U.S. Senate Finance Committee Holds a Hearing on the Nomination of Henry Paulson to be U.S. Treasury Secretary

CQ Transcripts Wire
Tuesday, June 27, 2006; 11:25 AM


























GRASSLEY: Today, our committee meets to consider the nomination of Henry -- better known as "Hank" -- Paulson to be the next secretary of the treasury.

Obviously, as we move from one secretary to another, we ought to remember the hard work of Secretary Snow -- and wish him well as he goes on to other endeavors or retirement or both -- for the job that he did as secretary of treasury.

The treasury secretary is an original Cabinet department position. Institutionally, there's been a very close relationship between the jurisdiction of the Finance Committee -- the oldest committee of the United States Senate; maybe more accurately spoken as the oldest standing committee of the United States Senate -- but between our committee and the Treasury, which happens to be the administration's second oldest department.

Since the treasury secretary is the top economic policy officer in the administration and the Treasury Department implements so much of the policy made by this committee, we have a tradition of moving with all deliberate speed when a vacancy occurs.

That tradition is held no matter which party controlled Congress or the White House. And I thank Secretary Baucus and all the members of the committee for helping us aggressively moving this nomination.

I have moved so, but the timeline is very consistent with past secretary nominations, and I'll just use one example, that of Secretary Rubin's timeline.

The Senate received that nomination January 4, '95 and that happened to be the first day that the Senate was in session that year. The official ethics-related paperwork was received on January 5 of '95. The Finance Committee staff expedited review of the complicated financial details of Secretary Rubin, who also happened to be a senior official at Goldman Sachs.

GRASSLEY: The Finance Committee held a hearing five days later, on January 10th, and on that same day, the committee reported Secretary Rubin's nomination. On that same day, the full Senate confirmed Mr. Rubin and he was then immediately sworn in as treasury secretary.

Now, we're moving as aggressively, in a similar manner, and on a similar schedule with this nomination, and I appreciate the cooperation that members have on what I'll acknowledge is a relatively short notice.

I also want to thank committee tax staff, and that's on both sides of the aisle, because they put in hard work and long hours to get here. My staff examined Mr. Paulson's complicated financial record, his tax returns, and the activities of his firm, Goldman Sachs, in the area of tax planning.

I'm pleased to say that Mr. Paulson, like Mr. Rubin over a decade ago, has been transparent with our committee staff and taken all necessary steps to cut his ties with Goldman Sachs. Mr. Paulson left a lucrative, exciting, interesting and successful position as head of one of the most prestigious financial service firms on this planet.

He brings to the table an enviable set of assets. Mr. Paulson spent a good amount of his youth in the corn fields of Illinois. As a bright young man with excellent academic credentials, he served in the Pentagon and served in the White House. After government service, Mr. Paulson rose through the ranks at Goldman Sachs.

When you look at Mr. Paulson's story, you come away with an impression that this is a person -- or in the Midwest, as we say, a guy -- that gets the best results at whatever he tackles.

That impression is obviously reinforced for those of us who meet Mr. Paulson for the first time. And I met him for the first time in a very satisfactory meeting that we had on another issue about three years ago when I had an opportunity to host him in the members' dining room.

GRASSLEY: So Mr. Paulson is here at just the right time -- when we have a lot of issues that must be dealt with in what is a very good economy in the United States, but there's still things that need to be done.

And he will have an opportunity to work with us and by himself and with other administration officials on things like tax reform, China currency, and with a whole host of major economic issues facing this country, and for that matter our influence on the world economy and other world issues.

I'm pleased that Mr. Paulson has answered the call to return to public service. And I look forward to his testimony and dialogue this morning, but over the next years as we work between the business of this committee and the business that he has as secretary of treasury.

Senator Baucus? And thanks, again, for your cooperation.

BAUCUS: Thank you very much, Mr. Chairman.

Today we meet to consider the nomination of Hank Paulson to become the secretary of the treasury. Since Alexander Hamilton took the job 217 years ago, this has been one of the most important jobs in America. The secretary has the potential to lead the American economy.

The great secretaries that we can think of have done just that -- they've dominated their times.

One thinks of Bob Rubin. One thinks of Jim Baker. And remember our departed colleague Lloyd Bentsen, sadly taken from us this past season.

Mr. Paulson, you have the potential to join these ranks. As chairman and CEO of Goldman Sachs, you have led one of the nation's premier financial institutions.

You, more than almost anyone, have seen the effects the United States government can have on markets. And you have seen how quickly those markets can judge what we do.

You have much work to do. The government has run $300 billion budget deficits for four years in a row. The balance of trade has been on a roller coaster ride to extremes. America faces new economic competition from China, India, most places on the globe. And the Treasury Department has suffered depressed morale and a diminished policy role.

BAUCUS: I wish you luck.

On the deficit, the government is plainly on an unsustainable path. The administration's budget looks through rose-colored glasses. It ignores the cost of war, the cost of fixing the alternative minimum tax, and the cost of realistic growth for the rest of government.

And like clockwork, people born in 1945 will reach age 62 next year. Baby boomers will begin becoming eligible for Social Security next year. Through a lifetime of work, they have earned their benefits under Social Security and Medicare.

With the zeal of Captain Ahab, this administration has focused solely on entitlement programs to bury the burden of balancing our books. But those numbers don't add up.

Let me suggest another option. The government should collect the taxes that people owe but do not pay. The government should shut down abusive tax shelters. And the government should close overly generous corporate tax loopholes.

The treasury loses $300 billion a year in taxes owed but not collected. $300 billion a year. The cumulative tax gap over the last six years is $2 trillion. Yet the administration's budget has a plan that it says would raise just $3.5 billion of that over 10 years. That's one-tenth of 1 percent of the solution.

Mr. Paulson, you'll be able to do something about this. And today I ask you to pledge to send this committee, in October, a credible plan to reduce the tax gap.

And on the same schedule, I also ask you for a plan to stem the proliferation of abusive tax shelters and offshore schemes.

Chairman Grassley and I have asked the IRS commissioner, in consultation with Treasury, to submit such a plan by October 1st of this year. I expect that we will also have a hearing shortly thereafter.

I hope and expect that the treasury will be ready to tell the American people how it's going to collect the taxes that are owed it.

Despite its flaws, our voluntary tax system is a remarkable tribute to the 85 percent of Americans who pay what they owe and contribute the more than $2 trillion that helps to fund our society's commitments.

And we owe it to the honest taxpayers to simplify the tax laws.

BAUCUS: We owe it to them to lessen its burdens and remove opportunities for those who want to cheat. That's our obligation. It's our goal.

The administration promised tax reform. Then the administration stacked its advisory panel. That panel reported to the treasury, but we have yet to see the administration's plan. And with your tenure comes a new opportunity to work together to modernize our tax system, and I reach out my hand to work with you on this.

On the current account, America's also on an unsustainable path. As night follows day, our current account deficits are bringing on a weaker dollar. Our growing trade imbalances risk precipitating a dollar crisis.

You are an acknowledged expert on international finance, and I'll be interested in your plan for how we can avoid this risk.

And you and I share a belief that America must work to maintain its preeminent standard of living in an environment of increasing competition from China, India and elsewhere.

As we have discussed, I have introduced legislation addressing American competitiveness in trade, energy, savings and research. Education, tax and health legislation will follow.

I look forward to working with you to advance this agenda.

You are an acknowledged China hand, having flown there more than 70 times. I'll be particularly interested in your take on how we should engage China. What's the proper way?

In the wake of China's much ballyhooed announcement of its managed float, China's currency has not appreciated as much as many of us had hoped, and China's relatively closed financial services sector, state-owned industries, and the weak local brokerages all add concerns.

This administration has spoken with many voices on China. With one voice it talks about China as a military threat. With another voice, it talks about China as a responsible stakeholder in the international economic system.

You know China. I hope that you will be able to play a greater role in the administration's China policy formation than prior treasury secretaries. And, again, I look forward to work with you on this.

Mr. Paulson, with great opportunities come great responsibilities. It is my hope and prayer that your tenure as secretary will be one that ranks with the likes of Hamilton and Rubin. Frankly, the economy that you have been given requires it.

BAUCUS: And for the good of the country, we all hope that you are a very, very lucky man.

Thank you.

GRASSLEY: Thank you, Senator Baucus.

It's the tradition of most committees to have either senators from the states or other states that want to introduce and/or sponsor a nominee, for us to turn to that now. And Senator Schumer is a member of this committee. So he won't be sitting down there beside you like is traditionally the way it's done.

So I'd call on Senator Schumer to introduce and to say whatever he wants to about the nominee.

SCHUMER: Well thank you, Mr. Chairman. And I want to thank you and Ranking Member Baucus and members of the committee for moving this nomination with alacrity.

And I am delighted and proud to introduce to this committee a great New Yorker, Hank Paulson, former chairman of Goldman Sachs, and now nominee to be the 74th treasury secretary.

I've known Hank for 15 years. I recommend his nomination wholeheartedly and without reservation. He's an extraordinary leader, financial thinker, businessman and father.

And though he isn't a native New Yorker, we consider him to be an adopted son like so many others who have come to our city from all over the country.

Hank has excelled in every area of life, from the classroom to the football fields to the board room, and everywhere in between. He's a straight shooter, and gives direct answers to direct questions.

We certainly need somebody like that now.

Hank graduated from Dartmouth College in 1968 and received his MBA from Harvard. After working at the Department of Defense and then the Nixon White House, he found his true calling when he joined Goldman Sachs as an associate 32 years ago.

Hank became chairman and chief executive officer of Goldman in 1999, and should he be confirmed, which I hope he will be, he'll continue the long history of Goldman Sachs heads, including former Treasury Secretary Bob Rubin, New Jersey Governor Jon Corzine, Deputy Secretary of State John Whitehead, serving their country with great distinction and success.

But the thing that Hank really goes off the charts about is the environment. I go into a meeting with Hank thinking we were going to talk about finance or a banking issue, and he'd end up talking about some bird he had recently seen.

SCHUMER: He's an avid environmentalist and a lover of all things nature, but I hope no one on the committee holds that against him. But actually he'd make a great secretary of interior. However, I'm glad the president nominated him for secretary of treasury, because financial issues and the health of the global economy are his passions.

In the world of finance and international markets, there is simply no equal to Hank. And at this critical point in our economy's history we need Hank's expertise and experience to lead the way.

I believe that the rise of China and economies in east Asia pose both the greatest threat and the greatest opportunity for the American economy. Expanding markets abroad can open up enormous new avenues for trade and business growth domestically, but only if our international partners play by the rules.

As this committee and Hank know, I've been very concerned about two issues relating to China -- currency and financial services liberalization.

On currency, Senator Lindsey Graham and I have worked closely with your predecessor, Secretary Snow -- and I want to give him praise and tribute and thanks for the wonderful job he did in this area, working with us closely.

We didn't always agree, but we were able to work very well I think towards a good result to push and prod China to allow their currency to float based on international market forces.

We made some progress, as I mentioned, but China has not moved enough since last July. Hank's extensive experience in China, personal relationships with its government and business leaders and unique knowledge of international markets make him the right man at the right place at just the right time to tackle the critical issues involving the American and Chinese economies and their interrelationship.

I believe that Hank will be able to show the Chinese that it is not only in our interests, but in theirs as well to allow the yuan to float freely. And I know that Hank will work to explain to the Chinese that reforming their practices and markets more quickly, rather than dragging their feet, can lead to a win-win situation for both countries.

On financial services liberalization, I know Hank will work closely with Ambassador Susan Schwab, who was just confirmed to be the new U.S. trade representative, to make sure that China lives up to its WTO commitments.

On December 11th of this year, many of the current restrictions faced by American financial firms that want to do business in China and purchase Chinese companies will be lifted.

SCHUMER: Hank is the perfect person, my colleagues, to monitor China's progress and also to prod the Chinese to go further than it has already promised.

In sum, Mr. Chairman, Hank is a thoughtful, dedicated and renowned financial leader. And all Americans of every political philosophy are lucky that he has decided to spend the next few years in public service.

I look forward to working with him to tackle significant issues and perils facing our economy.

I fully support his nomination and urge, Mr. Chairman, that he be confirmed as quickly as we can, hopefully this week, so that the Senate -- I hope we will move this nomination as quickly as we can so that the Senate can confirm this nomination before we break on July 4th and so that Hank can roll up his sleeves as secretary of the treasury and get down to the important tasks that we need to move this country forward economically.

Thank you, Mr. Chairman.

GRASSLEY: I heard you ask us to move very quickly.

SCHUMER: I hope so, yes.

GRASSLEY: OK, I always confer with the ranking member on that. But since you're also on the leadership of your party, could you speak to your leader...

SCHUMER: I have. And we're on board.

GRASSLEY: Thank you very much.

SCHUMER: Thank you.

GRASSLEY: That's good news, Mr. Paulson. Now, I'll be embarrassed. Some Republican will want to slow this up, see.


But I don't think so.

Now's your opportunity. Three things, usually.

One, we don't swear in nominees. So you don't have the opportunity to hold your hand up and get on the front page of the Post with that sort of posure.

But obviously, nobody's going to know that you're guilty of any crime, either, coming before Congress.


The second thing is for you to introduce any family or friends who are here to support you. And the reason I ask you if you want to endorse him -- we have a redacted copy of a statement of information that we received from you. And I don't know who redacted date and place of birth, whether or not you got a marital status, whether or not you got children.


You know, we get a lot of redacted stuff from the executive branch. I don't know why they wouldn't want you to know that information. But if you don't want us to know it, you don't have to introduce anybody.


(UNKNOWN): I think we would like to know how old you are, though.


GRASSLEY: So would you like to introduce family and friends? That's a tradition here.


GRASSLEY: No, it's not on, still.

PAULSON: Sorry. You can see I'm not terrific with technology.

GRASSLEY: But that wonderful lady behind you, who I presume is your wife, was trying to indicate to you to turn that on.

PAULSON: Absolutely.


And that's what I wanted to do, is to introduce that wonderful lady, my wife, Wendy. And I've made a number of good decisions in my life, but by far the best was the decision to marry her almost 37 years ago.

So she's a great partner and a great friend. And I'm delighted she's here today.

GRASSLEY: Wendy, we'd like to have you stand if you would, please. Thank you. Thank you.

Anybody else you want to introduce, family or friends?

PAULSON: Well, in terms of my family, I've got a 33-year-old son who works at the National Basketball Association and a 31-year-old daughter who's the bureau chief for the Christian Science Monitor in Chicago. They're both working, so they're not here today. But they're with me in spirit.

And then I have a number of friends. I have, sitting next to Wendy, John Rogers, who has worked with me very closely over the years and is a friend and works with me at Goldman Sachs. And then I have three other very good Goldman Sachs friends here, with Esta Stecher, Laurie Laudine (ph) and Greg Palm.

GRASSLEY: Thank you.

Now you have an opportunity for an opening statement. Say whatever you want to say, and then we'll have a series of questions.

PAULSON: Thank you very much.

GRASSLEY: You bet.

PAULSON: Chairman Grassley, Ranking Member Baucus and members of the Finance Committee, thank you very much for inviting me to testify here today.

I am honored that President Bush has nominated me to serve as the 74th secretary of the treasury, following the distinguished leadership of Secretary John Snow.

PAULSON: And I very much appreciate the time members of this committee have taken to meet with me and consider my nomination.

Frequent communication between the Treasury Department and this committee is of vital importance, and if confirmed I look forward to building on the dialogue that we have already begun.

I am also grateful to my family for supporting my decision to pursue this opportunity.

The Treasury Department has a critical role to play in helping to set the direction of the U.S. and global economy, a role that reaches back to America's founding. If confirmed, I will strive to carry forward the Treasury Department's rich legacy.

I have admired the work of the Treasury Department throughout my 32-year career in finance, and particularly during the last eight years, when I led a global financial institution.

As the steward of the U.S. economy and financial systems, the Treasury has helped lay the groundwork for the American economy to become a model of strength, flexibility, dynamism, resiliency.

This is a system that generates growth, creates jobs and wealth, rewards initiative and fosters innovation. It is also a system that offers considerable social and economic mobility.

We must never, never take this for granted, and we cannot allow Americans to lose faith in the benefits our system offers. America is the land of opportunity. We need to be vigilant in ensuring that each and every American has the opportunity to acquire the skills to compete, and to see those skills rewarded in the marketplace.

One way we can do this is to maintain a macroeconomic climate that enables workers, families, businesses -- both small and large -- to thrive. That calls for spending discipline and predictable taxation, combined with prudent regulation.

If confirmed, I will focus intensely on how the United States can maintain and strengthen our competitive position.

As a product of a mid-sized town in Illinois, I will, of course, always remember Chairman Grassley's succinct description of the treasury secretary's role: "to understand how tax policy, capital markets, international trade, and currency policy affect Main Street USA."

As we work to promote greater economic opportunity for the American people, we must always remember that the American economy is deeply integrated with the global economy. That brings challenges, but even greater opportunities.

PAULSON: While maintaining confidence in our ability to compete throughout the world, we must be prepared to embrace the change that will contribute to our long-term prosperity.

Open markets help to boost productivity and drive America's economic growth, which in turn creates new and better jobs for American families.

It's also true that the global integration of economies and markets holds the promise of a more prosperous and a more secure world. In my extensive travels throughout the world, I've seen countless examples of the benefits of economic reform.

If confirmed, I will be active in affirming America's leadership role in the global economy, where we continue to be a constructive and stabilizing force.

I also look forward to working alongside other colleagues in the Cabinet to advocate policies and actions which would provide open and level markets for U.S. investments and for U.S. products.

To close, I will briefly outline some of the steps that might be taken to achieve a stronger and a more competitive U.S. economy: first, addressing the long-term unfunded obligations of Social Security and Medicare that threaten to unfairly burden future generations; second, keeping taxes low and collecting them in a simpler and fairer manner that does not distort economic decision- making; third, expanding opportunities for American workers, farmers, and businesses, big and small, to compete on a level playing field with the rest of the world; fourth, maintaining and enhancing the flexibility of our capital and labor markets and preventing creeping regulatory expansion from driving jobs and capital overseas; finally, the U.S. economy will be stronger if we can continue to foster an entrepreneurial spirit and culture which generates innovation, risk- taking, and productivity growth, that raises living standards to keep America the economic envy of the world.

If confirmed, I look forward to frequent consultation with members of this committee to advance these and other ideas.

And if confirmed, I also look forward to working with the Treasury Department's select corps of professionals, who play a critical role in the stability and the vitality of the U.S. economy.

Thank you, Mr. Chairman.

GRASSLEY: Thank you, Mr. Paulson.

There are three questions that we ask every nominee. And I want to ask those questions and only those questions at this point and then call on Senator Baucus.

And then I'll go back to myself for my five-minute round of questioning. And then we would have, after Baucus and myself, we'll have Conrad, Wyden and Schumer and I'll go down the list later on in the order of arrival.

And these are questions that we ask every nominee, not just you.

The first is whether or not there's anything that you're aware of in your background that might present a conflict of interest with the duties of the office to which you have been nominated.

PAULSON: No, Mr. Chairman.

GRASSLEY: Do you know of any reason, personal or otherwise, that would in any way prevent you from fully and honorably discharging the responsibilities of the office to which you have been nominated?



Third, do you agree without reservation to respond to any reasonable summons to appear and testify before any duly constituted committee of Congress if confirmed?



Then I want to add to that, without your having to respond to it, an additional request that I have of every nominee. And anything I have to say about this subject to this point, obviously, wouldn't apply to you because you have not been in office.

In fact, I referred to a meeting you and I previously have had, and I've been very satisfied with the transparency that you evoked as a result of that meeting and how cooperative you were several years ago.

And this is an admonition that I give to every nominee -- and it involves transparency to some extent -- and that is the extent to which we not only ask you, as I did in that last question, to appear before a committee as you might be called, but it would be a request that when you get letters from us as individuals that they be fully responded to, and hopefully fully responded to in the first instance, not after we have to write two or three times back to get additional responses or to make phone calls as to why we haven't answered.

Now, I can only speak as one member of a group of 100, but I think to some extent every member takes somewhat seriously the responsibility of what I call congressional oversight; the responsibility of a senator, once laws are passed or money's appropriated to make sure that the laws are faithfully executed. And we call that congressional oversight. Sometimes it's done by an individual member. More often it's probably done by a committee.

But I want to give you an example of how people previously before this committee or people that haven't been before this committee, but we might be exercising -- I might be exercising my oversight in a manner other than as chairman of this committee.

GRASSLEY: And this is a series of letters, since January the 1st, that I have sent to various Cabinet people -- some of them in the jurisdiction of this committee and some not -- that I have not either received an answer to or haven't received a full response to.

And so I don't want to say that these have not been responded to to some extent, but in some instances maybe not at all, but more often not fully. And it just makes our job very difficult when we have communication with people like this.

Recently had a communication with a secretary who said that we couldn't talk to some line agent. Well, just two months before, in that same department, we talked to line agents.

So I don't get what the game is, except I think that maybe there's a desire lately to not be fully cooperative with Congress in its oversight work. And we aren't doing our constitutional job and Congress isn't being as transparent -- or, I mean, the administration's not being as transparent as it could.

Now, maybe that comes as a shock that a Republican would say that. But I think I've had a consistent standard under five different presidents, both Republican and Democrat, of doing a job of oversight. And just because we have a Republican president doesn't mean I'm going to stop my job of oversight.

The only thing I notice a little bit different is I get a little more cooperation from Democrats when we have Republican presidents than when I'm doing my oversight with a Democrat president. But, regardless, my standard's the same.

And so if you would let me admonish you, without any criticism whatsoever, because you haven't done anything that I can be critical of, but that you would help me, if I write you a letter -- and hopefully I don't have to write you letters, but I had to write you a letter, that you'd fully respond, and fully respond the first time.

GRASSLEY: And just as one example of what you might not be aware of, some official in OMB had a meeting of some staff people of some committees saying, "Isn't this oversight going a little bit just too far, and isn't it just a little bit too public?" and things of that nature, I think in an effort to dampen congressional oversight on the part of Congress.

And it happens that my staff was invited to that meeting. We didn't go, because I felt what it was is what it turned out to be.

And what we want to do is do what American government's all about. This is public business. The public's business ought to be public except maybe in two or three areas: national security, personal privacy and those things that are protected by the president of what you call executive privileged. And I'm not a lawyer, so I'm not going to define that.

But outside of those areas, there's nothing you do or nothing I do that shouldn't be made public. And our efforts to make it public makes everybody in government responsible.

Perfectly legitimate for you to say, "Grassley, I don't agree with you on this," or something. But that ought to be public information when we make these requests.

So I hope that you will help us do our job of constitutional oversight. I'd appreciate it very much.

Senator Baucus?

BAUCUS: Thank you, Mr. Chairman.

Mr. Paulson, I'd like to follow up a little bit on what the chairman just said. I did not know he was going to make that point, but it's a good one.

As we all know, in life first impressions count. You have an opportunity to create the right first impression. And the right first impression would include full cooperation with the Congress. That is, working with the Congress, open, accessible, candid, just talking to us.

Because we're all on the same team. We're all seeking these positions to serve our constituents, serve our country as public servants.

And there is a danger in this era that we are becoming a parliamentary form of government, not a constitutional government. That is, the government has a majority in both bodies, in the House and the Senate, so there's a tendency to be insufficient oversight, as is the case in the parliamentary form of government.

BAUCUS: There is no oversight to speak of.

And I just strongly urge you to create that first impression the right way, talk to us. And it will go a long, long way, I think, in not only developing a good sense of cooperation with this committee but also, more importantly, serving the public in the right way.

I know you'll do so.

My question, though, Mr. Paulson, really revolves around your views on how we get a handle on the fiscal problem that we're facing; that is, the deficits.

You mentioned it in one of your five steps. You have unfunded liabilities and baby boomers about to retire -- how we get a handle on all that.

And I'd like your sense of how we approach it because, to get a solution here, we have to work together at both ends of Pennsylvania Avenue.

This really should not be a partisan issue.

Regrettably it -- in my judgment, to this point -- has been a bit partisan, in the sense that the administration has proposed various entitlement commissions to clamp down on entitlements.

There's the Medicare Commission, the Social Security Commission. And they're both dead on arrival because they were stacked. It was a stacked deck. They were not perceived to be honest. They were not perceived to be a good-faith effort on: How do you handle the problem?

And now we see the chairman of the Budget Committee with another proposal: included in the line-item veto is another commission proposal that addresses really only entitlements and it addresses basically only some entitlements -- Social Security, Medicaid and Medicare.

In my judgment, there's no way in the world we're going to wrap our arms around, get a handle on the fiscal problems that we're facing now and will face in the future unless everything's on the table. It's all spending. Not just entitlements, but also other spending. And revenue's going to have to be on the table.

Somewhat similar to what this country did in the early '80s when Social Security was in a tough shape. President Reagan appointed a commission. It was bipartisan: Alan Greenspan, chairman; a member of this committee, Bob Dole and Pat Moynihan on the commission. And it was truly bipartisan.

BAUCUS: Push to shove near the end, and I think it was Secretary Baker, somebody called up Tip O'Neill and Pat Moynihan and said, "Hey, we got to work this out. Will you Democrats agree to reduce benefits a little bit if we Republicans agree to raise taxes a little bit?" "Yes." And they did. And they joined hands.

Nobody took potshots at each other. It was not partisan political statements. And in my view, that is about the only way we can honestly, realistically get a handle on the fiscal problem.

And I'd just like your views and how you think we should set up a process, a way to realistically solve it.

PAULSON: Senator, I do agree that, as we look at the fiscal issues, the biggest issues this country faces are out a number of years. They are related to the entitlement programs. Largely, the health care, Medicare and Social Security. And they're driven by demographics, the aging of our society and by the fact that health care costs are going up much faster than the GDP.

And as we look out, it's a formidable challenge. And as I've travelled around the world, I've witnessed on a firsthand basis what happens to countries if they don't begin dealing with these problems in advance, because it's much less costly if you can deal with them in advance.

And I believe that's what the president had in mind with the Social Security initiative.

But in any event, stepping back a minute, I do believe that there's no way we can solve these problems without approaching them on a bipartisan basis.

PAULSON: And one of the things that I look forward to doing if confirmed is spending time with my colleagues in the administration, Treasury, spending time with all of you, talking with the president about this topic.

Now, as I look at 2.5 years, there's certain things that may be easier to accomplish in a 2.5-year period. In some ways, it may sound naive to think that you could -- that these problems could be addressed in a 2.5-year period.

But I really do believe that we need to begin very seriously the process of addressing them because, the earlier we step up to these issues, the less costly will be the ultimate solution.

BAUCUS: I appreciate that. But let me just remind you that, when the Social Security commission was presented to the country, it was perceived -- accurately, I think -- to be a way to privatize Social Security accounts.

Therefore it was, as I said earlier, dead on arrival. That got nowhere, because it was perceived to be not an honest, good-faith effort to address Social Security, a way where different people keep their minds open and try to figure out, reasonably, how to solve it.

Rather, it was only one way, basically one way: Privatize Social Security. And that just doesn't work in this town -- in this country -- something of that magnitude and of that importance.

And I'm concerned that we're running up against the same kind of approach with the line-item veto. The commission approach is now being heralded in the Congress in a bill passed in the Budget Committee by the chairman of that committee, which, again, is perceived to be the back-door attempt to, again, privatize Social Security.

And it's not going to work. If we're going to solve these problems -- and we all want to -- they have to be in good faith.

BAUCUS: I was approached by the administration four or five months ago to see if there was some interest in working up some kind of process, a commission, a committee, or something to try to get a handle on it, to cut down the future excessive spending.

And I said to the administration, well, gee, I'm very interested, but, you know, it can't just be entitlements only that's on the table. You have to also have revenue. And to make it work -- I fully want to make it work, you know, this is truly nonpartisan, I'm an American citizen first, and we have to also put revenue on the table.

And the response I got back was, yes, that's interesting. Let's see what we can do about that.

And I kept talking to them, but they never came back again. It's my sense that they didn't really want to do it the right way.

And again, now, we come up with this new idea, at least in the Budget Committee.

So I'm just -- I don't want to take too much time here to say that I just urge you, if you agree that everything has to be on the table, if you agree -- and it's hard for you to say whether you agree or not, right now, I understand, because the administration has a different point of view thus far. But if you privately do agree, I strongly urge you to make that point known forcefully in the administration so they can finally solve it.

Your thoughts on that, please?

PAULSON: Senator, let me say again that I really do believe that the fiscal challenges that you've identified are significant ones. They're addressable one. And I'm really looking forward to, if confirmed...

BAUCUS: And I urge you to vigorously go after this tax gap. Some say it's more than $350 billion a year.

PAULSON: I hear you on this.

As I went around on my various courtesy calls, beginning with Chairman Grassley and with you and with many others, they all emphasized the importance of closing that tax gap. And I will be working very hard to do just that.

BAUCUS: And I might tell you that you have a huge challenge there, too, because unfortunately the Treasury has been asleep at the -- IRS has been asleep at the switch.

There are computer programs that have not been developed. Millions of dollars, I think it's more than tens of millions perhaps, have been spent allegedly on developing software for computer problems, it's just down the drain. And it's more than tragic; it's more than an outrage.

BAUCUS: And frankly, they don't want the public to know about those shortcomings, those failures.

So you've got a huge, huge battle ahead of you to work with the IRS to develop the capability, the resources and the software to finally address the problem.

We're in the dark ages -- we're in the Dark Ages -- IRS is in the Dark Ages. Insufficient computers, personnel is not up to snuff. You've got a huge problem ahead of you. And we want to work with you, but I'm just warning you, it's huge.

PAULSON: Thank you.

GRASSLEY: Thank you, Senator Baucus.

We've notified staff that we'll have 10 minute rounds instead of the five minute rounds, just so everybody is aware that Senator Baucus and I are not going over our time limit.

Mr. Paulson, I want to bring up the issue of the proliferation of tax shelters.

GRASSLEY: And I'm going to end my statement with three questions that are long, but I think my staff gave them to you so that you would have them, and you won't have to write notes about what I'm saying.

That activity underscored -- well, first of all, this committee has been very involved in that activity of proliferation of tax shelters, particularly in the late '90s and early part of this decade. That activity underscored the need for full disclosure of tax shelters, so that the IRS can better police abuses.

I believe sunshine is the best disinfectant. Unfortunately, the Finance Committee's proposals in this area became law in 2004, so it was a long time after this industry developed before we actually legislated in that area.

We have Treasury staff at that time very much helping us with that effort.

Finance Committee staff have reviewed your tax returns and found that you did not participate in tax shelter activities as an officer in Goldman Sach's efforts in that effort. They've also concluded that in your role as senior executive, you were not active in aggressive tax planning or shelter activities and I'm very pleased with that outcome. I hope that it would be true of your colleagues on Wall Street.

So three questions: Do you find tax shelter activity a serious tax policy problem? And if the answer is yes, do you pledge to continue Treasury's efforts to combat tax shelter activities?

My second question: Many commentators focus on what they describe as one of the breeding grounds of corporate tax shelters, meaning management's desire to maximize book income and minimize tax liability -- a particular role is played by the favorable tax treatment of debt over equity financing, and whether or not you agree with that view?

And then the third question: If there is a link between tax shelter activities and the tax treatment of debt versus equity, are there other reasons that we ought to examine this policy in the context of business tax reform?

And we just, within the last week, had such a hearing before this committee.

PAULSON: Let me be as brief as I can here.

First of all, clearly with regard to cracking down on tax shelters and abusive tax shelters, I feel very strongly about that.

PAULSON: And everything I do will be to encourage the IRS to continue with their efforts there. And I do believe, from what I understand, they are making significant efforts.

Secondly, as I look at corporate activity in the tax area, I think the very best corporations look to obey the law -- the letter and the spirit of the law -- and they look to minimize all of their costs within that guideline. And one of those costs are their taxes.

So clearly, no corporation is trying to say, "How can I pay more taxes?" They're saying, "How can we do it right, how can we comply with the law, but how do we minimize our taxes?"

Now, there is a bit of a bias favoring debt over equity. And that's why I really was very positive about the tax reform bringing down the taxation on dividends, equalizing it with capital gains, because I think that removed part of that bias.

If we all have a chance to deal with serious tax reform -- and let me say, as I talked with a number of members of the committee, I know a number of people on the committee would very much like the opportunity to deal with fundamental reform.

My own view is, if we're able to do that, that corporate taxes and individual taxes should all be on the table.

I do believe that, again looking at corporate taxes, simplicity is a good objective, as is the case in individual taxes. And I think an overriding objective with corporate taxation has got to be to make sure our businesses stay competitive.

That is just key to the long-term success of this country.

So those are my comments, Mr. Chairman.

GRASSLEY: OK. Thank you very much.

And now I would turn to an issue that I, reading about you, find very close to your heart, and that is the issue of charities, and particularly the environment. And I want to commend you publicly for your leadership, as chairman of Nature Conservancy.

GRASSLEY: I think that organization had lost its way, and I think you've brought it back on track. In addition, your family has its own private foundation that is well managed; and that you're active in supporting many, many charities.

As we talked privately in my office, you bring good understanding to the importance of tax-exempt sector to encourage charitable giving. As secretary of treasury that oversees the IRS, you're in a unique position to strengthen efforts to ensure that charities are operated in the best interests of the public good.

As you have seen firsthand with Nature Conservancy, with the best of intentions, things can run afoul. And unfortunately, there are far too many who take advantage of tax benefits of charity for personal benefit.

The IRS has been active in the area of oversight of charities, thanks to the leadership of Commissioner Everson.

GRASSLEY: But I want to understand your views in this area and your priorities as secretary of treasury to ensure that charities are acting in the best interests of the community -- in other words, protecting the tax exemption because the tax exemption is the one that encourages charitable giving and in turn, then, protects all the taxpayers who have to pay the bills when tax exemption brings in less money.

I believe your background allows you to be a tremendous leader on the best practices in the nonprofit area.

So your response?

PAULSON: Yes, Chairman Grassley.

Like you, I believe that charitable organizations play a unique and very, very positive role in this country. And that role, plus really the generous tendencies of U.S. donors is in many ways a differentiating characteristic of our society.

I believe that not-for-profits need to be well run and have good governance because, ultimately, the boards of not-profits have fiduciary responsibility to the donors.

And I think some of the things you've done to bring attention to this are precisely the right things.

Now, getting to my role, if confirmed, as treasury secretary. As I looked at this issue, it seemed to me that one area of abuse are situations where donors make gifts in kind to charities -- and this could be automobiles, it could be art, it could be land -- and where the donors might take an inflated appraisal and were really understating their taxes.

And to me, this is an area for the IRS to focus on, because I think at the end of the day, all that will do is make the charitable sector stronger.

People -- and many, many good people -- give money to charities for the right reasons. And I just think, like everything else, it's important to get the abusers who are using the charities.

And incidentally, the charities in many ways often are just unwitting accomplices and the donors are using the charities as unwitting accomplices to rip off the taxpayers.

And so it's that area where I think we need a focus. I would be hopeful that most of the vast majority of the donations are done properly.

GRASSLEY: I'd like to bring up the specific matter regarding Nature Conservancy.

GRASSLEY: Despite repeated requests by our committee, we still have not received a copy of Nature Conservancy, of its closing agreement with the IRS based on the IRS audit of Nature Conservancy.

It's important for the public to understand what was the resolution of matters raised by the press and the Finance Committee in the review of Nature Conservancy and I would ask for your commitment that the Finance Committee receive from Nature Conservancy today that closing agreement.

PAULSON: Mr. Chairman, we got the request. I am one member of the board of the Nature Conservancy. I'm the chairman of the board, one member of the board. I'm not the CEO.

And what the Nature Conservancy would prefer to do would be to have the IRS give you their closing agreement, so it would be kept in confidence.

GRASSLEY: It's going to work better for our purposes to get it from the organization.

I have more questions of you, but my time is out in the first round.

So now it's time to call on Senator Conrad and then Senator Wyden.

CONRAD: Thank the chairman.

Mr. Paulson, thank you for your willingness to serve. As I indicated to you, you come to this town with an outstanding reputation. The trick is when you come to this town with a good reputation is to keep it and it's not always easy to do, but I have confidence that you will be able to do that, because you are, by all accounts, a first-rate person.

CONRAD: Let me just pick up on something Senator Baucus said, which I think is very important, and that is the tax gap, now estimated at $350 billion a year. That's more than the deficit will be this year. So if we were collecting the amount of money that this current tax estimate is supposed to yield, we could eliminate the deficit -- not the increase in the debt, which, as you know, is much bigger, but at least we could make meaningful progress.

So Senator Baucus is exactly right to highlight that issue.

The second thing that I also wanted to share is something Senator Baucus mentioned with respect to tackling these massive fiscal shortfalls, really record budget deficits, record increases in debt that are completely unsustainable.

And I want to share the same view that Senator Baucus shared with you. That is, this is going to have to be done on a bipartisan basis.

Proposals that are before Congress now to have partisan commissions, whose results are fast-tracked up here, with limited ability to debate or amend are dead on arrival. That is not going to happen.

This is going to have to be done in a partnership. And if anybody thinks they're going to come up here and run this thing through with limited debate and limited right to amend, that is not the American way. That's not the way the Greenspan commission functioned and nobody should have an expectation that's the way it's going to be done, because that's just unacceptable.

Let me turn to a question that's being asked a lot in this town and that is the question of, "Do tax cuts pay for themselves?" I want to ask you that question.

The former Federal Reserve chairman Alan Greenspan rejected claims that tax cuts pay for themselves. He said, and I quote, "It's very rare and very few economists believe that you can cut taxes and you'll get the same amount of revenues." That's Chairman Greenspan.

The current chairman of the Federal Reserve, Chairman Bernanke, also believes tax cuts do not pay for themselves. He said, in testimony this year, "I don't think that, as a general rule, that tax cuts pay for themselves."

And the current OMB director, Rob Portman, also believes tax cuts do not pay for themselves. He said, and I quote, in a hearing, again, this year, "As a general matter, most tax cuts do not pay for themselves."

And, finally, the former chairman of the Bush Council of Economic Advisors said he believes tax cuts do not pay for themselves. In fact, he said, in an economics textbook, "There's no credible evidence that tax revenues rise in the face of lower tax rates. An economist claiming tax cuts pay for themselves," he said, "is like a snake oil salesman who's trying to sell a miracle cure."

CONRAD: Let me just, before I ask you directly what your view is, show you the historical record here, what we have seen since 2000 in terms of the real revenues of the country.

Real revenues in 2000 were over $2 trillion and then we had the massive tax cuts in 2001. We were told that that would generate more revenue; at least some made that claim.

We can see what happens in the real world. We didn't get more revenue. And we had more large tax cuts in 2003. Again, we were told we'd get more revenue and, again, what we saw in the real world is it didn't happen.

I'd ask you, what is your view? Do you believe that tax cuts pay for themselves?

PAULSON: Senator, no. As a general rule, I don't believe that tax cuts pay for themselves.

But I have clearly seen -- and I think some of those people you've quoted would say the same thing -- I've seen that tax cuts change behavior. There's no doubt.

And there's no doubt, I can remember very clearly what it was like running a Wall Street firm in 2001. The bubble had burst. We were in a recession. We'd had the terrorist attack September 11th. And I watched the tax cuts add to consumer confidence, investor confidence, market confidence, CEO confidence, and I watched it change behavior. So there's no doubt about that.

CONRAD: Thank you for that.

And I, for one, agree with your assessment.

I don't think tax cuts pay for themselves, by and large, they don't. There may be some anomalous situations where, for a short term, they do. But it's also true that tax cuts affect behavior.

And the problem with all of this is sustainability. Let me go to really my next question, which goes to that question.

We have got a circumstance in which the debt of the country, foreign-held debt, our own debt are skyrocketing. This chart makes the point with respect to foreign holdings of our debt. I've shown this several times.

It shows that it took 42 presidents 224 years to run up $1 trillion of external debt, U.S. debt held abroad. This president has more than doubled that amount in five years -- more than doubled. Most would say that's a completely unsustainable course.

Let's go to the next.

And in the midst of all this, we're also running up the debt of the country in a stunning way. This chart shows what's happened to the gross debt of the United States since this president took over and what will happen if the budget plan that's before Congress is actually enacted and implemented.

The debt will skyrocket to almost $12 trillion and at the worst possible time: before the baby boomers retire.

Let's put up the final chart that is, also, I think, striking.

CONRAD: This chart shows the percentage of world borrowing by country and what it shows is the United States is now, by far, the biggest borrowing nation. In fact, we have gone from being the biggest creditor nation in the world to being the biggest debtor nation in the world.

We were the biggest creditors as recently as the 1980s. Now, we are, by far, the biggest debtor nation. And of the borrowing that's going on in the world, we account for 65 percent of it. We are borrowing 65 percent of what's available to borrow.

Let me ask you: Do you think this is a sustainable circumstance?

PAULSON: Senator Conrad, as I look at the deficit -- let me begin by saying that charts are put together different ways, on a different basis, with different numbers. I don't understand all the numbers you have up there, but let me just comment on the overall fiscal situation, as I see it.

Like all of us, I wish our deficit was lower. But as I look at it, I am actually encouraged by the fact that despite the bursting of the bubble and the recession in 2001, despite the war on terrorism and Afghanistan and Iraq and the corporate scandals, we're in a situation right now where our economy has been growing; it's been growing for some time.

And as I look at the fiscal deficit, roughly two percent of GDP, that's within a realm of historical norm. And I think we're better prepared to do something about it when we have a growing economy.

So I look at the fact and say: Is it an issue? Yes. Would I like spending to be less? Yes. Would I like the deficit to be less? Yes.

But it's manageable, it's within the realm of historical norm, and we can attack it from the standpoint of a strong and growing economy.

The issue that I'm most concerned about, not that I'm not concerned about the deficit today, but the thing I'm even more concerned about is what Senator Baucus talked about in terms of what we have coming with entitlements, with Medicare, Social Security, when we look at...

CONRAD: Let me just stop you there, if I could, because my time is running out and just say to you if you're not concerned about this massive growth of debt before the baby boomers retire, I'll tell you, we've got a much more sobering circumstance once they do.

And I'd just say to you that this notion that the deficit is manageable because it's two percent of GDP, what that leaves out, of course, is that the deficit is growing much less rapidly than the debt.

If you look at how fast the debt is growing, the debt's not going to grow by $320 billion this year; the debt's going to grow by $600 billion, because we've completely left out of the calculation that you just mentioned the amount of money that's being taken from every trust fund in sight to float this boat.

So I'd just say to you we've got to be focused like a laser on what is clearly an unsustainable course of borrowing from abroad, borrowing from ourselves in amounts that are unprecedented and before the baby boomers retire.

I thank the chair.

GRASSLEY: Thank you, Senator Conrad.

Now, Senator Wyden?

Then after Senator Wyden, of those who are present now, to be Snowe and Bunning, unless Schumer and Crapo come back before.

WYDEN: Thank you, Mr. Chairman.

And, Mr. Paulson, welcome. I very much enjoyed our discussion in my office and I look forward to your service.

I want to begin by getting your thoughts on what can be done to improve the economic well-being of middle class Americans in, I think, exceptionally difficult times. And the reason I say these are exceptionally difficult times is that this is the first time in decades, for example, when we've seen corporate profits up; we're glad to see that -- productivity is up; we're glad to see that.

But the middle class just cannot get ahead. Their wages barely keep up with inflation. The Federal Reserve says that their net worth is hardly moving. And, in effect, those people are just living paycheck to paycheck, millions of middle class folks who, say, make $60,000 a year.

Now, I think what's needed are fresh policies that give everybody in the United States the chance to accumulate wealth. That's going to be pretty hard to do when Warren Buffett says that he is the second wealthiest fellow in America, paid a lower tax rate than his secretary.

So to try to turn that around, I introduced the Fair Flat Tax Act. We talked about that.

And I think what I'd like to do is set aside my legislation or any other bill, but give me your thoughts on what you might be able to do in your position to improve the economic security, the economic lot of those millions of middle class folks who are so hard-pressed now to be able to get ahead.

PAULSON: Senator Wyden, I, like you, care deeply about the economic well-being of the middle class in America.

As I've looked at the situation, I see an economy that, as you said, is strong, good GDP growth, good growth in employment, good productivity growth.

I believe that it would not be at all unusual -- and, matter of fact, I think it might be expected -- to see the employment growth lead create the opportunity, the productivity growth lead, but then find wage growth follow that.

So to begin with, I would be hopeful, I'd be optimistic that if we keep this economy growing, have good GDP growth, good employment growth, that we will see wage growth for the middle class Americans you're talking about.

Now, I do recognize that there are other factors. I do recognize that our economy is more and more connected to the international economy and there's no turning back there. And I do recognize how important education and training is to give our workers the skill sets they need to be successful in today's world.

So I think that's part of it and that's something I know the president has emphasized and it is important.

Now, to get to the issue of taxes and tax reform, I remember very well our conversation and some of your creative ideas. A number of people on the Senate Finance Committee expressed their views that they are hopeful that there would be an opportunity to get to look at fundamental tax reform. And that's something that I, if confirmed, really look forward to thinking about in a lot more detail, spending time with you and with others and colleagues in the administration.

But as I've learned, having good ideas is one thing; having good ideas that are doable is another. And so I don't underestimate the challenge of fundamental tax reform.

WYDEN: I thank you for it. And as I indicated to you, my jump shot isn't as good as Bill Bradley's, but I want to try to play that same kind of role that we saw several decades ago about trying to drive down rates for everybody, but also create more fairness and opportunities for people to accumulate wealth. And I think that's going to be essential for middle class folks to get ahead.

Let me turn to the second area I want to discuss with you. I also serve on the Intelligence Committee and I want to get your assessment about financial privacy law, particularly as it applies to national security.

Now, as you know, the U.S. statutes, particularly, the International Emergency Economic Powers Act, gives the president the power to investigate, regulate or prohibit several categories of financial transactions if the president declares a national emergency.

Now, the administration has said that the president declared such an emergency in September 2001 and delegated this power to the secretary of Treasury.

I've looked at the statute. The statute calls, for example, that you make periodic reports on this.

But let me begin the discussion by your assessment of what really constitutes an emergency here.

Does this mean that the administration can use these powers forever? How do we strike a balance here between fighting terrorism ferociously and still dealing with the expectation of privacy?

And how would you approach it, given the fact that this statute, and there are others, give you a role in trying to make sure that we strike this responsible balance?

PAULSON: Senator, I sort of guessed I might get this question today, after reading all of the newspapers. Clearly, I understand, just as you commented, how very, very important this war on terror is and I do understand the vital role the Treasury plays in seeking to cut off funds from terrorists.

So I understand that. I realize how important it is. I have, obviously, not been briefed on these confidential programs. So if confirmed, this will be something that I'm going to need to get my arms around very quickly, learn as much as quickly as I can.

You've laid out the issues. Financial privacy is an important objective. The safety -- protecting the safety of the American people is essential. When you really think about it, it's essential to preserving our fundamental freedoms.

So what's the right balance? I'm going to need to learn a lot and I look forward to learning a lot quite quickly.

WYDEN: Does an emergency, though, strike you as something that just goes on indefinitely? Because that's what the president's authority is, is to deal with emergencies.

Again, I want to emphasize the need to fight terrorism as aggressively as possible. But how do you look at the concept of what constitutes an emergency in this effort to strike a balance?

PAULSON: Senator, I really would like the opportunity to reflect on that, consult with others, learn the law. Clearly, an emergency doesn't go on forever. But I'll tell you: This war on terror is a very serious matter today. There's just no doubt about it.

WYDEN: It is, indeed. And your answer is a thoughtful one. And I look forward to working with you on both this committee and on the Intelligence Committee.

Let me get into one other issue that we touched on in the office, and that's health care. As you tackle this question of entitlements, the fastest growing piece of the entitlement equation, of course, is health care. There are no costs going up like health care costs in our country today.

What are some of your initial thoughts, again, as you just get into this, about health care cost containment?

PAULSON: Senator, there are many areas I'm not an expert in and you probably need to put health care at the top of that list.

I see the problem. And, of course, as I've often said to people on my job, "Don't come to me with just the problems. What are the solutions and what are the workable solutions?"

Clearly, some of the steps that have been taken, the HSA accounts, where they give the consumer, the individual consumer a bigger stake in the outcome, are steps in the right direction.

But I haven't seen yet sort of a credible, long-term, comprehensive plan for dealing with this and I really look forward to learning more.

WYDEN: My time is up. I would only say in this health care area and for those middle class folks that I was talking about, it's almost like two sides of the coin. The tax issue and the health issue go right to the heart of their economic security.

I think we're going to have to have some fresh strategies on the table. I happen to think that health savings accounts should play a role.

But if we're going to do more in terms of wellness and prevention, one of the problems is that health savings accounts go just the opposite direction of prevention and wellness.

I look forward to working with you and I thank you for your thoughtful answers this morning.

Thank you, Mr. Chairman.

GRASSLEY: Thank you, Senator Wyden.

Now, Senator Snowe?

SNOWE: Thank you, Mr. Chairman.

And welcome, Mr. Paulson, to this committee. We appreciate your willingness to serve our country at this time in the capacity as secretary of the Treasury. And, certainly, you'll have a leading role to play both as principal adviser to the president, as well as key spokesman on financial and economic matters, truly at a pivotal point in our country.

I mean, you'll be assuming the position of secretary at a critical economic juncture, at a time in which a confluence of events that you've already cited here today that have contributed to the historic deficits that we're now confronting in this country.

And I'm well reminded of back in 2001 when we were projecting $5.6 trillion in surpluses and today we're at a point not only with historic deficits, where we've had the last three consecutive years, the highest deficit recorded in history.

And so, obviously, we're at a troubling point in our nation's economy.

And I wanted to sort of explore your views with respect to when deficits matter and particularly which issues and which policies, whether it's spending or tax cuts, that contribute to increasing our deficits.

We have a dichotomy of views here in the Congress and it's been debated endlessly across America, as well. But, you know, there are those who believe that deficits matter in terms of which policies generate the deficits, whether its' tax cuts versus spending.

Do you ascribe to this policy that deficits only matter when it comes to spending restraint, but not when it comes to tax cuts?

For example, just a few years ago, in 2003 and 2004, the deficit was at a historic high as a percentage of the GDP. Today it's a little bit less, though, within the historic norms, as you indicated.

But a few years ago, the administration was not concerned about addressing the deficit question when it came to tax cuts.

Now, it's interested in addressing the deficit question when it comes to spending restraints.

Do you think that both should be considered in the context of reducing our deficits?

PAULSON: Senator Snowe, my view is clearly that deficits do matter. They're one of a number of things that matter, but they clearly matter, number one.

Number two, I would say going back to what the world was like after the bubble burst, when this economy headed into a recession, I really do believe the right thing to do there was to say, "What really matters is growth," getting this economy growing, restoring confidence, getting things going.

And so now that the economy is growing and revenues are coming in, we're in a stronger position to focus on deficit reduction and focus on spending cuts.

SNOWE: Do you think we ought to be considering whether or not we should extend the tax cuts permanently in the context of that issue? Because that is one of the debates that's looming on the horizon. That's what's affecting the estate tax debate, when, originally, frankly, it wasn't logical to have made that temporary at the time, but we did.

And we've had an endless merry-go-round of tax cuts with sunsets that are scheduled to expire each and every year. So we have to consider the extension of these tax cuts. And so we're in this perpetual cycle, unfortunately. Frankly, it's not responsible policy.

So we've had tax cuts in each of the last five years. And, granted, we need to do it to stimulate the economy at certain points.

But going beyond that, we're going to be facing, on the horizon, a $2 trillion extension, essentially, to make these tax cuts permanent.

Do you think that we ought to be considering selectively which should be made part of our permanent tax code and those that shouldn't, rather than just extending all of these tax cuts permanently that's going to have a tremendous impact on the deficit?

PAULSON: Senator, I appreciate your view there and I could just say I think it would be a big mistake to increase taxes. This economy is growing and jobs are being created. And I think we're going to be in a stronger position to deal with the deficits when we have a growing economy.

SNOWE: Well, would you agree with former Chairman Greenspan, who said, last fall, in this whole context of discussing whether or not to extend the tax cuts, that "We should not be cutting taxes by borrowing; we do not have the capability of having both productive tax cuts and large expenditure increases and presume that deficits don't matter"?

PAULSON: Chairman Greenspan, Alan Greenspan, is a very wise man. I just would simply say you're never going to get me to say deficits don't matter, because I know they do matter. And I feel very strongly we should not be increasing taxes now.

SNOWE: Well, I guess it gets back to the point -- well, one is on the question of permanency, because that does have an impact ultimately and weighs heavily; and, particularly, in terms of who these tax cuts benefit.

I mean, if you look at the tax cuts this year, 48 percent of the deficit is attributable to tax cuts. And the top percentile, 73 percent, are benefiting from the tax cuts that have been passed, extending the capital gains and the dividends.

So the weight and the burden is going to fall on the low- and middle-income taxpayer, without question. So you've got all of those issues.

But in addition to that is just simply extending permanent tax cuts of more than $2 trillion, irrespective of what the impact is on the deficit, I think raises serious concerns.

And the second issue is the question of sunsets.

Should we be engaged in this masquerading of the two sides of the tax cuts by just simply sunsetting these tax cuts every two or three years and going back to the drawing board and extending them, while we expand the overall size of the tax cut package?

PAULSON: Senator, I appreciate your point and I think you know how strongly the president feels about permanence and making the tax cuts permanent as opposed to sunsetting.

And I can just tell you, my experience, speaking from my experience on permanence, I'm well aware of how important it is for families to be able to, as they make their projections, to budget.

I've watched the private sector for a long time. I've looked at investment decisions that are forward-looking, whether they're by individuals or small businesses or companies, they want permanence. And, again, I just come back to what I said: I watched the role that the tax cuts played in getting this economy to where it now is. And I think we should all feel very fortunate the economy is growing. And I believe tax increases would be counterproductive.

SNOWE: Well, I think that some tax cuts certainly do. And I've certainly supported them for that purpose. And they do play a role.

The question is: To what extent and how much and who consistently benefits? And that's the concern, because, ultimately, the economy may be growing, but the average wage earner in America's income is not growing. It is not keeping pace with inflation.

And if economic growth is what it was this year -- 5.3 percent the first quarter 2006, 3.5 percent for all of 2005 -- but wages aren't keeping up with inflation and that is a fact.

So the average wage earner in America is losing their purchasing power and they're feeling it mightily. And that's a problem, because the economy has been growing for several years and there's a lag time between economic growth and wage growth.

And so if we're in sort of a downturn here, then exactly when do their wages ever grow?

And it's further distorted by the picture of where are those tax cuts and who do they benefit? And when you've got the top percentile assuming the greatest benefits from these tax cuts, that certainly weighs heavily on the average- and middle-income taxpayer in America, not to mention all the wage earners who are in those categories, as well.

PAULSON: Senator, did you want me to respond to that?


PAULSON: Because I think you raised two questions. The first one was the question that Senator Wyden had asked about middle income taxpayers.

And I do believe, and I think you made the point, that the economic growth, the job growth, productivity growth, hopefully, will be followed by increases in wage income.

And you also made the point that health care costs, rising health care costs and inflation, eat into their income. And, you're right; those are considerations.

And so, again, I believe if we keep this economy growing and create jobs and opportunities, have the proper education, training and so on, I think we're going to get where you want to get.

PAULSON: Now, your second question was on progressivity, OK, and who the tax cuts impact and how. And I've discussed this with a number of you in the courtesy calls. I know there are different definitions of progressivity.

The U.S. tax code is quite progressive, is progressive. And at least I believe, looking at it, that what the tax codes have done is that the wealthiest taxpayers, the highest income taxpayers are paying a bigger percentage of taxes than ever before. The lowest income taxpayers are paying less and we have the new 10 percent bracket.

So, again, I wouldn't be increasing taxes. I don't think that is the answer to the issues we're facing. I think what we need to do is keep this economy growing and keep creating opportunities for the middle-income taxpayers.

SNOWE: Thank you.

Thank you, Mr. Chairman.

GRASSLEY: Thank you.

And Senator Schumer is here and after Senator Schumer, then Senator Bunning, unless Senator Crapo was here a little bit before, but we'll go according to that.

SCHUMER: Thank you, Mr. Chairman.

Again, Mr. Paulson, I'm glad you're here. I believe you'll be a great asset to the administration and I think they need you right now.

My questions are going to focus, first, on China and this cartoon that my able aide is holding up. If you can't see it, it appeared in the Denver Post first and then The Washington Post. And there's a gentleman there saying, "I'm the new Treasury secretary. Where's our treasure?" And the answer is, "Beijing."

That just points out the importance of the China-American relationship in a whole lot of ways. It's funny, not so funny; you can use your judgment.

But here's what I wanted to talk to you about. First is about currency and the currency issues. As I mentioned before, we had a pretty good relationship, Senator Graham and I, with Secretary Snow. He didn't agree with our legislation, but he made it clear that something had to be done and our legislation was helping move the Chinese.

I'd just like to know your general view -- one other thing. On the trip that Senator Graham and I made to China, we came to the conclusion that the Chinese know it's in their interest to let their currency gradually revalue. They don't like change. They don't like instability.

But with their current problems, currency revaluation, as well as other things, would help them, because they realize that they cannot just be an economy that sucks in foreign capital, changes it into exports, and then accumulates wealth. It's creating discombobulation within China itself.

So could you just give me your general views on the China currency situation and if it will differ in any way from that of your predecessor?

PAULSON: Senator Schumer, I've spent a lot of time in China. I agree with your assessment that the Chinese have made significant change and they recognize that it's not only in our interest, but it's in their interest, over time, to have a more flexible currency. There's no doubt about it.

Now, as I think about the currency issue with China, there's the intermediate term, which is where they really need to get and where they want to get and where we need them to get and the rest of the world needs them to get is to have a currency that is freely tradeable, set in the marketplace.

And that's not possible until they have a modern, open, well- functioning capital market system, banking system.

And so they've been moving in that direction. They want to get in that direction. We need to encourage them to move quicker, because in my judgment, they're not going to be as successful as they'd like to be until they open that up to competition and to foreign competition.

If they try to just reform that with the internal players, the domestic players, it's going to take them a long, long time. And so I think we need to encourage them to do what they want to do anyway and encourage them to move quicker there.

SCHUMER: Glad to hear you say that.

PAULSON: Now, dealing with the immediate, I would give the administration and Secretary Snow a lot more credit than they are given by some people, because China has moved to accept the principle of the open capital account and a flexible currency. And that was a very big step in China and they see the need to show flexibility.

So, again, I, again, think we need to encourage them to move quicker there and show more flexibility. And so that's where I am.

SCHUMER: I agree with you they've made some changes and even more heartening to me was, when we visited, that they realize they have to go further. There almost seems -- and I'm not going to ask you to comment on this -- but there almost seems to be a division.

The people who know economics or are involved in economics want them to move more quickly and the people who are more political, namely, in the Communist Party, slow it down -- not so much from a communist doctrine, but they don't like change. They want it very gradually.

A lot of these people, they cut their political eyeteeth during the cultural revolution and they're very much afraid to change.

On the other hand, they don't like instability and there's a lot of discontent in the inland of China because of almost the two Chinas and this is something that will importune them to move.

But you brought up the second question I want to relate to, where we have less experience.

On December 11, 2006, China will have to comply with WTO on financial institutions. And you're exactly right, the best way they can get their on currency, but on a whole lot of other things -- allocation of capital in the most rational, efficient way -- is to let foreign companies -- and, as you know better than anyone, we lead the world; I say that proudly as an American and as a New Yorker -- into their country.

And I've had some experience with this with Japan, a different economy, but similarly reluctant about 15 years ago, and they're very slow. They're very slow.

I mean, they agree with it, in principle, but getting -- you know, they'll say, "Well, the governor of Hubei Province doesn't want to let Citigroup open up a branch," in whatever the biggest city in Hubei Province is, or, "We're not sure that we should let Goldman Sachs come in and be able to freely underwrite or let Chinese companies completely bid on that freely."

Tell me your approach in that regard. I think this goes hand-in- hand with the currency issue, as you point out. It's brand new for us.

Give me your prognosis, given your knowledge of China, as well as to how willing they're going to be to open up at the beginning and what we can, as a country, do to increase the speed with which they do it.

PAULSON: Senator, one thing I see around the world, which is sort of an interesting phenomenon, and that is that every country globally that has opened itself up to economic reform, market-driven economic approaches, relatively free trade, open markets, has benefited and the rest have been left behind.

But, yet, in almost every country, there is strong protectionist sentiment and there is strong protectionist sentiment in China. So there are some people, people that you were talking with who understand what good economic policy is and believe it makes sense to open up and there is strong protectionist sentiment there.

And, to me, everywhere, you're going to find the incumbents resist competition, but, yet, competition is a great thing for any society. And so, to me, what we are going to have to do and have to do it fairly aggressively is encourage the Chinese to do what not only is in our best interest, but clearly in their best interest.

They're a sovereign nation. They're going to make their own decisions. And, to me, it's clearly in their best interest, because until they have a fully functioning financial system, a modern financial system, which they don't have now, they are not going to be able to have a currency that trades in the competitive marketplace.

And so that's why that's got to be a big part of the focus, intermediate focus, in addition to the immediate focus of getting more flexibility with their RMB.

SCHUMER: Right. Final question on a different issue. This is a little more parochial. It's on terrorism insurance, something we have talked about wearing your other hat, your previous hat has head of Goldman Sachs.

There are 18 months left in the Terrorism Risk Insurance Extension Act. Many of my constituents, who tend to be in real estate, financial services, other issues in New York, are concerned that we won't be able to secure adequate coverage, they won't be able to get adequate coverage after 2007, unless terrorism risk insurance is extended.

They can get coverage at some ludicrous price, but it really puts a premium against us.

And so one of the first things you're going to have to do, wearing your hat as chairman of the president's working group on financial markets, is to review the future availability of terrorism insurance. I think your working group is going to have to report back on September 30 of this year.

What will be your approach to tackling this vital issue? How do you see the debate moving forward? Are you of the view that terrorism insurance is not needed anymore? Which I hope you're not.

PAULSON: Senator Schumer, just as a general proposition, like you and, I believe, probably everyone on the committee, I think wherever possible, the best way to do something is in the private market. That's the most efficient, that's the best way to do it.

Now, clearly, right after September 11, it was difficult or impossible to get terrorist insurance. So we clearly needed that.

I was very supportive, as you know, in 2005 when the administration made the decision to extend it and right now I really look forward to, if confirmed, spending time with this working group and getting more of the facts and understanding where things are. Because it isn't as obvious to me that we need it today as it was before, but that doesn't mean to say that we shouldn't.

And so, again, I just look forward to learning more and having an opportunity to talk more with you before coming up with a view on this.

SCHUMER: Thank you, again. And as I said, I think you're going to be an outstanding Treasury secretary and I hope we can move and confirm you this week so you can get right to work next week on all the issues we care about.

PAULSON: Thank you.

GRASSLEY: Senator Bunning?

BUNNING: Thank you, Mr. Chairman.

First of all, I'd like to put my opening statement into the record, please.

GRASSLEY: Without objection. Let me announce that anybody who had a statement that they want to include in the record, it will be.

BUNNING: Thank you for being here, Mr. Paulson. I really appreciate the fact that you're here and I have some questions, follow-up on Senator Schumer's on China.

Under the current law, in order to identify a country as a currency manipulator, the Treasury must find that a country is not only influencing currency, but also that it is doing so with the intent to gain an advantage over its trading partners.

Secretary Snow has repeatedly told me and, also, this committee and the Senate Banking Committee, which he has testified before, that the Treasury Department is unable to determine this intent requirement. Because the Treasury has not found evidence of intent, they have failed to cite China as a currency manipulator.

Can you comment on this intent requirement, as it stands in current law?

PAULSON: Senator Bunning, first of all, I appreciated the opportunity to talk with you about China earlier. I know how strongly you feel about it.

I am not an expert on the law, OK, and I will -- that is one of the things that I look forward to being briefed on in some detail and talking about that, if confirmed, with my colleagues in Treasury and with you.

But, again, to me, the issue here is to encourage the Chinese to show more flexibility with their currency. You and I share a common objective and that will be a big part of my job in working with China, is to help realize the objective that you have and that I have for there to be more flexibility with regard to their currency.

BUNNING: All right, in the early '90s, the Treasury cited China twice as a currency manipulator. As far as finding intent on the part of China, what was the difference in the '90s as compared to today?

PAULSON: Senator, I can't answer that question. I know that in the '90s, there was a far different economy in China than there is today. There's been tremendous changes in the world, tremendous changes in China.

China today are far along in their economic reform. They've recognized the principle of a open capital account, of a flexible currency. But as I said earlier, I'm not an expert on that law and what was the basis of the Treasury decision in the '90s or even the more recent one.

BUNNING: Well, let's talk about since the beginning of 2006, reports on China have been published by the Treasury Department, the Defense Department, and the United States Trade Representative.

China's enforced overvaluation of their currency has far reaching impact for the United States not only in economic terms, but also for national security.

Yet, these reports leave the impression that these agencies have not worked closely together to fashion a consistent response to China's concerted action to under valuate its yuan and the activities that rely on this misalignment.

For example, without the enormous currency reserves China has amassed, due in large part to its yuan under valuation, China's ability to purchase sophisticated military technology would be more limited.

Do you believe that our federal agencies have been working together in a manner appropriate to address the broad and interconnected challenges posed by China?

PAULSON: Senator, I haven't had a firsthand view, so I don't want to comment on how our agencies have been working together.

BUNNING: OK, under your leadership, will you, as the head of the Treasury Department, take further measures to achieve greater coordination in this regard?

PAULSON: Senator, I don't know whether measures need to be taken to achieve greater coordination. But I'm a team player. I'm someone who believes in coordination. So I look forward to collaborating with fellow Cabinet members, if confirmed, in thinking through the right approach to China.

BUNNING: Well, but, see, that's the judgment we have to make in making the confirmation judgment, whether you will or whether you won't.

PAULSON: And, Senator, I tried to answer that question and said I believe my role, if confirmed, will be to be a part of a team or I work closely and collaborate with other Cabinet members.

BUNNING: Mr. Paulson, as you know, the Fed is scheduled to meet again this week and it's anticipated that we will be facing yet another increase in the Fed fund rates. If this does happen, it will be the 17th straight increase, over 400 basis points, in the last two years.

Some feel that the effect of these increases is already starting to become evident in the deflating of the housing market, shaky consumer spending, and weakening economic growth.

As someone who has been closely involved with markets for years, can you comment on the effect that interest rates pushed too high too fast can have on investors and the economy, in general?

PAULSON: Senator Bunning, I have a very high regard for Chairman Bernanke and so I have strong confidence that he is going to do what's right to maintain price stability consistent with long-term growth.

BUNNING: Well, see, some of us don't have the same high regard for his decisions, not him personally, but for the decisions that the Fed has made over the last two years.

I'm looking at a prime rate very close to nine percent, if that is, in fact, if they do raise the Fed fund rates. We're looking at 8.75 percent prime. There are not too many Americans that are listening to this broadcast today that can borrow at prime. It's usually prime plus one or prime plus 1.5. And I get worried every time we get near 10 percent, because the economy doesn't react well to a 10 percent prime rate.

I am sincerely worried that they're going to overstep, like they did in the early '90s, like they did right after the bubble burst or right as the bubble burst.

Mr. Paulson, as you know, the Treasury Department influences our expert policy with Cuba through the office of foreign asset control. I have been very supportive of the positions taken by this administration in these matters.

Under your leadership of the Treasury Department, do you anticipate major changes in the United States' policy towards Cuba and the embargo?

PAULSON: Senator Bunning, President Bush's policy here and his position here is very well known. And as secretary of the Treasury, I know what my job is and it's to enforce the law.

BUNNING: All right, in 2001, the Congress enacted several important cuts, including a package of incentives to encourage retirement savings. The package includes such items as increasing IRA and 401(k) contribution limits and allowing catch-up contributions by older workers.

With more than 70 million baby boomers headed into the golden years, these incentives are an important way of helping them pave the way for a more comfortable retirement. However, these incentives expire at the end of 2010.

The House-passed pension reform bill includes a permanent extension of these provisions. I hope that the conference report we see on the pension bill will include the extension.

Mr. Paulson, how important is it to the country's future that we find ways to encourage Americans to save and invest for retirement? Does the confusion about the rules from year to year limiting the effectiveness of these incentives, are they important or are they not important?

PAULSON: Senator Bunning, as you and I discussed, I think there are few things that are any more important in the economic sphere than getting our savings rate up and encouraging Americans to save.

So we have no disagreement about that. That is very, very important.

BUNNING: Thank you, Mr. Chairman. My time has expired.

GRASSLEY: Senator Lott?

LOTT: Thank you, Mr. Chairman. I won't take the full 10 minutes, hopefully, because I know you've had a full morning. But I want to thank you, Mr. Chairman and the ranking member, for moving forward with this hearing.

This is a very, very important position for our government and the president's Cabinet. And I think we should, barring any problems, which I don't see, we should get this confirmation done as soon as possible and, hopefully, before we go out this week.

So thank you for scheduling the hearing this morning.

And thank you, Mr. Paulson, for being willing to take on this assignment. I know that perhaps there were some reservations, perhaps from your family, about this position for a while, but thank goodness you're doing it. You're doing the right thing. We need you and I think you are absolutely the right choice for this very critical position at this time.

We will overlook the fact that you obviously were a cradle- robber. Having been married for 37 years to such a young lady is very impressive, showing good judgment once again on your part.

But I'm excited that you have agreed to take this assignment and it's a very critical one. You know what the issues are and the problems are that we face. But your background, your experience in administrations over the years, your experience at Goldman Sachs, your education, you've got everything we need in this very important position.

So I congratulate you on your nomination and certainly will vote for your confirmation.

Now, just a couple of issues that I do want to address.

Number one, I'm sorry I missed this, but you have identified, I'm sure, some of the priorities you intend to focus on when you are confirmed.

Would you kind of, just quickly, enumerate that once again and maybe expand on it, if you'd like to take a couple of minutes to do so?

PAULSON: Senator Lott, as I think about this job, I probably have the same objective you do' that I would like my grandchildren -- who to the best of my knowledge are not yet conceived, so you can see I'm an optimist here -- but I would like them to grow up in the United States where they have the same opportunities I have.

And as I think about that, I would be hopeful that there will be some things we can find, all of us together, in the next two-and-a- half years that will be practical and actionable, that will help maintain and enhance the competitiveness of the U.S. economy.

And then there's a second topic that Senator Baucus brought up, which is looking to some of the really formidable, long-term economic challenges this country faces. So here we're talking about the entitlement spending, potentially leading to very big deficits, given the aging of this country's population and health care costs rising as quickly as they are, when you look at Medicare and Social Security.

And so one lesson you can learn in looking around the world is if you don't deal with these issues early on, they're more expensive, much more expensive to deal with later. There's that, there's other big, again, formidable issues, not easy issues.

The need for energy security, energy independence, again, difficult, long-term, very important. The fundamental tax reform, which, again, is not an easy issue, but a number of you all have talked about it.

So when I think about those, it would be quite naive to say that these could be addressed and solved in a two-and-a-half year period. But, again, at least I look forward to learning more about them, talking with my colleagues in the Cabinet, with the president, talking with all of you; hopefully, making some recommendations to the president.

And then the question is, "What is doable?", but at least beginning to seriously address some of these things, hopefully, will be helpful.

And then, thirdly, internationally, I would plan to be quite active, looking to work with some of my, if confirmed, counterparts around the world in managing some of the global imbalances, would look toward -- see a need to keep my finger on the pulse of the global economy and, again, advocate reforms, policies, actions that will create economic opportunity, particularly for U.S. products, U.S. investments.

LOTT: Well, thank you. That was very, very interesting. And I think you touched on all the right subjects.

I have four grandchildren and it does change the way you view things and I feel very strongly that we're going to have to, at some point, find the leadership and the courage to address some of these long-term issues, like Social Security and genuine tax reform.

The odds are minutia is going to gobble you up just because there will be so many things coming at you. But I hope that you will make sure that you take the time to also provide us some visionary leadership and that you communicate that directly to the president of the United States, because we've got some big issues we do need to try to address.

And it's so easy in this city just to get involved in trying to keep paddling instead of taking the big leap. And so I hope that you will consider that.

You have been a supporter of extending the 15 percent tax rate on capital gains and dividends. In fact, I think I met with you a year or so ago and we talked about that and, basically, you said it's unthinkable that you wouldn't do it, because the markets have already factored that into their thinking, that it was going to happen.

You do still feel that those are very important provisions and support the importance of getting that done, do you not?

PAULSON: Yes, Senator. I view those as being very fundamental, because I've just seen biases in a corporate tax system and I think those eliminated or minimized some of those biases.

LOTT: One point of personal privilege. I'm from Pascagoula, Mississippi, the Mississippi Gulf Coast, the area that was devastated by Hurricane Katrina. You and I had a chance to speak briefly about that and I think you're looking for some ways to have some public- private efforts to help in the recovery and I thank you for that.

I want to bring to your attention the need to extend the bonus depreciation provisions of the Gulf Opportunity Zone, the GO Zone. I think this is going to be very critical as we look to recovery and the job creation, the retention of jobs and the creation of new jobs.

We need to have the deadlines extended beyond 2007, the end of 2007, and that they're synchronized with the other provisions in the GO Zone and extended to December 31, 2009.

I hope you will take a look at that, be supportive of our efforts, and I look forward to working with you on trying to come up with some other innovative ideas of how we can have public-private partnerships to help the New Orleans and the Mississippi Gulf Coast area to recover.

PAULSON: Thank you very much, Senator Lott, and I look forward to working with you on those issues, I really do.

LOTT: Thank you.

Thank you, Mr. Chairman.

GRASSLEY: Thank you.

We'll have a second round of five minutes each.

And for the point that Senator Lott just brought up, that issue was still in conference between the House and Senate and it will be something that will be discussed just as soon as we get the conference on pensions done. When will that be?

Mr. Paulson, you've talked a lot about China and I don't want to go back to specific issues on China, but Senator Baucus and I have introduced a bill that would change the 1988 law that's been our policy, because we feel that the president doesn't have sufficient authority to deal with problems like China.

But I don't want to concentrate on China, because I think if our legislation had been in place 20 years ago, we would have been talking about Japan and who knows, 20 years from now, what country we might be talking about other than China.

But there was a 2006 economic report of the president attributing the trade deficit, in part, to China's foreign exchange regime. The report said that the president plans to push for greater exchange rate flexibility in Asia, including China, along with financial sector reforms.

Do you have any sense of whether our current legal framework for oversight of currency exchange rates, which dates back to '88, is sufficiently strong enough to help the president to achieve his stated goal and whether or not you have any opinion on whether our bill, meaning to strengthen and improve laws in this area, would be helpful?

PAULSON: Senator, I need to learn more and I look forward to learning more about the legal framework and I look forward to talking with you about that.

GRASSLEY: You may not have an opinion on our legislation. Does your answer apply, also, to our present policy based on the 1988 law, whether or not that's adequate?

PAULSON: Yes, yes.

GRASSLEY: I'd like to ask a question about the backdating of stock options, and that's been recently in the news, by executives of major corporations doing that.

I would like your general views on this and your commitment that Treasury and IRS would make it a priority to go after tax due and owing, as well as applicable penalties from both individuals and companies that engage in the transaction.

And besides your opinion, I'd like to have kind of an expansion, in the form of some sort of a report 30 days after you're sworn in, on what Treasury and IRS has been or will be doing in that area.

PAULSON: Senator, if confirmed, we will definitely get back to you on that topic.

Now, my general view is, as you know, executive compensation is a very, very sensitive issue, just generally. And when there are abuses, it undermines confidence in our whole system and undermines confidence in the corporate sector.

So I've been very disappointed, to say the least, to read some of these stories.

Now, again, I don't know the facts. I haven't investigated myself. I've just read the same press stories that everyone else has been reading in this area, but I've been disturbed to read them, number one.

Number two, I know, again, from what I've read, not from firsthand conversations, that the SEC is very involved here and I know a number of other enforcement groups are very involved.

So one of the things that I will do, if confirmed, is talk with Chairman Cox at the SEC, talk with others in the administration, obviously, talk with the people at IRS and make sure that I'm up to speed on this topic and that we're dealing with it in an appropriate way and that we're discussing it with you and reporting back to you.

GRASSLEY: Thank you very much.

On another area, I've been involved with legislation protecting whistleblowers over a couple decades, an author of the False Claims Act 20 years ago. And one of the loopholes in the False Claims Act is that it doesn't apply to tax matters.

Now, there may be some good reasons why we should be cautious about having the False Claims Act apply to whistleblowers in tax matters.

It's clear to me that government and the people can benefit significantly by making good use of whistleblowers in tax cases. The IRS already has clear legislative authority to have a broad-based program to reward tax whistleblowers.

What the IRS hasn't had is a clear-sighted management that has taken full advantage of the possibility of tax whistleblowers.

A recent report by TIGTA said that the matter has only made it all the more clear that there are great benefits to rewarding tax whistleblowers and that the IRS and Treasury has fallen down on the job of using that.

Based on this report, cases based on whistleblowers are far more productive for the IRS than other cases. The return to the Treasury for dollars per hour worked in cases from whistleblowers is $946 compared to $548 for IRS regular cases.

In addition, the no change rate is about a third lower for whistleblower cases, meaning that whistleblower cases are more likely to target tax cheats and not bother honest taxpayers as compared to regular IRS audits.

So since you're a smart businessperson, and I mean that from the heart, doesn't common business sense suggest that we should be encouraging a program that is highly productive, more productive than normal IRS exams, and has a lower no-change rate that it is less likely to hit innocent taxpayers?

Unfortunately, the exact opposite has happened at Treasury. Now, this report recommends that there be a centralization of whistleblower work at the IRS and other points.

But I would say to you, Mr. Paulson, that this is the tip of an iceberg, that we need to have leadership committed to moving this along.

So I'd like a commitment from you that you will ensure that there is leadership to make this program a success and that the necessary reforms will happen now, right now, to make this a success, because this is another one of those things that I'm kind of tired of waiting on the bureaucracy.

And so I would appreciate very much a time line along the spirit of Senator Baucus asking for things to get done on time, that this important work being done and that we have a written response to the committee in regard to this and your nomination in regard to this.

PAULSON: Mr. Chairman, I know how strongly you feel about this issue and how important the tax gap, closing that is, and cracking down on tax cheats and I share all those objectives.

I will just assure you that, if nominated -- if confirmed, that this is an area I will look into very, very quickly. I will make sure I understand all the issues. I will follow-up with you on it.

And I just know how you much you care about it. You know more about it right now than I do and I look forward to learning.

GRASSLEY: What I'd like to have, and you've answered it well and I believe in your intent, but if we could just have along the lines of a previous request that Senator Baucus made, not exactly on the same thing, but a time line in which certain things might be done in this area.

Not that you've got to have a complete response to me on how it be done, but it is the law. There is factual basis for it and I think it's just a point of giving us a plan and how you work it out.

This isn't going to close the entire tax gap that Senator Baucus is talking about, but it's going to help.

Senator Baucus?

BAUCUS: Thank you, Mr. Chairman.

Mr. Paulson, this means a lot to this committee, tax gap. When Commissioner Everson was before the committee not too long ago, the chairman and I asked the commissioner to give a plan to this committee by the end of this fiscal year, on which we'll have hearings shortly thereafter, the plan which outlined the dates by which we can achieve certain results in getting this tax gap closed.

I know, as a chief executive of a major company, that's the way executives think. They want a plan. As you mentioned earlier, don't bring me the problems, but if you do, bring me the solutions. And we're asking for the solutions and how do we get from here to there.

You're going to find us very reasonable, but also very firm. My general view on most subjects is be fair, but firm.

And we've set a firm date, end of this fiscal year, September 30, by which we want this plan from the IRS on how they're going to close the gap and that plan will include dates by which certain actions have to be taken to achieve certain numerical results to get this tax gap down.

So I'm asking you, will you commit to this committee to assure that that plan is put together and work with us when we have our hearings?

PAULSON: Senator, I will sure commit to be on top of this and to understand the issues and what's doable. I think it's difficult and maybe imprudent for me, before confirmed and before I've had an opportunity to talk with the people at the IRS, understand where they are and what the issues are, to commit to some plan I don't know all the details of.

BAUCUS: I'm asking you to put -- you're going to be confirmed quickly and you're going to have a couple months to work on a plan and I'm asking you just to help make sure that plan is, in fact, submitted on time and will work.

You'll use your best judgment as to what's in the plan, working with the commissioner, but we need to get moving.

PAULSON: Senator, I hear you and I tell you, I believe in -- I understand the important oversight role you have and I believe in working very closely with you and I'm sure going to do everything I can to be responsive there.

BAUCUS: Can you commit to have that plan here by September 30?

PAULSON: To have the plan here?

BAUCUS: You've got a big role in that what that plan is going to do.

PAULSON: The only reason there's any daylight at all here is one of the things I've tried to do all my life is rather than over- promising and under-delivering, to under-promise and over-deliver and so...

BAUCUS: We're expecting you to over-deliver on September 30.

PAULSON: So I hear you. I want to make you happy. I just would like...

BAUCUS: Thank you.

PAULSON: I just would like to have an opportunity to talk to Everson.


GRASSLEY: I think you and Commissioner Everson -- I think that we're expecting you to close the tax gap by October 1. We're not doing that. What we're trying to do is tell us a plan and time lines and how you're going to do that and we only want the plan and the time line by October 1.

PAULSON: I got it. I got it, I understand it.

You know, it's an interesting thing on the tax gap, and I'll just say this...

BAUCUS: Briefly, because I have another question.

PAULSON: OK, sorry.

BAUCUS: Thank you.

The other question is equally, I think, sensitive and important and that's the role of the Treasury in the Swift issue. It's my belief that there's a pattern and practice in this administration of challenging the Constitution's Fourth Amendment protection against illegal search and seizure.

First, we have the NSA tracking phone calls, now the Treasury looking at financial records. And, frankly, the first thing I did after reading about the Swift program was write a letter to the president asking whether the same methods are being applied to the tax records of American citizens.

We have, as you know, procedures in place to make it tough for the government to troll through our tax returns to make sure that their privacy is protected.

This is delicate, but it's extremely important. It gets to the constitutional question of the role between the Congress and its oversight roles and the executive, but, also, it's the Constitution and it's the Fourth Amendment.

What is the prohibition against illegal search and seizure in the Fourth Amendment mean in this case? I think you'll agree that we could fight terrorism properly and adequately without having a police state in America and, frankly, we're strong because we are not a police state and other countries have failed because they were police states.

We have to work ever harder, mightily, to find how we strike that balance. And it's my sense that it's lopsided now. The executive just willy-nilly, basically, does the things it wants to do without sufficient sensitivity to the Constitution. I'm speaking here about the Fourth Amendment.

So I'd like you to do a few things, please, a few simple requests. One is that you personally review this program, if you become secretary of Treasury; that is, commit that you will personally review it.

Do I have that assurance?

PAULSON: You do.

BAUCUS: Second, that you ensure every law related to these inspections is followed, that the law is followed.

PAULSON: We clearly need to follow the law.

BAUCUS: And I have that assurance that you will ensure, the best you can, that that is the case.

PAULSON: To the best I can, absolutely.

BAUCUS: And you commit, also, that you will regularly brief the finance committee about this program.

PAULSON: In terms...

BAUCUS: I'm not asking about the full committee, but just brief this committee, because after all, this committee -- you're here because we have oversight over the Treasury.


BAUCUS: So will you commit?

PAULSON: You're talking about which program?

BAUCUS: I'm sorry?

PAULSON: You're talking about the...

BAUCUS: I'm talking about both Swift and, also, my request to look at whether the administration is using the same basic methods to examine tax returns.

PAULSON: OK, let me just make a couple comments on that, because as I said earlier, I really understand how important this war on terror is and I understand the Treasury Department has a very major role and I have a very major role to understand that and help drive that and so I think that's very important.

And I believe very strongly that you have your oversight role, we need to communicate, I need to communicate and the communication's got to be done, it's got to be done through the proper channels.

And I don't know enough now about the security issues and others to say exactly how that communication should take place, but I will tell you I understand it needs to take place; it needs to take place through the proper channels.

And what I've been told, and I clearly believe this to be the case, with regard to the IRS, this committee -- and you would know a lot about that law, because this committee writes the law -- and that those IRS records are -- there's a strong legal right to privacy and my job is to enforce the law there.

BAUCUS: This committee was not informed about the Swift operation, even though we have jurisdiction over the Treasury. The Treasury did not inform this committee about that massive operation or billions of dollars that change hands worldwide daily.

And I'm asking you to change that and inform this committee. Now, I'm not saying exactly what you tell this committee, but you could certainly inform us of certain operations. Then we could take the next steps to see what the proper information should be.

And the same would apply to IRS material, that is, the degree to which the administration is also controlling, looking at, surveilling IRS records without American taxpayers knowing and without this committee knowing.

We have to know, because we represent Americans. We run for office and we seek these positions because we want to do best for our people.

You don't face the voters, we do, and I say that because it is the voters who are in charge. We're the servants. We work for them.

And I, frankly, sought this position I have, ran for public office, in many respects, because of my deep reverence for the Constitution and civil liberties, Bill of Rights, including the Fourth Amendment, because I believe that the strength of this country very much depends upon the adherence to the basic principles in the Constitution.

It takes work, it's difficult. It's easy for administrations to kind of push some of the protections of the Constitution aside or to fudge, because it's expedient to. It's messy, it's difficult, it's hard work to deal with some of the constitutional protections, but it's necessary for a strong government.

So I'm asking you to just go the extra mile, make sure that happens and to inform this committee of any operations along the lines of Swift or IRS or whatnot through the jurisdiction of the Treasury. As I said, we can then get to the point of what we discussed, but I'm urging you to go the extra mile, because we will protect and respect what you say, because we're all working together for the same purposes.

And if that includes any changes of the law that you think are necessary, then we're asking you to tell us that. If times have changed, new surveillance techniques are necessary and whatnot, whatever you suggest, if you think there need to be changes, let us know.

I'm quite disturbed, frankly, that the administration did not suggest any changes to this Congress with respect to telephone surveillance, changes with respect to the FISA court.

As you know, we have a system -- it's not in this jurisdiction, but a system called the FISA courts, where the executive branch has gone to the secret court -- it's not secret, the proceedings are secret -- and that court has 99 percent of the time agreed to any requests that administrations have made with respect to electronic surveillance.

This administration didn't use FISA, didn't go to it at all with respect to the recent telephone surveillance, I think, basically, because it found it inconvenient.

I understand, it's a war on terrorism, it's pretty hard to speak up about protection of the American privacy, because people will say, "Well, you're for terrorism."

Of course, we're not for terrorism, of course, we're not. Of course, we're trying to fight terrorism as much as we possibly can, but this is democracy. It's hard. It's not a police state. And we have to work even hard to make sure it's done properly.

GRASSLEY: Senator, did you want a response?

BAUCUS: I know my time is -- maybe one minute or two, but no more, Mr. Paulson, if you have any thoughts on what I just said.

PAULSON: First of all, I understand clearly what you've said.

Secondly, I won't repeat what I've said before about how important the responsibilities are, if confirmed, in the war on terrorism.

I read about the Swift case in the newspapers, because it clearly would be inappropriate for anyone to post me on that before confirmation. So I understand the points you've made.

I am going to, if confirmed, be all over it, make sure I learn everything there is to learn, make sure I understand the law thoroughly.

Let me say to you I appreciate what you said about our rights and freedoms. I really believe that we have a very important right to safety and I really do believe protecting that right is going to be fundamental to protecting other rights and freedoms.

So I'm not debating it with you. I'm looking forward to learning about it. I'm looking forward to talking to you about it more in the future.

BAUCUS: I appreciate that. And as you're learning, you are agreeing, aren't you, that you will regularly inform this committee of actions that the Treasury is taking in this area?

PAULSON: Yes, well, what I'm agreeing is it -- I totally agree that we need to communicate and we're going to figure out the proper channels to do that.

BAUCUS: I appreciate that. Thank you.

GRASSLEY: Senator Wyden?

WYDEN: Thank you, Mr. Chairman.

Mr. Paulson, I had asked you earlier about the issue of financial privacy and national security. And let me pick up on what Senator Baucus has been talking about, as well.

First, I do think it was constructive, in answer to my earlier question about this question of emergency powers, emergency powers that are granted under the International Emergency Economic Powers Act, that you had stated that emergency powers don't last forever.

And I think that that is a constructive step and is a key element of what I and other senators want to see, and that is striking a balance between fighting terrorism ferociously and protecting privacy.

But there is another issue that has not been addressed and I have seen it again and again in my work both here and as a member of the Intelligence Committee and I want to get your thoughts on it.

The key statute in this area is the National Security Act of 1947. It states that the executive branch keep Congress fully and currently informed about intelligence activities.

So what that means is that I, as a member of the Intelligence Committee, should be, quote "fully and currently informed." But what happens is, usually, the Intelligence Committee and even some of the leadership in the Congress basically doesn't hear in a current fashion.

We hear at the last minute when a program is about to be described in the paper. So I think we need to get at this issue and I would like to hear your thoughts about what constitutes keeping the Congress -- and in this case, it's the Intelligence Committee, on which I serve -- what constitutes keeping the committee currently informed?

PAULSON: OK, let me, Senator Wyden, make a couple of points.

But let me go back, because I don't want you to misread anything in my statement, which was, I think, a truism. I mean, it's intuitively obvious that, by definition, an emergency power can't last forever or then it wouldn't be an emergency power.

But I certainly didn't mean to imply that we weren't in an emergency situation right now because, as a matter of fact, what I do believe is that this war on terror is very serious, very real. There's nothing more important. And, as I said, I think that the rights to privacy are quite important. I think the rights to safety here are essential.

But putting that aside -- I just didn't want that to be taken out of context.

But a number of people, Chairman Grassley, Senator Schumer, were gracious in saying that I was an expert on financial matters. You serve on the Intelligence Committee. I really have a lot to learn about intelligence.

In other words, I've had no experience in there. I haven't been briefed on the law. I'm not a lawyer. So I really do think it would not be a very productive exercise for me to be speculating about these issues and what the right channels are for communication under the law and so on in this area.

So I think really the right way for me to leave this is this is an area that I've got the most to learn about. I realize how important it is. I look forward to learning about it and I really look forward to talking with you about it.

WYDEN: Well, I consider you to be very sincere in your approach to these issues.

I would only say -- and that was why I asked the question earlier and come back to it today. This means a real effort in a bipartisan way to look at what's being done anew to strike the right kind of balance, because this committee, certainly, the Intelligence Committee, wants to ensure that our government has the tools to fight and win the war on terror.

But we also have to comply with the laws of the United States and that was why I read the '47 law that says currently keep the key committee, the Intelligence Committee, informed. That has not been done.

I often joke the way people find out on the Intelligence Committee about what's going on is you buy a subscription to the newspaper. That's unacceptable.

You have said you will look into this and I appreciate it.

Let's talk about one other issue that I know you're interested in and have a lot of history in and that is the environment and I want to talk about how you could play a real role as a Treasury secretary and, particularly, using marketplace forces, using the private sector to help green up government and to create good paying jobs.

The area that I'm especially interested in your thoughts on is the global trading market in carbon credits. This is the market that allows for the opportunity to reduce pollution and create good paying jobs and it is a very fast-growing market. And it's growing quickly, in spite of the fact that the United States has largely been on the sidelines.

At this point, it looks like the market will be a $40 billion per year business worldwide and because you have, consistently and to your credit, said that making environmental policy, good environmental policy is also good business, I'd like to hear your thoughts on what you could do as secretary of Treasury to help the United States get into this very large, growing global market for carbon.

PAULSON: Senator Wyden, when I went around and made courtesy calls, my interest in the environment came up. And so it came up from people on both sides of this issue, those who agreed with some of my personal views and some that didn't.

And one of the first things that I said, no matter which side someone was on, is I said the president of the United States has nominated me to be secretary of the Treasury. He hasn't nominated me to be secretary of the interior. He hasn't nominated me to be head of the Environmental Protection Agency. And the really big focus I have is going to be on dealing with so many of the issues we've been talking about today, the economic issues that are on all of our agenda.

Now, as you've said in your comments, I have personally looked at climate change as being issue which is a very significant issue for this planet and I've said that good economic policies go hand-in-hand with good environmental policies.

I don't think they're a conflict. I think they're the opposite side of the same coin.

And as you said, I'm a believer in market-driven approaches. I believe that one of the big answers, as the president has said, is going to be investing in technology. And I believe we're going to have to invest in technology big time. We're going to have to invest in renewable fuels, alternative energy sources, all of those things.

Now, in terms of trading carbon credits and emission credits, that was a market-driven approach and Goldman Sachs had some experience there, largely in Europe, but to a small extent in the U.S. and that's a market that may develop.

I hadn't actually thought much about what the Treasury secretary should be doing in that capacity, because that isn't going to be a major focus for me relative to some of these other issues that are going to require a lot of time and attention.

WYDEN: I understand that and that's why I wanted to save it for last, but I think that we all understand that in the international trade arena, where you're going to have discussions, this is the chance to look at businesses that are clean energy business opportunities for American citizens, Americans to get high skill, high wage jobs.

That's something we all understand has bipartisan support around here. Probably the best way to ensure that you have influence in this area is for characters like me to give you a little breathing room to have a chance to get at it.

I just hope that you can help green up government using private marketplace forces as you go about your activities in the international trade arena, because I do think, at the end of the day, this is about something that is indisputably good for our country.

It's about creating good-paying jobs in an area that all Americans are looking with great interest at and, at the same time, improving our quality of life.

But I thank you. I've probably given you as many questions this afternoon as anybody, other than the chairman and Senator Baucus. And it is because I very much look forward to working with you on a variety of fronts and I thank you for the discussion today.

And thank you, Mr. Chairman.

GRASSLEY: Thank you, Senator Wyden.

We're done now. I was going to have one more question, but Senator Wyden really asked it and to repeat your answer I think would have been an answer that would have satisfied my question that you're being nominated to be secretary of the Treasury, not to be head of the EPA, not to be head of the Interior Department -- right?

PAULSON: Absolutely.

GRASSLEY: You know, I think that you have such a good environmental interest and record and reputation that precedes you, that probably the superintendent of that building you'll be in down there is probably right now figuring out how he can gain your favor. He'll have a birdwatching station built for you by the time you get sworn in, I would guess.

Anyway, let me close with just some administrative things in regard to this nomination, some for the committee members, some for the entire Senate, and some for Mr. Paulson.

Our goal is to report Mr. Paulson out of this committee as soon as possible and I think we've already had some indication from minority members that we would be able to do that.

I do want to make sure that members have a chance for follow-up questions. So you may get some follow-up questions in writing and those questions should be in by 5 p.m. today. So any members or anybody that has questions that need to be asked, get those in right away.

And then I'm hopeful that you would respond to these questions as quickly as possible, because that is almost necessary to get to your nomination, unless I would surmise that somebody is writing you 500 questions just to slow down the nomination for some unreasonable reason, because I think we ought to have a seamless transition from Secretary Snow to Mr. Paulson.

A vacancy in the secretary's office is something that we should all be concerned about and since Secretary Snow has announced that he intends to leave on July 3, we have six days to not have a vacancy in that office and we should be mindful then of that calendar.

I appreciate my colleagues' cooperation to this point and I ask that they continue to cooperate so we can help move this important position along and I would ask all of them for assistance in doing that.

Thank you, Mr. Paulson. You've been very forthcoming. We appreciate it very much.

PAULSON: Thank you, Mr. Chairman. Thank you.

GRASSLEY: Thank you.

Meeting adjourned.


Jun 28, 2006 14:11 ET .EOF

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