FROM THE OFFICE OF PUBLIC AFFAIRS

April 11, 2005
JS-2366

Remarks of
Treasury Acting Deputy Secretary Arnold I. Havens
before the School of Business Administration
University of South Carolina Aiken

Good afternoon, and thank you for inviting me to be here with you today.  It is always wonderful to visit a university in the springtime, because there is a palpable sense of freedom and possibility in the air.  Many of you are preparing to graduate in a few weeks.  Others are gearing up for summer jobs, summer internships, and summer travels.  And virtually all of you are dreaming big dreams--which is exactly what you should be doing-- about what you will eventually accomplish in the big world beyond this campus.

That kind of freedom – to follow your dreams, and to do what you want -- is at the core of our democracy and our economic system.  But as we have heard many times, real freedom comes hand-in-hand with a sense of responsibility.  When people are not responsible about exercising their freedoms, there can be tragic consequences for individuals, companies, and even the broader economy. 

I am encouraged that the organizers of this event--Dr. Ralph Byington and Dr. Rich Waugh--have asked me to speak about corporate responsibility and business ethics.  I also have a few remarks about Social Security reform, an important current topic that implicates our collective responsibilities to society and to future generations, and I will return to that subject in a few moments.

In recent years, we have seen a series of very serious abuses of our freedoms in the world of business.  Corporate scandals erupted in the headlines in late 2001 and early 2002, starting with Enron and followed quickly by Worldcom, Global Crossing and others.  Those headlines exposed a serious problem in our free market system.  Chairman Greenspan coined the term "infectious greed" to describe the attitude that had led some of our corporate leaders to falsify and inflate corporate results for their own substantial personal gain. 

By doing so, they violated a sacred trust that is so important for leaders to maintain in all walks of life, whether they have the privilege of serving as I do at this level of government or they hold important responsibilities in the private sector.

One response to the wave of corporate scandals--as all of you Business School students know--was the Sarbanes-Oxley Act of 2002, which was passed by an overwhelming vote of the United States Congress and signed into law by President Bush on July 30 of that year.  At the risk of over-generalizing, Sarbanes-Oxley did two important things.  First, it significantly increased the criminal penalties for anyone who perpetrates a fraud on the securities market.  The second thing it did was to create a vigorous and robust system for auditing and reporting on corporate conduct, designed to insure that the financial information furnished to our securities markets is honest and reliable.

Another major response also occurred in July 2002, and that was when President Bush created the Corporate Fraud Task Force chaired by the Deputy Attorney General.  The Treasury Department contributes to this task force, which coordinates the investigation and prosecution of crimes like securities and accounting fraud committed by businesses and their executives.  Under the leadership of the task force, the Justice Department has obtained over 500 corporate fraud convictions or guilty pleas since its inception.  About 1000 people have been charged, including almost 100 corporate CEOs and presidents.

I don't want to risk overstating the problem.  Even at the worst of the crisis, the vast majority of corporate leaders were honest and ethical.  They worked hard to earn and deserve the trust of employees and shareholders.  But selfish irresponsibility caught up with the few who perpetrated these high-profile frauds, and many innocent parties suffered the consequences.  Some were affected directly, such as the rank-and-file employees of companies like Enron who lost both their jobs and in some cases much of the value of their pensions as inflated stock values plummeted.  Others were hit indirectly as the scandals caused ripples throughout our economy.  Confidence in our markets was shaken, and, with over 50 percent of Americans owning stock, that was significant.

Coming just months after the tragic events of September 11th, which had their own negative impact on our economy, the corporate scandals shook Americans' trust in the capital markets, in corporate leadership, and in the whole system of corporate governance.

That's why the Congress and the President moved so quickly to take the kind of corrective action that was needed.  Not only did we have a need to address the immediate problems, but perhaps more importantly, we needed to restore confidence and faith in our system of corporate governance.  The Sarbanes-Oxley Act and the Corporate Fraud Task Force showed every executive in every board room in America that none were above or beyond the law.

Today, the law holds accountants more accountable, and it subjects auditors to audit.  It gives shareholders greater confidence that the financial information they receive from a company is reliable, because CEOs and financial managers who fudge the numbers will be held accountable.

Sarbanes-Oxley and the Corporate Fraud Task Force sent a message to every American: that there cannot be a different ethical standard for corporate America.  Business executives are expected to operate with the same high level of honesty and accountability as any small business, family, or community.

I don't want to pretend that this increased vigilance does not come with a cost.  The very substantial effort and expense that goes into monitoring and reporting on corporate activity is effort and expense that is not available for more productive uses.  But the ultimate costs of letting the public's confidence in our economic system be eroded would be even greater.

This Administration takes corporate governance and responsibility seriously.  One aspect of corporate responsibility that is particularly important to those of us in the Treasury Department is the misuse of our tax code.

Aggressive and improper tax shelters have been a problem for years.  Some taxpayers thought they could engage in these transactions with little risk of detection.  And if they were caught, some thought there was little risk of owing anything more than the correct tax payment plus interest.

The Bush Administration's approach to tax shelters has changed that risk-reward calculus. We have made it harder for taxpayers and shelter promoters to avoid detection.  The Treasury Department and the IRS are continuing to take the steps necessary to shut down tax shelters -- including appropriate but aggressive enforcement action against taxpayers and promoters -- as they are identified.

And these efforts are working.  In March, the IRS announced that it had collected $3.2 billion in taxes, interest, and penalties from about 1100 taxpayers who took part in just one form of bogus tax shelter, known as "Son of Boss."  As I'm sure you business students already calculated in your heads, that works out to an average payment of $2.7 million per tax cheat.  And of course responsibility wasn't distributed evenly--one individual paid a $100 million settlement in that case, and 18 people paid about $20 million apiece. 

In another example, the Internal Revenue Service recently publicly announced a settlement offer to corporate executives who had used a popular scheme in which the executives tried to realize the economic benefits of stock options while delaying the tax on those benefits, sometimes for up to 30 years.  To accept the IRS offer, taxpayers will need to pay the full tax on the whole amount, plus all interest, plus a 10 percent penalty, which is one-half of the normal 20 percent penalty that could be imposed if the cases were litigated.  The offer is still open, so we don't have final figures on the number of taxpayers who will ultimately accept, but preliminary numbers indicate that it will be a very substantial percentage.

But government enforcement cannot be the only solution to problems in business ethics and corporate responsibility.  We cannot impose ethics and good behavior by legislation or prosecution.  To help solve these problems at their root, we depend on citizens who know the difference between right and wrong and who decide to do what's right.  Treasury Secretary Snow once observed, "there is earning, and there is stealing. There isn't a whole lot of gray in between... and we all know it, in our hearts and our guts. So never stop listening to those places inside yourself."

Ethics is not simply a set of rules written in a book, but rather a sense of character you carry in your heart.  It is a sense of moral duty that one individual owes to the greater community.  Most of us would agree that this is a moral duty owed not only to ourselves but to future generations.  In that sense, America is facing a moral and ethical issue with regard to our Social Security system.  We cannot continue to simply operate a system that benefits ourselves at the expense of those coming into the workforce, including most of you.  It isn't sound economics, but more importantly, it isn't honest and it isn't fair. 

In Washington right now, your elected leaders have a real opportunity to give a gift to future generations, and I would like to spend just a few moments to talk with you about strengthening the nation's Social Security system. 

Let me be clear: the current Social Security system is financially unsustainable, and in need of expeditious and lasting change.  On March 23, the Board of Trustees of Social Security and Medicare issued its annual report.  This report showed that Social Security cash flows will peak in 2008 and turn negative in 2017.  The trust fund itself will be exhausted in 2041, when today's younger workers--including many of you--are beginning to retire.  The unfunded obligation--that is, the difference between Social Security's income and assets on the one hand, and its outflows on the other--is $11.1 trillion on a permanent basis, and $4.0 trillion over the next 75 years.

President Bush has shown real leadership on this issue.  For many years, the conventional wisdom in Washington was that Social Security reform was a conversation stopper, the "third rail" of politics.  The President had the courage to touch the "third rail," and now we're moving forward.  People recognize there is a problem in our Social Security system.  The President has called on Congress to help find a permanent fix.

Some Members of Congress have put some ideas on the table already.  The people of South Carolina are lucky in that your delegation has taken a real interest in Social Security reform and offered some serious proposals.  I know Congressmen Gresham Barrett and Joe Wilson recently hosted a series of town hall meetings here in Aiken and in other communities in this part of the state.  Senator Lindsey Graham has experienced firsthand the benefits of our Social Security system and he has helpfully contributed to the national conversation on this issue by starting a dialogue with his Senate colleagues.  Senator Jim DeMint also has been a leading voice in the Senate on the importance of fixing the Social Security system. 

The details of the different ideas that have been raised to date--and their pros and cons--will be fleshed out in the weeks and months ahead.  As the President said when he raised this issue to the country in his State of the Union Address, his first objective was to start a broad national dialogue to get people talking creatively about this issue. 

And Americans are talking about Social Security, from the National Mall in Washington to the local shopping mall.  It's in the local newspapers and on the TV news.  People have moved beyond the first question--"Is there really a problem?"--to the more important one--"How do we fix it?"

Fixing it is quite simply our responsibility to the next generation and beyond.  This is a matter of simple arithmetic.  Social Security has enough money now because for decades we have had more than enough workers paying into the system and supporting the retirees who draw benefits.  But you know the demographic trends.  In 1950, there were 16 workers to support every beneficiary of Social Security.  Today there are only 3.3 workers per beneficiary.  By the time one of you students turns 65, there will be just two workers to support your benefits.  That's why we're facing the multi-trillion dollar shortfall identified in the recent trustees' report.

For those of us who are 55 or older, the President has made clear that our Social Security benefits are solid.  They will not change.  We don't need to change our retirement plans or strategy because of Social Security reform, period.  But it's you, the young workers and future workers, who we need to worry about.  You are the ones for whom we need to save and strengthen this system.

The President would like younger workers and future generations to have the ability to save some of their payroll taxes they're already paying, to build a nest egg that belongs to them, not to the government.  With voluntary personal accounts, younger workers would have the chance to learn about their financial choices, build a nest egg and benefit from sound long-term investment in the free market system without disrupting the system of benefits for today's retired beneficiaries.

Personal accounts would give young workers more options to invest and build a better retirement for their future.  Personal accounts can be implemented in a way that costs the current Social Security system nothing; current and near-retirees would not be affected.  But they would give the next generation the promise of a better retirement, and they would help our country create a larger pool of savings. 

Some have argued that we can save the system by increasing the payroll tax.  But this multi-trillion dollar shortfall cannot be reasonably fixed by raising taxes.  The recent trustees' report showed that the payroll tax would have to be increased by nearly 30 percent to achieve long-term balance.  A 30 percent hike in the payroll tax would of course have significant, negative economic consequences.  American workers would be taking home less pay, and we mustn't forget that their employers would shoulder half of that tax increase.  For small businesses especially, a tax increase of that size could require terrible choices, from lay-offs to cuts in health benefits.  And it would make hiring new people even more difficult.  Quite simply, increasing payroll taxes hurts the economy and it hurts job creation.  That's why the President is against it.

We're making progress.  We believe that Social Security reform that doesn't raise payroll tax rates, that protects benefits for today's seniors, and that improves the system dramatically for the next generation of workers can be achieved.

I would like to close with an analogy I recently heard Secretary Snow use.  Someday, many of you in this room will own your own businesses, and you can expect to work hard over your lives to build them up.  It may seem a long way away, but I bet you probably want to pass your business on to your own children or grandchildren.  And you'll want your business to be in top shape, financially, when that time comes. 

Let's do the same with our Social Security system.  If we make responsible decisions now, we can make sure that Social Security, and our broader economy, are on sound financial footing for the next generation. 

Thank you for having me here today.  I'd be happy to take your questions now.