May 1, 2008
HP-955

Testimony of Deputy Assistant Secretary for Tax Policy
Karen Gilbreath Sowell
Before the House Ways and Means Subcommittee on Select Revenue Measures
on Tax Incentives for Higher Education

Washington --Mr. Chairman, Ranking Member English, and distinguished Members of the Subcommittee:

Introduction

Thank you for the opportunity to appear before the Subcommittee today to discuss tax incentives for higher education, which currently include more than a dozen credit, deduction, exclusion, and deferral provisions.  While my testimony today focuses on tax incentives, I note that there are numerous non-tax governmental and other programs to help make higher education affordable and that figure into an individual's or family's decisions regarding higher education.  The principal Federal student financial assistance programs are authorized under Title IV of the Higher Education Act of 1965, as amended, and this year will provide more than $90 billion in grant, loan and work-study assistance to students and their families.  The Title IV programs include Federal Pell Grants, which serve low-income undergraduate students, and Federal student loans, both the bank-based Federal Family Education Loan program and the Department of Education's Direct Loan program, which serve undergraduate students and their parents, as well as graduate professional school students.  In addition, colleges, universities, non-profit organizations, and the private sector furnish scholarships, tuition programs, and other assistance to students pursuing higher education, which according to the College Board exceeds $35 billion annually.  

Education is important to the Administration, and we recognize that there is room for improvement in the tax benefits currently provided through the Internal Revenue Code to encourage higher education.  We believe that the goal of providing incentives to make higher education affordable is best achieved by identifying the most efficient ways to address student needs and effectively utilizing those mechanisms.  My testimony will focus first on a brief review of current tax incentives for college and other post-secondary education, and then discuss areas for potential improvement. 

Over the last several decades, various provisions have been added to the Internal Revenue Code to facilitate savings for, and to incentivize the pursuit of, post-secondary education.  Building on these existing provisions, the Administration and Congress have made significant progress during the past seven years to provide tax benefits related to higher education, particularly in helping families save for post-secondary education.  Notably, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) expanded Qualified Tuition Programs, also known as section 529 plans, to permit tax-free distributions from plan accounts to be used for post-secondary education expenses, and to allow private educational institutions (in addition to states) to create section 529 plans.  The Pension Protection Act of 2006 made these changes to section 529 of the Internal Revenue Code permanent, which helped eliminate uncertainty with respect to this education savings vehicle.  Further, the Administration's Budget for FY 2009 includes a proposal to extend the Saver's Credit to contributions to section 529 plans in order to encourage and assist lower-income families in saving for higher education. 

EGTRRA also expanded Coverdell education savings accounts (formerly known as Education IRAs) by raising the annual contribution limit to Coverdell accounts from $500 to $2,000, and increasing the income phase-outs for joint filers.  In addition, EGTRRA eliminated the disallowance of qualified distributions from Coverdell accounts or section 529 plans for those taxpayers who claim an education credit.

Notwithstanding these savings programs for those who have the ability and who have sufficient time to save for higher education, students and families who are facing immediate education-related costs must confront a patchwork of education-related tax incentives.  Current law tax incentives may take the form of a credit against tax liability, a deduction from gross income, an exclusion from gross income, or a deferral of (or exemption from) tax.  A detailed table of all the major tax incentives related to post-secondary education is attached as Table 1. 

Set forth below is a brief overview of certain of the significant provisions under current law.  Focusing on but a few of the available incentives reveals the complexity of these tax incentives, all of which are aimed at post-secondary education, but which apply to different people, in different circumstances, and for different educational ends.  It is important to keep in mind that consideration of tax incentives is only one piece of the financial puzzle.  Students pursuing higher education – be they recent high school graduates, high school graduates returning to higher education after entering the job market or raising a family, or professionals interested in pursuing an advanced degree or a different career – also have available to them the panoply of government grant and loan programs, as well as the many forms of non-governmental assistance available from educational institutions, non-profit organizations and the private sector.

Overview of Major Current Law Tax Incentives for Post-Secondary Education

As noted above, current law tax incentives may take the form of a credit, deduction, exclusion, or deferral.  Many of these incentives have unique eligibility requirements, different phase-out limits, and various filing requirements.  Generally, if an expense would qualify under more than one provision, current law allows only one tax benefit for the particular educational expense. 

Credits

In 1997, Congress enacted a pair of tax credits to help families pay for higher education – the Hope Scholarship Credit (Hope Credit) and the Lifetime Learning Credit.  In 2008, a taxpayer may claim a Hope Credit for 100 percent of the first $1,200 and 50 percent of the next $1,200 in qualified tuition and related expenses (for a maximum credit of $1,800 per student) for the first two years of college for a student enrolled at least half-time.  A taxpayer may claim a Lifetime Learning Credit for 20 percent of up to $10,000 in qualified tuition and related expenses (for a maximum credit of $2,000) per taxpayer for any post-secondary education.  Both credits are subject to an adjusted gross income (AGI) phase-out.  In 2008, the credits phase out between $48,000 and $58,000 of AGI ($96,000 and $116,000 if married filing jointly).  Only one credit may be claimed by each eligible student. 

Dependent Related Deductions and Credits

For parents supporting college students, there is an extension of the benefit provided by the personal exemption for full-time students aged 19 through 23.  Dependent children over the age of 18 do not qualify as children for the personal exemption unless they remain full-time students (through age 23).  In 2008 the personal exemption amount is $3,500.

This favorable treatment of a full-time student aged 19 through 23 as a qualifying child also applies for purposes of the Earned Income Tax Credit (EITC).  The EITC is a refundable tax credit for working families with low incomes.  The EITC for families with one eligible child phases in over the first $8,580 of earned income for a maximum credit of $2,917.  The credit phases out between $15,740 and $33,995 of earned income ($18,740 and $36,995 for joint filers).  For families with modest incomes, allowing dependent students to qualify as children for EITC purposes provides the families supporting the students with a large tax benefit.

Deductions

A deduction may be allowed above-the-line (i.e., without itemization) for up to $2,500 of interest per year on any qualified education loan, subject to an AGI phase-out beginning at $55,000 ($115,000 if married filing jointly).  In addition, through 2007, a taxpayer could claim an above-the-line deduction for qualified tuition and related expenses.  The maximum amount of the deduction was $4,000 for taxpayers with AGI below $65,000 ($136,000 if married filing jointly), or $2,000 for taxpayers with AGI between $65,000 and $80,000 ($136,000 and $160,000 if married filing jointly) in 2007.  

Moreover, deductions may be allowed to taxpayers for work-related education expenses.  An employee who itemizes deductions may deduct work-related education expenses as one of a class of miscellaneous itemized deductions subject to a floor of 2 percent of AGI.  Similarly, if an employer pays an employee's education expenses and the reimbursement does not take place through an accountable plan, the amount reimbursed is included in the employee's gross income, but the employee may deduct the expenses as a miscellaneous itemized deduction subject to the 2-percent floor. 

Exclusions from Income

In addition to any available credits or deductions, any student who receives a qualified scholarship to a degree-granting program (including certain Federal medical training programs) may exclude from gross income amounts used to pay qualified tuition and related expenses, including fees, books, supplies, and required equipment.  Under another provision, originally enacted in 1976, a student may exclude from gross income the amount of a loan that is forgiven if the student works for a required period of time in certain professions or locations.  For example, after graduating from college, a student might have a loan forgiven if he or she were to become a teacher in an underserved community.  Additionally, there is an unlimited exclusion from the gift and generation-skipping transfer tax for tuition paid directly to a school on behalf of a student, resulting in an incentive to make gifts of college tuition

There are also incentives for individuals to continue their education while employed.  An employee may exclude employer-provided education expenses (up to $5,250 since 1986) that are part of an Educational Assistance Program (EAP).  Under an EAP, there is no requirement that the education be work-related.  In addition, like other work-related expense reimbursements, an employee may exclude from gross income employer reimbursements for work-related education made under an accountable plan. 

Certain colleges and universities offer tuition-reduction programs to their employees (which can include the employee's spouse or dependent child).  Tuition benefits under such programs may be excluded from gross income.  Also, certain graduate students employed in teaching or research may exclude tuition reductions from gross income. 

Savings Related Deferrals and Exclusions

Traditionally, tax deferral has been afforded to income saved for retirement in an Individual Retirement Arrangement (IRA).  Since 1998, an IRA distribution for qualified higher education expenses has been permitted, with penalties waived, although tax attributable to the amounts distributed is still due.  The exclusion covers both Traditional and Roth IRAs (effectively without income limits on contributors), encompasses grandchildren as beneficiaries, and extends qualified expenses beyond tuition and required fees to room and board (for students attending college at least half time), books, and supplies.

As noted above, tax deferral on income saved for college expenses has been available since 1996 through Qualified Tuition Programs, also called section 529 plans.  Individuals at all income levels may contribute to a section 529 account or prepaid tuition plan.  Contributors may use up to five years of annual gift tax exclusion amounts in advance for a gift-tax-free contribution to a student in a single year (for a total of $60,000 in 2008).  There is no limit on the number of permissible student donees per year.  Some states permit contributors to deduct a limited amount of contributions for state income tax purposes.  Not only does income accumulate tax-free in a section 529 account, but distributions from the account, which include a return of contributions and earnings on those contributions, are also excluded from gross income as long as they are used for qualified higher education expenses. 

In 1997, an additional deferral vehicle was created in the form of an Education IRA.  Subject to an AGI phase-out, contributors were allowed to contribute in the aggregate up to $500 per year to an Education IRA.  As noted above, EGTRRA increased contribution limits to Education IRAs, now named Coverdell Education Savings Accounts, to $2,000.  Not only does income accumulate tax-free in a Coverdell account, but distributions from the account, which include a return of contributions and earnings on those contributions, are also excluded from gross income as long as they are used for qualified education expenses, including college expenses.

Since 1988, there also has been a college saving incentive in the form of an exclusion of interest on qualified United States Savings Bonds, provided that the proceeds are used to pay for qualified higher education expenses, subject to an AGI phase-out. 

Complexity of Tax Incentives

As reflected in the overview above, the education tax incentives under current law are numerous, often overlapping, and complex.  The incentives vary in terms of who may receive benefits, which expenses may be covered, and how large an exclusion, deduction, or credit may be allowed.  For example, part-time students may be eligible for the education credits (at least half-time in the case of the Hope Credit) and savings bond interest exclusion.  Only full-time students may qualify for the dependent deduction or EITC.  Some provisions, like the Hope Credit, are calculated per student, but others, like the Lifetime Learning Credit and the student loan interest deduction, are calculated per taxpayer.  Different expenses qualify under different provisions.  For example, books, supplies and equipment are qualified expenses for many savings provisions but not for purposes of the credits.  Finally, phase-outs with different thresholds apply for purposes of the credits, dependent deduction, student loan interest deduction, Coverdell account contribution, and savings bond interest exclusion. 

Consider the following examples and their disparate results. The examples show the value of education benefits available under 2007 law to typical families facing a wide range of circumstances regarding their education expenses.[1]  In each example, we calculate the tax benefits that typical families would receive from five tax provisions that may help families with education expenses as in effect for 2007: (a) the Hope Credit, (b) the Lifetime Learning Credit, (c) the tuition deduction (expired December 31, 2007), (d) the dependent exemption, and (e) the EITC.   Savings incentives, such as Coverdell accounts and section 529 accounts are not considered.  

Because the provisions interact, and because only the EITC is refundable, some families may not have sufficient tax liability to benefit fully from all provisions for which they are eligible.  The examples show that total tax benefits vary with the family's specific circumstances: family income, filing status, age of the student, dependent status of the student, whether the student attends part-time, year of study, and their expenses.  The families in the examples presented are otherwise typical of families with similar incomes.  Of course, the results may vary as the facts vary from the typical family model.

Taxpayers may often be eligible for more than one benefit and only some benefits may be used together.  Thus, in many instances, the family must choose among the various benefits.  The first example shows the optimal choice may not be obvious before computing the family's taxes. 

Example 1:  A Family May Need to Make Many Calculations to Determine the Best Outcome

A family of three (Family A) has an income of $100,000.  Their 19-year-old son is a full-time freshman at the local state university.  His tuition and fees for the year are $6,000.  The family knows that they are eligible for the Hope Credit, the Lifetime Learning Credit, the tuition deduction, and the dependent exemption that the family would not be eligible for if the son were not a full-time student.  The family may use no more than one of the following three benefits: the Hope Credit, the Lifetime Learning Credit, or the tuition deduction.  The family is in the phase-out range for the education credits.

• Family A could receive $2,005 – from the Hope Credit ($1,555) and the dependent exemption ($850).
• Family A could receive $1,690 – from the Lifetime Learning Credit ($840) and the dependent exemption ($850).
• Family A could receive $1,850 – from the tuition deduction ($1,000) and the dependent exemption ($850).

Note that if this family had additional children with education expenses, the calculation exercise would be even more complicated.  For example, the Lifetime Learning Credit provides a maximum of $2,000 per family and thus, may be limited for families whose total tuition expenses exceed $10,000.

The remaining examples calculate the optimal education benefit for a series of taxpayers with different incomes, filing status, and education needs to demonstrate the potential range of results.

Example 2:  Individual in Part-time Training Programs – Income Affects Tax Benefits

A single taxpayer attends a training program that costs $1,000.  He attends less than half-time, is not in a degree program, and is not in his first two years of post-secondary study.

• If Taxpayer B earns $25,000, B could receive a Lifetime Learning Credit of $200 (the tuition deduction would be worth $150).
• If  Taxpayer B earns $50,000, B could receive a tuition deduction worth $250 (the Lifetime Learning Credit would be worth only $140 due to the phase out).

Example 3:  Moderate Income Students Working Toward an Associate's Degree – Family Structure Affects Tax Benefits

A student begins work on an associate's degree at the local community college.  The student's family has income of $25,000.  The student attends at least half-time.  Tuition and required fees are $4,000.

• C, a single student who is not dependent on his or her parents, could receive the maximum Hope Credit of $1,650.
• D, a married student who is not a dependent, could receive a Hope Credit or a Lifetime Learning Credit for $750.  (D's family does not have sufficient tax liability to benefit from the education credit fully.)
• E, the married parents of a 19-year old living at home and supported by his or her parents, could receive benefits totaling $2,387 from the Hope Credit ($410), the dependent exemption ($340), and the EITC ($1,637).

Example 4a:  Students Attending the Local State University – Income Affects Tax Benefits

A college-age student enrolls full-time at the local state university where tuition and fees are $6,000.  The student is in his or her first year of study. 

• F, a family earning $25,000, would receive $2,387 – from the Hope Credit ($410), the dependent exemption ($340), and the EITC ($1,637).
• G, a family earning $50,000, would receive $2,160 – from the Hope Credit ($1,650) and the dependent exemption ($510).
• H, a family earning $100,000, would receive $2,005 – from the Hope Credit ($1,155) and the dependent exemption ($850). 
• I, a family earning $150,000, would receive $1,350 – from the tuition deduction ($500) and the dependent exemption ($850).
• J, a family earning $200,000, would receive $952 – from the dependent exemption.

Example 4b: This example is the same as Example 4a, except that the student is enrolled in his or her third year of study.  As a result, the Hope Credit would no longer be available. 

• F, a family earning $25,000, would still receive $2,387 – from the Lifetime Learning Credit ($410), the dependent exemption ($340), and the EITC ($1,637).
• G, a family earning $50,000, would receive $1,710 – from the Lifetime Learning Credit ($1,200) and the dependent exemption ($510).
• H, a family earning $100,000, would receive $1,690 – from the Lifetime Learning Credit ($840) and the dependent exemption ($850). 
• I, a family earning $150,000, would still receive $1,350 – from the tuition deduction ($500) and the dependent exemption ($850).
• J, a family earning $200,000, would still receive $952 – from the dependent exemption.

Attached as Table 2 are figures that illustrate graphically the tax value of education benefits under 2007 law, taking into account the same five major tax provisions.  The figures show the value of the education benefits for typical families by AGI.  As in the examples above, the value of these provisions depends on a student's or family's circumstances:  the cost of tuition; family income (including whether the family has any income tax liability); whether the student attends college full-time or part-time; filing status; and for the Hope Credit, whether the student is in the first two years of post-secondary education. 

The tax savings for a student or family vary significantly with income and tuition level.  At the tuition levels paid by most full-time students whose families are eligible for the credits, the Lifetime Learning Credit offers less assistance than the Hope Credit.  The Hope Credit, however, is only available to students in their first two years of college.  Thus, the tax value associated with a college freshman or sophomore is larger in many cases than the tax value associated with a college junior or senior.

In general, families with incomes under $100,000 in 2007 owing tuition expenses would have maximized their benefits by claiming an education credit; higher income families would have claimed a tuition deduction.  As income rises further, the dependent deduction phases out.  Families with no income tax liability receive no benefit from the dependent deduction, the tuition deduction, or education credits.  However, a college student may qualify a low-income or moderate-income family for the EITC.  Large families may lose the benefit of the dependent deduction because they are more likely to be subject to the alternative minimum tax. 

Like the family filing a joint return, higher income individuals who file single returns would have maximized their benefits by claiming the tuition deduction, while individuals with incomes under $50,000 would have claimed a credit.  A low-income independent student may be eligible for the EITC, but there is no additional education-related benefit from the EITC and thus, the EITC benefit would be the same as for other low-income individuals.  Because independent students receive no benefit from the dependent deduction and no education-related benefit from the EITC, the tax value of the benefits associated with an independent student is smaller than the corresponding tax value for a dependent student.

As illustrated in the examples above and the figures in Table 2, the value of various tax incentives attributable to a student may range from a few hundred to a few thousand dollars depending on filing status and AGI.  In addition, a claim of one credit or deduction may adversely affect a taxpayer's eligibility for another credit or deduction.  From this variety of incentives, a student or parent must discern the optimal combination of tax benefits, which may require many taxpayers to generate alternative complex computations.  As in Example 1 above, taxpayers with dependent students who are eligible for a tuition deduction as well as a Hope or Lifetime Learning Credit must run multiple calculations to determine their maximum benefits.  Because a qualified expense may not be eligible for more than one benefit, careful recordkeeping is required to ensure both the optimal distribution of expenses and compliance.

Because of the complexity, it may be difficult for a student or parent to determine the value of the tax incentives.  In addition, for incentives based on AGI, their value is necessarily retrospective unless the student or parents can predict their income with precision.  The more difficult it is to predict the value of the tax benefit accurately, the less effective these benefits are as incentives for the pursuit of a college education.

In addition to the challenges that students face in navigating the myriad education tax incentives to optimize their use, the complexity of these provisions increases the record-keeping and reporting burden on taxpayers, while making it difficult for the IRS to monitor compliance.  For example, to claim an education credit, a taxpayer must file a Form 1040 even if he or she otherwise qualifies to file a Form 1040EZ, and the taxpayer must file an IRS Form 8863, a 17-line form with two pages of instructions. 

Observations on Simplification

Despite the complexity, because the tax incentives may provide significant value to a family or individual in pursuit of higher education, it appears the various incentives are widely utilized.  Table 3 sets forth statistics on the use of the education credits and the tuition deduction based on the most recent IRS data available (for tax year 2005).  In the fall of 2005, more than 17 million students were enrolled in college in the United States.  As noted in Table 3, a substantial number of these students claimed some combination of the deduction and credits.  Overall, in 2005, more than 11.6 million taxpayers claimed an education credit or tuition deduction.  Our data cannot capture whether students and families are utilizing the tax incentives optimally, nor what impact, if any, the tax incentives have on decision-making regarding post-secondary education.  However, one would anticipate that the complexity would detrimentally affect the efficient utilization and administration of the benefits.        

Because the value of a particular tax incentive may not become apparent until the end of the tax year, which may be months after the tuition or other expense was due, and the tax year does not coincide with the academic year, the tax system is not well suited to provide assistance on the "front end" of funding higher education.  Generally, tax benefits become available only after year-end (especially in the case of benefits limited by AGI, which is determined at year-end).  As a result, the complexity of the current provisions makes it difficult for even a very sophisticated taxpayer to adjust withholding to "advance" the benefit.

In addition, it is important to remember that recent high school graduates do not constitute the only type of person interested in pursuing a college education.  Prospective students also include older persons who entered the job market after high school as well as those who have an interest in pursuing an advanced degree or a career different from the one in which they were originally engaged.  The provision of different tax incentives for similar higher education expenses may result in the unequal tax treatment of similarly situated taxpayers.  

Suggestions have been offered regarding potential simplifications, primarily along three themes.  First, it has been suggested that uniform definitions for operative terms such as "qualified higher education expenses" or "qualified tuition and related expenses" and "eligible education institution" be adopted.  For example, currently only tuition may qualify for tuition reduction for college employees and gift tax exclusions; tuition and required fees may qualify for the Hope and Lifetime Learning Credits, tuition deduction, and savings bond interest exclusion; tuition, fees, books, supplies, and equipment may qualify for the scholarship exclusion, employer EAP, and student loan interest deduction; and tuition, fees, books, supplies, equipment (and in the case of a student attending at least half time, room and board) may qualify for penalty-free distributions from IRAs, section 529 accounts, and Coverdell accounts.   

A second suggestion has been to conform the phase-out thresholds and ranges and index all amounts for inflation.  As noted above, different income thresholds apply to the education credits, dependent deduction, student loan interest deduction, and the different savings provisions.

Third, it has been suggested that the education credits be consolidated along with certain deductions.  In particular, the AGI phase-out for the credits could be increased to eliminate the need for the tuition deduction; or a single credit could be designed to cover the same population. 

While there is clearly a need to address the complexity concerns arising from the current welter of tax incentives, it is important to remain cognizant that revisions to the tax regime may lead to unintended consequences, and any revision may unsettle taxpayer expectations.  Recognizing budgetary constraints, legislative reform of tax incentives will almost invariably result in additional benefits for certain taxpayers and fewer benefits for others.  Because of the varying profiles of those who seek the benefits of tax incentives for higher education, it may be challenging to streamline the incentives in a way that would benefit the entire target group.  Legislative reform of tax incentives would also need to address transition issues for those students or families who may be planning to rely on relevant provisions under current law.

In contemplating legislative reform of current tax incentives, a good starting point would be to focus on clear, simple ways to help students and their families meet the cost of higher education.  While efforts can be made to consolidate and streamline the education tax incentives, to be successful, those efforts should not overlook the non-tax benefits that are available to many students, especially those in low-income and middle-income families, either from Department of Education and other federal and state governmental programs or from private-sector sources.   

Thank you Mr. Chairman, Ranking Member English, and distinguished Members of the Subcommittee for the opportunity to participate in today's hearing on this important subject.  I would be pleased to respond to your questions. 

-30­-

REPORTS

• Table 1 - Summary of Tax Provisions Related to Higher Education
• Table 2 - The Tax Value of a Student under 2007 Law
• Table 3 - Use of Tax Incentives for Higher Education

Assistant Secretary for International Affairs Clay Lowery
Testimony Before the Senate Foreign Relations Committee

"Building on International Debt Relief Initiatives"

Deputy Assistant Secretary for Terrorist Financing
and Financial Crimes Daniel Glaser
Testimony Before the House Committee on Foreign Affairs
Subcommittee on the Middle East and South Asia
and the Subcommittee on Terrorism, Nonproliferation and Trade

Washington - Chairman Ackerman, Chairman Sherman, Representative Pence, Representative Royce and distinguished members of the Committee, thank you for the opportunity to speak with you today about the Treasury Department's efforts to counter Iran's nuclear program and its deliberate support of terrorism. I want to thank this Committee for its continued support and guidance in our efforts against an Iranian regime that continues to pursue threatening activities. Today, I will focus my remarks on the Treasury Department's strategy and actions to counter this threat and the impact we have achieved on Iranian financial institutions and businesses.

Iran poses significant threats to the international community. Chief among them is the regime's continued pursuit of nuclear ambitions in defiance of United Nations Security Council resolutions. Another paramount threat is Iran's provision of financial and material support to terrorist groups. The combination of these two threats presents a lethal challenge that is exacerbated by Iran's integration into the international financial system, and its deceptive financial practices.

Iran's continued pursuit of nuclear and missile programs present a deliberate and intolerable threat to the international community. Iran has ignored calls from the international community to suspend its enrichment-related reprocessing and heavy water-related activities, and defied numerous U.N. Security Council resolutions including:

• Resolution 1696 (2006)
• Resolution 1737 (2006)
• Resolution 1747 (2007)
• Resolution 1803 (2008)

The international community reiterated its position on this issue most recently on March 3, 2008, when the U.N. Security Council adopted Resolution 1803, imposing further sanctions on Iran for its refusal to suspend its proliferation sensitive nuclear activities. Iran has thus far ignored this recent resolution, announcing that it would proceed forward in expanding its uranium enrichment activities. Iran's defiance and disregard for international concern adds to the gravity of the threat.

The threat we face from Iran is not limited to its pursuit of a nuclear capability. Another dynamic of Iran's threat is its provision of financial and material support to terrorist groups. Iran has long been a state sponsor of terrorism and continues to support an unparalleled range of terrorist activities. For example, Tehran arms, funds, and advises Hizballah, an organization that has killed more Americans than any terrorist network except for al-Qa'ida, and does so via the Qods Force, a branch of the Islamic Revolutionary Guard Corps. In addition, Iran provides extensive support to Palestinian terrorist organizations, including the Palestinian Islamic Jihad (PIJ) and Hamas. In the case of PIJ, Iran's financial support has been contingent upon the terrorist group carrying out attacks against Israel. And we are all familiar with Iran's funding, training, and equipping of select Shi'a extremist groups in Iraq, further destabilizing that country and resulting in deaths of Americans, Iraqis and others. Iran's Qods Force also provides weapons and financial support to the Taliban to support anti-U.S. and anti-Coalition activity in Afghanistan

Iran utilizes the international financial system as a vehicle to fund these terrorist organizations. As Under Secretary Levey has previously testified, the Iranian regime operates as the central banker of terrorism, spending hundreds of millions of dollars each year to fund terrorism.

Iran is deeply integrated in the international financial system. Iranian state-owned banks have dozens of branches located all over the world. Additionally, Iranian banks have correspondent accounts at foreign banks for an even broader reach into the international financial system. Moreover, Iranian individuals and entities maintain accounts at foreign financial institutions.

Iran's integration into the global economy and the international financial system gives the Iranian regime global financial capability to support its threatening activities and exposes the international financial system to illicit financing risks posed by the regime.

Iran uses its global financial ties to pursue both the threat of terrorism and a nuclear program through an array of deceptive practices specifically designed to avoid suspicion and evade detection from the international financial community. Iran uses its state-owned banks for its nuclear and missile program and for financing terrorism. For example, Tehran uses front companies and intermediaries to engage in ostensibly legitimate commercial transactions that are actually related to its nuclear and missile programs. These front companies and intermediaries enable the regime to obtain dual-use technology and materials from countries that would typically prohibit such exports to Iran.

Another method Iranian banks use to evade controls is to ask other financial institutions to remove their names when processing transactions through the international financial system. This practice is intended to elude the controls put in place by responsible financial institutions and has the effect of potentially involving those institution in transactions they would never engage in if they knew who, or what, was really involved. This practice allows Iran's banks to remain undetected as they move money through the international financial system to pay for the Iranian regime's illicit and terrorist-related activities. This practice is even used by the Central Bank of Iran to facilitate transactions for sanctioned Iranian banks.

In addition to Iran's deceptive financial conduct, substantial deficiencies in Iran's anti-money laundering and combating the financing of terrorism (AML/CFT) regime present a significant vulnerability to the international financial system. Iran lacks an acceptable system of laws and enforcement capabilities that would allow it to detect and prevent money laundering or terrorist financing. Although Iran adopted an anti-money laundering law this year, its content has been heavily criticized by both the Financial Action Task Force (FATF) and International Monetary Fund (IMF) for failing to meet international standards. Moreover, both the FATF and IMF have recognized broader deficiencies in Iran's AML/CFT regime to include:

1. Insufficient criminalization of money laundering.
2. Failure to criminalize terrorist financing.
3. Lack of AML/CFT supervision.
4. Lack of a financial intelligence unit.
5. Lack of sanctions implementation.
6. Lack of international cooperation in AML/CFT investigations.

As FATF has stated in its advisories to the international financial system, these core AML/CFT deficiencies present a substantial vulnerability to the international financial system. The FATF took unprecedented measures to warn the international financial system about the risks arising from the deficiencies in Iran's AML/CFT.

Addressing this multifaceted threat – the threat of both proliferation and terrorism, reinforced by Iran's deceptive financial conduct and systemic AML/CFT deficiencies –requires a multifaceted strategy, including an essential financial component. In the years since September 11, we have substantially increased our understanding of vulnerabilities in the international financial system and how terrorist and other illicit financial networks exploit those vulnerabilities. Treasury's strategy to combat the threat that Iran presents, and application of financial pressure to the Iranian regime, builds upon these experiences and consists of three inter-related initiatives:

• Developing and implementing targeted financial measures to combat Iran's proliferation and terrorism support activities;
• Maximizing the impact of U.S. financial actions by securing international support; and
• Engaging in a strategic dialogue with the international private sector to explain the risks of doing business with Iran.

The U.S. has maintained trade and financial-related sanctions program against Iran for almost 30 years. The current program prohibits virtually all commercial trade between the U.S. and Iran. Our efforts in recent years have focused on a conduct-based targeted financial action aimed at disrupting Iran's proliferation and terrorism activities. We have shown that these types of targeted, conduct-based financial measures aimed at particular bad actors can be quite effective, in part because they unleash market forces by highlighting risks and encouraging prudent and responsible financial institutions to make the right decisions about the business in which they are engaged. They give us a concrete way in which to target directly those individuals and entities we know are bad actors and to strike at the heart of their operations.

The Treasury Department relies on Executive Order 13382, a targeted financial sanctions authority, for imposing targeted financial sanctions against weapons of mass destruction (WMD) proliferators and their supporters to pressure Iran. Executive Order 13382 was issued by President Bush in 2005 and added a powerful tool to the array of options available to combat WMD proliferation. By prohibiting U.S. persons from engaging in transactions with entities and individuals targeted by the order, we can effectively deny proliferators and their supporters access to the U.S. financial and commercial systems, cutting them off from the benefits of our economy. These prohibitions have powerful and far-reaching effects, as the suppliers, financiers, transporters, and other facilitators of WMD networks tend to have commercial presences and accounts around the world that make them vulnerable to exactly this kind of financial action, particularly since so many of the transactions are denominated in dollars.

To date, under Executive Order 13382 the Departments of Treasury and State have designated 52 Iran-related individuals and entities as supporting Iran's and missile programs. Targeted entities could range from those under the direct control of the Government of Iran to facilitators in the support network that act as conduits. Some prominent examples include:

• Aerospace Industries Organization - The Aerospace Industries Organization (AIO), a subsidiary of the Iranian Ministry of Defense and Armed Forces Logistics, is the overall manager and coordinator of Iran's missile program. AIO oversees all of Iran's missile industries and was designated in 2005 when the Executive Order 13382 was first issued. AIO was also identified by the UNSC Resolution 1737 the following year in 2006 and subject to target sanctions for its involvement in Iran's nuclear program.
• Treasury has designated numerous related AIO organizations, including, Sanam Industrial Group and Ya Mahdi Industries Group, both designated for their ties to AIO. Sanam Industrial Group has purchased millions of dollars worth of equipment on behalf of the AIO from entities associated with missile proliferation. Ya Mahdi Industries Group is subordinate to AIO and has been involved in international purchase of missile-related technology and goods on behalf of the AIO. These entities were also identified and sanctioned under UNSCR 1747.
• Atomic Energy Organization of Iran - The Atomic Energy Organization of Iran (AEOI) is the main Iranian organization for research and development activities in the field of nuclear technology, including Iran's centrifuge enrichment program. Treasury also designated AEOI in 2005, which was then followed by its designation under UNSC Resolution 1737. Treasury has designated numerous subsidiaries of AEOI network including:
• Kalaye Electric Company, Kavoshyar Company, and Pioneer Energy Industries Company are owned or controlled by the AEOI or acting for or on its behalf. Kalaye Electric Company has been linked to Iran's centrifuge research and development efforts. Kalaye is also listed in the Annex to UN Security Council Resolution 1737 as subject to targeted sanctions because of its involvement in Iran's nuclear program. Kavoshyar Company's sole shareholder is AEOI. Pioneer Energy Industries Company provides services to AEOI, including technological support.
• Pars Tarash and Farayand Technique are owned or controlled by, or act or purport to act for or on behalf of the AEOI. Pars Tarash and Farayand Technique were also listed in the Annex to UNSCR 1737 as subject to targeted sanctions for their involvement in Iran's centrifuge program and were identified in reports of the International Atomic Energy Organization (IAEA).

Treasury has also used this authority to designate several state-owned Iranian banks, including:

• Bank Sepah – Bank Sepah is the fifth largest Iranian state-owned bank, designated in January 2007 for providing extensive financial services to Iranian entities responsible for developing missiles capable of carrying weapons of mass destruction. Bank Sepah was sanctioned by UNSCR 1747 in March that same year. Since at least 2000, Bank Sepah has also provided a variety of critical financial services to Iran's missile industry, arranging financing and processing dozens of multi-million dollar transactions for AIO, which has been designated by the U.S. for its role in overseeing all of Iran's missile industries. By cutting off Sepah from the U.S. and the international financial system, we have made it more difficult for Iran to finance some of its proliferation-related activities.
• Bank Melli – Bank Melli is Iran's largest bank and provides banking services to entities involved in Iran's nuclear and ballistic missile programs, including entities listed by the UN for their involvement in those programs. Through its role as a financial conduit, Bank Melli has facilitated numerous purchases of sensitive materials for Iran's nuclear and missile programs. This includes handling transactions in recent months for Bank Sepah, Defense Industries Organization, and Shahid Hemmat Industrial Group. Following the designation of Bank Sepah under UNSCR 1747, Bank Melli took precautions not to identify Sepah in transactions Entities owned or controlled by the IRGC or the Qods Force use Bank Melli for a variety of financial services. From 2002 to 2006, Bank Melli was used to send at least $100 million to the Qods Force. When handling financial transactions on behalf of the IRGC, Bank Melli has employed deceptive banking practices to obscure its involvement from the international banking system. For example, Bank Melli has requested that its name be removed from financial transactions.
• Bank Mellat - Bank Mellat provides banking services in support of Iran's nuclear entities, namely the Atomic Energy Organization of Iran (AEOI) and Novin Energy Company. Both AEOI and Novin Energy have been designated by the United States under E.O. 13382 and by the UN Security Council under UNSCRs 1737 and 1747 respectively. Bank Mellat services and maintains AEOI accounts, mainly through AEOI's financial conduit, Novin Energy. Bank Mellat has facilitated the movement of millions of dollars for Iran's nuclear program since at least 2003. Transfers from Bank Mellat to Iranian nuclear-related companies have occurred as recently as this year.

The Treasury Department targets Iran's support for terrorism utilizing Executive Order 13224. This Executive Order, issued immediately after the September 11 attacks, allows Treasury to designate and block the assets of individuals and entities controlled by, acting on behalf of, or providing support to named terrorist organizations. This has the effect of freezing the target's assets that are held by U.S. persons and preventing U.S. persons from having any future dealings with them.

Using this terrorism authority, we have been able to expose Iran's terrorist support infrastructure. Two examples include:

• Bank Saderat Iran – In 2006, the Treasury Department initially took action against one of Iran's largest state-owned banks under the country sanctions program, cutting the bank from indirect access to the U.S. financial system revoking its authority to conduct U-turn transactions. In 2007, we intensified the action against Bank Saderat and officially designated it under E.O. 13224 as a supporter of terrorism.
• Government of Iran uses Bank Saderat to transfer money to terrorist organizations, most notably Hizballah and Hamas. From 2001 to 2006, Bank Saderat transferred $50 million from the Central Bank of Iran through its subsidiary in London to its branch in Beirut for the benefit of Hizballah fronts in Lebanon that support acts of violence.
• Qods Force (IRGC Qods Force) - The Qods Force, a branch of the IRGC, provides material support to the Taliban, Lebanese Hizballah, Hamas, Palestinian Islamic Jihad, and the Popular Front for the Liberation of Palestine-General Command (PFLP-GC).
• The organization is the regime's primary instrument for providing lethal support to the Taliban. It provides weapons and financial support to the Taliban to support to anti-U.S. and anti-Coalition activity in Afghanistan. The Qods Force has also funded Hizballah with $100 to $200 million and has assisted Hizballah in rearming in violation of UN Security Council Resolution 1701.

The effectiveness of targeted financial sanctions and other measures is significantly enhanced when other countries take similar actions. Accordingly, a significant part of the Treasury Department's efforts related to Iran has been devoted to a broader U.S. government campaign to facilitate international action against Iran's support of terrorism and nuclear program.

The FATF is the premier standard-setting body for AML/CFT (anti-money laundering and combating financing of terrorism) and provides a unique opportunity for Treasury to engage our international counterparts regarding the risks posed by Iran's AML/CFT regime deficiencies. Treasury leads the U.S. delegation to the FATF. Taken as a whole, the FATF's AML/CFT standards are recognized by more than 175 countries and have been endorsed by the United Nations, the World Bank and the International Monetary Fund.

In addition to setting the AML/CFT international standards, the FATF also identifies jurisdictions with serious vulnerabilities in their AML/CFT framework. In early 2007, Iran was identified by FATF as having significant deficiencies in its AML/CFT regime. As a result, the FATF issued a public statement in October 2007 expressing its concern that Iran's lack of a comprehensive AML/CFT regime represents a significant vulnerability within the international financial system. Iran subsequently adopted an anti-money laundering law and met with FATF to discuss its legal framework for AML/CFT. The FATF, however, concluded that the deficiencies in Iran's AML/CFT regime warranted the issuance of another statement that reiterated previous concerns. The latest FATF advisory issued on February 2008, called on all members and non-members alike to advise their financial institutions about the risks posed by Iran's AML/CFT regime. In response many countries – including the UK, Canada, France, Germany, Japan and Malaysia - have advised their financial institutions of the risks inherent in doing business with Iran.

Treasury also issued such advisories to the U.S. financial sector following FATF's advisories, warning them of the general risks of Iranian business and providing specific information about areas of concern related to Iran, including Iran's deceptive financial conduct. The most recent Treasury advisory identified Iranian state-owned and private banks and their branches and subsidiaries abroad. Significantly, it also warned financial institutions about the conduct of the Central Bank of Iran, both in obscuring the true parties to transactions and facilitating transactions for sanctioned Iranian banks.

The U.S. has worked within both the United Nations and the FATF to reinforce our targeted financial actions to counter Iran's proliferation activities. Indeed, the international community is working to establish a global framework that addresses the threats posed by Iran and develops effective financial measures. These efforts have focused on increasing multilateral implementation of both targeted financial measures and other financial prohibitions against entities involved in Iranian nuclear and missile proliferation. We have worked with the FATF to provide guidance on the effective implementation of those obligations.

(i) UN Obligations

The State Department has led important U.S. efforts at the UN in the adoption of three Chapter VII resolutions related to Iran's nuclear and missile programs that include significant financial components:

• Targeted financial sanctions: UN Security Council Resolution 1737, adopted December 23, 2006, requires the worldwide freezing of the assets of designated key actors associated with Iran's nuclear and missile programs. The Resolution targeted Iran's proliferation infrastructure, requiring all States to freeze the assets of identified individuals and entities and effectively deny them access to the international financial system. The adoption of the resolution and its successor resolution, 1747, also globalizes Treasury's action against Iran's proliferation infrastructure. Many of the individuals and entities identified in the UN Security Council resolutions were already publicly designated by Treasury and State under E.O. 13382.
• Activity-based financial prohibitions: UNSCR 1737 also requires states to prevent the provision to Iran of any financial assistance, or the transfer of any financial resources or services, related to the supply, sale, transfer, manufacture, or use of prohibited items associated with Iran's nuclear and missile programs. This measure effectively prohibits the provision of financial services that would allow Iran to procure the prohibited items needed for nuclear or missile programs. It places strong responsibilities on states to press financial institutions to make efforts to ensure they do not provide those financial services. This is a daunting task for financial institutions, and we have worked with the FATF to provide guidance that would assist financial institutions in this preventative effort.
• Exercising vigilance over financial institutions' activities with Iranian banks: With the most recent adoption of UNSCR 1803, the Security Council calls upon UN member states to exercise vigilance over the activities of financial institutions in their territories with all financial institutions domiciled in Iran, and their branches and subsidiaries abroad. This provision makes special mention of the risks posed by Bank Melli and Bank Saderat. This measure has critical importance to us, as it significantly reinforces the concerns Treasury has expressed for many months regarding some Iranian financial institutions' deceptive financial conduct and terrorism and proliferation support activities.

(ii) Working with the FATF to Implement UN Obligations

Treasury is working within the FATF to ensure effective implementation of the financial provisions contained in the UN Security Council resolutions. This guidance by the FATF works in conjunction with the UN's effort to develop international commitment and create a framework for countries to counter Iranian financial threat.

• In June 2007, the FATF issued initial guidance on the implementation of sanctions and finance-related provisions of UN Security Council resolutions related to proliferation activities in Iran, as well as the threat from other states and non-state actors.
• In September 2007, the FATF issued an annex intended to provide guidance on implementing targeted financial sanctions against financial institution, in particular, Bank Sepah, named in UNSCR 1747.
• In October 2007, FATF issued additional guidance on implementing activity-based financial sanctions identifying categories of high-risk customers and transactions on which financial institutions could focus their efforts. Risk factors include Iran-related customers or transactions, as well as transactions involving sectors that potentially produce the prohibited goods, among other factors.

UN Security Council Resolution 1803 welcomed the work of FATF and its efforts to provide guidance on how to implement targeted financial measure. Treasury will work with its counterparts within the FATF to continue these efforts.

We have also reached out to another important stakeholder: the international private sector. Since 2006, we have conducted an unprecedented, high-level strategic dialogue with the international financial private sector, meeting with more than 40 banks worldwide to discuss the threat Iran poses to the international financial system. Secretary Paulson initiated this effort in the fall of 2006 in Singapore during the annual IMF/World Bank meetings. Secretary Paulson met with executives from major banks throughout Europe, the Middle East, and Asia and discussed the various threats posed by Iran. Deputy Secretary Kimmitt, Under Secretary Stuart Levey and Assistant Secretary Patrick O'Brien continue to engage with these institutions abroad, as well as in Washington and New York. Through this outreach, Treasury has shared information about Iran's deceptive financial behavior and raised awareness about the high financial and reputational risk associated with doing business with Iran and the international financial institutions have taken action.

International financial institutions have responded to our message with action that reinforces governmental pressure on Iran. As evidence of Iran's deceptive practices has mounted, financial institutions and other companies worldwide have begun to reevaluate their business relationships with Tehran. Many leading financial institutions have either scaled back dramatically or even terminated their Iran-related business entirely. Many global financial institutions have limited their exposure to Iranian business by cutting off Iranian business in dollars but have not yet done so in other currencies. Regardless of the currency, the core risk with Iranian business – that you cannot be certain that the party with whom you are dealing is not connected to some form of illicit activity – remains the same.

The private sector plays a central role in the implementation of our sanctions. Our ability to effectively communicate with the private sector about Iran has been essential to the success of Treasury's broader efforts. The private sector has been receptive in part due to Treasury's targeted financial strategy that we have increasingly used to combat Iranian threats as well as other threats to the U.S.

When we use reliable financial intelligence to build conduct-based cases, it is much easier to achieve a multilateral alignment of interests. It is difficult for another government, even one that is not a close political ally, to oppose isolating actors who are demonstrably engaged in conduct that threatens global security or humanitarian interests. The private sector also reacts positively to the use of these targeted measures. Rather than comply with just the letter of the law, we have seen many in the banking industry voluntarily go beyond their legal requirements because they do not want to handle illicit business.

The private sector and Treasury share a common interest in protecting the international financial system from illicit conduct. Financial institutions want to identify and avoid dangerous or risky customers who could harm their reputations and business. And we want to isolate those actors and prevent them from abusing the financial system. Once some in the private sector decide to cut off companies or individuals we have targeted, it becomes an even greater reputational risk for others not to follow, and they often do. Such voluntary implementation in turn makes it even more palatable for foreign governments to impose similar measures because their financial institutions have already given up the business, thus creating a mutually-reinforcing cycle of public and private action.

By partnering with the private sector, including by sharing information and concerns with financial institutions, we are increasingly seeing less of a tendency to work around sanctions. In meetings with bank officials abroad, Treasury officials have learned that even those institutions that are not formally bound to follow U.S. law pay close attention to our targeted actions and often adjust their business activities accordingly.

Financial measures are an integral component of U.S. and international efforts to counter Iran's threatening behavior. Through our authorities and our engagement with counterparts around the world, we are implementing a financial strategy that is having an impact. This impact will only be enhanced as the international community continues to crack down on Iran's illicit financial behavior through national action and through organizations such as the UN and FATF. The international financial system is becoming an increasingly challenging and unfriendly environment for Iran's illicit conduct. But it is important that we and our international partners keep up the pressure. This remains a top priority for the Treasury Department and we will continue to work closely with our colleagues in the State Department, foreign governments and international financial community to maximize the effectiveness of our efforts.

Thank you again for the opportunity to appear before you today. I look forward to any questions you have regarding my testimony.

Assistant Secretary David G. Nason Testimony
before the House Committee on Financial Service Subcommittee
on Capital Markets, Insurance and Government Sponsored Enterprises

Washington - Thank you, Chairman Kanjorski, Ranking Member Pryce, and Members of the Subcommittee for inviting me to appear before you today to discuss the need for insurance regulatory reform.

On March 31, the Treasury Department ("Treasury") released a report on financial services regulation entitled, "Blueprint for a Modernized Financial Regulatory Structure." The Blueprint reflects a year-long effort in addressing complex, long-term issues and ideas intended to provoke thoughtful discussion as we collectively work toward modernizing all sectors of the financial services industry. The Blueprint is not, and has never been, intended to be a response to recent stress in the credit markets, but rather is a series of Treasury's recommendations to improve our regulatory structure in the future.

The Blueprint presented a conceptual model for an optimal regulatory framework. This structure is an objectives-based regulatory approach, with a distinct regulator focused on one of three objectives--market stability regulation; safety and soundness regulation associated with government guarantees; and business conduct regulation. The regulation of all financial services products, including insurance, is addressed in the optimal regulatory framework.

Treasury's Blueprint also presented a series of "short-term" and "intermediate-term" recommendations that could, in our view, immediately improve and reform the U.S. financial services regulatory structure. Some of our recommendations focus on eliminating some of the duplication inherent in the U.S. regulatory system, but more importantly, they try to modernize the regulatory structure applicable to certain sectors in the financial services industry within the current framework – including insurance.

Today, I will address some of Treasury's recommendations with regard to modernizing insurance regulation in the near-term.

Insurance performs an essential function in our domestic and global economies by providing a mechanism for businesses and citizens to safeguard their assets from a wide variety of risks. Insurance is similar to other financial services in that its cost, safety, and ability to innovate and compete are heavily affected by the substance and structure of its system of regulation.

Unlike banks and other financial institutions that are regulated primarily at the federal level or on a dual federal/state basis, insurance companies in the United States are regulated almost entirely by the states. The constitutional and statutory allocation of regulatory power between the federal government and the states has a complex evolution.

For over 135 years, states have regulated insurance with little direct federal involvement. In 1869, the U.S. Supreme Court concluded that the issuance of an insurance policy was not interstate commerce, and therefore outside the constitutionally permitted scope of the federal government's legislative and regulatory authority (Paul v. Virginia). In 1944, some 76 years later, the Court reversed itself holding that insurance was indeed subject to federal regulation and federal antitrust law (United States v. South-Eastern Underwriters Association). In 1945, before any assumption of federal regulatory authority over insurance, Congress passed the McCarran-Ferguson Act, which "returned" the regulatory jurisdiction over the business of insurance back to the states, and generally exempted the business of insurance from most federal laws unless they specifically relate to the business of insurance. While a state-based regulatory system for insurance may have been appropriate over some portion of U.S. history, changes in the insurance marketplace have increasingly put strains on the system.

Much like other financial services, over time the business of providing insurance has developed a more national focus even within the state-based regulatory structure. The inherent nature of a state-based regulatory system makes the process of developing national products cumbersome and more costly, thereby directly impacting the competitiveness of U.S. insurers.

There are a number of inherent inefficiencies associated with the state-based insurance regulatory system. Economic inefficiency appears to have resulted both from the substance of regulation (such as price controls), and also from its structure (multiple non-uniform regulatory regimes). Even with the efforts of the National Association of Insurance Commissioners (NAIC) to foster greater uniformity through the development of model laws and other coordination efforts, the ultimate authority still rests with individual states. For insurers operating on a national basis, this means not only being subject to licensing requirements and regulatory examinations in all states where the insurer operates, but also operating under different laws and regulations in each state.

In addition to a more national focus today, the insurance marketplace also operates globally with many significant foreign participants. A state-based regulatory system creates increasing tensions in such a global marketplace, both in the ability of U.S.-based firms to compete abroad and in the allowance of greater participation of foreign firms in U.S. markets. In particular, foreign government officials have continued to raise issues associated with having at least 50 different insurance regulators, which makes coordination on international insurance issues difficult for foreign regulators and companies. The NAIC has attempted to fill this void by working closely with international regulators on a number of projects. The NAIC itself is not a regulator but facilitates communications among the states on international regulatory issues.  In the end, whatever the NAIC accomplishes in the international arena, given the NAIC's structure as a coordinating body and the inherent nature of the state-based system, it will be increasingly difficult for the United States to speak effectively with one voice on some international insurance regulatory issues.

A number of countries are pushing forward with regulatory systems seeking more uniform, efficient and stronger insurance sectors, in order to underpin more and better products for their consumers with less risk to the financial system. In particular, the European Union is working on its Solvency II project to forge one insurance market for all of its member states. The interaction between the U.S. regulatory system and its foreign counterparts in these types of discussions will likely impact the ability of U.S. firms to conduct business abroad and the flow of capital to the United States.

Treasury believes the fundamental question is whether our current state-based system of insurance regulation is up to the task of meeting the challenges of today's evolving and increasingly global insurance market. In other words, is the state-by-state regulatory approach, as chosen by the Congress in 1945, and as it exists today, still the most effective and efficient system for regulating an evolving insurance marketplace?

A number of reform proposals have been considered over the years to modernize the U.S. system of insurance regulation: total federal preemption; dual federal/state systems under an optional federal charter (OFC) approach; mandating national standards on the state-based system; and harmonizing and making more uniform regulation among the states. In Treasury's view, the establishment of a dual federal/state system with an OFC provides the best opportunity for the establishment of a modern and comprehensive system of insurance regulation.

The establishment of an OFC structure would provide insurance market participants with the choice of being regulated at the national level or continuing to be regulated by the states. Such a structure is broadly consistent with the current regulatory structure that applies to banks and other insured depository institutions. An OFC insurance regulatory structure should enhance competition among insurers in national and international markets, increase efficiency, promote more rapid technological change, encourage product innovation, reduce regulatory costs, and, importantly, provide high quality consumer protection.

Treasury believes that an OFC structure should provide for a system of federal chartering, licensing, regulation, and supervision for insurers and insurance producers (i.e., agents and brokers). It should also provide that the current state-based regulation of insurance would continue for those insurers not electing to be regulated at the national level. States would not have jurisdiction over those electing to be federally regulated. However, insurers holding an OFC could still be subject to some continued compliance with other state laws, such as state tax laws, compulsory coverage for workers' compensation, and individual auto insurance, as well as the requirements to participate in state mandatory residual risk mechanisms and guarantee funds.

The establishment of an OFC should incorporate a number of fundamental regulatory concepts. For example, the OFC should ensure safety and soundness, enhance competition in national and international markets, increase efficiency in a number of ways, including the elimination of price controls, promote more rapid technological change, encourage product innovation, reduce regulatory costs, and provide consumer protection.

Treasury also recommends the establishment of the Office of National Insurance (ONI) within Treasury to regulate those engaged in the business of insurance pursuant to an OFC. The Commissioner of National Insurance would head the ONI and would have specified regulatory, supervisory, enforcement, corrective action, and rehabilitative powers to oversee the organization, incorporation, operation, regulation, and supervision of national insurers and national agencies. The ONI could be required to integrate current portions of the state-designed body of regulation into the new national system, which would limit major disruptions to the marketplace.

There are currently pending bills in both the House (H.R. 3200) and Senate (S. 40) entitled the "National Insurance Act of 2007" that would create an OFC and establish an ONI. These bills contain many of the core concepts surrounding the establishment of an OFC structure. We look forward to evaluating further the specific provisions of these bills.

Office of Insurance Oversight (OIO)

While Treasury believes an OFC offers the best opportunity to develop a modern and comprehensive system of insurance regulation in the near term, we acknowledge that the OFC debate in the Congress is ongoing. At the same time, however, Treasury believes that some aspects of the insurance segment and its regulatory regime require immediate attention. In particular, Treasury recommends that the Congress establish an Office of Insurance Oversight (OIO) within Treasury. The OIO through its insurance oversight would be able to focus immediately on key areas of federal interest in the insurance sector.

The OIO should be established to accomplish two main purposes. First, the OIO should exercise newly granted statutory authority to address international regulatory issues, such as reinsurance collateral. Therefore, the OIO would become the lead regulatory voice in the promotion of international insurance regulatory policy for the United States (in consultation with the NAIC), and it would be granted the authority to recognize international regulatory bodies for specific insurance purposes. The OIO would also have authority to ensure that the NAIC and state insurance regulators achieved the uniform implementation of the declared U.S. international insurance policy goals. Second, the OIO would serve as an advisor to the Secretary of the Treasury on major domestic and international policy issues. Once the Congress does enact significant insurance regulatory reform establishing an OFC, the OIO could be incorporated into the OFC framework.

We appreciate the efforts of the Chairman and Members of the Subcommittee in evaluating issues associated with modernizing insurance regulation.

We look forward to continuing to work with the Congress toward finding an appropriate balance as proposals for dual federal/state regulation of insurance are considered. Thank you.

-30-

April 15, 2008
HP-925

Testimony of U.S. Treasurer Anna Escobedo Cabral
before the House Committee on Financial Services

Washington- Good morning. Thank you, Chairman (Barney) Frank. I want to thank you Ranking Member (Spencer) Bachus, and the members of the committee for this opportunity to appear today.

Also, I would like to thank the Committee and the House for their leadership on financial literacy, including the Congressional resolution declaring April as Financial Literacy Month. I commend you for focusing a national spotlight on this issue.

The attention is timely. Today, many Americans are struggling – we have young adults struggling with debt, families struggling to understand the terms of their mortgages, and older Americans struggling with retirement issues. These are complex problems and there are no simple solutions. But what we can do to make a difference – and what is greatly needed in this country – is a little preventative medicine.  That is, to teach all Americans how to make smart, sound financial choices.  

During this financial literacy month, it is appropriate that we step back, assess our efforts, and enhance our financial literacy outreach. But be assured, our assessment and promotion of financial literacy doesn't begin on the 1^st and end on the 30^th of April. It is a 365-day effort every year.     

During my term in office as Treasurer, I have traveled across the country from the Bay Area to the Boroughs of New York to cities and towns in between spreading the financial literacy message to as many Americans as I can. This is more than just a message to me. I am the daughter of farm workers who grew up in communities where being unbanked was common, where saving for college was a rarity, and where financial education was oftentimes nonexistent. So for me, promoting financial literacy isn't just good policy. It's personal.

The President and Secretary Paulson are equally committed to their beliefs in the value of financial literacy. The President's new USA Freedom Corps Financial Literacy Volunteer Initiative, established just last month, provided more proof of this commitment. This initiative will encourage everyday Americans to volunteer to teach financial education in their communities.

I want to talk about three ways that we are addressing financial literacy.  The most recent of these efforts is an advisory group created by the President.

The President's Advisory Council

The President's Advisory Council was launched on January 22, 2008. The Council is comprised mostly of financial education leaders from the private sector, with one state government representative.  It is chaired by Charles Schwab.

This private-sector group, in addition to the federal efforts of the Financial Literacy and Education Commission, will increase the level of our nation's resources dedicated to financial literacy. To ensure close coordination with the Financial Literacy and Education Commission, the Council recently named a liaison to the Commission who will attend Commission meetings and report on them to the Council.

The Financial Literacy and Education Commission

An abundance of our financial literacy efforts are through the Financial Literacy and Education Commission. This 20-agency group was established by the Fair and Accurate Credit Transactions (FACT) Act of 2003. The FACT Act named the Secretary of the Treasury as chair of the Commission and gave the Commission and Treasury four mandates:  a Web site, a hotline, a multimedia campaign and a national strategy.

I am pleased to provide progress on each of these projects.

1.   Web Site

In October 2004, the Commission launched MyMoney.gov, a Web site designed to be a one-stop shop for federal financial education information. The Website is available in English and Spanish and is operated by the General Services Administration (GSA).  It is organized intuitively by topic rather than by agency. Web site topics include "Paying for Education," "Saving and Investing," "Home Ownership," "Privacy," and "Frauds and Scams." 

MyMoney.gov also provides links to financial education grants offered by different Commission member agencies.  The site has 402 links and has had more than 2 million hits. Visitors can access an interactive, instructional quiz on financial literacy, view a public service announcement promoting MyMoney.gov and get information on the activities of the Commission.

The Commission works to ensure that the topics are timely and relevant. For example, during hurricane season it features information on how to financially prepare for a weather-related emergency. More recently, the Commission has added a link explaining the economic stimulus payments, and the front-page features information on how to avoid foreclosure rescue scams.

2.  Toll Free Hotline

In October 2004, the Commission also launched a toll-free hotline called 1-888-MyMoney.  Operated by the GSA, the hotline is available in English and Spanish and permits callers to order a free MyMoney toolkit.  The English language toolkit contains eight federal publications covering topics from savings to investing to understanding the Social Security system.  The Spanish language toolkit has seven publications. Since its launch in October 2004, the MyMoney hotline has received more than 20,200 calls.

3.   Multimedia Campaign

The Treasury is working with the Ad Council on the production of a campaign that will address the topic of credit literacy, emphasizing the impact of one's credit score.  The project has progressed through the research, focus group, and creative stages, and is now in production. The campaign is scheduled to launch in the summer of 2008. It will feature television spots, radio spots, and a new Web site.

4.   National Strategy

The FACT Act also required the Commission to develop a national strategy for financial literacy.  In April of 2006, the Commission released Taking Ownership of the Future: The National Strategy for Financial Literacy.  The Strategy is a comprehensive blueprint for improving financial literacy in America, covering 13 areas of financial education in 13 chapters.  Approximately 7,600 copies of the Strategy have been distributed, and the Strategy has been downloaded an additional 102,860 times.

This month, the Commission submitted its third annual Strategy for Assuring Financial Empowerment Report.  The report contains updated information regarding the implementation of the Commission's principal duties and provides further details of current and future activities in which the Commission is or will be involved.   

GAO Report

A December 2006 Government Accountability Office (GAO) report on the Commission's activities made several recommendations.  The Commission welcomed the insights of GAO on how we could better accomplish our important mission on behalf of the American people.

The Commission incorporated many of the GAO recommendations into its 2007 revisions to the Strategy.  For instance, GAO recommended that definitions to "financial education" and "financial literacy" be added to the Strategy, and the Commission defined and incorporated both terms.  GAO recommended more of a focus on partnerships, and the Commission is highlighting agency partnerships with the private sector on its Web site. In response to a GAO recommendation, the Commission is also planning to conduct usability testing of and measure customer satisfaction with MyMoney.gov.

Additionally, GAO suggested an independent review of federal financial education programs and resources.  Although the FACT Act does not require an independent review of such programs and resources, the Commission decided to pursue such a review, with the first series of assessments to be completed in 2009.

The GAO also recommended that the Commission work closely with private entities and state and local governments to improve financial literacy.  In response, on April 17, 2007 Treasury and the Office of Personnel Management co-hosted the Commission's inaugural meeting of the "National Financial Education Network" of federal, state and local governments at Treasury.  This network will facilitate precisely the type of cooperation called for in the GAO report.   

We continue to work to respond to the GAO recommendations. 

Calls to Action

At the end of each chapter of the Strategy are specific, numbered Calls to Action.  Most of the actions are assigned to the federal government, but some of the activities are recommendations for the private sector or for individuals.  Since the launch of the Strategy two years ago, the Commission has been hard at work implementing these calls.  The Calls to Action are milestones for the Commission, and allow it to measure performance on many initiatives that would not be possible without the cooperation of all 20 member agencies.

I am pleased to provide a summary of progress on the Strategy's Calls to Action:

Chapter 1: General Saving

1-1   In April of 2007, Treasury and the American Savings Education Council launched a public service announcement (PSA) on the importance of saving.  The PSA promotes the Web site, MyMoney.gov and toll-free hotline, 1-888-MyMoney.  This ad can be viewed on MyMoney.gov.

Chapter 2: Homeownership

2-1   In July of 2006, the Department of Housing and Urban Development (HUD) and Treasury co-hosted a roundtable which highlighted successful partnerships that have advanced homeownership. During the meeting, the complexity of identifying partners to advance homeownership was discussed at length.  Participants cited best practices which have helped with foreclosure prevention, non-traditional mortgage products, and the identification of a variety of hidden costs to consumers.

In July of 2007 in Boston, Massachusetts, HUD, in partnership with the Treasury Department, hosted the second meeting highlighting successful partnerships that have advanced homeownership. The discussion was focused on how public-private sector partnerships can better deliver grassroots counseling and training programs. The Federal Deposit Insurance Corporation and the Federal Reserve Bank of Boston also contributed to the dialogue.

Chapter 3: Retirement Saving

3-1   In 2008, the Treasury Department and the Department of Labor (DOL) will co-host a roundtable with large employers on retirement saving.  Topics will include successful strategies in integrating the delivery of financial education into the workplace and other options for increasing participation and contributions in private pensions, such as automatic enrollment. 

An agenda is being developed. The roundtable is planned for the summer of 2008 in Washington, D.C.

3-2   In April 2006, the Small Business Administration (SBA) linked its online retirement training tools for small businesses to MyMoney.gov. In addition, the Department of Labor and the Internal Revenue Service (IRS) developed and released a new publication, Payroll Deduction IRAs, to complement a series on retirement plan options for small employers.  DOL, as part of its ongoing Fiduciary Education Campaign, Getting It Right - Know Your Fiduciary Responsibilities, conducted 27 Fiduciary Compliance Assistance Seminars, in coordination with the IRS, the American Institute of Certified Public Accountants, and the Society of Human Resources Management. 

3-3  DOL, working in partnership with a national non-profit organization and the IRS, has implemented the multi-faceted campaign to educate small businesses and their accountants about options for employee retirement plans.  The DOL and its national non-profit organization partner created a DVD that provides first-hand observations from small employers and their employees as well as the accountants for the businesses on the benefits of their retirement plans.  The DOL and the IRS are working on a new publication on the automatic enrollment 401(k) plan which will be published this spring and are updating the popular publication, 401(k) Plans for Your Small Business. The DOL and its national non-profit organization partner are completing work on an interactive Web site that will help small businesses and their accountants find the retirement plan options that are appropriate for their business.  This site will be available to the public later this spring. 

Chapter 4: Credit

4-1  Through an agreement with the Ad Council, Treasury has been working to develop and execute a multimedia public service announcement campaign on credit literacy for young adults, emphasizing the impact of one's credit score.  The project has progressed through the research, focus group, and creative stages, and is now in production. The campaign is scheduled to launch in the summer of 2008. It will feature television spots, radio spots, and a new Web site. Some elements of the Web site will also be available in Spanish.

Chapter 5: Consumer Protection

5-2  In April of 2006, Treasury released the DVD, Identity Theft: Outsmarting the Crooks, and made it available to the public through MyMoney.gov and 1-888-My Money.

All copies of the DVD, which totaled 60,750, were distributed.  A transcript of the DVD can be found online at http://treas.gov/offices/domestic-finance/financial-institution/cip/pdf/library_transcript.pdf.

Chapter 6: Taxpayer Rights

6-2  The Department of the Treasury and a Federal Reserve Bank have continued the national public education campaign, "Go Direct." The campaign is designed to encourage Americans who receive federal benefit payments, particularly Social Security, to use direct deposit.   From the start of the pilot program in September, 2004, through February 8, 2008, there were more than 1,670,000 conversions of paper check recipients to direct deposit enrollees.  The U.S. Senate declared February 2008 as "Go Direct Month" to motivate more Americans to select direct deposit for their Social Security and other federal benefit payments.

6-3  As a result of the Department of Health and Human Services' (HHS) public awareness campaign on the new Medicare drug benefit that encourages seniors and people with disabilities to take a look at their prescription drug coverage options, over 90 percent of those with Medicare have some form of drug coverage.  Of those, almost 24 million have prescription drug coverage through the new Medicare Part D benefit.  HHS worked with 40,000 partners and conducted more than 12,000 events to educate taxpayers and beneficiaries on enrolling in the Part D program.  More than 1.4 million beneficiaries have enrolled in Medicare's Part D program since June of 2006, bringing the total number of people with Medicare receiving comprehensive prescription drug coverage to more than 39 million.

Chapter 8: The Unbanked

8-1  Four regional conferences have been held on how to reach the unbanked.  The conferences were held in Chicago, IL in May 2006; Edinburg, TX in December 2006; Seattle, WA in March 2007; and New York, NY in October 2007.  The conferences have touched on topics such as building partnerships and identifying solutions, serving immigrant communities, reaching young customers, providing financial education to help new and potential bank customers, and what can be learned from alternative lenders. The conferences were accomplished by the Treasury along with the Federal Deposit Insurance Corporation (FDIC), National Credit Union Administration (NCUA), the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision ,the Federal Reserve Banks of Chicago, Dallas, New York, Philadelphia, Richmond, and San Francisco, and with assistance from HUD, the Washington State Department of Financial Institutions and the New York City Department of Consumer Affairs, Office of Financial Empowerment.  These conferences brought together a wide range of attendees on the topic of serving the unbanked population.

Chapter 9: Multilingual / Multicultural Populations

9-1  The Department of the Treasury has held three roundtable discussions on financial education topics of special concern to specific communities.  In March of 2007, the first roundtable took place at Treasury and was focused on American Indian or Alaskan Native populations. Topics included public and private partnerships, access to financial institutions and services, and public awareness events on reservations.

In July of 2007, the second conference on multicultural and multilingual communities took place at Treasury.  The focus was Asian and Native Hawaiian or other Pacific Islander communities. The main topics covered were financial education programs and partnerships that have successfully promoted financial education in the Asian and Native Hawaiian or other Pacific Islander communities.  Representatives from the business world, from nonprofits and from government participated in the discussion.

In March of 2008, the third conference took place and focused on Black or African American communities.  The main topics covered were using media to reach Black or African American markets, credit literacy, youth and higher education, and preparing for retirement.

On June 10, 2008, the fourth and final conference, which will focus on Hispanic or Latino communities, is expected to be held at the Treasury. 

Chapter 10: Kindergarten – Postsecondary Financial Education

10-1   In February of 2007, the Department of Education (ED) and Treasury co-hosted a two-day summit on kindergarten through postsecondary financial education. The summit brought together teachers, students, program providers and researchers from across the country to discuss the role of financial education at school, non-school venues and college-level programs. As part of this summit, a request for comments was published in the Federal Register on the topic of raising the financial literacy levels of kindergarten through postsecondary students. The findings from this summit and the request for comment are currently being reviewed.  The findings are expected to be made available by June of 2008.

Chapter 11: Academic Research and Program Evaluation

11-1   The Treasury Department, along with the Department of Agriculture's Cooperative State Research, Education and Extension Service, will convene a symposium of researchers who specialize in financial education. The goal of the symposium is to raise awareness of existing academic research and to define questions that require additional analysis. The symposium will result in a white paper that will survey current financial education research and will also identify areas of potential future research.   The symposium is scheduled for the fourth quarter of 2008.

Chapter 12: Coordination

12-1   The Commission has continued to update the Web site to make available the most current information on federal resources as well as federal financial education grant programs.  In the past year, the My Money Web site has added a new feature:  a calculator resource page.  There are calculators for mortgage computations, home buying, college planning, savings bonds, and tax withholding.  In 2008, a new link was added that takes users to the Money Math Lessons for Life curriculum.  Currently, all Commission members have links to MyMoney.gov from their agencies' Web sites.

The Commission continues to enhance MyMoney.gov. In 2006, the "Money 20" interactive quiz was added to the Web site, where visitors can test their knowledge with a 20-question online quiz which covers a variety of personal finance issues.  The quiz has proven to be popular.  Since its inception in fiscal year 2006 through the end of March 2008, 60,051 people have taken the quiz. 

12-2   In August of 2006, GSA and Treasury completed the first survey of federal financial education programs and resources. Findings have shown very little overlap or duplication among federal financial education efforts. The overlap noted was found to be minor and necessary to the completeness of a particular resource or topic.  Subsequent surveys have produced similar results.

12-4   The Web site Subcommittee developed criteria and features existing partnerships on MyMoney.gov. The Commission also encourages new partnerships through MyMoney.gov.

12-5   In April of 2007, Treasury and the Office of Personnel Management (OPM) hosted the inaugural meeting of the "National Financial Education Network" of federal, state and local governments. The Network, which brings together representatives from different areas and levels of government across the nation to advance financial education efforts, will meet regularly to discuss topics related to financial education. 

The Commission, in partnership with the Washington State Department of Financial Institutions and Washington Mutual, hosted the West Coast Summit of the National Financial Education Network on October 30 and 31, 2007. 

One of the accomplishments of the Network is the creation of a Web site. A non-profit organization, in consultation with the Financial Literacy and Education Commission and the Network developed a Web site (www.flecnationalnetwork.org) which is comprised of materials submitted by the members of the Network to provide resources on financial literacy to the general public.  The Web site addresses various topics including credit, retirement, financial planning and savings among others. To date, the Network is comprised of over 60 members and continues to broaden its membership. 

Chapter 13: International Perspective

13-1   The Treasury Department will host an international summit on financial education.  To bring about this multinational discussion the Treasury Department will invite the central government authorities responsible for financial literacy in their respective nations to convene and discuss recent developments, innovative methods, and successful strategies for improving financial literacy in their home countries.  Treasury is partnering with the Organization for Economic Cooperation and Development to co-host an international summit on financial literacy in May 2008, in Washington, D.C.  

Department of the Treasury

The third and final way we implement financial literacy initiatives is through Treasury's own outreach and education efforts.

Within Treasury, several bureaus and offices work in the field of financial education. These include the Bureau of Public Debt (BPD), the IRS, the U.S. Mint, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and, at department headquarters, my office and the Office of Financial Education.

While all of these offices perform important tasks in financial education, the bulk of Treasury's efforts in the field are conducted by its Office of Financial Education. This office was designated by Congress to lend its expertise and provides primary support to the Financial Literacy and Education Commission.

Since its establishment in 2002, the Office of Financial Education has undertaken a tremendous outreach effort. The staff has traveled to 47 states, plus the District of Columbia and Puerto Rico, has held 369 financial education sessions reaching more than 30,000 people.  The office produces and disseminates guidelines for quality financial education, provides technical assistance to local programs in English and Spanish, forms partnerships with groups nationwide to connect them with resources, and coordinates the activities across the federal government through the Financial Literacy and Education Commission. 

Conclusion

I hope this discussion has given a useful overview of our work.

As Americans, we share the desire to provide for our families, achieve financial security, and have a comfortable retirement. Being financially literate makes those goals more attainable. We hope that through our efforts to increase financial literacy people will lead better, more prosperous lives.