, I want to take a moment and just commend your budget for an initiative which is something I have shared an interest in over the last 2 years. I represent part of the city of Chicago and the south suburbs of Chicago. We have over 2,000 brownfields in the Chicago region, and I appreciate the initiative in which you have included in the President's budget. I know you were involved in that.
    I do want to express some concern that it is so targeted that many of the older industrial communities, which include the south suburbs as well as rural communities in Illinois, would not be able to participate, and I do desire to work with you on this initiative to come up with something that I feel would be able to benefit all of Illinois, not just some very targeted small areas in the State.
    Mr. RUBIN. Well, it was targeted—again, one cannot both eat one's cake and have it. We have limited dollars and we tried to use the dollars to the maximum public effect and that is how we got into the kind of definitions that we had, including with respect to brownfields.
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    I happen to think this brownfields' initiative is a very, very important initiative. It was initiated by the mayors. We really had not thought a lot about it until the mayors suggested it, and I agree with you. I think it is a very important initiative.
    Mr. WELLER. Well, it is an issue I have worked with Mayor Daley on. I know he has worked with you on it.
    Mr. RUBIN. Yes, he has.
    Mr. WELLER. It is important to Illinois, as well as Chicago, so I am anxious to work with you and look forward to sitting down with you and your staff.
    Mr. RUBIN. Good. I look forward to working with you.
    Mr. WELLER. Because the portion of the Chicago area that I represent economically has always kind of lagged behind the rest of the Chicago area, I am also very interested in the welfare-to-work initiatives in the President's budget. When I served in the general assembly, I worked to help establish what is called an ''earnfare'' program to take able-bodied, able-minded welfare recipients, provide incentives to employers in Illinois to hire them, give them job training and experience, and, of course, I realize that is the same goal the President is working toward.
    As part of his initiative, though, he has really proposed two things. One is extending the work opportunity tax credit which we passed last year as part of the minimum wage increase, then also enacting an additional welfare-to-work tax credit.
    What I want to ask you about is, essentially, you now have two separate hiring initiatives to encourage employers to hire those off of welfare and give them a job. In talking with many of the restaurateurs and retailers and the small employers in my district, which is very diverse, they have shared a lot of frustration about the burdens of qualifying for the program, and I am just trying to better understand why you feel we need two initiatives rather than improving upon the work opportunity tax credit which we established as part of a bipartisan effort just this past year.
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    Mr. RUBIN. Well, one of them, as you know, what you call the welfare-to-work tax credit—are you talking about the $10,000 with the 50-percent deduction and 18——
    Mr. WELLER. Yes.
    Mr. RUBIN. It is for those who have been on welfare for the long term and it was very specifically designed not just for those who—excuse me, not just for very low-income workers but for people who are long-term recipients of welfare. So it was thought best to set that as a separate and special program for welfare-to-work as well as having a general set of incentives for job creation for the poor.
    If there are problems, and I do not know why—it is funny. We thought we had actually created a relatively simple set of programs to qualify for. If there are issues like that, we would actually appreciate hearing about them because we thought we had created a simple, not a complex set of incentives.
    Mr. WELLER. Mr. Secretary, with the work opportunity tax credit in particular, I am very anxious to work with you to streamline and improve that. But I was wondering, what do you consider the bigger priority, the work opportunity tax credit or this new welfare-to-work——
    Mr. RUBIN. I do not think I would want to distinguish between the two because I think in a way, although they are complementary, they have somewhat different purposes. The welfare-to-work tax credit was designed for a very special issue, which is the new welfare reform legislation, and the other is more generally needed to create economic activity in our inner cities and depressed rural areas, so I do not think I would want to distinguish between the two.
    Mr. WELLER. As part of trying to improve the work opportunity tax credit, an idea I wanted to toss out at you, with the low-income housing tax credit, a lot of nonprofits participate in that program, then they syndicate the tax break as a way of providing housing opportunity, and I was wondering, have you ever looked at a similar mechanism to give nonprofit organizations or universities or local hospitals the opportunity to participate in the work opportunity tax credit?
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    Mr. RUBIN. That is an interesting question, the answer to which—I have not heard it discussed. Jack, do you know that?
    Mr. LEW. Congressman, actually, in response to both the first question and the second, in part, one of the reasons for having two approaches is that the tax credit only goes to certain entities and those are tax-paying entities. The welfare-to-work grants that go through the States and the local governments will be more flexible. They would be managed in conjunction with the State programs in the follow on programs to AFDC. One of the things that grantees might be able to do with the welfare-to-work portion of the program is have vouchers go to individuals who then take them but to entities that were both tax-paying and non-tax-paying entities.
    Mr. WELLER. Just to quickly follow up——
    Mr. RUBIN. But you are talking about the grants now. I thought you were talking about the two different parts of our tax——
    Mr. WELLER. Mr. Secretary, I was asking specifically about the work opportunity tax credit.
    Mr. RUBIN. So Jack is right on the grants. The grants could go to the tax-exempt organization.
    Mr. WELLER. But would you consider with the work opportunity tax credit an opportunity for the nonprofits, the hospitals, the universities——
    Mr. RUBIN. To do what people do with low-income housing tax credit?
    Mr. WELLER. As a way of——
    Mr. RUBIN. It is not something we have thought about. Why do we not give it some thought. I do not have an answer because we have not thought about it.
    Mr. WELLER. I would like to work with you on that.
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    Chairman ARCHER. The gentleman's time has expired.
    Mr. WELLER. Thank you, Mr. Chairman.
    Chairman ARCHER. Mr. Lewis.
    Mr. LEWIS. Thank you, Mr. Chairman.
    Thank you, Mr. Secretary, for being here today. Mr. Secretary, I strongly support the President's proposal to build a bridge to the 21st century with education and investing in our Nation's children. But I must tell you I am concerned that many of the education tax credits and deductions will not help the poorest of our Nation's children, those who are in the most danger of being left out and left behind.
    These children have not been blessed with parents who earn enough to invest in an education IRA or take advantage of a $10,000 tax deduction for education expenses. These are children who have grown up in rural poverty or in our large urban centers. Their families will not receive the full benefits of a tax credit for dependent children or the nonrefundable HOPE scholarship tax credit.
    I really believe, Mr. Secretary, with you and others in the administration, we must build a bridge to the 21st century, but a bridge that is strong enough and wide enough for all of our children. Today, I ask you and the President to pledge your support for providing opportunity, especially education opportunity, for all of the children of this Nation.
    Mr. RUBIN. Mr. Lewis, I can tell you that the sentiment you just expressed is one the President is totally committed to, and I will speak for myself personally, I agree with you totally. I think there is a real thrust in that direction in this budget. We increased the use of Head Start substantially. Mr. Lewis, as was discussed before, we increased Pell grants substantially, but I do not think there is any question, and I am just agreeing with what you said, that our Nation has an enormous stake in the least well-off kids from the poorest homes having the opportunity to get the kind of education that will bring them into the economic mainstream. So I think that is absolutely 100 percent right on.
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    Mr. LEWIS. Mr. Secretary, I believe your heart is there. I believe you, more than most people, realize education is the equalizer, and I appreciate your response.
    I noticed, Mr. Secretary, in reviewing the budget, that you take care of enterprise zones, but there is not enough, in my estimation, of an incentive for business to do much more for all urban areas. I believe my colleague from Florida, Mr. Shaw, and my colleague from Connecticut, Mrs. Kennelly, sponsored or supported an effort to provide a tax credit for historic preservation and rehabilitating old places in the inner cities. Do you think about this in drawing up the budget?
    Mr. RUBIN. We did, Mr. Lewis, and I apologize because I do not remember—I remember the suggestion and I remember that we considered it and I cannot recollect the pluses and minuses of our analysis, but I would be happy to get back to you with that.
    [The following was subsequently received:]

    Under current law, a 20 percent credit is available for rehabilitations of historic structures, including both nonresidential and rental residential buildings. The credit is not available for residential buildings that are not rental buildings. Mortgage credit certificates of up to 20 percent of mortgage interest each year are allowed for certain low-income, first-time homebuyers.
    H.R. 1134, as introduced by Mr. Shaw and cosponsored by Mrs. Kennelly, would allow a credit equal to 20 percent of qualified rehabilitation expenditures (not to exceed a credit of $50,000) made to an historic home. Certified rehabilitation would have the same meaning as under current law, with certain factors to be considered in the case of buildings in a ''targeted'' low-income area, an empowerment zone or enterprise community. The credit would be available to a homeowner who rehabilitates a principal residence or, if the seller has not claimed the credit, to a taxpayer who purchases a home if the taxpayer is the first to inhabit a rehabilitated historic structure as a principal residence. In lieu of the credit, a taxpayer could elect to receive an historic rehabilitation mortgage credit certificate, which the taxpayer could transfer to a lending institution in exchange for an equivalent reduction in the rate of interest on a loan to acquire or rehabilitate the building, and which the lending institution could then use against its regular tax.
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    The Treasury Department in the past has noted its concerns that such a subsidy would not necessarily or efficiently result in improving distressed neighborhoods, and that the transferability of the credit pursuant to rehabilitation mortgage credit certificates would raise significant administrative concerns.
    This Administration has strongly supported the goal of urban renewal. The existing rehabilitation tax credit has been successful in improving the ambience of many of our urban centers. In the President's Fiscal Year 1998 budget, we proposed several tax incentives specifically designed to spur private sector participation in revitalizing distressed communities across the country. We were pleased that the Taxpayer Relief Act of 1997 included important elements of these proposals, including new tax incentives for Empowerment Zones and Enterprise Communities, which will help address the need for jobs and new businesses in some of our most depressed urban and rural areas. In addition, that Act included an Administration proposal that is intended to speed the redevelopment of ''brownfields,'' urban areas that require environmental remediation before they can be reclaimed for housing or commercial purposes. Removing these areas of blight should do much to help achieve our common goal of rebuilding center cities. The Act also contained an extension of the work opportunity tax credit and a new Welfare to Work tax credit to move low-wage workers and welfare recipients into solid private-sector jobs.
    We look forward to working closely with you to help bring all Americans into the economic mainstream.



    Mr. LEWIS. Thank you very much, Mr. Secretary.
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    Thank you, Mr. Chairman.
    Chairman ARCHER. Mr. Hulshof.
    Mr. HULSHOF. Thank you, Mr. Chairman.
    Mr. Secretary, first of all, let me say how much I appreciate the fact that the administration recognizes that the American people are paying too much in taxes, and with all due regard to the senior Members of this Committee, the folks back in the Ninth District of Missouri sent me here with a message and that is they believe they are overtaxed, so I appreciate the efforts to move in that direction.
    I do want to visit with you briefly about what has been discussed by previous Members, Mr. Hayworth and Ms. Dunn, regarding the educational deduction and the tax credit. Do you have a figure, Mr. Secretary, perhaps you, Mr. Lew, if we were to expand the child credit to include children between the ages of 13 to 18? Do you happen to have that number handy?
    Mr. RUBIN. Yes. Actually, somebody gave it to me. While we talk, someone will get it to me. But I will tell you this, it very substantially increases the cost of the child tax credit—you are talking about the child tax credit?
    Mr. HULSHOF. Yes, the child tax credit.
    Mr. RUBIN. It very substantially increases the cost, but we will get it for you.
    [The following was subsequently received:]

    Extending the Administration's child credit to include children under the age of 18 would increase the estimated cost of the proposal over the FY 1997–FY 2002 period from $46.7 billion to $62.5 billion.

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    Mr. HULSHOF. The President's budget, the administration's budget that takes away the credit from families with teenagers, has been discussed and instead gives it only to those teenagers who have aspirations to go to college. Would it not be better, as the budget talks about with these expanded IRAs or super savings accounts, to allow families to collect the money over the course of a child's life and then make their own decision rather than the government's decision?
    Mr. RUBIN. You said it takes away the—I am sorry. I missed the beginning of that.
    Mr. HULSHOF. The credit, as has been discussed, the credit is taken away——
    Mr. RUBIN. It is not taken away from anybody. It does not exist right now.
    Mr. HULSHOF. Well, it does not exist, but if we include it for families with kids that are 12 or under, then they receive the benefit of the child credit, but once they get their 13th birthday and they blow out the candles on their cake, then there is no further——
    Mr. RUBIN. Actually, the budget has a child tax credit for kids 13 and under, but it is not taking anything away. It is giving something new to kids under 13 but it is not taking away anything from anybody.
    Mr. HULSHOF. But once the child reaches the age of 13, then the credit dries up in the wind and is not available.
    Mr. RUBIN. Well, it does not dry up in the wind. It just does not exist.
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    Mr. HULSHOF. OK. Would it not be better to allow families to accumulate in a super savings account, or as you mentioned, the special IRAs or some other fashion to allow families to keep more of their money through the course of their children's lifetime and then to use the moneys from these individual retirement accounts or super savings accounts for their own decisions on whether to use it to buy health care, as the President talked about, or to pay for college tuition? Would that not be a better way?
    Mr. RUBIN. Well, we have, as you know, an improved IRA and it does allow for penalty-free withdrawal for education and various other purposes. It is our judgment, and we have had this discussion before, that in a period when there are going to be scarce resources for tax cuts because of the imperative of going to a balanced budget, it is our judgment that the best public use to be made of the money available for tax cuts is to have a program of carefully targeted tax cuts directed toward middle-income people and also people in distressed areas and that is what we provided in our budget.
    Mr. HULSHOF. Mr. Secretary, let me ask you, make sure that I am clear regarding the education provisions. First of all, the tax credit, the $1,500 tax credit, and the accompanying requirement that the student maintain essentially a B– average, 2.75 on a 4.0 scale.
    Mr. RUBIN. A B– average, correct.
    Mr. HULSHOF. And yet, the $10,000 deduction, there is no corresponding grade requirement, is that true?
    Mr. RUBIN. That is correct.
    Mr. HULSHOF. Would it be your opinion that the $10,000 deduction would be probably used by the higher income families across this country?
    Mr. RUBIN. It depends on the circumstances of each individual. If you have a higher income, you have a higher marginal bracket. You might be more inclined to use—it depends on your deductions. I think it depends on your particular tax circumstances.
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    Mr. HULSHOF. Well, one example would be that a family that is in the 28-percent marginal income tax bracket, clearly, they would get a larger credit, a $2,800 credit being in a higher tax bracket as opposed to someone who is in a lower——
    Mr. RUBIN. Well, no. It depends on what their total expenses are.
    Mr. HULSHOF. At any rate——
    Mr. RUBIN. Not at any rate. If their expenses are only $2,000 and they have a 28-percent tax rate, then you have a $560 benefit.
    Mr. HULSHOF. Is there any reason that the President in this budget chose to——
    Mr. RUBIN. In fact, for many people, even if their brackets are higher and their income is higher, but because of a lower expenditure they might get more benefit from a $1,500 credit than they would from a $10,000 deduction.
    Mr. HULSHOF. Is there any reason that the President in this budget chose to subject lower income students to higher grade eligibility as opposed to——
    Mr. RUBIN. That was not what he was doing.
    Mr. HULSHOF. Let me ask you, as my time is——
    Mr. RUBIN. But the answer to your question is that is absolutely not the effect—the intent or the effect of this provision.
    Mr. HULSHOF. If the Chairman will indulge me for this last question, it is my understanding that you, in consultation with the Secretary of Education, would have the authority to issue regulations to implement HOPE scholarships, is that right?
    Mr. RUBIN. That is correct.
    Mr. HULSHOF. And has the Department of Treasury calculated the additional administrative cost that would be passed on to the colleges and universities of this country by requiring them to consider this grade requirement?
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    Mr. RUBIN. Oh, I think the additional cost would be nominal because the administrative procedure will be a simple form and all they have to do is check something off, qualified, did not qualify. So it will be the cost of a pencil, and then you qualify and you put it in an envelope and you send it back. It would not even be mailed. I assume there would be some sort of electronic transfer. So I think that the sum total would be nominal.
    Mr. HULSHOF. And have the administrative costs to the IRS also been included within your budget?
    Mr. RUBIN. The administrative costs to the IRS—have they been included in what?
    Mr. HULSHOF. In the budget. Are they included in these proposals?
    Mr. RUBIN. They are included in the costs in the IRS, Yes.
    Mr. HULSHOF. Thank you.
    Chairman ARCHER. The gentleman's time has expired.
    Mr. Neal.
    Mr. NEAL. Thank you, Mr. Chairman.
    Mr. Secretary, I know you are not feeling well, so just a couple of observations and a quick question. It does not seem as though it was that long ago that America was reacting to what they saw as the Japanese economic threat. Also, the S&L issue appeared to be out of control. The deficit 7 years ago was at nearly $300 billion. Seldom do we look in the rearview mirror here at issues. Today, all of those threats have receded or have been corrected.
    I think, as Mr. McCrery said earlier, much of that credit goes to you and to the administration for the manner in which you have handled many of these economic issues, oftentimes in the face of some rather strong opposition here.
    The balanced budget amendment strikes me as being intriguing, where you have many conservatives who, with some accuracy from time to time, have protested the steady encroachment of the Federal courts into legislative matters, who would now suggest that handing over many of these financial decisions to the Federal courts down the road, all of a sudden, is not such a bad idea. I think the measured response from many Members on this side is that you and President Clinton have responded to many of these international threats very well and your custody of the economy of the last 4 years, also under scrutiny, demonstrates the success you have had.
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    Having said all of that and gotten my point across, I hope, I now want to move on. We have talked a bit here about targeted tax cuts, political tax cuts, and tax cuts in general. What about the issue of tax reform, Mr. Secretary? Is there any appetite over at the White House this year? I thought last year, given the Presidential election, that we would have a chance to at least have some light cast upon that issue between the two candidates. That never happened. What is the response of the administration to tax reform this year?
    Mr. RUBIN. I think, Mr. Neal, that the administration's view is that our first priority—the administration's first priority and we believe the country's first priority—should be to put in place a balanced budget, and it is toward that end that we put forth the budget that we did last week, and then within that context to put in place the President's predominately middle-income tax cuts. That is where our energy, effort, and focus are directed.
    Mr. NEAL. Mr. Secretary, just let me close in the manner in which I opened. I think that 4 years ago, there were a lot of national doubts about the direction we were taking and I think here we are 4 years later and many of the suggestions and projections that you and President Clinton made have proved to be accurate. I think that it is time to give you two a tip of the hat.
    Mr. RUBIN. Thank you, Mr. Neal.
    Chairman ARCHER. Mr. Secretary, you are holding up very well.
    Mr. RUBIN. Well, we are getting there.
    Chairman ARCHER. Mr. Secretary, I have just been notified that I am expected to attend a leadership meeting, and with your indulgence, I am going to leave and turn the gavel over to the most competent colleague of mine, Mr. Shaw of Florida. I apologize.
    Mr. RUBIN. It is nice to have been with you this afternoon, Mr. Chairman.
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    Chairman ARCHER. But maybe that will shorten the amount of time that you have to continue to remain here.
    Mr. RUBIN. I am delighted to be here as long as the Members would like to have me.
    Chairman ARCHER. Thank you very much.
    Mr. RUBIN. Thank you, Mr. Chairman.
    Mr. SHAW [presiding]. I would like to add my welcome to you, Mr. Secretary.
    Mr. RUBIN. Thank you, Mr. Shaw.
    Mr. SHAW. We grew up in the same neighborhood down in south Florida and I am certainly glad that Chairman Archer referred to me as competent. I consider that a compliment. Somebody else behind me mentioned, he said, Well, what does that make the rest of us? I do not know. [Laughter.]
    I notice a certain amount of warmth in this room, or at least an absence of cold air that was in this room a couple of years ago. I hope we will continue this warmth and continue working together as Republicans, the administration, and Democrats here on the Ways and Means Committee in the best tradition of the Ways and Means Committee.
    As you know, as I sit as Chairman of the Human Resources Subcommittee, I am very concerned, as is the administration, in seeing that the welfare reform works, and as part of that, I think all of us know there has to be job creation, and particularly, it has to be targeted into areas of high unemployment.
    In that regard, I would like to get into two particular areas. One is what in the Tax Code are you recommending to us as to what we can do to stimulate the private sector to be sure that jobs are available as the benefits under welfare run out. That is, that people under welfare are going to be required to go to work but we have to be sure there are some jobs there. We cannot just shove them out into the cold.
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    Mr. RUBIN. You are talking about the programs specifically directed toward providing job opportunities for people moving off welfare, incentives to the private sector?
    Mr. SHAW. People who are on welfare now, and as you well know, this is intergenerational and there are some problems we are going to have with people who have never even lived in a household where there has been a worker, so it is going to be a totally new experience and a little frightening to these people, but we have to be sure there are jobs out there——
    Mr. RUBIN. I agree.
    Mr. SHAW [continuing]. That there is child care out there, their kids are taken care of, to be sure that—and at that point, you have to require people to stand on their own two feet and go to work, but you have to be sure there is work out there for them.
    Mr. RUBIN. Well, we have, at least in the narrowest sense, two programs designed toward this end. One is, I call it the welfare-to-work tax credit. I think maybe it is really just an expansion of the work opportunity tax credit, which came in two pieces.
    But in any event, the welfare-to-work tax credit, which is a tax credit available for employers who hire people who have been on welfare for a specified period of time, and they get to deduct 50 percent of $10,000 worth of wages over a period, and that goes on for a period of 18 months. So that is a tax credit.
    Then there is a substantial program of welfare-to-work challenge grants, and maybe Mr. Lew would like to describe those.
    Mr. LEW. The welfare-to-work challenge grants are proposed in the budget for $3 billion in addition to the tax credit provisions and the idea behind them is precisely as you said, Mr. Chairman, to encourage the States and local governments to work with the private sector to create job opportunities. It is on top of the TANF grants to the States through the program, and we will be working over the coming weeks with the Department of Labor and the Department of Treasury to design an integrated program on the tax and the spending side to encourage the creation of jobs.
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    The President indicated in the State of the Union that a private sector response is also necessary, and he pointed to the activities of private companies that were being urged to create opportunities to help in the transition from welfare to work. I do not think we can separate any one of these initiatives from the other. It is a huge challenge. It is probably the largest challenge in social policy that we face together, and to finish the job of welfare reform, we have to create jobs for people to go to.
    Mr. SHAW. Mr. Secretary, in a related area, but somewhat different than where we just were is the area of capital gains. We know that favorable capital gains treatment encourages capital formation and capital formation encourages jobs, and we are going to have to create new jobs in this country in order to meet the demands of welfare reform and to be sure that it works.
    I noticed in your budget that you offer favorable capital gains treatment for the sale of a residence, but I do not believe you address it with regard to other types of capital formation. Would you care to comment on that? I know the President has indicated, or at least the news media has indicated that the President has expressed a willingness to look into that and to come toward the Republican position on this, as doing some horse trading in a tax bill later on in the year.
    Mr. RUBIN. Well, yes. I think the news media—let us leave aside the news media's characterization of the President's position. Our view is that, given the resources we have to expend, the priorities we have expressed and the tax cuts we proposed in the President's budget are the right place to expend these scarce resources.
    The question with a general capital gains tax cut, Mr. Shaw, is, I think, a very complicated one and I guess I put my bottom line answer as follows, having lived with capital markets for 26 years. Most economists, most mainstream economists—not all, but most mainstream economists feel that a generalized capital gains tax cut probably has a relatively small effect on savings and a relatively small effect on capital formation. That would correspond to my own views, based on my experience in the capital markets. If that is true, then a generalized capital gains tax cut probably has a relatively small effect on economic growth.
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    So number one, there were a number of other things that we felt were real priorities, and that is in our budget. Number two, I think there is a very real question as to how much impact the generalized capital gains tax cut would have on general growth, and for all those reasons, it is not in our budget.
    Mr. SHAW. Going back to my first line of questioning, just for half a minute, I would like to see that many of the targeted areas in which we are going to be offering some tax breaks in order to get people from welfare into work, I think we ought to look very carefully through the geographical areas to be sure the money is put into the areas where they are needed the most. Has the administration looked into that?
    Mr. RUBIN. The geographical areas? We certainly looked at the criteria for targeting. Now, I do not know—Jack, I do not——
    Mr. SHAW. I can leave that question there, but I just want to tell you that that is something I think we ought to look into because there are going to be some areas where it is going to be very, very tough.
    Mr. RUBIN. When you say geographical areas, you mean by State?
    Mr. SHAW. No, pockets of poverty.
    Mr. RUBIN. By pockets of poverty. Well, look, I know, having been part of this process, we did try to get criteria that would hone in on the placement of the money where it was most needed. Now, it may be that pockets of poverty are buried in areas that are more generally prosperous and therefore would not——
    Mr. SHAW. Like enterprise zones, to pick areas that really are going to be very, very difficult to work our way out of. The fact that the Federal Government allowed this to go, the old welfare system to sit in place some 60 years, we have a responsibility now to help clean up this mess because we, in fact, paid people to stay where they are, people who probably their parents or grandparents would have gone elsewhere to find jobs had they not been paid to stay there. We have a responsibility, and particular in those areas, probably not our old neighborhood, but certainly there are areas around the country that are desperately in need of——
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    Mr. RUBIN. I agree with you about the importance of proper geographic targeting.
    Mr. SHAW [continuing]. Of jobs. One last question. I notice on some of these tax credits and all that you have put forward for education and other things, I do not think they are refundable unless there is tax to apply them against. What was the rationale behind the administration——
    Mr. RUBIN. Well, the principal issue in that regard was—you are correct in your observation. The principal issue in that regard was the HOPE tax credit, should it be refundable or not, and the judgment we made after a lot of analysis was that the interests of all concerned would be better served if the tax credit itself was nonrefundable and very low-income families were taken care of instead by an improvement in the Pell grants that Mr. Lew had described before.
    Mr. SHAW. We also have the income tax credit, which is already in law that is supposed to take care of that situation. I assume that came into your thought, too.
    Mr. RUBIN. The income tax credit?
    Mr. SHAW. The negative income tax credit.
    Mr. RUBIN. The child tax credit? Oh, the EITC?
    Mr. SHAW. Yes.
    Mr. RUBIN. Yes, and we obviously have the earned income tax credit, correct.
    Mr. SHAW. Mr. Johnson may inquire.
    Mr. JOHNSON. Thank you, Mr. Chairman.
    Before I ask a question, can I get unanimous consent to submit a statement, and with the Secretary's approval, submit some extra questions?
    Mr. SHAW. Without objection.
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    [The prepared statement and subsequent questions and answers follow:]

    [The official Committee record contains additional material here.]

    Mr. JOHNSON. Thank you. Thank you, Mr. Secretary. Relating back to what Chairman Archer said earlier concerning the trigger apparatus that you have in the budget, can you give us a list of all the tax reductions that are affected by the trigger and also a list of the 250 programs that you are eliminating? You indicated you would, but can you provide that list to all of us?
    Mr. RUBIN. You mean a list of the programs that would be affected by the——
    Mr. JOHNSON. Which ones you plan to terminate.
    Mr. RUBIN. We will give to the Committee our full plan with respect to the triggering mechanism, sure.
    [The following was subsequently received:]

    1. The proposed trigger mechanism would have affected the following tax provisions: Child credit; HOPE scholarship credit and tuition deduction; IRAs; and Brownfields.
    2. In its FY 1998 budget proposal, the Clinton Administration proposed to stop funding 254 programs (see attached list).

    [The official Committee record contains additional material here.]

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    Mr. JOHNSON. OK. Thank you.
    I have a question about R&D tax credit. I think we need to do everything we can to ensure international competitiveness in United States industries, and Germany and Japan, as you know, offer private industry attractive tax and financial inducements to perform R&D. Are we going to be able to retain this R&D work and the associated high-salary jobs here in the United States without an R&D credit? My question is, Since you have put an extension in the budget for that, are you committed to making it permanent?
    Mr. RUBIN. Well, the answer is that a permanent R&D tax credit is what we should have. The problem is, it is very expensive. What we have done is to, as you say, propose an extension but not a permanent extension and the reason is not because we do not believe in a permanent extension. We do believe in a permanent extension. We just do not have the resources to do it. That is one of the problems in going to a balanced budget. You have to make hard choices and forgo doing things that you would like to do, and I agree with you, Mr. Johnson. I think a permanent R&D credit is something we should have in this country.
    Mr. JOHNSON. Well, I think most of us feel like it is an important subsection.
    Mr. RUBIN. Yes.
    Mr. JOHNSON. This same proposal, I think, that you have here would repeal a so-called deferral on foreign oil and gas income, defined as the foreign oil and gas extraction income and foreign oil related income. In other words, instead of refraining from taxing a U.S. parent on the earnings of its foreign subsidiaries until the parent receives income through a dividend, the United States is going to tax the parent as soon as the subsidiary has earnings, regardless of whether those earnings are ever repatriated or not.
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    My question is, will this provision result in double taxation in cases where the subsidiaries' income is not repatriated?
    Mr. RUBIN. Mr. Johnson, I would have to think about that for a while. Let me get back to you on that, if I may.
    Mr. JOHNSON. That will be fine.
    Mr. RUBIN. OK.
    [The following was subsequently received:]

    The Internal Revenue Code has numerous so-called ''anti-deferral'' provisions. All of these provisions impose tax on U.S. shareholders with respect to those shareholders' allocable portions of the earnings of foreign corporations in which they are invested, even where the foreign corporations do not distribute their earnings to the U.S. shareholders. The provision to which you refer would help eliminate potential abuses by preventing taxpayers from shifting income from one class of income currently subject to these anti-deferral rules to a related class of income not currently subject to these rules. Consistent with the operation of anti-deferral provisions generally, however, the foreign oil and gas income that would be made subject to current taxation at the shareholder level by this proposal would, when included in the income of the shareholder, carry with it credits against U.S. tax for income taxes imposed by foreign governments on the foreign corporation's income. Thus, the provision should not generally result in double taxation.


    Mr. JOHNSON. I thank you for your questions and answers, sir.
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    Mr. RUBIN. I imagine it is a subject that is of interest in Texas.
    Mr. JOHNSON. It is, very much so.
    Mr. RUBIN. OK.
    Mr. JOHNSON. Thank you for being here today.
    Thank you, Mr. Chairman.
    Mr. MCCRERY [presiding]. Mr. Jefferson.
    Mr. JEFFERSON. Thank you, Mr. Chairman.
    Mr. Secretary, I would like to join with all those who have showered high praise on you today for your work and for your work that is as you promised, your budget proposals here today for the future.
    I want to tell you also that I sacrificed more than anyone else to be at this hearing today, both to wait here to speak last, I think, and because it is Fat Tuesday in New Orleans. And so it underscores how important I thought it was to come and hear what you had to say today and to participate in this hearing.
    I want to just ask one thing that maybe some of it follows up on what Clay Shaw said a few minutes ago. You speak in your statement about bringing the economically disenfranchised into the economic mainstream, some of whom are welfare recipients and some of whom are not, many of whom are not.
    The concern I have is what I consider to be a fairly limited approach to getting after that question. I know the enterprise zones are an important way to get after it, but I am concerned that the issue Mr. Shaw talked about, the issue of incentivizing the private sector through tax credits in the job credit area does not get after it in quite the right way.
    First, in almost every town, you are talking about welfare recipients in entry level jobs and there just are not enough of them. And so it is an entrepreneurial, it seems to me, approach that has to be taken here to empower the private sector to engage in entrepreneurial activities to create jobs, and that gets me to this issue of capital formation for these concerns. I think the major impediment to job creation is a lack of capital, a capital gap in these communities, and these proposals need to fairly address these concerns a little better.
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    We tried to scratch the surface of this question some years ago but we really just scratched the surface of it, and I would like to have some thought given to redirecting some of our efforts here, some of the dollars that are being spent here to the concern of helping to create jobs through the empowerment of small concerns, where almost all the jobs are created anyway, in these communities where there are no jobs now through directing larger capital concerns that drive pools of capital into places where these concerns can make some use of them.
    Mr. RUBIN. Well, let me say——
    Mr. JEFFERSON. I have some ideas along those lines that I will be glad to share with you.
    Mr. RUBIN. Yes. We would be very interested. I think your general proposition is one that we would agree with very strongly, access to capital, and that is why we have defended CRA and that is why we have put in place the President's vision of a community development bank network. It is now starting to take place around the country. Just 2 weeks ago, I think it was, the President gave the first awards for microenterprise lending. The low-income housing tax credit, we have defended for that reason as well. So I think your essential insight is correct. If you have additional ideas that you think we should be pursuing, we would very much welcome them.
    Mr. JEFFERSON. I would like you to think more, if you would, and I would like to share this with you, along the equity-capital formation lines. The ones you spoke about speak to debt capital formation——
    Mr. RUBIN. That is correct.
    Mr. JEFFERSON [continuing]. And there are all sorts of problems in that area. The equity capital formation, of course, will provide greater leveraging for even the debt capital funds that you have here and in the larger concerns around the country, equity capital is a driving force in the expansion and growth and creation of businesses. That is almost nonexistent in these other areas and it has to be addressed. It has to be introduced.
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    And I really think that there are ways to do it that are not very expensive, but well-targeted efforts can really do a good job here and I really hope that before we finish this process of giving tax breaks here and there to create these jobs, we look at a vehicle that will empower the private sector, small concerns, through the use of equity capital formation to get after creating—and I think it would yield more than the job credit idea, which will largely go to large concerns which are not really in the neighborhoods anyway and are not going to be that available to many of the people who we are trying to reach here.
    Mr. RUBIN. We would be happy to entertain the thoughts along those lines, Mr. Jefferson.
    Mr. JEFFERSON. Thank you, Mr. Secretary.
    Mr. MCCRERY. Mr. English.
    Mr. ENGLISH. Thank you, Mr. Chairman.
    Mr. Secretary, welcome. I would like to start by following through on Mr. Thomas' line of questioning, maybe taking it in a slightly different direction.
    I do not really want to reopen the debate over whether it is significant, the amount of tax relief you are proposing to provide as opposed to the level of savings you have proposed in Medicare. But since this is likely to be part of the debate, I wonder if the administration would be willing to support a lock-box provision as part of Medicare reform that would lock the savings in Medicare into the Medicare Program, in effect, and not make them available for tax relief for other programmatic spending and in this way put this issue behind us and move on to weightier aspects of the Medicare debate.
    Mr. RUBIN. I do not think we have an issue to put behind us. As I said to Mr. Thomas, he took two numbers and attached them together for whatever purposes. They were unrelated numbers and they are totally different programs. They were decided at different times in our process and the two have nothing to do with each other.
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    Mr. ENGLISH. Do you have a position on a lock-box provision?
    Mr. RUBIN. I will speak for myself, not for the administration. I do not see any need for it or any sense to it, but Mr. Lew?
    Mr. LEW. Obviously, we would need to look at how any lock-box provision would work, but in general, the unified budget is a unified budget and our view is we should balance the unified budget, which we do. As the Secretary has indicated, there is no relationship between those numbers other than coincidence and they are not, as he said——
    Mr. ENGLISH. Looking at the debate last year, I would not have thought that the administration would be arguing that there is no correlation between those numbers, but hopefully, we can work together——
    Mr. RUBIN. Well, the circumstances last year may have been somewhat different. He was talking about—Mr. Thomas, as I understand, was talking about our budget.
    Mr. ENGLISH. Yes.
    Mr. RUBIN. And in our budget, his comment was not relevant. That was all.
    Mr. LEW. Congressman, if I could just say one word about our Medicare policy, because I think it is really the relevant——
    Mr. ENGLISH. Let me move on to other issues. I will take back my time.
    With regard to the President's budget, I see he intends to extend the so-called temporary Federal unemployment surtax. I am astonished that we are still calling it a temporary tax because it dates back to 1976 and the debt that it was aimed at originally was paid off in 1987.
    But I was curious, How would you propose to explain, say to a small business man, that he should continue paying this tax for the coming decade if collections are not needed to support benefits and what you would propose we say to workers in our districts, why their jobs should continue to be taxed given the current state of Federal extended unemployment benefits, which are generally inaccessible in most conditions?
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    Mr. LEW. Congressman, we feel that the proposal is an appropriate one to keep the program funded adequately. It is, as you know, an extension of the current rate of payment. It is not an increase.
    As far as the details of the funding of the unemployment trust funds and year by year, we would have to take the question and get back to you on that.
    [The following was subsequently received:]

    The extension of the FUTA surtax in the 1998 budget reflects what we believe is prudent management of UTF, the Unemployment Trust Fund. The extension of the 0.2 percent surtax, $14 per worker annually, will help prepare the fund in the event of a future recession. While the general fund borrowing that the surtax was initially designed to address has been repaid, this does not mean that the surtax is no longer needed. When the EUC, Emergency Unemployment Compensation Program, was created in November 1991, it used FUTA funds set aside to pay extended benefits. By July 1992 those funds were depleted and general revenues were needed to continue the EUC Program.
    The administration's goal is to have adequate balances in the UTF accounts so thay borrowing or other infusions of general revenues are not needed when a recession occurs. While projected balances in the Federal accounts funded out of FUTA may appear to be adequate, we estimate that they will not be sufficient to meet the demands of a more than average recession. While neither the administration nor CBO currently project a recession, we do not believe that the business cycle has been eliminated, and we need to prepare prudently for changes in our economic fortunes.
    Extended benefits is a standby program that makes additional weeks of unemployment benefits available when unemployment in a State is high and rising. Costs are shared 50–50 with the States. While this program triggered on in very few States in the last recession, since then Congress created a more sensitive trigger and made it available at State option. To date, seven States have adopted this optional trigger. In a recession, however, we would expect more States to adopt this trigger, which would place greater demands on the FUTA-funded UTF accounts.
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    Mr. ENGLISH. OK. I am curious, also, why you propose extending this tax through 2007, not through 2002, which is the end of the budget period.
    Mr. LEW. I would be happy to get back to you. I suspect the answer has to do with the trust fund year-to-year balances, but I do not have them off the top of my head.
    [The following was subsequently received:]

    The administration believes that extension of the 0.2 percent FUTA surtax will contribute to prudent management of the Unemployment Trust Fund. Extension of the surtax, coupled with increases in the ceiling for one of the Federal accoiunts in the Unemployment Trust Fund, puts the government in a better position to weather a future recession. The extension of the surtax, though 2007, provides a financial cushion. If the economy unexpectedly weakens, the FUTA surtax revenues can be used for extended unemployment benefits, additional administrative costs, or for loans to States to pay benefits. If the economy remains strong, a portion of the FUTA revenues would revert back to the States, where they could reduce State unemployment taxes.



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    Mr. ENGLISH. Thank you.
    Mr. Chairman, I would like to follow through finally on something Mr. Levin had asked. In his State of the Union Address, the President noted that, ''The American people must prosper in the global economy.'' In discussing the importance of concluding new trade agreements, he went on to state that, ''We must act to expand our exports.'' I took these to be applause lines. On the other hand, the President's budget includes a proposal mentioned by Mr. Levin that, in effect, penalizes exports by cutting back the so-called source rule.
    I am curious how you can reconcile the apparent contradiction between the President's stated goal of increasing exports and a proposal to raise tax revenues by penalizing the way U.S. exporters do business under the current law.
    Mr. RUBIN. Because, Mr.—well, in the first place, the President has had an aggressive trade policy directed toward increasing exports and exports, as we know, have risen enormously in this country, partly for that reason and partly because of the increasing competitiveness of American business.
    The change of sale source rule does not penalize exports. What it does, as I was discussing, I think, with Mr. Levin, it relates to a provision that was put into the Code, as you probably know, 70 years ago to deal with the situation that existed before tax treaties protected exporters against double taxation. What had once been a provision very useful for certain purposes has now become an unwarranted benefit.
    What we are suggesting is that exporters get the full benefit, the full benefit of the Federal Income Tax Code with respect to their deductions but that they not have the unwarranted benefit. That is not penalizing them.
    Mr. ENGLISH. But are not exporters required to increase their overseas activities in order to avoid this tax penalty and does that not necessarily create the potential for shifting jobs overseas?
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    Mr. RUBIN. Well, any time you take away a benefit from somebody, Mr. English, you may have an effect. On the other hand, I do not think anybody is suggesting all business activities in the United States have unwarranted benefits. If you did, you would have an overwhelming Federal expenditure, you would have no tax revenues, and we would have an infinite deficit.
    Mr. ENGLISH. Thank you, sir, and again, Mr. Secretary, delighted you could make it here. I very much appreciate your answers.
    Mr. RUBIN. Thank you.
    Mr. MCCRERY. Mr. Becerra.
    Mr. RUBIN. I do think this is an issue we will be discussing at length because it is a very important issue and one that I know a lot of people are interested in.
    Mr. ENGLISH. Thank you, sir.
    Mr. BECERRA. Mr. Secretary, thank you very much, and actually, thank you to Mr. Lew, as well, for sitting through so many questions.
    Let me, before I begin any questions, thank you as well for at least trying to refocus this government's attention on education and middle-class America. I know that we all have some differences with the proposal that the President presented, but I think it is at least a step forward to try to refocus on an issue which really does deserve national attention, and that is education.
    By the way, I think you deserve a pat on the back, as well, for your forecasts. I know there was a debate 2 years ago as to whether OMB really should prepare forecasts or it should be left to the Congressional Budget Office. I think you have proven you have done even a better job than CBO, which typically does an admirable job, as well, so I think you deserve a pat on the back for that.
    Finally, I would be remiss if I did not say thank you for your words of caution on whether we should tinker with the Constitution of the United States of America when it comes to the issue of budgets. We saw what happened a little over 1 year ago when the government shut down as a result of discord on budget proposals, and I would hate to see what happens if we try to tinker with the constitution on this whole issue.
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    The education tax cuts, and again, I appreciate the effort to try to help middle-class America have some tax relief, it is fairly clear that those families who are on track to send their kids to college will have an opportunity to see some lessening of their burden as they send their kids off to college, but can you give me a sense as to whether or not you believe these tax cuts in education will have the effect of increasing the number of Americans who for the first time attend college?
    Mr. RUBIN. I think it is very hard—in fact, I think it is impossible to give a quantitative answer to that question. What you can say, I think with assurance, is that the tax credits and the tax deductions will help many very financially hard-pressed middle-class families who are sending kids to school. How large the additional incremental effect will be in terms of people who would not otherwise have gone, I do not think can be answered.
    The third effect is that there is, as you know, a very substantial dropout rate amongst those who start college. No one knows how much of that is a consequence of financial difficulty, but hopefully this will reduce that dropout rate, at least to some extent by providing additional financial resources.
    Mr. BECERRA. I am very interested in exploring that with you and others because I think that will be one of the factors that helps me decide on this whole issue of tax cuts. I am still one who believes we should balance the budget before we provide any type of tax relief, as much as I hate to say that because there are a lot of folks in my district, like anyone else's district, who deserve to have some lessening of the burden as their kids go on to college.
    Mr. LEW. Mr. Becerra, if I may just say one thing about the Pell grant provision to which the Secretary has referred a number of times. In 1993 the Pell grant maximum award was $2,300. We have taken it up to $2,700 and we are proposing now to take it to $3,000. That is a very substantial increase in the amount of grant award, and it will principally go to a lot of the first-time college students that you are concerned about.
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    Mr. BECERRA. And let me applaud you for that, because clearly, that will help a number of families for whom this will be the first occasion when they have a child go on to college, and I think that is very clear, although I must say, the increase, I do not think, will be commensurate with the increase in educational costs over the coming several years.
    I know my time is running short. Let me ask a quick question with regard to the exclusion of capital gains on the sale of a principal residence. I know you have tried to do things to help first-time home buyers, which I think is commendable. Let me ask why you decided to have a ceiling that provides a shield for $500,000 in profits for the sale of a home. I know most middle-class Americans would love to know that they are not going to get taxed on the profit on the sale of their home, but I do not think many middle-class Americans make a $500,000 profit when they sell their home.
    Mr. RUBIN. Well, I will tell you, the purpose of this was—there are several purposes, but I would say the primary purpose was that for many middle-income people who own homes, their home is really far and away their principal asset and the thought was that as they reach retirement or if they have a crisis in their life and they need to liquidate, that we wanted to protect that piece of their savings against taxation, since, as I say, it was such a large portion of their net worth.
    Mr. BECERRA. But if I can interrupt——
    Mr. RUBIN. Now, your question is why we picked $500,000 instead of some lower number.
    Mr. BECERRA. Right. I think most of the folks you are talking about, you are trying to help them in this time of crisis, if they sell that home will not collect $500,000 after they have paid the cost of the home.
    Mr. RUBIN. I think that is almost surely correct. In fact, it is surely correct. The other factor here was that by having as high a number as we did have, we have eliminated virtually all need for people who own homes—and there are people with very high-priced homes that it does not apply to, but almost all homeowners will no longer have to keep records of all little changes they make every year that then ultimately go into determining what their basis is when they sell their home.
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    So that was the other reason for the provision and it was the reason for picking this high a number, because it really eliminated, as I said, over long periods of time when one cannot forecast what inflation rates may be and all the rest, it eliminated the need to have people keep the kinds of records they would otherwise have to keep to ascertain basis.
    Mr. BECERRA. I appreciate the answer. I think the President, to the degree that he did have a tax cut proposal, at least did a commendable job of focusing it on middle America, and I think that this is one of those areas where perhaps the President could have focused a bit more to make sure the benefits enured mostly to middle-class America, not that we should not also provide some tax relief for others, but—and I suspect the cost of this particular component of the tax cut is small relative to the rest, but it——
    Mr. RUBIN. Very small.
    Mr. BECERRA [continuing]. It did startle me to see that you are going to provide a shield for $500,000 of profit on the sale of one particular home.
    Mr. RUBIN. And I am not arguing, because you raise an important point, but remember, part of what it does, if somebody buys a home today and they are 30 years old and they figure, who knows, maybe they will sell it 40 years from now, there is no way of knowing with inflation rates and all the rest what that home on a nominal basis will be worth 40 years from now. We wanted to be in a situation where that person did not have to keep records and do all the kinds of things that would be necessary to ultimately have to determine basis and that was part of what led to the choice of that number.
    Mr. BECERRA. And I can appreciate that for that homeowner, but for the person who has the $2 million home and sells it for $2.5 million and gets to deduct the $500,000 in profit, I think that is not what most middle-class Americans see as a way to try to help middle-class America. But I understand the thinking behind it.
    Thank you.
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    Thank you, Mr. Chairman.
    Mr. MCCRERY. Mr. Secretary, barring some late entrant, you have arrived at the last questioner for today.
    Mr. Portman.
    Mr. PORTMAN. Mr. Secretary, in that I am the last questioner, I will be mercifully short. I commend you for your stamina this afternoon.
    Starting by simply saying that we want to thank you for your cooperation with the IRS restructuring commission. I know Mr. Coyne mentioned earlier the work we are doing and one of our able commissioners is behind you, Ed Knight, ably representing your department. I really believe that with the continued cooperation and support of Treasury and OMB on the management side, we can do something meaningful, bipartisan, and bicameral within the next several months.
    One of the issues, of course, that we have uncovered is that there is a tremendous burden on the IRS that is brought about by this Committee and others through complex tax provisions. There is also a lot of concern on the line about IRS employees being asked to do what might be called nontax functions or noncore functions. We just finished a survey, as an example, of 300 online IRS employees and that was one of the concerns that was raised time and time again.
    We do not want to get into all those now necessarily, but the EITC might be one, child support might be another, and in listening to the conversation this afternoon regarding the President's new proposals for the HOPE scholarship programs and the B– average, I wonder whether the IRS is really the right agency to make those determinations and whether the administration has adequately costed out what the burden would be to an already overburdened IRS of having to make those determinations, deal with the schools, some of which might just possibly want to inflate grades for purposes of qualifying their students and parents for this.
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    So I would just ask that the administration continue to be mindful of that, the need not only to simplify our Tax Code but not to add more burdens to the Service that are so-called noncore functions. Do you have any comment on that?
    Mr. RUBIN. Well, you raise an important question, Mr. Portman, and you have been involved in what I think is a very important enterprise, which is working constructively together on getting the IRS back on track. I think we have a vital national interest in having an IRS that works. I think we all have to be supportive and constructive as we approach it, and I know that you have been part of a very important process in that respect. As you know, we at Treasury are enormously committed to doing this over time and are devoting a lot of resources to it.
    I think the Tax Code has always been used in our country as an instrument of economic and social policy and, I personally think, properly so. So I guess my view of this is that that is simply one of the burdens the IRS is going to have to bear. I think it does behoove us in designing programs to try to design them in ways that are readily administerable, but I, at least personally, do not think it should lead us away from continuing the practice that has been the——
    Mr. PORTMAN. Let me commend you for a proposal that Mr. Becerra just talked about as one example, and I am sure the administration took this into account when it came up with your new sale of home capital gains provision. But the fact that you no longer would have to be over 55 and the fact that it is no longer capped at $125,000 but at a higher number, in essence, that is simplification.
    Mr. RUBIN. Yes.
    Mr. PORTMAN. I guess all I would say is that, Yes, there will be temptations constantly to use the Internal Revenue Service and the Code for social goals and that is going to be difficult to stop, but at least we should be more mindful of the burden that we are putting on the IRS, and I think the line is drawn too far to the side of having the IRS take care of many of our problems, whether it is child support, EITC, or more recently here with the proposal for the IRS to help us with regard to funding higher education through determining what is a B–, what is a drug conviction, and so on.
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    Mr. RUBIN. Your general proposition about the administerability, I think, is a right one and I agree, but the B– thing actually would not be a problem. All that the IRS has to do—that becomes the Department of Education's problem. The IRS simply gets a form back and the school checks off qualified, does not qualify. That is all. The IRS does not go behind that check mark.
    Mr. PORTMAN. Again, thanks for your cooperation on the commission. We look forward to working with you.
    One just final, if I may, Mr. Chairman. Do you have timing or a status report, perhaps, on the administration's simplification proposals? I know yesterday Mr. McCrery mentioned that there was, indeed, something going on within Treasury and perhaps the White House with regard to a new series of proposals or a package of proposals. Is there a timeframe for that?
    Mr. RUBIN. Mr. Portman, I am not sure when we are going to have them ready. They are referenced in the budget, as you know, and they will be a series of measures that are designed in various ways to try to make the Tax Code simpler. These are not any sort of major reform measures with respect to the Code. They are efforts to clean up various provisions that now exist. I do not know when we will have them ready, but we have been working on them for quite some time. Maybe I can get you an answer right now.
    I am told by one person ''soon'' and by another, ''within a reasonable period of time.'' [Laughter.]
    Mr. PORTMAN. The check is in the mail. All right.
    Thank you.
    Mr. RUBIN. So the answer is soon and within a reasonable period of time.
    Mr. PORTMAN. Thank you, Mr. Secretary.
    Thank you, Mr. Chairman.
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    Mr. RUBIN. You are quite welcome, Mr. Portman.
    Mr. MCCRERY. Mr. Secretary, that concludes the Committee's questioning. Do you have anything further you would like to offer before we conclude the hearing?
    Mr. RUBIN. I have about a 30- or 40-minute address, if you would like, on subjects of interest to me. [Laughter.]
    No. I think I——
    Mr. MCCRERY. Bearing in mind——
    Mr. RUBIN. We very much enjoyed being with you and I thank you.
    Mr. MCCRERY. Thank you very much, Mr. Secretary. As usual, your appearance here was very straightforward and informative, and we wish you well and look forward to having you back with us.
    Mr. RUBIN. Thank you very much.
    Mr. MCCRERY. The Committee is adjourned.
    [Whereupon, at 4:08 p.m., the hearing was adjourned to reconvene on Wednesday, February 12, 1997, at 9:30 a.m.]

House of Representatives,
Committee on Ways and Means,
Washington, DC.

    The Committee met, pursuant to notice, at 9:37 a.m., in room 1100, Longworth House Office Building, Hon. Bill Archer (Chairman of the Committee) presiding.
    Chairman ARCHER. The Committee will come to order. Today, the Committee will continue to learn more about the President's budget, and we have with us this morning the Secretary of HHS, Donna Shalala. Madam Secretary, welcome back to the Committee.
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    Secretary SHALALA. Thank you.
    Chairman ARCHER. You are not a stranger here before us, and thank you for coming this morning.
    If there was ever a year for us to work together to balance the budget, this is it. The American people elected us to work together to get things done, and I personally have that as a goal, and I look forward to working with you and your people over at HHS. We have two major areas of the budget to discuss this morning. It is Medicare and welfare. I am pleased to note the recent movement of the administration in terms of the overall level of Medicare savings. I believe we will be able to come to a bipartisan agreement on the savings level.
    I am concerned, however, about the policies that get us to that level. The key is, as we all know, to save Medicare for today's seniors without harming the next generation of retirees, including our Nation's young people. A thoughtful observation was recently made, and I quote, ''The longrun structural deficit makes the current Medicare Program unsustainable. The issues involved require long-term, systematic, scholarly, bipartisan thinking and public discourse to reach a public policy consensus.''
    Those remarks are probably familiar to you, Madam Secretary. They were made by Bruce Vladeck, the administration's Medicare chief. If the administration pursues a plan to save Medicare by relying on shell games like the home health care shift or on tax increases paid by the next generation, then I believe we will miss the golden opportunity which this year provides us to lay the groundwork for a long-term solution to Medicare. And I personally hope that that is where we will focus our attention.
    In fact, because the block grant was established mostly at the 1994 funding levels, getting into the welfare end of things, the success, really, of our new law is for all of us to see already. Much of it is psychological. People are not applying for welfare, because they know that they will have to work. Welfare rolls are dropping, and they are dropping at a sharper rate since our law was passed. New child support provisions are kicking in, so mothers are getting the help they need to raise their children. Child care funding is up.
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    In fact, as I was about to say, the block grant was established mostly at the 1994 funding levels, and the welfare rolls have dropped since then. States have plenty of money to carry out innovative and flexible reforms. And, Madam Secretary, that is why I personally am concerned about the administration's proposal to increase welfare spending by $21 billion, most notably to pay welfare to people who are not U.S. citizens.
    From 1982 to 1994, noncitizen applications for SSI and welfare jumped 580 percent, compared to a 49-percent increase in applications by American citizens. The word was out that it is easy to come to America and to go on welfare. That is not what America is all about. That is not what made us into a great nation of immigrants. Our new law was designed to protect taxpayers from such abuses, and I personally am going to resist any proposal that lets the door to abuse swing wide open again.
    There are good provisions in your budget, and we should talk about them. On Medicare, you proposed items that Republicans offered in the last Congress, like provider-sponsored organizations and adjustments to the imbalance in health plan payments to rural areas. You have also proposed a package of Medicare prevention benefits patterned after the legislation introduced by Chairman Thomas and Congressman Cardin.
    On welfare, the administration has done an excellent and timely job on giving the States guidance in implementing the law, and you have given us a very helpful first draft for the technical corrections bill, and I salute you for these initiatives.
    Madam Secretary, I again look forward to working with you. I believe together we can accomplish a great deal that will be good for this Nation, and I yield to the Ranking Member of the Committee, Mr. Rangel, for any statement he might like to make.
    [The opening statement follows:]

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    [The official Committee record contains additional material here.]



    Mr. RANGEL. Thank you, Mr. Chairman, and let me continue the salute. There is no question that Republicans and Democrats agree that the President has given us a good beginning in terms of a road map to reach the goals we want to reach for our country and our sick and our aged. Of course, there are some bumps in that road in terms of how we will be going about it. But again, I want to publicly thank the Chairman and my Republican colleagues for at least accepting the package and their willingness to work with the administration in a bipartisan way.
    I want to focus for a moment on the welfare reform bill—it is difficult for me to call it reform, but in the spirit of bipartisanship with my President, I will use that term. The election is over now, and I guess we all can settle down and see what is working and what is not working. If people who are concerned about becoming American citizens and continuing the great history that we built by opening up our doors to people of foreign birth come here legally, then we ought to continue in the tradition of welcoming them. I do not believe people come to this country looking for a welfare check any more than they did 100 or 150 years ago. But if they do that, then there must be some way to stop it and, at the same time, not be meanspirited in how we treat people who play by the rules.
    Supposedly, welfare reform was about putting people to work. However, I am not sure the mayors and the Governors are as excited about these block grants as they were when they thought they were getting the Medicaid money. I know my Governor and my mayor want us to review how we treat illegal aliens under the welfare reform legislation, They also want us to provide day care money and job training money and a bridge between today's poverty and lack of education and tomorrow's decent job. Since I know my Chairman wants the same thing, I cannot wait for us to get started working on what we agree upon. I also look forward to working within the areas that we disagree on since I know we can work together as professionals.
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    Politics being what it is, I ask you to be patient. I am certain that in the end we can present something to the President that he will be proud of.
    Thank you.
    [The opening statement of Mr. Ramstad follows:]

    [The official Committee record contains additional material here.]



    Chairman ARCHER. Madam Secretary, again, welcome, and you may proceed. Your entire written statement, should it be lengthier than your oral testimony, will be put in the record without objection, and you may proceed.

    Secretary SHALALA. Thank you very much, Chairman Archer. As you noted, I do have a lengthy written statement and a much shorter statement right now.
    Thank you for giving me the opportunity to testify today about the President's fiscal year 1998 budget proposal. Someone described our country as the only country deliberately founded on a good idea. That good idea is we the people, and it has emboldened our country to face and overcome great challenges with courage and unity; to face and overcome tyranny in the forties and polio in the fifties; to land an American on the Moon in the sixties and win the cold war in the eighties.
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    Each of these triumphs came during times of great social and political change, but most important, each of them defined a generation, because in each of these moments, Americans put aside partisan differences to achieve a critical national goal. Today we must do the same. Right now, leaders on both sides of the aisle agree that we must balance the budget. The question is how. How can we balance the budget and reform Medicare and welfare while still keeping our promises to our citizens now and into the 21st century? The President's budget would allow us to do just that.
    Mr. Chairman, you and I know that Medicare now faces several short-term challenges and a long-term financing challenge, all of which demand action, and that is why the President has made it clear he wants to work with the Congress to make 1997 the year we forge a bipartisan agreement on Medicare. The President's own plan would reduce projected Medicare spending by a net $100 billion over 5 years and guarantee the solvency of the Part A Trust Fund until the year 2007, 10 years from today.
    The independent actuary for Medicare has written a letter confirming these numbers, and I will submit it for the record. We are able to achieve these savings with real reforms, with sound policies, while still maintaining a system that guarantees access to a defined set of services, a defined set of benefits, rather than providing a defined contribution per beneficiary.
    [The information follows:]

    [The official Committee record contains additional material here.]


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    Secretary SHALALA. To preserve Medicare for this and every generation, we must first modernize it. We are doing that in six ways: First, by making Medicare a more prudent purchaser of health care services; second, by adding new choices to be consistent with today's market; third, by strengthening our rural health care system; fourth, by protecting our beneficiaries by ensuring that they receive high-quality health care; fifth, by continuing to root out waste and fraud and abuse so that we spend our hard-earned tax dollars wisely and effectively; and sixth, by adding new, cost-effective benefits to reflect today's science.
    In my written testimony, I have outlined these six steps in great detail, but I want to take a few minutes to highlight some of these proposals. Mr. Chairman, it is imperative that Medicare, which is the largest purchaser of health care services for our Nation, be a more prudent purchaser. Unfortunately, in too many cases, Medicare is now paying the highest price in the market when we should be paying the lowest. A gel pressure pad which goes in a wheelchair, and people in wheelchairs sit on it to prevent pressure sores, we paid $72.94 for this retail. The catalog price is $59. Medicaid pays as little as $38, but Medicare, because of the rules written into legislation, pays $112. That simply should not happen, and we need change in the Medicare legislation that allows us to get the best deal for the American people.
    Make no mistake: Our reforms will make sure that Medicare is not paying retail while everyone else is paying wholesale. To do that, we have spread our savings across all providers but focused them, as it should be, on those areas where we are currently overpaying: Managed care, home health, and hospitals. Let me expand on the first two. Experts agree that Medicare's payment methodology for managed care results in serious overpayments. We would carve out from the payment methodology funds dedicated to graduate medical education and payments to disproportionate share hospitals and instead pay these funds directly to hospitals on behalf of managed care enrollees.
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    We will gradually reduce the regional variation in payments to managed care plans and create a payment floor for plans in low payment areas to encourage enrollment, and beginning in 2000, we will reduce the Medicare payment from 95 percent of the average adjusted per capita cost to 90 percent.
    We know that home health care is one of the fastest growing components of Medicare. To curb these costs, we will immediately revise our home health cost limits to curb excessive spending and institute a new, per-beneficiary payment limit for home health agencies. We will implement a new prospective payment system for home health services in 1999, and we will base our payments on where the services are delivered, not where the billing offices are located.
    In addition to our strategy to control home health spending, we want to return to the original intent of the Medicare statute by reassessing payment for those home health services not associated with posthospital recovery from part A to part B. This reallocation is not—and let me repeat—is not counted in the overall $100 billion Medicare savings number that we submitted to Congress.
    We are also proud of our record of increasing choice for Medicare beneficiaries while continuing to protect the quality of care. The President's budget continues this progress. Beneficiaries will now have two new types of plans to choose from: Preferred provider organizations, or PPOs, and provider-sponsored organizations, or PSOs. To promote real and informed choice among health plans, Medicare will establish coordinated annual open enrollment periods and additional enrollment opportunities for managed care and Medigap plans. And to make sure that choice is a two-way street, that those who want to go back to fee-for-service always find an open door, we will prohibit Medigap insurers from imposing preexisting condition waiting periods when beneficiaries enroll or switch plans.
    To protect beneficiaries, we also believe we can balance the budget; we can preserve the Medicare Trust Fund and we can modernize Medicare for the 21st century while still protecting the vulnerable Americans who rely upon it for their care, and we must. The fact is, more than three-fourths of seniors in this country have incomes of $25,000 or less. The average woman on Medicare has an income of $13,000. And Medicare enrollees today spend—let me get that chart—more than 21 percent of their incomes on out-of-pocket health care costs. That compares to 8 percent for the rest of us. And that is why our plan keeps part B premiums at 25 percent of program costs.
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    And for outpatient hospital services, it brings the coinsurance rate down from about 50 percent to the 20 percent charge for most other part B services by 2007. But even as we work to decrease costs for our beneficiaries, we have to continue to ensure they have access to quality health care. Two months ago, we told Medicare managed care plans that gag rules have no place in our Medicare Program. Today, we are taking another important step. The President has condemned the practice of discharging women from the hospital too early after having a mastectomy, and he has called for bipartisan legislation to stop it in private health plans. I am proud our Medicare beneficiaries are already protected. Today, Medicare pays for about one-third of all of the mastectomies in this country, and by law, the women who receive them are entitled to coverage for all medically necessary care. Let me repeat, medically necessary care. This morning, I sent a letter to 350 contracting Medicare plans to remind them that they must use this standard when providing mastectomies and other related surgical procedures.
    Mr. Chairman, while the Medicare benefit package has remained relatively unchanged since 1965, it is obvious that our science has not. From decades of research, we know that preventive services not only can save money but can save lives, and now, we are putting our money where our science is. Thanks to Mr. Thomas, Mr. Cardin, and others, there is bipartisan leadership for the expansion of the Medicare benefit package. The President's plan will include 32 hours' respite care for families of people with Alzheimer's disease and a series of new prevention benefits, from colon cancer screening to annual mammograms with no cost sharing.
    Mr. Chairman, I would like to turn now to the second challenge we must meet together. Today, there are more than 10 million American children without health insurance. The vast majority of them live in families where parents work hard and play by the rules. Our administration's proposal is designed to cut the number of uninsured children by up to 5 million over the next 4 years. It is a bold strategy that builds on existing services and harnesses the skills of our private and public partners to improve our children's health and their parents' piece of mind.
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    Finally, let me turn to our third goal, moving our citizens from welfare to work. When the President signed the Personal Responsibility and Work Opportunity Reconciliation Act of 1996, he made it clear that this was the beginning, not the end, of welfare reform. I am proud of the progress that we have made together. Because of the intensity of our efforts and because of the strength of our economy, welfare rolls have gone down by 2.5 million. That is more than a 16-percent drop since the President took office. We are providing guidance to the States by spotlighting the flexibility that they have to design their own programs and, at the same time, emphasizing the importance of moving families from welfare to work.
    Although the States have until July 1997 to implement the new program, we have already given the green light to 35 States to begin their reforms. As we move forward, we will be closely monitoring State performance, examining the impact of the legislation, and compiling information, so that the States and the Congress know what is working and what is not. And we will be challenging States and communities to transform our welfare program into a jobs program.
    The President's budget includes two new initiatives that help States, cities, and employers create new jobs and help our citizens to prepare for them. First, a welfare-to-work jobs initiative to help States and cities create job opportunities for the hardest to employ welfare recipients; and second, an enhanced Work Opportunities Tax Credit to provide powerful, new private sector financial incentives to create jobs for long-term welfare recipients.
    But the President has made it clear that real welfare reform does not mean punishing people who cannot go to work, and that is why his budget restores Medicaid benefits to disabled children and to legal immigrants who are either children or disabled adults, people who are part of our American community and cannot work. Also, for refugees, we lengthen the 5-year exemption to 7 years to give them more time to naturalize.
    Overall, we believe that our proposals address the concerns of State and local officials. They give a hand up to those who can work and restore benefits to those who cannot.
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    Mr. Chairman, the budget I have discussed today discards tired, old solutions and meets our challenges creatively and cooperatively. It balances the budget without abandoning our values and our commitments. It makes very tough choices, and it shows tough management. Now, we must act on it together. Mr. Chairman, as Teddy Roosevelt once said, nine-tenths of wisdom consists of being wise on time. This is our time and our test.
    Thank you very much.
    [The prepared statement and attachments follow:]

Statement of Hon. Donna E. Shalala, Secretary, U.S. Department of Health and Human Services

    Mr. Chairman and members of the committee: Thank you for giving me the opportunity to testify today about the President's Fiscal Year 1998 Budget proposal. We in the Administration look forward to working closely with you as we move toward our shared goals of strengthening the Medicare trust fund and balancing the budget.
    Someone once described America as ''the only country deliberately founded on a good idea.''
    That good idea is ''We the people,'' and it has emboldened our nation to face—and overcome—great challenges with courage and unity.
    In the 1940s, we faced a broken Europe, but we summoned the will to fight and win—and saved the world from tyranny.
    In the 50s, we faced the terrible scourge of polio. But children contributed their dimes, and America's best scientists dedicated their lives to finding a vaccine. And we found one.
    And, in the 1960s, we faced a Soviet Union that had taken the lead in the race for space. But, President Kennedy issued a challenge to land an American on the moon by the end of the decade. We did, and no country has done it since.
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    What do all of these triumphs have in common? They came during times of great social and political change. But with a deep sense of urgency, Americans put aside partisan differences, answered the call to unity, and achieved a critical national goal. Today, we must do the same.
    Because today, we face another great challenge: At a time when we have fewer resources, a population that is rapidly aging, and a deficit that while much improved, still plagues us, we must come together again: This time to balance the budget and truly reform Medicare, Medicaid, and welfare, while still keeping our promises to the citizens we serve.


    For more than thirty years, Medicare has provided a blanket of health security for older Americans and people with disabilities. It has helped lift a generation of senior citizens out of poverty and into the middle class. It has helped change what it means to be old in America; what it means to be sick in America; what it means to be disabled in America. And it has often served as a fault line between a life of comfort and good health and a life of struggle and illness.
    The gift that Medicare has given to those who came before us must be preserved for those who come after us—for our children and our grandchildren, for every generation. That is our moral responsibility.
    But you and I know that Medicare now faces several short-term and a long-term financing challenges that demand action. For nearly four years, we have been unable to come to a consensus on the best way to preserve Medicare and improve it for the future. The President has made it clear that he wants to work with the Congress to make this the year of bipartisan agreement on this vital program.
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    In this budget, the President has reached out to the congressional majority by offering a plan to meet them halfway. His Medicare proposals will extend the life of the Hospital Insurance Trust Fund into 2007, ten years from today. I have with me today a letter from the independent chief actuary of the Medicare program that verifies that fact. I will be happy to submit it for the record.
    The President's plan contributes $100 billion to the five-year balanced budget, which corresponds to $138 billion over six years.
    And we do that by maintaining a system that guarantees access to a defined set of services rather than creating a defined contribution per beneficiary.
    These proposals are made in good faith and are based on sound policy. They make sense for both the Medicare program and its beneficiaries. Our savings are scoreable. I ask for your careful consideration of our proposals, and for your partnership in enacting them.
    But Medicare reform is not and cannot be simply an exercise in number crunching. The actions we take this year to preserve the Medicare trust fund also must prepare Medicare for the future. Not many of us would drive cross country in a car that's more than 30 years old. Likewise, we can't move into the next century with a health insurance program built in 1965. That's why to preserve Medicare, we must modernize it. This modernization requires us to do six things:
    First, we must make Medicare a more prudent purchaser of health care services.
    Second, we must add new choices to compete with today's private market.
    Third, we must strengthen our rural health care system.
    Fourth, we must protect beneficiaries, by ensuring that beneficiaries receive higher quality health care.
    Fifth, we must continue to root out waste, fraud, and abuse so that we spend our hard-earned tax dollars wisely and effectively.
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    And sixth, we must add new cost effective benefits to reflect developments in today's science.

Prudent Purchasing

    Mr. Chairman, it is imperative that Medicare—which is the largest purchaser of health care services in our nation—be a more prudent purchaser. Unfortunately, in too many cases, because of limitations in the law, Medicare is now paying the highest price in the market for certain drugs, lab services and durable medical equipment when, given the volume of beneficiaries, we should be paying one of the lowest. From managed care premiums to medical devices, the reforms we propose will make sure that Medicare isn't paying retail while everyone else is paying wholesale.
    These proposals are sound health policy and they require a shared burden. They will result in a slower rate of growth in Medicare spending and ensure that Medicare is paying a competitive price for the services it buys. The savings that these proposals generate are spread across all providers of health care and are focused, as they should be, on those areas where growth is the greatest.
    Managed Care. Experts agree that Medicare's payment methodology for managed care, which was created in 1982, results in serious overpayments for services. For example, under contract to HCFA, Mathematica Policy Research, came to such a conclusion with its 1993 review of the Medicare Risk Program. Both the Physician Payment Review Commission and HCFA studies indicate that Medicare should be paying managed care plans at a rate between 88 and 90 percent of fee-for-service costs. At the same time, however, payments to many smaller, rural plans are too low and are failing to attract much market interest.
    The President's budget includes reforms to move us to a better, more competitive system of paying for managed care. Through our Medicare Choices demonstration, we are working on risk adjusters to HMO payments to counter selection bias. We expect to have a proposal for a new risk adjusted payment methodology as early as 1999, with phase-in of new payments beginning as early as 2001.
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    We recommend three interim and important changes in Medicare payments for managed care plans. First, we propose to carve out from the payment those funds that are intended to cover the cost of direct and indirect graduate medical education and payments to disproportionate share hospitals. We will pay these funds directly to hospitals on behalf of managed care enrollees.
    Second, we will gradually reduce the regional variation in payments to managed care plans and create a payment floor for plans in rural counties to encourage enrollment in managed care plans.
    And, third, we will reduce the Medicare payment from 95 percent of the average adjusted per capita cost or AAPCC to 90 percent. However, to give plans a sufficient amount of time to adjust to these new payment levels, we would not begin this policy until 2000.
    Hospital payments. We propose a series of Medicare hospital payment changes to safeguard the program and to reflect market changes. Under the President's budget, the hospital payment update will be reduced by one percentage point every year from fiscal year 1998 through 2002 to reflect increases in hospital productivity and efficiency.
    The Prospective Payment Assessment Commission (ProPAC), created by Congress to offer advice on policies affecting Medicare payments to hospitals and other facilities, recently announced preliminary data showing that the majority of the nation's hospitals have record-setting Medicare margins. ProPAC believes that these margins are evidence that hospitals have become more efficient. Accordingly, ProPAC recommends that hospitals receive no update in their Medicare payments in FY 1998; this would be equivalent to ''market basket– 2.8 percent.''
    In light of its other hospital savings provisions, the Administration does not propose the deeper update reduction as recommended by ProPAC. Instead, the Administration spreads the hospital reductions across a number of different areas of hospital payment. When viewed as a whole, the Administration's hospital proposals balance the need to contain Medicare costs with ensuring access to quality care.
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    Home health care. Home health care is one of the fastest growing components of Medicare, with a projected average annual growth rate of 10.6 percent over the period FY 1997–2002. The average number of home health visits per user increased over 40 percent between FY 1992 and FY 1997. The average payment per visit also has increased, rising from $57 per visit in FY 1992 to an estimated $68 per visit by FY 1997.
    We know that this growth has its roots in changes in medical practices and technology, in the expansion of the benefit, and in our current reimbursement system, which can contribute to overpayment and abusive practices. And we know that we must reduce the rate of growth in Medicare home health spending and keep it under control. And, that's what our reforms will help us do.
    We will immediately revise our cost limits to establish a set of interim limits that will curb excessive spending and institute a new per-beneficiary payment limit for each home health agency.
    We will implement a new prospective payment system for home health services in 1999. This system, which has been recommended by experts to control spending, will reduce incentives for overutilization.
    We will eliminate periodic interim payments for home health agencies, which were originally established as an incentive for new agencies to serve Medicare patients. With 100 new agencies joining Medicare each month, this incentive clearly is no longer necessary.
    In addition, we will pay for home health services based on where the service is delivered. Frankly, many agencies are taking advantage of a loophole by locating their billing offices in expensive urban areas to take advantage of higher prevailing payments, regardless of where services are actually rendered. We will close that loophole.
    Along with our strategy to control home health spending, we propose to reassign payment for home health services that are not associated with post-hospital recovery from Part A to Part B. This reallocation is not counted in the overall $100 billion Medicare savings number that we submitted to the Congress. We would limit Part A home health coverage to the first 100 visits following a 3-day hospital stay, just as this part of the program covers 100 days of skilled nursing care following hospitalization. But, visits beyond 100, and those not following a 3-day hospital stay, would be paid under Part B, along with other outpatient services.
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    This return of non-post-hospital visits to Part B—Medicare policy prior to 1980—makes the home health benefit consistent with the original intent of the Medicare statute and its division of services between Part A and Part B. It relieves the Part A trust fund of the responsibility for financing care that doesn't belong there, thereby significantly extending the life of the trust fund. And it achieves these goals without subjecting beneficiaries to increases in premiums and cost-sharing.
    Beneficiary Centered Purchasing. To become a more prudent purchaser of other health services, our plan gives the Secretary payment authorities to secure better deals for Medicare and the citizens it serves. From setting payments based on competitive bidding to selectively paying centers of excellence a single rate for all services associated with a specific diagnosis, these—and our other purchasing reforms—will help us economize, modernize, and create a Medicare program that will not only survive, but thrive, to serve every generation.

New Choices

    When it comes to health care for older Americans—or any Americans for that matter—there should be no conflicts between choice and quality. We need both. We are proud of our record of increasing choice for Medicare beneficiaries while continuing to protect the quality of care. Since 1993 the number of beneficiaries in managed care has increased by 108 percent and is rising at a rate of 80,000 per month. Today, approximately 13 percent of our Medicare beneficiaries—about 5 million—are enrolled in managed care plans.
    The President's budget continues this progress by adding new choices to Medicare plans. We will include preferred provider organizations or PPOs, which offer patients a greater ability to choose their doctors and other providers. And we will offer beneficiaries the chance to enroll in provider sponsored organizations or PSOs, offered by hospitals and physicians under integrated arrangements that we hope will improve care and reduce cost.
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    At the same time, to promote real and informed choice among health plans, Medicare will establish coordinated annual open enrollment periods as well as additional enrollment opportunities to subscribe to managed care and Medigap plans.
    To make sure that choice is real and that beneficiaries who choose managed care have an open door to go back to fee-for-service, if they so choose, we will prohibit Medigap insurers from imposing pre-existing condition waiting periods when beneficiaries initially enroll or any time they switch plans. In addition, Medicare will establish continuous Part B enrollment opportunities for beneficiaries.

Rural Health

    The Administration continues to promote Medicare reforms that strengthen health care in rural America.
    For example, our plan would expand the Rural Primary Care Hospital Program to all 50 states. It would update the payment for sole community hospitals, improve the rural referral center program, and reinstate the Medicare Dependent Hospital program to provide resources to those rural hospitals that need it most.
    The reforms will create a national floor to better assure that managed care products can be offered in low payment areas, which are predominantly rural communities. In addition, the proposal includes a blended payment methodology, which combined with the national minimum floor, will dramatically reduce geographical variations in current payment rates.

Protect Beneficiaries

    We believe we can balance the budget, preserve the Medicare Trust Fund and modernize Medicare for the 21st century, while still protecting our beneficiaries. And we must protect our beneficiaries.
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    The fact is, more than three-fourths of seniors have incomes of $25,000 or less. We believe that balance billing limits must protect all beneficiaries, regardless of which Medicare coverage option they choose.
    Our plan proposes Medigap reforms to assure portability, protect against pre-existing condition limits, and provide equitable and affordable premium rates.
    It keeps Part B premiums at 25 percent of program costs. This division of costs, first enacted in the Tax Equity and Fiscal Responsibility Act of 1982, has protected beneficiaries while ensuring that the cost of Part B is shared by those who use it. As noted, the plan creates an opportunity for continuous Medicare Part B enrollment.
    For hospital outpatient services, it brings the patient co-insurance rate down from about 50 percent to the 20 percent charged for most other Part B services by 2007.
    And, it ensures that managed care plans pay for emergency services when a ''prudent layperson'' would have reasonably believed they were necessary.

Quality Protection

    We must also ensure that beneficiaries receive higher quality health care. We will institute a series of reforms to further improve the quality of care provided to all citizens who rely upon Medicare. We will adopt a new, integrated quality management system for Medicare and Medicaid. This will replace quality related requirements focusing on each provider entity individually. We will also collect and disclose more of our survey data on safety, quality of care, and program integrity so that citizens can have better comparative information on plans and providers. And we will replace the so-called 50–50 rule for managed care plans with more modern quality measures. Protecting and improving health, and increasing satisfaction with the care received are the goals of the program.
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Fighting Fraud and Abuse

    Modernizing Medicare for the 21st century also requires eliminating the fraud and abuse that robs our health care system and our taxpayers. Since I took office a little more than four years ago, I have made this a top priority by setting a policy of ''zero tolerance'' for health care fraud and abuse.
    Just two years ago, the President and I unveiled a pilot project called ''Operation Restore Trust'' to target our anti-fraud efforts to fight fraud and abuse in 5 key states. We have significantly increased the resources of our Inspector General and have strengthened our payment reviews using technology to prevent fraud, and to detect it when it occurs.
    And, it's paid off. We estimate that every dollar we invest in our anti-fraud effort yields $10 dollars in savings for the American people. In fact, just last month, Inspector General June Brown reported that ''Labscam,'' her investigation of payment fraud by independent clinical labs, could net the Medicare program millions in recoveries and penalties.
    We intend to maintain and intensify these efforts. I will be submitting to Congress a fraud and abuse bill that will enable us to strengthen the identification and enrollment procedure to ensure that only legitimate providers bill Medicare. The President's Budget includes provisions to prevent home health agencies from using a loophole in the current reimbursement system to bill a higher urban rate for service provided in rural areas. We will require insurers to reject insurance coverage so that Medicare does not pay inappropriately for beneficiaries covered by private insurance. We would repeal the anti-kickback exemption for managed care plans, and the requirement that we provide advisory opinions on the anti-kickback statutes enacted last year and scored by the Congressional Budget Office as a considerable cost to the Medicare program. And we propose to reinstate the requirement that providers use reasonable diligence when submitting accurate claims to Medicare. Finally, we will strengthen our ombudsman function in the States, building a cadre of elderly volunteers.
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New Benefits

    The Medicare benefit package has remained relatively unchanged since 1965. But our science has not. From decades of research, we know that preventive services not only can save money, but also can save lives. Now we're putting our money where our science is. I am very pleased by the bipartisan support for expansion of the Medicare benefit package. The President's plan will cover the following:
    •  We expand the availability of annual mammograms for Medicare beneficiaries to eliminate economic barriers to mammography, . We also will waive the Part B deductible and coinsurance for both screening and diagnostic mammograms.
    •  To save lives, we want to provide annual screening to detect signs of colon cancer.
    •  Because better management of diabetes leads to better health, we include monitoring of blood glucose levels and outpatient self-management training for diabetics.
    •  To improve access to adult vaccinations and help seniors avoid serious and sometimes deadly illnesses, we would increase provider payments for vaccines against pneumonia, influenza, and hepatitis B and waive patient cost-sharing for the hepatitis B vaccine.
    •  And, finally, to offer some relief for the families who are primary caregivers of a relative with Alzheimer's disease and other dementias, we would provide a new respite care benefit of 32 hours per beneficiary per year.

Children's Health Initiative
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    Mr. Chairman, I know that all of the members of this Committee agree that the tragedy of some 10 million American children without health insurance demands bipartisan action. The vast majority of these children live in families where parents work hard and play by the rules.
    We believe that situation is unacceptable for a great nation. No working parent should have to live with the fear that his or her children will become sick or hurt one day—and there will be nowhere to take them to ease the pain.
    Our goal is to cut the number of uninsured children by up to 5 million over the next five years. And, the President's budget takes important steps to help us do just that.
    First, the President's health insurance for the families of workers who are in-between jobs initiative, which provides up to six months of premium assistance, is expected to add another 700,000 children to the private-sector insurance rolls.
    Second, we will make available to the states $750 million annually to support innovative programs designed to purchase insurance for an estimated one million uninsured children in families that receive neither Medicaid nor employer-sponsored insurance.
    Third, we will give states the option to allow 12 months of continuous Medicaid coverage for all children who are eligible. By stopping the churning of children in and out of Medicaid, we can provide stable coverage for children and better continuity of services. We estimate this change will help one million children annually.
    Fourth, the Department will work closely with the states to enroll 1.6 million of the estimated three million children who are eligible for Medicaid today but who, for a variety of reasons, are not enrolled. We are committed to working with the nation's governors, communities, providers, and businesses to make this a reality.
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    And fifth, States will enroll an additional 250,000 low-income children in each of the next four years as part of the current law expansion of coverage to children between the ages of 14 and 18 under current law.
    Mr. Chairman, let me say that we view these proposals as a package. My Department estimates they will dramatically reduce the number of uninsured children in America, thereby improving their health and their parents' peace of mind. And, they will create an affordable Medicaid program that fulfills the promises we have made to our most vulnerable citizens.


    Now let me turn to welfare reform. When the President signed the Personal Responsibility and Work Opportunity Reconciliation Act of 1996, he made it clear that this was the beginning—not the end—of welfare reform. He made it clear that we all have a responsibility to come together and make this law work—especially for our children. And, he made it clear that this was an opportunity for us to create a welfare system that requires work, promotes parental responsibility, and protects children.
    I'm proud of the progress we've made together. Before welfare reform became law, we gave 43 states the flexibility they need to test innovative welfare strategies. Paternity establishments have gone up 50 percent since 1992. In 1996, we collected a record of over $12 billion in child support payments. And the tough new provisions in the welfare law are projected to increase child support collections by an additional $24 billion over 10 years.
    The result? Because of the intensity of our efforts and because of the strength of our economy, welfare rolls have gone down by 2.5 million since the beginning of President Clinton's first term—the largest drop in history. Moving people from welfare to work, enabling them to support their families and maintain their independence—that's the goal upon which all of us have always agreed.
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    We are committed to combining all of the leadership, talent and resources possible to implement the new welfare law. The effort to make welfare reform a success is one in which many departments and agencies—SSA, the Departments of Treasury, Labor, Transportation, HUD, and others—have joined together.
    Let me briefly give you a progress report on our implementation of the new Temporary Assistance for Needy Families (TANF) program. Although states have until July 1997 to implement the TANF program, we have already given the green light to 35 states (as of 2/10/97) to begin their reforms. HHS has provided guidance indicating that States have flexibility in designing their TANF programs, but at the same time emphasizing the importance of moving families from welfare to work and ensuring that Federal costs do not increase due to the potential loss of child support collections.
    At the Federal level, we are challenging States to transform the very culture of the system from a welfare program to a work program. We must launch a national effort in every State and every community to make sure there are jobs for people making the transition from welfare to work. So they can leave the welfare rolls, they must have opportunities not only to find jobs, but to keep them.
    As I indicated earlier, the hallmark of this welfare law is the broad flexibility it gives states to design innovative reforms that address their unique challenges. We are confident that States will use this considerable new flexibility and the President's new initiatives to strengthen their focus on work as well.
    We will be monitoring state performance and, pursuant to the statute, ranking them accordingly. We will be identifying and studying the high performers and the low performers, tracking child poverty, and providing an overall assessment of the legislation's impact on children and families.
    We will look closely at how states comply with some key statutory requirements, including child support enforcement, work participation rates, maintenance of effort, and data reporting.
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    We also will assume major new responsibilities for compiling and disseminating information. As the number of options continues to grow, states will need better information about these options, and the Congress will need better information to assess how effectively federal funds are used.
    I know that several members of Congress have suggested a wait-and-see approach to the new welfare system. They advise that state implementation should be carefully reviewed before undertaking major policy changes to the TANF program. Our Department has proposed a number of technical and conforming changes to the TANF program that I believe maintain the spirit and intent of its policies.
    Our Administration believes that welfare reform has always been—and must always remain—a bipartisan issue. But, just as we came together to make work and responsibility the law of the land, we believe it is time to come together again to ensure that the centerpiece of welfare reform remains a real effort designed to find work for everyone who is able to work.
    Creating these opportunities will take a commitment from business and labor, from religious organizations and communities, from officials at the federal, state, and local levels. And, it will take the bipartisan Congressional spirit that brought us this far—and must continue to carry us down the road to success.
    That is why the President's FY 98 budget contains funds to help States and cities create new jobs, prepare individuals for them, and provide employers with incentives to create new job opportunities for long-term welfare recipients.
    To help welfare recipients move from welfare to work, and to supplement TANF funds, the President proposes two new initiatives: A Welfare-to-Work Jobs Initiative to help States and cities create job opportunities for the hardest-to-employ welfare recipients and a greatly enhanced Work Opportunities Tax Credit to provide powerful new private-sector financial incentives to create jobs for long-term welfare recipients.
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    The Welfare-to-Work Jobs Initiative, which would be administered by the Department of Labor, would provide $3 billion in mandatory funding over three years for job placement and job creation to move a million recipients off the welfare rolls by the year 2000. We will encourage States and cities to use voucher-like arrangements as they deploy these funds to empower individuals with the tools and choices to help them get jobs and keep them.
    Under the enriched Work Opportunities Tax Credit for hiring long-term welfare recipients, employers could claim a tax credit of 50 percent of the first $10,000 in wages paid to these hires.
    Another major focus for the Administration is to change parts of the welfare reform law that have nothing to do with welfare reform. When the President signed the welfare reform bill he made clear his disappointment with the harsh provisions in the bill relating to benefits to immigrants. The President stated:
    ''My Administration supports holding sponsors who bring immigrants into this country more responsible for their well-being. Legal immigrants and their children however, should not be penalized if they become disabled and require medical assistance through no fault of their own.''
    The President's FY 1998 budget makes good on his promise to correct provisions that were included to save money, and which burden States and punish children and the disabled who cannot work. Legal immigrants should have the same opportunities, and bear the same responsibilities, as other members of society. The welfare law denies most legal immigrants access to fundamental safety net programs unless they become citizens—even though they are in the U.S. legally, are working and paying taxes and are responsible members of our communities.
    The Administration has always supported making individuals who encourage their relatives to emigrate to the United States more responsible for the immigrant's well being. However, as a nation, we should not turn our backs on anyone who has lost their ability to earn a living due to injury, disease or illness. The Nation should protect legal immigrants and their families—people admitted as permanent members of the American community—when they suffer accidents or illnesses that prevent them from earning a living.
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    Consequently, the budget proposes to make legal immigrants who become disabled after entering the United States eligible for SSI and Medicaid. This proposal would allow 320,000 legal immigrants who experienced an accident or illness which resulted in disability after entering the U.S. to receive SSI and Medicaid benefits. We are pleased that the governors, in an NGA resolution last week, agreed—we must not balance the budget on the backs of States or legal immigrants.
    The budget would lengthen the five year exemption from the ban for refugees to seven years in order to give them a more appropriate amount of time to naturalize. The United States admits refugees and asylees into this country on a humanitarian basis. Assistance for this population while they adjust to their new circumstances is a matter of simple decency. The budget also would delay the Food Stamp ban on legal immigrants until the end of FY 1997 in order to give immigrants more time to naturalize.
    The budget would also provide poor children of legal immigrants the same Medicaid health care coverage low income citizen children receive. In addition, under our budget, disabled children who are currently eligible for Medicaid because they are receiving SSI benefits will be able to retain their Medicaid coverage—even if they lose their SSI benefits as a result of the tightened definition of childhood disability. Under this proposal, the families of these needy disabled children will be assured that medical assistance will continue to be provided.
    Finally, the Administration is proposing to restore some of the overly deep benefit cuts to the Food Stamp program. The proposal includes replacing the 3 month time limit for childless workers with a real work requirement which would not punish those looking for but unable to find work. Also changes would be made to help families with high housing costs and to ensure that families' ability to purchase an adequate diet keeps up with inflation.
    Overall, our proposals strengthen our commitment to a new welfare system focused on work and responsibility while addressing the concerns of State and local officials and restoring benefits to those who can't work—particularly children and the disabled. We must give all Americans a hand-up and get on with the real business before us; reforming our welfare system together.
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    Mr. Chairman, the budget I have discussed today discards tired old solutions and meets our challenges creatively and cooperatively.It balances the budget, without abandoning our values and commitments.
    It makes tough choices and shows tough management.
    Now we must act upon it.
    Because, just like the past when we faced down diseases and tyranny, future generations will look back on today.
    The question is, whether they will see a nation that put aside politics and came together to protect the health of its citizens in the 21st century.
    The answer is up to us. Thank you.

    [The official Committee record contains additional material here.]



Medicare FY98 Legislative Proposals
(Proposals in addition to the Medicare Savings and Investments released February 6, 1997)

Beneficiary Improvements

Beneficiary Improvements
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    Program Improvements
    •  Definition of DME
    •  PACE Demonstrations
    •  Extend Social HMO for Three Years


    Medicare Managed Care
    •  Permit Enrollment of ESRD Beneficiaries
    •  Limits on Charges for Out-of-Network Services
    •  Coverage for Out-of-Area Dialysis Services
    •  Clarification of Coverage for Emergency Services
    •  Permit States with Programs Approved by the Secretary to Have Primary Oversight Responsibility
    •  Modify Termination and Sanction Authority

Improved Quality

    •  Modify the Deeming Provisions for Hospitals to Require that the JCAHO/AOA Demonstrate that All of the Applicable Hospital Conditions are Met or Exceeded and to Enhance Monitoring and Enforcement of Compliance
    •  Permit the Secretary to Disclose Accreditation Survey Data from Accrediting Organizations for Purposes Other than Enforcement
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    Survey and Certification
    •  Permit Collection of Fees from Entities Requesting Initial Participation in Medicare
    •  Create Authority for an Integrated Quality Management System Across HCFA Programs (Medicare and Medicaid)
    Managed Care
    •  Deem Privately Accredited Plans to Meet Internal Quality Assurance Standards
    •  Replace 50–50 Rule with Quality Measurement System
    Nurse Aide Training
    •  Permit Waiver of Prohibition of Nurse Aide Training and Competency Evaluation Programs in Certain Facilities and Clarify that the Trigger for Disapproval of Nurse Aide or Home Health Aide Training and Competency Evaluation Program is Substandard Quality of Care (Medicare and Medicaid)

Modernizing Medicare

Prudent Purchasing

    Post-Acute Payment Reform
    •  Secretarial Authority to Create New Post Acute Care Payment System, and

Collection of Assessment Data

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    Beneficiary Centered Purchasing
    •  Centers of Excellence
    •  Competitive Bidding Authority
    •  Purchasing through Global Payments
    •  Flexible Purchasing Authority
    •  Inherent Reasonableness Authority
    Contracting Reform
    •  Reform contracting for FI's and Carriers

Improving Efficiency and Eliminating Overpayments

    •  Hold-Harmless for DSH(technical)
    Part B Issues
    •  Replace ''Reasonable Charge'' Methodology (and ''Reasonable Cost'' Methodology for Ambulances) with Fee Schedules

Fraud and Abuse

    •  Clarify the Definition of ''Homebound''
    •  Provide Secretarial Authority to Make Payment Denials Based on Normative Service Standards
    •  Requirement to Provide Diagnostic Information ICFs/MR with survey and certification requirements
    •  Create Alternative sanctions in ICFs/MR
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Fiscal Year 1998 Legislative Proposals
Proposals for Beneficiary Improvements, Modernizing Medicare, and Fraud and Abuse
(Proposals in addition to the Medicare Savings and Investments released February 6, 1997)

Beneficiary Improvements

Program Improvements

    •  Definition of DME
    Modify the definition of DME to include items needed ''for essential community activities.'' The Secretary would have the authority to limit the benefit to assure the efficient provision of items needed by the beneficiary (e.g. through the use of prior authorization of equipment). Under current law, durable medical equipment (DME) is limited to those items appropriate for use in the home. This definition was developed in 1965, when Medicare only applied to the elderly, and beneficiaries who used DME were not expected to function outside the home. The expanded definition will encourage independent activity by disabled beneficiaries.
    •  PACE Demonstrations
    Grant full permanent provider status for Program of All-inclusive Care for the Elderly (PACE) demonstration sites that currently meet the PACE protocol. PACE has proven to be a successful model for a unique service delivery system for frail-elderly persons who live in the community.
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    •  Extend Social Health Maintenance Organization (SHMO) Demonstrations
    Extend both the first and second generation of SHMO demonstrations until December 31, 2000. SHMOs enroll a cross-section of the elderly living in community and provide standard Medicare benefits, together with limited long-term care benefits. These congressionally-mandated demonstrations are currently set to expire on December 31, 1997. A three-year extension would provide additional time to evaluate this delivery model.


Medicare Managed Care

    •  Permit Enrollment of ESRD Beneficiaries
    Permit beneficiaries with ESRD to enroll in a managed care plan. Currently, while beneficiaries who develop ESRD can stay enrolled in a plan, beneficiaries with ESRD are prohibited from enrolling. ESRD beneficiaries should not have their coverage options limited because of their health status.
    •  Limits on Charges for Out-of-Network Services
    Expand current limits on charges to plans by non-contracting entities for authorized services. Limits which now apply in the case of inpatient hospital, SNF, physician and dialysis services would apply in regard to all services for which there is a fee schedule or limit under fee-for-service Medicare. Apply these same limits to unauthorized, out-of-network services. Providers should not have a windfall payment as a result of providing an authorized or unauthorized service to a Medicare beneficiary enrolled in a managed care plan. Beneficiaries who decide to receive unauthorized services should have the same protections as beneficiaries who remain in fee-for-service Medicare.
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    •  Coverage for Out-of-Area Dialysis Services
    Require plans to pay for out-of-area dialysis services when an enrollee is temporarily out of the plan's service area. Under current law, plans are only obligated to pay for out-of-area services in two instances: emergency care and urgent care. Since services such as dialysis are foreseeable, plans have no obligation to pay for them. As a result, managed care enrollees with ESRD are effectively barred from ever leaving their home town.
    •  Clarification of Coverage for Emergency Services
    Clarify the obligation of managed care plans to pay for emergency services provided to their plan's enrollees (whether through the plan or by a non-plan provider) by defining ''emergency services'' as services that a ''prudent layperson'' would, from his or her perspective, reasonably believe were needed immediately to prevent serious harm to his or her health. This clarification of Medicare policy will be helpful to states as they determine what requirements should apply in regard to emergency services provided to commercial managed care enrollees.
    •  Permit States with Programs Approved by the Secretary to Have Primary Oversight Responsibility
    Authorize States, with programs approved by the Secretary, to certify whether a plan is eligible to contract with Medicare and to monitor certain aspects of plan performance. Such certification and monitoring would be subject to Federal standards. The Secretary would retain final authority in regard to contracting and compliance actions. User fees would be collected from plans for both the certification and monitoring activities. Effective 1/1/98. The proposal would eliminate certain duplication of effort that exists between States' traditional licencing role and HCFA oversight of managed care contractors.
    •  Modify Termination and Sanction Authority
    Authorize the Secretary to terminate a contract prior to a hearing in cases where the health and safety of Medicare beneficiaries are at-risk. Delete requirement for corrective action plans and for hearing and appeals prior to imposing intermediate sanctions. Conform sanctions options add by the existing sanction authority. When the health and safety of beneficiaries is at risk, HCFA should not be required to hold a hearing prior to terminating a contract. In regard to intermediate sanctions, HCFA already provides plans with the opportunity to respond to findings that the plan has committed an act subject to an intermediate sanction. Requiring a hearing and an appeal in all instances, however, would unnecessarily hinder enforcement actions.
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Improved Quality


    •  Modify the ''Deemed Status'' Provisions for Hospitals to Require that the JCAHO Demonstrate that All of the Applicable Hospital Conditions are Met or Exceeded and to Enhance Monitoring and Enforcement of Compliance
    This would require the Joint Commission on the Accreditation of Healthcare Organizations (JCAHO) to demonstrate that, under its accreditation process and standards, accredited hospitals meet or exceed all federal health and safety standards (called the Medicare ''conditions of participation''). Further, the JCAHO would be required to enforce compliance with the standards and monitor those entities that are found out of compliance. Under current law, hospitals that receive JCAHO accreditation are automatically deemed to have met Medicare conditions of participation and the Secretary has no statutory authority to require the JCAHO to monitor compliance. The Omnibus Consolidated Rescissions and Appropriations Act of 1996 raised the standards for deemed status of other (non-hospital) providers by authorizing the Secretary to grant Medicare deemed status to providers if the accrediting body has demonstrated to the Secretary that a provider category meets or exceeds all of the Medicare conditions and requirements. This proposal would bring hospital ''deemed status'' requirements in line with deeming requirements for other providers.
    •  Permit the Secretary to Disclose Accreditation Survey Data from Accrediting Organizations for Purposes Other than Enforcement
    This would broaden the instances when the Secretary may disclose accreditation survey information to include instances where the Secretary deems disclosure to be in the interests of beneficiary safety, quality of care, and program integrity. Under current law, the Secretary may not publicly disclose any accreditation survey result unless the information relates to an enforcement action taken by the Secretary. Such limited authority restricts the Secretary from fully safeguarding quality.
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Survey and Certification

    •  Permit Collection of Fees from Entities Requesting Initial Participation in Medicare
    This would permit the Secretary to charge entities (including dually-participating Medicare/Medicaid providers but excluding clinical labs under CLIA) a fee for the initial survey required for participation in the Medicare program. Under this new authority, HCFA would charge fees through its agreements with State survey agencies. As HCFA's agents, States would collect and retain these fees and apply them to their survey costs. HCFA's survey and certification budget has been held constant since 1993, while the number of entities seeking to enter the Medicare program has grown dramatically each year. This under-funding has forced HCFA to prioritize State survey workloads and has resulted in extensive delays of initial certification surveys. This proposal would allow a greater number of providers to enter the Medicare program in a timely fashion, thereby enhancing beneficiary access to, and choice of, providers. In addition, program certification allows providers to derive a financial benefit from participating in Medicare and Medicaid. Charging for initial program participation surveys is consistent with the fee-based approach for other government services.
    •  Create Authority for an Integrated Quality Management System Across HCFA Programs (Medicare and Medicaid)
    This proposal would provide for a uniform authority for all Medicare and Medicaid quality management activities. A re-engineered, integrated quality management approach would include, but not be limited to: authorities for data collection, quality conditions, enforcement, publication of provider-level data, user fees, deeming flexibility, and designated accountability. Prior to full implementation of an integrated quality management system, HCFA would test out various models through demonstrations. For the last five years, HCFA has been building the foundations of a truly re-engineered approach to survey and certification activities, which creates a new conceptual framework and reshapes many operational features of the current system and breaks through current limitations. HCFA would like to test this re-engineering concept through a demonstration.
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Managed Care

    •  Privately Accredited Plans Deemed to Meet Internal Quality Assurance Standards
    Authorize the Secretary to deem plans with private accreditation as meeting internal quality assurance requirement. This proposal, without reducing Federal standards, would eliminate certain duplication of effort that exists between private accreditating organizations' review of plans internal quality assurance programs and HCFA's own efforts.
    •  Replace 50/50 Rule with Quality Measurement System
    Eliminate the current requirement that managed care plans maintain a level of commercial enrollment at least equal to public program enrollment, once the Secretary, in consultation with the consumers and the industry, develops a system for quality measurement. Authorize the Secretary to terminate plans that do not meet standards under the quality measurement system. Until the quality measurement system is in place, expand the Secretary's waiver authority for 50/50 (e.g., plans with good track records). The Administration believes that the 50/50 rule should be retained until an adequate quality measurement system is in place. This system, once in place, should drive contracting decisions.

Nurse Aide Training

    •  Permit Waiver of Prohibition of Nurse Aide Training and Competency Evaluation
    Programs in Certain Facilities and Clarify that the Trigger for Disapproval of Nurse Aide or Home Health Aide Training and Competency Evaluation Programs is Substandard Quality of Care (Medicare and Medicaid) This would allow States to waive the prohibition on nurse aide training and competency evaluation programs offered in (but not by) a SNF or Medicaid NF if the State: (1) determines that there is no other such program offered within a reasonable distance of the facility; (2) assures, through an oversight effort, that an adequate environment exists for operating the program in the facility; and (3) provides notice of such determination and assurances to the State long-term care ombudsman. The proposal would also make clear that a survey finding substandard quality of care, rather than the mere occurrence of an extended or partial extended survey is what triggers the sanction of the training program. The current prohibition on nurse aide training and competency evaluation programs causes a special problem for rural nursing home where a community college or other training facility may be inaccessible to nurse aides. This proposal would safeguard the availability of nursing homes which might otherwise stop participation in Medicare and Medicaid as a result of losing a training program's approval. This proposal is also a part of the Vice-President's ''Reinventing Government'' initiative. A clarification of the circumstances under which a program must be sanctioned is needed because the fact that an extended or partial extended survey is conducted is not, in itself, an indication that substandard quality of care exists in the SNF, NF, or HHA.
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Structural Reform—Modernizing Medicare
Prudent Purchasing

Post-Acute Payment Reform

    •  Secretarial Authority to Create Integrated Post Acute Care Payment System, and to Collect Assessment Data
    This would signal the Administration's intention to develop, in the future, a fully integrated payment system for all post-acute care services (including SNFs, HHAs, rehabilitation and long-term care hospitals). It would give the Secretary the authority to implement, through regulations, a single payment system that includes (at a minimum) a case-mix adjustment mechanism predicated on a standard core patient assessment instrument; equitable payment among provider types; budget neutrality to post-acute payments in some base year; and geographic adjustments. The uniform payment system would be built upon the prospective payment system for home health and an expanded PPS for SNF that more appropriately reflects costs across all post-acute inpatient settings, including the higher intensity of service in rehabilitation and long-term care hospitals. It would authorize the Secretary to collect any and all data, on a national basis, that would be necessary to implement such a system. There is considerable overlap in the types of services provided and the types of beneficiaries that are treated in each of the post-acute settings. Despite this overlap, Medicare's current payment and coverage rules vary by setting and may create perverse incentives to treat patients in one setting rather than another in order to maximize reimbursement. A ''site-neutral'' integrated post-acute care payment would help to ensure that beneficiaries receive high quality care in the appropriate settings. This system would ensure that reimbursement is sufficient for all patient types, including high intensity patients who in the current environment are cared for in rehabilitation hospitals. In addition, any transfers among settings occur only when medically appropriate and not in an effort to generate additional revenues. A consistent patient classification system would allow meaningful comparisons of the diagnoses, severity, and functional limitations of patients in all these settings; permit case-mix adjustment for payment purposes; and permit greater coordination of care. ProPAC has cited the perverse incentives that currently operate under separate and distinct payment methods for post-acute care services.
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Beneficiary-Centered Purchasing

    In general, provide the Secretary with authority to pay on the basis of special arrangements as opposed to statutorily-determined, administered prices. This proposal has five components which are fully described below: Centers of Excellence; Competitive Bidding; Global Payments; Flexible Purchasing Authority; and Inherent Reasonableness Authority. Two years after enactment, and annually thereafter for the next three years, the Secretary would report to Congress by March 1st on the use of these new authorities, including the impacts on program expenditures and on the access and quality of services received by beneficiaries.
    —Centers of Excellence—Authorize the Secretary to pay selected facilities a single rate for all services (including potentially post-acute services) associated with a surgical procedure or hospital admission related to a medical condition, specified by the Secretary (The Secretary would be required by January 1, 1999 to establish Centers of Excellence for CABG surgery, other cardiac procedures and for hip and knee replacements across the country). Selected facilities would have to meet special quality standards. The single rate paid to a Center would have to represent a savings to the program. There would be no requirement for beneficiaries to receive services at Centers. However, Centers would be allowed, subject to approval by the Secretary, to provide additional services (such as private room) or other incentives (waiver of cost-sharing) to attract beneficiaries.
    —Competitive Bidding Authority—Authorize the Secretary to set payment rates for Part B services (excluding physician services) specified by the Secretary based on competitive bidding. The items included in a bidding process and the geographic areas selected for bidding would be determined by the Secretary based on the availability of entities able to furnish the item or services and the potential for achieving savings. Bids would be accepted from entities only if they met quality standards specified by the Secretary. The Secretary would have the authority to exclude suppliers whose bid was above the cut off bid determined sufficient to maintain access. Automatic reductions in rates for would be triggered for clinical laboratory services and DMEPOS (excluding oxygen services) if by 2001 a 20 percent reduction had not been achieved.
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    —Purchasing Through Global Payments—Authorize the Secretary to selectively contract with providers and suppliers to receive global payments for a package of services directed at a specific condition or need of an individual (e.g. diabetes, congestive heart failure, frail elderly, cognitively or functionally impaired, need for DME). The Secretary would select providers on the basis of their ability to provide high quality services efficiently, to improve coordination of care (e.g. disease management, case management), and to offer additional benefits to beneficiaries (e.g. prescription drugs, respite, nutritional counseling, adaptive and assistive equipment, transportation.) Within the global payment, providers would have flexibility in how services are provided, and they may, subject to approval by the Secretary, offer additional, non-covered benefits financed through the global payment. The global rate would have to represent a savings to the program. Beneficiaries would voluntarily elect on a month-to-month basis to participate in such arrangements and during that period would be ''locked-in'' for the services covered under the arrangement.
    —Flexible Purchasing Authority—Authorize the Secretary, after rulemaking, to negotiate alternative administrative arrangements with providers, suppliers and physicians who agree to provide price discounts to Medicare. These discounts could be based on current fee schedules or payment rates or could involve alternative payment methods. The alternative administrative arrangements could not include any changes to quality standards or conditions of participation. The Secretary would have the authority to permit sharing of these savings with beneficiaries who use these entities—for example, through a reduced deductible in the case of hospital services or lower coinsurance payments in the case of other services.
    —Inherent Reasonableness Authority—Restore Medicare's carriers authority to make ''inherent reasonableness'' payment changes for durable medical equipment, prosthetics and orthotics (DMEPOS) as well as surgical dressings.
    Medicare's statutory framework was based on a Blue Cross/Blue Shield model from the 60's. Although payment methodologies have improved over time, current payment authority is too rigid for the fee-for-service program to meet the challenges of the 21st century. Each component of this initiative represents an approach that has been used successfully by the private sector, other government program or under Medicare's demonstration authority.
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Contracting Reform

    •  Reform Contracting for FIs and Carriers
    This proposal would end the requirement that all Medicare contractors perform all Medicare administrative activities, and would allow Medicare to contract with entities other than insurance companies. New contractors would be awarded contracts using the same competitive requirements that apply throughout the government. The proposal would give HCFA the tools to take advantage of innovations and efficiencies in the private sector when it comes to beneficiary and provider services, and claims processing. It builds on the Medicare Integrity Program contracting changes established in HIPAA.

Improving Efficiency and Eliminating Overpayments


    •  Hold-Harmless for DSH
    Freeze hospital-specific disproportionate share hospital (DSH) adjustments at current levels, for a period of 2 years. Require the Secretary to submit a legislative proposal to Congress by 18 months after enactment for revised qualifying criteria and payment methodology for hospitals that incur higher Medicare costs because they serve a disproportionate share of low-income patients. Without action by FY 2000, the old (current) formula would be reinstated. The current formula for identifying DSH hospitals relies on counting the number of days the hospital serves Medicare/SSI beneficiaries (as a proportion of total Medicare days) and the number of days it serves Medicaid beneficiaries (as a proportion of total days). The resulting ''DSH percentage'' is plugged into a formula that computes the increase in Medicare payments for DSH hospitals.
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    However, this measure is becoming increasingly unreliable. The recently enacted welfare reform law will have an impact both on the number of people eligible for SSI and the number of people eligible for Medicaid but mot necessarily on the number of low-income individuals seeking hospital care. Furthermore, as the number of uninsured Americans increases, the reliability of this measure to reflect the a hospital's level of uncompensated care decreases. Concurrently, HCFA has lost a series of court cases on the DSH formula, resulting in varying definitions of ''eligible Medicaid days'' across the country. By freezing the current DSH levels for the next two years, the level of support for DSH hospitals will be sustained while the Secretary develops a proposal to refine the DSH criteria and adjustment.

Part B Issues

    •  Replace ''Reasonable Charge'' Methodology (and ''Reasonable Cost'' Methodology for Ambulances) with Fee Schedules
    Create fee schedules, on a budget neutral basis, for the few Part B services still paid according to ''reasonable charge'' methodology (the most significant services affected would be ambulances, and enteral and parenteral nutrition). Specify that ambulance services provided by hospitals or ''under arrangements'' would also be covered by the new ambulance fee schedule, with adjustments allowed for certain ''core services'' that may have higher costs. This proposal will make the payment methodology consistent for all Part B services and improve administrative efficiency. Including hospital based ambulance services under the fee schedule will remove incentives for independent suppliers to evade fee schedule limits by establishing costlier arrangements with hospitals.

Fraud and Abuse
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    •  Clarify the Definition of ''Homebound''
    This would redefine the ''homebound'' definition by adding several calendar month benchmarks to emphasize that home health coverage is only available to those who are truly unable to leave the home. The current definition of ''confined to the home'' is vague and over broad. It allows for considerable discretion in interpretation and fraud and abuse. Financial reviews show that Medicare routinely reimburses care to beneficiaries who are not truly homebound. Without a more concrete definition, this eligibility requirement is very difficult to enforce. The March 1996 GAO report cites the problematic homebound definition as contributing to excessive spending and fraud and abuse.
    •  Provide Secretarial Authority to Make Payment Denials Based on Normative Service Standards
    This proposal would allow the HHS Secretary to establish normative numbers of visits for specific conditions or situations. For example, HCFA could establish a normative number of aide visits for a particular condition, and deny payment for those visits that exceed this standard. Allowing the Secretary to establish more objective criteria will help HCFA gain more control over excessive utilization. A March 1996 GAO report criticizes current statutory coverage criteria as leaving too much room for interpretation and inviting fraud and abuse.
    •  Requirement to Provide Diagnostic Information
    Extend to non-physician practitioners, the current requirement that physicians provide diagnostic information on all claims for services that they provide. Also require physicians and non-physician practitioners to provide information to document medical necessity for items or services ordered by the physician or practitioner, when such documentation is required by the Medicare contractor as a condition for payment for the item or service. Diagnostic information is needed by Medicare's contractors to determine the medical necessity of physician services and for use in quality/outcome research. Given the need for this data, there is no reason to exclude non-physician practitioners from the current requirement to include diagnostic codes on claims forms. Also, in regard to non-physician services and DMEPOS items, suppliers providing the services and items ordered by physicians or non-physician practitioners have reported having difficulty obtaining diagnostic information required by Medicare's contractors. This proposal will clarify that the ordering physician or non-physician practitioners is required to provide such information.
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    Chairman ARCHER. Thank you, Madam Secretary. We have noted that in your budget that you have sent up, there is $100 billion of tax relief, and there is $100 that will be reduced spending in Medicare. However, when you come to the tax component, you are talking about a gross number, and when you come to Medicare, you use a net number. To be consistent, could you tell us what the gross amount that you propose to reduce Medicare spending is over 5 years?
    Secretary SHALALA. It is $115 billion.
    Chairman ARCHER. OK; so, it is $115 billion, which, in comparison to the tax number, if we use both gross or both net, becomes a little bit different relationship. And that is over 5 years, as I understand it; is that correct?
    Secretary SHALALA. That is correct.
    Chairman ARCHER. When the President first announced his Medicare number, he announced he was moving toward us with a figure of $138 billion over 6 years, which is the number we had been talking about in the previous Congress. Now, in the new 5-year number, of course, we deal with a different number. But if you were to convert this $115 billion, 5-year number to a 6-year number, what would that amount be?
    Secretary SHALALA. Well, we go from $100 billion to $138 billion, and so, the $100 billion, a net number, becomes $138 billion for the 6-year number.
    Chairman ARCHER. But what would the gross number, which is the savings that are going to be coming out of the current Medicare Program of $115 billion, convert to over a 6-year period?
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    Secretary SHALALA. The spending is $115 billion. We will have to calculate that for you. We will do that right now.
    Chairman ARCHER. OK; while that is being done, let me just ask one other question, and then, I will yield to the Ranking Minority Member of the Committee. We had, in our Medicare recommendations back in 1995, a fail-safe mechanism in order to get our savings which was at least to some degree criticized by the administration, and we spent a good bit of time designing that fail-safe mechanism to make it as fair as possible, so that it would not just be a meat ax approach in reducing spending.
    In your administration's budget, you have proposed, as I understand it, a fail-safe that would affect the entitlement programs as well as discretionary spending and most tax cuts, so that if the budget is not balanced, this mechanism would apply automatically. As I understand it, it is an across-the-board reduction on everything except Social Security; is that correct?
    Secretary SHALALA. Let us see. Social Security is exempt; Medicare is not exempt.
    Chairman ARCHER. OK; so, Medicare would be included in the automatic reduction. And I wonder if you can tell the Committee how that would work relative to Medicare.
    Secretary SHALALA. Well, I can give you a sense of what we would do as a——
    Chairman ARCHER. I think about 2.5 percent.
    Secretary SHALALA. We do a uniform reduction of 2.25 percent, applied to the budget accounts for fiscal year 2001 and 2002. The reduction is calculated to be sufficient to bridge the gap in the forecasts between CBO and the administration. It will affect only discretionary accounts in the year 2001 and both the mandatory and discretionary accounts in the year 2002, and it affects all of the mandatory accounts not specified on the exempted list, and as I have already indicated, Social Security is exempt; Medicare is not.
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    The percentage reduction in the discretionary spending will be increased, if necessary, after the CBO has actually scored the President's budget, so we have not actually seen a final scoring on our budget submitted. But that gives you some sense of how we intend to apply it.
    Chairman ARCHER. OK; but for the purposes of this Committee's jurisdiction, I would like to focus on just how it would impact on Medicare. How would that cut occur in Medicare in addition to the reductions in spending increases that are already in your budget? How do you perceive or anticipate that that would impact on the Medicare payment of benefits?
    Secretary SHALALA. Well, I think the first point I want to make is to repeat what Frank Raines said yesterday, that we think this budget does achieve balance. And since we do believe the budget actually achieves balance, I think the best I can say at this point about the system that the President has put in place, and because we are very confident about the projections we have made in the budget, and we have a very good track record on those projections, my assumption is that it would be about proportional in terms of what we do to a mandatory program like Medicare.
    But I think I want to go back to our original point, and that is that we have a good track record on our original projections, and we think we will not have to do this. We believe we actually have the budget in balance with these numbers.
    Chairman ARCHER. So, basically, are you telling the Committee that as far as the OMB estimates are concerned and as far as the administration's proposal is concerned, within those basic assumptions of OMB that you do not need a fail-safe mechanism?
    Secretary SHALALA. We do not believe that we will need it, but we obviously outlined a plan to protect the budget and to make the point that, number one, we are committed to a balanced budget and that number two, while we do not think it is necessary, it obviously is a backup that we do not believe we will need to use.
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    Chairman ARCHER. Well, would you then say it is primarily in there to take care of any variance in the Congressional Budget Office scoring? Is that the reason it is in there?
    Secretary SHALALA. Well, I think that is basically what the discussion was. But what he basically said is that, having said that we have an excellent track record on our own projections, we recognize we had to include a mechanism that would show the budget in balance according to CBO projections.
    Chairman ARCHER. OK; but if the CBO projections do not correlate to the OMB projections, which we do not know yet whether they will or not but which we think they may not, and this fail-safe mechanism takes effect in order to get us to a balanced budget, because that is the overriding commitment, I think, on your part and it certainly would be on our part, do you have any idea at all how this would impact on Medicare benefits?
    Secretary SHALALA. No; we have not played it out, because the fact is that for the last 4 years, OMB has been quite conservative, and the deficits have come in actually lower than what OMB projected. So, I am not at that point yet. What I need to do is to make sure that what we are doing will actually produce the savings we are projecting under our Medicare proposals.
    Chairman ARCHER. Well, I would only say that having gone through this with our Medicare proposal in 1995, and we had to carefully think ahead that if, in fact, the trigger occurred, and there was put in place additional spending savings, how they would impact, and I would hope that before we complete our deliberations on what we are going to do together on Medicare that we would give a lot of thought to that also.
    Mr. Rangel.
    Mr. RANGEL. Thank you, Mr. Chairman.
    Madam Secretary, it is my understanding that you hope to cut $100 billion over 5 years from the Medicare package. Much of that will be aimed at reducing the budgets of the home health care community, as well as the skilled nursing homes. I know you want to find these savings without reducing the benefits. That is just hard for me to believe—that we have been spending $100 billion out there that can be saved without anyone being indicted. I hope we can find these savings without causing a decrease in service. However, it is difficult for me to believe that someone in this room is not going to disagree with you. Ultimately, I hope that when the Medicare beneficiaries back home hear about these savings, I am not going to have to explain that they were either not getting the services that they were being billed for, someone was stealing the money, or it was fraud.
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    On this Committee, when we need some money, we just improve the collection of the resource, and we pick up a billion or two or go after fraud and mismanagement. That is a couple of billion. But $100 billion and no blood on the floor, how do you do it?
    Secretary SHALALA. Well, Mr. Rangel, I think the basic point here is—and I am not accusing anyone of fraud, though we clearly have found some problems, significant problems, in the home health care services that are being provided—is that the legislation itself has loopholes in it that allow certain health care institutions to overbill us. Let me give you a very simple example from home health care: Home health care agencies can bill us from their corporate headquarters for a service. The average wage where their corporate headquarters is located is higher than where the service is being provided. Most of the home health care agencies are now located in large metropolitan areas or in metropolitan areas—for a good reason, because under the law, they can actually bill us according to the wage levels of that area as opposed to the wage levels of where they delivered the service.
    We will recapture that money. We will pay for the service a much more accurate figure, based on the wage levels in the area where the service was delivered. The prudent purchasing point that I make: We overpay for durable equipment and for a wide variety of things because of the nature of the law. We cannot bid out a wide variety of services and get better prices, not simply the way the private sector can, but frankly, the way the Defense Department and the Veterans Administration can for the same items.
    So, what we have done is we have gone through the Medicare Program and said it is time the reforms take place that allow us to manage this in a more businesslike way and get more accurate figures for the American taxpayers.
    Mr. RANGEL. How long have these loopholes existed in current law?
    Secretary SHALALA. Well, a lot of these loopholes have existed for a long time, and we have been asking for a long time to get some of these changes. The fact is that paying attention to the management of Medicare, everybody has been so concerned about bringing down the cost that they have looked more crudely at the reimbursement rates as opposed to what we are actually paying for things we need to purchase for the beneficiaries of Medicare.
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    We believe we can continue to provide high-quality services at more accurate costs. We also believe there is going to be some pain out there as part of this process, because people and organizations and institutions are used to living off a much higher base.
    Mr. RANGEL. Well, I am not talking about that kind of pain, but I do hope you will be able to show the percentages of the savings we can find without reduction of services within that $100 billion in total savings over 5 years. I believe that the quicker you can get people out of the hospital, the more money you are saving, because it is a very expensive visit. I am under the impression that there was a time when we did not have enough skilled nursing homes. So, we were paying higher costs for people to stay in the hospital longer. Now, we have to save billions of dollars by changing that.
    And, of course, home care—I was under the impression that home health care was the cheapest care. You can undertake dialysis and all of these things in your home today and not pay for all of the doctors and nurses in the hospital. Therefore, I thought it was just quality care, just less expensive. If we are going to take $100 billion out of it or maybe $200 billion, depending on how much we need, it would help if you could break out where the specific extra costs were that we now can save.
    But I think we ought to be prepared to go back home with some better material just to say what we are doing is perfecting the system and not limiting the options that old, sick folks have as to how they are going to be treated. On that I am not that clear. But if you could send a separate sheet based on your research in finding out where this waste is, it would be very helpful to all of us.
    [The following was subsequently received:]

    We are witnessing both an increase in the elderly population, and an unprecedented rate of change in the health care environment. The challenge for HHS and the Medicare program will be to keep pace with changes in the health care arena, understand the impact of these changes on Medicare beneficiaries and recognize the potential for fraud, waste, and ''loopholes''. The changing demographics of our society indicate that not only a greater proportion of the national economy will be devoted to care of the elderly, but that this concentration of elderly will create territory that is ripe for exploitation by profiteers. The vulnerability of older patients encourages individuals seeking to defraud Medicare to target the very ill or elderly, who may not be able to monitor their own bills for fraudulent charges or detect fraudulent scams.
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    When we talk about ''loopholes'' we need to clarify the definition. Some of the waste and abuse in the Medicare program is a result not only of honest mistakes in the billing and payment process, but of the statutory constraints built into the Medicare program. An example of the latter is the fact that Medicare commonly overpays for oxygen supplies under current law because it cannot use competitive bidding as do other government entities such as the Veterans Administration. Further, since DME suppliers have not been required to prove their financial stability, some of these suppliers might not be appropriate for Medicare services. Another illustration involves home health services where the location of billing has been one point of concern, since Medicare bills are often sent from a corporate headquarters in a region with a higher wage rate than the actual rate at the location where the service was provided. The President's 1998 Budget proposed to address these problems through provisions for a surety bond for DME suppliers, point-of-service billing, fee schedule reforms and general authority for competitive bidding for Part B other than physician services.
    As another example, it has been fairly easy to enter the Medicare program as a provider. In fact, providers view receipt of Medicare funds as an entitlement. Once enrolled, provider and suppliers are essentially in an ''honor system'' because of HCFA's limited resources for reviewing claims and conducting cost report audits. Even where we apply resources to reviewing providers, many of them complain about the burden of being reviewed, and attempt to argue that we should not look at them closely. The President's Budget provisions would address these problems by stricter provider enrollment standards in known problematic areas like home health services and DME. A more stable funding source for the Medicare Integrity Program (MIP) provided for by the 1996 Health Insurance Portability and Accountability Act (HIPAA) should also allow greater oversight with its incremental increases in funding.
    Other ''loopholes'' are found by providers and suppliers who serve beneficiaries in home health, partial hospitalization, or hospice care. In some cases, Medicare overpays for some services that may not be medically necessary, such as cases where an individual is prescribed hospice care for an extended period of time in lieu of skilled nursing facility care. Hospice care, which was intended to be provided for patients with a terminal illness, is an area which requires close monitoring of the patient to determine not only if the hospice services are being provided, but if in fact they continue to be needed by the patient. A clear definition of need for hospice care is a fundamental step toward eliminating confusion about the intent of the benefit. Similarly, partial hospitalization may occur in lieu of an inpatient psychiatric hospitalization or continued psychiatric hospitalization. These intensive outpatient day programs, which include individual and group therapies, diagnostic services, and drugs that cannot be self-administered, are intended for patients who would be likely to be hospitalized without these services. As other examples, inadequate oversight of patients' needs in skilled nursing facilities may result in wasteful allocation of services from which they cannot properly benefit, such as group therapy services for patients lacking speech ability. We are optimistic that the new provisions proposed in the President's Budget, such as clarification of the definitions for eligibility for hospice, partial hospitalization, and skilled nursing facility benefits, will prevent abuse of these costly services.
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    Payment systems that do not accurately identify health care services may also be a source of ''loopholes'' and waste of Medicare dollars. The President's FY98 Budget includes provisions to develop a prospective payment system (PPS) for several services in Medicare. A PPS pays a set rate according to the characteristics of the patient, and removes many of the incentives for providers to provide excessive services or submit fraudulent cost reports to receive high reimbursement.
    In addition, a PPS would preclude double-billing medical services which should properly be provided as part of inpatient services. Pre-admission hospital tests are a case in point. Current law prohibits providers from billing for pre-admission outpatient tests and services performed within 3 days of the time a patient is admitted to a hospital, if the tests and services are diagnostic or other services related to the admission. Most improper billing relating to pre-admission services results from a misunderstanding of the law, which was originally instituted to curb further ''unbundling'' of services, i.e., separating of the various pre-admission tests in order to obtain additional payments.
    Consolidated billing as part of the prospective payment system would address the problem of double- billing, especially in the case of dual eligibles, i.e. beneficiaries eligible for both Medicare and Medicaid, and will also ensure that Medicare is purchasing the best rate for services such as laboratory tests, therapy, rehabilitative and others.
    HHS is firmly committed to aggressively fighting health care fraud and abuse in Medicare and Medicaid. Our fraud and abuse strategies have become more efficient and sophisticated and we are spending our anti-fraud dollars more efficiently. In 1989 we recovered $6 for every dollar invested in fraud and abuse activities. In 1996, we were able to recover $14 for every dollar spent. We have worked closely with medical professional societies to ensure that the provider community is educated about the proper way to bill Medicare and thus reduce the incidence of improper billing. We know that we must be vigilant to remain a step ahead of fraudulent providers and suppliers, in order to safeguard Medicare for future generations.
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    Mr. RANGEL. Thank you.
    Secretary SHALALA. Thank you.
    Chairman ARCHER. Madam Secretary, do you by any chance have the extrapolation of $115 billion into a 6-year number at this point?
    Secretary SHALALA. The $100 billion, as I said, was plus $15 billion, and the $138 billion would be plus $24 billion.
    Chairman ARCHER. OK.
    Secretary SHALALA. The 6-year beneficiary investments cost $24 billion.
    Chairman ARCHER. So, the gross reduction in spending in Medicare on a 6-year basis in your proposal would score at $162 billion.
    Secretary SHALALA. Right.
    Chairman ARCHER. Is that correct?
    Secretary SHALALA. Yes; that is correct.
    Chairman ARCHER. So, that actually gets above the $158 billion that was—no, I am sorry; that was a 5-year number.
    Secretary SHALALA. Mr. Chairman, if your point is that we are moving close together, the answer is yes. We have said that openly——
    Chairman ARCHER. Yes.
    Secretary SHALALA [continuing]. In a very straightforward manner. Let me also say it is the net number that is important, because what we do is, though I seem to have some trouble explaining it, reform the program, add new benefits to modernize it at the same time.
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    Chairman ARCHER. But relative to a static program of benefits, the saving over 6 years would be $162 billion.
    Secretary SHALALA. No, it would be $138 billion because we add new benefits.
    Chairman ARCHER. No, but relative to the current program of benefits.
    Secretary SHALALA. Yes, but we are not doing that.
    Chairman ARCHER. Well, but this has to come out of—the current benefit structure has to save $162 billion over 6 years in order to accommodate the additional new benefits that would reduce the number.
    Secretary SHALALA. Yes, but we are reorganizing. I think my point is that we are reorganizing the benefit. The important thing to the beneficiaries, and I think to the people in this country, is what is the net number of savings, and what does the program look like at the end of the day. And at the end of the day, the program obviously has some front-end new benefits, prevention benefits, and is reorganized and remanaged.
    Chairman ARCHER. Well, I appreciate what you are saying, and I certainly do not want to debate that, but I hope we will use the same standard on taxes, which is not your field of activity, but we should also talk about what is the net impact on taxes when we get to that later on with other people.
    Mr. Thomas.
    Mr. THOMAS. Thank you, Mr. Chairman.
    Welcome, Madam Secretary. I do hope at some point perhaps you and your staff will reevaluate the policy that was present in the 104th Congress that you do not do Subcommittees. It would be helpful to us if we had a little more time. I have 5 minutes, so I am going to go fairly quickly. And if I cut you off, it is because I only have so much time, so I will try to structure it.
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    I agree with you that in some areas of the President's proposal, we do move closer together. We tried in our proposal to freeze the premium and not let current law continue to reduce it. I notice in the President's proposal, you freeze the premium and do not let current law continue to reduce. So, at least conceptually, we are fairly close together there. My understanding is that when you freeze it at the 25 percent, that would apply to everyone who voluntarily goes into the part B premium area.
    The President mentioned on a television program in New York that he might be willing to examine whether some folks should actually pay more than the 25-percent share. Do you support the President's indication that that might be an area you would examine?
    Secretary SHALALA. Yes; absolutely. And as you know, we had it in one of our original health care bills, though we had a different benefit structure in that proposal. But certainly, I would repeat what the President said, and there will be a number of things during the course of this discussion that people will want to put on the table, and I think it is very important that we be open about different approaches.
    Mr. THOMAS. I appreciate that. You mentioned again on this home health transfer, and I do not want to continue to dwell on it, but there are some specifics; if you could respond briefly to them, because there are some general statements in language that has been provided that I need to understand better. You indicate that you want to go back to the original intent, which was that certain types of home health care would be under part B versus part A, and I do not want to spend a lot of time on the fact that you are going to move it 100 percent to the general fund, when pre-1980, it was included in the premium portion and deductibles.
    But what was also a law in 1980 was that there was a limit on the number of home health care visits at 100. Currently, in materials that HCFA has provided, in 1994, you had almost 20 percent of the home health care recipients receiving more than 100 visits. In fact, in that 19.3 percent, the average number of home health care visits was 227. Does the administration, in following its ''original intent,'' notwithstanding the failure to put it under the premium or the deductible as it was pre-1980, does the administration intend to cap the number of home health care visits and therefore reduce the benefit currently available to beneficiaries under the current structure?
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    Secretary SHALALA. Under our proposal, the first 100 visits following a 3-day hospital stay would be paid for under part A.
    Mr. THOMAS. That is the old one.
    Secretary SHALALA. And any subsequent visit would be paid under part B.
    Mr. THOMAS. Unlimited number of visits?
    Secretary SHALALA. Yes.
    Mr. THOMAS. OK; you mentioned verbally—and I believe you were a little bit ahead of the letter, because you intend to send the letter, but you have not sent it yet in terms of the notification on the mastectomy hospital stay. My understanding is that the letter will say basically, any decisions on length of stay following a mastectomy or a lumpectomy should be left to the discretion of the doctor and the patient on a case-by-case basis. Is that basically one of the key concepts?
    Secretary SHALALA. As you well know, in the Medicare system, health plans must provide all medically necessary procedures, and we have a way of getting at that.
    Mr. THOMAS. OK.
    Secretary SHALALA. So that we have a process in Medicare which does not exist in much of the private sector.
    Mr. THOMAS. But the President announced at the State of the Union that he was going to support a piece of legislation that specifically, arbitrarily fixed the time. That is different than what your letter will contain. Is that a conceptual difference in what should be done?
    Secretary SHALALA. No, it is actually not a conceptual difference in what should be done. Within the Medicare system, we have a way of—a process that we go through to arrive at what is ''all medically necessary procedures.'' And what has happened in the private sector, because they do not have this system in place, is that there have been too many horror stories.
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    Mr. THOMAS. OK, but I want to look at the conclusion. Your conclusion is there should be no arbitrary, fixed time for the stay; is that correct?
    Secretary SHALALA. No, because we know that our process——
    Mr. THOMAS. No, is that correct?
    Secretary SHALALA [continuing]. Produces a different outcome. The process for determining how long the stay is produces a different outcome than what has been happening in the private sector, and that outcome—obviously, we have older patients—involves a lot more time, and we are satisfied with that outcome.
    Mr. THOMAS. Well, they are not all older patients, because otherwise, we would not provide in our preventive care structure under Medicare mammography for women who are 50. So, I guess you are not willing to contradict the President and the legislation, but I compliment HCFA on a second letter that has been sent, which, if we can get the private sector to understand and accept the parameters that you have outlined, we can perhaps head off another legislative calamity in terms of the arbitrary legislating of decisions that I think should properly be left to the doctor and the patient.
    Secretary SHALALA. Mr. Thomas, I agree with you, and one of the reasons the President will soon announce a quality commission is we need to get away from dealing with these individual cases, as you pointed out, and to make sure there is a quality process in place.
    Mr. THOMAS. I could not agree with you more. I only wish the President, who announced the quality commission prior to the election, would have followed through on creating the quality commission so that these kinds of decisions would not be left to legislation, nor would he then have had to endorse a piece of legislation which goes directly against what he indicated he was going to do with the quality commission.
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    Thank you very much.
    Chairman ARCHER. Mr. Ramstad.
    Mr. RAMSTAD. Thank you, Mr. Chairman.
    Madam Secretary, I was pleased to see in your written statement the six elements that you described for Medicare modernization, specifically numbers two and three, which we have discussed and I have discussed with your staff as well, adding new choices to Medicare to compete with the private market and strengthen our rural health care system. Certainly, there is a consensus that this is the way to save Medicare, to reform it by testing new options to compete with the private market.
    Now, in Minnesota, as we have discussed before, CNO, the Community Nursing Organization Demonstration Project, has actually saved Medicare dollars by providing better and more accessible care in home and community settings and allowing beneficiaries to avoid unnecessary hospitalizations and unnecessary nursing home placements. I think we need to extend this authority, this study of coordinated care, and we really need a full and fair test of the CNO managed care concept. It has worked in Minnesota and other places, Madam Secretary, and I believe it could work across the country.
    Now, last year, the authority was set to expire on December 31, 1996. We had legislation to extend the authority, but it got caught up in the legislative process and did not make it. I was glad to see that HCFA extended that authority another year. Now, I do not see it in your budget summary or in the President's budget as one of the options. Would you support continuation? I have introduced bipartisan legislation to do this, and seven of the eight members of the Minnesota delegation have signed on to it. This really is an option that works, and I hope you will support the extension for at least another 3 years.
    Secretary SHALALA. I would be happy to, Mr. Ramstad.
    Mr. RAMSTAD. You would be happy to?
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    Secretary SHALALA. Yes, sir.
    Mr. RAMSTAD. Well, that is certainly appreciated, Madam Secretary. We can work together in a bipartisan, pragmatic way to get things done, and I appreciate that agreement.
    The other area I wanted to touch on briefly in my 5 minutes, Madam Secretary, concerns the age-old problem of Medicare reimbursement, the AAPCC formula. Certainly, something has to be done to reform the drastic regional variation in payments to managed care plans, and I was very, very pleased to see in your written statement that the President's proposal does contain a major first step to reduce the disparities in the reimbursement payments and to create a payment floor to encourage enrollment in managed care plans.
    I have been told by staff that the payment floor is set at $350 or 150 percent of the 1997 AAPCC rate, whichever is less; is that correct?
    Secretary SHALALA. Yes, that is correct.
    Mr. RAMSTAD. Well, a number of us, 26 to be exact, a bipartisan group, have introduced H.R. 554, which would instill yet greater equity and fairness to Medicare with some further reforms in the payment formula. Let me just ask you this: While I think you have made a big first step in recognizing and in trying to do something about this disparity, I want to ask you, How does the President's set dollar amount compare to the approach in our legislation? Are you familiar with H.R. 554?
    Secretary SHALALA. I am not, but I certainly would be prepared to give you in writing a comparison between our proposals. We have a floor. What we are trying to do is to bring in the outside edges and deal with areas like yours as well as rural areas, which are underreimbursed. This may, in fact, help us to attract more people into managed care, because the reimbursement rates will be fairer. We also need to be fair to areas like yours that have done a very good job in terms of getting more efficiencies into the system. So, it is a first step.
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    That step, combined with the cut that there is a lack of enthusiasm for, in the amount of overpayment for managed care or a better payment system for managed care that I think we can get to by the year 2000, will make a big difference in evening out the differences across the country.
    [The following was subsequently received:]

    [The official Committee record contains additional material here.]



    Mr. RAMSTAD. Well, again, I appreciate your recognition here, because everyone knows you can get 2 1/2 Medicare surgeries at the Mayo Clinic or the University of Minnesota Hospital for one Medicare surgery in many other parts of the country. And my problem, or what I am seeing from the President's proposal, Madam Secretary—I know my time is about to expire—but how does the President's set floor adjust every year to stay up to date, to stay current?
    Secretary SHALALA. Well, what we are trying to do is to make it somewhat painless, because obviously, it is budget neutral, and we are not adding a lot of new money into the system. So, what the floor does is, for all practical purposes, protect a lot of areas around the country that would otherwise, perhaps, go below the floor. This is not a radical proposal. It is an attempt to take some incremental steps to try to deal with the disparities in the payment system, in reimbursement, that we have around the country so that we both can take advantage of efficiencies and eliminate some of the overpayment in the system. But it is not very radical, and I am sure your proposal moves a lot more quickly, but we are also trying to be in the sensible middle on these proposals to get something done this year.
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    Mr. RAMSTAD. Well, I think my proposal is certainly in the sensible middle. We are trying to get more fairness, and we are just trying to inch you a little bit further toward a blended national-local rate to further reduce the disparities in reimbursements, Madam Secretary, across the country.
    So, I appreciate your movement, your proposal, and hopefully, we can work together to make it better.
    Thank you, Madam Secretary.
    Secretary SHALALA. On your specific question on the floor, it is indexed annually to the Medicare per capita growth. So, it does have an index in it. But again, it is not going to move as quickly as I think you are proposing, but we have to figure out something that is politically possible at the same time.
    Chairman ARCHER. Mr. Matsui.
    Mr. MATSUI. Thank you, Mr. Chairman.
    I will not get into too much on this, but I would just like to follow up on what Mr. Ramstad has said, Madam Secretary. If you raise the floor for rural hospitals, then, you obviously may create problems for urban hospitals; is this correct?
    Secretary SHALALA. Well, for high-cost areas that are not necessarily all urban areas in the United States. In fact, we are doing the runs now to see what the actual county-by-county effect would be on the combination of proposals. That is, what happens if, by the year 2000, you want to take 5 percent out of the reimbursement for HMOs at the same time you want to change and start bringing some people up. Some people, obviously, will have to come down.
    Mr. MATSUI. I just wanted to bring that up, because the dilemma that you face is obviously——
    Secretary SHALALA. Well, and for California and New York, it obviously——
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    Mr. MATSUI. Right.
    Secretary SHALALA [continuing]. Raises some questions.
    Mr. MATSUI. Exactly. Thank you.
    I want to go into two other areas, if I may. Many of the monitoring devices for the welfare program under your department have been eliminated under the welfare bill in 1996. And I think the Chairman aptly mentioned the fact that we are seeing a decrease in the amount of people on welfare today. Some of it is because of the economy; maybe some of it is in anticipation that benefits would be cutoff, and we have always known that about 60 percent of the people go off welfare within a short period of time anyway. It is just that underclass of 40, 30 percent that has been the problem.
    My concern is that 24 months from now or even 5 years from now, in the year 2001, How do we know the welfare bill of 1996 worked as we hoped it would work or anticipated it would work? Because under the work requirements, when we will be at 50 percent, in other words, 50 percent of the people will be off, How do we know that these people are not just going to go to another State or disappear and not actually be in a job? Are you anticipating that now? Is there somebody in your department working on this with the notion that you want to come back to us on an annual or periodic basis with statistics as to how this program is actually working?
    Secretary SHALALA. Yes; first of all, the welfare bill did provide some resources to set up a monitoring program, and we are focusing on two things in particular: whether and how the States move recipients into employment and the effects on children. And we are collecting data from the States.
    In addition to that, in the private sector, in the foundations in particular, I can assure you this is going to be the most studied change in social policy in American history. Everybody has a study going on somewhere, many of them with very sophisticated methodologies, such as the Urban Institute. We need, in coordination with all of them, to be able to answer some very straightforward questions. If we find at the end of 1 year we are not getting the data we want, that we are not able to answer the kind of straightforward questions about not only whether people are moving into work, but what is their situation as they move into work—are they able to stay into these jobs? Are they being pushed into poverty—the kinds of questions all of you will ask us, you can be assured we will come back to the Congress and say we need some more resources; we need some more data collection, because we have no intention of not knowing what is going on around the country.
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    But we will combine our information when we report with a lot of other information that is being collected around the country.
    Mr. MATSUI. I really appreciate that, the latter, where you would come back to us if you need more resources.
    Let me ask you another question. You have an increase in spending for the basic welfare: Food stamps, work requirements and obviously the benefits for legal aliens of about $21 billion. Where will the Governors be on all of this? Because it is my belief, with only 101 Members voting against the bill last year and only 21 senators voting against it, we have quite a challenge on our hands. And if the Governors do not care, because this has really been a devolution; this bill was really a devolution of functions. If they say they can get by without the resources, I am wondering how we are going to get the 218 majority votes both in the House and the Senate in order to achieve this.
    I do not want anybody to be misled. If Governor Wilson thinks he can get by without this, that is fine. But if he thinks he does not have to say anything, and he is going to get this money, I think he is going to have to wake up, because he is going to have a horrible time balancing his budget and taking care of many of these people.
    Are the Governors involved in this? Are they going to speak out? Have you heard? Or where are we on all of this?
    Secretary SHALALA. Well, if one were to read the National Governors' Conference, there is not a consensus now among the Governors. They all are concerned, particularly as they look at people who are sitting in nursing homes, or children, for example. I think all of us are committed not to reopening the bill, but everybody is concerned about people who cannot work who were swept into the discussion. We clearly wanted to make some changes in the rules for new people coming in, but for the people who are here or became disabled after they came here, we think that we clearly have some obligations.
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    There also will be a discussion from the health care community, because putting large numbers of people out without having health insurance could cause serious problems with urban safety net hospitals or rural hospitals. Increasing the number of people without health insurance in this country is not a good idea. And so, we have laid out some proposals very narrowly targeted to protect people for whom we do not believe are involved at all in the welfare system in the United States. They are not people who can move from welfare to work. And we have done that in a way without reopening the welfare debate. I think the Governors will come into the discussion and have probably some more targeted ideas eventually, but it is very early, I think, in this process for everyone.
    Mr. MATSUI. Thank you.
    Chairman ARCHER. Mr. English.
    Mr. ENGLISH. Thank you, Madam Secretary, and welcome. We are delighted to have you again before this panel.
    I wanted to focus my remarks on exploring the administration's potential interest in a couple of ideas on Medicare. I have reviewed the administration's proposal. I think it is a good starting point. I think we will probably have to go further, and I think probably you and the administration recognize that. Looking down the road, one of the weaknesses that the President's plan shares with many of the other proposals that have been offered is that we recognize it addresses the immediate problems in Medicare but not the long-term problems in Medicare, and I think everyone interested in this issue recognizes that.
    At the risk of suggesting a process answer to a very serious substantive problem, I wanted to get your feeling about the possibility of establishing as part of Medicare reform a permanent, standing, bipartisan commission on Medicare that would be empowered, as the BRAC Commission was empowered, to issue annual reports that would go directly to the floor of the House or Senate for an up or down vote. This would give Congress input on the final proposal; however, it would obviously reduce the influence of panels such as this, and I understand there is resistance to doing that.
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    I wonder if the administration might consider, as part of the negotiation, including this as part of a final proposal.
    Secretary SHALALA. Well, Congressman English, I think that we are not cutting off any discussion of any reasonable proposals that ought to be put on the table as part of the long-term discussion. So, we obviously have trustees to report directly to Congress on the solvency of the fund. I do think, though, that we have to have this discussion with the American people; that the kinds of changes we need to think about for the long-term Medicare Program require people understanding what they have now, and what are the costs in the future. I would not want to have an elite group substitute for a broader discussion with the American people about the issues that are involved. That could be put in place afterward, after some of the fundamental decisions were made as part of the political discussion, but certainly, we are not saying no to anything as we begin laying out some of our initial ideas. But we have done this budget within the context of a balanced budget. It clearly is a short-term proposal. We have talked about a process for a long-term discussion.
    Mr. ENGLISH. And I appreciate that very much. Mr. Vladeck has, in the recent past, made some statements critical of the proposal that has been put forward in legislation by myself and Mr. McHale on a bipartisan basis and has the support of the American Hospital Association, which is a group, as you will recall, that shared your skepticism of the Medicare proposal that the majority on this Committee produced 2 years ago. I appreciate your being open to it.
    Second question, Yesterday——
    Secretary SHALALA. I will also inform Mr. Vladeck that we are open to it.
    Mr. ENGLISH. Very good. [Laughter.]
    Second thing, Chairman Archer has proposed recognizing the needs of teaching hospitals with a teaching hospital trust fund as perhaps part of the solution. Could you comment on that idea and comment on whether that is part of what you would consider?
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    Secretary SHALALA. Yes; in fact, in this proposal, we carve out a fund for the teaching hospitals. We also have taken a look at Chairman Archer's and Mr. Thomas' ideas about teaching hospitals. The proposals that were put forth last year by them actually found some resources which we did not have. We have carved the pieces out of the Medicare Program. But we are all going in the same direction. We all believe very strongly that we have to find a better way of paying for the great academic teaching hospitals in this country.
    So, the principles are the same.
    Mr. ENGLISH. OK.
    Secretary SHALALA. How we finance it will be on the table for discussion. This is one area where I am absolutely convinced, particularly most recently from my conversations with Mr. Thomas and Chairman Archer, that we can work out a proposal that will be satisfactory to all of us.
    Mr. ENGLISH. Thank you, Madam Secretary, and we appreciate your being here.
    Chairman ARCHER. Mr. Watkins.
    Mr. WATKINS. Madam Secretary, welcome, and we are glad you are here, and I know in Oklahoma, we are making a lot of headway in some of the things. In fact, there is an article here in front of each of the Members. Headway in the welfare to work is something that is really moving forward, we think definitely in the right direction.
    One of the things I would like to discuss is a little bit on the Medicare phase, and I think if I interpret it correctly in the President's budget and all, I think we might be headed in the right direction on a couple of things there.
    I have personally sustained back injuries and gone to chiropractors and received quite a bit of assistance along the way, and I have talked to a lot of the older citizens who have been going through similar problems. One of the things they were confronted with in Medicare is they could not have their x rays done with a chiropractor, and it ended up costing them a lot more money, or if they did, they did not have it covered. And it is kind of like that—I think that is a back cushion there, is it not, or something that you have there?
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    Secretary SHALALA. Yes, you mean the seat, yes.
    Mr. WATKINS. And I think that is a good example of some of the things which can be done. The way it is set up, it costs four times as much, and there is no question that some of the cost of the x-ray situation, because we have not been able to or have not allowed that x ray to be covered that has been given by a chiropractor, a doctor, to give that x ray and cover it.
    It is my understanding, if I have interpreted the President's budget correctly, that he has moved now to allow in his budget, your budget and all, the opportunity for x rays to be covered by chiropractors. Am I interpreting that correctly?
    Secretary SHALALA. No; actually, the Medicare physician expert panel has determined the x ray is unnecessary, so the chiropractors can go ahead and proceed with the procedure without the x ray. And we notified the chiropractors some months ago, did not we? Yes. But we also determined the x ray was unnecessary.
    The original policy was the chiropractors could not order the x rays. The x rays had to be ordered by a physician. We went back and reviewed that policy and determined the x rays actually were not necessary for the procedure we reimburse chiropractors for. So, they can go ahead with some kind of a back manipulation procedure that they do without the x ray being necessary. That seemed to have satisfied the request we had.
    Mr. WATKINS. I think it is a step maybe in the right direction, but I think there has to be some additional help in that way for the people 65 and above under Medicare. It has become a real problem. And I know I for one found that even insurance, a lot of times, they will cover a lot of the medical costs but not cover some of the other activities which can be a lot less.
    Secretary SHALALA. That is correct.
    Mr. WATKINS. And I would appreciate your looking into that and seeing—I think just like that cushion there, you will find there can be a big savings in the long run to Medicare.
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    Thank you. I see my time is about up.
    Chairman ARCHER. Thank you for giving us back some of your time, Mr. Watkins.
    Mr. WATKINS. Thank you, Mr. Chairman.
    Chairman ARCHER. Ms. Kennelly.
    Mrs. KENNELLY. Thank you, Mr. Chairman.
    Thank you, Madam Secretary, for being with us this morning. I want to start by commending you for including annual mammograms in the Medicare portion of the budget. I know you had a great deal to do with it and eliminating the copayment, and I thank you for that. As far as hospital stays, I know you will be there working on it for the older women in America.
    I want to talk to you about this chart we all have before us regarding the savings in Medicare. When I look at it, I see that the first savings is $34 billion in managed care, and the second amount, the highest amount of savings, of course, is in hospitals.
    Secretary SHALALA. Yes.
    Mrs. KENNELLY. And then, except for home health care, you go down to $10 billion in your part B premium, which we know is really just an extension of present law. Madam Secretary, you were just talking about the discussions with the American people. But we Members of Congress spend an incredible amount of time discussing Medicare with our constituents. They are often retired. They are willing to see us, and they do really give us a thorough discussion about our debate on Medicare.
    We are used to talking about hospital care. We try to remind them that they do not want to have any cuts in the beneficiaries' benefits. However, if you go too hard against the hospitals, quality of care gets hurt, and as a result, beneficiaries also get hurt. And this has been an ongoing discussion as long as I have been a Member of Congress. I wish you would expand further for me on the decisionmaking process about managed care having a savings of $34 billion. Managed care is relatively new to us. We were going to do health care reform, and we ended up with managed care. There are the proponents who see so much good in it, others who have problems over the lack of regulation, a continuing debate.
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    But I see this $34 billion, the highest amount in savings, and if you could just give us a further thought on how this came to be to this extent, and I would go further to say, Do you think this might stop what some might hope was going to be the growth in managed care, Medicare managed care? Or will it hold back, say, prescription drugs from being offered by managed care plans? It is an area that is brandnew to me and, I think, to many people, and I wish you would expound on it.
    Secretary SHALALA. Well, first of all, as you know, there have been a number of studies which have demonstrated that we are overpaying managed care companies. Now, some of the earlier studies were because clearly, there was some selection of healthier people to go into managed care. So, as a result, we were overpaying, because the pool that managed care attracted was a healthier population, and we were reimbursing on the basis of the fee-for-service average in the county, so we were reimbursing at 95 percent of that.
    It turned out that, as one of the recent studies indicated, we were overpaying by 8 percent. And in study after study, including studies that were not commissioned by us, it has been very clear that Medicare has lost a lot of money because our payment system is a crude system. The question, though, is what happens if you start squeezing down on managed care payments, because many managed care companies have taken that extra money and reinvested it in extra services; some of them have taken it out in profits.
    I happen to be a big advocate of managed care and organized care, and I want to make that very clear. I come from a State that has a lot of this. To remain competitive, will they offer some additional benefits, some reduced premiums? We think they will. We think we have to be very careful about this—and we take this out in the year 2000, for example, we start taking the managed care savings out—we think that we have to look at other methods of payment. We are in a competitive demonstration out in Denver that may yield some results on a different way to price managed care. But the data are clear. I cannot come before Congress and not tell you that we lost $1 billion last year because we were overpaying.
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    We believe because of the way the economy works that managed care companies will not drop benefits, because they will want to keep taking a larger and larger share of the market. We believe they have been able to get efficiencies in the system. We do not want to destroy the industry. But we cannot honestly come before you in a very tight budget year and say we should not take a fair share out of managed care while we are simultaneously asking the hospitals to tighten up.
    Mrs. KENNELLY. Well, obviously, this is not going to be the last word we have on this, and I am open on this. You say you are a supporter of managed care; I am, too, in the general populace. I have always had to wrestle with it with Medicare, and we know that when we are dealing with a program like Medicare; a national, big-dollar program that when you say 5 percent, 95 to 90 percent, that is huge amounts of money. And so, we will continue this dialog about its impact on the system.
    Secretary SHALALA. The important thing is to preserve choice for Medicare recipients, so that if they do not like managed care, they can go back into fee-for-service, so they have some choices of managed care companies, and they are increasing rapidly around the country. It is also important, as was pointed out in the earlier discussion, to even out the reimbursements across the country, because there are parts of the country which are very tight, in which managed care companies cannot offer extra benefits because they do not have those extra resources.
    So, we have to figure out a way to do this in a way that encourages the industry and these different parts of the industry. At the end of the 20th century, it is not going to be called managed care. It is going to be organized care; we are going to have niche markets for children, for example, but we are going to have different kinds of organizations. We want to encourage that, but at the same time, we should not be overspending.
    Mrs. KENNELLY. Well, I thank you for that, but I just caution all of us to make sure we do not go forward in such a manner that everybody ends up being squeezed, especially the patient.
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    Chairman ARCHER. Mr. Hayworth.
    Mr. Hulshof.
    Mr. HULSHOF. Madam Secretary, welcome.
    Secretary SHALALA. Thank you.
    Mr. HULSHOF. I want to echo what Mr. Ramstad said earlier about the administration's budget proposal with rural health care. My district is one in which we have 22 separate hospitals; actually, 21, as a recent merger just occurred. And so, I do applaud the administration's efforts to look at this blended formula so that we can reduce the geographic variation. So, I do support that.
    But a question Mr. English asked about teaching hospitals and having a trust fund, and you said you were carving that out. I do not understand your answer. What does the budget say regarding graduate medical education?
    Secretary SHALALA. We would carve out that piece, put it in a separate fund, reimburse the teaching hospitals as well as managed care where they are providing that teaching function. One of the frustrations I had when I was at the University of Wisconsin was the difficulty of being able to take advantage of all of the providers that wanted to participate in our teaching program at the university's medical school, because we could not reimburse them. And this would give us an opportunity to reimburse a different group of providers at the same time for that teaching.
    Both sets of proposals do a carve-out, and what we need to do is to talk about whether we want to keep it as part of Medicare or whether we want to set up a separate fund outside of Medicare, and that gets us into a wide variety of issues, including jurisdictional issues and everything else. I think we can work it out. We all know what we want to do: Preserve absolutely first-rate academic medical centers in this country.
    Mr. HULSHOF. Let me ask you a couple of quick questions, Madam Secretary. Are there any medical malpractice reform provisions in the President's budget?
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    Secretary SHALALA. Medical malpractice reforms? I would not talk specifically about malpractice. The implementation of Kassebaum-Kennedy in terms of waste and fraud in the system is clearly built into this proposal, but let me ask my colleagues.
    Mr. HULSHOF. No?
    Secretary SHALALA. I think the answer is no.
    Mr. HULSHOF. OK.
    Secretary SHALALA. We have had that discussion before within this Congress.
    Mr. HULSHOF. And one of the charts—and actually, I think it is part of your written statement regarding modernizing medicine.
    Secretary SHALALA. Right.
    Mr. HULSHOF. You indicate annual open enrollment for Medigap and managed care plans. How is this going to affect premium costs?
    Secretary SHALALA. Well, actually, most people do not move. Most people stay where they are. It is the idea of being able to move if you do not like the system. And managed care in general has favored annual enrollment as opposed to what we have now, which is every month, you can basically do it. The interest in annual enrollment is really a consumer issue. You can lay out everybody's options; you can tell them what the differences are between the plans. You can show them what the consumer satisfaction rates are.
    The other reason for it is you want people to be able, if they do not like their managed care plan, to go into fee-for-service; if they do not like fee-for-service, to go into managed care. So, it will make the management of health care more orderly, fairer. It will protect consumers, and I think industry is actually going to be enthusiastic about this.
    Mr. HULSHOF. As a final matter, and shifting gears just a bit and actually following up on Mr. Matsui's concerns regarding welfare, you indicate in your written statement that you know several Members of Congress have suggested a wait-and-see approach, in that we have just recently enacted—not we, because I was not here—but recently enacted significant reforms in welfare, which States still have until July of this year to implement. And certainly, in Missouri, they have been very proactive in getting people off the welfare rolls.
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    In light of that, what evidence is there that additional funding for States is needed, especially as we are watching dramatic caseload drops across the country?
    Secretary SHALALA. We have made it very clear that we do not want to reopen welfare reform. The only proposals we have on the table are not about welfare reform but about people who are not involved in the welfare-to-work process: Elderly, disabled immigrants sitting in nursing homes; children. These are issues that were swept into the discussion last year, but they have nothing to do with the welfare-to-work commitment that all of us have made, and they do not, in our judgment, involve reopening that debate.
    Mr. HULSHOF. Thank you, ma'am.
    Chairman ARCHER. The gentleman's time has expired.
    Mr. Coyne.
    Mr. COYNE. Thank you, Mr. Chairman.
    Madam Secretary, the proposal includes a section that would remove funding currently going through managed care organizations, HMOs, and would allow it to go directly to the teaching hospitals. That is part of the proposal that you outlined today. Do you know how much more money will go to the teaching hospitals as a result of that?
    Secretary SHALALA. What we are proposing to do is to carve out much of the money which is currently being spent at the teaching hospitals. There is a cap on specialties; an increase in primary care providers. The money goes to both teaching hospitals as well as to other teaching institutions like the managed care. So, it would be whatever the number is that we are currently spending in this area plus some differences that we do with those numbers, and I am not sure I have the actual—it is $10 billion, I am told.
    Mr. COYNE. $10 billion?
    Secretary SHALALA. $10 billion.
    Mr. COYNE. $10 billion over 5 years?
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    Secretary SHALALA. Over 5 years.
    Mr. COYNE. Do you anticipate there are going to be additional subsidies needed to be able to train health care professionals?
    Secretary SHALALA. Pardon?
    Mr. COYNE. Do you anticipate there are going to be further subsidies, additional funding, necessary to fund the teaching hospitals to train health care professionals?
    Secretary SHALALA. There are some other sources of money in the Department. We have cut back a little bit on our health professions. If we target this money directly, as opposed to what is happening now—they sometimes get it, and they sometimes do not get it—I think that teaching hospitals will be pleased. They are also being reimbursed when they treat a Medicare recipient or a Medicaid recipient, so there is a lot of money coming in. And, of course, the major funding for the great academic health centers in this country continues with the National Institutes of Health.
    So, since I ran a university that had a great teaching hospital, I cannot assure you they will ever say that they have enough money, but I think by carving it out and retargeting it, we are reaching the goal that all of us have, and that is a much more targeted and more efficient use of the money so it gets directly to them.
    Mr. COYNE. On another subject—the Work Opportunities Tax Credit—have you made any provision or looked into the possibility that as a result of giving the 50-percent tax credit on the first $10,000 of wages to help place welfare recipients in work, that it may displace other low-income workers?
    Secretary SHALALA. No; we do have concerns about that, and everyone is trying to build in whatever protections they possibly can. These programs work most successfully when they are combined with other kinds of support pieces, and in Missouri, for example, where the State has organized the kind of support system working with the private sector, we must be very careful as we administer all of these programs, whether it is the child care money or the tax credit, that we are not displacing other workers, often with the same kind of socioeconomic characteristics, who have gone directly to the job and may need something like child care.
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    So, I think all of us are aware of it and are very sensitive to that issue.
    Mr. COYNE. Relative to your wheelchair pad there and the example you make about Medicare paying more than Medicaid pays for one, you indicated that is as a result of some regulation or law that you have to live with. How did it come about that you are forced to pay that kind of money?
    Secretary SHALALA. Throughout the Medicare bill—if you look at the long history of Medicare, when the program was first put into place in 1965, people were so frightened that the health care providers would not participate that we did all sorts of things as part of the program that we would not do now if we had to redesign it. And we have repeatedly asked over the years to be able to get the best price. Some of it is, I am sure, industry-specialized, industry protection. Some of it is that whenever you put money out there, there seems to be a number of institutions and people who fill out the gap. That has certainly happened in home health care particularly.
    But here, we have clearly identified that we need to go out and act more businesslike, be a more prudent purchaser. We are telling you now that we are overspending in certain areas, and I cannot believe Congress will not be responsive, as clearly as we have laid out these issues.
    Mr. COYNE. Thank you.
    Mr. SHAW [presiding]. Mr. Ensign, you may inquire.
    Mr. ENSIGN. Thank you, Mr. Chairman.
    Madam Secretary, first of all, I would like to thank you and the administration for starting a process, I think, that is very, very critical in this country, and that is changing our current sick care system, which is basically what we have. We do not have a health care system in this country; we have a sick care system. We reimburse people when they get sick; we do not reimburse people to keep them healthy.
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    I think what you have done with some of the diabetes, colorectal screening, even the annual mammographies, are attempting to keep people healthier longer, and we need to be doing more of that, not only with Medicare but also throughout our health care system in this country, and so, I applaud your efforts.
    The one thing that I would like to encourage you also, even though we do not have the jurisdiction here, is with Medicaid, and that is with dentistry. Dentistry is one of the easiest things for preventive health that we can do in this country, and we just do not do enough on teeth cleaning. Teeth cleaning is one of the easiest ways to keep bacteria, all kinds of disease from coming into the oral cavity, which takes it through the rest of the body, and that is something I think we need to look at: More prevention throughout our health care system and reimbursing providers for keeping people healthy.
    Let me address something while applauding some of your efforts. Let me address some of the things that I think are problems with your budget that you have submitted, and that has to do with what you have done with home health care costs: Taken it out of part A and transferring it to part B. From what I understand, first of all, we are all concerned about the trust fund and making the trust fund solvent. The problem that I see with taking home health care out and having that extend the trust fund is, Well, why not just take hospital payments out of part A, put those into part B? You would extend the trust fund out forever if you did that.
    It seems to me that that is just a phony way of bookkeeping and not addressing the real structural problem with Medicare.
    Secretary SHALALA. We actually do both. part A was originally set up for hospital costs, and, therefore, we take the part of home health care that is related to hospital costs and leave it in part A. Now, none of this affects the $100 billion in savings, because the transfer is overall budget neutral. So, it does help the solvency of the trust fund. But what we have done is keep to the intent of part A. The intent of part A was to pay hospital costs. So, those visits associated with a 3-day hospital cost, as was originally intended, stay in part A, and the rest goes to part B, which again is, from a policy point of view, consistent.
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    But let me repeat again: This has nothing to do with our overall savings.
    Mr. ENSIGN. I know; but is there not a problem? You say that you keep part B premiums at 25 percent. But home health care right now is in part A. When it switches to part B, you cover 100 percent of that. So, in effect, part B percent of premiums will go down to somewhere around 20 or 21 percent over time.
    Secretary SHALALA. Well, let me explain to you exactly why we do that. The reason for that decision is this: People over 65 are already paying 21 percent of their incomes on out-of-pocket costs for health care, and it is a separate policy decision that we made. Neatness would have dictated that you just slide it in under the 25 percent and raise the premiums of Medicare beneficiaries. But if you are really paying attention to people's health and to what is happening to their incomes because the Medicare benefit is not comprehensive enough, and you see that 21 percent, which has been a growing percentage, compared to what the rest of us pay, which is about 8 percent, then every single time you raise that cost for beneficiaries, you ask yourself a series of hard questions: Do we absolutely need to do this to balance the budget? And our answer was we could get to a balanced budget without sliding that in under the 25 percent and raising costs for beneficiaries. It was a straight-out concern about lots of low-income people.
    Mr. ENSIGN. Mr. Chairman, since she took some of my time exercising back and forth, could I just ask one quick question.
    Secretary SHALALA. Because I cannot get my staff to walk over there.
    Mr. ENSIGN. I am just kidding.
    Just one brief comment that I would like to end with, and that is because we know part B is paid by general revenues, I would encourage and implore the administration to consider wealthy Americans to pay, since this is not the part of Medicare that they have paid into and invested in, that the administration show leadership on this issue and come forward to where we are actually asking more of wealthy Americans. I know this sounds funny to most Americans that Republicans would be asking wealthy Americans to pay more, but that is indeed what we are asking them to do.
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    Thank you.
    Secretary SHALALA. Thank you, Congressman. And in my answer to the previous question, the President has clearly said he is prepared to consider that option at the same time.
    Chairman ARCHER [presiding]. Ms. Dunn.
    Ms. DUNN. Thank you very much, Mr. Chairman.
    And Madam Secretary, it is nice to have you back. One of my special interests is the area of welfare reform, and you will recall that we worked long and hard on that over the last—for me, at least, over the last 2 years and some people for many years beyond that.
    In our hearings, we heard, for example, from custodial parents who said they were owed money by spouses who had left the State and that as a result, their children ended up on welfare, and we found out that of the parents who are deadbeat parents, 30 percent of these folks did leave the State, and we are talking about a number that is close to $34 billion that currently does not get back to custodial parents and, as a result, causes those children to end up on welfare. It is something we all want to work together to alleviate.
    One of the solutions we came up with, because we saw our Federal role as being necessarily narrow, was additional funds for data processing, to provide networks, nationwide networks, that States could tap into to find where these people were. And I am most interested in hearing your thoughts on how this is going to work out. I have seen over the past, since we did our legislation, that we put lots of money into data processing for lots of welfare programs before, and the results have generally not been up to what we expected.
    Do you see that we are in a position here to make this more effective? And then, will you also be working with us regularly to update us during this oversight period on the effectiveness of our proposal?
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    Secretary SHALALA. Yes, thank you, Congresswoman Dunn. Absolutely. Child support payments are up 50 percent now. We are at the highest child support payment numbers in American history. And the Congress did put an investment in the States in particular to make sure they were establishing paternity, they were doing followups. These systems are getting up. It is one of our highest priorities to get this whole system in place. For some of the States, they are very far along. Others are not as well along. But we will have regular reports to Congress. They will be reports about higher and higher child support payments, not simply for those going through the welfare system, but as you well know, there are lots of women out there waiting for their payments who have jobs for whom that money makes all of the difference in the world.
    So, it is for me and for you one of the most critical parts not just of welfare reform but of social policy in this country. The pressure is on the States to deliver and on us to make sure that that national network is there so that people cannot cross State lines and escape their responsibilities.
    Ms. DUNN. I agree, and I think reports back on how the States are complying with their obligations under the new legislation will be of great interest to us.
    Following up on a comment that Mr. Hulshof made on reopening the whole welfare portion and your response to him, I do have concerns about the $14 billion that the administration would like to add in dealing with legal aliens, and I continue to have a concern that folks who have come into our country, some after the President signed this legislation and many who have had sponsors who have agreed to sign a contract to provide support for legal aliens until they become citizens, I am really very bothered by this effort to provide them welfare benefits when we spent so much time on that issue and we agreed we are a generous country; we want people to come in to take advantage of opportunity. But when a sponsor has made a contract to support somebody, I am bothered by the fact we are trying, and I think that in a sense, you are trying to open this up again.
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    I guess I would like to hear your thinking why you are not letting this bill work for a period of time and then do the responsiveness that we need to do, and why we are taking a huge amount of money to support these folks who have been told they will be supported in other ways.
    Secretary SHALALA. Congresswoman Dunn, I actually think you and I agree, and that is until the welfare bill was passed, we did not have a legal way of enforcing the affidavit the sponsors sign. After the welfare bill was passed, for all immigrants, new immigrants coming into this country, we will be deeming income and holding their sponsors legally responsible.
    What we are talking about and what Governors like Bush and Childs and Pataki are concerned about is people who came into this country under the old rules who are old and disabled and sitting in nursing homes who have no one to take care of them and who will become wards of the State and whether we should continue their Medicaid, for example, or for children who came in, again, under the old rules and for disabled children. So, there is a difference between—we are talking about a transitional period, and we believe that that really is not part of the welfare-to-work debate, and that is why I am arguing that it does not have anything to do with welfare. These are not able-bodied people who can walk into an office and get a job ever. They are children; they are old people; they are disabled. They are sitting in nursing homes, and they are people who came in under a different set of rules.
    So, you and I do not have a difference of opinion about the new rules and holding people accountable. The issue is that we have a transitional problem here, and we need to work with the Governors, and I think Chairman Shaw has indicated that he has no intention of reopening the welfare bill, and the President is not asking him to. But at least, let us talk about it as we get to the table about the special kinds of problems we have seen out there, that the Governors are concerned about, that we are concerned about, but no one is asking us to change the fundamental approach that we have laid out here.
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    Ms. DUNN. Mr. Chairman, if I may, I think it is important for people to understand that we did allow waivers for some of these folks who came in. For example, if they are 75 years old or older; if they have paid taxes in the United States for a period of 10 years; if they have been veterans, those are waivers. And we thought this through. We did not just come up with this. So, I think, Madam Secretary, we ought to think long and hard here in the Congress before we fund this program before we even know how it is working in real life.
    Secretary SHALALA. Thank you, Congresswoman, I am sure we will.
    Chairman ARCHER. Mr. Levin.
    Mr. LEVIN. Madam Secretary, welcome, and I would like to follow up on Congresswoman Dunn's question. But before I do that, Mrs. Kennelly asked you about the proposal to change from 95 to 90 percent for the AAPCC. I think it will be one of the more controversial suggestions. I think the sooner we have information about the potential impact of this, the better. And you talked about the need for balance and retaining choice, and I believe most of us completely agree. And so, the sooner we have your insights as to the impact of this, the better.
    Now, if I might, I hope we have the same spirit of openness when it comes to the proposals you have made on legal immigrants and food stamps. You stated, I think, very usefully that you have no intention of reopening the AFDC reform, that the proposals relate to issues outside of welfare reform. So, let me suggest that you provide the Committee—I am sure Chairman Archer, the distinguished Chairman of the Subcommittee, and Ms. Dunn and others and myself and every other person involved will want to take an objective view at the data.
    So, I would appreciate if you could provide the Committee and the Subcommittee as soon as possible information on the following pinpointed suggestions that are incorporated in your testimony on legal immigrants, food stamps, and the work provisions. First of all, the effective dates of these provisions, because unlike the welfare reform provisions, the legal immigrant provisions, the food stamp provisions go into effect almost now. So, I think it would be useful for the Members to have that.
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    Second, the percentage who are refugees or asylees, people who did not come in with sponsors; I believe that represents about 25 percent of the people we are talking about. Third, as much aid-specific information as you can provide; there has been some reference—Ms. Dunn referred to the exceptions or waivers. But we need to know the age specificity as much as we can of these people and when they came in, to the extent possible, because I think when we look at the age profile, we are going to see that we are talking about an older group, many of whom came here much more recently; could not possibly meet the requirements for waiver.
    Next, I think it would be useful for you to break these data out by the States that are involved. Also, if you would, spell out—we know the gross amount that is allocated or estimated for medical care, but if you could be more specific about who would be covered by the $4 billion-plus in Medicaid. And this, I think, will get to the question, whether we are talking about people who came here essentially to beat the system, or we are talking about people disabled after it and under what circumstances and what age.
    Last, on the work provisions, I think it would be useful—I understand task forces are going to be set up, and one would include the welfare-to-work provisions that are being suggested. I think it would be useful in that regard if you could take a look at the State budgets, because there is some suggestion that there is going to be a windfall in this transition from AFDC to TANF, and the States are in a position to carry the load themselves. The original Republican proposal had a $10 billion provision for work. The coalition budget had $3 billion and Castle-Tanner had $3 billion.
    You are suggesting $3 billion. If the States can do this alone, I think we should say to the States, Do so. The same relates to the immigrant provisions. I think we need to hear from the States. And also include, if you would, in the info to us the State provisions that would click in in lieu of SSI and food stamps.
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    But going back to the welfare-to-work provisions, let us know, if you would, about the State budgets and the increases they are going to receive, because I think everybody on this Committee and on the Subcommittee will want to look at the facts. So, if you would, working with whatever outside groups you need to, send us that information, if you could, in the next few weeks so we can have an informed debate or discussion, not about reopening welfare reform, but provisions that are going to have essentially immediate impact on the lives of, you estimate, a half a million people in the case of legal immigrants and many others in terms of food stamps.
    Secretary SHALALA. I would be happy to do that, Congressman Levin. I think that at the end of the debate, some people did not realize that while there were some discussions, for instance, of exempting people over 75, it was not done in the bill. I think Members will be surprised when they actually go back and take a look that there were some things that were not done that they were concerned about at the time, and people over 75 is an example. Obviously, Congresswoman Dunn raised that issue as if we had exempted people over 75, but we did not as part of the bill.
    Mr. LEVIN. So you will provide——
    Secretary SHALALA. Yes, we will provide——
    [The following was subsequently received:]

    [The official Committee record contains additional material here.]



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    Chairman ARCHER. The gentleman's time has long since expired.
    Secretary SHALALA. Yes.
    Chairman ARCHER. Mrs. Johnson.
    Mrs. JOHNSON. Thank you and welcome, Madam Secretary.
    I want to just pursue the issue of Medicare reimbursements, because I think the rate cuts proposed to us today are far deeper than I understood them to begin with and far deeper than I think is coming across. In the Republican Medicare reform proposal of 2 years ago now, we solved the problem of funding medical education through a separate Medicare Trust Fund.
    Secretary SHALALA. Correct.
    Mrs. JOHNSON. And we put $14 billion into that trust fund from the general revenues. And the reason we did that was because we wanted to have high enough premiums to assure that these new plans, managed care plans, would offer the kind of comprehensive benefits—in fact, improved benefits, improved over the current Medicare bundle of benefits—that seniors so desperately need.
    Now, as I understand your proposal, you have reduced the AAPCC in order to assure the money currently in the reimbursement rate structure goes to hospitals to fund medical education. I appreciate that, but that has the effect over 2 years of cutting reimbursement rates 5 percent: 40 percent the first year, 60 percent the second year, according to your budget. Now, that is a 5-percent cut in how we reimburse HMOs and the new PPOs and PSOs. So, instead of 95 percent of Medicare rates, it will be 90 percent of Medicare rates. On top of the 5-percent cut will also be the cut in rates that we are doing to control spending, so that is an indirect effect.
    Then, in your budget in the year 2000, you cut Medicare rates another 5 percent, and then, if the budget does not balance, that will be another 2.5 percent. So, there is at least a 10-percent cut plus the indirect effect cut in reimbursement rates to any integrated care system that develops under managed care and a possible 13-percent cut in rates from this year.
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    Now, to me, that is very heavy, and it is particularly heavy when those integrated care systems do offer us the best opportunity for seniors to get coverage for prescription drugs, which Medicare does not offer now. First of all, do you not think this is going to discourage the development of the PPOs and the PSOs that you want? Second, do you provide any antitrust relief and something to deal with the asset problem that we have so that we can get the PSOs, that is, the provider-sponsored organizations, out there? The reason I mention this is that seniors need managed care options that will address quality as well as cost. To do that, you have to have a market in which there are not just insurance company managed care plans, but there are managed care plans that are hospitals and docs, where the logic and the responsibility for decisionmaking are with the medical provider.
    So, I want, and the Republican proposal assured, the development of choices for seniors in which the provider himself was making the decision as to what care, not an insurance company. So, unless you provide antitrust relief and unless you deal with the asset problem, you are not going to get provider-sponsored organizations. But if you are telling them now we are going to cut your rates at least 10 percent and probably 12 percent, then you are not going to get provider-sponsored organizations developing.
    I think your proposal to cut 5 percent out of the AAPCC—and I know that is arcane for people listening—but it has the effect of cutting reimbursements to integrated care systems way beyond what we are going to cut fee-for-service medicine, and that really worries me. I think it will truncate the development of a care system that provides seniors reasonable choices. Am I misreading something? I know this is a longer discussion, but I would like a little comment from you, and then, there is one other thing I must get into my time.
    Secretary SHALALA. No, actually, it is a much longer discussion, and it is a very important question you are asking and point you are making.
    First of all, the money was put into the integrated health care systems for the academic health centers, to be spent on the academic health care centers, so that we are simply taking out what was put in originally to pay for the academic centers. Second, managed care is uneven in whether it has taken the additional money and expanded services. As you well know, in some areas, there are zero premiums; in other areas, there are some additional benefits that are added, so that your suggestion that there was actually a systematic strategy to buy an additional benefit package, That is an interesting proposal, but I am not sure that in the process of developing a very crude way of paying managed care, those of you who were here at the time—and I am not sure you were—actually thought that systematically every single HMO was going to provide a range of benefits that we had agreed upon.
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    In fact, because, I would suggest, we have paid so well managed care plans, and we have been enthusiastic about them getting a niche market, I have, in fact, privately argued we should have a little bit more extra money there, because we wanted the industry to develop and to attract a group of people. Our debate is about how much and whether there is fairness introduced in the system. So, I think what we have to do is to talk about what you need to do to get some other choices out there. How much additional money do we want to put out there? Do we actually want to say that we want some additional benefits in every managed care plan as a way of pulling people out of fee-for-service? And that is what our discussion is.
    We have made a decision based on what our numbers and our analysis show, which we would be happy to lay out for you. You are absolutely right, though, that we are pulling a piece out that was specifically designated for academic health centers. If someone had walked up to me with $17 billion, I unfortunately or fortunately—but I think unfortunately—do not work for Chairman Archer. No one offered me this extra money to set up a new pool. But we had to do it within the context of a balanced budget, and that is how we did it.
    But the fundamental issues you raise are exactly the issues we need to discuss as we sit down and try to work out a bipartisan agreement here. And, Congresswoman Johnson, I think those are exactly the issues. And I am not saying we are perfect, and we know exactly what the right answer is, but I am saying we ought to be very clear about what we are putting the money in for and how we think the market will respond. Some of us believe, even in tight markets, when no additional benefits are offered, someone comes in to get a niche in that market, offers additional benefits, even in places where we know we have not——
    Mrs. JOHNSON. The red light has gone on. This is a longer discussion. But I do want the record to note that the Republicans intentionally chose a high level of reimbursement for the managed care plans so that they would be able to modernize the benefit package for seniors as seniors desperately need, including prescription drugs, and did draw, within the context of a balanced budget, new money into the medical education system in a very generous and supportive way, and we did it because we did not think the direction you have taken, which is cutting reimbursements for managed care plans, will provide the benefits seniors need. This is a bigger discussion, and I appreciate your comments today.
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    Secretary SHALALA. Exactly; and my only point was a quick point, and that is that if that was your intent, then some of managed care did it, and some did not.
    Mrs. JOHNSON. Well, actually, I do not know of a managed care plan that does not provide better benefits than——
    Chairman ARCHER. I am sure this discussion can continue in the Health Subcommittee. The gentlelady's time has expired.
    Mr. Houghton.
    Mr. HOUGHTON. Thank you, Mr. Chairman.
    Madam Secretary, as always, good to see you. I would like to step back 1 minute. There are a lot of specific things I would like to ask, and I can ask them of you or somebody on your staff later, particularly in terms of provider service organizations. But I guess the question I ask, really, is, Are we doing what we want to with this program in the long term, or, to put it another way, Are we doing the things in the short term which will be good for that long-term program?
    For example, we are increasing some of the benefits. Now, you can say the cost of these benefits are not very much, but they always start small. The question is, What do they mean later on? And there is clearly an imbalance between the revenues and the expenditures. But even if they were in balance, Do we want that money, the way this thing is moving and the way it is prescribed, to go toward Medicare?
    One of the worries that I have is that we spend so much more on senior citizens than we do on younger people. The President has now come up with a program for education, but when this big wave comes in, Are we going to be able to handle this thing? And what about the next wave behind it and putting so much of our money into the Medicare system, which we have been obligated to do?
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    Secretary SHALALA. Well, thank you, Mr. Houghton. I guess I am talking to the same Republican Party, because I have just been defending deep cuts to get the program more coordinated. The benefit enhancements we laid out are ones that save us money in the long run: Vaccines, for example. The Medicare benefit was designed in the sixties. It was never changed sufficiently to put prevention on the front end, so that a number of Members of this Committee—Mr. Thomas, Mr. Cardin—have suggested we put some prevention benefits on the front end of the Medicare Program. These prevention benefits will save us money in the long run. Whether it is flu shots or pneumonia shots, we know they will save us money.
    The other kinds of changes we have recommended, including the conversation I have just had with Mrs. Johnson—pulling out funding for the academic health centers and making it a more targeted program so that we know we are buying what we are paying for; squeezing down on some of our reimbursement rates, getting better prices for things—are all things we would do as part of a longer term discussion for Medicare of modernizing the program. But we would do them now and not save all of these things for the long-term discussion. Everything we are recommending, if we were sitting in a long-term discussion, we would be recommending at the same time.
    So, I think we are doing things that are consistent. We know we have to pull down the growth of this program. We also know we have more elderly coming online and that that requires a very different kind of financing. But we need to get this program under control. It needs to be managed in a more businesslike way. And then, looking at the bottom line will be more realistic than what we are doing now. And, as you can see, people are very reluctant to start down that road. As soon as I say we are spending $1 billion more on managed care this year than we should be spending—we are overspending—people say, But are we going to curb people's attractiveness to managed care? So, finding the right balance is exactly, I think, what we have to do together.
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    Mr. HOUGHTON. Thank you.
    Chairman ARCHER. Mr. Cardin.
    Mr. CARDIN. Thank you, Mr. Chairman.
    Madam Secretary, it is a pleasure to have you before the Committee. I particularly want to thank you and compliment your statement as it relates to several issues we have been working on for a long time. In your statement, you endorsed the prudent layperson standard for managed care and emergency services, and I want to compliment you on that, and we hope we can establish that standard not only in Medicare but throughout the managed care provisions.
    Second, in response to Mr. Houghton's question, I want to underscore the importance of the preventive health care benefits you are recommending. I am pleased to see that it looks like we have bipartisan support for these changes, and I agree with you that we will save money for the Medicare system and just as importantly, we will improve the quality of life for our seniors in earlier detection of dreaded diseases that will save money and provide for a better standard of living and quality of life for our seniors.
    One point that you responded to in response to Mr. Ensign that I found rather informative is that as we are switching home health care into part B, we are not assessing our seniors the traditional share of the cost of the premium. You do that for good reason, which is that our seniors have a significant out-of-pocket cost that younger Americans do not have. I would just ask that we perhaps look at two other alternatives that could be used, and that is to reduce the percentage that our seniors are paying to get the same revenue so that we do not violate the traditional 25–75 split or the traditional split; or second, we look at ways of targeting relief to those seniors who have these extraordinary out-of-pocket costs. Both, I think, would deal with the problem that you raised and perhaps in a way that does not change the policy of having our seniors pay for a consistent percentage of the cost of part B.
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    I want to talk a little bit about the point that Mrs. Johnson raised on academic health centers, and I support your proposal of removing the AAPCC money. I think that makes sense. And we should point out that the managed care companies are free to negotiate with the academic centers, and with the academic costs now being directly reimbursed, there should be some rate reductions, and the managed care companies should be able to deal—if they do deal with academic centers to be able to recoup some of those costs by reduced premiums or rates, excuse me.
    But I think your proposal only goes halfway. You are only dealing with the Medicare system. You are dealing with it appropriately, but there are the other users of the system, the other payers of the system that are not contributing to the cost of academic health care in this country or the training costs, and you deal somewhat with the work force issues but not very aggressively with the work force issues to make sure that at the end of the day, if we are putting up these Federal funds that we have a medical work force that is consistent with the needs that are out there.
    So, I would just urge you—and I appreciate your response to this—that we look at dealing with the other half of the problem and perhaps trying to come up this year with a comprehensive solution. Quite frankly, the Republican approach of general funds in helping to solve the problem makes some sense if we cannot get an all-payer source, and I would appreciate in the few seconds that remain perhaps your observations in that regard.
    Secretary SHALALA. Congressman Cardin, I think those are very thoughtful points, and we ought to consider them. What I have said is that all of the proposals for academic health centers adhere to the same kinds of principles. Everybody wants a separate fund. How we pay for it, in some ways, we took the easy way out. We simply pulled it out of Medicare, but you are absolutely right: It does not solve the other half of the problem.
    I think what I ought to say is what I have said consistently right through: This is an area where we clearly can reach bipartisan agreement, where we are not absolutely—we think we have a good proposal; it is defensible, but we ought to look at some of these ideas, including how should the other payers make a contribution in this area. The academic health centers in this country are really the jewels of our health care system. We need to maintain first-rate institutions, and we need to get them secure financing if they are going to survive in this changing health care world.
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    Mr. CARDIN. Thank you. I look forward to working with you.
    Chairman ARCHER. Mr. Portman.
    Mr. PORTMAN. Thank you, Mr. Chairman.
    Secretary Shalala, welcome again. I enjoyed your Teddy Roosevelt quote during your prepared remarks, in which you said nine-tenths of wisdom depends on being wise on time. And I agree with you that today we are at a very crucial time and we need to push ourselves a little bit to be sure we are, indeed, protecting Medicare until the time at which the baby boomers, my generation, retire. And having said that, my general approach is perhaps just the opposite of some of our colleagues whom you have heard from today, which is to say I think we ought to be more aggressive on the structural reforms that you begin to make with this proposal.
    I would focus on two areas: One is home health. The other is choice. With regard to home health, there has been some discussion about the shift from part A to part B and the savings that generates, and I have an initial question for you: Do you agree with CBO's projections that without shifting the home health from part A to part B as proposed in your budget, that we are only protecting the trust fund until the year 2004 and not the 10 years out that President Clinton talks about?
    Secretary SHALALA. I do not. Our actuary has reported that it is 2002, and it is the HCFA actuary who determines the solvency of the trust fund, and that accentuates the importance of the home health transfer.
    Mr. PORTMAN. The shift from part A to part B.
    Secretary SHALALA. Yes.
    Mr. PORTMAN. So, indeed, you would say that we preserve the solvency of the trust fund 2 years less if we do not follow through with that accounting change of moving part of home health from part A to part B.
    With regard to home health, I support the PPS system. I think the prospective payment system is overdue. I think those are good reforms; again, they are good structural reforms. My concern is, again, that we continue to challenge ourselves on the structural reforms with regard to home health, skilled nursing, other areas where we have seen big increases over the last several years so that we, indeed, can prepare ourselves for the baby boomers.
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    With regard to choice, I have so many questions for you, but I guess my fundamental question is, Have you given us something to build on? I agree with you in terms of the PSOs. I think that is an important new choice, not only with regard to Medicare but with regard to our health care system generally. I think that would add competition in the private health care market, and maybe that is a start. But I think we need to do more, as many of my colleagues do, particularly with regard to medical savings accounts, which I think are something we did properly last year in the context of HIPA by making at least a demonstration project there. I wonder how you feel about that specific choice and whether that could be added to the PSO option you are giving in your proposal.
    Secretary SHALALA. I think we would oppose it. As we indicated last year, we do have a demonstration out there. We would like to see the results of that demonstration before we test it on elderly and disabled Americans, and I think we have committed ourselves to that demonstration, and we will wait to see the results.
    Mr. PORTMAN. How about other choices that have been offered, again, proposals in the past: Taft-Hartley and union plans are some we have talked about; plans proposed by an association; we have talked about allowing beneficiaries to choose private fee-for-service plans. Do you think we can increase the choice, again, build on what you have provided us here?
    Secretary SHALALA. Well, what we have always said is, and the reason we are moving for two new choices is that if we can figure out the financing so that these are stable alternatives, and the government does not end up picking up the bill if they go belly up, and if there is an even playingfield so there is genuine choice, and if people can go back and forth if they do not like a plan—the annual enrollment period is extremely important—we are certainly open to looking at different kinds of organizations.
    As I have indicated, I think organized care is going to end up with a very different configuration than what we currently see, including some niche markets. We can see some carve-outs now for certain diseases, where we are testing some things in demonstrations. There are going to be lots of choices. But the even playingfield on the financing, making sure they have the necessary financial underpinnings, are going to be terribly important, and making sure there is not adverse selection so that everybody can get into that choice is also going to be important.
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    But the fundamental thing is that we have to guarantee a benefit, a quality benefit. At the end of the day, this is not a discussion about financing; it is a discussion about health care and about making sure people are healthy, not just that we make some contribution to helping them pay for a health insurance plan. That is a very different philosophical underpinning.
    Mr. PORTMAN. I think it has a different philosophical underpinning. I think it actually supports the notion of more choice, expanded choice, that you have begun to provide with this proposal, and I think your concerns, frankly, are things we can talk about with regard to the level playingfield; with regard to some sort of annual process whereby people can go in and out of these plans. I think those are not inconsistent at all with the choice ideas that might go beyond what you have proposed. So, I appreciate those comments.
    Thank you, Mr. Chairman.
    Chairman ARCHER. Mr. Kleczka.
    Mrs. Thurman.
    Mrs. THURMAN. Thank you, Mr. Chairman.
    Secretary SHALALA. Thank you.
    Mrs. THURMAN. Thank you for being here and for the patience you have shown today. We really do appreciate that.
    Madam Secretary, just so that you know, this is of great importance to the district that I represent. I have the second-largest senior population in the State of Florida, the second-poorest district in the State of Florida, and also the number one veterans population in the country. So, all the Medicare issues have directly hit us at home.
    I have a couple of questions that may have already been talked about today. Specifically, can you give us an outline of what this blended payment is going to do? In some of my north Florida areas, on the floor issue, we just barely make it, and then, we are not high enough on the other end of it. It is not only about what is going to happen to them in a reimbursement issue, but it also has a lot to do with the beneficiaries. What we are finding is that in one part of our State, their deductibles might be lower. The benefits they receive from the plan are better, and we get an awful lot of questions about that.
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    So I do not know if you have that information available on you, but I certainly would like to have the opportunity to discuss this problem.
    Secretary SHALALA. Right. I think we should provide you with that information. And the other thing is we need to take a look at it, make sure we have provided you with data on what happens county by county when we start changing these reimbursement issues. But again, we are high in some areas, not necessarily because of costs but because of historic reasons. We need to get control of this and to make sure we have a fair payment for the provision of quality services.
    And you can reassure the people in your district that none of us have any intention of not providing a quality benefit, but we think we can do better. We think we are overpaying in some areas; we think we are overpaying for certain kinds of things we purchase. The people who live in your district have complained bitterly that they think the system is being ripped off; that there is fraud in the system, and we have to make sure we have integrity as we get to the end of the day and pull these pieces together.
    [The information is being retained in the Committee's files.]
    Mrs. THURMAN. In Florida, it looks like we are going to start putting out a report card on this issue.
    Secretary SHALALA. Right.
    Mrs. THURMAN. Are there any ideas going on in the administration?
    Secretary SHALALA. Yes; we actually are requiring consumer satisfaction surveys that will be made public as well as quality requirements and measures. The great hope, of course, is that as we go to these open enrollment periods that we will have all of that information, so people actually can compare plans, so it will not be just word of mouth. That is the exact kind of consumer response we need to have as part of the modernizing of the Medicare system.
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    Mrs. THURMAN. The other area that has been somewhat successful in my State, and certainly from your initiatives, has been the Operation Restore Trust. Are we looking at any expansion of this program? Also, is there a possibility or is there something that we need to do legislatively to help you in that aspect?
    Secretary SHALALA. No, you actually did it last year with Kennedy-Kassebaum. Operation Restore Trust is going national. The elderly residents, senior citizens in Florida, were of a great help. They were integrated into the program. As you know, they helped us to identify areas for investigation. We hope to expand that around the country. At the same time, Florida was one of our model places, and I am very pleased that we will be going national with Operation Restore Trust.
    I believe that in the years to come, when the actuaries report on the Medicare baseline and the solvency of the fund, they are going to report that what Congress has done over the last couple of years with Operation Restore Trust is actually going to have an impact on the baseline of Medicare.
    Mrs. THURMAN. Mr. Chairman, may I just ask one more question that deals with veterans?
    Chairman ARCHER. Very quickly, thank you.
    Mrs. THURMAN. Thank you.
    Madam Secretary, in the President's budget, there are some issues of the transfer of some Medicare dollars into the VA system to help pay for some of that cost. Are your numbers taking that into account at this point?
    Secretary SHALALA. They are, because that is a demonstration, so that is built into what we are doing, and we are going to try it out.
    Mrs. THURMAN. OK; I would be happy to help you with that issue.
    Secretary SHALALA. Thank you very much.
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    Mrs. THURMAN. Our veterans are extremely excited about that and want to see us press on with that.
    Thank you, Mr. Chairman.
    Secretary SHALALA. Thank you.
    Chairman ARCHER. Mr. McCrery.
    Mr. MCCRERY. Thank you, Mr. Chairman.
    Madam Secretary, I am curious about your actuary's conclusion that $78 billion in savings in part A only buys us 1 more year of solvency, but then, the $82 billion in shift from part A to part B gets us another 4 years. I do not know how they arrive at that, but I do not think you and I can solve that. I think our actuaries are going to get with your actuaries and see what they can figure out, but it does seem rather curious that equal amounts buy us different numbers here.
    Secretary SHALALA. Well, actually, there is only one set of actuaries. We all work off of the HCFA actuary, who is the legal adviser to all of us on explaining that. He could certainly be asked about why he has a different conclusion from the CBO, but the fact is that the HCFA actuary, I do not have the right to tell him he is wrong or right.
    Mr. MCCRERY. Sure.
    Secretary SHALALA. All I can do is ask him for an explanation. But that is what he said, and that is what I am reporting.
    Mr. MCCRERY. Does it not seem odd to you, though, that $78 billion in savings buys us 1 year, but then, if we throw in another $82 billion, it buys us 4 more years? It just seems kind of odd to me.
    Secretary SHALALA. I think it is the interaction between the home health care transfer and the other savings. That is what is going on there. And it ramps up differently. It is the way in which we made a series of policy decisions. And what CBO did when it laid out some options is it did not have policies underlying the ramp up, so we will sort all of this out as we work through it.
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    Mr. MCCRERY. Yes.
    Secretary SHALALA. In the same way we are going to sort out any differences we have in economic assumptions between the administration and the CBO.
    Mr. MCCRERY. Sure.
    Secretary SHALALA. It is the kind of thing that we will work out. But there really is only one actuary, and he does not report to me; he just tells me.
    Mr. MCCRERY. I understand completely. But it is something, I think, worth investigating a little more.
    Secretary SHALALA. Right.
    Mr. MCCRERY. And getting a little more explanation for.
    I really only have one question, Madam Secretary, and that is, What is your rationale for not including in the premium calculation the home health shift from part A to part B?
    Secretary SHALALA. That—that——[pointing to chart]
    Mr. MCCRERY. Could you be a little more verbal?
    Secretary SHALALA. Bring it over [the chart].
    Elderly and disabled Americans in the Medicare Program now pay 21 percent of their incomes on out-of-pocket costs for additional health care expenditures, including the premiums and copayments and everything else. We all pay about 8 percent. The average woman on Medicare has an income of $13,000 a year; 80 percent have incomes under $25,000 a year. We are talking about poor people. We got to the balanced budget without sliding that in under the premium, and every time we have to add costs to Medicare beneficiaries, we have to think about their total health costs, not just about the financing of the health care system, and that is the reason we did it. It was pretty straightforward.
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    Mr. MCCRERY. Well, it is no surprise that the elderly pay a larger share of their income for out-of-pocket health care expenses. After all, they are elderly; they generally have more health care expenses than younger folks, and, as a general rule, their income is less. So, that chart does not really surprise me.
    Secretary SHALALA. Actually, Congressman, the reason they do it is because the Medicare benefit does not include drug costs and other kinds of things that most of our benefits do. So, they actually pick up the cost for a more limited benefit than the rest of us have.
    Mr. MCCRERY. And the very poor, Madam Secretary, are taken care of with respect to their premiums——
    Secretary SHALALA. Absolutely.
    Mr. MCCRERY [continuing]. And their drug costs.
    Secretary SHALALA. Absolutely.
    Mr. MCCRERY. And so, we are not talking about the very poor. But in keeping with your testimony that you want to get back to the original intent of part B, the original intent of part B—part of the original intent of the program—included beneficiaries sharing in the costs. In fact, originally, it was, I think, up to 50 percent of the costs. We are now down to 25 percent of the costs of part B being borne by the recipients, and by now, artificially taking part of the part B expenditures and putting them completely into financing by general revenues is, I think, further subverting the original intent of that program.
    One thing that I really like about the Medicare Program is that it does impose some discipline on us because of the financing mechanism, either through payroll taxes or through premiums. And what you are proposing, in my view, is lessening that pressure on us policymakers to make sure the program is efficiently run; to make sure we control that program to the greatest extent possible.
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    So, I wish you would give some thought to, perhaps, agreeing to include in the premium calculation all of the part B expenses, even that which you propose to shift from part A to part B.
    Secretary SHALALA. Thank you.
    Mr. MCCRERY. Thank you.
    Chairman ARCHER. If I may, just very quickly, Madam Secretary, you commented, and I agree with you, that we have to look always at a bigger picture and not just zero in on some isolated area, and our Committee has—beyond what you are testifying about today, we have a major portion of the balanced budget considerations in this Committee. So, we have to look at it from a totally overall standpoint. And once this has shifted home health care benefits or at least a portion of them are shifted out of the trust fund and are being paid for out of the General Treasury, who is going to pay for that?
    Secretary SHALALA. Congressman, the same people who pay for part A. The taxpayers pay for both sides. Either we pay for it through a payroll tax, or we pay for it through our taxes on general revenues. I take all of this very seriously, because I think taxpayers pay for all of Medicare one way or another. And my only point was that we have to look at the interaction of all of these proposals. Some of these proposals may, in fact, bring down some of the costs for people, some of the things we are doing in outpatient care.
    So, if we can get all of the modernizing pieces that start to squeeze and make the program more efficient and more businesslike and make sure we are not increasing the out-of-pocket costs for the elderly, if Mrs. Johnson is correct that the original intent was for all of these HMOs to cover drug benefits and all of these other benefits, then some of that helps relieve some of the out-of-pocket costs for individuals. And my only point was that we got there by balancing the budget without increasing these costs for senior citizens.
    I understand it was actually the intent to cover home health care that was connected with a hospital stay, to shift everything else into part B. Most things in part B are under the 25-percent premium level. We simply took a look at what was happening to elderly people, to real people, and said if we do not have to increase their out-of-pocket costs, we should not do that.
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    Chairman ARCHER. Well, maybe I did not frame my question well enough, but would you agree with me that Medicare, as designed originally, was a pay-as-you-go program and a matter of earned right that you gained by paying a portion of your wages during your work life?
    Secretary SHALALA. I agree not only was it that but——
    Chairman ARCHER. Or is it a welfare program? Or how would you characterize it?
    Secretary SHALALA. It was originally designed as a program that was going to be paid for by all of us paying through our payroll taxes over a period of time. The actuaries at the time did not realize people were going to live so long and could not price medical services. And we have added some benefits. But the benefit package has not changed as much as the fact that technological breakthroughs and medical breakthroughs cost more than the inflation rate, and people are living 10 years longer than they were predicting at that time.
    Chairman ARCHER. No, I understand all of that, but certainly, I do not believe that you are telling this Committee that you think the concept of Medicare as an earned right ought to be discarded and that it is really just a welfare program——
    Secretary SHALALA. Absolutely not.
    Chairman ARCHER [continuing] Paid for by all of the citizens.
    Secretary SHALALA. Absolutely not.
    Chairman ARCHER. OK; well, see, that is what troubles me about this shift, because when you make this shift, instead of these benefits being paid out of the trust fund where people have paid in to deserve them and earn them as a matter of earned right, they are being shifted over to the General Treasury. And as you said, everybody pays for it that way. Everybody pays for it. It is no longer an earned right. It becomes a subsidized program.
    But as I understand, and I know technically, under the budgeting concept that we use up here, that it is revenue neutral to do that. It is taking money out of one pocket and putting it in the other, in effect, under the Federal budget. However, there is no provision that I see in your budget to provide the funding for that extra charge on the General Treasury, and that does trouble me. And I do not want to belabor it, because I have already had my time, and I apologize to the other Members of the Committee.
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    Secretary SHALALA. Chairman Archer, just a final point on that. When people agreed to pay the payroll tax, and the Medicare system was set up, what we have been saying from the beginning is that that benefit that costs so much now in part A was designed much more narrowly, and in some ways it got out of control by design, but it was designed much more narrowly. It was designed as a hospital benefit which properly was in part A.
    We are putting it in part B, and you are absolutely correct: We are not sliding it under the 25 percent. And the reason I am giving you is an honest one: We are deeply concerned about senior citizens and what they are now paying in out-of-pocket expenses.
    Chairman ARCHER. Mr. Neal, I believe, is next.
    Mr. NEAL. Thank you, Mr. Chairman.
    Thank you, Madam Secretary, for your presentation this morning.
    Chairman ARCHER. Mr. Neal, would you suspend for a moment?
    Madam Secretary, if you will excuse me, I have a speaking engagement at 12 noon that I committed to before we set up this hearing, and so, I am going to have to leave, and I apologize for that. We appreciate your coming——
    Secretary SHALALA. Thank you.
    Chairman ARCHER [continuing]. And being with us today, and Mr. Crane will preside until the conclusion of the hearing.
    Mr. Neal.
    Secretary SHALALA. Thank you, Mr. Chairman, and thank you, as always, for your graciousness.
    Mr. NEAL. Thank you, Madam Secretary.
    I thought the presentation was very strong. I think it is a good starting point. I just want to call attention to something that we have spoken of many times, and more references were made on the first row today to the teaching hospitals than to any other single item that came up, and again I cannot emphasize enough how important that is, particularly to the Northeast. And I know we have gone back and forth over this issue for some time during the last 4 years, and I appreciate your continued interest.
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    And I must tell you there still is a good deal of nervousness among those institutions, and they constantly bring those issues to our attention. Though I thought the presentation was very good this morning, I nonetheless would tell you that on an overall basis, they are still very nervous about what your prescriptions call for in Medicare proposals.
    Secretary SHALALA. Congressman Neal, those institutions, by their nature, as someone who has spent her career in them, their culture is nervous. They are going to be nervous until we get this fund put together in a way that works for them. I think there is a bipartisan consensus about the outlines of how to do it, and I really do believe we are going to be able to do it this year.
    I have told them that, but they are not going to believe it until they see it.
    Mr. CRANE [presiding]. Mr. Shaw.
    Mr. SHAW. Thank you, Mr. Chairman.
    I, first of all, would like to add my welcome to the Secretary, and thank you, Secretary Shalala. I know some people over in your shop were less than enthusiastic about the passage of the welfare bill, but they have been great warriors in jumping aboard and have now committed themselves to see that it is going to work, and I really feel very strongly that we are a very solid team now in trying to work together. That is not to say that we are not going to be without our differences, because we obviously will, and we know where some of those differences are right now.
    However, I would like to ask a question in an area in which we always had the enthusiastic support of you as Secretary and of my colleagues on both sides of the aisle, and that is in the area of child support, which was one of the most important goals, the enforcement of child support. And in passing the reforms last year, it was to help the States use automatic data processing to improve their child support programs. For well over a decade, the Committee has been providing States with enhanced funding to create and maintain automatic data processing capability in conducting their child support, child protection, and cash welfare programs.
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    And yet, in each of these instances, the results have been disappointing. Do you have reason to think the child support data processing requirements of the welfare reform bill can be more successful than previous programs?
    Secretary SHALALA. Well, as you know, you and I have struggled over this together. We have moved the dates up for the States in which they need to get these automated systems. It is now October 1, 1997. All of the States are currently using these automated systems for at least some of their case management activities, and they are clearly benefiting from the automation. Twelve States are now certified as meeting the automation requirements, and we are confident we are going to have a lot more in position in advance of the deadline.
    In general, the States are working very hard to meet the requirements. We are supporting their efforts through technical assistance. I think that this issue in particular is going to require both of us to keep on the States, to make sure they understand what a high priority this is not only for their welfare caseload but clearly for a broader group of women and their children who will benefit from these more sophisticated systems.
    The Congress has acted; it has done everything it has been asked to do, and the States now need to come through.
    Mr. SHAW. It was Mr. Matsui, I believe, who asked the question early on in the hearing, a question on what safeguards there might be to keep someone whose 5 years had expired in one State, simply moves to another and starts in the welfare system all over again. The legislation we passed requires you to come up with some suggestions with regard to how we might safeguard ourselves in that area. There may be some opportunities to not only check on these but other types of programs so that we can keep tabs and records, accurate records, on who is receiving benefits and where.
    Secretary SHALALA. Right.
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    Mr. SHAW. What we need is some type of identification of these people and these children so that when the technology is there, we can accurately define these people and who they are and where they are, and it may be that this whole thing can be worked together with this data processing so we do not continuously reinvent another data processing system and require the purchase of more and more hardware.
    Secretary SHALALA. I agree, Congressman, and when Olivia Golden testifies before your Subcommittee, she will be prepared to of lay out some of our ideas about that. As you know, some States have actually been doing it for a period of time; that is, comparing caseloads to make sure that people are not on two different systems. New York and New Jersey, for instance, have long cross-checked their computer systems.
    So, certainly the technology is there in many parts of the country, and Olivia can lay out the kinds of things we are thinking about.
    Mr. SHAW. Mr. Chairman, if I may just add one comment here at the end. In your budget, you put in some targeted job credits for people coming off of welfare. That is something I want to take a very hard look at in our Committee and hopefully support; hopefully, we will find the dollars to support it. I would, however, throw this out as just an observation. I think we would get much more bang for the buck if we require the construction of new employment centers, and if we also look to see where they are being placed, to be sure they are going back to the inner cities; to be sure we are providing jobs in the most impoverished parts of our country, so that where we are going to have the real problem of the poorest of the poor and people who have never had job experience, so that we can be sure those are the people we are targeting to bring in and also make sure that this is not corporate welfare, that we are not simply helping to pay somebody's payroll but encouraging them to make a very hard business decision, and that is to go into some of these pockets of poverty throughout the country.
    Secretary SHALALA. Well, Congressman, I think you will find us good partners in efforts to make sure these initiatives are carefully targeted and have the various kinds of supports of some of the other pieces built around them.
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    Mr. SHAW. Thank you.
    Thank you, Mr. Chairman.
    Mr. CRANE. Mr. Collins.
    Mr. COLLINS. Thank you, Mr. Chairman.
    And thank you, Madam Secretary. I know this has been long and drawn out, and I am going to be brief; just a couple of questions and a followup on the targeted tax credits.
    I understand the meeting with the President yesterday went very well, and in his opening, he mentioned the fact that we have some 2 million people we are moving from welfare to work. And I think that is a good approach, a good way to open up dialog. And I understand and respect the targeted tax treatment for businesses who do move people into the workplace. I think that is one solution. But I think another solution would be, too, to look at further tax simplification very similar to what Chairman Archer wrote the President about this past weekend.
    And, of course, the President's comment, too, gives us the open door to go home and to meet with our businesspeople and ask them what would be best to enable them to hire additional personnel, whether it be welfare or nonwelfare, because the more jobs that are created, the more need there is for workers out there, and the more we will be able to move. So, I am hoping you and others in the administration will work with us on more than just one solution to this area.
    Secretary SHALALA. Absolutely.
    Mr. COLLINS. Georgia has a good work-first program.
    Secretary SHALALA. Yes.
    Mr. COLLINS. Governor Miller has done an excellent job in Georgia in promoting the welfare reform, the welfare changes that are leading more people into the workplace. And as a followup to what Mr. Shaw was asking about, reports on data and data processing and how States are adapting to the changes in the child support recovery area, I wrote to Governor Miller earlier this year and asked that he set aside one day somewhere around May or June and invite all of the members of the Georgia delegation from both ends of the hall to meet with him and others who are involved in welfare reform and the welfare system in Georgia to give us a personal update. We could bring that information back to other Members of this Committee and other Members in the Congress and other Committees that our delegation serves to see just how reform is taking effect and what possible changes may be further needed. So, hopefully, he will follow up on that.
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    Now, a question: In the area of postacute care and dealing with an article that was in the Wall Street Journal back in October 1996, referring to double dipping, where several hospitals or hospitals have a tendency to move people quicker from acute care into skilled nursing care, and there seems to be some possible opening for double dipping. Are you in any way addressing that?
    Secretary SHALALA. Yes, we do address it. What happens is that we pay the hospital for the patient. They move the person more quickly to a skilled nursing facility which is theirs; they get paid twice on it. And yes, we do address that and a variety of other kinds of things that are similar that are really loopholes in the law that need to be fixed.
    Hospitals are not necessarily breaking the law in the process. We just have to make sure we are paying once for a service as opposed to twice.
    Mr. COLLINS. Good.
    Secretary SHALALA. And if I could make a point about Governor Miller, I love the idea of all of you getting together with him, because what you are going to find is that his is one of the States that has integrated his education system.
    Mr. COLLINS. Yes.
    Secretary SHALALA. For instance, the training of welfare recipients in community colleges to get child care certification, because there is a job market now in child care. And I spent some time with Governor Miller, and I think he has just been very imaginative in how they have put their program together.
    Mr. COLLINS. Well, he has, and a lot of the approach that he has taken to some of the welfare change has been more in the line of our side of the aisle, maybe, than the other side. But regardless, he has done a good job, and it seems to be working. We hope to get a good report from him, and we thank you again for your time.
    Secretary SHALALA. Thank you.
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    Mr. COLLINS. Mr. Jefferson.
    Mr. JEFFERSON. Thank you, Mr. Chairman.
    Madam Secretary, it is a pleasure to be with you again. I want to ask you a few questions about the children's health insurance initiative. I am glad, of course, to see some movement in that direction, some significant movement. The problem, of course, is that it involves only half the children. And the Secretary of the Treasury yesterday, Mr. Rubin, told us that that was not so much policy driven as it was budget driven; it just costs a lot of money to get it all done.
    I want to ask you, though, how the proposal makes the decision between those children who are covered and those who are out of coverage, and then, I want to talk to you a little bit about whether we could not on the reconciliation, the tax part of the reconciliation bill, try and address the kids who are left out. But tell me, please, how it makes a distinction now between those children who are covered and those who are not covered by the plan.
    Secretary SHALALA. Let me talk first about the children's health initiative. I am looking up Louisiana's numbers. Twenty percent of the children in Louisiana do not have health insurance. What we have done here with admittedly a modest proposal is to recognize that this is hard to do. The 10 million American children who do not have health insurance are not easy to find. Most of them have parents who are working. Sometimes, their parents are seasonal workers or minimum wage workers. Some of these children are eligible for Medicaid, 3 million, as a matter of fact, and we need to go find them.
    You will be interested in knowing that in States that have comprehensive managed care for their Medicaid population, they find the kids, because for the managed care companies, kids are cheap and healthy. They go out and find the kids and get them registered and get them their shots and do all of the other things they need to do. We have assumed we can find 1.6 million of them.
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    Second, one of the things the industry has said to me is we get kids registered for Medicaid; their mom gets a job; they are just above the income limit; we have to take them off of Medicaid. Let us keep them for 1 year. And then, if the State has another program for working parents, we can move the kids into that. We pick up another 1 million kids in that number. Low-income adolescents, those are the famous Waxman kids. They are coming in at 250,000 a year. There is another 1 million kids over the next 4 years.
    There are partnership grants with the States. Many of the States have started either by expanding Medicaid or finding innovative ways to set up pools for working-class kids so that their parents pay a small fee to get them a basic health care plan, buy an HMO for them. The States need some flexibility. We think we can get another 1 million children in that number. It may be more, depending on the States. And our Workers Between Jobs Initiative, which is the President's broader initiative to help low-income workers who lose their jobs, usually for less than 6 months, pay for their health insurance, might be paying for their COBRA. Again, the States will develop that plan and we can pick up another 700,000 children.
    We may, if we are very efficient, end up finding more kids on Medicaid; we may be able to leverage more of this money to cover more kids with some creative efforts by the Governor. This is an effort that does not add a lot of new money to the system. It works with the States but starts toward a goal that we all ought to be for, and that is that there ought to be no kid in this country who goes without health insurance at any point in their life, and filling in the gaps——
    Mr. JEFFERSON. I agree with the goal. I want to suggest two things before my time runs out. One is in Florida, of course, you know, there is a refundable tax credit for working poor families that participates in a school-based group insurance plan. I want to ask your ideas about that perhaps at some other time or perhaps, well, now, if I could.
    Secretary SHALALA. Let me give you a quick answer on tax credits.
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    Mr. JEFFERSON. And the last thing, so I can throw it in here, is, What do you do on the inclusion of drugs, the coverage of drugs in the plan? And here is my point, because I want to tie these two things together about ways to save money within the context of your budget proposal. Right now, the only drugs that are permitted to be covered are those that deal with physician-administered drugs. And every day, there are new drugs coming onto the market that can be provided orally, that do not require the intravenous application that cost a great deal less that now are not allowed to be used in the system, to make a long story short.
    Have you looked at ways to allow HCFA to get involved here, to make some approvals of these drugs as they are made available that do not require the physician-assisted treatment? The suggestion is that it saves a tremendous amount of money, maybe about as much as half. And I guess what I am trying to find is a way, either on the tax reconciliation part or in some other place in the context of this budget where we are working to find savings we can apply to make greater application to include more children. That is what I am trying to find a way to do, and I know you want to work with that, because we all agree on the goal.
    Secretary SHALALA. Thank you. I certainly will think about it.
    The problem with tax credits for dealing with this group of children is that their parents often do not have any tax liability. They are too low income. This is the group that participates in the earned income tax credit. So, unless it is a refundable tax credit, they just do not participate.
    Mr. JEFFERSON. Refundable, it would be, is what I would have in mind.
    Mr. CRANE. Mr. Becerra.
    Mr. BECERRA. Thank you, Mr. Chairman.
    Madam Secretary, thank you for being with us, and I suspect I am the last one to question you, and hopefully, you are pleased about that for reasons other than my questions.
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    Let me begin by first saying that I would like to applaud your work and, of course, the work of the President on a number of matters: One, your effort to bring 5 million children within the net of health care, and I think it is a shame we have approximately 10 million kids who do not have health insurance, but your efforts to bring in at least one-half of that population is something that I think deserves recognition. Your preventive approach, I hope we continue in that vein, because the more we do that, I think, the more we are able to make some other cuts that will help us balance our budget and certainly your efforts to try to get people to work who are on welfare; recognizing that it is going to cost money to do so I think is important, and the fact that you have included $3 billion in the budget is a sign that the President recognizes putting people to work will not be free.
    And if I can finally say thank you so much, and please extend to the President, as I have said to him in the past, my thanks for his efforts to try to help States and local governments address the needs of some of its residents who are not yet citizens who happen to become disabled after they legally enter the country or who are yet still minor children in this country.
    If I could ask a couple of questions that pertain to hospitals and physicians: I know that you are including some extra dollars for teaching hospitals and disproportionate share hospitals to try to address some of the concerns and having made some cutbacks and so forth to allow teaching hospitals to continue to exist—I will not say thrive but just to exist—and disproportionate share hospitals that always take on a larger burden of the nonpaying public. Can you tell us exactly what are the components of those proposals with respect to those two types of hospitals?
    Secretary SHALALA. Well, what we basically do is we carve out from what we are now paying for Medicare the amounts of money we are now spending, and then, we retarget it more effectively. There are hospitals now that are not serving the populations that are needy that are getting these resources. We need to target it more carefully toward hospitals that do, in fact, have a disproportionate share, and we need to do that gradually so people can work their way from a management point of view. But that is essentially what we do. It is a better targeting, going back to the purposes for which this money was allocated in the first place.
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    Mr. BECERRA. Now, I know there is a concern in States like California that any kind of cap or limiting of the moneys will penalize States which, with few dollars, do quite a bit of work as opposed to States that with lots of dollars do little work. Is there anything in the proposal you have that will ensure each dollar that is sent out to the various States will try to provide the same amount of service?
    Secretary SHALALA. Well, that is the point of the discussions that we are going to have. We want to make sure we target the money to places that really should be getting it in the first place. So, that will be part of the discussion to make sure that we are not wasting the taxpayers' money.
    Mr. BECERRA. I am very much looking forward to seeing what you come up with and perhaps having a chance to work with the administration on that particular aspect of it.
    May I ask a question with regard to occupational health and safety? I note—and I do not know much about it, and I would like to look into it more—that you will be spending less on consumer and occupational health and safety. An outlay of $2.1 billion in 1997 will go down to $1.9 billion in 1998. Can you give me an explanation of why we would spend less to provide health and safety for our workers and consumers?
    Secretary SHALALA. I will have to provide that for the record.
    Mr. BECERRA. OK; I would appreciate that.
    Secretary SHALALA. I do not know that off the top of my head.
    Mr. BECERRA. I would appreciate getting that information.
    Secretary SHALALA. OK.
    Mr. BECERRA. I would think that that would be something that we want to continue to provide. Maybe there are some cost savings there.
    Secretary SHALALA. My guess is that it is just savings in terms of the estimate of what was needed, but let me go back and take a look.
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    Mr. BECERRA. I appreciate that.
    Mr. Chairman, I will not ask any further questions. I suspect the Secretary has had a long day, and I will let her go, and I thank her for her responses.
    Secretary SHALALA. Thank you.
    [The following was subsequently received:]

    HHS plays an important yet small role in occupational health through NIOSH, the National Institute on Occupational Safety and Health, in CDC, Centers for Disease Control and Prevention. This program which does leadership and training, detection and investigation of health problems in the workplace, and surveillance of work-related disease and injury, receives a $7.2 million increase under the administration's budget proposal for fiscal year 1998. During fiscal year 1997, their activities were funded at $173.3 million.
    You may want to check with the Department of Labor's OSHA office for further information concerning expenditures on worker health and safety.


    Mr. CRANE. Thank you.
    Mr. McDermott.
    Mr. MCDERMOTT. Thank you, Mr. Chairman.
    Welcome, Madam Secretary.
    Secretary SHALALA. Dr. McDermott.
    Mr. MCDERMOTT. I have a couple of questions, policy questions, one about PSOs. Your proposal includes PSOs. What kinds of mechanisms have you put in place to deal with adequacy of the quality of care and fiscal solvency of these kinds of operations?
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    Secretary SHALALA. All of the above, and we would be happy to provide you with some detail on that. The PSO is essentially—I think we have essentially stuck to the standards that we had last year. It is very similar to last year's bill. What it would be is a grouping of affiliated providers, and they could directly provide the Medicare benefit package or a substantial proportion of it. This is similar to the definition in the 1995 budget bill, however, we would leave more of the definition to the regulatory process in terms of those kinds of pieces.
    [The following was subsequently received:]

    The administration's proposal would encourage the growth of PSOs, provider-sponsored organizations, while also maintaining a level playingfield amoung managed care plans. PSOs would be held to all of the same standards related to quality, access, marketing, beneficiary liability, benefits, and appeals and grievances.
    Because of differences between the PSOs' and HMOs' delivery systems, PSOs would be subject to special standards in two areas—(1) fiscal soundness and solvency and (2) private enrollment requirements; e.g., 50–50 rule and minimum private enrollment requirements.
    The administration's proposal would also permit PSOs to meet the 50–50 rule and the minimum private enrollment requirements in a different manner than HMOs. The PSO could ''count'' as commercial enrollees those individuals for whom the PSO was at substantial financial risk. For example, if the physician group of the PSO had received capitated payments from an HMO for a number of the HMO's enrollees, those individuals could count toward meeting the 50–50 requirement or the minimum private enrollment requirement for the PSO.

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    Mr. MCDERMOTT. The regulatory process at the State level or at the Federal level?
    Secretary SHALALA. At the Federal level. Our bill would require a separate solvency standard be developed for the PSOs, and the PSOs that wanted to contract with Medicare would not initially be required to have a State license unless the State standards were identical to the Federal standards.
    Mr. MCDERMOTT. So, they could not be higher at the State level, and if they were higher than the Federal level at the State level, they would not be required to get a license to be a Medicare provider.
    Secretary SHALALA. Actually, 2 years after the enactment of the provision, the States could impose more stringent standards than the Federal requirements if that standard was approved by me, and that is what the provision provides for.
    Mr. MCDERMOTT. OK; let me go to one other issue, which I would appreciate any additional information you could give me about the PSOs, because I think that is going to be an area of——
    Secretary SHALALA. OK; we will give you our detail on it.
    [The following was subsequently received:]

    Prior to approval of a State's certification and monitoring program, the Medicare Program would not require PSOs to be State licensed in order to obtain a Medicare contract. State licensing requirements would be preempted unless the State's requirements were identical to Federal contracting standards.
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    Once the State has a certification and monitoring program approved by the Secretary, the PSO would be required to obtain a license from the State.
    Prior to 1999, State standards would have to be substantially equivalent to Federal standards in order to be approved.
    After 1999, the State could impose more stringent standards but these standards would have to be approved by the Secretary.



    Mr. MCDERMOTT. Thank you.
    The other issue is the whole issue of HMO rate reductions. Those of us who come from the Northwest, I am sure you have heard this.
    Secretary SHALALA. Right.
    Mr. MCDERMOTT. We started this business of HMOs, and we have cut all of the fat out, and so, every single county in the State of Washington under the AAPCC, we are below the national average. So, when you cut us 5 percent, you are already cutting out of nonprofit HMOs a big chunk of dough, and it seems to me that that kind of meat ax approach lacks the precision of kind of a surgical look at what is happening. And some people—PhysPRC, for example, has suggested using encounter data or some other mechanism by which you would make a somewhat more rational assessment of what kinds of cuts could be made, and I wonder where you are in the thinking process, where you are in the planning process of trying to use encounter data as PhysPRC has suggested or some other mechanism.
    Secretary SHALALA. First of all, the way in which we now pay is sort of meat ax.
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    Mr. MCDERMOTT. Yes.
    Secretary SHALALA. It is 95 percent of the fee-for-service average. To be fair, both of these are rather crude approaches. In Denver, we have a competitive pricing demonstration, where we are going to have a bidding process that may give us a new methodology for how we price and reimburse HMOs. So, we are looking at some other mechanisms at the same time.
    The other thing is that the 5 percent is not 5 percent for every HMO. We are, in fact, at the same time trying to even out some of the reimbursements across the country, so there is some blending that is going on around the country. So, there are two or three things happening at the same time. And third, let me point out that we do that in the year 2000, so our ability to find—if we can find a scalpel before the year 2000, we may be able to find a scalpel. But if we cannot, then the studies still show that we are overpaying, unless Congress has a different intent as part of this process.
    But we are going to run the numbers by States with the interactions of the reimbursement changes as well as what we plan to do in terms of other proposed changes; let us see where we are. At the same time, we will be watching and looking for other kinds of methodological approaches. But this, certainly, is part of the discussion, the short-term as well as the long-term discussion.
    Mr. MCDERMOTT. I guess my worry is that you and I may not be here in the year 2000 when this hits, but we might be out there being beneficiaries, and the question will be, What did we set in motion here? I think many Members want to look at balancing the budget today but not look at what that implication is out there someplace down the road if we do not take into account what this is setting in motion.
    Secretary SHALALA. No, I understand that, and we are very concerned about that. In fact, almost everything we are setting in motion is either a more sensitive payment system or a more accurate one or a more efficient way of purchasing goods and services. But we are also assuming that the longer term discussion is going to be part of the final agreement, and that longer term discussion is, in part, shaped by some of these decisions we are making now. We are pretty sure about the overpayment. How we recapture some of that and are sensitive in a way that still provides a thriving industry is part of the discussion that all of us are going to have.
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    Let me assure you that we have no intention of cutting a relatively new industry in some parts of the country off at the knees, but we do need to recapture where we are overpaying in the system and at the same time make sure that we continue a kind of competition out there and a healthy movement from fee-for-service to managed care with all of the protections we want to build in.
    Mr. MCDERMOTT. Can I expect that the rates in Seattle will go up before you cut the 5 percent; is that what you are suggesting when you say we are blending rates?
    Secretary SHALALA. Well, let me look at our numbers before I assure you of that. I think that you would like to say to me that you would expect the rates to go up before we take the cuts. Let me take a look at our printouts when we finally play this out which are being done as we speak.
    [The following was subsequently received:]

    When I talk about blending rates, I am referring to the President's proposal to start basing payments on a combination, or ''blend,'' of local rates and national rates. At present, an HMO's payment rate is set at 95 percent of the average annual per capita cost (AAPCC) of a beneficiary enrolled in fee-for-service in that county. Due to geographic variations in average fee-for-service costs, rates vary dramatically across counties, ranging from $221 to $767 per month this year. The President's proposal will reduce this variation by basing rates partly on local fee-for-service costs and partly on national fee-for-service costs. This new system will be phased in over five years, so that by 2002 thirty percent of a county's rate will be based on national costs. Since Seattle is now a relatively low-costs area, its HMOs will receive higher payments as a result of this blend.
    Our actuaries estimate that under the President's plan, HMOs in Seattle will see increases in their payment rates every year between now and 2002. Even in 2000, when the 5 percent favorable selection adjustment is implemented, HMO payments in Seattle will still increase by 2.33 percent. The following chart shows our estimate of the annual percent increase in HMO payment rates for King County, Washington under the President's plan: 1998, 0.98%; 1999, 1.37%; 2000, 2.33%; 2001, 8.11%; and 2002, 8.13%.
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    Mr. MCDERMOTT. The other thing, Mr. Chairman, if you would give me some idea at some point of what it would mean to the budget if we did not transfer home health care from A to B, what kinds of cuts you would have to make elsewhere to have the same kind of balanced budget. I would like to see that. If you would give me that in writing or whatever; it does not have to be done here today. But I would like to know what the alternative is if we do not move.
    Secretary SHALALA. It would cost us probably more than $30 billion. We are talking about big money that we would have to take out of part A.
    Mr. MCDERMOTT. So, then, in terms of reimbursements to hospitals and HMOs, what kind of cuts would you——
    Secretary SHALALA. Well, if you looked at our original chart for where we took our savings, the major savings were taken from managed care and from hospitals. You could see how it plays itself out in terms of what we would have to do. I think it would actually be the provider cuts of $82 billion could mean an additional $30 to $40 billion in hospital cuts, for example. We are talking about a very different kind of discussion than the one we are currently having.
    Mr. MCDERMOTT. Thank you very much.
    Thank you, Mr. Chairman, for your indulgence a little longer than—
    Mr. CRANE. Well, it is understandable.
    Madam Secretary, you realize that Mr. McDermott is Mr. McDermott, M.D., and he is anticipating he may be back in private practice after the turn of the century. [Laughter.]
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    Secretary SHALALA. No, we are being very tough on the specialties, and he is a psychiatrist.
    Mr. CRANE. Right, yes, indeed.
    Secretary SHALALA. And I think he is better off staying in Congress, actually. [Laughter.]
    Mr. CRANE. Well, Madam Secretary, we want to thank you for your endurance.
    Secretary SHALALA. Thank you.
    Mr. CRANE. And we look forward to working with you.
    And with that, the Committee stands adjourned.
    [Whereupon, at 12:36 p.m., the hearing was adjourned.]
    [Submissions for the record follow:]
Statement of American Bankers Association

    The American Bankers Association (ABA) is pleased to have an opportunity to submit this statement for the record on certain of the revenue provisions of the Administration's fiscal year 1998 budget.
    The ABA brings together all elements of the banking community to best represent the interests of this rapidly changing industry. Its membership—which includes community, regional, and money center banks and holding companies, as well as savings associations, trust companies, and savings banks—makes ABA the largest banking trade association in the country.
    The Administration's 1998 budget contains several proposals of interest to banks. We believe that the Administration's revenue plan contains several significant proposals which, with modification, would provide much needed tax relief. Although we would welcome some of those tax relief proposals and agree with curtailing tax abusive transactions, we are deeply concerned with certain of the corporate reform proposals that have been inaccurately and pejoratively labeled ''corporate welfare'' and ''loophole closers.'' Some of the proposals are actually tax increases rather than ''loophole closers.'' In this connection, many of the Administration's proposals would be more properly addressed under the rubric of overall tax reform and should not be included in the budget. As a package, they will inhibit job creation, inequitably penalize business and lessen the overall economic stimulative impact of the budget tax package.
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    Our preliminary views on the tax relief and corporate reform proposals and other proposals are in the following paragraphs.

Tax Relief Proposals

Individual Retirement Accounts

    The Administration's proposal to expand the availability of individual retirement accounts (IRAs) is of particular interest to ABA. The banking industry fully supports efforts to revitalize IRAs, and we are particularly pleased that the concept of tax-advantaged retirement savings has garnered long-standing bi-partisan support. In this regard, we note that ABA fully supports the expanded IRA proposed by Senate Finance Committee Chairman William Roth (R–DE) and Senator John Breaux (D–LA), in the Senate (S. 197), and Representatives William Thomas (R–CA) and Richard Neal (D–MA), in the House (H.R. 446). That legislation would provide a model IRA vehicle designed to address the nation's emerging need to increase retirement savings.
    By way of background, the personal savings rate in this country has trended down over the past several decades. During the 1970s, individuals saved 7.8 percent of their disposable income; in the 1980s, the personal savings rate declined to 6.5 percent; for the first half of the 1990s, individuals saved only 4.7 percent of their disposable income. This declining trend means that individuals will be less well prepared to meet a variety of financial needs they are likely to encounter during their lives—including buying a home, paying for college, covering medical emergencies and providing an adequate retirement income. Since savings and investment are critical ingredients in economic growth, a declining savings rate also has negative implications for the future of our economy and for our ability to create new jobs.
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    The primary appeal of the IRA concept to individuals is based upon the tax advantage associated with it. That tax advantage is often viewed as a supplement to savings, making the IRA an appealing product for an individual's long-term savings growth. Individuals concerned about the availability of retirement funds can appropriately complement social security and other retirement savings vehicles with IRAs. Once an IRA has been established, the tax penalties that accompany early withdrawals provide further encouragement to save for the long-term.
    The challenge, then, is to develop a viable IRA product with sufficient appeal to attract a wide range of individuals to participate. We believe that, to be successful, an IRA must meet three criteria:
    •  first, it must be simple enough to be easily understood by consumers;
    •  second, eligibility criteria must be sufficiently inclusive to permit broad participation; and
    •  third, it must be flexible enough to be responsive to the financial needs of today's consumers.
    If such criteria are met, we believe that individuals will view the new and improved IRAs as valuable tools for long-term savings, and the product will be far more successful than the IRA vehicle that is currently available. The Administration's proposal is an important first step in creating a more viable IRA vehicle.
    Simplicity. One problem that has diminished the effectiveness of the current version of the IRA for bank customers is its complexity. Particularly, the rules for determining eligibility for today's IRAs are simply too difficult to understand. Millions of consumers have been so confused about the tests, eligibility determinations, and income limitations, that even when they are eligible, many individuals do not participate in IRAs. The problem has been exacerbated by the changes, and by constant discussions of changes, in IRAs. The importance of simplicity cannot be over-stressed. We strongly recommend that any new proposal be simple to understand in its terms and conditions.
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    Eligibility. In 1981, almost all working Americans were eligible for IRA coverage, and IRAs became immensely successful. However, after the 1986 tax reform act, the eligibility rules were changed dramatically—individuals covered by private pension plans were no longer eligible and the income limits established ($25,000 for individuals and $40,000 for couples) significantly reduced eligibility. Participation declined dramatically, and contributions have continued to shrink every year since 1986.
    Inflation also contributed to the decline in the effectiveness of IRAs. Many of those in the low to middle income bracket who remained eligible after the 1986 tax act have gradually been forced out of eligibility simply because of inflation-based pay increases. In the near future, inflation will continue to shrink the base of those eligible to invest unless some type of indexing is permitted under the statute.
    For a tax-favored savings incentive to be effective in generating new savings, the pool of those eligible to participate in the plan should be as wide as possible. The Administration's plan would, inter alia, raise and index the income limitations on deductible IRAs. The proposal represents an important first step in resolving the eligibility problem of the currently available IRA vehicle. It could be further improved by eliminating income phaseout limits altogether, which would allow a much greater number of individuals and households to participate in the expanded IRA vehicle.
    Flexibility. If there is any single reason why people have been reluctant to establish IRAs, it is probably the lack of flexibility. Individuals are understandably concerned about sinking their money into a totally illiquid account from which funds can not be retrieved without significant penalties—except by crossing the retirement age threshold. For a savings incentive to work, people need to have a certain comfort level that their savings can be accessed for emergencies and for certain other important expenditures.
    In our opinion, the Administration's proposal offers sufficient flexibility and will eliminate much of the anxiety that younger investors experience when they consider putting their money into what is perceived, by some, as almost a lifetime investment. Moreover, indexing of contribution limits addresses a long-term flexibility concern. An IRA plan should protect the contribution limits from erosion by the effects of inflation so that contribution limits will not need to be adjusted by law in the near future.
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    We also believe that a plan should be flexible in offering a range of options to the customer. Many of the current savings proposals differentiate between whether the IRA is ''front-loaded'' or ''back-loaded.'' With a front-loaded IRA, the taxpayer may take a tax deduction for the amount of the contribution. Alternatively, with a back-loaded IRA, there is no tax deduction for the contribution; instead, all earnings and contributions from the investment can be withdrawn tax-free for qualifying expenditures. A tax-favored savings plan should be flexible enough to offer both options to customers, since the decision as to which plan would be preferred may differ among individuals.
    The Administration's plan offers individuals indexation and special purpose options for both IRAs and Special IRAs, thus making the proposal more attractive and more effective in accomplishing the desired goal of increasing long-term savings.
    Economic Benefits of an Expanded IRA. A properly designed retirement savings instrument will result in higher usage by individuals and more long-term savings. The single most important long-term issue for this country is inadequate savings. Savings promote capital formation, which is essential for job creation, opportunity and economic growth.
    We support legislative efforts to restore tax-favored retirement vehicles for individuals at all income levels. In order to encourage people to return to a routine, long-term savings plan, we need an attractive product that meets the tests of simplicity, eligibility, and flexibility. The Administration's IRA proposal is a positive step toward creating a useful IRA product. It has many of the characteristics that we believe are important to attract individuals to contribute to IRAs.

Capital Gains

    The American Bankers Association supports legislative efforts to reduce the tax rate on capital gains. We believe that capital gains tax relief is necessary in order to increase capital formation, stimulate saving and investment, raise real wages for U.S. workers and boost economic growth in the U.S.
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    A reduction in capital gains tax rates would encourage domestic investment, particularly venture capital investments by financial institutions, by lowering the excessively high cost of capital. A broad based reduction would benefit a wide variety of income groups and economic sectors, including retirees, middle income families, large and small investors, businesses, farmers, and entrepreneurs. The banking industry continues to promote savings and investment. Reducing the capital gains tax rate would ''unlock'' capital assets, lower interest rates and spur the economy, resulting in raising federal revenues.
    We believe the Administration's capital gains tax cut proposal evidences acknowledgment of the positive economic impact of reducing the tax on capital gains. Although we support the proposal to exclude capital gains on sales of principal residences, we are disappointed that the proposal is so narrow and does not provide for a broad-based capital gains tax cut. We urge passage of a broad-based capital gains tax cut.

Estate tax relief for small business

    ABA supports estate and gift tax reform. Although the Administration's plan does not provide for much needed relief with respect to the burdens placed on small and family-owned businesses by the current estate tax rules, we appreciate the Administration's recognition of the immediate need for such relief.

Educational assistance

    ABA supports the permanent extension of tax incentives for employer provided education. The banking and financial services industries are experiencing dramatic technological changes. This provision will assist in the retraining of employees to better face global competition. Employer provided educational assistance is a central component of the modern compensation package and is used to recruit and retain vital employees.
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Research and experimentation tax credit extended for one year

    ABA supports the permanent extension of the tax credit for research and experimentation. The banking industry is actively involved in the research and development of new intellectual products and services in order to compete in an increasingly sophisticated and global marketplace. The proposal would extend sorely needed tax relief in this area.

Contributions of appreciated stock to private foundations

    ABA supports permanent extension of the full fair market value income tax deduction for gifts of publicly traded stock to private foundations. We agree that allowing donors to deduct the full value of such stock encourages taxpayers to devote the stock exclusively to charitable purposes.

Corporate Reforms

Increased Information Reporting Penalties

    The ABA strongly opposes the Administration's proposal to increase penalties for failure to file information returns. The Administration reasons that the current penalty provisions may not be sufficient to encourage timely and accurate reporting. We disagree. The banking industry prepares and files a significant number of information returns annually in good faith for the sole benefit of the IRS. The suggestion that the Administration's proposal reduces ''corporate welfare'' or closes ''corporate loopholes'' presumes that corporations are noncompliant, a conclusion for which there is no substantiating evidence. Certainly, the proposed increase in penalty is unnecessary and would not be sound tax policy. Further, the available evidence does not support the assertion that the current penalty structure is inadequate.
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Modify Net Operating Loss Carry-back and Carry-forward Rules

    The ABA opposes the Administration's proposal to limit carry-backs of net operating losses (NOLs) to one year and extend carry-forwards to twenty years. Current law permits NOLs to be carried back three years and carried forward fifteen years to correct income distortions resulting from losses reported at the end of the taxable year. In many instances, NOLs result from general business cycles. Business cycle periods may not necessarily conform to the twelve month calendar year nor the taxable year. Accordingly, a one-year carry-back limitation would further distort and prevent the accurate reporting of income for previous years.
    By way of explanation, the Administration cites the increased complexity and administrative burden associated with carry-backs vis-a-vis carry-forwards. This rationale is inconsistent with sound tax policy and is not an adequate justification for so significantly limiting the NOL carry-back period. The instant proposal may also have deleterious regulatory implications for banks. We are currently analyzing this proposal to determine its potential impact on regulatory capital and urge that it not be included in the budget tax package.

Modify foreign tax credit (FTC) carryover rules

    The ABA opposes the Administration's proposal to limit carry-backs of foreign tax credits (FTC) to one year and extend carry-forwards to seven years. The proposed FTC carryover limitation would further distort and prevent the accurate reporting of income for previous years. The Administration's explanation for the proposed limitation on NOL carry-backs cites increased complexity and administrative burden associated with carry-backs as opposed to carryforwards. The Administration's rationale is inconsistent with sound tax policy and is not an adequate justification for so significantly limiting the FTC carry-back period. This proposal may also have deleterious regulatory implications for banks. We are currently analyzing this proposal to determine its potential impact on regulatory capital. In any event, there is little, if any, justification for making such a significant tax policy change. We suggest that this proposal not be included in the budget package.
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Repeal section 1374 for Large Corporations

    The ABA opposes the proposal to repeal Internal Revenue Code section 1374 for large S corporations. The proposal would accelerate net unrealized built-in gains (BIG) and create a corporate level tax on BIG assets while also creating a shareholder level tax with respect to their stock. The BIG tax would apply to gains attributable to assets held on the first day, negative adjustments due to accounting method change, intangibles such as core deposits and excess servicing rights and recapture of the bad debt reserve. Congress only recently changed the tax laws to permit financial institutions to elect subchapter S status. Effectively, this proposal would close the window of opportunity for them to elect sub S by making the cost of conversion prohibitively expensive for the majority of eligible banks, which is contrary to Congressional intent.

Limit Dividends Received Deduction

    The ABA strongly opposes the Administration's proposals to reduce the dividends-received deduction (from 70 percent to 50 percent for corporations owning less than 20 percent of the stock of a U.S. corporation), modify the holding period requirement, and to deny the deduction on limited term preferred stock. In explaining the proposed changes, the Administration states, inter alia, that the 70 percent deduction is too generous; that the holding period requirement does not assure that the owner of stock bears sufficient risk of loss; and that the current rules for the deduction are too complex. We disagree. The ABA, along with other members of the financial services community, has steadfastly opposed limitation of the dividends received deduction.
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    The dividends-received deduction currently prevents multiple level taxation of earnings from one corporation paid to another and does not constitute ''corporate welfare,'' nor should it be considered a ''corporate loophole.'' Cutting back the deduction from 70 percent to 50 percent would be not only a tax increase but, in effect, would create a multiple level corporate tax. We do not believe that the tax policy should sacrifice equity in order to achieve simplicity. We strongly urge that this proposal be stricken from the 1998 budget package.

Basis of Substantially Identical Securities Determined on an Average Basis

    The ABA opposes the Administration's proposal to require taxpayers to determine their basis in substantially identical securities using the average of all of their holdings in securities. We also oppose the proposal to require that taxpayers use a first-in, first-out method for purposes of determining whether gain or loss on the sale of a security is long or short term. These proposals would unnecessarily create additional and complex recordkeeping burdens. Taxpayers would be required to maintain two sets of records for each investment: one for average cost (which must be adjusted at the time of each purchase) and another for acquisition dates (which must be adjusted at the time of each purchase or sale). The burden would be further complicated for taxpayers who maintain computerized records. Programming, in and of itself, in order to establish, maintain and adjust two sets of records at the time of each transaction, would be substantial. We oppose the significant imposition of costs and compliance burdens associated with this proposal to change the timing aspects of reporting gain or loss from the sale of stock or securities. This proposal is not targeted toward abuse, but is a significant tax policy change with respect to the timing of reporting gain or loss from the sale of stock.

Other Provisions
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Require reasonable payment assumptions for interest accruals on certain debt instruments

    ABA opposes the proposal to require prepayment assumptions for interest accruals that would cause credit card issuers to pay tax on grace period interest before having a fixed right to the income. The proposal would require issuers to include in currently taxable income an estimate of the amount of grace period interest that will accrue in the future. This estimate would be based on the credit card issuer's assumptions of the likelihood that its credit card customers will not pay their entire balance before the end of the applicable grace period. This proposal is not a ''loophole closer'' nor does it constitute ''corporate welfare.'' Moreover, this proposal can only be viewed as a tax increase and an arbitrary departure from well established tax policy.

Extend pro rata disallowance of tax-exempt interest expense to all corporations

    The Administration's budget proposes to treat all corporations the same as financial institutions without regard to the small issuer exception of section 265(b)(3). The proposal would also apply section 265 disallowance to a consolidated group rather than on an entity-by-entity basis. ABA is concerned that this proposal may have an unintended and deleterious impact on banks. We are currently analyzing this proposal and look forward to further discussion of this issue.


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    We appreciate having this opportunity present our preliminary views on the tax proposals contained in the President's fiscal year 1998 budget. We look forward to working with you in the further development of the revenue proposals to be contained in the fiscal year 1998 budget.



Comments of the Chicago Board of Trade and the Chicago Mercantile Exchange

    The Chicago Board of Trade (''CBOT'') and the Chicago Mercantile Exchange (''CME'') are submitting this statement in response to Chairman Archer's request for comments by the public on tax provisions contained in the President's 1998 Budget proposals. Our comments are directed to the proposal to impose a constructive sale on certain appreciated financial positions—a proposal apparently designed in reaction to a ''short-against-the-box'' transaction in the stock market.
    The CBOT and CME are the two largest markets in the world for transactions in futures contracts and options on futures contracts. The principal purpose of these contracts is to provide a means for the hedging of business and investment risks. The functioning of our markets can be impaired if tax rules threaten to penalize legitimate risk management activities.
    The constructive sale proposal causes some concerns for our markets. Although the tax planning strategies seemingly targeted by the proposal cannot be implemented on U.S. futures exchanges, the outer boundaries of the proposal's scope are not clearly delineated in the Treasury Department's explanation. Moreover, the proposed statutory language submitted last year in connection with the constructive sale proposal in the President's 1997 Budget was so ambiguous that adoption in its proposed form would have cast unwarranted doubts on the tax treatment of some transactions on our markets.
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    We urge that, if it is believed desirable to address the tax results for the short-against-the-box transaction, the provision be drafted narrowly to ensure that U.S. exchange-traded futures and options on futures not be adversely affected.

Description of Proposal

    Under the proposal, there is deemed to be a constructive sale of an appreciated position if the taxpayer (or a related person) enters into a position with respect to ''the same or substantially identical property'' that for some period ''substantially eliminate[s] risk of loss and opportunity for gain'' on the appreciated position. For this purpose, an appreciated position is apparently any position with respect to stock, a debt instrument, or a partnership interest if there would be gain upon the sale of the position. A constructive sale is not deemed to occur under the proposal if the appreciated position is subject to the existing constructive sale treatment under the mark-to-market rules of sections 475 or 1256.
    A U.S. exchange-traded futures contract (or an option on a futures contract) would generally not itself be subject to constructive sale treatment under the proposal because it would generally be marked to market already under existing section 1256. However, the current Treasury explanation (when read in connection with the proposed statutory language for the 1997 Budget proposal) suggests that such contracts could result in constructive sales of other property. At least in theory, U.S. exchange-treated futures (or options on futures) could trigger a constructive sale of appreciated stock or an appreciated debt instrument under the proposal if the taxpayer holding such appreciated property entered into a futures contract (or an option on a futures contract) under circumstances where (i) the futures or options contract is with respect to property that is considered to be the same or substantially identical to the appreciated stock or debt obligation, and (ii) the futures or options position is considered to have the effect of substantially eliminating, for some period, both risk of loss and opportunity for gain on the appreciated stock or debt obligation.
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Impact of Proposal on Futures and Options on Futures

    The CBOT and CME, like other U.S. futures exchanges, offer standardized futures contracts with respect to underlying property or indices. In the case of a conventional futures contract, one contracting party (the ''long'' party) agrees to buy and the other contracting party (the ''short'' party) agrees to sell a specified quantity of underlying property at a specific price on a specific delivery date in the future. Other futures contracts, particularly with respect to indices of property prices or other market information, call for final settlement in cash to reflect price fluctuations, as opposed to actual delivery of property. The exchanges also offer trading in options with respect to futures contracts. In the case of either futures or options on futures, most contracting parties close out their positions prior to the delivery or final settlement date by engaging in an offsetting transaction on the exchange (e.g., a party with a long futures position enters into a short position having the same underlying property, quantity and delivery month).
    The most actively traded contracts on the CME and CBOT are futures that relate to financial instruments. For example, the CME has cash-settled futures (and options on futures) with respect to various broad-based stock indices (e.g., the S&P 500 stock index). Both the CBOT and CME have futures (and options on futures) with respect to debt obligations, some of which call for actual delivery of a debt obligation (e.g., the CBOT's contract for Treasury bonds) and some of which call for cash settlement (e.g., the CME's Eurodollar contract). Accordingly, taxpayers using these financial futures contracts in connection with underlying stock holdings or holdings of debt obligations might potentially be affected by the constructive sale proposal.
    Any such cloud of doubt should be removed. Irrespective of whether it is considered desirable to alter the current law treatment of a short-against-the-box transaction, a constructive current sale should not be imposed on a taxpayer who uses financial futures transactions to hedge the risk associated with holdings of stock or debt obligations.
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    A contract to sell in the futures market and a current sale in the so-called ''cash'' market cannot be regarded as being interchangeable versions of the same substantive transaction.
    •  Unlike a sale in the current (or ''cash'') market, a futures transaction involves no current transfer of property and no current payment for a transfer of property. Any purchase, sale and payment of sale proceeds occurs in the future. In contrast, a short-against-the-box involves a current transfer of property (borrowed by the short seller) to a purchaser, who pays currently a purchase price for the transferred shares (with the sale proceeds generally being held by the stock lender to secure the short seller's obligation to ''repay'' the borrowed property).
    •  Because futures transactions involve sales (or cash settlements) in the future, the sales price in a futures transaction is rarely the same as the sales price in the cash market. The futures price may be higher or lower than the cash price, depending upon such factors as the period of time to delivery (or final cash settlement), costs associated with holding the underlying property, and the amount of current earnings realized by a holder of the underlying property. In any event, these price differences reflect a real economic difference between a futures transaction and a transaction in the cash market, including a short-against-the-box transaction.
    •  Because a futures contract involves no current sale or purchase, the holder of a short futures position who also holds stock or a debt obligation has the right to any dividends or interest on the underlying securities. In contrast, a short seller against-the-box effectively foregoes earnings on the securities he continues to own by obligating himself to make dividend or interest substitute payments to the securities lender.
    •  Persons who enter into short futures contracts (i.e., contracts to sell) in lieu of selling in the cash market generally do so to serve nontax risk management objectives related to the distinct economic characteristics of futures transactions, not to postpone a gain that would be realized in a sale on the cash market.
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    It would be especially inappropriate to impose constructive sale treatment in the case of hedges on U.S. futures exchanges because all transactions on those exchanges involve standardized contracts traded in public markets.
    •  Persons who enter into countervailing positions on a futures exchange and another public marketplace (including a public cash market) perform an important economic function of minimizing inter-market pricing distortions and enhancing the future price discovery function of the futures market. As noted above, there is generally a difference between a futures price and a cash market price. Arbitrageurs place appropriate trades in the respective markets to benefit when the price spreads are too wide or too narrow, and this profit-seeking activity also benefits the marketplace by tending to bring the respective price relationships back into proper alignment.
    •  Because U.S. exchange-traded contracts are standardized, a financial futures contract is rarely a perfect offsetting match for a position in the underlying property. The resulting ''basis risk'' means that hedges using U.S. exchange-traded financial futures (or options on futures) rarely, if ever, ''substantially eliminate'' risk of loss and opportunity for gain.
    •  Most futures contracts call for delivery (or final settlement) in the relatively near future and, in any event, rarely more than two years distant. This short-term feature, coupled with the mark-to-market and straddle rules, discussed below, makes U.S. exchange-traded futures (and options on futures) less susceptible than some off-exchange contracts to long-term deferral of tax on ''locked-in'' gain.
    •  Because of the liquidity of contracts traded on U.S. futures exchanges, futures positions can be readily disposed of. As a consequence, a hedge may be held for only a short period of time before being closed out through an offsetting exchange transaction. Unlike a typical short-against-the-box transaction where the taxpayer actually makes a sale (with borrowed shares) subject to an obligation subsequently to repay the borrowed shares, most holders of a short futures position never actually engage in a sale of the underlying property through the futures markets.
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    Most U.S. exchange-traded futures (and options on futures) are already marked to market under section 1256 and are also subject to the straddle rules of sections 1092 and 263(g).
    •  A taxpayer motivated solely by a desire to postpone recognition of gain on appreciated securities finds the futures markets an unaccommodating mechanism for doing so. Assume that a taxpayer with appreciated debt securities enters into short interest rate futures, and add the unlikely assumption that the appreciated securities and the short futures are so perfectly matched that risk of loss and opportunity for gain are ''substantially eliminated.'' Under these circumstances, any subsequent market movement in the cash securities is offset by an opposite market movement in the short futures position, so that the preexisting gain might be regarded as being locked-in. But the locked-in gain is not effectively shielded from tax. If the appreciated securities subsequently lose value, the offsetting futures gain, and thus effectively a portion of the overall locked-in gain, will generally be taxed currently under the mark-to-market rules of section 1256. On the other hand, if the appreciated securities subsequently gain additional value, the resulting mark-to-market loss on the offsetting futures position cannot generally be recognized currently on account of the loss suspension rules for straddles under section 1092.
    •  Under section 263(g), interest and other costs of carrying a security must be capitalized, rather than deducted currently, if the security is hedged in a manner that substantially diminishes risk of loss.
    •  There is no need to create an additional constructive sale rule to prevent any taxpayer manipulations using futures contracts. A new constructive sale rule would only add complexity and create uncertainty for legitimate market-driven transactions.

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    We are concerned with the notion that a contract for future sale and delivery of property should be treated for tax purposes as a constructive current sale of the underlying property. Such a proposal is particularly disturbing if it has potential application to futures contracts traded on U.S. exchanges, which serve important non-tax risk management functions. A proposal inspired by purported tax manipulations through short-against-the-box transactions in the cash market for stock, should not cast any doubt on the continuation of current law treatment for futures transactions.
    At a minimum, if the basic proposal is adopted, the legislation should make the following changes or clarifications:
    •  It should be made clear that stock index positions are not covered by the proposal. The regulations under section 246(c)(4)(C) and section 1092(d)(3)(B)(i)(II) provide detailed rules specifying the instances in which a taxpayer's stock portfolio sufficiently mimics a stock index so that a short position with respect to the index is regarded as being ''substantially similar or related property'' with respect to the stock portfolio. Under these Code provisions and regulations, the consequence of such a ''substantially similar or related property'' finding is application of straddle rules and, for corporate taxpayers, limitations on the dividends reduced deduction. The implication of these provisions is that a position with respect to a stock index is never considered to be a position with respect to property that is ''substantially identical'' to stocks in a portfolio. Cf. sections 246(c)(4)(A) and (C); sections 1092(d)(3)(B)(i)(I) and (II). If the short-against-the-box proposal is adopted, this implication should be confirmed to avoid undesirable disruption of stock portfolio hedging activities.
    •  If it is considered desirable to apply the proposal to debt obligations, notwithstanding the absence of evidence of tax deferral abuses with respect to such securities, the constructive sale treatment should not be applied with respect to debt obligations hedged through U.S. exchange-traded futures (or options on futures). Because of the standardization of exchange-traded contracts, it is very unlikely that such contracts should ever be regarded as ''substantially eliminating'' risk of loss and opportunity for gain with respect to debt obligations held by the taxpayer. Even if such a ''substantial elimination'' test could be met in a particular instance, the combination of the mark-to-market rules of section 1256 and the straddle rules of sections 1092 and 263(g) should be more than sufficient to prevent tax manipulations.
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Statement of Dwight S. Cenac, Chairman of the Board, Home Care Association of America (HCAA)

    Mr. Chairman and members of the committee, on behalf of Home Care Association of America (HCAA), I am honored to share our views concerning the critical issues related to Medicare policies for post-acute services, especially home health care. HCAA represents over 350 freestanding home health agencies across the United States.
    This submittal is divided into four sections:
    •  Section I—Part A to Part B shift for home health services
    •  Section II—Hospital Self-Referrals
    •  Section III—Operation Restore Trust
    •  Section IV—Payments to HMOs
    Before beginning my written testimony, I wish to convey that the National Association of Home Care (NAHC) and the PPS Work Group do not fully represent the over 350 freestanding home health agencies of HCAA. I hereby request that, if the full committee or the Health Subcommittee considers holding hearings pertaining to home health care, that I be invited to offer verbal testimony before the committee on behalf of freestanding agencies which represent 49 percent of the industry. HCAA is the only national association that solely represents the interests of the freestanding, proprietary home health agencies. It is imperative that this committee and the Health Subcommittee be aware of the issues that affect freestanding agencies and their patients.
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Section I—Part A to Part B shift for home health services

    On this issue, HCAA agrees with the National Association for Home Care (NAHC) that patient care will be seriously jeopardized if Congress allows the shift of payments from Part A to Part B, pertaining to home health services.
    The motive to shift home health payments from Part A to Part B clearly is ''smoke and mirrors.'' This shift will give the false impression that the Part A Trust Fund is being shored up, however, by shifting home health payments over to Part B, the threat of a ''sick-tax'' would be greater due to the co-pay provision in Part B. Assurances that home health would not be exposed to a co-pay are just a diversionary tactic to deceive Congress in approving this ''shell-game'' tactic.
    Shifting some home care payments from Part A to Part B would make Part A home care services more vulnerable to being bundled with hospital DRGs. Bundling will give hospitals a virtual monopoly on the health care market. Bundling will encourage hospitals to ''self-refer'' to their own hospital-based/owned post-acute care facilities, (i.e. home health agencies and skilled nursing facilities). Freestanding home health agencies would not have a level playing field to compete for health care patients. Hospitals would be the gate-keeper for Medicare dispersement, and it is unlikely that they would allow patients the freedom to choose a health care provider ''outside'' their control.
    By enacting this proposal, Congress will in fact be adding a tax to our nation's senior citizens. In addition, home health care is far less costly than hospital or nursing home care and should be promoted, not discouraged. We urge you to reject the proposal to shift home health spending from Part A to Part B.

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Section II—Hospital Self-Referrals

    One of the most critical issues to freestanding, entrepreneurial home health care agency owners is the issue of hospital self-referrals. The key words that we have heard over the last three years of the Republican-controlled Congress are ''competition'' and the ''free-market.'' If this committee and this Congress truly believes in these principles, then we ask that freestanding home health agencies be allowed to compete on a level playing field with hospital-owned/based agencies.

Currently, 42 CFR 424.22 entitled, ''Requirements for home health services'' states:

    (d) Limitations on the performance of certification and plan of treatment functions.—(1) Basic rule. Beginning November 26, 1982, and except as provided in paragraph (e) of this section, need for home health services to be provided by an HHA may not be certified or recertified, and a plan of treatment may not be established and reviewed by any physician who has a significant ownership interest in, or a significant financial or contractual relationship with, that HHA.
    Section (e) states: Exception to limitations—(1)Exceptions for governmental entities. The limitations of paragraph (d) of this section do not apply to an HHA that is operated by a Federal, State, or local governmental authority.

In addition, 42 CFR 424.22 section (3) clearly states:

    Significant financial or contractual relationship. Beginning November 26, 1982, a physician is considered to have a significant financial or contractual relationship with an HHA if he or she—
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    (i) Receives any compensation as an officer or director of the HHA; or
    (ii) has direct or indirect business transactions with the HHA that, in any fiscal year, amount to more that $25,000 or 5 percent of the agency's total operating expenses, whichever is less. Business transactions means contracts, agreements, purchase orders, or leases to obtain services, supplies, equipment, and space and, after August 29, 1986, salaried employment.


    HCAA has always believed that this regulation is crystal clear. Hospitals are prohibited from having doctors certify or recertify plans of treatment to hospital based/owned agencies if the doctor is employed by the hospital, and that doctor receives compensation over $25,000. Opponents of this regulation say that new health care systems developed over the past several years have made this regulation outdated and obsolete. The American Hospital Association (AHA) has lobbied hard to have Secretary Shalala declare a ''moratorium'' on enforcing this regulation until Stark II legislation is finalized. HCAA believes that improper hospital self-referrals drive up costs, eliminate competition and denies patient choice.
    I recently read a quote from Representative Thomas Bliley of Virginia pertaining to competition. Representative Bliley stated, ''Last Congress, we broke up one of the biggest monopolies still standing, giving consumers a choice in local telephone service. It's time we did the same thing with electricity.'' Also he said, ''no economist can quarrel with'' the notion that ''competition lowers prices, competition improves productivity, and monopolies are always inefficient and expensive—always. That's not opinion, it's fact. You know it, I know it, ... and history proves it.''
    Chairman Bliley is correct in his comments. Competition is the key to lower prices, higher quality and patient satisfaction. When telephone companies, airlines, cable television operators and fast food restaurants are allowed to compete fairly, prices go down and quality goes up. However, that doesn't mean that safeguards are done away with. It is imperative that regulations remain in place to ensure companies do not sacrifice quality in favor of profit. Federal agencies, like the FDA are necessary to ensure that food is safe to eat. In the same way, the Department of Justice, OIG and FTC should ensure that, in the health care sector of our economy, patients have the freedom to choose their own health care provider, especially home health care.
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    Consider that the hospital has a ''captive patient.'' The patient has received services while in the hospital and then when the patient is discharged to home health care, it is logical that the hospital would want to have that patient remain in the hospital system. The excuse a hospital may use is, ''we want to ensure that you are given continuity of care.'' Eventhough freestanding, Medicare-certified home health agencies are in the community, the hospital may be reluctant to lose the Medicare dollars associated with that patient. Then, if the patient returns to the hospital, the hospital may be able to receive that patient under a new DRG and again drive up health care costs.
    The main issue you should consider is PATIENT CHOICE. In many instances throughout the country, we have heard from freestanding home health agency owners that patients they have been treating, when readmitted into the hospital, are in some cases discharged to the HOSPITAL-OWNED/BASED HOME HEALTH AGENCY. Hospitals must honor patient choice and put aside profit. It is imperative that the patient is allowed, without coercion or manipulation, the freedom to choose his post-acute provider, and the choice must be honored by the hospital.
    The freedom to compete for providing health care services is also a concern. HMOs and hospitals have the financial resources to place FULL PAGE ADS in newspapers and have LARGE ADVERTISING BILLBOARDS to lure patients into their care. Freestanding home health agencies do not have the resources to compete with this type of advertising. Certainly, Medicare provides reimbursement for limited types of education, but HCFA is reluctant to pay for any advertising except in the case of recruitment.
    We urge the committee to ask HCFA to maintain and vigorously enforce the ''Hoyer Commentary'' pertaining to 42 CFR 424.22 and ensure that hospitals allow freedom of choice to patients.

Section III—Operation Restore Trust
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    Another critical issue to the survival of the freestanding home health agencies is Operation Restore Trust.
    Do not be deceived by reports from HCFA that this program is taking in $7.00 for every $1.00 spent. This committee (and the media) must ask HCFA these questions:
    1. How many cases, that ORT has brought have forward been OVERTURNED by an Administrative Law Judge and by other branches of the judiciary?
    2. How many freestanding agencies have been targeted by ORT, and how are they targeted?
    3. How many agencies targeted by ORT are MINORITY-OWNED?
    4. How many hospital-based/owned agencies have been targeted by ORT?
    On behalf of the over 350 members of HCAA, I applaud efforts by the federal government to root out fraud and abuse. I offer my services as, Chairman of the Board of HCAA, to work hand-in-hand with the government, in any way, to ensure that when Medicare funds are spent, they are well spent. It is critical that we get what we pay for. However, in the past ORT and HCFA have been not only reluctant, but adamant about NOT ALLOWING cooperation between the industry and the government, pertaining to ORT. Are we asking for leaders in the industry to be directly involved when considering possible cases? No. Are we asking for a cooperative, ongoing effort to work with Judy Berek, Special Assistant to the Administrator of HCFA, on possible issues pertaining to fraud and abuse? Absolutely, yes.
    In addition, a Providers' Bill of Rights must be adopted to ensure that providers are free from strong-arm tactics sometimes used by ORT. In the case of CSM Health Services in California, HCFA stripped the home health provider of their provider number before the administrative process was allowed to work. An Administrative Law Judge overturned HCFA and ORT, and even The Honorable John G. Davies (Case No. CV 96–4651–JGD), United States District Court-Central District of California stated, ''I think the surveyors—I think CSM has a case. The evidence this is before me that I have perused, read, considered, leads me to those conclusions. The Surveyors, I had the impression, were not reticent to wear their power on their cuff and to manifest it and exercise it in ways that are undesirable in today's society. The bureaucracy overreacted once again.''
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    We ask the committee to urge HCFA to respect freestanding agency owners and order HCFA to cease and desist using strong-arm tactics in Operation Restore Trust.
    In addition, the committee should ask HCFA to honor the favorable and correct decision in the CSM case in California.
    We ask the committee to urge HCFA to expand Operation Restore Trust to hospital-owned/based agencies and large chains. We also request that a Providers' Bill of Rights be developed, with input from HCAA.
    In conclusion, let me be clear. I believe that HCFA is using ORT to circumvent due process of freestanding home health agencies. With the enormous influx of funds from Kennedy-Kassebaum, HCFA will be given a green light to force freestanding home health agencies out of business. I urge the committee to ask HCFA for detailed reports on their fraud and abuse activities, not limited to funds recovered, but cases appealed and overturned in favor of freestanding agencies.

Section IV—Payments to HMO's

Stop HMOs from Overbilling Medicare Billions!

    HCAA applauds the President for proposing to save $20 Billion over five years by reducing payments to HMOs. Congress should embrace this proposal.
    In fact, HCAA believes we can do more. HCAA recommends HMO legislation to save the desired six percent (over $16 billion) in Medicare dollars annually, by requiring HMO Medicare reimbursements to incorporate a ''case-mix'' capitation adjustment. Currently, HMOs are paid an average of $4,500 per Medicare beneficiary, which was falsely computed based upon the naive assumption that HMOs would enroll a case-mix of both healthy and sick Medicare beneficiaries. Because it has now been proven that HMOs seem to target the healthy elderly for enrollment, and because these healthy enrollees cost Medicare less than $500 a year (Consumers' Research, 7/95), HMOs are costing (not saving) Medicare the billions of dollars that, alone, would keep the program solvent. For example, a ''case-mix'' capitation adjustment factor (i.e., payment of only $500 for healthy elderly enrollees, versus the current $4,500), would guarantee that HMOs would be paid only what it costs to provide quality care, plus a fair reimbursement for administration and profit. On Nov. 11, 1995, the GAO delivered its fourth HMO report to Congress with this statement, fully supporting HCAA's conclusion: ''HMO Rate-Setting Methodology Thwarts Medicare's Efforts to Realize Savings.'' In fact, an NBC News expose documented that a full 90 percent of all Medicare beneficiaries cost an average of only $1,900 per year under traditional Medicare. HMOs currently overcharge Medicare $16 BILLION annually.
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    We respectfully disagree with Senator Trent Lott who said several days ago that HMOs would not stay in business if the profit motive was taken out of the equation. HMOs should be in the business of health care for providing care, not for profit. Freestanding home health agencies are NOT ALLOWED to make a profit. HMOs, while driven by the stockmarket and stockholders, should remain committed to the patient first.
    In addition, we urge Congress to move forward on hearings pertaining to managed care that President Clinton suggested last year.


Statement of International Swaps and Derivatives Association, Inc.

    The International Swaps and Derivatives Association, Inc. (''ISDA'') is an international trade association whose membership includes 309 of the largest commercial, merchant and investment banks, corporations and other institutions that are engaged in privately negotiated derivatives transactions. ISDA is, therefore, vitally concerned about the effects of a proposal included in the President's budget that would ''Require Recognition of Gain on Certain Appreciated Positions in Personal Property'' (the ''Proposal''). The Proposal would effectively impose a new tax regime on certain hedging transactions and thus would seriously affect use of derivatives transactions in hedging by businesses and investors.
    The Proposal would require a taxpayer to recognize gain (but not permit recognition of loss) upon a ''constructive sale'' of any appreciated position in stock, a debt instrument or a partnership interest. A constructive sale would occur when the taxpayer or a related person either (a) ''substantially eliminates'' risk of loss and opportunity for gain by entering into one or more positions with respect to the same or ''substantially identical'' property, or (b) enters into a transaction that is marketed or sold as being economically equivalent to eliminating the risk of loss and opportunity for gain, regardless of whether the transaction involves the same or substantially identical property. The Proposal is retroactive, because it applies to constructive sales entered into after January 12, 1996 and before the date of enactment, if the transaction resulting in the constructive sale remains open 30 days after the date of enactment.
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    ISDA strongly opposes the Proposal, for the following reasons, which are explained in more detail in this statement:
    •  Although the Proposal was motivated by certain well-publicized transactions that are perceived by some as abusive, including ''short-against-the-box'' sales of stock, the Proposal is much broader than necessary to deal with those transactions. The Proposal potentially applies to a variety of legitimate hedging techniques used by investors and businesses to manage risk. Current law rules applicable to taxpayers that enter into straddles and similar transactions—including Sections 1092, 263(g) and 1258 of the Internal Revenue Code—adequately address transactions that use offsetting positions to manipulate the timing and character of income.
    •  The Proposal, at least as it applies to derivatives transactions, is based on a flawed analogy between hedging transactions and sales. An actual current sale of stock owned by a taxpayer involves a current transfer of stock, including the risks and rewards of stock ownership, by the taxpayer-seller to a new stock owner in exchange for cash. In contrast, a taxpayer in a typical hedging transaction does not transfer stock to a new owner, reduces risk only temporarily, receives no immediate cash payment and incurs counterparty credit risk. As a result, the position of a taxpayer that has entered into a hedging transaction treated as a ''constructive sale'' under the Proposal is quite different from the position of a taxpayer that has actually sold a financial instrument.
    •  The Proposal represents a major departure from the fundamental tax principle that capital gains must be realized before they are taxed. The realization requirement is essential to the administration and perceived fairness of the federal income tax system. Any exception to the realization requirement—particularly one that is as broad and unclear in scope as the Proposal—should be adopted only after careful and thorough consideration.
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    •  The Proposal will discourage economically useful risk management transactions, and thus may reduce both economic efficiency and market liquidity, while increasing market volatility.
    •  The Proposal is so vague and uncertain in its scope that it will be difficult or impossible to administer in certain cases. If the Proposal is enacted and is not limited to short-against-the-box transactions, we strongly urge that it not apply to other transactions until after the Treasury Department has issued regulations resolving a number of technical issues.
    •  Even apart from the merits of the Proposal, retroactive application would be unfair, and the threat of retroactive application will disrupt normal market activities and business transactions. We respectfully suggest that the Chairman of the Ways and Means Committee announce that, if the Proposal is approved by the Committee, it will be prospective only.

I. Proposal is Much Broader than Necessary to Deal with Transactions Perceived as Abusive

    The Proposal is directed at so-called short-against-the-box sales in which a taxpayer that owns appreciated stock borrows identical stock and then sells the borrowed shares, rather than the appreciated shares already owned, thus recognizing no gain or loss. In such a transaction, the taxpayer completely eliminates any risk of loss or potential for profit from changes in price, and does so for an indefinite term. If the taxpayer is an individual, and dies owning the stock that was sold short, the unrealized appreciation in that stock is never taxed because the basis of the stock is increased to its fair market value at death. The Proposal was motivated, in particular, by well-publicized transactions in which individuals have engaged in short-against-the-box sales, intending to benefit from this ''step-up'' in tax basis of the hedged shares at their death. The Proposal would treat the sale of the borrowed shares in a short-against-the-box transaction as a constructive sale of the appreciated shares already owned.
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    Although it is targeted primarily at short-against-the-box sales by individuals, the Proposal adopts rules that apply much more broadly. The Proposal applies to transactions in which—in contrast to a short-against-the-box sale—the taxpayer has not actually sold any property, but instead has merely used various contractual arrangements to hedge the risk of holding property for a limited time period. Such contracts include equity swaps, which provide for payments based on changes in the value of (and, sometimes, dividends from) the property. Thus, the Proposal would treat a taxpayer that enters into an offsetting position to hedge the risk of holding a security as having sold that security.
    The Proposal also applies to positions in financial instruments other than stock, including positions in debt and partnership interests. We are particularly concerned about the Proposal's potential application to debt instruments. Targeting debt instruments is especially misguided because, so far as we know, there is no evidence that transactions involving debt instruments are tax motivated in the way that some short-against-the-box transactions in stock are perceived to be. Moreover, the potential scope of the Proposal as applied to debt instruments is particularly unclear and broad. Based on the statutory language released in March 1996 with President Clinton's proposed Fiscal Year 1997 budget, it appears that if a taxpayer owning an appreciated bond enters into an interest rate swap having roughly the same term as the remaining term of the bond, the taxpayer would be treated as having constructively sold the bond.
    We believe that current law is adequate to prevent use of offsetting positions to manipulate the timing and character of income. Congress has already enacted a number of provisions that serve to prevent such manipulation, including Sections 1092, 263(g) and 1258. Section 1092 defers a deduction for losses in certain straddles to the extent that a taxpayer has an unrealized gain in an offsetting position. Section 263(g) requires capitalization of costs to carry straddle positions. Section 1258 prevents use of forward sales to convert what might be viewed as equivalent economically to interest income into capital gain.
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II. Proposal Ignores Fundamental Economic Differences Between Hedging Transactions and Actual Sales

    The Proposal's application to equity swaps, forwards, options and other derivative contracts appears to be based on the premise that entering into these contracts is economically equivalent to an actual sale. This premise is incorrect and ignores a number of fundamental differences between a hedging transaction and an actual sale.
    First, in a sale, the taxpayer exchanges its position for cash or other property, which it may then use as it pleases. In a hedging transaction, such as a swap or forward contract, the taxpayer does not receive cash. A hedger may have reduced its price or market risk, but the hedging transaction has not increased the hedger's liquidity. We recognize that a taxpayer may be able to realize cash by borrowing against the hedged item. However, a taxpayer can borrow against any appreciated marketable security. The ability to borrow does not distinguish a taxpayer that enters into an equity swap from a taxpayer holding an appreciated security that does not enter into a swap.
    Second, in an equity swap or other derivative contract, the taxpayer retains ''counterparty risk'', meaning that it may not be paid if the counterparty to the contract defaults. Thus, the taxpayer is not fully insulated from market risk on its underlying hedged position. There is no similar risk faced by a taxpayer that sells its position (except in the case of a taxpayer that enters into an installment sales contract).
    Third, in an actual sale there is a real transfer to a new owner of all the incidents of ownership of stock, including the right to vote the stock, the right to all dividends and the right to transfer the stock to a third party. In contrast, an owner of stock that enters into an equity swap, a forward contract, or a combination of options retains the right to vote the stock and generally retains the right to transfer the stoce these rights. In addition, an owner of stock that enters into a forward contract, a combination of options or an equity swap (other than a ''total return'' swap) retains the right to dividends.
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    Fourth, many derivatives used to hedge, including equity swaps, cash settled options and forward contracts, are temporary arrangements. A sale is a permanent disposition of a position. At the end of the equity swap, the taxpayer is in the same posture with respect to the hedged position as it was before the transaction. A short-term hedging transaction does not resemble an outright sale of appreciated property as an economic matter, even if the hedging transaction eliminates all the burdens and benefits of ownership for a limited time period. In an outright sale, in contrast, a taxpayer disposes of all the burdens and benefits of ownership forever.

III. Proposal is a Broad and Unprecedented Departure from the Realization Requirement, Which is Crucial to the Administration and Fairness of the Tax Law

    A fundamental principle of the income tax system is that gain from appreciation of an asset is generally subject to tax only when it is realized by sale or exchange. The realization requirement is essential to the administration and fairness of the income tax system. The realization requirement ensures that taxpayers (and the Internal Revenue Service) know when tax is due. In general, gain is realized when, but only when, a taxpayer receives cash or property in exchange for appreciated property. The realization requirement generally also ensures that taxpayers have the ability to pay tax, because tax is imposed only when a taxpayer has received cash or property that can be used to pay the tax.
    Although Congress has enacted several exceptions to the realization requirement, those exceptions have been both narrow and precise. The exceptions include Sections 1256 and 475. Each of these exceptions applies to very limited classes of taxpayers and positions, and each was based on a rationale that does not generally apply to positions subject to the Proposal.
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    Section 1256 generally requires mark-to-market accounting for regulated futures contracts and certain other narrowly defined categories of positions, including foreign currency contracts, nonequity options and dealer equity options. The legislative history of Section 1256 states that mark-to-market accounting was justified for regulated futures contracts because, under the rules of U.S. commodities exchanges, holders of such contracts can withdraw cash on a daily basis as their positions appreciate, and thus are in constructive receipt of appreciation. In contrast to appreciation in regulated futures contracts, appreciation in positions subject to the Proposal cannot be realized in cash, other than by borrowing. The mere ability to borrow against an appreciated position has never before been seen to justify taxation of that appreciation, and the ability to borrow does not distinguish positions subject to the Proposal from any position in marketable securities.
    Section 475 generally requires taxpayers classified as dealers in securities to use mark-to-market accounting for their positions in securities. The legislative history of Section 475 explained that this requirement was justified for dealers because inventories of securities ''are currently valued at market in determining their income for financial statement purposes and in adjusting their inventory using the LCM method for Federal income tax purposes''. This rationale does not generally apply to taxpayers and positions that would be subject to the Proposal.
    Each of Sections 1256 and 475 was enacted only after exhaustive review by Congress, the staffs of the tax writing committees and experts in the Treasury and the Internal Revenue Service. Each of these two sections applies to losses as well as to gains. In contrast, the Proposal would, if enacted, impose a partial mark-to-market regime for gains—but not losses—in certain hedging transactions without the benefit of such review and debate.

IV. Proposal Will Deter Economically Useful Risk Management
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    The Proposal will discourage investors and businesses from prudent risk management by imposing tax when they enter into certain kinds of hedging transactions. Risk management through temporary hedging is useful economically for a number of reasons. First, it increases the efficiency of markets by disseminating pricing information more widely and more rapidly than would be the case in the absence of hedging. Second, it reduces the volatility of markets. Third, it increases the liquidity of markets. The economic benefits produced by hedges of equity positions are analogous to the economic benefits that result when businesses hedge price, interest rate and currency risk through commercial hedging transactions. In both cases, hedging, like insurance, allows risks to be reallocated to those market participants that can bear them most efficiently.
    The economic value of hedging has been recognized by both Congress and the Treasury Department. Commercial hedging transactions are excepted from the mark-to-market rules under Section 1256 and the straddle rules of Sections 1092 and 263(g). There are also special rules for hedges under Section 475, and the economic benefits of hedging are acknowledged in the legislative history of that section. In addition, hedging regulations promulgated within the past few years, under Sections 1221 and 446, were intended to provide tax rules that do not discourage commercial hedges. In light of the recognized concern regarding possible tax impediments to hedging transactions, the potential application of the Proposal to legitimate hedges seems especially inappropriate.
    We recognize that the Proposal would not impose tax on all hedging transactions. The Proposal would apply only where the taxpayer ''substantially eliminates'' risk of loss and opportunity for gain. Thus, a taxpayer that eliminates risk of loss by purchasing a put option, but retains opportunity for gain, would not be affected by the Proposal. Such hedging is frequently not practical, however. Taxpayers often cannot afford to purchase temporary loss protection (e.g., by buying a put) unless they also temporarily sell at least some of the opportunity for gain by selling a call.
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V. Scope of Proposal Is Very Unclear, Making Administration and Compliance Difficult

    Based on the description of the proposal released by the President on February 6, the scope of the Proposal is uncertain. Extension of the Proposal beyond core cases (tax-motivated short-against-the-box transactions) creates significant ambiguity for transactions that may not be within the intended reach of the Proposal. The Proposal raises many complex interpretive questions and will create real uncertainties, which will result in market distortions and inefficiencies.
    The financial markets have already witnessed the real economic costs that can result from a state of uncertainty in the tax treatment of common hedging transactions. Such uncertainty resulted from the Supreme Court's decision in Arkansas Best v. Commissioner, 485 U.S. 212 (1988), and was remedied only by the Treasury Department's issuance of regulations in 1993 clarifying the treatment of business hedges (Treasury Regulation Section 1.1221–2). In the interim, this uncertainty discouraged economically useful hedging transactions, resulting in inefficiencies that were recognized in the Conference Committee's report on the Revenue Reconciliation Act of 1993.
    We are concerned that these uncertainties may be inherent in the Proposal, at least in its current broad form, and will not easily be resolved as statutory language is drafted. Our concerns are borne out by the statutory language released in March 1996 with President Clinton's proposed Fiscal Year 1997 budget, which included a proposal very similar to the Proposal.
    The Proposal does not achieve its goal of clearly identifying a specific class of transactions that are economically equivalent to actual sales. Uncertainties arise in a number of different respects.
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    First, the Proposal, in its current broad form, requires a determination of whether a particular transaction ''substantially eliminates the taxpayer's risk of loss and opportunity for gain'' with respect to a position. Neither the Proposal, nor the statutory language released in March 1996, gives any guidance as to the degree to which a taxpayer must shift risk of loss and opportunity for gain before they are ''substantially eliminated''. Has a taxpayer substantially eliminated opportunity for gain if it retains the first 5% of price appreciation? the first 10%? the first 25%? Is there a constructive sale if the taxpayer retains a significant portion of the upside (or downside) potential, but not the first portion (e.g., the taxpayer retains the benefit of appreciation of between 15% and 30%)?(see footnote 1)

    Second, it is not clear whether the Proposal applies if a taxpayer retains the right to dividends and enters into option contracts, a forward contract or an equity swap that provides for payments based only on price changes. Arguably, application of the Proposal in these cases should depend on whether dividends are a substantial part of the expected return from the stock. In the case of a nondividend paying stock, retention of the right to dividends may be insignificant.
    In contrast, if the owner of a dividend-paying stock retains the right to dividends, it cannot be said to have substantially eliminated risk of loss and opportunity for gain. For example, a forward contract to sell a dividend-paying stock does not substantially eliminate opportunity for gain unless the forward price provides for adjustment to reflect actual dividend payments. Similarly, put and call options with strike prices that are not adjusted to take into account actual dividends do not eliminate risk of loss and opportunity for gain if the underlying stock pays dividends.
    A taxpayer that enters into a forward contract to sell a dividend-paying stock is in a significantly different economic position compared to a taxpayer that actually sells the same stock. The price at which an actual sale takes place is the price in the cash (or ''spot'') market. In contrast, the pricing of forwards (as well as options and certain swaps) reflects pricing in the forward market. There are significant differences in pricing in these two markets. The forward price of a financial instrument is based both on the cash price and on the expected net cost to carry the instrument during the period ending on the settlement date. The net cost to carry an instrument is equal to the excess of the cost of financing a position in the instrument over the return from the position (including dividends). Because of the cost-to-carry factor, and the resulting pricing differences between the cash and forward markets, a taxpayer that hedges with certain derivatives has not substantially eliminated risk of loss and opportunity for gain.
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    Third, there is uncertainty as to how the Proposal would apply to swaps involving the return from a market sector or a broader market index. For example, an investor might exchange the return from a single equity for the return from a market sector or broad market index that includes the single equity, in order to diversify risk. Alternatively, an investor might enter into a swap under which it pays the return from a portfolio of stocks that includes a stock in which the investor holds an appreciated long position. In these transactions, would the Proposal be applied by decomposing the index or portfolio, so that the swap is treated as separate swaps on each of the equities that make up the index or portfolio? We note that the Treasury Department has issued regulations under Section 246, which provide complex rules to address analogous issues.
    Fourth, it is not clear from the Proposal or the March 1996 statutory language how long the term of the hedging transaction must be before the Proposal applies. Under the statutory language released in 1996, a constructive sale would occur if a taxpayer substantially eliminates risk of loss and opportunity for gain ''for a period''. This is vague language. Does it mean that constructive sale treatment applies if a taxpayer has substantially eliminated risk of loss and opportunity for gain for a very short time period? for a day? for a week?
    We believe that the Proposal should be clarified so that no constructive sale is deemed to have occurred unless the taxpayer has substantially eliminated risk of loss and opportunity for gain for a specified time period that is substantial. Such a limitation is consistent with the purposes of the Proposal. Taxpayers that wish to achieve the equivalent of an actua, because such contracts most closely approximate the elimination of price risk that results from an actual sale.
    Fifth, it is not clear how much weight, if any, is to be given to counterparty credit risk in determining whether the ''substantially eliminates'' test is met.
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    Sixth, it is not clear what, if any, significance is to be given to the taxpayer's lack of subjective intent to use a transaction to eliminate risk with respect to an appreciated long position. In the case of a derivative that is marketed to a taxpayer as eliminating risk of loss with respect to a particular long position, the taxpayer's subjective intent is clear. In many other cases, particularly in cases involving groups of related business entities, there may be no subjective intent to eliminate risk of loss. Frequently, affiliated groups of corporations include a number of different business units that operate largely independently. One unit may enter into a derivative contract either as a speculation or a hedge of its own position, without knowing that the derivative has the effect of hedging the risk from a position held by another business unit in the same affiliated group.
    These issues are particularly likely to arise in the case of debt instruments. Consider for example, an affiliated group of corporations, one of which owns appreciated investment grade debt securities. Another member of the group enters into an interest rate swap in order to hedge a future borrowing. The Proposal, in contrast to Sections 1256 and 1092, provides no exception for such business hedging transactions, and it appears (based on the March 1996 statutory language) that the Proposal could treat the swap as a constructive sale of the debt securities.
    The foregoing questions are not hypothetical. If the Proposal is enacted in its current broad form, all the issues discussed above will arise immediately from transactions that already are widely used in the market. It can be expected that taxpayers and their advisors will, quite reasonably, take a wide variety of positions as to how these issues should be resolved, and thus as to whether the Proposal applies to very common transactions. We submit that such uncertainty will seriously undermine confidence in the fairness and predictability of the law.
    Some supporters of the Proposal might seek to dismiss our concerns on the ground that uncertainty will create a useful in terrorem effect. Those supporters may believe that uncertainty about the scope of the Proposal will deter taxpayers from entering into any transaction that, under the broadest possible reading of the Proposal, would be a constructive sale. If the Proposal were in fact to have such effects, the Proposal would discourage economically useful transactions that the Proposal was not intended to cover. However, we do not believe that all taxpayers will necessarily construe the Proposal so broadly; in the absence of clear answers, taxpayers likely will take a variety of positions. More conservative taxpayers and their advisors are likely to construe the Proposal broadly, while more aggressive taxpayers and advisors will take the position that the scope of the Proposal is very narrow. Vague and poorly defined provisions, such as the Proposal, thus tend to put conservative taxpayers and their advisors at a competitive disadvantage.
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    We note that the issues summarized above are analogous to difficult technical issues that arise under Section 246(c)(4), which denies a corporation the deduction for dividends received with respect to stock if that corporation hedges its risk of loss from holding that stock in certain ways. Sections 246(c)(4)(A) and (B) may effectively deny the dividends received deducts under a contractual obligation to sell, has made a short sale of, or grants an option to buy, substantially identical stock and securities. Section 246(c)(4)(C) may effectively deny the dividends received deduction if a taxpayer has diminished its risk of loss by holding one or more other positions with respect to substantially similar or related property. Whether Sections 246(c)(4)(A) and (B) apply to a particular case generally is clear, and thus these rules took effect prior to issuance of regulations. In contrast, the scope of Section 246(c)(4)(C) is vague and poorly defined. Accordingly, Congress wisely provided that Section 246(c)(4)(C) was to take effect only under regulations. We strongly urge that, if the Proposal is to apply to transactions other than short-against-the-box transactions, any such broader application not take effect until regulations are issued addressing the technical issues summarized above.

VI. Retroactive Application Is Unfair and Disruptive

    Although the Proposal generally would be effective for constructive sales entered into after the date of enactment, the Proposal also would apply to constructive sales entered into after January 12, 1996 and before the date of enactment if the transaction resulting in the constructive sale remains open 30 days after enactment. In such a case, the constructive sale is deemed to occur on the date that is 30 days after enactment.
    ISDA strongly opposes the Proposal's retroactive application.
    Retroactive application of the Proposal would be contrary to a joint statement issued March 29, 1996 by the chairs of the Senate Finance Committee and the House Ways and Means Committee. The Proposal's retroactive effective date is the same as that of the similar proposal included in President Clinton's proposed Fiscal Year 1997 budget, which was released on March 19, 1996. Shortly after that budget was released, Ways and Means Committee Chair Bill Archer and Finance Committee Chair William Roth stated that new revenue provisions would be effective no earlier than the date Congress approves them. They said that the effective dates would be delayed ''so that business and investment decisions can move forward while Congress considers the merits of the administration's tax proposals''.
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    Accordingly, businesses and investors have entered into transactions that might constitute constructive sales under the Proposal, believing that those transactions would continue to be subject to existing law. Although a taxpayer theoretically can close a transaction within 30 days after the date of enactment, and avoid the Proposal, sometimes it is not possible to do so. Although a taxpayer can close a short-against-the-box transaction by delivering shares, a taxpayer that has entered into a derivative contract generally cannot do so without the consent of the counterparty. Generally change to, or termination of, a swap, option or forward contract of the kind entered into by ISDA's members requires the consent of the other party to the contract. Even if it were practical for a taxpayer to terminate a contract within 30 days after enactment of the Proposal, it would be unfair to require a taxpayer to do so to avoid taxation. A taxpayer entering into a derivative contract agrees to pricing and other terms based on the assumption that the contract will remain in effect for its full term, and arranges its risk management strategies accordingly.
    Release of the Proposal on February 6 with a retroactive effective date may already be disrupting normal business transactions. We are concerned that many taxpayers contemplating entering into derivative contracts to manage risk are unwilling to do so because they cannot predict the tax consequences of those transactions.



Interstate Conference of Employment        
Security Agencies, Inc.    
Washington, D.C.
February 12, 1997

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Honorable Bill Archer, Chairman
Committee on Ways and Means
Room 1102, Longworth House Office Building
Washington, D.C. 20515

    Dear Mr. Chairman:

    The Interstate Conference of Employment Security Agencies is the organization of state administrators of unemployment compensation laws, public employment services and labor market information programs throughout the country. We are writing to express our opposition to a proposal, which is included in the President's budget for FY 1998, that would require that state and federal unemployment taxes be collected on a monthly rather than a quarterly basis.
    This three-fold increase in the number of employer payments processed by states would increase significantly the cost of collecting and processing state unemployment revenues while creating the appearance of a revenue increase in the year it takes effect because collections are accelerated. Trading a one-time revenue ''increase'' for the on-going additional state administrative costs (which are counted as federal outlays) and increased compliance costs for employers appears to be economically unproductive budget gamesmanship.
    Resources appropriated to administer unemployment insurance services become scarcer each year. As state administrators we have a responsibility to use our administrative funds as efficiently as possible. If we are forced to divert some of those scarce resources from productive purposes such as tax audits or eligibility reviews in order to collect unemployment taxes each month rather than quarterly, it will be detrimental to the integrity of the unemployment insurance system and may, in fact, result in lower tax collections and higher benefit outlays.
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    We see no sound budgetary or tax policy basis for this proposal, and we are dismayed that the Administration would risk real damage to the unemployment insurance system and triple employers' unemployment tax compliance burden in order to create the illusion of a one-year revenue increase. Although we communicated these concerns to OMB Director Raines during formulation of the FY 1998 budget, this proposal remains a part of the President's package. As you consider tax provisions in the FY 1998 budget, we urge you to reject this proposal.

Debra R. Bowland

cc: Committee on Ways and Means


Statement of National Association of Realtors, Russell Booth, President

    The National Association of Realtors (NAR) appreciates the opportunity to submit comments concerning President Clinton's Fiscal Year 1998 Budget. This statement is presented on behalf of NAR's approximately 720,000 members. NAR represents virtually every facet of the real estate industry, including residential and commercial Realtor brokers and salespersons, developers, counselors, appraisers and property managers.
    Real estate contributes about 16% of the goods and services that comprise our national economy. The industry has repeatedly demonstrated its capacity to lead the nation out of recession into economic recovery and growth. NAR supported the 1995 Contract With America provisions that would have reduced the tax rate on capital gains, recognized capital losses on the sale of a principal residence, indexed the cost basis of capital assets for inflation, permitted first-time homebuyers to make penalty-free withdrawals from their Individual Retirement Accounts (IRAs), and increased the amount of the unified gift and estate tax credit. Unfortunately, President Clinton vetoed these important measures. We believe that his veto was detrimental to our members, and, moreover, that it had the effect of keeping many Americans locked into investments, and barred them from rearranging their portfolios to make the most productive use of their savings and their real estate holdings.
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Capital Gains and Real Estate

    NAR enthusiastically and actively supports all efforts to restore a meaningful capital gains differential. An exclusion and indexing are both important elements of a differential, and we fully support both approaches. NAR supports S. 66, a bill introduced in the Senate by Senators Hatch (R–UT) and Lieberman (D–CT).
    NAR would also support an approach such as that included in S. 306, offered by Senator Wendell Ford (D–KY). His approach would create a sliding scale capital gains tax rate. The rate for an asset held for one year would be 28%. The rate would be reduced by 2 percentage points for each succeeding year, down to a minimum rate of 14% for an asset held 8 years or more.
    One of the things that we know about American is that they buy real estate. Generally, they buy as much real estate as they can afford. They buy homes, condos, cottages at the lake, hunting lodges, speculative parcels, a safe new home for mother and farms and ranches.
    The incidence of the ownership of real estate is more widespread than one might expect. Federal Reserve data in the Survey of Consumer Finances show a remarkably high incidence of ownership of real estate by all individuals, and especially in income classes below $50,000. The 1992 Survey shows that 63.8% of all families own a principal residence, and that 20% of all families own investment real estate. Among families with $25,000–$50,000 of income, 69% own a home, and a surprising 20% also own investment real estate. Among families in the $50,000–$100,000 income category, 85% own their home, and 30% own investment real estate.
    The reasons for ownership are varied, and some of those reasons, we fully admit, are likely to be influenced by the tax effects of ownership. The important fact to note is that nonowner occupied real estate is more widely held than CDs, mutual funds, or stocks and bonds. Since real estate is so widely held, the markets for it are large and diverse. (Source: 1992 Survey of Consumer Finances, Federal Reserve Bulletin, Oct., 1994.) We strongly believe that the power of those markets can be augmented through the unlocking power of reduced capital gains taxes.
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$500,000 Exclusion on Sale of a Principal Residence

    President Clinton has proposed that taxpayers filing a joint return be permitted to exclude up to $500,000 of gain ($250,000 on a single return) on the sale of a principal residence. Owners qualify if the home has been used as a principal residence for two of the five previous years. Gain in excess of these amounts will be taxable at capital gains rates. Thus, a homeowner who filed a joint return and realized a gain of $600,000 would receive $500,000 tax-free, and $100,000 of gain would be taxable at capital gains rates.
    Under current law, the so-called ''rollover'' or deferred gain rules of Internal Revenue Code Section 1034 govern transactions involving the sale or exchange of a principal residence. Under the rollover rules, a taxpayer may exclude all gain on the sale of a personal residence from taxation, so long as the proceeds of the sale are reinvested in a home of the same or greater value. Each time a homeowner sells and reinvests, he/she is required to calculate the deferred gain, and make an adjustment to the purchase price of the new home to reflect the deferred gain in the tax basis of the home. In addition, the tax basis must be adjusted by the cost of any improvements that are made to the home. The taxpayer is required, for this purpose, to differentiate between repairs and improvements. Over the course of a lifetime, all this record keeping becomes subject to error, omission, and misunderstanding. In addition, the documentation becomes burdensome to maintain over the course of a lifetime. Not surprisingly, the IRS has indicated that taxpayer compliance with these requirements is low.
    The rollover rules of current law have also been criticized for their impact on housing decisions. Critics have alleged that current law forces people to over-consume housing. Stated another way, the rules have the effect of forcing people to buy ever more expensive housing, even though they might not need it, and even though they may not want to incur the debt load needed to carry it. In addition, homeowners who relocate from high housing cost areas are perceived as driving up the cost of housing when they relocate to lower cost areas.
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    As homeowners grow older, they currently have the option to make a once-in-a-lifetime exclusion of up to $125,000 of gain on the sale of their residence at age 55 or older. While this provision enjoys a broad base of support, it has been criticized because it applies only once, and because spouses who take the exclusion and are subsequently widowed are not permitted to use the exclusion again, even if the individual remarries someone who has never used the exclusion himself/herself.
    Now, President Clinton has proposed replacing the rollover and $125,000 exclusion rules with a single $500,000/$250,000 exclusion that may be used as often as once every two years by homeowners of any age. NAR supports this proposal. First, it is an exceptional simplification of current law. In fact, we believe that it merits support for this reason alone. Next, this is the ultimate ''Get the IRS out of your life'' proposal. Only a very small number of transactions annually will be taxable, so nearly all taxpayers will be relieved of the burdensome record keeping requirements of current law. In addition, this proposal preserves the savings value of the home. For most individuals, their home is the primary source of savings. Finally, the proposal has the great advantage of allowing individuals to make their housing decisions based on their circumstances, and not on the basis of the tax code. For the first time, the proposal would allow individuals to trade up, stay in roughly the same circumstances, or trade to a smaller and/or less expensive home. This is of critical importance to boomers and to empty-nesters who wish to change the configuration of their savings and housing arrangements.
    Today, less than two percent of all existing home sales occur at price levels above $500,000. Thus, in order for the gain to exceed $500,000, the sales price will generally be substantially higher than the $500,000 amount. The practical effect of this provision is to provide substantial record keeping and simplification relief to all but a very small number of taxpayers. Table I (attached) illustrates the volume of sales in different price categories nationally and regionally.
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    NAR commends the Administration for developing this remarkable simplification proposal. We view it principally as a simplification provision that happens to fall within the capital gains regime. We view it as a proposal that is desirable and supportable on its own merits as a simplification. We do not view it as a substitute for a broad-based capital gains reduction, and we believe it should be evaluated as separate from that debate.

Loss on Sale of a Principal Residence

    The early 1980's saw the beginning of a phenomenon that came to be known as ''rolling recessions,'' in which different regions of the country experienced recessions, even though the national economy was performing reasonably well. This phenomenon was accompanied by a circumstance that had not occurred widely during the entire post-World War II period. For the first time, homeowners in these regions experienced losses on the sales of their personal residences. Over the last 15 years, this situation has occurred in regions as diverse as the oil belt, the Rocky Mountain states, New England and, most recently, California (and southern California in particular).
    Since the purchase of a home has generally been considered a personal expenditure, losses on the sale of a personal residence have not been recognized for tax purposes. Chairman Archer has sought for many years to ameliorate this circumstance as a matter of fairness. After all, a home is generally the greatest source of individual savings. Taxpayers who are in the difficult position of incurring a loss on that sale are often in an economically vulnerable posture. In 1995, the Chairman proposed and Congress passed provisions that allowed these taxpayers to receive capital loss treatment if their home sold at a loss. Earlier versions of a relief provision allowed a basis adjustment at the time of purchase of a replacement residence. NAR supports either method of providing relief in these circumstances.
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    NAR wishes to bring the Committee's attention a situation that is becoming increasingly common in areas where the market value of housing is declining. In many circumstances in some regional markets, homeowners are found to be ''under water'' or ''upside down'' on their mortgages: they owe more on the mortgage than they can realize on the sale of a principal residence. First-time homeowners who have purchased under low down payment programs are especially vulnerable. If an individual purchases a home with a 3 %–5% down payment, and the market value declines by 10%, then the individual is technically ''under water.'' If those individuals were forced to sell, they could easily come out of the transaction owing more than they would realize. An example can illustrate this problem.
    Family A purchases a home under a low down payment program that requires only a 3% down payment The purchase is for $100,000, with $3,000 down and mortgage indebtedness of $97,000. (This configuration is often typical of VA and FHA mortgages.) After a few years of ownership, A must sell the home. At the time of the sale, the outstanding mortgage is $92,000. A is able to realize only $89,500 on the sale. A must pay closing costs and commissions, even though there is not enough cash to satisfy the mortgage or to make these payments. A successfully works out an arrangement with the lender in which A will pay $88,000 on the note, and be forgiven $4,000 of the debt. Thus, A has a loss on the sale of $10,500, and at the same time has incurred a tax liability on the $4,000 of forgiven debt.
    This situation occurs in about 3% of the sales currently being closed in California. It can even occur, in some locations, in situations where the homeowner has made down payments of 10% or more. It defies logic that the homeowner would incur a loss, and at the same time generate a tax liability. Thus, NAR believes that the loss on sale provisions should also address this circumstance. Since the loss on sale provisions are based on fairness and equity, it seems that this discharge of indebtedness problem should be dealt with in the same context.

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Broad-based Capital Gains Cuts

    The capital gains issues that affect residential real estate are substantially different from those that affect commercial and investment real estate. Even after the $500,000 exclusion, loss on sale and discharge of indebtedness provisions are favorably resolved, the more fundamental issue of capital gains taxes for all capital assets, not just real estate, will linger.
    Before its repeal in 1986, the capital gains exclusion operated as a sort of rough justice to give taxpayers some incentive to hold property for the long haul, while giving an imprecise recognition to the effects of inflation on an investment. Real estate tends to be a very illiquid investment, so it was particularly important to the holders of real estate that some means of mitigating the impact of inflation would be available. The repeal of the capital gains exclusion in 1986 destroyed even that imprecise mechanism. Lower tax rates simply did not overcome the impact of removing the exclusion.
    The dirty little secret of current law is that middle income Americans who have the good fortune to realize a capital gain are not treated as favorably as higher income individuals. The effect of the higher tax rates enacted in 1993 was that one class of upper-income taxpayers enjoys a tax benefit equivalent to a 30% exclusion. Individuals in the 15% and 28% tax brackets pay that rate on the full amount of any capital gain they might realize. By contrast, individuals in the 31%, 36% and 39.6% brackets pay no more than 28% tax rates on the full amount of any of their capital gains. For individuals in the 39.6% bracket, this rate differential is the equivalent of a 30% exclusion.
    A significant volume of capital gains transactions occurs for individuals in the 15% and 28% brackets, which reach to about $85,000 on a joint return. This income group has the largest number of capital gains transactions by volume, even though the dollar amount is relatively small. Many of those taxpayers will have only a limited number of capital gains transactions in a lifetime, yet their limited number of assets is presently taxed less advantageously than the larger, diversified portfolio of an upper income individual. A broad-based capital gains cut, accomplished by an exclusion or a sliding scale rate cut, and combined with indexing, would redress the fundamental unfairness of having two classes of taxpayers—those with a capital gains differential, and those without a differential.
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    NAR fully subscribes to the view of capital gains advocates that a cut in capital gains tax rates would unlock significant amounts of investment that would be plowed back into ever-more productive uses. We cannot quantify what the volume of new transactions would be. Measuring pent-up demand is all but impossible, because there is no baseline that can be fixed for transactions that don't occur. Every Realtor we meet, however, has stories to tell about properties that would have sold, except that the tax beating of current law would be too great. Realtors have hardship stories, as well, about people in reduced circumstances forced to sell their assets, only to face large tax bills.
    No issue in the current tax debate is more important to NAR members than across the board capital gains tax reductions.


    NAR supports proposals that permit indexing on the sale of assets. While many of our members would hope to have a look-back provision, we acknowledge that such a provision would be costly to enact, and difficult to administer. We take no position on the choice of index used, but simply urge that the compliance provisions associated with administering an indexing scheme be as simple as possible. We look forward to working with the IRS to develop record keeping and compliance programs that will be easily understood by taxpayers. Taxpayers will need some education about the record keeping challenges posed by an indexing scheme, and we are committed to doing our part in assisting in that effort.

Depreciation Recapture

    For more than a year, rumors have circulated that a capital gains cut would create new rules for depreciation recapture. This rumor was confirmed in a Wall Street Journal story on February 14, 1997, noting that Joint Tax Committee Chief of Staff Ken Kies was urging that previously-allowed depreciation deductions be recaptured and taxed at 28%, with any remaining gain taxed at the new, reduced rate. His rationale is that current law, which permits capital gains treatment of depreciation recapture, creates unfair advantages for real estate and could lead to tax sheltering. We reject this view, and further urge that current law as provided in Code Section 1250 be retained.
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    After the Tax Reform Act of 1986, commercial real estate values plummeted. Since 1990, that market has been recapitalized. Between 1990 and the present, however, there has been very little, if any, appreciation for commercial real estate. According to analysis performed by Price Waterhouse, about 60 percent of all commercial real estate transactions between 1990 and 1995 have occurred at a price that is less than the original purchase price. If the depreciation recapture rate were to remain at 28% or more, the owners of those properties would receive no benefit whatever from the capital gains cut. Thus, they would be at a disadvantage relative to other assets that receive the full benefit of rate reduction and they would not, at present, be inclined to sell or improve those properties.
    We also note that owners who invested for long holding periods would be seriously disadvantaged, because they would bear disproportionate recapture burdens. Holding the recapture rate at 28 percent has the effect of raising the tax rate on the entire investment, no matter how long it is held. Where the asset has been held for long periods of time, the recapture amount could be quite large as a proportion of the total amount of gain in excess of adjusted basis. The greater the proportion of recapture to gain, the more the tax rate would be distorted (and increased) under the rumored proposal.
    A fundamental principle in the capital gains debate has been that all capital assets should be treated in the same manner, and that no industry or class of assets should be singled out for discriminatory treatment. We believe that the proposed recapture regime does not satisfy this standard. We believe that it discriminates against real estate. Given the performance of real estate markets in recent years, we believe it would be singularly unfair to impose real estate-specific taxes on an industry that is still somewhat fragile.
    Table 2 illustrates that very fragile condition and compares it with the price volatility in the stock market, as measured by the Dow Jones and Standard & Poor's indices. The chart shows the value of a dollar invested in real estate in 1985, and compares it with the value of a dollar invested in securities. The chart refers to price effects only, and not to rate of return. What it does illustrate, however, is the extraordinary surge in the market value of securities over that period, compared with a very flat real estate market. Notably, this chart is not adjusted for inflation. Thus, it shows that a dollar invested in real estate in 1985 is worth less than a dollar if the property sold today, while a dollar invested in the stock market in 1985 would yield about $4 today. If the chart were adjusted for inflation, the real estate price in 1996 would be even less than shown on the graph.
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    Because of the continuing interest in simplification and tax reform, we feel obligated to note that the proposed recapture regime would be very complex. Even as presently drafted, recapture is, at best, very complex. The proposed regime would graft yet another layer of complication onto this already-burdensome set of rules. We believe that it is inappropriate to advocate complex solutions at this time, particularly when those complexities do not improve the fairness of the code or enhance the performance of an individual's business or the national economy.
    We therefore believe that the proposed recapture regime would achieve none of the unlocking of gain that is envisioned by capital gains advocates. In many markets, there has been little appreciation in real estate for several years. Accordingly, individuals who sold properties under the proposed regime would find that much, if not all, of their gain was attributable to depreciation recapture, and not to appreciation. Thus, a taxpayer who experienced minimal appreciation would not be any better off than under current law, while the owners of appreciated non-real estate capital assets would receive far more benefit from a capital gains tax rate reduction. Only a scheme that retains existing Section 1250 recapture taxes would keep all asset owners on a level playing field.

Individual Retirement Accounts

    President Clinton, Mr. Thomas and Chairman Roth all have all offered proposals to expand the classes of taxpayers eligible to make tax-deductible contributions to an Individual Retirement Account (IRA) and/or to a new tax-deferred ''back-loaded'' savings vehicle. NAR supports these proposals, because they expand the savings pool. Expanded national savings should have beneficial effects in keeping interest rates low. No sector of the economy is more sensitive to interest rates than housing, and so we support these endeavors.
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    In the context of improved and expanded IRA provisions, we urge that the Committee include a provision that has passed the House at least 3 times this decade, twice in 1992 and again in 1995. This provision permits a penalty-free withdrawal from an IRA or 401(k) plan for use as a down payment by a first-time home buyer. Significantly, it also permits a parent or grandparent to make penalty-free withdrawals to assist a child or grandchild in making a down payment for a first-time home purchase. NAR actively advocated this approach in earlier years, and strongly believes that the ''parent and grandparent pass-through'' is crucial to making any new IRA plan a genuine vehicle for advancing first-time home purchases. NAR's research shows that young people are increasingly relying on family members to fund some portion of their home purchase down payments. Accordingly, this parent/grandparent feature of the proposal is a critical feature of the efforts to permit IRA withdrawals to further home ownership.

Estate Tax Relief

    President Clinton has proposed a very modest timing and interest rate change to the estate tax rules. While NAR believes that his heart is in the right place, we far prefer the approach taken in legislation passed in 1995 and introduced in varying forms in the current congress to expand the unified credit and/or reduce estate tax rates. While we view full-scale repeal of the estate taxes as politically unlikely, we also believe that approach has merit. To that end, we support efforts to provide relief to small business owners and to curtail the reach of the estate tax laws.

Table 1

"The Official Committee record contains additional material here."

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UBA, Inc.        
1331 Pennsylvania Avenue, N.W.    
Washington, D.C. 20004–1703
February 4, 1997

The Honorable Bill Archer
House of Representatives
Washington, D.C. 20515

    Dear Congressman Archer:

    Oh behalf of employers and a sound unemployment compensation system, UBA respectfully urges you to reject two Federal Unemployment Tax Act (FUTA) proposals that are likely to be included in the Administration's FY 1998 budget. UBA is a national business organization specializing exclusively in public policy advocacy relating to unemployment and workers' compensation. The first budget proposal would extend the current 0.2% FUTA surcharge (now scheduled to expire at the end of 1998) through the year 2007. The second proposal would require employers to pay FUTA and state unemployment taxes monthly instead of quarterly, beginning in the year 2002. These proposals, which are motivated by budgetary rather than unemployment policy reasons, will be costly to employers, states, and the federal government. Moreover, by adding to the cost of employment, they will also have a detrimental impact on job creation and impede integration of welfare recipients into the work force.
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    An extension of the 0.2% FUTA surcharge would again violate a commitment to employers that this ''temporary'' tax increase would be allowed to expire. Congress imposed the surcharge in 1976 to retire a deficit created by Congress under a federally funded supplemental benefits program, which lengthened the duration of unemployment benefits beyond the normal 39 weeks of regular and extended unemployment benefits. The cost of emergency benefits should never have been an employer obligation, which Congress recognized by financing later supplemental extensions out of general revenues rather than FUTA. The FUTA deficit for which the surtax was imposed was paid in full in 1987. Although employers kept their side of the bargain, previous Congresses violated this commitment and extended the surcharge. Continuation of the surcharge has caused an unhealthy build-up in the FUTA-funded accounts in the Unemployment Trust Fund (UTF). A further continuation of the surcharge is not just unfair to employers. It is also totally unnecessary for sound financing of the unemployment compensation program. Because FUTA revenue may be used only for limited purposes, and the UTF has more than adequate FUTA balances into the foreseeable future, there is absolutely no reason for another extension of this tax.
    The proposal to change to monthly collection of both federal and state unemployment taxes would triple the number of required submissions. This acceleration of payment is nothing more than an accounting ''gimmick.'' While it would be ''scored'' for budget purposes as a one-time federal budget revenue increase, it actually captures no net additional revenue it just requires that the same amount of money be collected in an earlier fiscal year. We believe this is an exceedingly flimsy reason the triple the tax filing paperwork for employers and states.
    UBA has long been outspoken in our advocacy of responsible financing and efficient administration of the unemployment compensation program, which is vital to workers and employers. In fact, we have developed a proposal on devolution of FUTA (copy attached), which would improve services to jobless workers while reducing costs for employers. We hope Congress will soon consider devolution and other necessary reforms. However, extending the 0.2% FUTA surcharge and accelerating the payment of FUTA and state unemployment taxes would move in precisely the wrong direction. As you make final decisions about the federal budget for FY 1998, we urge you to reject these unwise proposals, whose enactment risks real harm to the unemployment compensation system and needlessly raises costs for the federal government, states, and employers.
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Eric J. Oxfeld,

cc: Ron Haskins

    [The official Committee record contains additional material here.]



January 24, 1997

UBA Devolution Proposal

    Devolution of state unemployment compensation (U.C.) administrative financing and operations has the potential for significant cost savings for employers while (1) maintaining the integrity of the U.C. system, which is also important to employers, and (2) enhancing services for unemployed workers, whiloe preserving all benefits and legal protections workers are accorded under current federal law. UBA has developed this devolution plan to accomplish these objectives. To be acceptable to employers, devolution must satisfy three principles:
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    •  The 0.2% FUTA surcharge is discontinued.
    •  Employer taxes used to finance the U.C. system are imposed consistent with sound U.C. operations rather than federal deficit reduction.
    •  Financing for U.C. administration is provided at adequate levels, avoiding under funding and excessive taxes.

Minimum Federal Requirements for State Law

    Transfers administration and funding of U.C. administration to states. Each state would be required to maintain a U.C. program and a public employment service (but each state would be responsible for funding).
    •  Federal requirements for due process, payments when due, etc., are retained.
    •  States would be required to continue responsibility for the interstate compact.
    •  State financial responsibilities include DVOP/LVER programs. LMI would be funded from federal general revenues. States would continue to negotiate with federal government for services such as Alien Labor Certification.
    Comment: The DVOP and LVER programs have been criticized by some interested parties as unncessary and inflexible, and others have questioned employer funding for them. UBA agrees that there is some merit to these concerns. However, because of the relatively small amount of funding provided for DVOP and LVER, UBA recommends that any discussion over possible changes to these programs should be handled separate and apart from basic devolution legislation that focuses on services to U.C. claimants.
    •  To enhance the accountability of state U.C. agencies, states must provide to the state legislature, the U.S. Department of Labor, and the public annual data and reports on employment services provided to U.C. claimants. The initial report would be due within 90 days after completion of the first fiscal year in which the devolution system is implemented, and then annually thereafter.
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    Comment: There is active debate over whether devolution legislation should include performance standards for state U.C. agencies, once devolution is implemented. UBA believes that it would be preferable to give each state the maximum latitude to determine how best to serve its own claimants, while providing information on agency performance needed by employers and others interested in the U.C. program.
    •  The full cost (including administrative costs) of Federal programs such as Trade Adjustment Assistance, emergency unemployment assistance, and UCFE and military programs are funded by the federal government out of general revenues.
    Comment: Congress has recognized that benefits under these programs should not be an employer financial responsibility and has provided general revenue funding. UBA believes that it is also inappropriate to tax employers for their administrative costs, which currently are financed out of FUTA revenues.


    •  The FUTA would remain in effect, but the employer offset would be changed to 100% (now 90%). This is necessary to enforce the federal requirements to maintain the U.C. program and employment service, as well as federal oversight.
    •  Rate would be changed to 6.0% through repeal of .2% surcharge, or the 100% offset could be applied to the present 6.2% rate. The latter would not require any change in the present requirement for each state to have a maximum tax rate no less than 5.4%.
    •  States would be guaranteed control over benefits and administration accounts, which would remain held by federal government within the Unemployment Trust Fund (UTF) structure.
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New State Tax for U.C. Administration

    Each state would enact a new state tax for administration. Employers would pay this state U.C. administration tax separate from the state U.C. benefits tax but collected as a line item on the state U.C. tax form. As a transition measure during a 5-year hold harmless period, the state U.C. administration tax would be levied at a rate that when applied to the taxable wage base would generate an amount not to exceed $42 per full-time employee/year. The present FUTA wage base of $7,000 would be retained for the 5-year hold harmless period for this purpose in states that use a higher amount. States would be expected to reserve for future administrative needs but could borrow from federal general revenues (with interest) if necessary.
    Comment: The recommended limitation of $42 during the transition period was a compromise to maintain the relative share of contributions from high-wage and low-wage employers. UBA recognizes that there may be states where insufficient revenues would be generated because of the $42 limit; the proposal would provide access to accumulated ESAA balances where necessary during this period. After the transition period, states could set their administrative tax at the level they determine necessary and appropriate.

Administration Costs: FUTA-Exempt Entities

    States would be empowered to assess a flat fee for U.C. administration on employers who currently are not subject to FUTA, such as state and local government agencies, 501(c)(3)/non-profit employers, and reimbursable employers. While workers employed by these employers collect unemployment benefits through the U.C. system, these employers do not contribute to the cost of financing the administrative costs of the U.C. system, and some of them do not pay the federal share of extended benefits—shifting these costs to other employers. Although the federal government cannot tax state and local governments, there is no constitutional impediment to the states imposing such a user fee.
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    Comment: Private employers currently pay the full cost of administering claims by workers employed by FUTA-exempt employers. Although states would not be required to collect administrative fees from such employers, the devolution plan would permit them to do so.

Administration: Contingency/High Workload

    States would be required to have a plan to address this need. For example, a state could reserve for it, borrow from federal general revenues with interest, or use other resources. The plan would be due by the January 1 following the next regular session of the state legislature after the effective of the act.
    Comment: UBA believes is important that states be required to have a financing plan for these functions formerly funded from FUTA, to ensure the financial integrity of the U.C. program and avoid a ''race to the bottom.''

Balances in ESAA (Administration Account)

    Each state would have a separate U.C. administration account (in addition to its U.C. benefits account) within the Unemployment Trust Fund. Balances in the ESAA, EUCA, and FUA accounts would be distributed to the state administration accounts (paper distribution). These funds will provide resources that are available to the states as a hold-harmless mechanism. The distribution would be contingent on repeal of existing state surtaxes, such as those imposed to supplement U.C. administration, pay for training programs, etc. States would be free to enact new taxes if desired to support training programs. A prohibition against diversion of U.C. funds for other programs would be added.
    Comment: Additional review is indicated regarding distribution of balances that are not needed for the hold harmless mechanism. The impact of releasing the entire amount of these balances into administrative accounts in states where the funds are not needed for administration needs further consideration. For example, one option would be to release these funds into state benefits accounts, thereby reducing the state U.C. tax burden on employers. An intermediate step would be to release the EUCA and FUA funds into the state benefits accounts because these amounts were levied for the purpose of paying benefits, while the ESAA funds are released into the new state administration accounts. Because of the potential impact on the federal budget deficit, the timing of when the funds are released must be carefully considered.
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Formula for Distribution of Trust Fund Balances to States

    Distribution to states would be based on share of covered employment.
    Comment: There may be other acceptable ways to distribute the trust fund balances.

Loan Account for State Benefits

    There is no need for a pre-funded loan account. States may borrow from federal general revenues, subject to interest, or borrow from other sources.

Extended Benefits (EB)
    Require states to have an EB program that provides benefits that are no less than mandated under current law. The portion of EB currently funded from FUTA would be funded from the new state U.C. administrative tax (states would be required to have a plan to address this funding need, due on same timetable as contingency funding see above). States would be allowed to borrow from federal general revenues, with interest.
    Comment: The proposal envisions preservation of the present EB program as a matter of federal law, with the only difference being that the portion of EB now financed from FUTA would be financed out of the new state administrative tax. States would continue to be free to provide their own EB programs that are financed out of state unemployment taxes, if they wish to do so. UBA believes is important that states be required to have a plan for funding the share of EB formerly funded from FUTA, to ensure the financial integrity of the U.C. program and avoid a ''race to the bottom.''
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Federal Oversight

    A portion of the funds collected by the states for administration would be earmarked for the US Department of Labor in order to maintain oversight and provide continued funding for any additional functions such as DVOP and LVER.
    Comment: Because the federal presence would be greatly reduced, this amount would not exceed 1% of the state administrative tax revenues. May need to set a floor of some amount to assure adequate revenue.

Property Owned by State U.C. Agencies

    Property owned by states would remain state-owned.

Unified Federal Budget

    Funds would remain within unified federal budget, but need to get CBO opinion on scoring devolution proposals before proceeding.
    Comment: Inclusion of the UTF within the unified federal budget has greatly contributed to the present administrative funding problem, but removal from the budget would greatly complicate consideration of acceptable devolution legislation.

(Footnote 1 return)
If a provision similar to the Proposal is enacted, we urge that Congress include in the legislative history examples to clarify that a taxpayer in the following situations has not constructively sold stock because it has retained meaningful benefits and burdens of ownership. First, a taxpayer who owns stock worth $100 buys a put with a strike price of $95 and sells a call with a strike price of $105. Second, the same taxpayer buys a put at $100 and sells a call with a strike price of $110. Third, the same taxpayer buys a put with a strike price of $105 and sells a call with a strike price of $115.