U.S. Executive Director of the Inter-American Development Bank Nominee
Miguel R. San Juan
Testimony Before Senate Committee on Foreign Relations

Washington - Chairman Menendez, Senator Lugar, Members of the Committee, thank you for the opportunity to appear before you today. I am honored that President Bush has nominated me to serve as the United States Executive Director of the Inter-American Development Bank. I am grateful to have the support of the President and Secretary Paulson and the privilege of your consideration.

I would like to introduce members of my family sitting in the audience, my wife Lucia, and my sons Migue, Marcus and Maximo. My family continues to support me, as a full partner in my quest for public service.

I have long held aspirations of working in the public sector, especially in a capacity dealing with the Americas.  Further, I believe strongly in the Inter-American Development Bank's mission. I look forward to having this opportunity to state my objectives as a candidate for the position, as well as to answering any questions regarding my experience and qualifications. 

By the good graces of many, my family and I reunited in Houston, Texas after many years of separation following our departure from Cuba. I feel extremely fortunate that my career in economic development has given me an opportunity to give back to the country that welcomed us with open arms so many years ago.  I am very eager to apply the lessons I learned at one of the nation's premier chamber organizations in service to the United States and another region dear to my heart, Latin America and the Caribbean.

Vicious cycles of poverty and crime pose an ongoing threat to the region's vast potential. The words of Nobel Laureate Octavio Paz come to mind: "Amιrica no es tanto una tradiciσn que continuar, como un futuro que realizar." America is not so much a tradition to continue, as a future to realize. If Latin America is to realize the future it deserves, it must overcome these longstanding obstacles. There are, however, signs of hope and progress everywhere.

I believe the IDB plays a critical role in accelerating economic and social development in the region. In so doing, it also fosters hemispheric and global security. And at a critical point in the hemisphere's history, the IDB constitutes a force that can hold the region together, while others threaten to tear it apart.     

Another area on which I hope to focus is the development of small to medium size industries in the region. President Bush has stated the relevance of SMEs to the health of this nation's economy. The same logic applies to the whole of the Americas. Today's SME's are tomorrow's multinationals. They are the seeds that create jobs and economic prosperity. To stimulate their growth in the region, I advocate increased cooperation and coordination between the IDB and Chambers of Commerce throughout Latin America and the Caribbean.

Above all, I view the principal role of the IDB Executive Director as representing the United States.

In closing, I want to acknowledge my family as the bedrock of my value system. We are hard-working, God-fearing people who keep and treasure our immigrant roots. Public service allows us to give back some of the many blessings that have come our way.

Mr. Chairman, Senator Lugar, Senators, Members of the Committee, I respectfully ask for your favorable consideration of my nomination and stand ready to respond to any questions that you may have. Thank you.

U.S. Executive Director for the African Development Bank Nominee
Mimi Alemayehou
Testimony Before Senate Committee on Foreign Relations

Washington - Chairman Menendez, Senator Lugar, and Members of the Committee, I am grateful for the opportunity to appear before you today. I am honored that President Bush has nominated me to serve as the U.S. Executive Director for the African Development Bank.

After his recent visit to Africa, the President commented: "things have changed in Africa since my first visit, I mean striking changes;" and then he continued: "We're treating African leaders as equal partners. We expect them to produce measurable results. We expect them to fight corruption, and invest in the health and education of their people, and pursue market-based economic policies."

I share the President's vision of a `partnership of equals' between the United States and Africa. It is through such respectful and engaged partnership that Africans can play a driving role in Africa's development and African leaders can be accountable for their actions. If confirmed, I pledge to work with this Committee, Congress, and the Administration in furthering U.S. International Policy and Development goals. Increasingly, America's prosperity is becoming linked to peace and the raising of living standards for all individuals in the developing world. The African Development Bank is one of the most important regional development bank as it serves the world's least developed continent. The Bank's activities have a very high impact on the region and therefore command the focused attention of Africa's leadership.

Throughout most of my life, I made personal and professional choices which prepared me for a focused and challenging role – to serve as a bridge, an enabler, between our country of opportunity, and the continent of Africa, with its tremendous yet far from realized potential. I am grateful for the educational and professional opportunities the United States has afforded me. This, I believe prepared me for a role in the development of Africa and the international private sector as early as my days serving as an aide on Capitol Hill. Africa and the private sector re-emerged later in my work in international telecoms focusing on the introduction of a new technology to African countries, and more recently as an entrepreneur supporting the efforts of the United States-sponsored Africa Growth and Opportunity Act. I started TradeLinks in order to assist AGOA eligible member countries in the regional grouping of the Common Market for Eastern and Southern Africa (COMESA) so that they may increase their exports to the U.S. While I enjoyed working with the African governments and U.S. officials, I took the most pleasure from working with African entrepreneurs with great skills and products but were in desperate need of basic tools. They were in need of training or adequate equipment so that they can produce consistently high quality goods on a meaningful scale and in a tight timeframe.

Today's Africa is a far cry from my early years in Ethiopia under a communist regime that left an indelible mark on me. Entrepreneurship and democracy are now the order of the day; but the African private sector cannot thrive without a significant upgrade of the continent's infrastructure and financial systems. These challenges call for a strong and active African Development Bank to finally help turn Africa's long held promise into a reality. This optimism does, however, bring increased expectations with respect to governance, transparency, regional integration, and the need to develop African skills. That is the reason why Africa needs reliable partners such as the United States and strong institutions such as the African Development Bank. America's style of government and its liberalized economic model put us in an exceptional position to help steer the Bank towards the right policies and usher an unprecedented era of sustainable economic growth in Africa. The implementation of U.S. policy towards Africa, as well as our role on the Board of the African Development Bank, together constitute key tools to help Africa achieve this growth. It would therefore be a privilege to work with Secretary Paulson, the Treasury Department, and Congress to increase the African Development Bank's impact and effectiveness.

While humbled by the nomination, I am excited about the prospects and challenges facing the African continent. I do hope to have the opportunity to play a role in getting the United States and the African Development Bank to work more closely together in order to help improve the lives and dignity of all 940 million Africans.

Mr. Chairman, Senator Lugar, Members of the Committee, thank you for considering my nomination. I would be pleased to answer any questions.

U.S. Executive Director to the European Bank for Reconstruction
and Development Nominee Kenneth L. Peel
Testimony Before Senate Committee on Foreign Relations

Washington - Chairman Menendez, Senator Lugar, and Members of the Committee, I am grateful to the President for my nomination to be U.S. Executive Director to the European Bank for Reconstruction and Development, and I am deeply honored to appear before the Senate Foreign Relations Committee to discuss my qualifications for this position.

Being here today, I feel that I have come home. Since July 2001, I have served in a series of foreign and economic policy positions in the Administration. For six years before that, I served two Senators on this Committee: Senator Hagel, when he chaired the International Economic Policy Subcommittee, and Senator Snowe during her first two years in the Senate when she chaired the International Operations Subcommittee.

The great bulk of my professional career has been working on foreign policy and international economic policy in Congress, with a special focus on multilateral diplomacy. Before working in the Senate, I spent 12 years in the House, ten of those as professional staff on the House Foreign Affairs Committee.

Since July, 2001 I have held three positions in the Executive Branch. I served:

• as a Member of Secretary of State Colin Powell's Policy Planning Staff working on international organization and Eurasian issues,
• as an NSC Director covering international environment and energy issues, and
• as Deputy Assistant Secretary for International Development Finance and Debt at the Treasury Department.

In short, I believe that I am well equipped both by my academic and professional background to take on the position for which I have been nominated. My current position prepares me particularly well. As Treasury Deputy Assistant Secretary, I oversee U.S. policy towards all of the major multilateral development banks such as the World Bank and the regional development banks, including the European Bank for Reconstruction and Development.

Even though this nomination is coming late in the Administration, there are huge issues currently at the EBRD that will affect our interests in both the institution and in the region over the next six months. As you know, U.S. Executive Directors at the multilateral development banks are essentially our Ambassadors to those institutions. Since I work day in and day out on MDB policy, I see how important is to have strong Senate-confirmed Directors in place.

If confirmed by the U.S. Senate, I look forward to bringing my skills and background to advancing U.S. interests at the EBRD. I believe in our sometimes complicated system of government. Our co-equal, separate branches of government give us a unique strength when we work together, genuinely consult on policy directions, and speak with one voice. If confirmed, I look forward to being available to speak or meet with you or your staff at any time, and hope you won't mind if I seek out your advice at critical junctures in several of the key issues facing U.S. interests at the EBRD in the months ahead.

Mr. Chairman, Senator Lugar, Members of the Committee, I am grateful for the opportunity to appear before you today. I would be pleased to answer any of your questions.

Testimony by Secretary Henry M. Paulson, Jr.
on GSE Initiatives
before the Senate Banking Committee

Washington-- Good morning. Thank you Chairman Dodd, Senator Shelby and committee members for your leadership and for the opportunity to discuss these important issues.

As you know, our financial markets have been experiencing turmoil since last August. It will take additional time to work through challenges and progress has not come in a straight line. However, our financial institutions are repricing risk, de-leveraging, recognizing losses, raising capital and seeking to improve their financial positions. And policy makers and regulators are vigilant in their efforts to address the current challenges.

Fannie Mae and Freddie Mac, two of the government-sponsored enterprises (GSEs), are also working through this challenging period. Fannie and Freddie play a central role in our housing finance system and must continue to do so in their current form as shareholder-owned companies. Their role in the housing market is particularly important as we work through the current housing correction. The GSEs now touch 70 percent of new mortgages and represent the only functioning secondary mortgage market. The GSEs are central to the availability of housing finance, which will determine the pace at which we emerge from this housing correction.

In addition, debt and other securities issued by the GSEs are held by financial institutions around the world. Continued confidence in the GSEs is important to maintaining financial system and market stability.

Market stability and support for housing finance are among my highest priorities during this time of stress in our markets. Therefore, after consultations with the Federal Reserve, the Office of Federal Housing Enterprise Oversight (OFHEO), the Securities and Exchange Commission (SEC) and Congressional leaders we are asking Congress, as it completes its work on a stronger GSE regulatory structure, to also enact a three-part plan to address the current situation. Our plan is aimed at supporting the stability of financial markets, not just these two enterprises. This is consistent with Treasury's mission to promote the market stability, orderliness and liquidity necessary to support our economy.

Our proposal was not prompted by any sudden deterioration in conditions at Fannie Mae or Freddie Mac. OFHEO has reaffirmed that both GSEs remain adequately capitalized. At the same time, recent developments convinced policymakers and the GSEs that steps are needed to respond to market concerns and increase confidence by providing assurances of access to liquidity and capital on a temporary basis if necessary.

The plan we announced will strengthen our financial system as we weather this housing correction and establish a new world class regulator for the GSEs; it has three parts.

First, as a liquidity backstop, the plan includes an 18-month temporary increase in Treasury's existing authority to make credit available for the GSEs. Given the difficulty in determining the appropriate size of the credit line we are not proposing a particular dollar amount. Flexibility is the best means of increasing market confidence in the GSEs, and also the best means of minimizing taxpayer risk.

Second, to ensure the GSEs have access to sufficient capital to continue to fulfill their mission, the plan gives Treasury an 18-month temporary authority to purchase – only if necessary – equity in either of the two GSEs.

Let me stress that there are no immediate plans to access either the proposed liquidity or the proposed capital backstop. If either of these authorities is used, it would be done so only at Treasury's discretion, under terms and conditions that protect the U.S. taxpayer and are agreed to by both Treasury and the GSE. I have for some time urged a broad range of financial institutions to raise capital and at Treasury we have constantly encouraged the GSEs to do just that. In March, at my request, both the Chairman and Ranking Member of this Committee hosted a meeting with me and the CEOs of the two GSEs where they agreed to raise capital and you began the effort to move your GSE reform bill, which is now hopefully about to be enacted with the modifications we are recommending today.

Third, to help protect the financial system from future systemic risk, the plan strengthens the GSE regulatory reform legislation currently moving through Congress by providing the Federal Reserve authority to access information and perform a consultative role in the new GSE regulator's process for setting capital requirements and other prudential standards. Let me be clear, the Federal Reserve would not be the primary regulator. As I have said for some time, the Fed already plays the role of de-facto market stability regulator and we must give it the authorities to carry out that role. This role for the Federal Reserve with respect to the GSEs is consistent with the recommendation made in Treasury's Blueprint for a Modernized Financial Regulatory Structure. Clearly, given the scope of the GSEs' operations in world financial markets, a market stability regulator must have some line of sight into their operations.

We have long maintained that the GSEs have the potential to pose a systemic risk and worked with Congress on legislation to create a GSE regulator with authorities appropriate to the task and on par with other financial regulators. We must complete this work. The Senate passed GSE reform legislation last Friday, and we urge the House to act quickly to advance this process.

As I have said, we support the current shareholder-owned structure of these enterprises. Our plan addresses current market challenges by ensuring, on a temporary basis, access to both liquidity and capital, while also ensuring that the GSEs can fulfill their mission – a mission that remains critical to homeowners and homebuyers across the country, especially during this housing correction.

I look forward to working closely with you, your colleagues in the House, and Congressional leadership in both chambers to enact this plan as part of a complete legislative package, as soon as possible. Thank you.

July 10, 2008
hp-1076

Testimony of Treasury Deputy Assistant Secretary for
International Tax Affairs
Michael F. Mundaca
Before the Senate Committee on Foreign Relations
on Pending Income Tax Treaties

Washington, DC -- Mr. Chairman, Ranking Member Lugar, and distinguished Members of the Committee, I appreciate the opportunity to appear today to recommend, on behalf of the Administration, favorable action on three tax treaties pending before this Committee. We appreciate the Committee's interest in these treaties and in the U.S. tax treaty network overall.

This Administration is committed to eliminating barriers to cross-border trade and investment, and tax treaties are the primary means for eliminating tax barriers to such trade and investment. Tax treaties provide greater certainty to taxpayers regarding their potential liability to tax in foreign jurisdictions; they allocate taxing rights between the two jurisdictions and include other provisions that reduce the risk of double taxation, including provisions that reduce gross-basis withholding taxes; and they ensure that taxpayers are not subject to discriminatory taxation in the foreign jurisdiction.

This Administration is also committed to preventing tax evasion, and our tax treaties play an important role in this area as well. A key element of U.S. tax treaties is exchange of information between tax authorities. Under tax treaties, one country may request from the other such information as may be relevant for the proper administration of the first country's tax laws. Because access to information from other countries is critically important to the full and fair enforcement of U.S. tax laws, information exchange is a top priority for the United States in its tax treaty program.

A tax treaty reflects a balance of benefits that is agreed to when the treaty is negotiated. In some cases, changes in law or policy in one or both of the treaty partners make the partners more willing to increase the benefits beyond those provided by the treaty; in these cases, negotiation of a revised treaty may be very beneficial. In other cases, developments in one or both countries, or international developments more generally, may make is desirable to revisit a treaty to prevent exploitation of treaty provisions and eliminate unintended and inappropriate consequences in the application of the treaty; in these cases, it may be expedient to modify the agreement. Both in setting our overall negotiation priorities and in negotiating individual treaties, our focus is on ensuring that our tax treaty network fulfills its goals of facilitating cross border trade and investment and preventing fiscal evasion.

The treaties before the Committee today with Canada, Iceland, and Bulgaria serve to further the goals of our tax treaty network. The treaties with Canada and Iceland would modify existing tax treaty relationships. The tax treaty with Bulgaria would be the first between our two countries. We urge the Committee and the Senate to take prompt and favorable action on all of these agreements.

Before discussing the pending treaties in more detail, I would like to address some more general tax treaty matters, to provide background for the Committee's and the Senate's consideration of the pending tax treaties.

Purposes and Benefits of Tax Treaties

Tax treaties set out clear ground rules that govern tax matters relating to trade and investment between the two countries.

One of the primary functions of tax treaties is to provide certainty to taxpayers regarding the threshold question with respect to international taxation: whether a taxpayer's cross-border activities will subject it to taxation by two or more countries. Tax treaties answer this question by establishing the minimum level of economic activity that must be engaged in within a country by a resident of the other before the first country may tax any resulting business profits. In general terms, tax treaties provide that if branch operations in a foreign country have sufficient substance and continuity, the country where those activities occur will have primary (but not exclusive) jurisdiction to tax. In other cases, where the operations in the foreign country are relatively minor, the home country retains the sole jurisdiction to tax.

Another primary function is relief of double taxation. Tax treaties protect taxpayers from potential double taxation primarily through the allocation of taxing rights between the two countries. This allocation takes several forms. First, the treaty has a mechanism for resolving the issue of residence in the case of a taxpayer that otherwise would be considered to be a resident of both countries. Second, with respect to each category of income, the treaty assigns the primary right to tax to one country, usually (but not always) the country in which the income arises (the "source" country), and the residual right to tax to the other country, usually (but not always) the country of residence of the taxpayer (the "residence" country). Third, the treaty provides rules for determining which country will be treated as the source country for each category of income. Finally, the treaty establishes the obligation of the residence country to eliminate double taxation that otherwise would arise from the exercise of concurrent taxing jurisdiction by the two countries.

In addition to reducing potential double taxation, tax treaties also reduce potential "excessive" taxation by reducing withholding taxes that are imposed at source. Under U.S. law, payments to non-U.S. persons of dividends and royalties as well as certain payments of interest are subject to withholding tax equal to 30 percent of the gross amount paid. Most of our trading partners impose similar levels of withholding tax on these types of income. This tax is imposed on a gross, rather than net, amount. Because the withholding tax does not take into account expenses incurred in generating the income, the taxpayer that bears the burden of withholding tax frequently will be subject to an effective rate of tax that is significantly higher than the tax rate that would be applicable to net income in either the source or residence country. The taxpayer may be viewed, therefore, as suffering excessive taxation. Tax treaties alleviate this burden by setting maximum levels for the withholding tax that the treaty partners may impose on these types of income or by providing for exclusive residence-country taxation of such income through the elimination of source-country withholding tax. Because of the excessive taxation that withholding taxes can represent, the United States seeks to include in tax treaties provisions that substantially reduce or eliminate source-country withholding taxes.

As a complement to these substantive rules regarding allocation of taxing rights, tax treaties provide a mechanism for dealing with disputes between the countries regarding the treaties, including questions regarding the proper application of the treaties that arise after the treaty enters into force. To resolve disputes, designated tax authorities of the two governments – known as the "competent authorities" in tax treaty parlance – are to consult and to endeavor to reach agreement. Under many such agreements, the competent authorities agree to allocate a taxpayer's income between the two taxing jurisdictions on a consistent basis, thereby preventing the double taxation that might otherwise result. The U.S. competent authority under our tax treaties is the Secretary of the Treasury. That function has been delegated to the Deputy Commissioner (International) of the Large and Mid-Size Business Division of the Internal Revenue Service.

Tax treaties also include provisions intended to ensure that cross-border investors do not suffer discrimination in the application of the tax laws of the other country. This is similar to a basic investor protection provided in other types of agreements, but the non-discrimination provisions of tax treaties are specifically tailored to tax matters and, therefore, are the most effective means of addressing potential discrimination in the tax context. The relevant tax treaty provisions explicitly prohibit types of discriminatory measures that once were common in some tax systems. At the same time, tax treaties clarify the manner in which possible discrimination is to be tested in the tax context.

In addition to these core provisions, tax treaties include provisions dealing with more specialized situations, such as rules coordinating the pension rules of the tax systems of the two countries or addressing the treatment of Social Security benefits and alimony and child-support payments in the cross-border context. These provisions are becoming increasingly important as more individuals move between countries or otherwise are engaged in cross-border activities. While these matters may not involve substantial tax revenue from the perspective of the two governments, rules providing clear and appropriate treatment are very important to the affected taxpayers.

Tax treaties also include provisions related to tax administration. A key element of U.S. tax treaties is the provision addressing the exchange of information between the tax authorities. Under tax treaties, the competent authority of one country may request from the other competent authority such information as may be relevant for the proper administration of the first country's tax laws; the information provided pursuant to the request is subject to the strict confidentiality protections that apply to taxpayer information. Because access to information from other countries is critically important to the full and fair enforcement of the U.S. tax laws, information exchange is a priority for the United States in its tax treaty program. If a country has bank-secrecy rules that would operate to prevent or seriously inhibit the appropriate exchange of information under a tax treaty, we will not enter into a new tax treaty relationship with that country. Indeed, the need for appropriate information exchange provisions is one of the treaty matters that we consider non-negotiable.

Tax Treaty Negotiating Priorities and Process

The United States has a network of 58 income tax treaties covering 66 countries. This network covers the vast majority of foreign trade and investment of U.S. businesses and investors. In establishing our negotiating priorities, our primary objective is the conclusion of tax treaties that will provide the greatest benefit to the United States and to U.S. taxpayers. We communicate regularly with the U.S. business community and the Internal Revenue Service, seeking input regarding the areas in which treaty network expansion and improvement efforts should be focused and seeking information regarding practical problems encountered under particular treaties and particular tax regimes.

The primary constraint on the size of our tax treaty network may be the complexity of the negotiations themselves. Ensuring that the various functions to be performed by tax treaties are all properly taken into account makes the negotiation process exacting and time consuming.

Numerous features of a country's particular tax legislation and its interaction with U.S. domestic tax rules must be considered in negotiating a treaty or protocol. Examples include whether the country eliminates double taxation through an exemption system or a credit system, the country's treatment of partnerships and other transparent entities, and how the country taxes contributions to pension funds, earnings of the funds, and distributions from the funds.

Moreover, a country's fundamental tax policy choices are reflected not only in its tax legislation but also in its tax treaty positions. These choices differ significantly from country to country, with substantial variation even across countries that seem to have quite similar economic profiles. A treaty negotiation must take into account all of these aspects of the particular treaty partner's tax system and treaty policies to arrive at an agreement that accomplishes the United States' tax treaty objectives.

Obtaining the agreement of our treaty partners on provisions of importance to the United States sometimes requires concessions on our part. Similarly, the other country sometimes must make concessions to obtain our agreement on matters that are critical to it. Each treaty that we present to the Senate represents not only the best deal that we believe can be achieved with the particular country, but also constitutes an agreement that we believe is in the best interests of the United States.

In some situations, the right result may be no tax treaty at all. Prospective treaty partners must evidence a clear understanding of what their obligations would be under the treaty, especially those with respect to information exchange, and must demonstrate that they would be able to fulfill those obligations. Sometimes a tax treaty may not be appropriate because a potential treaty partner is unable to do so.

In other cases, a tax treaty may be inappropriate because the potential treaty partner is not willing to agree to particular treaty provisions that are needed to address real tax problems that have been identified by U.S. businesses operating there or because the potential treaty partner insists on provisions the United States will not agree to, such as providing a U.S. tax credit for investment in the foreign country (so-called "tax sparing"). With other countries there simply may not be the type of cross-border tax issues that are best resolved by treaty. For example, if a country does not impose significant income taxes, there is little possibility of double taxation of cross-border income, and an agreement that is focused on the exchange of tax information ("tax information exchange agreements" or TIEAs) may be the most appropriate agreement.

A high priority for improving our overall treaty network is continued focus on prevention of "treaty shopping." The U.S. commitment to including comprehensive limitation on benefits provisions is one of the keys to improving our overall treaty network. Our tax treaties are intended to provide benefits to residents of the United States and residents of the particular treaty partner on a reciprocal basis. The reductions in source-country taxes agreed to in a particular treaty mean that U.S. persons pay less tax to that country on income from their investments there and residents of that country pay less U.S. tax on income from their investments in the United States. Those reductions and benefits are not intended to flow to residents of a third country. If third-country residents are able to exploit one of our tax treaties to secure reductions in U.S. tax, such as through the use of an entity resident in a treaty country that merely holds passive U.S. assets, the benefits would flow only in one direction as third-country residents would enjoy U.S. tax reductions for their U.S. investments, but U.S. residents would not enjoy reciprocal tax reductions for their investments in that third country. Moreover, such third-country residents may be securing benefits that are not appropriate in the context of the interaction between their home country's tax systems and policies and those of the United States. This use of tax treaties is not consistent with the balance of the deal negotiated in the underlying tax treaty. Preventing this exploitation of our tax treaties is critical to ensuring that the third country will sit down at the table with us to negotiate on a reciprocal basis, so we can secure for U.S. persons the benefits of reductions in source-country tax on their investments in that country.

Consideration of Arbitration

Tax treaties cannot facilitate cross-border investment and provide a more stable investment environment unless the treaty is effectively implemented by the tax administrations of the two countries. Under our tax treaties, when a U.S. taxpayer becomes concerned about implementation of the treaty, the taxpayer can bring the matter to the U.S. competent authority who will seek to resolve the matter with the competent authority of the treaty partner. The competent authorities will work cooperatively to resolve genuine disputes as to the appropriate application of the treaty.

The U.S. competent authority has a good track record in resolving disputes. Even in the most cooperative bilateral relationships, however, there will be instances in which the competent authorities will not be able to reach a timely and satisfactory resolution. Moreover, as the number and complexity of cross-border transactions increases, so does the number and complexity of cross-border tax disputes. Accordingly, we have considered ways to equip the U.S. competent authority with additional tools to resolve disputes promptly, including the possible use of arbitration in the competent authority mutual agreement process.

The first U.S. tax agreement that contemplated arbitration was the U.S.-Germany income tax treaty signed in 1989. Tax treaties with several other countries, including Canada, Mexico, and the Netherlands, incorporate authority for establishing voluntary binding arbitration procedures based on the provision in the prior U.S.-Germany treaty. Although we believe that the presence of these voluntary arbitration provisions may have provided some limited assistance in reaching mutual agreements, it has become clear that the ability to enter into voluntary arbitration does not provide sufficient incentive to resolve problem cases in a timely fashion.

Over the past few years, we have carefully considered and studied various types of mandatory arbitration procedures that could be used as part of the competent authority mutual agreement process. In particular, we examined the experience of countries that adopted mandatory binding arbitration provisions with respect to tax matters. Many of them report that the prospect of impending mandatory arbitration creates a significant incentive to compromise before commencement of the process. Based on our review of the U.S. experience with arbitration in other areas of the law, the success of other countries with arbitration in the tax area, and the overwhelming support of the business community, we concluded that mandatory binding arbitration as the final step in the competent authority process can be an effective and appropriate tool to facilitate mutual agreement under U.S. tax treaties.

One of the treaties before the Committee, the Protocol with Canada, includes a type of mandatory arbitration provision negotiated contemporaneously with, and very similar to, a provision in our current, recently ratified treaties with Germany and Belgium, which this Committee and the Senate considered last year. 

In the typical competent authority mutual agreement process, a U.S. taxpayer presents its problem to the U.S. competent authority and participates in formulating the position the U.S. competent authority will take in discussions with the treaty partner. Under the arbitration provision proposed in the Canadian protocol, as in the similar provisions that are now part of our treaties with Germany and Belgium, if the competent authorities cannot resolve the issue within two years, the competent authorities must present the issue to an arbitration board for resolution, unless both competent authorities agree that the case is not suitable for arbitration. The arbitration board must resolve the issue by choosing the position of one of the competent authorities. That position is adopted as the agreement of the competent authorities and is treated like any other mutual agreement (i.e., one that has been negotiated by the competent authorities) under the treaty.

Because the arbitration board can only choose between the positions of each competent authority, the expectation is that the differences between the positions of the competent authorities will tend to narrow as the case moves closer to arbitration. In fact, if the arbitration provision is successful, difficult issues will be resolved without resort to arbitration. Thus, it is our expectation that these arbitration provisions will be rarely utilized, but that their presence will encourage the competent authorities to take approaches to their negotiations that result in mutually agreed conclusions in the first instance.

The arbitration process proposed in the agreement with Canada, consistent with the German and Belgian provisions, is mandatory and binding with respect to the competent authorities. However, consistent with the negotiation process under the mutual agreement procedure, the taxpayer can terminate the arbitration at any time by withdrawing its request for competent authority assistance. Moreover, the taxpayer retains the right to litigate the matter (in the United States or the treaty partner) in lieu of accepting the result of the arbitration, just as it would be entitled to litigate in lieu of accepting the result of a negotiation under the mutual agreement procedure.

Arbitration is a growing and developing field, and there are many forms of arbitration from which to choose. We intend to continue to study other arbitration provisions and to monitor the performance of the provisions in the agreements with Belgium and Germany, as well as the performance of the provision in the agreement with Canada, if ratified. We look forward to continuing to work with the Committee to make arbitration an effective tool in promoting the fair and expeditious resolution of treaty disputes. The Committee's comments made with respect to the German and Belgian arbitration provisions have been very helpful and will inform future negotiations of arbitration provisions.

Discussion of Proposed Treaties

I now would like to discuss in more detail the three treaties that have been transmitted for the Senate's consideration. We have submitted a Technical Explanation of each treaty that contains detailed discussions of the provisions of each treaty. These Technical Explanations serve as an official guide to each treaty. The Technical Explanation to the Protocol with Canada was reviewed by Canada, and Canada subscribes to its contents, as will be confirmed by a press release from the Canadian Ministry of Finance.

Canada

The proposed Protocol with Canada was signed in Chelsea on September 21, 2007, and is the fifth protocol of amendment to the current Convention negotiated in 1980 and amended by prior protocols in 1983, 1984, 1995, and 1997. The most significant provisions in this treaty relate to the taxation of cross-border interest, the treatment of income derived through fiscally transparent entities, the taxation of certain provisions of services, and the adoption of mandatory arbitration to facilitate the resolution of disputes between the U.S. and Canadian revenue authorities. The proposed Protocol also makes a number of changes to reflect changes in U.S. and Canadian law, and to bring the current Convention into closer conformity with current U.S. tax treaty policy.

The proposed Protocol eliminates withholding taxes on cross-border interest payments.  The elimination of withholding taxes on all cross-border interest payments between the United States and Canada has been a top tax treaty priority for both the business community and the Treasury Department for many years. The proposed Protocol represents a substantial improvement over the current Convention, which generally provides for a source-country withholding tax rate of 10 percent. This provision would be effective for interest paid to unrelated parties on the first day of January of the year in which the proposed Protocol enters into force, and it would be phased in for interest paid to related persons over a three-year period. Consistent with U.S. tax treaty policy, the proposed Protocol also provides exceptions to the elimination of source-country taxation with respect to contingent interest and payments from a U.S. real estate mortgage investment conduit.

The proposed Protocol also would provide that a U.S. person is generally eligible to claim the benefits of the treaty when such person derives income through an entity that is considered by the United States to be fiscally transparent (e.g., a partnership) unless the entity is a Canadian entity and is not treated by Canada as fiscally transparent. The proposed Protocol in addition contains anti-abuse provisions intended to address certain situations involving the use of these entities to obtain treaty benefits inappropriately.

The current Convention generally limits the taxation by one country of the business profits of a resident of the other country. The source country's right to tax such profits is generally limited to cases in which the profits are attributable to a permanent establishment located in that country. The proposed Protocol would add provisions related to the taxation of permanent establishments. Most importantly, the proposed Protocol includes a special rule allowing source-country taxation of income from certain provisions of services not otherwise considered to be provided through a permanent establishment. This rule is broader than the permanent establishment rule in the U.S. Model tax treaty but was key to achieving an overall agreement that we believe is in the best interests of the United States and U.S. taxpayers. 

As previously noted, the proposed Protocol provides for mandatory arbitration of certain cases that have not been resolved by the competent authority within a specified period, generally two years from the commencement of the case. Under the proposed Protocol, the arbitration process may be used to reach an agreement with respect to certain issues relating to residence, permanent establishment, business profits, related persons, and royalties. The arbitration board must deliver a determination within six months of the appointment of the chair of the arbitration board, and the determination must either be the proposed resolution submitted by the United States or the proposed resolution submitted by Canada. The board's determination has no precedential value and the board shall not provide a rationale for its determination.

The proposed Protocol also makes a number of other modifications to the current Convention to reflect changes to U.S. law and current U.S. tax treaty policy. For example, the proposed Protocol updates the current Convention's treatment of pensions for cross-border workers to remove barriers to the flow of personal services between the United States and Canada that could otherwise result from discontinuities in the laws of the two countries regarding the tax treatment of pensions. In addition, the proposed Protocol updates the current Convention's limitation on benefits provisions so that they apply on a reciprocal basis. The proposed Protocol also addresses the treatment of companies that engages in corporate "continuance" transactions and revises the current Convention's rules regarding the residence of so-called dual resident companies.

The proposed Protocol provides that the United States and Canada shall notify each other in writing, through diplomatic channels, when their respective applicable procedures for ratification have been satisfied. The proposed Protocol will enter into force upon the date of the later of the required notifications. For taxes withheld at source, it will generally have effect for amounts paid or credited on or after the first day of the second month that begins after the date the proposed Protocol enters into force, although certain provisions with respect to interest may have earlier effect. With respect to other taxes, the proposed Protocol will generally have effect for taxable years that begin after the calendar year in which the proposed Protocol enters into force. Certain provisions will be phased in or have a delayed effective date. Provisions regarding corporate continuance transactions will apply retroactively, consistent with prior Treasury Department public statements.

Iceland

The proposed Convention and accompanying Protocol with Iceland was signed in Washington, D.C., on October 23, 2007. It would replace the current Convention, concluded in 1975. The most important change from the current Convention is the addition of a limitation on benefits provision. The proposed Convention also makes changes to some of the withholding tax rates provided in the current Convention. In addition, the proposed Convention makes a number of changes to reflect changes in U.S. and Icelandic law, and to conform to current U.S. tax treaty policy.  

As just noted, the proposed Convention contains a comprehensive limitation on benefits provision, generally following the current U.S. Model income tax treaty. The current Convention does not contain treaty shopping protections and, as a result, has been abused by third-country investors in recent years. For this reason, revising the current Convention has been a top tax treaty priority. 

The proposed Convention generally provides for withholding rates on investment income that are the same as or lower than those in the current Convention. Like the current Convention, the proposed Convention provides for reduced source-country taxation of cross-border dividends. In addition, the proposed Convention would eliminate source-country withholding tax on cross-border dividend payments to pension funds. As with the current Convention, the proposed Convention generally would eliminate source-country withholding tax on cross-border interest payments. However, while the current Convention eliminates source-country withholding taxes on all cross-border payments of royalties, the proposed Convention would allow the country in which certain cross-border trademark royalties arise to impose a withholding tax of up to 5 percent. Inclusion of this provision was key to achieving an overall agreement that we believe is in the best interests of the United States and U.S. taxpayers. 

In addition, the proposed Convention provides for the exchange between the tax authorities of each country of information relevant to carrying out the provisions of the agreement or the domestic tax laws of either country.

The proposed Convention provides that the United States and Iceland shall notify each other in writing, through diplomatic channels, when their respective applicable procedures for ratification have been satisfied. The proposed Convention will enter into force on the date of the later of the required notifications. It will have effect, with respect to taxes withheld at source, for amounts paid or credited on or after the first day of January of the calendar year following entry into force, and with respect to other taxes, for taxable years beginning on or after the first day of January following the date upon which the proposed Convention enters into force. The current Convention will, with respect to any tax, cease to have effect as of the date on which this proposed Convention has effect with respect to such tax. However, where any person would be entitled to greater benefits under the current Convention, at the election of the person, the current Convention shall continue to have effect in its entirety with respect to such person for a period of 12 months from the date the provisions of the proposed Convention are effective.

Bulgaria

The proposed income tax Convention and accompanying Protocol with Bulgaria signed in Washington, D.C., on February 23, 2007, and the subsequent Protocol with Bulgaria signed in Sofia, on February 26, 2008, together would represent the first income tax treaty between the United States and Bulgaria. The proposed Convention is generally consistent with the current U.S. Model income tax treaty and with treaties that the United States has with other countries.

Under the proposed Convention, withholding taxes on cross-border portfolio dividend payments may be imposed by the source state at a maximum rate of 10 percent. When the beneficial owner of a cross-border dividend is a company that directly owns at least 10 percent of the stock of the company paying the dividend, withholding tax may be imposed at a maximum rate of 5 percent.  The proposed Convention also provides for a withholding rate of zero on cross-border dividend payments to pension funds.   

The proposed Convention generally limits withholding taxes on cross-border interest payments to a maximum rate of 5 percent. No withholding tax on a cross-border interest payment is generally permitted, however, when the interest is beneficially owned by, or guaranteed by, the government or the central bank of the other country (or any institution owned by that country), a pension fund resident in the other country, or a financial institution (including a bank or an insurance company) resident in the other country. 

The proposed Convention provides that withholding taxes on cross-border royalty payments are limited to a maximum rate of 5 percent. 

The proposed Convention also incorporates rules provided in the U.S. Model tax treaty for certain classes of investment income. For example, dividends paid by entities such as U.S. regulated investment companies and real estate investment trusts, are subject to special rules to prevent the use of these entities to transform what is otherwise higher-taxed income into lower-taxed income. 

The proposed Convention limits the taxation by one country of the business profits of a resident of the other country. The source country's right to tax such profits is generally limited to cases in which the profits are attributable to a permanent establishment located in that country. The proposed Convention includes a rule, similar to a rule in the proposed Protocol with Canada, allowing source-country taxation of income from certain provisions of services. The proposed Convention also provides that certain employees or agents that maintain a stock of goods from which the agent regularly fills orders on behalf of the principal, and conduct additional activities contributing to the conclusion of sales, may result in a permanent establishment.

Consistent with current U.S. tax treaty policy, the proposed Convention includes a comprehensive limitation on benefits article, which is designed to deny treaty shoppers the benefits of the Convention. The proposed Convention provides for non-discriminatory treatment by one country to residents and nationals of the other country. In addition, the proposed Convention provides for the exchange between the tax authorities of each country of information relevant to carrying out the provisions of the agreement or the domestic tax laws of either country. This will facilitate the enforcement of U.S. domestic tax rules. 

The proposed Convention provides that the United States and Bulgaria shall notify each other, through diplomatic channels, when their respective applicable procedures for ratification have been satisfied. The proposed Convention will enter into force upon the date of receipt of the later of the required notifications. It will have effect, with respect to taxes withheld at source, for amounts paid or credited on or after the first day of January in the year following the date upon which the proposed Convention enters into force and, with respect to other taxes, for taxable years beginning on or after the first day of January in the year following the date upon which the proposed Convention enters into force.

Treaty Program Priorities

A key continuing priority for the Treasury Department is updating the few remaining U.S. tax treaties that provide for low withholding tax rates but do not include the limitation on benefits provisions needed to protect against the possibility of treaty shopping. Accordingly, we currently are in ongoing discussions with both Poland and Hungary regarding the inclusion of anti-treaty shopping provisions.

In addition, we continue to maintain a very active calendar of tax treaty negotiations. We recently initialed a new tax treaty with Malta. We also are currently negotiating with France and New Zealand, and expect to announce soon the opening of other negotiations.

We also have undertaken exploratory discussions with several countries in Asia and South America that we hope will lead to productive negotiations later in 2008 or in 2009.

Conclusion

Mr. Chairman and Ranking Member Lugar, let me conclude by thanking you for the opportunity to appear before the Committee to discuss the Administration's efforts with respect to the three agreements under consideration. We appreciate the Committee's continuing interest in the tax treaty program, and we thank the Members and staff for devoting time and attention to the review of these new agreements. We are also grateful for the assistance and cooperation of the staff of the Joint Committee on Taxation.

On behalf of the Administration, we urge the Committee to take prompt and favorable action on the agreements before you today. I would be happy to respond to any question you may have.

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REPORTS

• Canada Technical Explanation
• Iceland Technical Explanation
• Bulgaria Technical Explanation

Oral Statement by Secretary Henry M. Paulson, Jr.
on Regulatory Reform before House Committee on Financial Services

Washington, DC-- Mr. Chairman, Ranking Member Bachus, thank you for holding this hearing, and for your leadership on these important issues. As you know, our financial markets have been experiencing turmoil since last August. It will take additional time to work through challenges. Progress has not come in a straight line but much has been accomplished. Our financial institutions are repricing risk, deleveraging, recognizing losses, raising capital and improving their financial position. Their ability to raise capital even during times of stress is a testament to our financial institutions and our financial system.

Fannie Mae and Freddie Mac are also working through this challenging period. They play an important role in our housing markets today and need to continue to play an important role in the future. Their regulator has made clear that they are adequately capitalized.

Market practices and discipline on the part of financial institutions and investors are also improving. Our regulators are shining a light on our challenges. Through the PWG, we have issued a report analyzing the causes of the turmoil and recommending a comprehensive policy response, implementation of which is well underway. Regulators are enhancing guidance, issuing new rules, and communicating more effectively across agencies – domestically and internationally.

Although our regulatory architecture and authorities are outdated and less than optimal, we have been working together, while respecting our different authorities and responsibilities, to ensure the stability of the financial system, because it is in the interest of the American people that we do so. Today this is by far our most important priority. And our seamless cooperation to achieve it is made possible by the leadership and support provided by this committee and other leaders in Congress.

I have confidence in our regulators and markets.  We need to remain focused and continue to address challenges with your help and support, but we will ultimately emerge with strong capital markets, which in turn will enable our economy to continue to grow.

Looking beyond this period of market stress, which will eventually pass as these situations always do, I have presented my ideas for improving our regulatory structure and expanding our emergency powers. And I look forward to discussing these ideas with you today, even as we continue our primary focus on confronting current challenges and maintaining stable, orderly financial markets.

In March, I laid out a Blueprint for a Modernized Financial Regulatory Structure, in which we recommended a U.S. regulatory model based on objectives that more closely link the regulatory structure to the reasons why we regulate. Our model proposes three primary regulators: one focused on market stability across the entire financial sector, another focused on safety and soundness of institutions supported by a federal guarantee, and a third focused on protecting consumers and investors.

A major advantage of this structure is its timelessness and its flexibility and that, because it is organized by regulatory objective rather than by financial institution category, it can more easily respond and adapt to the ever-changing marketplace. If implemented, these recommendations eliminate regulatory competition that creates inefficiencies and can engender a race to the bottom.

The Blueprint also recommends a number of near-term steps. These include formalizing the current informal coordination among U.S. financial regulators by amending and enhancing the Executive Order which created the President's Working Group on Financial Markets and, while retaining state-level regulation of mortgage origination practices, creating a new federal-level commission, the Mortgage Origination Commission to establish minimum standards for, among other things, personal conduct and disciplinary history, minimum educational requirements, testing criteria and procedures, and appropriate licensing revocation standards.

The Blueprint includes recommendations on a number of intermediate steps as well – focusing on payment and settlement systems and on areas, such as futures and securities, where our regulatory structure severely inhibits our competitiveness. We recommend the creation of an Optional Federal Charter for insurance companies, similar to the current dual-chartering system for banking, and that the thrift charter has run its course and should be phased out. We also recommend the creation of a federal charter for systemically important payment and settlement systems and that these systems should be overseen by the Federal Reserve, in order to guard the integrity of this vital part of our nation's economy.

When we released the Blueprint, I said that we were laying out a long-term vision that would not be implemented soon. Since then, the Bear Stearns episode and market turmoil more generally have placed in stark relief the outdated nature of our financial regulatory system, and has convinced me that we must move much more quickly to update our regulatory structure and improve both market oversight and market discipline. Over the last several weeks, I have recommended important steps that the United States should take in the near term, all of which move us toward the optimal regulatory structure outlined in the Blueprint. I will briefly summarize these.

First, Americans have come to expect the Federal Reserve to step in to avert events that pose unacceptable systemic risk. But the Fed does not have the clear statutory authority nor the mandate to do this; therefore we should consider how to most appropriately give the Federal Reserve the authority to access necessary information from complex financial institutions – whether it is a commercial bank, an investment bank, a hedge fund, or another type of financial institution – and the tools to intervene to mitigate systemic risk in advance of a crisis.

The MOU recently finalized between the SEC and the Federal Reserve is consistent with this long-term vision of the Blueprint and should help inform future decisions as our Congress considers how to modernize and improve our regulatory structure.

Market discipline is also critical to the health of our financial system, and must be reinforced, because regulation alone cannot eliminate all future bouts of market instability. For market discipline to be effective, market participants must not expect that lending from the Fed, or any other government support, is readily available. I know from first hand experience that normal or even presumed access to a government backstop has the potential to change behavior within financial institutions and with their creditors. It compromises market discipline and lowers risk premiums, ultimately putting the system at greater risk.

For market discipline to effectively constrain risk, financial institutions must be allowed to fail.

Today two concerns underpin expectations of regulatory intervention to prevent a failure. They are that an institution may be too interconnected to fail or too big to fail. Steps are being taken to improve market infrastructure, especially where our financial firms are highly intertwined - the OTC derivatives market and the tri-party repurchase agreement market, which is the marketplace through which our financial institutions obtain large amounts of secured funding.

It is clear that some institutions, if they fail, can have a systemic impact. Looking beyond immediate market challenges, last week I laid out my proposals for creating a resolution process that ensures the financial system can withstand the failure of a large complex financial firm. To do this, we will need to give our regulators additional emergency authority to limit temporary disruptions. These authorities should be flexible, and – to reinforce market discipline – the trigger for invoking such authority should be very high, such as a bankruptcy filing. Any potential commitment of government support should be an extraordinary event that requires the engagement of the Treasury Department and contains sufficient criteria to prevent costs to the taxpayer to the greatest extent possible.

This work will not be done easily. It must begin now, and begin in earnest. Thank you.

Fiscal Assistant Secretary Kenneth E. Carfine
Testimony Before the Senate Committee on
Homeland Security and Governmental
Affairs, Subcommittee on Federal Financial
Management, Government Information
Federal Services, and International Security

Washington – Mr. Chairman and Members of the Subcommittee:

Thank you for inviting me to this hearing to discuss the Financial Report of the United States Government (Financial Report) for Fiscal Year 2007. Your interest in improving Federal financial management and, in particular, fiscal sustainability is appreciated. The Financial Report, incorporating the consolidated government-wide financial statements, is designed to report on the financial position and condition of the federal government pursuant to generally accepted accounting principles (GAAP).

The Financial Report reflects Treasury's long-standing responsibility to provide the Congress and the public with timely, reliable, and useful information on the cost of the government's operations, the sources used to fund them, and the implications of the government's financial commitments. It is designed to encompass and does substantially cover the financial results of all three branches of the federal government. Treasury constantly strives to improve the utility and value of the Report as well as the process by which it is produced.

This year, all 24 CFO Act agencies published their audited financial statements by November 15, and we issued the government-wide Report approximately a month later on December 17. These timely submissions are evidence that both the Federal agencies and Treasury continue to improve their systems and processes. As I will discuss, these improvements notwithstanding, due to long-standing material weaknesses, the Government Accountability Office again issued a disclaimer of opinion on most of the statements in the Financial Report. However, this year's report brings with it two significant achievements: 1) an unqualified audit opinion on the Statement of Social Insurance and 2) the issuance of a Citizen's Guide to the Report.

As Treasury and OMB reported in October, for Fiscal Year 2007, revenues increased to a record level of $2.6 trillion--an 8 percent increase over the previous fiscal year. Consequently, the 2007 federal net operating cost of $276 billion was better than anticipated and was a significant improvement over the 2006 net operating cost of $450 billion.

The Government's balance sheet shows that its liabilities exceed its assets by more than $9 trillion dollars. Much of this difference is attributed to: 1) the government's debt to the public of more than $5 trillion and 2) another nearly $5 trillion in anticipated federal employee and veterans postemployment benefits and commitments for which funding (i.e., employee and employer contributions) has not yet been obtained. The Statement of Net Cost presents cost by agency.

Because the Budget Deficit is such a well-publicized and generally-accepted figure, we provide two statements that facilitate the comparison and reconciliation of the government's activity.

The Reconciliation of Net Operating Cost and the Unified Budget Deficit statement ties the more widely recognized budget results (e.g., $163 billion unified budget deficit) to the government's net operating cost of $276 billion.

The budget deficit and net operating cost differ because the government uses a different basis of

accounting for each. The budget is prepared generally on a cash basis, which more appropriately pertains to the inflow and outflow of funds during the fiscal year, regardless of the amount or nature of the transaction. By comparison, the government's audited financial statements are prepared generally on the accrual basis pursuant to GAAP promulgated by the Federal Accounting Standards Advisory Board. Accrual accounting recognizes revenues when earned--not necessarily collected; and expenses when incurred--not necessarily expended. The bulk of this difference is due to the inclusion of actuarial increases in both federal employee pension and health liabilities, and environmental liabilities in net operating cost, but not in the budget deficit.

The Report also contains a Statement of Social Insurance (SOSI), which shows the present value cost of the government's exposures of its social insurance programs, primarily Social Security and Medicare. As indicated earlier, the SOSI became the first and, to date, the only government-wide financial statement to receive an unqualified audit opinion from the Government Accountability Office (GAO).

The FY 2007 Report adds new information related to fiscal sustainability. It provides a discussion of the extent to which the government will be able to financially support its critical programs in the near and distant future. This discussion is largely based on the information contained in the SOSI as well as the government's stewardship report (which is drawn from the Social Security and Medicare Trustees Reports).

Regarding the Social Security program, an important milestone was reached this year when the first baby boomers began drawing retirement benefits from Social Security. The retirement of the baby boom generation will have a profound impact on the finances of Social Security and Medicare. There are currently 3.3 covered workers per Social Security beneficiary; that number will fall to 2.1 by 2034. Medicare faces the same demographic challenges as Social Security, but additionally must cope with the rapid expected growth in health care costs. While Social Security expenditures are expected to grow considerably over the next 75 years, from 4.3 percent of GDP in 2007 to 6.3 percent of GDP in 2081, Medicare's expenditure growth is expected to increase from 3.2 percent of GDP in 2007 to 11.3 percent of GDP in 2081.

From a government-wide perspective, Medicare obligations are expected to dwarf those of Social Security. The 75-year present value of projected Medicare expenditures less tax and premium revenue is $34 trillion (4.7 percent of the present value of GDP), rising to $36 trillion in the 2008 report, while the 75-year present value of projected Social Security expenditures less tax revenue is $4.7 trillion (0.6 percent of GDP).

The Financial Report shows that the Federal Government's current policies, particularly with respect to Social Security and Medicare, are unlikely to be sustainable. Total expenditures, including interest, are expected to grow to 50 percent of GDP by 2070 and 60 percent by 2080. Such spending levels have only been witnessed once before--during World War II, when Government expenditures reached a then-record high of 44 percent of GDP. If revenues in the future continue at the historical average level of 18 percent of GDP, they will barely cover 1/3 of total government expenditures and would not be sufficient to cover the net interest on the Government's debt.

The consequence of the projected growing gap between revenues and expenditures would be a rapidly-increasing debt-to-GDP ratio. By 2030, the need to fund government deficits will drive the debt-to-GDP ratio to 68 percent--far surpassing the non-wartime peak of 49 percent in 1993. By 2040, this ratio is projected to reach 128 percent, well above the World War II peak of 109 percent. Thereafter, the ratio of debt held by the public to GDP rises sharply to 300 percent by 2060, doubling again to 600 percent by 2080. A rapidly rising debt-to-GDP ratio creates uncertainty over the form of future government financing, portends adverse long-run consequences for the economy and could impact other countries' willingness to lend money to or invest in the United States.

As noted earlier, these are merely projections based on a myriad of assumptions that can change and alter the outlook. Yet, the projections provide an important signal about the difficulties that the Government faces in attempting to sustain current policies. The Government can neither reasonably grow into nor tax its way back to sustainability. Nor can it realistically expect to continue to borrow without incurring a substantial negative impact on the economy. Avoiding the consequences of this fiscal path will require actions to bring program expenditures in line with available resources. How soon those actions are taken will greatly influence their ultimate impact on the Nation.

For Fiscal Year 2007, GAO was unable to express an opinion on the financial statements, due to long-standing material weaknesses. I recognize that until our financial statements can withstand audit scrutiny, we will not benefit from the Report's full value in informing the Congress and the Public about the Government's fiscal position and condition.

We agree with GAO on the following three principal material weaknesses:

1. Serious financial management control issues at the Department of Defense,
2. The government's inability to properly eliminate transactions between agencies, and
3. The government's deficiencies in the process for preparing the consolidated financial statements.

GAO raised many valid points in its audit, and there is no one more than I who would like to see a "clean" audit opinion on the consolidated financial statements. Across government, we have been addressing the weaknesses relating to the elimination of intragovernmental balances and the report preparation process, and are making progress.

We concur with GAO that the out-of-balance condition, resulting from intragovernmental transactions, continues to represent a significant material weakness. This occurs when two agencies conducting business with each other as trading partners record and report the same transaction differently. We are addressing this issue in several ways:

• We have started requiring significantly greater detail from the agencies. In addition, we have developed tools to track the imbalances, identify the problems, analyze the data, and implement solutions. We have also formed inter-agency groups to examine each pair of related transactions to resolve the imbalances.
• Partnering with OMB, we developed a method and vehicle to report these inter-agency transactions throughout the government. Agencies use these reports, which are posted on the Web, to analyze their transactions and balances. We have also worked with OMB to develop a "watch list" of agencies with the largest intragovernmental differences.
• We worked with the CFO Council to develop new intragovernmental transaction "business rules," which are helping to bring about more consistent accounting among business partners. Finally, we require agency auditors to review the intragovernmental balances in the hope that greater auditor involvement will encourage agencies to accurately record these transactions and correct the imbalances.

These and other actions have reduced the differences in reporting intragovernmental transactions from $86 billion in FY 2006 to approximately $67 billion in FY 2007.

We continue to address the report preparation issues by developing and following corrective action plans, which include strategies for short-term and long-term solutions. At the beginning of this fiscal year, there were 81 outstanding recommendations from GAO for improving the internal controls over the report preparation process. This year, we closed out 35 recommendations relating to prior year's reports. Based on the audit of the 2007 report, GAO identified an additional 10 recommendations for improving the report preparation process bringing the current total recommendations to be resolved to 56. Our plan is to resolve 8 of the 10 new recommendations by the end of the fiscal year and continue to aggressively address the 46 prior years' findings and recommendations.

We have strengthened our report preparation processes, by enhancing our data collection systems to meet disclosure requirements prescribed by generally accepted accounting principles. We have also focused our attention and resources on improving and fully documenting our standard operating procedures to increase the efficiency and effectiveness of our processes. Additionally, we have continued to enhance and clarify our guidance to federal program agencies for accurate and complete information and to ensure consistency of agency information for the Financial Report.

A common critique of the Financial Report of the U.S. Government is that, despite the fact that it contains more than 180 pages of detailed information on the government's financial position and condition, it is not a practical document for communicating with the American citizen or the Congress. At a minimum, the Report should provide an opportunity for all interested parties to easily gain an understanding of the significant fiscal challenges that the federal government faces now and in the future. In 2005, the Treasury Department consulted with a number of communication and accountability reporting experts (including some international colleagues) to identify ways to improve the Report's informative value and, more importantly, its ability to communicate with the general public.

In response, for the first time, the Treasury Department and OMB, in cooperation with GAO developed and issued a summary report entitled, The Government's Financial Health--A Citizen's Guide to the Financial Report of the U.S. Government. This Guide provides a summary of the key data and issues addressed in the full report in a "user-friendly" manner to the general public. We attempted to minimize the use of detailed technical and political jargon to make it easy to read. We have made a point of sharing this document not only with members of Congress, but also educational institutions around the country and in public professional forums. The document is eight pages in length and while printing was limited, it is freely accessible on the Internet. We have received valuable feedback, thus far, and are looking forward to improving on the Guide in subsequent editions.

As the primary investors in our country, U.S. citizens are entitled to, and our government is obligated to provide, up-to-date financial performance results about the government's current and future financial health. It is our hope that this document is the first of many of its kind--and that it sparks interest not only among committee members but the general public and encourages continued discussion of these important issues.

I am committed to working with OMB and the Chief Financial Officers Council on developing the government's financial management strategy for the near future. The improvements in financial systems and business processes that many agencies have made as a result of audited financial statements and accelerated timelines has led to better underlying financial data. We are now looking toward improving efficiency through standard systems and processes and a common language and structure for exchanging information and financial data among agencies and between agencies and Treasury.

The process of producing the Financial Report of the U.S. Government and annual agency financial reports and the reports themselves can have an impact on improving management and control of the government's finances. However, these reports are of limited or even minimal value if they go unread. As such, in addition to continuing to pursue resolution of the Government's financial reporting weaknesses, this year, the Treasury focused on how to make the document and the information that it contains more relevant and useful to the general public. We believe that the Citizen's Guide is a solid first step and hope that its visibility will inspire the public to ask questions about the government's and our own financial future.

Thank you, Mr. Chairman. This concludes my formal remarks. I look forward to your questions.

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June 26, 2008
HP-1058

Testimony of Treasury Benefits Tax Counsel Thomas Reeder
before the House Ways and
Means Subcommittee on Select Revenue Measures on
Individual Retirement Arrangements

Washington, DC--Chairman Neal, Ranking Member English and Members of the Committee, I appreciate the opportunity to appear today to discuss the issue of individual retirement arrangements (IRAs) and their vital role in generating and maintaining retirement savings of American workers and their beneficiaries.

IRAs are available to all Americans with compensation income (including net earnings from self-employment involving personal services). Certain tax preferences of IRAs, however, are dependent on the individual's level of income and whether the individual is covered by an employer-sponsored retirement plan. There are several types of IRAs, including traditional deductible IRAs, traditional nondeductible IRAs, and Roth IRAs. In addition, there are special types of IRAs available in the employment context referred to as SEP IRAs and SIMPLE IRAs.

Individuals under age 70½ may make contributions to a traditional IRA, subject to certain limits. The contributions are generally deductible. The deduction is phased out, however, for workers with incomes above certain levels who are covered by an employer-sponsored retirement plan. For taxpayers covered by employer plans in 2008, the deduction is phased out for single and head-of-household filers with modified adjusted gross income (1) (AGI) between $53,000 and $63,000, for married couples filing jointly with AGI between $85,000 and $105,000, and for married couples filing separately with AGI between $0 and $10,000. For a married individual filing jointly who is not covered by an employer-sponsored plan, but whose spouse is covered, the deduction is phased out between $159,000 and $169,000 in AGI. IRA earnings are not includible in gross income until distributed. Distributions (including both pre-tax contributions and account earnings) are includible in gross income for income tax purposes.

To the extent a taxpayer cannot or does not make deductible contributions to a traditional IRA, a taxpayer under age 70½ may make nondeductible contributions. Distributions representing a return of basis are not includible in gross income, while distributions representing account earnings are includible in gross income. There is no income limit for nondeductible contributions to a traditional IRA.

Individuals of any age with sufficiently low income may make contributions to a Roth IRA. The contributions are not deductible. Allowable contributions are phased out for workers with incomes above certain levels. In 2008, contributions are phased out for single or head-of-household filers with AGI between $101,000 and $116,000, for married couples filing jointly with AGI between $159,000 and $169,000, and for married couples filing separately with AGI between $0 and $10,000. Account earnings accumulate tax free, and qualified distributions (including account earnings) are not included in gross income for income tax purposes. Distributions from Roth IRAs prior to age 59½ or before the individual has had a Roth IRA for 5 years are included in income to the extent they exceed basis, unless the distribution is on account of death or disability or, for an amount up to $10,000, for a first-time home purchase. Distributions are deemed to come from basis first.

The annual aggregate limit on contributions to all of a taxpayer's IRAs (traditional, nondeductible, and Roth) is the lesser of earnings or $5,000 in 2008, and will be indexed for price inflation after 2008. Individuals age 50 and over may make an additional "catch-up" contribution of up to $1,000.

Taxpayers (other than married taxpayers who file separately) with AGI of $100,000 or less can convert a traditional IRA to a Roth IRA. In general, the conversion amount is included in gross income (but not for purposes of determining eligibility to convert). The Tax Increase Prevention and Reconciliation Act of 2005 repealed the income limitation for conversions from a traditional IRA to a Roth IRA made after December 31, 2009. Taxpayers who make such conversions in 2010 may elect to delay half of the income inclusion resulting from the conversion to 2011 and the other half of the income inclusion to 2012. Conversions made on or after January 1, 2011 will result in the full amount of the converted amount not previously included in taxable income to be included in they year of the conversion.

Distributions from traditional IRAs prior to age 59½, or from Roth IRAs prior to age 59½ or 5 years after the first Roth contribution, are generally subject to an additional 10 percent income tax. The tax is imposed on the portion of an early distribution that is includible in gross income. It applies in addition to ordinary income taxes on the distribution. The additional tax does not apply to a rollover to an employer plan or to another IRA, or if the distribution is made in the case of death or disability, certain medical expenses, first-time homebuyer expenses, qualified higher-education expenses, health insurance expenses of unemployed individuals, to a qualified reservist, or as part of a series of substantially equal periodic payments.

Beginning at age 70½, minimum distributions gauged to life expectancy of the IRA holder (or the joint life expectancy of the IRA holder and beneficiary) must be taken from a traditional IRA. Roth IRAs are not subject to minimum distribution rules during the account owner's lifetime.

Employers with 100 or fewer employees and no other retirement plan may establish SIMPLE IRAs. Unlike traditional IRAs, participants may defer up to $10,500 and SIMPLE participants aged 50 or over may make additional "catch-up" deferrals of up to $2,500. All contributions are immediately fully vested. In lieu of the nondiscrimination tests applicable to most other employer-sponsored retirement savings plans, SIMPLE IRAs are subject to special contribution rules, including a lower annual elective deferral limit and either a matching employer contribution for each employee up to 3 percent of compensation (which may be reduced to 1 percent under certain circumstances) or non-elective contribution of 2 percent of all eligible employees' compensation.

An employer may contribute to its employees' IRAs under a simplified employee pension (SEP). Under a SEP, the employer must contribute to all employees' IRAs in the same percentage (with certain exceptions). Employee contributions to SEPs are not permitted, except with respect to grandfathered salary reduction SEPs that were in existence on December 31, 1996.

An employer may also establish payroll deduction IRAs under which employees may elect to have a portion of their pay contributed to a traditional or Roth IRA in any amount up to the annual limits for individual traditional or Roth IRAs (plus the catch-up amount, if applicable). Like a SIMPLE IRA, these may be set up on an automatic basis. That is, the employee may be deemed to elect to participate in the program at a certain level unless the employee affirmatively elects not to participate or to participate at a different level. Although a payroll deduction IRA is essentially the same as an individual IRA, there are tremendous advantages to the payroll deduction process. It is generally accepted that employees are more likely to save if the amounts are automatically diverted to an IRA before they reach the employee's hands or checking account.

In summary, IRAs provide a valuable long-term savings tool. They are particularly valuable to those individuals who do not have access to other employer-sponsored savings plans and they are quite useful as a portable entity into which employees can combine the retirement savings they amass over their working careers. With all their retirement assets in a single trust or custodial account, employees can more efficiently and cost-effectively diversify their investments and otherwise manage their retirement savings.

The Treasury Department and the Internal Revenue Service (IRS) generally have interpretive and enforcement authority over the establishment and operation of individual IRAs and payroll deduction IRAs. The Employee Benefits Security Administration (EBSA) of the Department of Labor, however, has jurisdiction over various aspects (including fiduciary and disclosure requirements) of SEP IRAs and SIMPLE IRAs, as well as certain payroll deduction IRAs that entail such employer involvement that they constitute an employee benefit plan under Title I of the Employee Retirement Income Security Act of 1974. EBSA also has jurisdiction with respect to the interpretation of the prohibited transaction rules applicable to IRAs and has statutory authority to issue individual and class exemptions from the prohibited transaction rules for transactions involving IRAs. (2)

The Administration has long been concerned that the rules of employer retirement savings plans are unreasonably complicated. This complexity imposes substantial compliance, administrative, and enforcement costs on employers, participants, and the government (and hence, taxpayers in general). Moreover, because employer sponsorship of a retirement plan is voluntary, this complexity discourages many employers from offering a plan at all. This is especially true of small employers, which employ a majority of American workers. Complexity is commonly cited as a reason the coverage rate of employer-sponsored plans has not grown above about 50 percent overall and has remained under 25 percent among employees of small firms. Thus, the Administration is dedicated to reducing the complexity through proposed legislation and providing tools for employers – especially small employers – to use in creating and administering plans.

The Administration continues to be dedicated to educating employers about retirement plan options. Although most large employers sponsor workplace retirement savings programs, such as 401(k), 403(b), or 457 plans, many small employers lack the knowledge or resources to adopt these plans. Along with the Department of Labor, the Treasury Department and the IRS have taken significant steps to publicize the advantages of employer-sponsored IRA-based savings programs and to educate employers and individuals on the ease of setting them up. For example, the IRS has developed model plan documents for SIMPLE IRAs and SEPs and has created the following publications:

• Retirement Plans for Small Business (SEP, SIMPLE, and Qualified plans) (Publication 560)
• Individual Retirement Arrangements (Publication 590)
• Choosing a Retirement Solution for Your Small Business (co-produced by the IRS and EBSA) (Publication 3998)
• SEP Retirement Plans for Small Businesses (co-produced by the IRS and EBSA) (Publication 4333)
• SIMPLE IRA Plans for Small Businesses (co-produced by the IRS and EBSA) (Publication 4334)
• SIMPLE IRA Plan Checklist (Publication 4284)
• SEP Checklist (Publication 4285)
• Have you had your checkup this Year? For SIMPLE IRAs, SEPs and Similar Retirement Plans (Publication 4405)

In addition to these publications, the IRS operates an extensive on-line resource for IRA-based retirement plans for small employers, "The IRA Online Resource Guide," which is also available as a CD-ROM. There is also video entitled "How to Set up a Retirement Plan for Yourself and Your Employees" available on the IRS online classroom site for small businesses (www.irs.gov/businesses/small). Of particular note is the Retirement Plan Navigator geared to small employers (http://www.irs.gov/pub/irs-tege/online_navigator.pdf), which includes a video and leads small employers through the process of choosing a type of plan and goes through the process of adopting and maintaining the plan.

The Employee Plans division of the IRS participated in over 300 events last year throughout the country, many of which are directed at small employers and their advisors. The IRS has partnered with various groups, including the United States Chamber of Commerce, the National Federation of Independent Business, and the Small Business Administration, in putting together materials and events for small employers.

One of the key features that makes employer-sponsored IRAs attractive to small employers with limited resources is the fact that the employer is not required to file annual reports with the Department of Labor or the IRS. This feature, however, makes it more difficult to determine precisely how many employers are adopting them and how many employees participate. Requiring more reporting would make it harder for employers with limited administrative resources to adopt employment-based IRA programs. But the IRS has data on the level of individual contributions and year-end account balances because those data are reported to the IRS by the IRA custodian. In 2004, contributions were made to the SEP IRAs of 1.6 million taxpayers in an amount of $13.8 billion, or approximately $8,625 per taxpayer. This amount was 28.2 percent of all IRA contributions in 2004. Contributions were made to the SIMPLE IRAs of 1.9 million taxpayers, in the amount of $7.6 billion, or about $4,000 per taxpayer. This amount was 15.6 percent of all IRA contributions in 2004. As of the end of the 2004, 3.5 million taxpayers held $169 billion in SEP IRAs and 2.5 million taxpayers held $34 billion in SIMPLE IRAs. This difference is likely due to the fact that SEP accounts are very common in businesses in which only the owner participates, have much higher contribution limits than SIMPLE IRAs, and have been in existence much longer than SIMPLE IRAs. (3)

Because the Administration has been concerned about the hurdles employers face in trying to establish savings plans for their employees, the Administration's Budget has included for the past several years a proposal (the "Employer Retirement Savings Account" or ERSA) to combine the various types of employer-sponsored savings plans into a single type of plan (with simplified administrative rules for small employers). Of course the Administration would be open to other proposals that decrease the complexity or administrative burden on small employers that want to provide savings opportunities for their employees.

While the Treasury Department and the IRS have been promoting employer-sponsored retirement savings programs and developing new ideas to make plan sponsorship easier, we are concerned about imposing mandatory requirements that could affect the ability of an employer, particularly a small employer, to run its business efficiently and compete effectively in its marketplace. Operating a business already involves a significant amount of investment (typically the employer's time and money) and adding yet another stringent requirement could have an adverse effect, particularly on small employers, which are an essential sector of America's economy. Moreover, mandating a particular benefit on small employers, particularly to the extent such benefits imposes a significant cost on the employer, could affect the employer's decision to offer other employee benefits that may be more relevant for the employer's workforce, particularly health coverage.

Finally, we should not lose sight of the fact that IRAs generally are not as powerful of a retirement savings tool as other tax-qualified retirement plans, such as 401(k), 403(b) and other defined contribution plans and defined benefit plans. This is primarily because the restriction on pre-retirement distributions in such plans avoids much of the pre-retirement leakage that occurs in IRAs. We should not encourage employers to adopt IRA programs if they are instead willing and able to adopt these more sophisticated and flexible retirement plans to benefit their employees.

Mr. Chairman and Members of the Committee, thank you for the opportunity to appear today, and I will be happy to respond to any questions.

(1) Modified adjusted gross income for this purpose is adjusted gross income plus income from education savings bonds, interest paid on education loans, employer-provided adoption assistance benefits, IRA deductions, deductions for qualified higher education expenses, and certain other adjustments.

(2) For example, if a non-exempted prohibited transaction occurs, under rules enforced by the IRS, an excise tax would apply. If the prohibited transaction involves the IRA-owner or a beneficiary of the IRA, the balance in the IRA would be subject to income tax.

(3) SEPs have been available since 1979, while SIMPLE IRAs have been available only since 1997.

Deputy Assistant Secretary for Fiscal Operations and Policy
Gary Grippo
Testimony Before the House Committee on Ways and Means
Subcommittee on Social Security

Washington – Chairman McNulty, Ranking Member Johnson, and other members of the subcommittee, thank you for inviting me here today to discuss garnishment practices and their impact on federal government beneficiaries who receive their benefit payments electronically. The Committee is to be commended for continuing to focus on this issue, and I am hopeful that we will be able to achieve a solution based on sound public policy that provides appropriate protections and a balancing of consumer, government and business interests.

Treasury is willing to offer expertise and assist the federal benefit agencies in crafting a solution to this problem, leveraging our role in regulating Federal payments and working closely with the banking industry. Today, I will provide background on our role as a disburser of federal payments, our use of technology in disbursing government benefits, and our perspective on potential solutions to the garnishment issue.

One of Treasury's core functions is to develop policy for and to operate the financial infrastructure of the federal government. Treasury's Financial Management Service (FMS) provides central payment services to federal program agencies. FMS disburses 85% of the federal government's payments, including income tax refunds, Social Security benefits, veterans benefits, and other federal payments to individuals and businesses.

FMS disburses payments based on certified payment files received from program agencies. In FY 2007, FMS disbursed 982 million payments, of which 78% were issued electronically. Focusing specifically on federal benefits payments, such as Social Security and veterans benefits, or those categories of payments generally exempted by law from garnishment, FMS disbursed almost 800 million payments, of which approximately 81% were issued electronically. The largest federal benefit programs are Social Security and Supplemental Security Income, together comprising 71% of the payment volume. While the other federal benefit programs – veterans benefits, railroad retirement, civil service retirement, and black lung disability programs – represent a much smaller payment volume, the issues their beneficiaries may face when attempting to access lifeline benefits are the same. In our role as a central disburser, we would strive to ensure that any potential solution would work for all federal programs with exempt funds that are protected by law from garnishment.

Integrating and leveraging technology into our payment programs is a long-standing strategic vision for the Department of the Treasury. Treasury's strategic goal to effectively manage the government's finances includes strategies for expanding all-electronic transactions to ensure timely and accurate payments at the lowest possible costs. Electronic payments provide real and meaningful savings not only to the government and the taxpayer but also to the financial industry. For Treasury, it costs approximately 98 cents to issue a check versus 10 cents to issue an electronic payment. When this 88 cents per item savings is multiplied over the millions of federal payments issued annually, and as recipients convert from checks to electronic payments, the savings can become substantial.

On our path toward an all-electronic treasury, we have benefited from statutes, such as the Debt Collection Improvement Act of 1996 (DCIA), that generally require federal payment recipients to receive their payment electronically. As the regulation implementing the DCIA was proposed and finalized, an appropriate public policy on electronic payments was developed, with waivers and carve-outs to electronic requirements so as to not impose an undue hardship on the payment recipients. With the implementation of the DCIA, the rate at which federal benefit payments were made by electronic payment increased from 56% in FY 1996 to 75% in FY 2000. However, since obtaining a 4-5% annual growth rate in the late 1990s, we have leveled off to a 1-2% growth rate, with some years seeing less than a 1% increase.

Treasury has also benefited from the broader acceptance of electronic banking technology as we strive to increase the use of electronic payments. In assessing our future, we recognize a changing landscape, with rapidly increasing federal benefit payment volumes resulting from baby-boomer retirements. One of our strategies to manage future payment issuance costs is to actively market and promote electronic payments, specifically direct deposit of benefit payments.

Federal benefit recipients may opt to receive their payment by check or electronically. For those recipients choosing electronic payments, Treasury offers two programs: Direct Deposit and the recently launched Direct Express card.

Direct Deposit is a payment program for consumers who authorize the deposit of payments automatically into a checking or savings account via the Automated Clearing House (ACH) network . It is Treasury's preferred payment method and is the best way for Americans to receive their federal benefit payments. The advantages of direct deposit to the government, banking system, and recipients are well documented. It is safe, convenient, reliable, and eliminates the risk of lost or stolen checks.

Ideally, individuals would sign-up for direct deposit when they apply for their benefit payment. Treasury is working with the Social Security Administration in encouraging more individuals who have a bank account to opt for direct deposit when applying for their benefit.

Just this month, Treasury launched the Direct Express card. The Direct Express card is a prepaid debit card offered to Social Security and Supplemental Security Income check recipients who wish to receive their benefits electronically. While specifically designed as a product for unbanked federal beneficiaries, anyone receiving Social Security or Supplemental Security Income benefits can sign up for the card. Treasury has designated a financial agent to issue this nationally available card for the payment of federal benefits. The features of the card were formulated after a one-year pilot program and discussions with consumer groups and other stakeholders. Most of the card services are free. There is no cost to sign up for the card and there are no monthly fees. While there are fees for a limited number of optional transactions, it is possible to use the card for free, and while the Direct Express card is currently available to only Social Security and Supplemental Security Income benefit recipients, Treasury plans to add other federal benefit programs at a later date.

Treasury strongly encourages and actively promotes electronic payments, but we do recognize that electronic payments may cause problems in certain instances. Specifically, individuals who have bank accounts and are subject to garnishment actions may find direct deposit unattractive. Financial institutions may freeze accounts that receive federal benefits as they perform due diligence in complying with a myriad of state laws and court orders. An account may be temporarily frozen even when the account contains federal benefits which are exempt from garnishment. Thus, a federal benefit recipient who receives direct deposit may not be able to access lifeline funds because they have been automatically routed in to a frozen account. If the recipient had received their benefits by paper check, they could cash the check without depositing it into the frozen account and have full access to the funds.

Treasury believes that any solution to this problem, whether operational, regulatory, or if necessary statutory, would ensure that federal benefit recipients have access to a certain amount of funds that cannot be frozen while the garnishment order is adjudicated by the courts and financial institutions, and while the final amounts of exempt and non-exempt funds are determined. The model used to establish the appropriate amount of funds excluded from an account freeze would need to be developed based on an analysis of benefit payment amounts and the ability of financial institutions to implement it without complex accounting or research. This type of solution seems essential to ensure that benefit recipients have access to their statutorily protected funds while the details of a garnishment order are resolved.

As referenced above, one operational solution to the problem that we currently have in place is the Direct Express card. The card account contains primarily Social Security benefit payments, which, under federal law, are protected from garnishment by creditors other than the United States government. This means that creditors do not have the right to have these funds taken out of the account, none of which would be frozen pending resolution of a garnishment order.

Treasury is willing to coordinate a joint inter-agency effort in establishing a regulatory solution to the problem, based on our expertise in managing federal payments and working with the banking industry. Treasury, the Social Security Administration, and other federal benefit agencies are working together to provide specific guidance to financial institutions on actions they must take if there are benefits in an account subject to a garnishment order. We have discussed options with Social Security Administration staff and look forward to collaborating with them and other federal benefit agencies. Treasury can offer its expertise in the payments and banking systems to help craft a government-wide policy solution. As part of this interagency effort, Treasury is willing to assist the federal benefit agencies by serving as central point-of-contact on implementation, compliance, and general administration of a rule, and in working with the appropriate federal banking regulators on enforcement.

We envision that through this interagency effort, we would provide guidance to financial institutions on how to discern if there are exempt funds in an account and what amount of funds should not be frozen. For example, a regulation could provide a safe harbor to financial institutions that follow the guidance and allow recipients access to funds. Treasury is working closely with the Social Security Administration and other federal benefit agencies on a number of complex issues that would need to be addressed as we move toward a solution. These issues include commingling of funds, account fees, look-back periods, compliance costs, and enforcement. We believe further discussion with stakeholders and a public comment period are essential to fully address these issues.

The impact of garnishment orders on recipients of federal benefit payments is a public policy issue that needs to be addressed. Progress has been made over the last 18 months in evaluating the complexities of this issue. Garnishment practices are also an impediment for Treasury as we strive to further promote direct deposit and electronic payments. Treasury is willing to use its expertise with Federal payments and commercial banking practices to help develop and implement a solution. We look forward to working with the federal benefit agencies, consumer groups, banking regulators, financial institutions, and the Congress to come to a consensus solution.

This concludes my formal statement. I am pleased to address any questions you may have.

Testimony of
Deputy Assistant Secretary for Tax, Trade, and Tariff Policy
Timothy E. Skud
Before the Senate Finance Committee

Washington--Mr. Chairman, Ranking Member Grassley, and Members of the Committee, thank you for the opportunity to appear here today to discuss the Treasury Department's responsibilities for customs revenue functions and the International Trade Data System (ITDS).

As the Committee is aware, the Secretary of the Treasury has authority for "customs revenue functions," as defined by The Homeland Security Act of 2002. Customs policy is important to the Treasury Department not only for revenue collection, but also because the way we approach taxation and regulation of international trade has an important effect on our economy and on promoting global growth. Our overall goals are promoting trade and growth, simplifying and clarifying regulations, and collecting tax accurately and efficiently, with minimal burden on the taxpayer.

While the authority for enforcing the laws involving customs revenue functions has been delegated to the Department of Homeland Security (DHS), the Treasury Department has retained an important role in this area. Specifically, the Treasury Department has sole authority to approve regulations concerning a wide range of functions involving revenue or regulating trade for economic purposes including import quotas, trade bans, user fees, origin, copyright and trademark enforcement, duty assessment, classification, valuation, preferential trade programs, and recordkeeping requirements. The Treasury Department also reviews Customs and Border Protection (CBP) rulings involving these topics that constitute a change in practice. In addition, the Treasury Department shares the chair of the Commercial Operations Advisory Committee (COAC) with DHS.

Moreover, as part of the Treasury Department's responsibility for customs revenue functions, we have worked with DHS and CBP over the past year on particular areas of concern to this Committee.

One area is simplification of the duty drawback rules, a concept we support. In conjunction with the Committee's staff and other interested offices, we have worked with CBP to provide detailed technical advice on draft legislation to simplify administration of duty drawback. We appreciate the Committee's interest and efforts in this area and look forward to continuing to work with you on this important legislation.

Another area of concern to the Treasury Department, CBP, and other trade agencies has been problems in collecting antidumping and countervailing duties. In response to Congress' interest in this area, the Treasury Department provided a report on this issue last year. Although CBP's collection rate is over 99 percent for duties overall, CBP is able to collect less than 50 percent of antidumping and countervailing duties that have been retroactively assessed in excess of bonds or cash deposits. We concluded in the report that the chief obstacle to ensuring collection of such duties is the difficulty of obtaining adequate security (cash deposits, bonds, or other instruments). This problem appears to have been exacerbated in some cases by unscrupulous importers who imported knowing they were likely to incur duties not fully secured by bonds or cash deposits following retrospective duty assessment and who then absconded when payment was due.

One of the most significant areas on which the Treasury Department has worked closely with CBP is the International Trade Data System (ITDS). The SAFE Port Act (P.L. 109-347, October 13, 2006) formally established ITDS and gave the Secretary of the Treasury the responsibility to coordinate interagency participation in ITDS in consultation with an interagency committee consisting of the agencies participating in ITDS and the Office of Management and Budget (OMB).

The goal of ITDS is to make the Federal government's collection of international trade data less burdensome and more efficient by integrating and fully automating the government-wide collection, use, and dissemination of international trade data. Under the ITDS concept, agencies harmonize their data requirements, eliminating redundancies and minor definitional differences. Traders submit standardized electronic import and export data one time to a single collection point, commonly called the "single-window system." The data is then distributed to agencies depending on what information they need to perform their respective trade-related missions.

ITDS is not a separate computer system. Rather, it is a feature of the Automated Commercial Environment (ACE), the new system for processing imports and exports that is being built by CBP. ITDS is being developed and will be operated by CBP with the collaboration of 43 other government agencies.

Today, international traders are confronted with duplicative and non-uniform reporting requirements, both paper and electronic. A number of Federal agencies maintain separate international trade reporting systems. Other agency processes are not automated at all, requiring traders to present CBP officials with paper documentation before their goods are allowed to enter or depart the United States.

The cost of redundant reporting requirements burdens not only importers and exporters, but also the government and the performance of the economy as a whole. These requirements protect consumers, the environment, health and safety; provide information for accurate taxation and for trade statistics; and accomplish numerous other worthwhile goals. Nevertheless, the multiple reporting schemes, superimposed one on top of another, result in a significant cumulative burden.

The very separateness of these collection systems also limits their effectiveness. Agencies do not necessarily have access to information that other agencies collect or know what actions other agencies have taken in response to that information. They act in isolation rather than together.

Once fully implemented, ITDS will have a number of significant benefits to the private sector and the government, including:

• Reducing the burden on business and increasing the efficiency of the government's collection of international trade transaction data by substituting standard electronic messages for the redundant reporting – often on paper forms – that occurs today.
• Enhancing the ability of CBP and other agencies to target risky cargo, persons, and conveyances.
• Extending the capabilities of ACE by bringing together critical security, public health, public safety, and environmental protection agencies through a common platform.
• Reducing the technical barriers to authorized sharing of data with other governments by accepting electronic filings reported using international standa